Hostile Takeover

What is Hostile Takeover?

A hostile takeover is a kind of acquisition by the target company by another company referred to as an acquiring company, where even though the target company’s management is not in the favor of the acquisition but still the bidder uses other channels to acquire the company such as acquiring the company through tender offer by directly make offer to the public to  buy the shares of target company at the pre-specified price which is more than the prevailing market prices.

We note from above that the French Laundry service company Elis made a hostile takeover offer valuing the company at over Euro 2 billion.

Elis Hostile Takeover

Examples of Top hostile takeovers of all time

AOL and Time Warner2000$164bnWhen AOL announced it was taking over the much larger and successful Time Warner, it was touted as one of the biggest deals of the period.
Sanofi-Aventis and Genzyme Corp    2010$24.5bnSanofi put up a tough battle to acquire the biotechnology company Genzyme in 2010. It had to offer a significantly higher premium than they initially wanted and assumed control over around 90% of its target company.
Nasdaq OMX/IntercontinentalExchange and NYSE Euronext2011$approx 13.4bnIn 2011, NASDAQ and Intercontinental Exchange wanted to acquire NYSE with an unsolicited and bid. However, Nasdaq eventually had to withdraw its offer amid a directive from the Antitrust Division of the U.S. Department of Justice
Icahn Enterprises and Clorox2011Approx. $12.6 bnYears ago, Carl Icahn launched a hostile takeover bid against Clorox.  He offered to take over at $7.65 per share, which was about a 12% premium. Clorox rejected the offer and used a poison pill strategy to safeguard itself from various such offers in the future.

Strategies for a Hostile takeover

A company aiming at a hostile takeover can approach this in two major ways, namely-Tender offer and Proxy FightProxy FightThe proxy fight occurs when all of a company's shareholders vote to remove the company's current management. This usually occurs when shareholders are dissatisfied with management. There could be a variety of reasons for this, including capital structure, performance, and poor decisions.read more.

#1 – Tender Offer

A Tender OfferTender OfferA tender offer is a public proposal by an investor to all the current shareholders to purchase their shares. Such offers can be executed without the permission of the firm’s Board of Directors and the acquirer can coordinate with the shareholders for taking over the firm.read more when a company or group of investors offer to purchase the majority shares of the target company at a premium to the market price and this offer is made to the board of directors who may reject it. In these circumstances, the bidder can place the offer directly to the shareholders. The shareholders, in turn, may decide to accept the offer if they find merit in it. Only when the majority of the shareholders decide to accept the offer, the sale of shares takes place.

#2 – Proxy Battle

Proxy Battle, on the other hand, is a rather unfriendly fight of control over an organization.

Hostile Takeover

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Source: Hostile Takeover (wallstreetmojo.com)

The above decision tree diagram shows the entire process that goes behind the hostile takeover bid.  The targeted offer is termed as hostile when the bidder deliberately chooses not to inform the target company about the unsolicited offer. Naturally, in such a scenario, a proxy contest will also be considered unamicable by the existing management. Even a 5% purchase of shares of the target company or what is termed as a “Toehold position” may be either considered hostile or friendly depending on the situation.  Actually, it is the intention behind the Toehold purchase that determines how the hostile takeover is viewed. It could still be termed as friendly if the purchase is driven by a reduction of transaction costs or gaining a strategic position in the auction; however, if a toehold purchased with the intention of gaining authority over the management will definitely be considered as hostile. The path of hostile takeover seems to be full of twists and turns. A bid that started as a friendly one initially could also turn into a hostile one in due course.

Hostile Takeover Defense Strategies

Since this hostile takeover bid is unwelcome, the target company takes various hostile takeoverTakeoverA takeover is a transaction where the bidder company acquires the target company with or without the management's mutual agreement. Typically, a larger company expresses an interest to acquire a smaller company. Takeovers are frequent events in the current competitive business world disguised as friendly mergers.read more defense strategies (reactive as well as pre-emptive factors) such as-

Hostile Takeover Defense Strategy

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Source: Hostile Takeover (wallstreetmojo.com)

#1 – Macaroni Defense

Quite a lip-smacking name, isn’t it. On a more technical front, a macaroni defense entails a company issuing many bonds with the situation that they must be redeemed at a high price if the company is taken over. When the bonds of a company are redeemed at an excessively higher price, the deal seems economically unappealing. This defensive strategy works in a two-pronged way. After making the deal unattractive, it also limits the powers of the potential buyer. The expansion of macaroni when cooked has been used as an allegory to depict that redemption of bonds at higher prices increases the cost of the hostile takeover. It is actually a tough nut to crack for a potential buyer when the redemption price of bond increases.

Let us assume that company A is forcibly trying to acquire company B. The management of the target company does not want to go ahead with the deal because it might not seem quite appealing to them, or they do not have adequate confidence that A will be able to manage the company successfully. Additional fears of corporate restructuring and layoffs also loom large. In such a case, company B might decide to go for the macaroni strategy. They may issue bonds of $100 million, which will be redeemable at 200% of the face value. Hence, whoever has invested $2000 will have to be paid $4000, which will inflate the overall cost of acquisition and will eventually dissuade the acquirer from going ahead with the offer.

#2 – Poison Pill

A Poison PillPoison PillPoison pill is a psychologically based defensive strategy that protects minority shareholders from an unprecedented takeover or hostile management change by increasing the cost of acquisition to a very high level and creating disincentives if a takeover or management changes happen in order to alter the decision maker’s mind.read more is a popular defense mechanism for a “target company” wherein it uses shareholder’s right issue as a tactic to make the hostile acquisition deal expensive or less attractive for the raiders.  This strategy also acts as a tool to slow down the speed of potential hostile attempts in the future.  The Board of directors generally adopts poison pills without the approval of shareholders. It also comes with a provision that the rights associated can be altered or redeemed by the board when required. It indirectly compel direct negotiations between the acquirer and the Board, to build grounds for better bargaining power.

Carl Icahn, an institutional investor, caught Netflix off-guard in 2012 by acquiring a 10% stake in the company. The latter responded by issuing a shareholder’s right plan as a “Poison Pill,” a move that irked Carl Icahn to no end. A year later, he cut his holding to 4.5%, and Netflix terminated its right issue plan in December 2013

netflix-poison-pill

source: money.cnn.com

#3 – Scorched Earth Policy

Scorched Earth PolicyScorched Earth PolicyScorched Earth Defense Policy is the strategy used by the target company to prevent itself from any takeover by making itself less attractive in the eyes of the hostile bidder using tactics like borrowing high-level debts and selling the crown assets.read more is a term borrowed from the military parlance. Most of the time in the military, generals order the soldiers to destroy anything and everything that could be of potential use to the opponent army. According to this defensive tactic, companies sell off their most important assets or make the acquiring companies enter into long-term contractual obligations.

#4 – Golden parachute

Technically, Golden ParachuteGolden ParachuteGolden parachute refers to the clause in the employment contract whereby the top-level executives entitled to receive significant benefits if the company faces a merger or takeover. Such benefits comprise liberal severance pay, cash bonus, retirement packages, stock options, etc.read more is defined as a contract between the Company and its top-level management, which entails that the executives will be offered considerable benefits in case the latter is terminated as a result of the restructuring activity. These benefits usually include cash bonuses, stock options, a retirement package, medical benefits, and of course, a handsome severance payA Handsome Severance PaySeverance pay is paid to employees removed or terminated from the employment of the company. It is generally paid to employees who are being let go due to job elimination or downsizing rather than the reasons for voluntary termination of employment.read more. It is also used as a tool for an Anti-takeover mechanism or Poison pill to dissuade any potential mergerMergerA merger is a voluntary fusion of two existing entities equal in size, operations, and customers deciding to amalgamate to form a new entity, expand its reach into new territories, lower operational costs, increase revenues, and earn greater control over market share.read more. The quantum of benefits or compensation promised to the crème-de- la-crème of the company might lead many acquirers to change their hostile takeover decision.

Ever since Verizon agreed to buy Yahoo, the industry has been abuzz with the exorbitant Golden Parachute that Marissa Mayer (CEO Yahoo) would be flying within case the former decides to terminate her.

Golden Parachute Compensation

source: Yahoo Schedule 14A

#5 – Crown jewel

It is quite a similar strategy to the Scorched Earth Policy. In this case, the sale of assets by the target company during a hostile bid is focussed mostly on its most valuable ones (Crown Jewel). It is done assuming that selling such assets will make the company less appealing to the potential acquirers. It might eventually compel the purchasing company to withdraw the bid.

However, there is another way in which this strategy can be implemented. The target company chooses to sell its most prized assets to a friendly company, also known as White KnightWhite KnightA white knight is a friendly investor who acquires the company with the help of the company's board of directors or top-level management at a fair price so that the company can be protected from a hostile takeover attempt by another potential buyer or from bankruptcy.read more. Later on, when the acquiring company drops its decision for a hostile takeover, the target company again buys back its assets from the White Knight at a predetermined price.

#6 – Lobster trap

Another popular defense mechanism is the Lobster TrapDefense Mechanism Is The Lobster TrapLobster Trap Defense is a strategy used by the target company to protect itself from a hostile takeover, in which shareholders who own more than 10% of the company's converting stock are unable to convert their securities into voting stock.read more. In this, the target company issues a mandate in which individuals with more than 10% convertible securitiesConvertible SecuritiesConvertible securities are securities or investments (preferred stocks or convertible bonds) that can be easily converted into a different form, such as shares of an entity's common stock, and are typically issued by entities to raise money. In most cases, the entity has complete control over when the conversion occurs.read more (includes convertible bonds, convertible preferred stock, and warrants) are deterred from transferring these securities to voting stock. Here individuals with more than 10% ownership are symbolic of big fish or lobsters.

Effect of the hostile takeover on shareholders

Usually, shares of the target company have been seen to rise. When a group of investors or acquiring companies perceive that the management is not maximizing shareholder valueShareholder ValueShareholder's value is the value that company shareholders receive as dividends and stock price appreciation due to better decision-making by the management that ultimately results in a company's growth in sales and profit.read more, they directly approach shareholders to buy their stock at a premium to market value. At the same time, they engage in certain tactics to topple the management and create a notion amongst the public, media, and shareholders that new management is the need of the hour.

As we see, the stock price of Berendsen jumped after Euro 2 billion Hostile Takeover Bid by Elis.

Elis Hostile Takeover - Stock Price Increase

source: Yahoo Finance

As a result of this, there is an additional demand for shares in the market. What follows is a bitter fight for control of the company. Hostile takeovers are nothing but a battle against the existing management. Only when shareholders have the acumen to judge the vision of the management in juxtaposition to the luring profits offered by a hostile takeover can some value can be realized out of it.

The share price increases follow a rather convoluted path in the share repurchase process. Even if the Hostile takeovers are eventually made, these involve management to make certain offers that are friendly for the shareholders. Usually, these offers are made so that the shareholders reject the hostile takeover bid.

Most of the time, these offers include special dividends, share buybackShare BuybackShare buyback refers to the repurchase of the company’s own outstanding shares from the open market using the accumulated funds of the company to decrease the outstanding shares in the company’s balance sheet. This is done either to increase the value of the existing shares or to prevent various shareholders from controlling the company.read more, and spin-offs. All of these measures drive up the price of the stock in the near-term and longer-term. Let us try to understand each of these offers in detail. Special dividendsSpecial DividendsThe term "Special Dividend" refers to an amount distributed to shareholders in the name of a dividend that is in addition to the regular dividend. Companies do this in the event of an unexpected inflow of cash or assets.read more are one-time payouts to shareholders. These boost the sentiment of the stockholdersThese Boost The Sentiment Of The StockholdersA stockholder is a person, company, or institution who owns one or more shares of a company. They are the company's owners, but their liability is limited to the value of their shares.read more and make the stock appear more attractive, mainly in the scenarios when interest rates are at a low. Share buy-back creates an increased demand for the stocks and reduce its supply. Spinoffs are strategic decisions to divest non-core business units to show higher valuations and provide a more focused vision and business for shareholders.

Conclusion

While most companies put up a tough fight against hostile takeovers, it is not exactly clear why they do so. Many experts and analysts are of the opinion that since the acquirers pay the shareholders a premium over the share price, it is always beneficial for the target company. Another side of the story is that the bidders take up huge debts to arrange funds to pay the premium amount to the target company shareholders. It, in turn, drops the share value of the acquiring company.

However, some analysts opine that hostile takeovers have an adverse effect on the overall economy. When one company takes over another one by force, the management may have limited or no understanding of the business model of the target company, their work culture, or technology. Basically, it will be an acquisition without any synergies, and such M&A activity can never be successful in the long run.

In a hostile takeover, both the target company and the acquiring company incurs a heavy cost at all levels. The target company lives in constant fear of hostile takeover, which creates a sense of insecurity amongst them and hinders its progressive functioning. As a result, the target companies put in a lot of costs in undertaking defense strategies.

However, the outcome of hostile takeovers, like every other Merger and acquisition, cannot be generalized. Hence, it is difficult to conclude whether they are successful or not. The cost-benefit analysisCost-benefit AnalysisCost-benefit analysis is the technique used by the companies to arrive at a critical decision after working out the potential returns of a particular action and considering its overall costs. Some of these models include Net Present Value, Benefit-Cost Ratio etc.read more has to be done on a case by case basis. Some of the hostile takeovers have been doomed, while others have resulted in industry consolidation and fairly strong companies.

Hostile Takeover Video

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This article has been a guide to a hostile takeover, types of a hostile takeover, top takeover, and the effect of shareholders. You may also look at the following articles on Investment Banking to enhance your knowledge further.

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  1. Joshua says

    Very informative article. Thank you

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