The “German back-end” trade is a form of corporate activism used by event-driven hedge funds in the context of public takeovers in Germany. This approach, centered around leveraging litigation post-takeover to profit from minority shareholder rights under German stock corporation law, continues to evolve. In this update, we delve into the intricacies of this strategy in the current legal and economic landscape, highlighting new developments and examples.
In this brief, we delve into the intricacies of this strategy in the current legal and economic landscape, highlighting new developments and examples.
How Does It Work?
In a typical corporate takeover transaction, the buyer will wish to integrate the target’s business in order to realize synergies. To do that, they will first need to control the target’s strategy and business decisions, as well as access its cash flow. A common way of achieving this level of control is to conclude a domination and profit and loss transfer agreement (“DPLTA”), which under German stock corporation law, is possible if the buyer holds at least 75% of the share capital.
Furthermore, if an investor seeks to own the target company in its entirety (i.e. 100% of its shares), German law offer a variety of “squeeze-out” procedures allowing a principal shareholder owning at least 90% or 95% (depending on the procedure chosen) of the target’s share capital to force the transfer of the remaining shares held by minority shareholders to the principal shareholder.
A DPLTA must include the obligation on the part of the dominating company to acquire the shares of the minority shareholders (in cash, typically), if so requested by the latter. However, minority shareholders have the right to challenge their compensation in court.
How Is This Used By Activist Hedge Funds?
The tactical playbook remains largely unchanged;The typical fund strategy can be described as follows:
- Once a public tender offer has been announced, acquire a substantial stake in the target company (usually ca. 10%) within a short period of time.
- Tender a portion of their shares into the offer in order to help it succeed. For instance, the takeover offer could be made conditional upon a minimum acceptance threshold being met, typically set to 75% of the outstanding shares, which is the qualified majority under German stock corporation law necessary to implement DPLTA.
- Wait for the DPLTA to be concluded. German law required buyers to offer shareholders a compensation based on a company valuation rather than the original offer price. Historically, judges tended to set compensation at a level between the original offer and the amount demanded by other shareholders.
- Start court proceedings challenging the “appropriateness of the consideration” in an effort to achieve a higher price for their shares.
Situations where this strategy has the highest probability of success are typically characterized by a higher free float and a more fragmented shareholder structure, as they make it easier to acquire a large stake via the stock exchange within a short period of time following the announcement of a tender offer.
Unintended Consequences
Arbitrage opportunities, as well as legal challenges to the adequacy of minority shareholders’ compensation, have been increasingly taken advantage of by sophisticated investors. However, While the strategy offers lucrative arbitrage opportunities, it also presents substantial deal-completion hurdles.
ParkView Partners estimates that successful closing of deals involving companies valued at more than €1bn is down 28% to just 43% between the period 2005-2017 and 2017-2019.
Furthermore, according to ParkView’s research, the average total weighted cost of ownership is about 40% on top of the company’s undisturbed share price, which breaks down into 25% represented by the initial takeover offer premium, “an additional increase of 10% through the DPLTA, squeeze-out and delisting processes (the “back-end game”), and a further 7% due to the court proceedings challenging those processes”.
Prominent Examples
Elliott Management is one of the top players of the “back-end game” in Germany, as this strategy has been one of the most profitable ones in the history of the firm. Below are some of the high-profile transactions they have been involved in:
- UniCredit’s acquisition offer of HypoVereinsbank in 2005 and the subsequent “squeezing-out” of HypoVereinsbank’s remaining minority shareholders in 2007
- Terex’s acquisition offer of Demag Cranes in 2011
- Vodafone’s acquisition offer of Kabel Deutschland in 2013, and the subsequent “squeezing-out” of Kable Deutschland’s minority shareholders in 2021. Elliott, Davidson Kempner and York sued Vodafone in July 2014 for a higher compensation
- Bain/Cinven’s acquisition offer of Stada in 2013
- McKesson’s acquisition offer of Celesio in 2013
Conclusion
The "German back-end" trade strategy remains a complex yet potent tool for event-driven hedge funds, with its legal underpinnings and strategic implementations continually evolving. As the economic landscape shifts and new legal precedents are set, understanding this strategy's nuances becomes increasingly crucial for investors and companies alike.
