Corporate exercise, Merger and Acquisition, and re-organisations.

Abstract

The change of MAS to MAB took effect on 1.9.2015. The reorganization of the company had taken places after years of losses. From 2001 to 2014, the Malaysian Government had pumped in RM17.4 billion of the rakyat’s money to MAS only to see the company made cumulative losses of RM8.4 billion. A new blood of management was brought in and around 7,000 out of 20,000 of its current workforces had to exit the company. 13,000 workers has been reemployed with 4,000 of that number are on short-term contract. In banking sector, CIMB Group Holdings Bhd and its subsidiary in Indonesia, PT CIMB Niaga due to high operating expenses, had embarked in reducing 3,599 employee or 11.1% of its total workforce in both Malaysia and Indonesia through Mutual Separation Scheme (MSS). The CIMB Group will need to fork out RM443.3 million to pay successful MSS applicants. The reduction of number of employee will benefit the banking group in term of reduction of cost up to RM291.6 million a year. In this challenging economy landscape, companies need to trim their bloated number of employees to achieve the right number of employee. Salary is a cost to the company and when a company wants to reduce their operational cost, they need to let go some of their staff. In this article, we will explore some corporate restructuring methods that a company may adopt to ensure the survival of the company.

Scheme of Arrangement under section 176 of the Companies Act 1965 (“CA 1965”)

For debt-laden companies like MAS, the company may protect themselves under scheme of Creditors Arrangement under section 176 of the CA 1965. The arrangement sought to protect the company from a never-ending harassment from the creditors. This method can be adopted when a company is in financial distress but the parties recognized that there lot of potentials that can be exploited if company continues its business operations. The creditors and the company will sit down and negotiate how to pay off the debt. Once all parties had agreed with the payment plan, it needs to get the confirmation from the court. Hence, the agreement will bind all the parties. There are two forms of compromise and arrangement: (1) moratorium scheme of arrangement, or (2) compromise scheme.

However, the process of getting the confirmation from the court may be delayed if creditors file objections to the arrangement. In the case of Transmile Group Bhd & Anor v Malaysian Trustees Bhd & Ors [2013] 9 MLJ 43, Transmile Group had filed an application under section 176 of the CA 1965 at the High Court for orders to convene class meeting of the scheme creditors. Malaysian Trustee Berhad (“MTB”) had objected the application as it claims priority over other creditors. The court later rejected MTB objection.

The court at page 44 held that;

The matter therefore turned on a consideration of the nature of MTB’s objections and the manner in which they were put forward. If there was reasonable and justifiable basis for the objections and they served to clarify and assist the court to evaluate the scheme more fully then the cost ought to be borne by the company. If however, the objections lacked substance, were prolix, and calculated to delay the sanctioning of the scheme then the cost ought not to be borne by the company in keeping with the general approach, but ought to be borne by the MTB.

Companies making an application under section 176 can take comfort that creditors who want to object to the scheme must be with substance and valid reasons. Unsubstantiated opposition to the application for scheme of arrangement may cause unnecessary delay and cost as additional cause papers had to be filed and research to reply the objections. The additional unnecessary cost must be borne by the creditors.

Restructuring

MAS is fortunate that being a national carrier, it was backed by Khazanah, the investment arm of the government. Any other companies may not be that fortunate. The government had enacted Malaysian Airline System Bhd (Administration) Act 2014 to take over the function of the airline, and to act as commercial enterprise. The new entity will be called MAB, and being the administrator of the airline, it will have full immunity when running the operation of the airline. The administrator has full powers in appointing new directors, remove and suspend anyone from the company.

The idea is to take MAS out from the Bursa and turn the airline into a private company. All the operations and the assets of the old entity will be transferred to MAB. The current 20,000 strong employees of MAS employee will be terminated and renegotiate. Only 14,000 will be hired to work with the new entity with some hired as permanent and some rehired on short-term contractual basis. Being a government backed company, the airline able to renegotiate the current contract with its suppliers. I doubt that there is any equilibrium of bargaining power in negotiating the contract in this case. Of course the suppliers have to come to the negotiating table because after the establishment of MAB, the previous contract with MAS shall be terminated. Hence, the new entity will start its operation on a clean slate.

Some companies have adopted the same tactic. Taking advantage of the separate legal entity principle, management of the companies might just shut down their companies and open a new company. This is especially true when the individual management personnel are not made personally liable to the company’s debt.

Merger and acquisition

Sometimes, a company may not be in financial distress (not yet) but preventive measures need to be taken before matters goes out of hand. A company may also found that that they are not recording a significant growth for the past few years. To survive is to grow and to grow is to survive. The management of a company is under a constant pressure from the shareholders to increase the shareholders value. Some companies adopted organic growth, slowly expanding their operations.

Merger and acquisition (“M&A”) is one aspect of corporate strategy, corporate finance and management dealing with buying, selling, dividing and combining of different companies and similar entities. The corporate strategy is to create synergy in growing the company in the target market/industry without creating a subsidiary company.

A merger is a legal consolidation of two or more companies into one entity. A merger is a lawful act executed by one or more companies to merge with existing companies, which causes the dissolution of the merging companies but the continuing existence of the surviving company.

A consolidation is a lawful act executed by two or more companies to ‘fuse’ together, forming a new company, followed by the dissolution of both (or all) of the consolidating companies.

An acquisition is a lawful act executed by a legal entity in the form of a company or other entity, or by an individual, to take over all or majority of a target company’s shares, which may cause a change in the control of the target company.

Type of transactions under M&A

Purchasing shares or purchase of assets of another company can make the task of gaining control of another company such a daunting exercise. The option (acquiring shares or assets) depends on the rationale of the acquisition, resources, financial health and viability of a target company.

Before the acquisition, we need to conduct a proper due diligence to check the assets and liabilities, contracts with third parties, provisions, and encumbrances over the company’s assets.

We also need to be aware that buying of shares attracted ad valorem stamp duties. Stamp duty are payable by the purchaser but parties may come up with an agreement to share the stamp duties.

Statutory consents and approvals

Foreign Investment Committee (“FIC”)

This is a control of the M&A activities in malaysia, which is more administrative in nature rather than legal. FIC is in control through 2 sets of guidelines:-

i.           Guideline on the acquisition of interests, mergers and takeover by local and foreign interest; and

ii.         Guideline on the acquisition of properties by local and foreign interests.

FIC need to approve the Acquisition, Mergers and Takeovers activities if:

i.               Acquisition of interest in a local company or business in Malaysia which is RM10 million or more in values, by local or foreign companies;

ii.             Acquisition of interest in a local company or business in Malaysia by foreign companies;

iii.           Acquisition of interest in any local company or business in Malaysia by:

(a)  Acquisition of 15% or more of voting power of local companies by a foreign companies; or

(b)  Acquisition of Malaysian companies or business in Malaysia of more than 30% or more of the voting power by any foreign companies, its group of companies or non – associated groups of companies.

iv.            any joint venture involving two or more local companies;

v.           any transaction by statutory bodies, companies and their subsidiaries owned by the federal or state government;

vi.            local company pledging their shares as security to any foreign company where the value of the loan or the market value of the share is RM10 million or more.

  

Exceptions to the guidelines

(a)  acquisition of interest in a company by the Malaysian ministries and government departments;

(b)  privatization projects which involves parties who are the original signatories of contracts of the said privatization projects;

(c)   acquisition of interest in manufacturing companies which are licensed by the Ministry of Trade and Industry;

(d)  acquisition of interest in companies with the Multimedia Super Corridor status;

(e)  local companies which operates in and given the status of the Iskandar regional Development;

(f)   local companies which operates in the approved area in any regional development corridor by companies granted by the local authority; and

(g)  company which has obtained endorsement from the Secretariat of the Malaysian International Islamic Financial Centre.

Bumiputra equity conditions

Non Bumiputra companies or companies with bumiputra equity less than 30% are required to increase its bumiputra equity to at least 30% whilst the remaining shareholding can be held by a combination of local and foreign interests.

Non-Compliance

The FIC guidelines do not have the force of law. However, FIC comprises representatives from EPU, Ministry of Finance, Implementation Coordination Unit of the Prime Minister’s department, Ministry of Natural Resources and Environment, MITI, Ministry of Entrepreneur and Co-operative Development, Ministry of Domestic Trade and Consumers Affairs, Bank Negara Malaysia, MIDA, Securities Commission and Companies Commission of Malaysia. For example, compliance is pre-requisite to applications for licenses from other authorities and sometimes even to obtaining banking facilities.

The advantages of M&A

However, some companies need to grow at a much faster pace through merging their company with other company. The merging of two or more companies is believed to create synergy of the new merged entity (synergy: 1+1=3). The merged entity can capture bigger market share or to penetrate into the existing or new market. For example, the merger between Sapura Crest and Kencana Petroleum had created SapuraKencana Petroleum that made way to the Bursa Malaysia in 2012. The merger between the two companies had enable the new entity SapuraKencana Petroleum to become the biggest oil and gas service provider in Malaysia which was not owned by Petronas. The new entity also commands 90% of the oilfield services value chain, including drilling, engineering, procurement and construction, transportation and installation, and marine services.

CIMB Bank had embarked on the acquisition method in expanding their operations. CIMB had been aggressively acquiring other banks and the acquisition of notably Bumiputra-Commerce Bank and Southern Bank had positioned CIMB Bank as second largest bank in Malaysia after Maybank. This year, the proposed deal to acquire RHB Bank and MBSB has been aborted. If the propose acquisition had gone through, the deal would see CIMB Bank to emerge as the biggest bank in Malaysia and the fourth largest Bank in ASEAN.

Although merger and acquisition was thought to bring in synergy to the growth of the new entity, it is not without any problems. For example, the proposed deal between CIMB, RHB and MBSB will cause a major Human Resource headache to the HR department. The issue on the duplication of works between the three entities needs to be solved. Workforce surplus need to reassign to other position and that requires reallocation of workforce and hours of training sessions. There is also a possibility of MSS and this would cost the new entity million of ringgit expenses. HR needs to identify the candidates for the MSS so that they would not lose out on the talent that would contribute to company’s growth in the future.

Then the HR department needs to look at the remaining workforce that survives the merging process. HR need to make the employee to work as a team and shares the same values and working culture. Again, more training and programs are needed and all this will take some time.

Although the objective of merger and acquisition is to create synergy, it is a double edge sword as the strategy can backfired and produced negative results. Hence, the merger and acquisition may not always the best method to grow your company. There is plethora of issues that you need to consider before you make that leap of faith.

Does it always works?

Companies sometimes paid higher premiums versus book value to merge and acquire. As a result, the buyer had to bear debt loads. Some resort to divestitures and downsizing; selling off parts of the business and lay off excess employees as a short term measures. Many companies make acquisition for wrong reason because most of the time the M&A is to satisfy the CEO’s inflated ego. Sometimes M&A fail because of the buyer’s attitudes towards risk taking, return on investment, and the disposition of profits do not match the buyer’s expectation.

Documentation and Due Diligence in M&A

(a) Preliminary Agreement – Memorandum of Understanding/ Letter of Intent

A memorandum of understanding (“MOU”) entered by parties to spell out the responsibilities of the parties involved in the transaction. MOU sometimes creates exclusivity; preventing the parties from negotiating with other third parties.

MOU can be a binding contract, depends on the intention of the parties and the way MOU was drafted.

(b) Due Diligence

Due Diligence are usually done by the buyer to avoid or minimize complications in the course of undertaking the acquisition and after the acquisition.

For public listed companies, the Malaysian Securities Commission requires information given in any document relating to the takeover, for instance a takeover offer document to be true, accurate and not misleading and should not contain any material omission.

What is the benefit to conduct of Due Diligence exercise?

1.     It is truly essential for public companies – Securities Commission requires information relating to the take over to be accurate, true, must not misleading in nature, or omitting material facts. Due diligence exercise can be used as a defense that proper due diligence had been properly conducted. 

2.     Due Diligence that made public can prevent insider trading. Insider trading law prohibit parties from providing material non-public, price sensitive information to a potential purchaser without a proper authorized due diligence.

Documentation and agreements

The lawyer will prepare the first draft of the acquisition documentation and agreements. The buyer and the target company would be obliged to prepare the necessary statutory declaration and other relevant documentations to inform the authorities and the shareholders of the target company of the proposed takeover offer.

The buyer is required to prepare an offer document and the target company an independent advice circular for the shareholders. Both documents are required to contain information that is true, not misleading, and free from material omission.

Representation and warranties

This is an assurance from the buyer has been given proper authorization to proceed with the transactions and its action is in accordance to its internal rule.

The target company is required to warrant that it has authority to sell the assets/shares to the buyer.  The buyer is also required warranting the detail of its financial conditions such as obligations and profits.

Checklist for provisions in an acquisition agreement

There is no standard checklist or template that we can use. The checklist will vary based on the specific requirements of the Merger and Acquisition.

Completion of the M&A

The M&A will take effect on the fulfillment of the condition precedent specified in the transaction agreement. 

Conclusion

A company needs to grow in order to survive. However, the path chosen to grow the company depends on host of considerations. There are no best methods that you have to adopt. The considerations really depend on the nature of your company. There are also other methods that can be used to reorganize your company that have not been covered in this article.