Hugo Mendes Domingos

Morals and the takeover code

do not always mix

CMVM, the Portuguese equity market regulator, has recently opened a
public consultation period (which is now over) for proposed changes to the
takeover code. At present, the code allows the use of so-called defensive
measures during takeovers. In practice, if an acquirer launches a takeover
offer for a company quoted on Euronext Lisbon without the prior approval or
the companys core shareholders, chances are that the offer will not be
successful. Most quoted companies are controlled either by families or core
shareholders, whose rights are protected by shareholder agreements and
other locking mechanisms.

The proposal, in short, consists in removing voting rights limitations and
defence mechanisms.


It is safe to say that, in larger European exchanges and in the US,
shareholders' rights are respected. Take the UK as an example: if a foreign
or UK investor, be it a corporate or an investment fund, decides to launch a
credible takeover offer for a company listed on the London Stock Exchange,
offers a suitable premium and convinces more than 75% of shareholders to
accept the offer, it will achieve control over the target. It is as simple (and
powerful) as that.

In Portugal, if an investor launches a public takeover without gaining prior
approval from core shareholders, the targets Board will likely block the
offer before it even gets to a stage where other shareholders can vote on
it.

Also consider the following facts:
O So far, no one has found a way to convince core shareholders to
let go of their control rights over quoted companies.
O It is widely accepted that most Portuguese quoted companies
would be taken over by larger, foreign competitors, if such
shareholders did not exist.
O Most Portuguese consider that, if foreign competitors acquired the
leading Portuguese quoted companies, this would be a disgrace.
International investors (investment funds, pension funds) already
own the majority of shares of those companies, which makes it
hard to understand this belief. Yet most politicians appear to share
this view.
O A large number of investors buy equities purely for financial
purposes. These investors will usually hold on to a stock for less
than a year. Large volumes of equities are also traded as part of
derivatives trades.
Hugo Mendes Domingos

O The State and the State-owned bank, Caixa Geral de Depsitos, are
under increased pressure to sell non-core assets in order to reduce
the public deficit.
O A number of companies quoted on Euronext Lisbon are former
State-owned companies that were privatised during the 90s.
I went through the regulators consultation document and what caught my
attention was the emphasis on principles and moral values. At a certain
stage, the regulator attempts to justify the reason why changes to the code
are necessary. Reference is made to principles including "shareholder
sovereign rights" and "the proportional rule" according to which "capital and
voting rights should be proportional", as if those principles were part of
some sort of universal declaration.

Why is it so hard to recognise the following?
O The State, directly or indirectly, contributed to create a system in
which most quoted companies are controlled by Portuguese core
shareholders.
O Some (but not all) of these shareholders depend on the State or
State-owned banks for financing. In other cases, the acquisition of
the shares was partly debt financed and shareholders will need to
reduce their leverage in the short term.
The Status Quo is no longer sustainable and the takeover code simply needs
to be amended in order to reflect the new reality. Why call on principles,
moral values or use emotionally charged words to justify these changes? As
with most policy decisions which result from the financial crisis, this one is
pragmatic and owes little to principles.

Still, the proposed changes are a step in the right direction. The regulator
had to refer to some principles in order to justify this initiative, which is fine
by me.

I can understand the reasons why a number of people would oppose these
changes - as well as why others will back the reform. One side will defend
that the budget needs to be balanced and that the country needs to attract
foreign investors. Others will defend the need to preserve the independence
of quoted companies and fend off attacks from larger international
competitors. The positions of the protagonists will depend on their political
allegiances and professional interests.

My view is that the benefits of change are far greater than the
disadvantages. Advantages would include improved efficiency: while quoted
companies will be more vulnerable to being taken over by larger
competitors, this could result in improved management practices as
management teams develop competitive advantages in order to retain their
independence. Another benefit could be improved access to equity markets,
which is crucial at this stage when companies need to deleverage.