Current market conditions have set the stage for a wave of REIT public-to-private transactions. For private equity funds, flush with record levels of cash, REITs trading at a discount to net asset value represent an attractive investment opportunity. This article provides an overview of a REIT take-private transaction, highlighting key considerations that shape the process.
Take-Private Process – Overview. The take-private transaction begins with either the target board’s decision to sell or an initial approach by a potential acquiror. During the pre-financial crisis wave of REIT activity, most targets ran a traditional auction process, hiring an investment bank and contacting potential bidders. In 2018, we have seen an increase in the number of take-private transactions initiated by an unsolicited bid or initial approach from a private equity fund.
For both the target and potential acquiror, moving quickly at this phase is critical, regardless of how the decision to sell is initiated. Information leakage and rumors are likely to result in the target inadvertently or prematurely placing itself “in play”. Once the target is in play, it is often difficult to pull back as a practical or market matter.
Market Check – Auction vs. Negotiated Sale. In response to an unsolicited bid, the target board may choose to negotiate with the unsolicited bidder or instead solicit other bidders in a pre-signing auction. Fiduciary obligations imposed on the target board means that the sale of every public company will include a market check, whether pre- or post-signing, including through the absence of preclusive lock-up arrangements.
In this context, a key factor in the board’s decision is the universe of potential acquirors, which may be quite small depending on the size of the target and the diversification of its portfolio.
In some instances, the target board may choose to actively shop the company after signing a definitive agreement through the means of a “go-shop” provision. Go-shop provisions empower the target and its advisors to actively solicit a superior bid for target shareholders for a specified period immediately after signing a deal. This approach is customary in the context of a related-party transaction, such as an external manager buying its managed REIT, where the related acquiror has intimate knowledge of the target and its assets.
Even without a go-shop provision, the target board is provided with a “fiduciary out” that would allow it to terminate the initial agreement if presented with a superior offer. Accordingly, the acquiror will negotiate certain deal protection devices, including a “break fee”, or an agreed-upon percentage of the overall transaction value payable by the target if the target terminates the proposed transaction. What constitutes a superior proposal will be heavily negotiated by the parties. In addition, “matching rights” granted to the original acquiror will be heavily scrutinized.
There is no one-size fits all process for take-private transactions. Delaware and Maryland courts give the board broad discretion to implement the process which they judge best to maximize shareholder value. Target boards will carefully consider the full range of alternatives, including a pre-signing full auction, limited auction, accepting a preemptive bid, go-shop provisions, and low break-fee deals, to determine which option is most likely to maximize shareholder value under the circumstances.
Negotiating the Definitive Agreement – Special Committees. Typically, a take-private transaction involves a controlling shareholder or management insider acquiring the target it controls. To avoid any perceived conflict of interest, the target board typically establishes a special committee of independent directors, or non-management directors unaffiliated with the controlling shareholder, to retain advisers and negotiate the transaction.
Once the target board or special committee decides to pursue a transaction, the target and successful bidder will conduct due diligence and negotiate the definitive transaction agreement.
Many buyers, private equity funds in particular, seek to retain the target REIT’s senior management. The target board or special committee should insist that management be excluded from negotiating the potential transaction, or discussing future employment arrangements with the private equity fund, until the parties have reached a definitive agreement on the economic terms of the deal.
Post-Signing – Shareholder Approval. The vast majority of REIT take-private transactions are structured as a one-step merger. For these transactions, the target will prepare and file a proxy statement with the SEC and mail to target shareholders ahead of the annual shareholder meeting. For a Delaware target, a one-step merger must be approved by a majority of outstanding shares (or a higher threshold if specified in the certificate of incorporation). For a Maryland target, the merger must be approved by holders of two-thirds of outstanding shares (or the threshold specified in the REIT’s declaration of trust, but never less than a majority). This post-signing process will generally take three to four months.
The majority of take-private transactions are challenged by shareholders, on claims that the target board breached its fiduciary duties and that insufficient disclosure was provided to shareholders to make an informed decision to approve the proposed deal. Shareholder litigation may require payment in the form of settlement or could result in additional disclosures in the proxy statement, delaying the closing. Courts in Delaware and Maryland will generally respect the board’s decision if the record demonstrates that an appropriate and thorough process was followed, including with respect to addressing any conflicts of interest. The target board and special committee processes should be well-documented, which will allow all parties to minimize the risk and cost of litigation.
There is no single process by which REIT take-private transactions are initiated and negotiated. However, so long as REITs trade at a discount to net asset value and private equity groups are fully capitalized and searching for investment opportunities, the trend of unsolicited privatizations of publicly-traded REITs is certain to continue.
