Private investment in public equity – PIPE deals in Australia

The current economic climate has made private investment in public equity (PIPE) more attractive for both sponsors and listed companies. We examine the reasons why and outline the key considerations for potential investors and issuers.

In brief

• PIPE deals involve private capital investors acquiring securities of a listed company by way of a private placement, often having debt characteristics and resulting in a non-controlling interest.
• PIPE deals were expected to become popular when COVID-19 first broke-out, but for the most part this did not come to fruition. Although considered in a number of situations, traditional equity raises by way of placements with share purchase plan or pro rata rights issues were very well supported by more passive equity investors during the initial stages of COVID-19.
• We believe the current economic climate has made PIPE deals more compelling than during COVID-19. For sponsors, the returns on debt have become more attractive. For issuers, the option to convert into equity provides more flexibility where they may not be willing to raise at today’s share price, but they also face uncertainty regarding access to capital to repay debt.
• We explore the common characteristics of these instruments, as well as the shareholder and regulatory approvals required in connection with them.

Background

Private investment in public equity (PIPE) deals involve private capital investors acquiring securities of a listed company by way of a private placement, often having debt characteristics and not resulting in control passing to the investor.

PIPE deals were expected to become popular when COVID-19 first broke-out, but for the most part this did not come to fruition. Although considered in a number of situations, traditional equity raises by way of placements with share purchase plan or pro rata rights issues were very well supported by more passive equity investors during the initial stages of COVID-19.

In the current economic climate, we believe the following factors have made PIPE deals more compelling for both sponsors and listed companies, warranting greater consideration:

• Interest rates: increased interest rates have made the returns on debt increasingly attractive for sponsors.
• Credit funds: there has been a proliferation of credit funds globally and locally, this has been supported by investor demand for debt-like returns and sponsors broadening their product offering.
• Uncertainty: uncertainty in equity market valuations may lead to issuers being reluctant to issue equity at today’s share price, but uncertainty regarding access to capital to repay debt and access to traditional bank financing makes the option to settle instruments in shares attractive.
• Flexibility: convertible PIPE instruments can give issuers more optionality on maturity (i.e. conversion as an alternative to repayment) and give the sponsor more optionality (i.e. to move from debt to equity returns).

Exploring this type of instrument as an alternative to a traditional equity raise or change of control transaction presents an additional tool for issuers. In deciding whether to commit the resources to engage on the structure, there will be a question for sponsors as to whether the proposal is a stalking horse rather than a real alternative.

Structuring PIPE deals

PIPE deals are generally undertaken by way of issuing ordinary shares, preference shares (likely convertible) or convertible loan notes. In this article we focus on the latter two instruments. For investors they provide debt-like downside protections, but with the optionality through equity upside. For issuers they can be cheaper and less dilutive than issuing equity and provide an alternative to bank debt, including an option to settle in shares rather than cash repayment.

The terms of these instruments are highly bespoke and specific to the company’s circumstances, as well as the economic environment in which they are negotiated.

Instrument type – convertible preference share vs loan note

A fundamental question is whether to use a convertible preference share or loan note. For the sponsor, the convertible loan note has the benefit of ranking ahead of preference shares and ranking alongside other unsecured creditors in a liquidation.

Preference shares are typically cumulative, so that any unpaid dividend is paid in the next period, and usually redeemable so that the company can remove them from the capital structure. Preference shares can only be redeemed out of the company’s profits or the proceeds of a further issue of shares.

Core terms such as dividend or interest rate would be set by negotiation. The tests required to be satisfied to pay a dividend (in section 254T of the Corporations Act) equally apply to dividends on the redeemable preference share, and both sponsor and issuer should consider any anticipated challenges in meeting these tests.

Usually, loan notes would be unsecured, though it is possible for security to be granted (the need for FIRB approval would need to be considered, noting that the money lending exception may be available to some investors).

Of course, tax considerations will be important to the analysis of whether the preference share or convertible loan note are preferred.

Additional rights

Sponsors will typically seek to negotiate additional rights associated with their investment. As well as the nature of these rights, the circumstances in which they will cease to apply (e.g. the sponsor selling down its interest) will be important.

Common additional rights that are sought include:

• anti-dilution rights if further capital raisings are pursued;
• the right to nominate one or more directors to the listed company’s board;
• the right to access certain company information, such as management accounts or board papers;
• the right to veto certain actions or decisions of the company; and
• exclusivity rights in respect of a change in control transaction (which is considered further below).

Any additional rights will ordinarily need to be proportionate to the investor’s holding in the company given the requirement in ASX Listing Rule 6.1 that terms be ‘appropriate and equitable’.

Exclusivity

The Takeovers Panel’s guidance on deal protection devices will apply to PIPE deals involving the issue of shares or instruments capable of conversion into shares.

The Panel will consider the circumstances (i.e. the need for, and availability of, financing for the issuer), but this will not override restrictions on lock-up devices that are anti-competitive or coercive.

The key considerations for convertible notes are as follows:

• Mandatory repayment on a change of control likely to be permissible.
• Mandatory repayment fee must not be anti-competitive.
• No shop provision likely to be permissible.
• No talk and no due diligence must be subject to fiduciary carve-out for superior proposals.
• Break fee to be within the Panel’s guidance of 1% of equity value (or, where the company is heavily geared, 1% of enterprise value).
• “Naked no vote”: adverse consequences for the company if its shareholders vote against the issue, such as a fee or a rachet in the interest rate, may be coercive and therefore unacceptable. There may be a level of compensation that is proportionate and reasonable.

The Takeovers Panel considered these issues in Billabong International Limited [2013] ATP 9 where the following terms were considered unacceptable:

• Termination fee of 20% of the principal amount payable on a change of control.
• An interest rate of 35% if shareholders did not approve conversion, versus 12% if obtained.
• A make-whole premium of 10% on the principal plus interest for the full term payable on a change of control.

Approval considerations

Shareholder approval under the Corporations Act

The Corporations Act requires shareholder approval for acquisitions of voting power in voting shares comprising more than 20%.

For the purposes of this rule, preference shares with limited voting rights or convertible notes will not constitute voting shares unless and until they are converted. This would mean the shareholder approval could be deferred to after the preference shares or loan notes had been issued by having shareholder approval as a condition precedent to conversion. However, the investor will want certainty that conversion is an option and therefore typically shareholder approval is required before the investment is committed. The disclosure to shareholders requires disclosure of the voting power the investor would have, which may be difficult to predict where conversion is to occur some time after the approval. This issue can be managed.

The approval threshold required under the Corporations Act is an ordinary resolution (i.e. more than 50% of votes cast by shareholders excluding the person to whom the shares are being issued and their associates). ASIC requires an independent expert’s report to be procured by the company for its shareholders, usually assessing whether the transaction is fair and reasonable for shareholders.

Shareholder approval under the ASX Listing Rules

The ASX Listing Rules require shareholder approval for the issue of securities (including convertible securities) comprising more than 15% of share capital in the last 12 months (subject to certain exceptions). If the issuing of a convertible note is approved by shareholders, then the subsequent conversion does not need a further approval under this Listing Rule.

Foreign Investment Review Board considerations

Acquiring shares or entering into an agreement to acquire shares, including by way of a convertible note, will attract the FIRB rules. It is possible to have conversion subject to FIRB approval being obtained, including staging conversion into tranches, with later tranches to be subject to obtaining FIRB approval.

Foreign government investors, which would typically include many financial sponsors, will need to obtain FIRB approval if they would acquire either 10% or more of the voting shares or 5% or more of the voting shares plus a legal arrangement (such as board nomination rights, veto rights or exclusivity). Exceptions may apply to this.

For all other foreign person investors, FIRB approval will be required only if 20% or more of voting shares would be acquired.

Examples

PAG Capital convertible into REX

In September 2020, REX Regional Airlines agreed to issue convertible notes to PAG Capital with an aggregate face value of $150 million to be used exclusively for Rex’s launch of its domestic city jet operations and removing certain debt from the capital structure. The key terms were disclosed:

• First ranking senior secured notes with a 5 year term (extendable by either party by a further one year), draw down to occur in agreed tranches over the term, and an interest rate of 4% p.a..
• Issue was subject to certain conditions, including FIRB and shareholder approval (given PAG would covert to 23% of the shares on issue if the first tranche fully converted).
• PAG had the right to convert into ordinary shares at a pre-agreed share price on certain trigger events occurring (including a change of control transaction) or at any time after the 3 years.
• If the full $150 million available was not drawn down, then REX was to issue warrants with an exercise price equal to the pre-agreed conversion share price, for which the exercise price in aggregate equalled the undrawn component. This guaranteed PAG the option to take up the total ordinary shares available assuming full draw down.
• Right to nominate up to 2 non-executive directors, unless PAG’s interest falls below 20% (assuming conversion) or certain other events occur.
• PAG could only dispose of the convertible notes within the first three years from first draw if after 1 year the share price is 150% of the conversion share price. Beyond three years, PAG can dispose of the notes, but the company has a first right of offer.
• REX agreed certain conduct of business restrictions, including paying dividends outside of agreed parameters.
• PAG agreed to pay a $2 million fee if it withdrew from the transaction.

AustralianSuper’s convertible note into Syrah Resources

In 2019, Syrah Resources issued convertible notes to AustralianSuper, coupled with an entitlement offer sub-underwritten by AustralianSuper to raise approximately $111.6 million. This was followed by further convertible notes being issued in 2023 on similar terms for up to $150 million, but with a more favourable interest rate for the investor.

The terms of the initial 2019 note included:

• Unsecured debt with a 5 year term (unless redeemed earlier) at 8% capitalised or 7.5% if paid in cash.
• Syrah could defer issue for up to 120 days to pursue alternate debt funding.
• Right to convert into ordinary shares in certain circumstances at a pre agreed price (5% premium to the ex-TERP price). AustralianSuper would convert to 26.7% of the shares on issue if the notes fully converted.
• Shareholder approval to be obtained prior to convertible note issue.
• 2% establishment fee (capitalised).
• 1% of face value break fee if Syrah terminates.
• Right to appoint 1 non-executive director.
• Consultation right before issuing securities for the primary purpose of raising capital.
• Right to convert in certain circumstances, including where a third party announces a takeover.

CHAMP’s convertible note into Bradken

In 2015, a consortium of Sigdo Koppers and CHAMP invested $70 million in Bradken by way of redeemable convertible preference securities issued by a subsidiary of Bradken.

At the time of issue, the parties had been discussing a potential change of control transaction and had entered into an exclusivity arrangement.

The terms of the preference securities included:

• $2.1 million establishment fee to be paid by the issuer.
• Semi-annual dividends to be paid by the issuer, 7.5% p.a. with further 5% step up if not redeemed after a subsequent capital raising or 5 years after issue.
• Right to convert securities into ordinary shares on later of 12 months after termination of change of control discussions or 18 months after issue. Pre-agreed conversion price for ordinary shares to be issued (16% premium to pre-announcement share price).
• Redemption rights after merger discussions cease (at 102% of issue price) or approximately 5 years after issue date or where Bradken undertakes capital raising or CHAMP acquires control of Bradken.
• Right to transfer securities to any person (except a vulture fund) after consultation with Bradken.
• Requirement that holders accept / vote in favour of alternate control transaction if recommended by the Board from agreement to 6 months after termination of merger discussions.

Conclusion

PIPE deals provide an alternative form of financing for listed companies and have features attractive for financial sponsors. With uncertainty remaining over the economic conditions, including share price volatility and interest rates on debt instruments becoming more attractive, interest in PIPE deals is expected to increase.