Legal aspects of the French privatization program: review of the Pechiney privatization as a practical case.

Borde, Dominique ; Dang-Tran, Marie-Chrystel

Description of the Privatization Program

Under a law dated 19 July 1993, providing for the second privatization program, the French government generated a list of 22 public sector companies to be privatized, including Banque Nationale de Paris (BNP), Bull, Companie Nationale Air France, Credit Lyonnais, Rhone Poulenc, Elf-Aquitaine, Assurances Generales de France (AGF), SEITA, Thomson SA, Renault, Union des Assurances de Paris (UAP) and Pechiney. Most of these companies became part of the public sector as a result of the nationalization measures implemented after the Second World War. In addition, in 1982 the Socialist government decided to increase the number of state-owned firms and nationalized five of the most important industrial groups (Compagnie Generale d'Electricite, Saint-Gobain, Rhone-Poulenc, Pechiney and Thomson SA) as well as the 39 largest French banks. These nationalizations cost the state over 60 billion French francs (FF) (approximately US$9 billion).(*) Between 1993 and the first half of 1995, BNP, Elf-Aquitaine, Bull, Rhone-Poulenc, SEITA, UAP and Usinor-Sacilor were all privatized.

In connection with the economic policy of reducing public expenditures, the French government decided to accelerate the privatization program in July 1995, since it expected revenues from the program in an amount equal to approximately FF40 billion for that year. In this respect, a decision was made pursuant to a decree dated 17 July 1995, to proceed with the transfer to the private sector of the French state's shareholdings in Pechiney, Compagnie Generale Maritime and Renault.

Background on Pechiney

Anticipating its privatization, the Pechiney group decided at the beginning of 1995 to restructure its activities. The group's core businesses were the production and sale of primary aluminum and aluminum products (25 percent of its turnover for 1994) and the production of packaging materials. The total amount of Pechiney's turnover equaled FF70 billion for 1994. At that time, Pechiney was also the third-largest worldwide aluminum producer and the second largest in Europe.

As part of its strategy of focusing on core aluminum and packaging activities, the Pechiney group launched a major divestiture program aimed at disposing of certain non-strategic businesses and improving the financial structure of the group through debt reduction. Through this divestiture program in 1995, the group sold assets valued at approximately FF10 billion. Assets sold included shareholdings in the components and system division (Carbone Lorraine), the group's North American glass activities (Foster Forbes), the group's North American food metal and specialty activities and the group's turbine components division (Howmet).

Given the extent of its divestiture program, the consequent debt reduction and the increase in operating results for the first half of 1995 (as a result of the high market price for aluminum at that time), Pechiney appeared by October 1995 to be in a good position to be effectively privatized.

When the privatization process was launched in November 1995, the French state held 55.8 percent of the share capital and 80.4 percent of the voting rights of Pechiney. AGF, a public sector company at the time of the Pechiney privatization, which itself was recently privatized in May 1996, and BNP, a company privatized in 1993, owned respectively 8.8 percent and 7.6 percent of the share capital and voting rights. In addition, 3.2 percent of the share capital and voting rights of Pechiney were owned by financial institutions including the Caisse des Depots et Consignations. The remaining percentage of the share capital (24.6 percent) was held by the public in the form of non-voting securities with dividend priority rights called certificate d'investissement privilegies (CIPs); the corresponding voting rights evidenced by certificates had been granted to the French state at the time of the issuance of the CIPs. The purpose of the issuance of such nonvoting securities, listed on the Paris Bourse, was to finance the development of Pechiney's activities on the capital markets. The issuance of common shares granting voting rights was prohibited at this time since it would have been considered the equivalent of a partial privatization of Pechiney. Furthermore, in order to finance other investments, Pechiney created Pechiney International in 1989. Its common shares were listed on the Paris Bourse, with Pechiney holding 67 percent of the capital.

This article highlights the principal rules of the French privatization process with particular emphasis on issues related to the Pechiney case.

The Privatization Procedures Chosen by the French Government

Absence of a Group of Stable Shareholders

Most previous privatization processes in France have been conducted pursuant to capital market procedures and off-market private sales. Such off-market private sales were implemented in order to create a group of stable shareholders selected by the French government after consultation with the Commission on Privatization. Off-market private sales are generally made by invitations to tender. The potential purchasers have a minimum period of 15 days after the announcement of such a procedure has been published in the Official Journal, to submit their offers and provide for a payment guarantee. The purchasers are chosen on the basis of their offers and guarantees and they must agree to abide by certain limitations (e.g., not to dispose of the shares for a certain period of time) set forth in a shareholders' agreement (Cahier des Charges) whose terms and conditions have been defined by the minister of economy. The main purpose of the creation of a group of stable shareholders is to provide the privatized company with "friends" who might help to defend it in the event of a hostile take-over.

In the Pechiney case, the French government decided for marketing reasons not to create such a group of stable shareholders.(1) The chairman of Pechiney also considered that in any case, the duration of the 18-month, non-transferability provision that is generally imposed on the group of stable shareholders was too short to actually prevent the company from a hostile take-over. However, without creating a formal group of stable shareholders, the French government encouraged two public sector companies, the Electricity Company of France (EDF) and the Caisse des Depots et Consignations, to acquire, respectively, five percent and three percent of the share capital of Pechiney. In addition, BNP and AGF, two "core" shareholders of Pechiney had decided to maintain their respective interests in the company.(2) Moreover, the Credit Suisse Holding had made known to the French Government its intention to acquire two percent of Pechiney's share capital. These shareholders were not bound by a shareholders' agreement.

As a consequence, the Pechiney privatization was implemented through a public offering in France, an international global placement, and a placement reserved for Pechiney's employees. The choice of a capital market procedure instead of a total private off-market sale resulted primarily from one of the principal goals of the privatization program: to encourage large numbers of small investors to invest in the French capital markets.

A Public Offering in France

The Pechiney common shares offered in connection with the French public offering were provided from those held by the French state. As was the case in previous privatizations, several categories of orders were created. French citizens or residents and European Union (E.U.) nationals were granted equal access to the public offering in France. A category of orders were, in particular, reserved for individuals rather than legal entities. These individuals were granted priority rights for subscriptions (50 shares per subscription) and preferential conditions. These conditions included an allotment of bonus shares up to a countervalue of FF30,000 subject to a ratio of 1 share for 10 shares acquired. The bonus shares had to be held at least 18 months after they were paid in full.

The Privatization Law states that the offering price may not be less than the price resulting from the minimum valuation of the company set forth by the Commission on Privatization.(3) This Commission is composed of seven members designated by decree who serve five-year terms. They are chosen according to their economic, financial and legal training and experience. The Commission's main role is to evaluate the companies which are to be privatized according to objective methods commonly used in cases of total or partial disposition of assets, taking into account the following elements, adjusting the proportions as appropriate for each case: the quoted price of the securities issued by the company, the value of the assets, the accrued profits, the existence of subsidiaries and the future prospects.(4)

Prior to the definitive determination of the price, a premarketing procedure is generally implemented to enable the issuer or the seller to collect revocable share purchase orders and allow for market testing before initiating the public offering. This pre-marketing procedure determines demand for volume only, not price. It differs in this regard from the bookbuilding process, which consists of collecting purchase orders according to a price range, thereby allowing for a better determination of what the offer price should be. The pre-marketing period may only begin at the time of the distribution of the preliminary prospectus which has already been registered with the Commission des Operations de Bourse (the French Stock Exchange Commission). This prospectus, describes the characteristics of the proposed transaction including, in particular, the various allotments that are contemplated as well as the priority rights granted in connection with the public offering. Only the offering price and the anticipated time for completing the transaction are not disclosed. Given the unfavorable conditions of the capital markets at the time of the launching of the public offering, the French government finally decided to fix the offering price at an amount equal to the minimum value determined by the Commission on Privatization.

An International Global Placement

The privatization of Pechiney was also conducted through an international global placement divided into three allotments: one reserved to French legal entities (including French mutual funds), another for U.S. investors and a third for all other foreign investors. The common shares offering resulted from shares currently held by the French state and from Pechiney's capital increase due to its need for additional equity capital. In most of the previous privatizations, the company to be privatized carried out a capital increase subscribed to by the current shareholders of the company prior to the privatization transaction. However, in the Pechiney case, the capital increase was implemented through the allocation of share warrants giving rights to subscribe to Pechiney common shares (bons de souscription d'actions) to the current shareholders of Pechiney (prior to the privatization).

In previous privatizations, the share warrants granted to the French state had been sold to the stable shareholders pursuant to off-market private sales since only these shareholders were entitled to exercise the warrants. In the absence of any group of stable shareholders in the Pechiney privatization, and in order to simplify the placement process (the subscription of the newly issued shares by the current shareholders and their subsequent sale to the public), the underwriters were authorized by such shareholders, in connection with the global placement, to exercise the share warrants and to sell the newly issued shares directly to investors. The shareholders received a portion of the offering price corresponding to the value of the share warrant and Pechiney received the remaining portion.

As generally applied in most of the previous privatizations, the terms and conditions of the global placement provided for a "claw-back" provision which allows for the reallocation of shares as part of the international placement to the French public offering. In the Pechiney case, this provision specifically stated that, if the demand for common shares in the French public offering exceeded the number of shares offered, the ones offered in the global placement, up to an amount equal to 13 percent of the total number of shares offered, would be reallocated to the French public offering, if so requested by the French government. However, the French government granted the underwriters an option to purchase additional shares (the "green shoe" provision) to cover over-allotments up to an amount of 12 percent of the number of shares offered in the international global placement.

In consultation with Pechiney, the French government and the lead underwriting managers determined the global price offering subject to the condition that it not be less than the price offered in France. The price for the global offer was determined pursuant to the bookbuilding procedure in accordance with several factors, including a purchaser's ability to ensure the development of a secondary market, the amount of shares requested and the price at which an investor was ready to buy. In the end, it was decided that the Pechiney international offer would be equal to the French placement offer in order to attract institutional investors, who were more skeptical about the privatization than individuals. As a further enticement to foreign institutional investors, it was decided that shares of Pechiney would be listed on the New York Stock Exchange, the first time a newly privatized French company was listed in New York. (Elf Aquitane's shares and Rhone-Poulenc's shares were already listed on the New York Stock Exchange prior to their privatizations in France).

An Offer Reserved to Employees of the Pechiney Group

As required by Article 11 of the Privatization Law, 10 percent of the shares offered must be reserved for current or former employees of the privatized company and its subsidiaries and offered under preferential conditions, such as discounts of 20 percent or deferred payments. In the Pechiney case, such preferential conditions were offered to the then-current employees of Pechiney, those of its French and foreign subsidiaries and to former employees who had been employed at least five years by any company of the Pechiney Group. In addition, Pechiney proposed various options granting these employees preferential conditions, such as the payment by Pechiney of a specific premium for those employees buying shares. The shares offered could be directly purchased by the employees or through a specific in-house mutual fund.

In the case of deferred payments made in several installments, specific rules have been provided for by the Privatization Law in case of failure to make a payment when due. In this regard, the French state shall automatically recover ownership of the shares for which payment in full has not yet been received. These shares are then sold on the capital markets. After payment to the French state of the sums remaining due, increased by interest due for late payment and by the cost of transfer, the balance of the transfer price is reimbursed to the defaulting investor.(5)

As in most of the previous privatizations, the employees and trade unions voiced concerns that the privatization process would harm the existing rights of employees (salary, profit sharing and employment policy). They also protested against the divestiture program, arguing that such assets could ensure some linear results compared to the cyclical results common in the aluminum production business. Specifically, employees in France were afraid that the future business activities of the company would be primarily located outside of France and Europe.

Whereas French corporate law provides for an optional representation of the employees on the board of directors of commercial companies,(6) the Privatization Law requires that the board of directors of certain categories of privatized companies be comprised of at least two employee representatives and at least one representative of employee-shareholders.(7) The candidates who represent the employee-shareholders are designated by the supervisory boards of the in-house mutual funds and/or directly by the employee-shareholders at a special meeting. The final selection of the representatives is done at the general meeting of shareholders. The candidates to represent the employees are designated by one or several trade unions or by 20 percent of the electoral body (i.e., employees of the company and its subsidiaries in France who have been employed at least three months prior to the election). The representative is then appointed according to the ordinary election process specified by French corporate law.

Public Exchange Offer for Certificates of Investment Privileges (CIPs)

Originally, Pechiney issued CIPs to obtain financing without giving voting rights, as in most public sector companies. In order to simplify the shareholding structure of Pechiney, these CIPs had to be eliminated through a public exchange offer launched by the French state. As required by the Privatization Law, the chosen exchange ratio had to take into account the value of the voting rights as well as the elimination of the dividend priority rights attached to such CIPs.

In the Pechiney case, the value of the dividend priority right was determined to be greater than the value of the voting right: the exchange ratio of the public offer was 10 CIPs for 11 common shares. As a consequence, a specific mechanism was implemented which allowed the French state to hold a sufficient number of common shares to be exchanged in connection with the offer. Once the CIPs were tendered to the French state along with the voting right certificates already held by the French state, preferred shares were created. Pursuant to an agreement between Pechiney and the French state, the latter waived the dividend priority rights attached to each preferred share, which the French state held after the completion of the exchange offer, and such preferred shares were reclassified as common shares on the basis of one common share per preferred share. In consideration for such a waiver, the French state was entitled to receive a dividend credit from Pechiney. The credit was then applied to the subscription price to be paid for common shares issued as result of a capital increase reserved for the French state in connection with such an agreement.

In cases of a capital increase through the issuance of common shares, holders of CIPs have a preferential right to subscribe to CIPs under French corporate law. Therefore, in connection with the allocation of share warrants to the previous shareholders of Pechiney, warrants giving the right to subscribe to new CIPs also had been granted to the CIP holders prior to the privatization. The CIP holders had to exercise such warrants before the closing date of the public exchange offer in order to tender the newly issued CIPs.

The offer was successful, as 91.3 percent of the existing CIPs were tendered to the French state.

Specific Issues Resulting from the Previous Listing of the Major Subsidiary of Pechiney on the Paris Bourse

With the privatization transactions (public offering, global placement and offer reserved to employees), Pechiney had requested that its common shares be listed on the Paris Bourse, and in the form of American Deposit Shares on the New York Stock Exchange. As a result, the initial reasons for the listing of Pechiney International, as mentioned above, were no longer justified. Moreover, the coexistence on the capital markets of two listed securities of the Pechiney Group with different shareholders could have a negative impact on the market. Therefore, the most efficient solution was to merge Pechiney and Pechiney International prior to the privatization. However, for political reasons, the French government preferred to proceed with a public exchange offer initiated by Pechiney on Pechiney International common shares. Pechiney had informed the public that depending on the results of the exchange offer, it would decide to carry out further financial transactions for the purpose of obtaining the delisting of the Pechiney International common shares (such as a buy-out offer followed by a squeeze-out procedure). As part of this offer the board of directors of Pechiney International, which was required by French Stock Exchange Regulations to issue a recommendation to the shareholders, had requested an independent appraiser to deliver a fairness opinion on the exchange ratio determined by Pechiney.(8) At the closing of the offer, 97 percent of the Pechiney International shares were tendered to Pechiney.

Absence of a Golden Share

According to the Privatization Law, the French government may decide that an ordinary share belonging to the French state be transformed into a "golden share" with some specific rights, such as the right to appoint one or two representatives (with no voting rights) of the state to the board of directors or the board of surveillance, and the power to veto any decision by the privatized company to dispose of assets or to use assets as collateral which could impair national interest. In the Pechiney Privatization, no golden share had been requested by the French government. In the Thomson privatization, given the national security concerns associated with part of its business (i.e., the defense industry), the French government required that a golden share be granted to the French state which gives rights to veto any decision to dispose of certain assets of Thomson-CSF in order to protect national security interests.(9)

Conclusion

Although the French state had anticipated generating significant revenues from the Pechiney privatization (i.e., FF8 billion), as a result of the poor market conditions existing in December 1995, institutional investors were hesitant to purchase Pechiney's shares. Therefore, the actual revenues obtained amounted to only FF4.7 billion and consequently, the French state was left holding approximately 11 percent of Pechiney's share capital. For similar reasons, the capital increase resulted in generating only FF1.8 billion (compared to the FF2.4 billion which had been projected at the beginning of the process).

Finally, although on the next trading day following its listing on the Paris Bourse, the price of Pechiney's shares fell from FF187 to FF175, the listed price of Pechiney shares two months after the privatization increased 19 percent over its offering price. As of mid-November 1996, the current average listed price was FF230. As much as 53 percent of French employees and 30 percent of foreign employees purchased Pechiney shares pursuant to this offer.

(*) The U.S. dollar figure is based on the 1982 average dollar-French franc exchange rate at 6.57 francs to the dollar, quoted in International Financial Statistics (Washington, DC: International Monetary Fund, 1988).

(1) It should be noted that the major shareholder of Pechiney after the French state (with 11.5 percent reserved for bonus shares) is a U.S. asset management company, Templeton Global Investors which holds about 9 percent.

(2) At the time of the Pechiney privatization, AGF was still a public sector company

(3) Law No. 86-912 of 6 August 1986 as amended by Law No. 93-923 of 19 July 1993, and Law No. 96-314 of 16 April 1996, hereafter referred to as the "Privatization Law.

(4) Article 3 of the Privatization Law.

(5) Article 4-1 II of the Privatization Law.

(6) Article 93 of the Law No. 66-537 of 24 July 1966 on Commercial Companies.

(7) Companies mentioned in Article 2 of Privatization Law No. 93-923 of 19 July 1993, including companies directly or indirectly majority-held by the French state or mentioned in the list attached as an appendix to the law.

(8) Nine Pechiney International Common Shares for five Pechiney Common Shares.

(9) Decree No. 96-689 dated on 2 August 1996.