By Tim Hepher
PARIS (Reuters) - France's Safran (PA:SAF) has crafted a deal to persuade family investors in Zodiac Aerospace to give up control in a merger that would create the world's third largest aerospace supplier.
But in a rare two-stage deal Safran must first convince ordinary investors, who hold 68 percent of the company, to sell their shares in the company for cash.
If more than half of those investors accept, the deal will proceed to the second phase. This would offer the handful of families with historic ties a chance to keep shareholdings and industrial links while maintaining longstanding tax breaks - key to getting the families on board.
The families lead a group that hold 32 percent of Zodiac voting rights and spurned Safran's first approach six years ago.
The dual deal structure reflects how Safran is caught between the need to make the deal attractive to markets and keep long-term investors on board. Safran, which is 14 percent owned by the French state, wants to create a new aerospace champion and the tax umbrella reflects the policy of successive governments to smooth the path for such deals.
Without that structure, the Safran deal with Zodiac would collapse, legal experts and people involved in the deal said.
"It has to be done this way or there is no deal," a person directly involved in the negotiations told Reuters.
A Zodiac spokesman and Safran spokeswoman both declined to comment on the discussions.
But the unusual split structure has puzzled some ordinary Zodiac investors, who could collectively block the deal, according to people briefed on the discussions.
Under the deal, Safran is first offering cash worth $9 billion or $29.47 a share for Zodiac, aimed at most investors.
It does not allow shareholders outside the core group to exchange their own Zodiac shares for stock in the new Safran.
"Some shareholders are saying 'Why should we have to take cash? If the story is so good, why shouldn't we be able to take up shares? Why exclude us from the club?'," said a European analyst, asking not to be named because of company policy.
The analyst said he had been told this by his clients who are investors in Zodiac.
WEALTH TAX
Safran's backers say that is offset by a hefty 26 percent premium compared to Zodiac shares prices before the offer.
Changing part two of the deal to a classic share offer would expose descendants of Zodiac's founders to French wealth taxes and other penalties that one analyst estimated could reach hundreds of millions of euros.
"The problem ... is the wealth tax. If you don't find a way to make the deal interesting for the families, it can't happen...That is why a merger was chosen rather than a simple share swap," said a person close to the group of families.
While France's tax system pounces on gains from selling shares for either cash or stock, shareholders tied together by a special pact don't face the same exposure when companies merge.
That is not the reason bringing the two firms together, but is one factor Safran hopes will prevent the deal falling apart.
After five weeks of intensive and secretive talks, held in rented rooms and protected by code names, the two companies last week unveiled a deal designed to satisfy two very different shareholder bases.
Their offer aimed to reconcile two red lines: Zodiac's families wanted to be able to maintain their fiscally neutral shareholder pact and preserve their role as stable partners.
And Safran wanted to avoid just taking majority control of Zodiac with a large minority block in place that might make it harder to get synergies needed to justify its tie-up with a company only just emerging from industrial problems. Full mergers typically lead to bigger cost cuts such as closing one company's headquarters.
LOOKING FOR A SWEETENER
Tax is not the only issue, people involved in the talks said. Zodiac's core shareholders were also unwilling to fritter away double voting rights accumulated over many years, and negotiated the right to keep them in the enlarged group, those people said.
Finally, Zodiac Chairman Didier Domange stressed the families wanted to stay involved industrially with Safran.
The families also made concessions. They will be locked in for two years, limiting options at a volatile time, and the deal is structured to give them a slight discount.
On Tuesday the merger ratio, 0.485 Safran shares for each Zodiac one, implied a 2.6 percent discount to the cash offer after stripping out a special Safran dividend adjusted for tax.
Even so, success is only assured if Safran wins three quarters of Zodiac's freely traded stock in the cash bid. Sensing Safran's potential difficulty, some investors see a chance to put pressure on it to raise its bid.
"We consider this group of shareholders could push for a sweetener in order to take the cash offer," Barclays (LON:BARC) said.
Safran betrays no sign of being prepared to raise the offer and analysts say it could walk away with less egg on its face than Zodiac's ordinary shareholders if the deal fails.
"Zodiac is nice to have, but not a must-have for Safran," a person familiar with the company's strategy said.
While embracing Zodiac as an industrial partner, Safran appears to be gambling that the risk of Zodiac shares dropping sharply if the deal fails, with no new partner for the industrially stretched company in sight, will bring in votes.
Under the merger, the French state plans to join a pact with the current core shareholders in Zodiac, which employs 7,000 workers in France. Some analysts view the state with suspicion.
Two days before the deal became public, its four main architects - the CEOs and chairman of both firms - visited the Elysee palace to talk to President Francois Hollande.
But while Hollande later welcomed the creation of a French aerospace giant, securing jobs ahead of elections in April, insiders said the government only joined talks in the final stages and did not try to steer the deal one way or the other.
"There was never any state interference," one said.