Greater regulation has brought the issue of pension deficits to the forefront in mergers and acquisitions, writes Hugh Thompson. But if dealt with early, it needn't be a deal breaker
When the £8.2bn cash takeover of BOC by German rival Linde was announced, the
commitment on pensions was at
the forefront of the deal. Linde stated that within three years BOC’s £450m
pensions deficit would be paid off.
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This was an important factor in ensuring that the transaction went through,
not to mention a key concern for BOC’s 30,000 employees. A BOC spokesman said:
‘The pension component was a key part of the deal.’ The fact that the BOC
pensions deficit issue was a headline part of the takeover says a lot about the
modern mergers and acquisitions environment.
As Marc Hommel, PricewaterhouseCoopers pensions partner, says: ‘Pension
deficits have never been bigger and higher profile. This has been reinforced by
the new regulatory scene presided over by the pensions regulator and the new
IFRS accounting rules [IAS 19].
‘When companies are either buying or selling, they now have to think about
the pension fund very early on in the deal process. Pensions deficits are now on
the balance sheet and treated as unsecured creditors and are therefore a prime
consideration in any deal.’
There has been a very real fear in the world of corporate finance that the
regulator’s power to issue contribution notices and financial support directives
could seriously inhibit takeover deals where a defined benefit plan is involved.
However, the regulator has stated: ‘Pensions should never be a deal breaker
they should be a pricing issue.’
This point has been taken up by Hommel, who feels that companies should take
great care in how they value pension funds and their deficits. What happens to a
company after takeover whether it is hived off, floated, stripped or closed
down has a crucial bearing on how the pension fund is viewed, although the
regulator is at pains to point out that only two out of 200 deals submitted for
clearance by December were turned down (see below).
Oliver Lightowers, finance director of £140m services group Spice Holding,
says: ‘During the past year we have made six acquisitions, but we do not have
any final salary pension schemes in the group. We have walked away from two
deals where the pension funds were a real issue. Now they are on the balance
sheet they are very cash-draining and can contribute to the earnings volatility,
neither of which is desirable when you are a quoted company.’
Clearance is needed from the regulator if a transaction could be financially
detrimental to the ability of a defined benefit plan to meet its liabilities. Of
particular concern is where there is a change in the level of security for
creditors, a reduction in shareholders’ funds, or a change in asset or debt
structures.
The role of the trustees is crucial and getting them and the regulator onside
early on is one reason why there have been relatively few problems with the
pensions issue in the mergers and acquisitions field. Clearance will come if the
regulator feels that the plan’s position is sufficiently guaranteed and that the
trustees are content for the proposed merger to continue.
Mark Garnett, associate director with business advisers Smith &
Williamson, says: ‘Some mergers and acquisitions, such as the one proposed for
newsagent WH Smith, have failed because no-one would sign the cheque to cover
the pension deficit.
However, the sum involved depends on how you calculate the deficit. Do you
see it as a one-off problem calculated on low-yielding double AA bonds, or on
more realistic mark-to-market asset values? There are many ways of working out
values cash flows among them.’
Although the legislation suggests that there could be conflict between
pension fund trustees and companies in these estimates, the fact there has been
no let-up in merger and acquisition activity suggests a sense of realism among
trustees. They realise that if they obstruct the flow of capital into a company,
they could end up killing the goose that lays their pensions. Despite the
potential for conflict and problems, it seems that companies and trustees are
working together.
Nevertheless, the legislation does provide a situation where the pension fund
trustees and the company managers could kill each other off. That is not to say
that trustees will not use their elevated position in mergers and acquisitions
to squeeze more out if the company that is to get all or part of the deficit is
to be paid off as in the BOC case.
As Hommel says: ‘There is no need for the new obligations on pensions to be a
deal blocker, provided that deal makers take pensions into account with their
processes, and involve the trustees and, where appropriate, the regulator along
the way. It’s all about recognising what needs to be done early in the process.’
Stuart Benson, principal M&A consultant with Mercer HR Consultants,
agrees that the new regime has not blocked deals and points out that the WH
Smith and M&S pension-related deal failures happened before 2005.
‘What the new situation is doing is making companies face reality,’ he says.
‘There has been an effect on due diligence and pricing, but not on the deals.
Having an accounting standard which provides a benchmark on pension scheme
liabilities is a great help. But there are still creative solutions, such as
when Ericsson placed half a billion pounds in escrow for any future liabilities
for the Marconi pension scheme.’
Mergers and acquisitions under strain
Are mergers and acquisitions being stifled? Are they being harmed by the new
scheme funding requirements?
The pensions regulator replies: Commentators have noted that M&A activity
is running at a high level and that demonstrates that our clearance procedures
are not preventing mergers and acquisitions from proceeding. It also highlights
that the new scheme funding requirements are being factored into company
transactions, bids and takeovers.
In the event of a corporate transaction involving a company with a defined
benefit pension scheme, the sponsoring employer – and others involved in the
transaction – should consider the impact of the proposed transaction on the
company’s ability to fund its defined benefit liabilities (both for past and
future service) in the pension scheme.
The regulator does not have the power to stop transactions from taking place.
The clearance process is entirely optional, but was requested by industry to
give assurances that anti-avoidance powers will not be used later.
Anti-avoidance powers can be used to direct a sum of money into a pension
fund if a transaction is judged to have a detrimental effect on a scheme.
Between April and December 2005 we received more than200 applications for
clearance and only two were subsequently turned down. The regulator cannot go
into detail about these (two) cases, but neither was related to M&A
activity. The problems centred around failure to resolve conflicts of interest
among the trustees, and, above all, the considerable weakening of the scheme’s
position without a meaningful attempt to mitigate the resulting risks.
These cases have very much been the exception. The vast majority of employers
want to do the right thing by their pension scheme members, and the regulator’s
involvement has helped to achieve results beneficial to schemes and affordable
for employers.
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