2018 M&A Report: Bahrain

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The trend of consolidation within the highly fragmented financial industry has continued albeit at a slower pace than originally envisaged. This consolidation is expected to further pick up in 2018. Furthermore, the recent dynamic of oil prices, with Brent oil futures trading in the range between $60 and $70 since November 2017, could also have a positive knock-on effect on the local M&A market. Other sectors which may see increased M&A activity are the hospitality, education and real estate sectors. With the respect to the latter, in particular, an increase of M&A activity for distressed real estate assets is being pursued by the government as part of its development policies towards the real estate sector.

The pace of M&A activity in 2017 remained broadly in line with 2016. In public M&A, the financial sector has been the most active. In the insurance sector, Bahrain & Kuwait Insurance Company BSC has launched and completed a mandatory tender offer on the shares of Takaful International Company. In the banking sector, a voluntary offer has been launched on the shares of Bahrain Middle East Bank by one of its shareholders. Another significant transaction that took place in 2017 was the share swap between shares in United Gulf Bank and the shares of the newly established United Gulf Holding Company, which was accompanied by a de-listing of the shares of the former and the listing of the shares of the latter.

The market is driven primarily by private M&A transactions, as public M&A activity is still relatively infrequent. The reasons underpinning such dynamics may be related to the high ownership concentration in most of the listed companies and the scarce liquidity of the stock market. A significant change of these dynamics could be triggered by a partial privatisation by the government of certain companies which would at the same time boost market liquidity and reduce ownership concentration with positive effects on public M&A activity.

M&A activity in Bahrain has been affected to an extent never seen in the past by strategic investors from neighbouring GCC countries, which have provided much needed demand for local assets. This trend has been facilitated by a large restructuring taking place in the local banking industry where certain players (mostly investment banks) are proactively seeking to offload part of their investment portfolio by disposing of non-strategic investment assets, also in the light of the highly penalising capital adequacy regime associated with ownership of such assets.

The mandatory tender offer on the share capital of Takaful International Company constituted the first mandatory tender offer to ever take place in Bahrain under Volume 6 of the Rulebook (Rulebook 6) published by the Central Bank of Bahrain (CBB). The transaction originated from a block acquisition on the Bahrain Bourse of a significant shareholding in Takaful International Company which triggered one of the mandatory tender offer thresholds. This transaction has been relevant to the market being the first of its kind and having casted light into the mechanics of mandatory tender offers in Bahrain.

Widening valuation gaps between seller side and buyer side are denting liquidity on the domestic M&A market and this negatively impacts deal volumes. This is forcing practitioners to devise structural elements (including but not limited to earn-outs) in order to overcome these issues.

The Takeover, Mergers and Acquisitions Module (TMA Regulation) Rulebook 6 is the primary governing regulation for public M&A in Bahrain and it works in conjunction with other regulations issued under Rulebook 6. It applies where there is an acquisition or consolidation of control of a Bahrain domiciled publicly listed company; or an overseas company whose primary listing of equity securities is on a Bahrain exchange. Rulebook 6, including the TMA Regulation, is administered by the Capital Markets Supervision Directorate at the CBB. Private M&A, as such, is not a regulated activity beyond registration of share transfers and transfers of business premises.

There have been recent changes to the share transfer mechanics applicable to Bahrain closed joint stock companies, which are expected to have an impact on private M&A as such changes are aimed at simplifying the mechanics for share transfers in line with the procedures for Bahrain public joint stock companies.

A revised TMA Regulation was put to consultation during 2017, though no action has been taken by the CBB following such consultation. New laws on secured transactions and bankruptcy are expected to be enacted during 2018 (or early 2019), which may have impact on M&A market as well. Implementation of VAT in Bahrain may also be impactful to the extent that share or asset transfers will be deemed as supplies of goods for VAT purposes (which we do not know at the present stage).

One common mistake is to structure and implement M&A deals following schemes and solutions developed in overseas jurisdictions without paying the necessary attention to the local legal and regulatory framework, both in cases of cross jurisdiction and of purely domestic transactions. This mistake can go unnoticed insofar as no conflict arises between vendor and buyer, though this may result in the completion process conflicting with local regulations. If a conflict arises, the pitfalls of such approach become readily intelligible, including difficulty in obtaining legal redress in the local jurisdiction, uncertainties surrounding application of foreign law provisions in domestic court proceedings and impasse to meeting local requirements for completion.

Post-closing activities are often an overlooked area as action plans and timelines are often drawn up until the closing date leaving post-closing activities to proceed without a clear structure, sometimes even managed by a team that did not work on the deal. This neglect often subsists notwithstanding the number and importance of post-closing activities which are often implicated (such as changes to public registers which cannot be completed at closing, etc). Transitional services arrangements involving continued seller involvement are common but may have dubious validity and enforceability.

The key to a successful M&A transaction is an early involvement of the local lawyer in the structuring phase of the transaction in order to explore, analyse and eventually find legal solutions translating the commercial objectives pursued by the parties into viable solutions under Bahrain law.

Obtaining control of a public company often involves the launch of a public tender offer (whether on a voluntary or a mandatory basis) unless de facto control is achieved by the acquisition of less than 30% of the target company voting share capital. The threshold triggering an obligation to launch a mandatory offer is set at 30% of the voting share capital of the target company and further thresholds are contemplated for any incremental purchase between 30% and 50% of the voting share capital occurring within a specified timeframe. The launch of a voluntary or mandatory tender offer is accompanied by the publication of an offer document containing all information required under Module TMS of Volume 6 of the Rulebook published by the CBB and subject to CBB approval.

Usual conditions attached to an offer include levels of acceptance, approval of shareholders for the issue of new shares and listing/regulatory approvals. A voluntary offer must not be made subject to conditions whose fulfilment depends on the subjective interpretation or judgment by the bidder or lies in the bidder's hands. Once a firm intention to make an offer is formally announced, the bidder is committed to proceed. Scope to withdraw by invoking the conditions to the offer is limited. To the extent that the bidder intends to attach conditions other than normal conditions, the CBB must be previously consulted. As a general rule with limited exceptions, financing for an offer must be fully committed when the announcement of the firm intention to make an offer is made

Break fees are not used in Bahrain and their validity is uncertain as a commitment to a break-up fee can be seen as unlawfully impinging upon each shareholder right to decide whether to sell or retain the shares. In the absence of more legal clarity as to the permissibility of break-up fees, we do not expect that this instrument will be adopted in the structuring of public M&A deals.

The use of completion accounts is still the prevailing consideration mechanism in the realm of private M&A, though the financial data tracked for the purposes of determining any price adjustment with respect to the headline purchase price vary from working capital only adjustments to full-fledged adjustments based on net worth variations. Locked box mechanisms are still relatively uncommon, though we expect to see an increased use of such mechanisms especially in the context of vendor-initiated private auctions. We have seen an increase in the use of earn-outs in private M&A and believe these are being used as a tool for bridging widening valuation gaps between seller sides and buyer sides. Escrows are very common and are mostly used in connection with management of claims against representations and warranties.

Regulatory approvals are invariably attached to private offers in respect of target companies operating in regulated industries. It is not uncommon to also find MAC clauses associated with specific quantitative metrics, though same are usually bitterly negotiated. It is quite common to bring down all representations and warranties to closing so that any breach (or material breach) of them may give a deal exit to the buyer.

It is a rather common practice, albeit we strongly advise against the use of foreign jurisdiction clauses in M&A transactions in light of the enforceability issues that these may give rise to. In case of foreign governing law, foreign arbitration should be seen as a must due to problems faced in proving the provisions of a foreign law in front of a Bahraini court and difficulties in enforcement in Bahrain of foreign court decisions. Bahrain governing law with Bahrain court enforcement may be valuable to facilitate enforcement of local obligations associated with the transaction and may be favourable for a foreign party who received robust local law advice against a Bahraini counterparty.

Warranty and indemnity insurance is slowly gaining recognition, though it is still rare to see in practice in purely domestic deals as opposed to the Bahraini leg of multinational deals where it is somehow more common.

The exit environment is very challenging. The main exit channel still consists in a private sale to an industrial or private equity purchaser. The IPO exit route is uncommon in light of the structural liquidity issues affecting local capital markets, though recent developments, such as the Bahrain Investment Market launched by Bahrain Bourse, may enhance the possibility for an exit through public offer in the local capital market. Sales to financial sponsors are also often unviable because of the reluctance by financial sponsors to take on balance sheet equities also in light of the penalising capital treatment that this asset class receives under the newly implemented capital adequacy regulations. Finally, restrictions on introducing new partners into closely held LLC entities make exit infeasible without full shareholder cooperation.

We expect that consolidation in the financial industry will continue, propelled by structural reasons going beyond the existing economic cycle. Relatively higher oil prices may also induce increased M&A activity though recent market volatility would suggest caution on this. Increasing bond yields brought about by the peg to the USD and the tightening of monetary policy taking place in the US, may induce companies to reconsider their capital structure and this may open up M&A possibilities. We expect market practice to embrace innovative structuring options to face persistent liquidity challenges, and we also expect that new legislation which is the making will be generally positive for the M&A market.

About the author
		Simone Del Nevo Senior associate, ASAR – Al Ruwayeh & Partners Manama, Kingdom of Bahrain T: +973 17 533 182 F: +973 17 533 185 E: sdelnevo@asarlegal.com W: www.asarlegal.com Simone Del Nevo is a senior associate with ASAR-Bahrain and has been with the firm since December 2014. Del Nevo currently practices in the areas of banking, finance, securities and capital markets. He received his law degree from Bocconi University of Milan, Italy, in 2004. He was admitted to the Milan Bar Association as a qualified lawyer in 2007. Del Nevo's practice languages are English and Italian.