Barloworld gets its MAC on

• South Africa
• Barloworld, Conditions Precedent, M&A, MAC, Material Adverse Change, Shareholder approval, Tongaat Hulett
• May 13, 2020

Corporate mergers and acquisitions are fascinating beasts. In case you’re wondering, MAC doesn’t stand for mergers and acquisitions, but more on that later.

The headlines always describe the deal as though nothing can go wrong.

“Tongaat Hulett sells Starch division to Barloworld for R5.35 billion,” screamed the business media back in March.

The better media houses (like Creamer Media) typically noted at the end of their articles that “the deal remains subject to shareholder approvals and other conditions precedent” – but what does that even mean?

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Shareholder approvals and conditions precedent

Firstly, large transactions by companies require shareholder approvals. This is also true for unlisted companies, as some of the approval requirements are found in the Companies Act which applies to all companies.

For listed companies, there are JSE rules that give even more protection to shareholders than they would ever have in unlisted companies.

If the shareholders vote down the deal, it dies a sorry death and management feels embarrassed.

The second part, conditions precedent, is more complicated. These are things that must happen before the deal is finally implemented.

Regulatory conditions precedent are common, such as competition commission approval. This may be needed before a deal closes but can only be sought after the basic terms of the deal are agreed. Commercial conditions precedent would typically include the raising of finance or a successful due diligence.

I know this is tricky, but bear with me. If nothing else, all you need to understand is that the concept of conditions precedent allows you to negotiate and agree the terms of a deal before running off to get all your ducks in a row to actually implement the transaction.

It’s a bit like “yes, you can go out with your friends on Friday, but only if you behave yourself this week.”

This is why M&A specialists earn such high fees. The deals are incredibly complex and a lot of thinking goes into the timeline of the transaction, particularly around conditions precedent from a regulatory and commercial standpoint.

However, there is another legal clause that is almost always included in documents but rarely called into action.

Get your MAC on

The material adverse change (MAC) clause protects the parties against a situation where things change drastically before the deal is concluded.

The lawyers often hash this out, having long (and fully billable) debates about the % change that constitutes a MAC and the way it should be measured. Executives often use this opportunity to go to the bathroom or try out the finger food.

It all sounds unimportant, until it isn’t. Let’s look at a practical example of this.

Tongaat Hulett: not so sweet

The only sweet thing about Tongaat Hulett is the sugar. The company had a truly revolting 2019. It was awful even before the accounting scandal hit in June, with the share price down 75% by that stage with no market crash to blame.

When the news of the alleged R11 billion accounting fraud hit, the share was suspended from trading because shareholders weren’t able to reliably estimate the value of the company.

PricewaterhouseCoopers (PwC) was brought in as an independent advisor to produce a forensic report which named and implicated 10 executives in the fraud.

As always, the employees suffer when executives behave badly. The company guided that 8,000 employees will likely lose their jobs as the company struggles to reduce its debt.

When the trading suspension was lifted in February, the share price was mutilated, dropping 65% as desperate shareholders tried to get out after their very own version of lockdown.

Those who took the risk have seen incredible returns, with the share price running 450% in a matter of weeks. That’s a 4.5x return.

However, the rollercoaster isn’t over

The ray of light that was the Barloworld deal could now fall over.

It was a real win for Tongaat Hulett’s new management team, selling the starch division for an enterprise value of R5.35 billion with all jobs in the division retained. The proceeds would be used to pay down the debt that is crippling the company.

Unfortunately for Tongaat Hulett, Barloworld’s clever lawyers had negotiated the inclusion of a MAC clause. Barloworld released a SENS announcement with the following unpleasant paragraph:

“Barloworld is of the view that COVID-19 global pandemic and the consequences thereof constitute an event that is reasonably likely to cause the EBITDA of the Sale Business for the financial year ending 31 March 2021 to be 82.5% or less of the EBITDA of the Sale Business for the financial year ended on 31 March 2020, and that, therefore, a MAC has occurred.”

EBITDA stands for Earnings Before Interest, Tax, Depreciation and Amortisation – or, in other words, a reasonable accounting proxy for operating profit.

In other words, the business is buckling under lockdown and Barloworld doesn’t want it anymore, at least not for the originally agreed transaction value.

Tongaat Hulett released an announcement that they are “firmly of the view that a MAC has not occurred,” and reminded shareholders that the disposal agreement is currently still of force and effect.

Now what?

If there is a MAC event, the parties would need to agree to amend the terms of the deal or walk away altogether. Barloworld might still want the asset but would pay a lot less.

Tongaat Hulett is desperate and must stop the deal falling over, so they cannot agree that a MAC has occurred.

The existence of a MAC will now be determined by one of the large audit firms, whose decision will be final. It’s hard to see how this isn’t a MAC, but Tongaat Hulett will fight it hard.

They have no choice. The fees to the audit firm are inconsequential in a R5.35bn deal.

Sadly for Tongaat Hulett shareholders and especially employees of the starch division, it’s hard to see how this isn’t a MAC. The deal stands a high chance of falling over entirely, or being renegotiated on new (and less favourable terms). This could end particularly badly for employees.

Like for those couples who had to cancel their weddings, the timing of the lockdown couldn’t have been worse for Tongaat Hulett. Barloworld will be thankful that there might still be an escape hatch..