Risk & Compliance

Power Play

The shareholder tussles at Dutch media group VNU touched many of 2006's hot-button issues.
Tony McAuleyDecember 29, 2006

Of all the deals in 2006, the one that touched on many of the current issues in corporate finance and governance was the pitched battle for the Dutch media group VNU. Running for over a year from the summer of 2005, the VNU saga pitted “activist” shareholders against the company’s supervisory and executive boards—first, over the company’s attempt to do a transformational acquisition, then over its recommendation of a leveraged buyout (LBO) by a private equity consortium, which ultimately became the biggest LBO of 2006, at just over €9 billion. To top it all, management also faced a bondholders’ revolt in August, when it was forced to improve terms on the refinancing after the private equity sale.

Many commentators have interpreted VNU’s turbulence as marking a kind of watershed for European companies, whereby equity investors showed that they were prepared to say “no” to management, especially over potentially value-destroying mergers and acquisitions. Some also felt that VNU’s turmoil underlined the fact that institutional investors were no longer prepared to hand value far too cheaply to the all-consuming private equity groups. Events at VNU also fed into the debate in the Netherlands and elsewhere in Europe about the effectiveness of recently updated governance codes and the proper role of shareholder activism.

VNU may indeed signify a new level of shareholder engagement, though the talk of a turn in the private equity surge may prove to be overblown as the liquidity and leveraged lending that has driven it continues apace.

For Rob Ruijter, who came from KLM Royal Dutch Airlines to join VNU as CFO in early 2005—unaware of the maelstrom that awaited him—the long-running battle highlighted some basic errors that the company had made, but also flaws in the system that, he believes, allow opportunistic investors to skirt the rules. But asked what is the main message he takes from the episode, Ruijter has no hesitation: “The investor relations lesson was very much the first one—listen to your investors.”

By the time he had joined, however, and certainly by the time VNU launched a €6 billion takeover bid for US-based healthcare data provider IMS Health a few months later, in July 2005—an acquisition that would’ve nearly doubled the size of the company—that lesson had been forgotten.

Doing Battle

In the previous five years, VNU’s CEO, Rob van den Bergh, had grown the company through acquisitions, transforming it from a traditional European magazine publisher to a US-focused market data provider, principally with the purchases of market researcher AC Nielsen, Nielsen Media Research and a majority stake in NetRatings, an internet traffic measuring service. Having been with VNU since 1980, rising to the top job in 2000, van den Bergh was clear about his vision for the company and had no patience for analysts and investors who might differ. “Rob—and this is a personality issue—never had a great relationship with his investors,” Ruijter recounts. “He had little sympathy for young people with these laptops doing their models, and that showed. For you not to like it is one thing; for you to show it is another.”

Apart from his unconcealed disdain for investment analysts, van den Bergh had also been prone to promise too much, something that shareholders tend to punish. For example, the company had acquired AC Nielsen in 2001 when it was making a net margin of about 8%, improving that to 12% by 2004. That was a pretty respectable performance; the problem was that VNU had promised to get that margin up to 15%.

Also, after selling its World Directories business to private equity groups Apax Partners and Cinven Group in September 2004, for just over €2 billion, van den Bergh promised to use half the funds to reduce debt and half for acquisitions. But if no appropriate targets could be found, he’d said, the money would be returned to shareholders. As Ruijter says, “From that moment on, it appeared that a number of shareholders put on blinkers and were only focused on the return of money, as opposed to the company doing any major acquisition.”

Coming Distractions

One reason for the blinkers, perhaps, was disappointment with past acquisitions. Indeed, Ruijter had been brought into VNU to sort out the underperformance of some of those. As he puts it, “Rob had a philosophy of looking at individual acquisitions and trying to drive the margin on those. I was brought in by the supervisory board, and by Rob as well, to take a somewhat more operational role and start to look at what integration opportunities there were.” Failure to integrate had held back topline growth and efficiency savings. There were also some obvious cross-selling opportunities that had gone begging—for example, linking media data with consumer behaviour data for both TV and the internet.

“That is something that we had talked about but hadn’t delivered on, and really hadn’t started working on too much either,” Ruijter says. “Rob had brought together a fantastic portfolio of assets, one that we can continue to build on. What I hadn’t realised, though, was the limited amount of, or even lack of, integration there. That became very relevant later on, because I think that was one of the issues that investors had with VNU; ie, that some of the promises hadn’t been brought to the bottom line. “The idea had been to use the takeover of IMS as “a concluding acquisition,” and the arrival of Ruijter as a new operations-focused CFO, to kick-start a programme of integration and rationalisation. Indeed, Ruijter outlined this plan a month after announcing the IMS bid at his first half-yearly results presentation in August 2005, calling it “Project Forward.” This plan essentially is what is now expected to deliver value to the new private equity owners.

In the event, the programme had to be shelved for another year as a group of investors, led at first by funds under the Fidelity and Templeton umbrellas, representing about 30% of VNU’s equity, began to fight against the IMS acquisition. Also vocal in opposition, though his fund owned just over 1% of the company, was Eric Knight, chief investment officer of Knight Vinke, a fund which had originally been staked by the $200 billion (€151 billion) California Public Employees’ Retirement System (CalPERS) with a brief to agitate for better governance, and which had gained notice the previous year by lobbying for Shell Group to drop its century-old Anglo-Dutch holding structure. The Dutch governance code, which came into effect at the beginning of 2005, had increased substantially the power of investors holding more than 1% of a company’s shares.

After four months, VNU finally gave up in mid-November and dropped its bid for IMS. The company’s cave-in dropped like a bombshell in the Netherlands’ investment community.

“If we look at the altered relationship between businesses and shareholders [in the Netherlands], then the 17th of November last year becomes a crucial date as far as I’m concerned,” says Peter Paul de Vries, director the Dutch Investors’ Association (VEB). “After VNU [dropped its IMS bid], Dutch directors started to realise that they could no longer push this type of decision through without the approval of the shareholders.”

However, it wasn’t simply a victory for shareholders’ rights. The IMS failure put VNU itself in play. That, in turn, attracted hedge fund investors with an agenda simply to extract maximum value in the shortest time. As Ruijter puts it, “The first and second battles were totally different. A number of these funds, quite frankly, all they wanted was to make a quick buck and had no interest in what the company was all about.”

It is debatable whether Knight Vinke can be lumped into the hedge fund category, although the VNU management certainly put it there.

Knight Vinke spokesman Martin Forrest argues forcefully that the fund is a “long investor,” and its shareholdings are not the typical quick-flip of a hedge fund. The company describes itself as a fund that specialises in “institutional shareholder activism” using “a variety of shareholder engagement techniques.” But the definition of a hedge fund investor has become so broad that it might easily include “corporate governance arbitrage” of the type that Knight Vinke engages in.

When VNU executives met with the main agitating shareholders in October 2005, they made a deal to explore “strategic alternatives” for the company and van den Bergh agreed to resign after that process was completed. While the CEO then concentrated on day-to-day operations, CFO Ruijter was charged with negotiating the private equity terms, which resulted in a €28.75 per share bid in March by the Valcon Acquisition consortium—comprising AlpInvest of the Netherlands, Blackstone, Carlyle Group, Helman & Friedman, KKR and Thomas H. Lee Partners.

Puttin’ on the Ritz

The ensuing three-month battle was one of the most closely watched hostile takeovers of the year and has been well documented. Ultimately, investors accepted an offer in June that was 2.5% higher than the original, valuing the equity at €29.50 per share. It is still debatable, however, what conclusions can be drawn.

In the prevailing version, Eric Knight—Dutch-born polyglot, educated at Eton and Cambridge in the UK and Massachusetts Institute of Technology in the US—rallied a majority of VNU investors with a smooth presentation of an alternative plan in London’s Ritz Hotel in April. “We took the initiative to defend the long-term interests of shareholders,” he said soon after that meeting.

By the end of the year, Knight was concentrating on rallying support via full-page newspaper advertisements and political lobbying efforts for alternatives to the Gaz de France/Suez merger, part of a long-running campaign aimed at breaking up Suez.

But did the shareholders’ stand mark a victory over management and its private equity partners? Was the extra 2.5% worth it? “In the end, raising the price by just 2.5% was about equal to the time value of money from when the deal was announced to when it was completed,” says Wieland Janssens, London-based head of the financial sponsors (that is, the private equity) group at Dutch bank ABN AMRO, Valcon’s principal adviser on the bid.

Of Knight’s alternative plan, Janssens says, “It was just part of the deal noise and Knight Vinke was the one with the biggest megaphone. Eric Knight was the only one who was making a public stand on it and he had left, if I may say so, the realm of the rational.”

Ruijter says, “An annoying factor was we had three different versions of [Knight Vinke’s] Plan B.” When the third version arrived, which included a proposal to buy back a third of the company’s shares, he describes now, “we put our foot down with the AFM [the Dutch financial market authority] because bidding for a company is a highly regulated process here.”

To finally win the deal, the private equity consortium made shrewd tactical moves. It increased the bid by that relatively small amount and simultaneously declared that it would accept 80% approval—in other words, it would carry Fidelity and other minorities up to 20% if it had to, rather than insist on the full 95% needed to squeeze out minority shareholders.

“Investors saw that this was it,” says Ruijter. “If the private equity deal was going to be rejected, then clearly there was going to be a rough ride ahead of us.”

Full Value

When the dust settled, both sides would say that VNU was “fully valued.” So, the broader question remains: does the fact that private equity groups are now going for much larger deals, and prepared to go hostile, mean that they’ve run out of good ideas and are becoming a far riskier investor class because of their ever-increasing leverage levels?

In November, the UK’s Financial Services Authority (FSA) issued a discussion paper on private equity risk, in an attempt to spur the debate and put it in context. It noted that the growth of the private equity industry was partly at the expense of the public markets, with PE funds raising a record £11.2 billion (€16.6 billion) in the first half of 2006 in the UK alone, outstripping the £10.4 billion raised via IPOs on London’s public markets in the same period.

(According to Dealogic, private equity LBOs reached a record $741 billion globally by late November, a record 21% share of total global M&A, which itself was up 17% up on the year at a new record $3.5 trillion.)

The FSA noted that the private equity industry was maturing and forming into three categories—a few big firms that concentrated on large deals, such as VNU; a big middle market, estimated to comprise about 60 firms throughout Europe; and a smaller country-focused category of firms. It generally welcomed the maturing of the private equity investor class, but identified a number of governance risks and other broader risks to the financial system, some of which may require tighter regulation. Chief among them was excessive leverage. “Given current leverage levels and recent developments in the economic/credit cycle, the default of a large private equity-backed company, or a cluster of smaller private equity-backed companies, seems inevitable,” the FSA paper warned.

Janssens of ABN Amro agrees that leverage levels may have reached a plateau: “Multiples have expanded to the point where they probably won’t go any further—there is a limit to how much the balloon can expand. But they probably won’t deflate precipitously either.”

Another risk the FSA identified was conflict of interest. This question was raised when it was revealed that Danish telecom company TDC, which was sold to a private equity consortium at the end of 2005 for €12.9 billion—a European record—would pay Henning Dyremose more than €5m in November when he relinquished his CEO job and moved to chairman, with a third of that identified as a special “transition bonus.” Dyremose said he had not negotiated with the private equity firms while they were bidding and that the terms had been negotiated by TDC’s chairman.

Push Play

Does Ruijter now feel more comfortable working in a private equity environment, finally able to begin implementing Project Forward, maybe even looking again at a major acquisition like IMS Health with new CEO David Calhoun, who was brought in from GE? “Not really,” he says, “I’ve felt comfortable for many years working in a public company. But given the failed merger with IMS, how things developed for VNU with its clients and employees, it is the best environment for the company to be in private equity for a while.” Looking back, would it have been a better strategy, perhaps, to go for an LBO before bidding for IMS? “If I’d known all that would happen, I probably wouldn’t have joined VNU in the first place,” he says, almost forgetting to add a laugh.

Stately Presence

Governments’ fingerprints were all over some of the year’s biggest M&A and IPO deals.

The fate of French utility Suez, for example, was likely to remain undecided until well into 2007, as 80% government-owned Gaz de France pursued its $43 billion (€32.5 billion) merger strategy, which would leave it owning 34% of the combined group—requiring a change in French law. Both French trade unions and a group of investors led by Knight Vinke opposed that move for different reasons. Investors want a higher cash offer or the way cleared for other bidders, such as Italy’s Enel, whose overtures towards Suez were blocked by the Gaz de France move.

GdF’s CFO, Philippe Jeunet, has remained silent throughout the process. A GdF executive, who didn’t want to be named, says, “Jeunet is frustrated. There has been so much political focus that the industrial logic has been lost—the creation of Europe’s number-one [liquid natural gas] producer, a top-five European electricity supplier, giving Electricité de France real competition, a balanced portfolio in terms of natural gas, electricity, nuclear and hydro, as well as suppliers.”

There was a similar politicised situation next door in Spain, where the government was imposing conditions on German utility E.ON’s €55 billion bid for Endesa. This despite an €18 billion bid by Spain’s Iberdrola for Scottish Power in late November.

Indeed, energy was the most politicised sector, reflecting its strategic importance and positioning ahead of the July 2007 deadline for opening energy markets in the EU.

Even the relatively open UK market rebuffed enquiries from Russia’s giant Gazprom about the country’s main gas distributor, Centrica, on strategic grounds.

In the IPO market, by far the largest deal of the year was the highly contentious Rosneft offering, which had become Russia’s second-largest oil company when it acquired the assets of Yukos after Russian President Vladimir Putin’s government confiscated its assets and put its owner, oligarch Mikhail Khodorkovsky, in jail for tax evasion. (See Selling Russia,CFO Europe, June 2006.)

It wasn’t clear whether the taint of the Rosneft deal or the drop in commodity prices in the spring caused many of the scheduled London IPOs for Russian companies to be postponed.

“Rosneft was exceptional,” says Sergei Yuschenko, the 33-year-old CFO of Lenta, Russia’s second-largest food and general goods retailer. “That was a case of Putin putting a gun to the oligarchs’ heads and making them step up. Also, the international oil companies,” he says, referring to the fact that several of Russia’s most prominent oligarchs bought in excess of $1 billion of Rosneft’s IPO shares, while Shell and Petronas of Malaysia each bought multibillion-dollar blocks of shares. “But I don’t think Putin will do the same for us.”

Yuschenko says Lenta is not rushing to do an IPO. Earlier this year, it was able to halve its borrowing costs to LIBOR 2.8% and raised €90m—€20m more than it had sought—because of liquid debt markets and rapid Russian economic growth. Yuschenko is also near to finalising a €125m equity investment from the European Bank for Reconstruction and Development.

Greater Fool

Nearing the end of 2006, there’s been no shortage of warning bells about the levels of debt in corporate Europe.

Typical was a November report from credit rating agency Standard & Poor’s. “There is no doubt that the credit cycle has turned, as reflected by the staggering increase in debt-funded dividends, share buybacks and acquisitions,” according to the report. “Standard & Poor’s expects this trend to not only continue, but also accelerate over the coming quarters, with the intoxicating promise of higher shareholder returns financed by abundant cheap money.”

Looking at Europe’s largest 50 companies, S&P said that credit quality remained stable, but it identified debt-funded acquisitions as the major threat to that quality for most industrial sectors, whether the companies were the acquirer or the target.

Edward Eyerman, head of leveraged finance at Fitch Ratings in London, notes that more than €250 billion of debt taken out in leveraged buyouts is coming due in Europe over the next two years.

The vast bulk of the leveraged buyout activity remains in the middle market, for lower credit quality companies. But lending trends continue to favour this sector.

“In 2006, we’ve seen institutional investors becoming a much larger component of the sub-investment grade market compared with European banks and we’ll see this trend continue in 2007,” says Fenton Burgin, a debt advisory director at investment bank Close Brothers.

An example of this was the €1 billion takeover at the end of October of Swedish mattress maker Hilding Anders by private equity group Candover, where leverage multiples were more than seven times Ebitda. Overall, average debt multiples have been climbing too.

As Burgin notes, “The more remarkable feature of 2006 has been the way in which some medium-sized companies have been able to access multiples historically reserved for far stronger credits. We have seen structures pushed to the limits in a number of highly competitive LBO auction situations over the summer months. It is fair to say that the private equity firms have taken advantage of the ‘spray and pray’ mentality of some lenders.”

The worry over leverage can be exaggerated. Paul Watters, head of loan and recovery ratings at S&P, notes that private equity sponsors “drive about 90% of the leveraged finance market in Europe. But not all of this volume is new debt—strip out secondary buyouts and dividend recap deals and it shrinks by about half.” Furthermore, Watters says, “These trends have been positive for companies. They’ve seen an increased capacity for debt and terms have been more favourable. There is less amortising debt, which is easier to service, and companies have been able to take on higher debt levels than in the past. When the credit cycle turns again, people will discern more on pricing, but this is not happening yet.”