When a fixed life investment trust nears the date on which it is obliged to repay capital to shareholders, typically by way of compulsory winding up provisions, its directors’ thoughts turn to the options available for its future.
Despite its apparent finality, the end of a fixed life need not mean the end of a successful, popular portfolio; with sufficient shareholder support, a successor vehicle can be created from the ashes of the old company.
Alternatively, the time-consuming and costly nature of such arrangements has led some companies to seek out new ways to entirely avoid winding up, allowing investors to stay on board if they wish, while providing fair value for those looking for an exit.
The need to liquidate a mature portfolio to repay capital will not necessarily be in line with the wishes of a significant proportion of investors, particularly if it has consistently performed well.
For example, many of these portfolios contain a high proportion of relatively illiquid assets, such as smaller companies or unlisted stocks, which may be difficult to liquidate for a fair value.
Existing investors may also be enticed by the prospective tax benefits of staying invested, in that they avoid crystallising a capital gain.
Where a company has a sector specific focus, it may not be possible to gain a similar exposure to that sector elsewhere.
In addition, there may well be appetite among would-be new investors who, as well as benefiting from the mature and potentially well managed portfolio, would also avoid the set-up or portfolio acquisition costs associated with an entirely new company.
With such new investors potentially replacing those looking for an exit, companies may be tempted to seek alternative options to a straightforward winding up.
Traditional options often include delivering a successor vehicle either through the operation of a court-sanctioned scheme of arrangement, or by rolling over interests into a new vehicle through a liquidation process under a Section 110 scheme.
These routes have been favoured, as they were regarded as the safest way to ensure departing shareholders, who required their capital to be returned, could be repaid.
However, while creating a successor vehicle has its attractions, it is both expensive and time consuming, sometimes to the point where any benefits are lost in the significant costs involved.
In recent years, therefore, directors have explored new ways to continue the existing company, while still delivering both the capital return to exiting shareholders and ensuring new investors can come on board to preserve the size of the company.
One such innovative restructuring was implemented in December 2009 by Premier Energy & Water Trust PLC (PEWT).
PEWT has two classes of shares: ordinary and zero dividend preference shares, known as zeros, which deliver a capital return at the end of a set period at a predetermined rate.
The zero shares have a gearing effect on the portfolio for the ordinary shares, so potential total return on the ordinary shares is influenced by the final capital entitlement, or gross redemption yield (GRY), of the zero shares.
Essentially, a lower GRY on the zeros means a better the return for ordinary shareholders.
The pricing of the zero – the level at which the GRY is set – is affected, among other things, by the capital cover on the zeros, the perceived risks in the underlying portfolio and the prevailing level of interest rates and bond yields.
Extending a life investment trust
PEWT was approaching the end of its fixed life, set for the end of 2010, but the directors recognised there was appetite for continuing the company beyond that date. They were also aware of investor sentiment that new investment may be possible, given the company’s recent track record. Because of the existence of zeros, there was also scope to take advantage of increased market appetite for paying tax on capital gains, as opposed to income, in the UK.
The company devised a package of proposals which extended its life, while offering a tender option for both ordinary and zero shareholders who wished to exit.
This was combined with a matching purchase facility and placing, where new and existing investors who wished to increase their holdings could be matched with departing shareholders.
The interesting dimension to the proposal was how the board would balance the interests of shareholders – both departing and continuing – with the need to attract prospective investors when fixing the price for the ‘new’ zeros. The exit price was also the purchase price for any new investment.
In response to this challenge, PEWT offered a variation of the concept of a reverse tender, where shareholders are invited to bid for the lowest price at which they would be prepared to sell their shares.
In PEWT’s case, shareholders were invited to indicate the level of GRY at which they were willing to remain invested in zeros in PEWT, and below which they would, therefore, sell their shares.
New investors were similarly invited to indicate the lowest level of GRY at which they were prepared to buy in. The GRY was set at the level which permitted the optimum size for the company going forward.
This mechanism enabled the company to set the GRY at a level which was directly linked to market demand for zero shares, thus ensuring the ordinary shares were not penalised by the zeros being priced more generously than was necessary.
Such mechanisms are not without their potential pitfalls, not least because backroom systems must be able to operate the facility being offered.
The documentation also needs to accurately and fairly describe the complexities of the mechanism, to ensure that shareholders can, and do, participate in the proposition.
Similar challenges are likely to face other companies looking for an innovative solution as their wind up date approaches.
However, particularly in the current difficult market conditions, the potential advantages for shareholders – whether they wish to remain or exit – may still make it worth reconsidering the options available.
Maria McCormick is a lawyer in the Financial Services Group at national law firm Maclay Murray & Spens LLP, which advised PEWT on its restructuring.