September 12, 2012, By STEVEN M. DAVIDOFF -
dealbook.nytimes.com
The bombshell announcement of a possible tie-up between EADS and BAE Systems is only that – a possibility. Before
a deal can be reached, the intense national issues surrounding this tie-up still need to be navigated.
And a review of the parties’ announcement shows that multiple governments will be involved and extremely complex agreements will need to be negotiated. In other words, a combination may take a
while — if it ever comes.
In their announcement, EADS and BAE Systems stated that if they agreed to a transaction the two companies would not actually combine; instead, they would enter into a dual-listed company
structure. The two stated that “both companies would operate as one group by means of equalization and other agreements but would be separately listed on their existing exchanges.”
As I have written before, such a deal “is a virtual merger structure utilized in cross-border
transactions. The companies do not actually effect an acquisition of one another, but instead enter into an unbelievably complex set of agreements in which they agree to equalize their shares,
run their operations collectively and share equally in profits, losses, dividends and any liquidation.” These arrangements are entered into by agreement and not by combining the two companies.
A dual-listed company structure has traditionally been used instead of a full merger when there are tax issues related to dividends. The two companies, based in different countries, will want
their local shareholders to continue to have their dividends taxed by the home country to take advantage of local quirks and avoid foreign withholding.
The best examples of this are again BHP
Billiton and Rio Tinto which are
both dual-listed companies involving a British public limited company and an Australian public limited company. The reason is to allow Australian stockholders to take advantage of a dividend tax
credit that British shareholders cannot. British shareholders thus invest in the British company (e.g. BHP) and Australian ones in the Australian entity (e.g., Billiton).
There are other reasons to use a dual-listed company structure. Flow-back – where shareholders of a target subsequently sell shares
issued by an acquiring company from another country leading the shares to return to that country — is also a common problem in big cross-border deals. The shareholders of the company that is
disappearing will simply sell their shares either because they are a mutual fund which cannot hold foreign shares or simply because the investor prefers local investments.
A dual-listed company can stop this flow by allowing shareholders to retain a local investment option. In fact, the key point of a dual-listed company is that the shares are not exchangeable. A
holder in BHP-Billiton’s Australian company – again, the Billiton part — cannot exchange their shares for the BHP part. They really are separate companies.
Finally, a dual-listed company is a way to salve issues of national pride or national security allowing the combined entity to claim two homes.
EADS and BAE Systems are likely using a dual-listed company structure for all three reasons. BAE is an English company and EADS is a Dutch one. Prior examples of Dutch/English dual-listed
companies include Royal Dutch
Shell, Reed Elsevier and
Unilever all of which used this
arrangement to preserve national heritage and dividend tax treatment.
But in all probability, the nationality issue was the primary driver for the BAE-EADS talks. BAE is a very British aerospace institution having been once owned by the British government. EADS was
formed in 2000 by a merger of industrial companies from Spain, France and Germany. The Netherlands was picked as the locus of incorporation for EADS since it is neutral territory. Today, 49.35
percent of EADS’s shares are owned by the public with the French government and German company Daimler controlling a 22.35 percent interest each and Spain a 5.45 percent interest.
A dual-listed company structure thus allows BAE to preserve its British heritage while EADS can still claim to be a Continental European company which will still be owned by these French, German
and Spanish entities.
But by contractual agreement EADS shareholders and BAES shareholders will now vote as a group for the boards of both companies which will be identical. Even then, though, the EADS shareholders
will still wield substantial influence. According to today’s announcement the combination will give EADS shareholders 60 percent and BAE shareholders 40 percent control.
As a further sop to national interests the two companies announced that “the parties envisage issuing special shares in BAE Systems and EADS to each of the French, German and U.K. governments to
replace the existing U.K. government share in BAE Systems and the stakeholder concert party arrangements in EADS.” These special shares, also known as golden shares, will allow the four countries
to veto any subsequent takeover of the combined entity and may provide for other rights.
In addition, both companies have extensive worldwide defense operations, and BAE in particular has built up its United States presence. The companies will have to make arrangements with the
American government and obtain national security clearance for any tie-up. BAE and EADS anticipate that the United States government will require that BAE’s defense interests be kept separate
from EADS, announcing that “certain of their defense activities would be ringfenced” specifically mentioning the United States as one place where this would have to happen.
Dual-listed companies are notoriously complex beasts. They require intricate contractual documentation and negotiation that can take months if not years to complete. In this case, the structure
of this combination needs to be coordinated with national governments not only in Europe but to account for American security demands.
Under the British takeover rules, the parties are now required to announce a transaction by Oct. 10 or obtain an extension from the U.K. Takeover Panel. Given what is at stake, expect that an
extension will be needed.
Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the world of mergers and acquisitions.
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