Hostile Takeovers: The Battlefield of the Finance World
“What do you do for a living?” “Hostile takeovers.” One would expect the respondent to be a black ops unit leader or some other esoteric military operator. However, there was a time that some of the leading Wall Street investors would have given this answer. Some of the greatest corporate raiders (those who do hostile takeovers) include Carl Icahn, Asher Edelman, Victor Posner, and Bill Ackman, just to name a few. Hostile takeovers defy the stereotype of finance jobs. Most people picture a businessman in the finance world as someone who spends countless hours analyzing reports and in boring business meetings. But being involved in a hostile takeover is fast-paced, requires quick decision making, a ruthless strategy, and enormous risk.
What is a hostile takeover? When a company wants to acquire another company they have two options. The more common, peaceful one involves mergers and acquisition (M&A), where one company buys the other at an agreed-upon price. This calendar year has been full of M&A deals. In the United States, M&A deals in 2015 total so far a record $1.97 trillion, 43% higher than the previous record in 2007. In fact, according to Forbes, 54% of CEO’s in the U.S. plan to complete an acquisition deal in 2015. However, when a targeted company does not want to be bought (they may feel they are being undervalued or that their business would not mesh well with the acquirer), the acquiring company is forced to either give up, or engage in some form of hostile takeover. Meaning, the acquirer will attempt to forcefully wrench authority of the company from the hands of the board of directors. The acquiring company would do this if they felt that buying such a company could complement their products and significantly improve their balance sheet.
Hostile takeovers differ from activist investing in that they involve purchasing a company, rather than influencing its decisions and direction. When it comes to activism, contemporary corporate raiders often agitate for change and push shareholders to fight their board, even if it won’t result in a takeover. Activist investors can coerce the target company to negotiate with the acquiring company and result in a beneficial outcome for the acquiring company. Hostile takeovers on the other hand, are utilized as a more aggressive technique to achieve a controlling stake in the target company.
Hostile takeovers in a sense benefit the market, as the external pressure it produces incentivizes the board to keep the shareholders’ interests in mind at all times. Furthermore, a hostile takeover attempt puts the fate of the company in the hands of the shareholders. The number of hostile takeovers launched by U.S. companies in 2015 has doubled the total for the same period in 2014.
There are two methods of conducting a hostile takeover- tender offers and proxy contests. The more common method nowadays is tender offers. In a tender offer, the acquiring company will attempt to garner a controlling percentage of the target company by offering to buy stock from stockholders at a premium to the market price. Often, for the purposes of mitigating risks, the acquiring company will offer to buy stock at this higher-than-market-value price with the condition they are able to reach their goal. The amount required to take control of a company ranges from 90%, to just having the majority, 50.1%, depending on the State of incorporation and corporate structure. In Delaware, where most public companies are based (due to friendly regulations), the law changed in the past few years to only require a majority stock ownership in many circumstances to be able to squeeze out the rest of the stockholders and buy all of the company. In most cases, once the acquiring company has obtained the required percentage to take control, the board of the “victim” company will work together with them to reach their goals. This is a basic overview of a tender offer. However, as I will discuss below, since the heyday of hostile takeovers in the 1980s, companies have erected defenses to prevent takeovers without the approval of the Board of Directors.
The second method is a proxy contest. In a proxy fight, the acquiring company does not attempt to become the majority stockholder - rather they appeal to the current ones. In order to achieve their goal, they attempt to get control of a majority of the board of directors in the target company. The members of the board are elected by the shareholders so the shareholders can decide to replace them. The acquiring company attempts to convince the current stockholders that the acquirers’ vision for that company’s future will give stockholders the highest returns on their investment. If they are successful in persuading the shareholders, the shareholders can influence the board to follow the acquiring company’s plans. If they do not listen, they face the threat of being replaced by someone who will. Proxy contests are more expensive than tender offers, as they take more time, effort, and resources to persuade shareholders, as such they are the less-preferred method. The advantage of a proxy fight is that it can be more direct to win and gain control of the target company, as once you have the majority of the board on your side, it’s game over. However, in a tender offer, you may need more than majority stocks since you still have to contend with the dissident minority.
To clarify, here is an example illustrating hostile takeover methods. In a hypothetical situation, Company A (acquiring company) is a global, well-known, and internationally connected company specializing in selling ice cream. They are looking to acquire a company which produces the highest quality milk to enhance their ice cream. They discover Company T (target company), which produces exactly the kind of premium milk Company A is looking for, while being publicly traded, smaller, and more local. Company A projects that acquiring such a company and using its milk in their ice cream can greatly improve the demand for their products and triple their income in just two years. Company A offers Company T $100 million to buy them out and incorporate them into Company A, but the board of directors at Company T refuses. They are happy in their niche market and aren’t looking to expand. Plus, they feel that they are being significantly undervalued. Company A decides they will not take no for an answer and determines to forcefully take over Company T.
At first, Company A offers all stockholders 1.5 times the current trading price of Company T stock on the condition that they receive tenders from shareholders holding enough stock to guarantee control of Company T. This is a small price to pay considering the fact that they expect to triple their income within just a couple of years. Company T is based in Delaware, so all Company A needs is 50.1% to buy all of the company. This is a tender offer. But let’s assume that Company A could not get enough shareholders to sell them their stock, so they move on to a proxy fight. Company A demonstrates to the shareholders of Company T that allowing Company A to buy them would be beneficial for both companies. Therefore, Company T shareholders would receive a higher return on their investments. If they succeed in convincing the shareholders, these shareholders would now pressure the board of directors and demand that Company T accept a merger offer from Company A (perhaps at an even lower value than they were originally offered). If four of the nine board members still refuse (which is rare), the stockholders can vote two of the current board members off the board, and replace them with new members who are supportive of selling themselves to Company A. Company T has become a victim of a hostile takeover and would have been better off accepting the original offer proposed in the first place.
Hostile takeovers are a board member's worst nightmare as it will force the Board to go in a direction they vehemently protest. In most cases, companies subject to hostile takeovers have previously rejected an offer by the acquirer, so being forced into a situation they objected to is very unpleasant, to say the least. It is for this reason that most companies have put defense strategies into place, to protect themselves from these corporate raiders. Some of the most common protections are known as poison pills, staggered boards, golden parachutes among others - continuing the trend of having cool battle field names in the finance world and transforming the mundane into the fascinating.
The most prevalent defense installed in companies is the poison pill. What this means is that if any one shareholder obtains a certain percentage of stock (generally 10-20%), this triggers the right of the company to take action. A typical reaction is to issue a large amount of stock to every other stockholder other than this individual, thus diluting his ownership tremendously. The second defense mechanism mentioned, the staggered board, lengthens the takeover process to the point where most activists would not have the patience or resources to follow through with the takeover. The target company does this by making company policy that only a third of the board can be replaced in a given year. If shareholders are convinced to try to overthrow the majority of the board, with this barrier, it would probably take two years to obtain a majority, which is impractical from a corporate raider’s point of view. The third method is known as the golden parachute. In this system, top-level executives protect themselves from being thrown out by giving themselves contractual severance packages worth obscene amounts of money. In this way, acquiring companies will be deterred from taking over and firing those that oppose their goals, as this would turn out to be extraordinarily expensive. These are just a few of the defenses companies can erect to protect themselves. Others include the lobster trap, the search for a white knight, and a crown jewels defense.
Due to the prevalence of corporate defenses from hostile takeovers, a complete hostile takeover is both difficult and rare. Takeover attempts fail often, and the outcome can be costly, Take the recent failed attempt of Mylan to acquire Perrigo this past month as an example. Although traditional hostile takeovers are not the same as when Carl Icahn was heavily involved with them, they are still a significant power in the finance industry. Hearing the term “hostile takeover” can still instill fear in any company’s board, no matter how big they are.