A Failed $6 Billion Deal Shows the Perils of Tracker Funds

(Bloomberg Gadfly) -- Something is awry with the way Germany manages its takeover situations. A bid at a generous 50 percent premium has been thwarted by the people who stood to benefit most.

Back in April, drugmaker Stada Arzneimittel AG backed an all-cash takeover from private equity groups Bain Capital LP and Cinven Ltd. It was hard to argue with the 5.3 billion-euro ($6 billion) price tag, set as it was in a heated auction. 

Yet 34 percent of shareholders declined to accept. The offer fell short of the 68 percent acceptance hurdle set by the bidders, the lowest level they could stomach while securing sufficient influence to satisfy their bankers. The result? Unhappy bidders, a disappointed shareholder majority and a stock price down as much as 9 percent.

A Failed $6 Billion Deal Shows the Perils of Tracker Funds

Stada management has been left making strange statements that the poll represents a vote of confidence and a mandate to drive forward the strategy -- even though most shareholders wanted the deal, just not enough of them to get it over the line.

What was up with the refuseniks?

One group was hedge funds betting that other shareholders would deliver the minimum level of required acceptances, leaving them with a minority holding. That way, these holdouts could have cornered Bain and Cinven on the price for mopping up the last remaining stock. It’s a risky bet to make: if you withhold your vote hoping others will accept, it makes it less likely that the deal will proceed at all, and puff goes the opportunity to hold the bidder to ransom. As happened here.

Such behavior is a feature of many takeover situations, in Germany and abroad. That’s why Vodafone still doesn’t have full ownership of Kabel Deutschland Holding AG, four years after securing a 75 percent stake. But these dynamics alone don't explain what went on here.

Passive funds were a likely problem. Their job is to track an index and so they may be constrained by their mandate from taking investment decisions -- even accepting a knock-out takeover bid. In German takeover situations, shareholders accept an offer by switching into newly created shares in the target.

But tracker funds may only switch into the new shares once they replace the existing stock in the index. Under index rules the old shares tend to get replaced when more than half of the new equity's been accepted, which means that for the passive investors to get on board enough other investors must make the switch first. In Stada’s case, the last disclosed acceptance level was below 50 percent, so index funds probably sat tight.

A Failed $6 Billion Deal Shows the Perils of Tracker Funds

Finally, there’s a small shareholder problem. Around a quarter of Stada’s shares are in the hands of individuals. Until 1993 only pharmacists could own the stock, so it may be now owned by people who are either deceased or don’t know they have them.

In isolation, these factors would not kill a deal. Together, the result is that a bid that made sense has been thwarted. Stada may be a historical oddity with its quirks. Still, the rise of passive management is having unintended consequences that takeover supervisors need to address.

The immediate question is what Bain and Cinven do. Technically they are forbidden to re-bid for 12 months. But regulator Bafin will consider waiving that stricture if Stada wanted to accept a fresh offer.

So Bain and Cinven could come back with a higher offer in the hope of getting more acceptances. The snag is that price probably wasn't the issue. In fact, they would just need to lower the acceptance hurdle. That likely means swallowing higher finance costs from their lenders, as well as nudging the bidders further away from the 75 percent level where they would have more substantial control. If Bain and Cinven really want this deal, it is going to be even more expensive than they thought.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

To contact the author of this story: Chris Hughes in London at chughes89@bloomberg.net.