Equitable tender offer price in illiquid equities market

Serbian capital markets are rich with illiquid equities (shares). The prices of such shares quoted at trading venues tend to be inflated. This current state of the Serbian capital markets, coupled with the tender offering pricing rules under the Serbian Takeover Act, warrants heightened scrutiny and clever acquisition planning for M&A deals in Serbia.

Serbia – An illiquid and shallow equity market

Serbian issuers predominately have been public issuers and their equities (shares) have been admitted to trading at a regulated market (i.e. stock exchange) or multilateral trading facility ("MTF"). This tendency has its roots in two Serbian capital market rules. The first rule – which was valid until 2011 – forced issuers to become public issuers and to list their shares on the Belgrade Stock Exchange. The second rule, which is still valid, requires all public issuers to have their equities traded at a regulated market or multilateral trading facility.

Nonetheless, Serbian capital markets are not in great shape. The regulated market and MTF (run by the Belgrade Stock Exchange) are quite illiquid and shallow. Equities (shares) of issuers are traded rarely and at low trading volumes. Against this background, the prices of these equities quoted at the regulated market or MTF are far from representing their true value.

Investors eyeing Serbian assets must take into account Serbian takeover rules when structuring a potential M&A deal. These rules can be burdensome and pricy, to the extent that sometimes they have the potential to spoil the entire economic rationale underlying a potential deal.

Pricy tender offer rules

The Serbian Takeover Act (2006) sets pricing rules that are applied in both mandatory and voluntary tender offers.

Under the statutory liquidity test, target shares are liquid if (i) their trading volume in the last six months was at least 0.5% of the total of the same class of shares issued by the target and (ii) the monthly trading volume for at least three months during that 6-month period was at least 0.05% of total of the same class shares issued by the target.

If target shares are liquid, the minimum price offered in the takeover bid must be the highest of the following:

"Market prices"

(i) the volume weighted average share price ("VWAP") at the regulated market or MTF for the last 3 (three) months preceding the announcement of an intention to make a bid;

(ii) the closing trade price at the regulated market or MTF on the day before the takeover bid intention is published if the trading volume for the shares on that day was at least equal to an average daily trading volume for the target shares over the last three months;

"Historical prices"

(iii) the highest purchase price paid by the bidder or any party acting in concert with the bidder for target shares in the last 12 (twelve) months preceding a takeover bid trigger; or

(iv) the VWAP paid by the bidder or any party acting in concert with the bidder for the target shares in the last two years preceding a takeover bid trigger, provided they acquired more than 10% of the shares during that period.

If the target shares are illiquid, a minimum price offered in a tender offer must be the highest of the following:

(i) the highest share price calculated by applying the aforementioned formulas for liquid shares;

(ii) the book value of the shares calculated according to the most recently published annual financial statements of the target; or

(iii) the appraised value of the shares determined by a licensed auditor/appraiser.

(In)Equitable price in a mandatory tender offer

When structuring an M&A deal, these takeover pricing rules often generate pricing risks that cannot be controlled by either the seller or buyer.

It is not uncommon to have illiquid target shares listed at a regulated market or MTF even in the absence of any trades involving them for months or years. Due to this apparent lack of liquidity, it is difficult to argue that these markets (regulated market or the multilateral trading platform run by the Belgrade Stock Exchange) are efficient. As a result there are no reasonable grounds to assume that prices quoted at these venues incorporate all information about the equities (shares) traded there or that the prices reflect their true value. What is more, such prices are sometimes several times more than any equitable price that could be negotiated in a direct deal between a buyer and seller (for the controlling stake in the target). For these reasons, these prices should not be trusted or considered when trying to determine an equitable price of these illiquid equities.

Yet, the (often-inflated) market price of the target illiquid shares is a benchmark for setting a minimum price in a back-end mandatory tender offer. So even if at least one target share is traded at these inflated "market" prices, in the dawn of the mandatory tender offer, however, this usually inflated price could immediately represent the floor for any offer the buyer has to make to the target minorities in the follow-on mandatory tender offer. Practically, then the buyer will be forced to buyout the minorities at a price significantly above the price paid to the controlling shareholder. No matter how strong an "appetite" the buyer might have for the target, few investors' "appetites" are strong enough to digest the risk of such a pricy deal.

Unfortunately, the pricing risk in a mandatory tender offer is further compounded by the fact that the specific book value of the target shares serves as a benchmark for setting a minimum price. Under the Serbian SEC's rules, such book value of the target shares is determined by a reference to the last published annual financial statements of the target. Such financial statements are usually prepared as of 31 December of the previous calendar year, as most Serbian issuers report on a calendar year basis.

The application of this rule can lead to absurd situations. Let's say the buyer closes a deal to buy a controlling stake in the target on 1 December. In a follow-on mandatory tender offer, the buyer will be forced to offer to minority shareholders (at least) the book value of a target share calculated by reference to the most recent 31 December (over 11 months old at that point date). This situation would be even more bizarre in circumstances where a buyer is forced to launch a mandatory tender offer in the first quarter of a year – when most Serbian targets have not yet released/published new financial statements. In such circumstances, the last published annual financial statement would be that of 31 December from the year before the last year. In other words, the book value of a target share in such cases will be calculated based on financial statements prepared more than 13 or 14 months before. In both hypotheticals, the book value of the target share would fail to reflect any financial events that happened or information that relates to the target's business discovered in the interim.

Need for change

The application of these rules falls short of the ultimate goal of the takeover rules – to afford minority shareholders an option to sell out their shares to a new controlling shareholder of a target at an equitable price. The hypotheticals presented above show that the Serbian tender offer pricing rules come with the flaws embedded in them that in practice could act as deterrents to M&A activity, as these rules afford the minority shareholder a right to request not simply an equitable price, but an unreasonable price.

Serbian lawmakers and the Serbian SEC could address these anomalies and propose betterments to these pricing formulas – by dropping the market prices as benchmarks for illiquid shares and re-calibrating the book value rule to capture a share value as it is immediately before a launch of a tender offer.

Author: Vojimir Kurtic

Moravcevic Vojnovic and Partners Law Office

Moravčević, Vojnović I Partneri OAD Beograd

Komisija za hartije od vrednosti Republike Srbije Beograd

M&A transakcije

Belgrade Stock Exchange

multilateral trading platform

MTP

illiquid shares

price of illiquid shares