Opting-out clause: does it still make sense in light of recent Sika transaction?
The sale of a controlling stake in Sika by long-term family shareholder to its French competitor Saint-Gobain has been widely discussed since its announcement last December. It is in the spotlight as (i) it gives Saint-Gobain full control over Sika by acquiring only a minority capital stake (preferred voting rights) and (ii) Saint-Gobain does not plan a tender offer to the minority shareholders. As the opting-out clause allows to avoid a mandatory offer, the minority shareholders cannot sell their shares at the same premium offered to the family. At announcement Sika’s shares fell 23%. Ethos, the Swiss sustainable investment advisory, now urges abolishment of the clause. In our view, other measures should be taken instead.
Change of control at Sika, but no mandatory takeover offer due to opting-out
The founder family of Sika in its fourth generation owns a stake of registered shares with privileged voting rights (16% of capital bearing 52% of votes) and agreed to sell the stake to Saint-Gobain. As an outcome, the French competitor obtains majority control over Sika with a relatively small capital stake. The following aspects are being discussed as controversial:
- Acquisition of minority capital but majority voting rights by a competitor to Sika (in certain markets)
- High control premium (ca. 80%) paid to seller
- No takeover offer planned by buyer to minority shareholders (representing together ca. 84% of capital and 48% of votes)
- Synergy potential of transaction questioned by Sika management (was not consulted prior to transaction)
While there is abundant publicity analyzing the details of Sika transaction, in this letter we look closer at the “culprit” opting-out clause (an exemption for the investor from making obligatory offer to remaining shareholders upon surpassing the 1/3 of control rights threshold). In our assessment, the opting-out has its merits and as such should not be perceived per se as a red flag for external shareholders.
Opting-out: ensures founders’ flexibility – yet may work against minority shareholders’ interests
The opting-out clause is largely unique to the Swiss legislation and reflects the strong tradition of family-controlled companies in Switzerland. The opting-out clause appeared together with the new Swiss Stock Exchange regulation end of 1990s as a self-regulating tool for companies to abolish the mandatory takeover offer requirements that have been newly introduced.
Effectively the clause was installed as a compromise for family owned companies to make the capital markets more attractive and to protect them from facing a discount when selling their controlling stake (as otherwise the buyer would be forced to place a potentially unattractive mandatory offer). The latter now causes controversy among investors of Sika, given the high premium paid on privileged shares (family’s stake) and a significant price drop in common shares (minority investors).
The substantial losses to minority shareholders of Sika triggered criticism and Ethos Foundation demanded to abolish the opting-out at all Swiss companies. While the clause indeed allowed to bypass paying the control premium to minority shareholders, in our opinion its role should not be viewed as generally detrimental.
Family-controlled companies deliver strong outperformance
There is persistent evidence of superior performance by family-controlled companies. The study of Isakov and Weisskopf in the Journal of Banking & Finance 2014 documents the superior profitability of family-controlled businesses among listed Swiss firms with on average 3-5% better annual return on assets as compared to widely held firms or firms with non-family blockholders. They relate this outperformance to business expertise and strong commitment of family members. It is particularly beneficial when family members (especially the founder) are actively involved in business, as opposed to passively owning a controlling stake.
Therefore family control brings tangible benefits and certain shareholder restrictions might be justifiable if necessary for the family to open the capital of attractive companies for external investors. As such, the minority investors obtain the choice to invest into well-performing family companies, but might have to agree to certain limitations to their equity provisions (such as opting-out). Therefore we view the existence of opting-out clause as historically justified in Switzerland – so long as misappropriation of minority shareholder value is not taking place.
Despite strong drop in Sika’s shares, capital market does not see opting-out a problem
Historically, the Swiss market has not seen the control premium on selective part of the share capital to reach levels of magnitude as in case of Sika.
The market reacted negatively on the news and sent shares of both companies into decline. The decline in Sika share price (23% on announcement day; decline further deepened to ca. 30% over the next two days) corresponds to ca. CHF 2 billion losses for minority shareholders – mirroring concerns that the minority shareholders’ interests will not be fully guarded under the new ownership structure. Saint-Gobain’s stock too reacted negatively on the announcements, with ca. EUR 1.1 billion decline in market cap (net of decline in CAC 40).
Despite the abrupt drop in Sika’s share price, the shares of other companies with opting-out clauses showed nearly no reaction at announcement. We analyzed 20 listed companies with opting-out in Switzerland (we excluded the financial sector), and observe most of them moving broadly in line with the underlying SMI index both on the day of the announcement and within the subsequent 1-2 days. Among the companies with price declines the negative returns did not exceed 1-3%, while the overall average return was slightly above zero. In summary – the capital market does not see opting-out as a (new) problem.
No major regulatory changes needed but proactive communication of family’s intentions suggested
While Sika case is currently subject of heated debate and can result in litigation, we believe it will take considerable time before a final assessment can be made, and the case may find its way into corporate governance textbooks.
For the time being, we do not see a need for a major regulatory change such as abolishing of the opting-out. We believe the following three measures however will help to restore trust in corporate governance of companies with privileged control rights provisions:
- Family shareholders should be more proactive and transparent in their communication with the minority shareholders. One idea in this direction is to require the controlling family to publish a letter with the unambiguous statement of their mid-term strategic intentions in the annual report.
- Shareholders should carefully assess the involvement of family members in active management (board and executive roles). Lack of family’s active involvement indicates weaker bond with the company and reduces justification for an opting-out clause.
- Last but not least it remains the obligation of management and board to keep close contact with all key shareholders, including a blockholding family; to read their intention and anticipate and react to change of their strategic intentions.