This article is written by Naimishi Verma, pursuing a Diploma in M&A, Institutional Finance, and Investment Laws (PE and VC transactions) from LawSikho. The article has been edited by Tanmaya Sharma (Associate, LawSikho) and Ruchika Mohapatra (Associate, LawSikho).

Introduction 

Hostile takeovers have been a part of M&A transactions for a very long time. As per M&A terminology, a hostile takeover refers to the acquisition of a target company by an Acquirer without the acquirer seeking the permission of the target company and directly approaching the shareholders. A hostile takeover comes into existence when the initial offer has been rejected by the target company. In simple terms, when an acquirer receives disapproval from the target company regarding the acquisition, there arises a possibility that the proposed acquisition will become hostile. One of the reasons for such hostile takeover is that acquisitions and mergers allow companies to increase their overall performance by expanding and diversifying their businesses and reducing competition. 

However, the target companies also have the right to avoid any such hostile takeover by the acquirer. There are many hostile takeover strategies that target companies can make use of to prevent unwanted acquisitions. One of such strategies is the crown-jewel strategy which allows for target companies to sell off their assets in order to maintain a low profile and make it less desirable in the corporate world so that they are able to avoid any kind of acquisitions by larger companies.  

How does this process work?

Crown-jewel strategy can be described as an anti-takeover strategy that is used by the target company to prevent the hostile takeover of the company. Under this strategy, the target company tries to sell off its most valuable assets in order to become a less attractive acquisition target in the market and to avoid a hostile takeover. The valuable assets of the target company are sold to a third party and this third party is known as ‘white knight’. This strategy compels the hostile bidder to withdraw from the bid. Crown jewel strategy is a self-destructive strategy and after the hostile bidder withdraws from the bid, the target company again purchases the assets from the third party at a predetermined price.

In order to understand how this defence strategy works, it is important to understand the meaning of crown jewel. Crown jewels are the most valuable and important assets of the company in terms of profitability, future business prospects and asset value. The intention behind this kind of strategy is to prevent  the hostile company from taking over the target company. The target company not only sells the crown jewels but also ends up selling the properties that diminish its worth in the market. This approach has often been labelled as the radical ‘scorched earth approach.’

Taking two companies, Company X and Company Y, the process involves-

• Company X makes a bid to acquire Company Y.
• However, Company Y rejects the bid. 
• In order to acquire Company Y, Company X offers a 25% premium to buy the shares of the company.
• In this situation, Company Y will resort to a crown jewel defence strategy and reach out to a friendly third party, say Company Z, and enter into an agreement with it to sell the crown jewels of the company and the properties in order to diminish its worth in the market.
• The agreement signed between Company Y and Company Z states that Company Y will buy back its assets at a predetermined price once Company X withdraws the bid.
• Since Company Y sold off its most valuable assets, the market standing of the company diminished and Company X withdrew its bid as it became less attractive for acquisition.
• Now that Company X has retracted from the bid, Company Y will buy back its assets at a predetermined price.

Advantages and disadvantages of crown jewel strategy

Advantages of crown jewel strategy

• Crown jewel defence is the strategy under which a popular group can buy a major portion of the target company at a price that is less than the market price.
• It gives an added advantage to the target company as it reduces its attractiveness in the market and avoids unwanted customers. 
• A good strategy for those who want to avoid a hostile takeover.

Disadvantages of the crown jewel strategy

• It is considered to be a dangerous strategy as it ruins the worth of the company in the market. 
• The presence of a third party or the white knight is significant as in the absence of it, the company would lose all of its valuable assets.
• As assets include tangible as well as intangible assets, assets like intellectual property, trade secrets, patents, etc. might lead to a revelation of the secrets of the company during the transfer of assets to the third party.

Applicability in the real world

As mentioned, crown jewels are the most valuable units of a company.  These could be any line of business or department that is most profitable or holds great value as compared to the other departments. Crown jewels are the assets that a target company sells in order to protect itself from a hostile takeover. These assets include tangible as well as intangible assets like intellectual property, patents and trade secrets. Hence, a company can also sell its intangible assets to another company (third party) to make it less desirable in the eyes of other companies in the market. These crown jewels are heavily guarded by the company as they are worth a lot of money. Only certain people of the corporation are aware of the intellectual property and trade secrets so as to protect such information from the competitors.

For instance, in a consultancy firm, research and development is the most valuable department and is, therefore, termed as the company’s crown jewel. When a hostile bid is made, then, to protect itself from such an unwanted takeover, the company will sell its research and development department to another company or make it a separate entity. A company can make use of this strategy by generating anti-takeover clauses which will compel the company to sell off its crown jewels during a hostile bid. Some examples where companies have employed this strategy in the real world are-

• Suez-Veolia case: These are the two water and waste management leaders in France. In the year 2020, Veolia made an attempt to take over Suez by purchasing 29.9% of the stocks for $3.4bn and Suez tried the crown jewel strategy as a defence move.
• Sun Pharma-Taro case: Sun Pharma and Israeli company-Taro entered into an agreement in the year 2007 related to a merger. However, there were some violations on the part of Taro and therefore, the agreement was terminated unilaterally with Sun Pharma. The Supreme Court of Israel passed an injunction against Sun Pharma for non-closure of the deal. In order to keep away Sun Pharma, Taro employed strategies like crown jewel defence and sold off its Irish unit.

Conclusion

The sale of crown jewels is considered to be a risky process. As per experts, companies, in order to protect themselves from acquisition, tend to nearly kill their own company by selling off their assets at a predetermined price and then buying them at a premium. Not only this, but by selling off their intellectual property and trade secrets, the company is indirectly sharing its own confidential information with another company, which harms the reputation and standing of the company in the corporate world. This strategy should be used with utmost care and caution to ensure that it does not harm the company.

Therefore, a defence strategy like the crown jewel strategy has always acted as a shield and protected target companies from hostile takeovers by larger companies. Hostile takeovers are discouraged in the market through the presence of such strategies and provide protection to the weaker/smaller target firms to analyze their own business structure and maintain their identity in the market by avoiding such hostile takeovers by bigger companies. Where the right of taking a company in a hostile manner has been given to the larger companies, the remedy to avoid it has been given to the target companies.

References

• https://www.wallstreetmojo.com/crown-jewels-defense/
• https://corporatefinanceinstitute.com/resources/knowledge/deals/crown-jewel-defense-takeover/
• https://blog.ipleaders.in/types-takeover-strategies/#Crown_Jewel
• https://dealroom.net/blog/hostile-takeovers-the-dark-side-of-m-a
• https://bsic.it/hostile-takeover-defense-strategies-a-practical-guide/

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