The UK has a unique structure for the regulation of public company merger and acquisitions (“M&A”). Takeovers are regulated by the Panel on Takeovers and Mergers (the “Panel”), a non-statutory body, within the framework of the Takeover Code (the “Code”), a series of rules designed to ensure fair and equal treatment of shareholders in relation to takeovers. Successful execution of public company M&A in the UK requires a good understanding of the detailed mechanics of the takeover process.

The recent landmark contest between Carnival Corporation (“Carnival”) and Royal Caribbean Cruises Ltd. (“RCL”), two US-listed cruise operators, to combine with the UK-listed P&O Princess Cruises plc (“P&O Princess”) demonstrates the importance of having an integrated advisory team that can marry global industry knowledge with local market and regulatory expertise. The contest ultimately resulted in a dual listed company (“DLC”) transaction between Carnival and P&O Princess, which is expected to complete in the first half of 2003, and contained a number of unusual features, including:

• First DLCs to be proposed between US and UK listed companies
• First DLC to involve a takeover rather than a merger
• A US-style merger agreement competing with a UK-style offer
• The withdrawal of a public offer for a UK plc and its substitution with a different structure

P&O Princess
P&O Princess was created from the demerger of the Peninsular & Oriental Steam Navigation Co. in October 2000 and is an international cruise company with 22 ships offering 33,100 berths. It has operations in North America, the UK, Germany and Australia and carries over one million passengers annually.

Following demerger, P&O Princess invited Schroder Salomon Smith Barney (“SSSB”) to act as its financial adviser. In this capacity, SSSB participated in a detailed analysis of the cruising industry and its dynamics, which concluded that scale was increasingly important to long term success in the cruise industry.

P&O Princess, while having excellent prospects as an independent company, had the opportunity to accelerate the creation of shareholder value if it were to combine with another industry player.

SSSB worked closely with P&O Princess in the first half of 2001 to identify the strengths and weaknesses of potential merger partners as well as the benefits and risks to P&O Princess shareholders of various combinations. Overlaid on this analysis was a study of the regulatory issues each combination might face.

The RCL transaction
Discussions with RCL commenced in the summer of 2001, although were suspended following the events of September 11. They resumed in late September against a changed geopolitical and economic backdrop. Since September 11, the share price performance of each of the major cruise lines had been poor as markets reacted to concerns about the effect that the terrorist attacks would have on consumer confidence and global tourism. RCL, with higher relative balance sheet gearing, had been affected more than its industry peers.

Both sides wanted to create a stronger combination post-merger, but had specific concerns that would need to be allayed before any merger could be consummated. In particular, an all share offer by P&O Princess for RCL, or vice versa, was structurally unattractive as a number of existing shareholders would be unwilling or unable to hold shares in the other company. This would lead to potential flowback of the offeror shares following completion as offeree shareholders sold into the market.

The solution was for the transaction to be structured as a DLC. A DLC is a structure involving two companies entering into irrevocable contractual arrangements whereby the economic interests of shareholders in the two companies are fixed in perpetuity by an equalisation ratio. The two companies retain their existing share listings and shareholders do not tender or exchange their shares.

RCL had concerns that Carnival might try to disrupt any merger. Carnival was significantly larger than both P&O Princess and RCL, and had a strong A-rated balance sheet. RCL did not wish to be a stalking horse and so wanted to start working together with P&O Princess in a new Southern European joint venture immediately following announcement of the transaction, and prior to shareholder approvals being obtained. This joint venture would also contain change of control provisions that would be triggered by a takeover of either RCL or P&O Princess.

As a UK listed company, P&O Princess would be regulated by the Panel if it was the target of an offer (whether from RCL or from any other party). The Code contains specific provisions preventing offeree companies from implementing “frustrating actions” – broadly those actions that might frustrate the ability of an alternative bona fide offeror to complete a transaction – without first obtaining shareholder approval. The existence of these provisions would seem to prevent P&O Princess from incorporating a joint venture of this type without obtaining shareholder consent which, in turn, would prevent P&O Princess from agreeing terms with RCL.

The proposed DLC structure would not, however, be regulated by the Code, as a DLC does not involve an offer for securities. Consequently, provided that P&O Princess had no reason to believe a bona fide offer from another third party might be imminent, the provisions of the Code that would preclude P&O Princess from entering into the joint venture without first obtaining shareholder approval would not apply. As P&O Princess had not had substantive conversations with any other third parties in the recent past, the Board concluded that P&O Princess could enter into the joint venture.

The joint venture was unusual in the context of a UK transaction and so the Board negotiated the inclusion of certain provisions that would allow P&O Princess to exit the joint venture at no cost in due course. Accordingly, while the joint venture might act as a hurdle to any potential third party bidder, it should not impose an insurmountable barrier. The ability to exit the joint venture at no cost was critical to the Board’s assessment of its acceptability to P&O Princess shareholders. The Board determined that the potential negative impact of incorporating the joint venture into the transaction was a price worth paying to allow a transaction to be put to shareholders. The proposed DLC combination with RCL was announced on 19 November 2001.

Carnival intervenes
On 16 December 2001, Carnival Corporation announced an unsolicited pre-conditional takeover offer valuing P&O Princess at 450p per share. Importantly, Carnival also indicated its willingness to consider a DLC structure with P&O Princess. Due to the existence of a “no shop” clause in the agreement between RCL and P&O Princess, P&O Princess could only enter into discussions with a third party in a situation where the third party’s proposal was deemed “superior” from a financial point of view and “reasonably likely” to be consummated. P&O Princess concluded that neither of these thresholds had been met by Carnival and continued to recommend the RCL transaction.

Carnival improved its offer on a further three occasions prior to the P&O Princess EGM on 14 February 2002. The third increase valued P&O Princess at 550p per share, which the Board of P&O Princess concluded was approaching a realistic level for those shareholders who wanted to cash out of both firm and industry. However, due to continuing concerns regarding the regulatory review process and the fact that significant UK institutional shareholders could not hold Carnival shares, the Board continued to recommend the RCL transaction. At the EGM, P&O Princess shareholders voted to adjourn the meeting pending completion of the regulatory review process.

The Regulatory Process
Attention now switched to a complex antitrust review process. The RCL transaction had already been cleared by regulators in Germany but had yet to be scrutinised by the UK Competition Commission and the US FTC. The Carnival transaction was yet to be scrutinised by the European Commission and by the FTC.

The regulatory reviews completed in October 2002 when the FTC announced the clearance of both the Carnival and the RCL transactions. On receipt of regulatory clearances, the Board of P&O Princess met with its advisers to consider a new and very different landscape. In Autumn 2001, both transactions faced significant regulatory uncertainties. With regulatory approval, the questions now facing the Board were which transaction offered the greatest financial benefits to P&O Princess shareholders and whether either transaction was superior to P&O Princess remaining independent. The conclusion reached by the Board, with SSSB, was that if Carnival’s takeover proposal of 7 February 2002 was structured as a DLC, eliminating the risk of flowback, then the Carnival transaction would prove superior.

The Carnival DLC transaction
Negotiations commenced in early October and focused on the detailed provisions in the DLC agreements that P&O Princess required to ensure that the structure contained adequate protections for P&O Princess shareholders. The additional protections were necessary given that existing Carnival shareholders would own approximately 74% of the combined group on completion. Carnival also indicated a willingness to consider a partial share offer, which would allow P&O Princess shareholders to elect to hold their shares in either the US or the UK leg of the DLC. In parallel, P&O Princess agreed with RCL to terminate their existing DLC agreements and joint venture.

On 25 October 2002, Carnival announced a pre-conditional DLC with P&O Princess, together with a partial share offer for up to 20%, of P&O Princess shares. Following representations from both sets of advisers, the Panel indicated that, on satisfaction of the pre-conditions and receipt of certain confirmations regarding the conduct of the existing offer, it would allow Carnival to withdraw its existing takeover offer, on the basis that the existing offer could never complete. Importantly for P&O Princess shareholders, each of the pre-conditions was entirely within the control of P&O Princess. In the event that the pre-conditions were not satisfied, Carnival would be obliged to reinstate the existing takeover offer.

On 8 January 2003, the Board of P&O Princess announced its recommendation of the DLC transaction and the Panel confirmed that Carnival would be allowed to withdraw its existing takeover offer. Shareholder meetings to approve the DLC will be held in April 2003 with completion shortly thereafter.

On the date of demerger, the P&O Princess share price was 292p. The value of a P&O Princess share implied by the Carnival transaction on 8 January 2003 was 481p. Over the same period, the FTSE 100 share index fell by 38%.

The P&O Princess advisory team for both the Carnival and RCL transactions comprised Schroder Salomon Smith Barney (exclusive financial adviser), CSFB (Corporate Broker), Sullivan & Cromwell and Freshfields Bruckhaus Deringer (legal counsel), KPMG (accountants) and Brunswick Group (public relations). The P&O Princess Carnival DLC has been selected as one of the Investment Dealers Digest, Euromoney and Financial News 2002 “Deals of the Year”.