This article is written by Arka Biswas pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions). This article discusses how to defend hostile takeovers in an analytical manner.
This article has been published by Sneha Mahawar.
Takeover is an acquisition of shares including voting rights of a company and gaining control over the management of that company. The takeover may take place through either friendly negotiation or a hostile manner.
Every public listed company has a risk of getting targeted by an acquirer for a hostile takeover. Those companies prepare & exercise various strategies and make wise decisions to save themselves by discouraging the acquirer, preventing any hostile takeover or bargaining the highest possible price. Such strategies can be either ‘Proactive’ or ‘Reactive’.
Thus, when a company gets hostile takeover bids, i.e. against the will of that company, it does not stand helpless. The target company can adopt some wise moves and take defensive measures to prevent or discourage the acquirer from taking over the target company. Such defence strategies may also be used by the target company in negotiating higher offers.
Some of those defensive measures must be approved by the shareholders, while others are not. Some of those may have strict regulations in a specific jurisdiction. Most countries enacted strict laws to regulate such defences. The acquirer may challenge such defences in a court of law. So, while taking such defensive steps, it is necessary for the target company to keep in mind all the legal aspects, frameworks and regulations.
Factors that determine a takeover bid
The acquirer analyses several important factors before initiating a takeover. Those factors can determine the vulnerability of a company to be taken over. The major factors which can make a company vulnerable to a takeover bid are –
- Affordable stock price with respect to replacement cost of assets or the earning potential;
- Liquid balance sheet;
- Excessive cash flow;
- Valuable portfolio of securities;
- Assets that can be sold off without affecting the cash flow;
- Unused debt capacity.
A combination of such characteristics makes the target company very attractive for investment and also desirable for takeover by an acquirer.
Different proactive and reactive defence strategies against hostile takeovers
The Staggered Board
The acquirer tries to gain representation and voting power in the board of the target company in order to influence the shareholders to accept the bid. The target company can construct a staggered board which will make the process of gaining influence very time-consuming and costly for the acquirer. It is created by dividing the members into small groups. All members of the board are not re-elected annually. Rather, only a single group of members are re-elected every year. So, the acquirer will not be able to replace the entire board in a single year. Thus, it prevents the acquirer from gaining control over the board and resists hostile takeover.
It should be noted that the formation of a staggered board needs to be approved by the shareholders in a Shareholders’ Meeting.
The target company offers and issues securities, preferred shares, and stock warrants to its shareholders at a lower price than the current market price. Usually, poison pills are adopted without the approval of the shareholders. And also, it is quickly alterable after the occurrence of the triggering event. But in some countries, it must be adopted through shareholders’ voting. Thus the acquirer’s share is diluted and prevents a takeover or enhances the opportunity to bargain a fair price.
A fill-in pill is where preferred shares are offered to the existing shareholders at a discounted price. And a fill-over pill is where rights are issued rather than preferred shares to existing shareholders. These rights are triggered only when a hundred percent of the company’s shares have been bought.
In this mechanism, few anti-takeover amendments are made in the corporate chart or Articles of Association. Before making such amendments, it is necessary to be voted and approved by the shareholders.
There are several types of anti-takeover amendments, such as –
- Supermajority Amendment:- For the approval of any takeover, making any large decisions in the meeting require greater than fifty percent votes. But, the target company can implement a supermajority amendment which sets the percentage of votes needed for decision-making much higher. This amendment can be placed in the corporate chart only by the shareholders, not the board of directors. Thus, it makes it hard for the bidder to make a takeover proposal in the shareholders’ meeting and gain approval.
- Fair Price Amendment:- This is a supermajority amendment with a board-out provision and an additional clause for waiving the supermajority requirement if a fair price is paid for acquiring the shares. Thus, it doesn’t completely prevent a takeover but helps to make a very good bargain on the transaction.
- Authorisation of Preferred Stocks:- This amendment authorised the board to issue preferred stock with voting rights to a friendly firm. Thus, the hostile bidder will not be able to take over the majority of shares in the target company.
- Attack the Logic of the Bid:- The Board of the target company tries to influence its shareholders that the takeover will be harmful to the company and the stock price. It is a very effective and cost-effective strategy. This discourages the shareholders from approving such a takeover and convinces them to react against the hostile bidder.
- Golden Parachutes:- It announces some lucrative packages to the employees and managers who would lose their jobs in a change of control scenario; and distributes a lump sum amount to the board of directors of the target company. It is initiated when the acquirer has acquired a specific amount of shares. Golden Parachute strategy creates incentives for the shareholders and executives. So, it protects the interests of those who are risking their jobs in a hostile takeover.
- Crown Jewel:- When a hostile bid is initiated based on the target company’s valuable assets or the ongoing business, then the target company can use this Crown Jewel strategy. The target company sells the whole or some of the assets to make itself less attractive in the eyes of the acquirer. Thus, the acquirer is deprived of the primary intention behind the takeover.
But, this strategy is quite risky and may be self-destructive, which sometimes causes even worse situations than a takeover. Selling the most valuable assets may stop the entire business operation of the company. So, the target company needs to be very careful whether it can buy back those assets or run the business without having the assets.
In addition, it will send negative signals to the market. The market will have knowledge of the situation of that target company and may push the selling price of those assets to the lowest, even below the current market value. So, the benefit achieved as a result of the defensive strategy by the target company will be minimal. On the contrary, the stock price of the target company will skyrocket after the news of the possible takeover.
Also, if such an asset sale has generated excessive liquid cash, then it will be more attractive for a takeover by the acquirer.
- Greenmail:- It is used when the acquirer has already taken over a significant chunk of shares or when the bidder has only short-term goals. Greenmail is a comparatively simple process and also known as Goodbye Kiss. The target company repurchases or buys the shares back once the short-term goal of the acquirer has been achieved. It is a very costly process as the target company has to offer a premium at a high price to buy the shares back. When the target company buys back the shares, then a standstill agreement is made, which restricts the acquirer from buying more shares for a long period of time.
- White Knight and White Squire:- These strategies involve a third party. When the target company approaches a friendly firm that can acquire a majority of stakes, that firm is called White Knight. Under the friendly white knight, the target company operates independently and the target company slips away from the hostile bidder. It is generally done because of friendly intention; the belief of better competence, better synergies; belief of not dismissing the existing employees and managers. After the hostile bid expires, the target company can buy its shares back from the white knight. But, mostly it gets acquired by the white knight.
In the white squire process, the third party acquires a small portion of shares instead of large chunks; but enough to keep the hostile bidder from taking majority stakes. It can be done through raising an investment, usually from hedge funds or banks.
- Pac-man:- If the acquirer is comparatively small and the target company has enough cash flow or liquid-able assets, then the target company reversely purchases the shares of the acquirer company.
- Self-tender:- After getting the news of a possible takeover, the target company can start buying back its shares from the existing shareholders to that extent, so it will be impossible for the hostile bidder to acquire a majority of shares. It is a very helpful and effective strategy.
- Litigation:- After receiving the hostile bid, the target company can challenge the bid and sue the acquirer. Litigation often includes seeking injunctions, filing antitrust suits or restructuring orders. During the litigation process, the target company can adopt other defence measures and initiate a fantastic bargain in exchange for dropping the litigation. The litigation also pressurises the bidder to disclose its intention and post-acquisition plans which immensely helps the target company to make decisions. The litigation also can be used to drive shareholders’ opinions and make them react against the bidder in any meeting.
Statutory aspects in India
A takeover is a well-established and essential strategy for corporate growth. After Bhagwati Committee’s recommendations, the SEBI takeover regulations came into force. While applying the takeover defences, it is necessary for the target company to follow the takeover regulations and statutory aspects regarding the obligations of the target company.
Crown Jewel’s strategy is not so easy to implement. The board of directors cannot sell the whole or part of the company’s undertakings without voting and getting approval in a general meeting. However, selling a single immovable asset that does not form any undertakings are excluded from this provision.
SEBI (Substantial acquisitions and takeover) regulations restrict the target company from selling, transferring or disposing of its assets after the acquirer has made a public announcement. So, the Crown Jewel defence is to be exercised only before the acquirer makes a public announcement about his intention to initiate a takeover.
While exercising the Self-tender or buyback strategy, the company has to disclose the reason for initiating a buyback. Also, the company cannot issue shares for the next one year after the buyback or cannot issue shares to fund the buyback. If the buyback is initiated during a public offering, it has to comply with the prescribed competitive offer. Also, once the offer to buyback is made, it cannot be withdrawn. Even if the possible acquirer withdraws his bid, the target company cannot withdraw its offer of buyback. So, this strategy may be quite risky and costly.
As per these provisions, the compensation for loss of office in the Golden Parachute contract is allowed only for managing and whole-time directors. Hence, a Golden Parachute contract with the whole senior management is not applicable in India.
The payment of compensation is prohibited for the director who is resigning as a consequence of corporate restructuring or takeover.
In the Shark Repellant strategy, the company derives the right to alter its articles of association. Such an amendment shall not have retrospective effect. The amendment must not violate any provisions of the Companies Act, 2013 and the amendment has to be in accordance with the Memorandum of Association. Alteration of articles related to the management of the company is allowed, but not the basic nature or the constitution of the company. And the alteration should not cause fraud on minorities.
Gillette and Revlon Corporation
The President of Revlon Corporation attempted to take over the famous blade producer – Gillette for 4.12 billion USD. The bidder had 9.2 billion shares of Gillette and wanted to acquire the rest of the company by offering a super attractive premium to the shareholders of Gillette. They offered 65 USD for each share against the current market price of 58.25 USD.
Gillette exercised the Greenmail strategy and defended the hostile takeover by entering into a standstill agreement. The target company decided to buy back its own shares from the acquirer at the price of 558 billion USD; which provided the bidder a net profit of 43 million USD. In return, the hostile bidder agreed not to buy out the shares of Gillette without obtaining the consent of the board of directors of the target company.
Gillette also paid 1.75 billion USD to the bank representing the Revlon Corporation in consideration of not undertaking any possible potential takeovers of Gillette in the future. Because Gillette was quite aware of its weaknesses which could easily attract another bidder. Gillette took several steps to prevent future takeovers as well. They formed a staggered board.
Mittal and Arcelor
Mittal Steel announced a hostile bid to the target company, Arcelor, at a price of 18.6 Euros. Mittal Steel offered 28.21 Euros per share which was very lucrative as it provided a 27% premium per share. The merger would result in a new company that will operate in both the steel and automotive industries.
Arcelor used the strategy of attacking the logic of the bid to defend the hostile takeover. The board of Arcelor declared that the merger proposal didn’t make any Industrial sense as the two companies didn’t share the same strategy, vision, mission and business model. Arcelor argued that Mittal Steel had no strong corporate governance and management.
Arcelor developed a communication plan, “Tiger Project”, in order to prove the incompetence of the bidder and convince the shareholders that Arcelor was better off being independent without getting merged with Mittal Steel.
Arcelor approached Severstal Company with a €13.8 billion merger proposal. Severstal bought each share of Arcelor at the price of 44 Euros which was far more attractive than the offer of Mittal Steel as it gave a 100% premium per share on the closing share price of Arcelor.
Lundin Mining Corporation and Equinox Minerals Ltd
Lundin Mining Corporation received a hostile takeover bid from Equinox at a price of 4.8 Canadian Dollars. It offered 26% premium to the closing price of 6.45 Canadian Dollars per share.
Lundin took the defence of attacking the logic of the bid and convinced its shareholders to reject the offer of Equinox. The board of Lundin argued that Equinox undervalued the assets, paying inadequate premium for shares. They also declared that they didn’t see any strategic gains for the shareholders of Lundin. Lundin also adopted Poison Pill to defend the hostile takeover.
It is not possible to be totally certain about the possibility of future takeovers. So, it has become very crucial for any company to develop these kinds of defence strategies and make decisions wisely with extreme caution to have a smooth transaction.
If the majority of shareholders have cleared their position by voting that they are against any takeover, it will be the most favourable scenario because, in that case, there will be no limit on the combination of strategies to be exercised in order to make the acquirer cancel the bid.
The most advisable & easiest combination will be prepared with a well-established proactive defence strategy and some reactive alternative actions in hand.
- Thakur, Jayant M; Takeover of Companies: Law, Practice and Procedure (1995), p-357
- Ryngaert, Effects of Poison Pill Securities on Shareholder Wealth, Journal of Financial Economics, (Vol 20, 1988, page – 246)
- A.S Dalal, Analysis of Takeover Defences and Hostile Takeover, NALSAR Law Review (Vol. 6, page – 87)
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