Hostile M&A has been part of the transaction space for decades and was especially popular in the late 1900s.
In fact, perhaps you have heard the sometimes soap-opera- like stories behind the AOL-Time Warner hostile takeover, or the InBev and Anheuser-Busch hostile takeover, or more recently the Sanofi-Aventis takeover of Genzyme Corp.
While these takeovers gather a lot of media attention, hostile takeover is generally a space in the M&A world not well understood.
Usually, large companies flush with cash will attempt to take over a promising company to enhance their own position or to simply kill competition.
However, companies and practitioners must remember the intent, be it hostile or friendly, must ultimately create shareholder value.
Together with DealRoom in this article we will explore several attack and defense strategies deployed during hostile M&A.
There are multiple mechanisms, such as proxy fights and tender offers, that the Acquirer will leverage during a hostile takeover.
Conversely, there are multiple mechanisms, such as poison pills and the crown jewel, the Target will use as defenses in attempt to thwart hostile takeovers.
Understanding both sides of Hostile M&A can be useful for companies and practitioners.
The operating reality
Even a potential threat of a hostile takeover causes the Target’s board to deploy “killer bees” and develop anti-takeover defenses.
However, clarity on who to protect, when and how is a key consideration. Courts typically want to balance shareholder and management interest, but this is not possible all the time and often things skew to protecting management at the expense of shareholders.
Shareholders have also pressurized boards of companies like Hewlett-Packard and Bristol-
Myers Squibb to weaken their anti-takeover defenses to ensure the balance does not tilt only towards the company management.
All publicly traded companies generally deploy at least one anti-takeover mechanism by adopting shareholder rights plans.
Attack vectors in hostile M&A
There are a few well known attack techniques when it comes to hostile takeovers.
Let us examine a few takeover techniques that tend to follow the “bear hug:”
- Dawn raids. A Dawn Raid is the sudden entry into the stock market by the predator Acquirer at a price above the prior market level with the objective to acquire a major stake in a very short time. Often a Dawn Raid leads to further takeover offers or actions within a few days.
- Toehold acquisition. A Toehold Acquisition allows the Acquirer opportunities, such as the opportunity to sue the Target if the takeover attempt derails, through the purchase of the Target’s shares on the open market.
- Tender offer. A premium price offer to the Target’s shareholders is referred to as a tender offer. Tender offers entail a two-trajectory attempt: one front-loaded offer and a second intended offer for acquisition. Furthermore, they are publicly announced. While a tender offer is generally considered a hostile takeover technique, it is not hostile if oriented to create shareholder value, which would often lead to deal approval.
- Creeping tender offer. There is a variant of the tender offer referred to as the “creeping tender offer” during which the Acquirer starts buying stock of the Target at market value until the threshold of control is reached. It is a more gradual process than a tender offer or dawn raid. Additionally, it is cheaper to implement (i.e. no premium purchase price), but has a higher risk of failure if the controlling threshold is not reached.
- Proxy Fight. This technique solicits shareholder’s proxies to vote for insurgent directors on the board or even vote out the current board with the intention of eventually appointing new management and board members who favor the deal. A Proxy Fight is typically accomplished by approaching shareholders owning large blocks of shares individually. Proxy fights can also increase the number of board members who can then sway the voting decisions.
Figure: The Proxy Fight, HR vs Compaq
Designing an effective attack strategy
An effective attack strategy for a hostile takeover entails organizing yourself, understanding the Target, evaluating legal pitfalls, preparing the arsenal, disarming defenses, and finally launching the attack using one of the methods mentioned above.
- Organizing yourself. One must first ask the most important question – have all approaches outside of a costly and time-consuming hostile takeover been explored and exhausted? Compromises, trade-offs, risks, and opportunities all need to be well understood, and clear plans must be drafted to address the inability to conduct proper diligence and/or gain Target cooperation.
- Understanding opponents. An intricate understanding of the Target needs to be mapped (e.g., shareholders, management, board members, defense mechanisms, public sentiment, and killer bee capabilities). This will help determine the time, cost, and resources of a potential attack and identify the attack vector to be deployed.
- Evaluating legal pitfalls. All other things being in place, a deep understanding of restrictions around legal, regulatory, investment, export, and country specific matters must be mapped; tactical mitigation plans must also be created to address items such as change of controls and accelerated options.
- Preparing the arsenal. The bid arsenal is informed by all the prior stages. It is comprised of designing an effective PR/media campaign, mobilizing professionals required (i.e. lawyers and consultants), and stress testing the timing of the bid. A common practice is to either fully or partially lock-in support agreements as early as possible.
- Disarming defenses. How do you disarm the Target’s potential defenses? Best practices include: taking steps to maximize shareholder value, tightening arrangements to avoid violating fiduciary duties of the Target board, wargame tripping of each defense mechanism and creating counter strategies. In addition, it is wise to create anti-dilution provisions and test them.
Finally, pick the right attack strategy for your deal and run a wargaming exercise to test all assumptions at play.
Hostile takeover vulnerability
While a comprehensive vulnerability assessment can be a daunting task, corporate vulnerabilities toward a hostile takeover are also constantly shifting, requiring constant analysis.
They largely fall into three areas:
- Strategic Attractiveness. A company’s strategic attractiveness is dependent upon several factors, ranging from changing industry dynamics (consolidation), economic cycles, timing, attractiveness of disruptive technology or IP owned, other potential bidders, strategic fit with the Acquirer and/or weak management teams. Of course, there are other factors, such as limited need for due diligence, which can become vulnerabilities. As you can see, the strategic aspects need to be constantly monitored and understood in the context of the possible hostile approaches.
- Valuation Weakness. The lower valuation compared to peers or own history coupled with credit impact, capital structure, weaker management teams and macro-economic conditions can leave the Target vulnerable to hostile takeovers. Other factors such as currency fluctuations and increased supplier risk also cause valuation related vulnerabilities.
- Weak Defense Architecture. The obvious aspects of weak defense hinge on the following: existing shareholder mix, defense mechanisms (e.g., change control clauses and shark repellents to name a few), and inadequate response capability to hostile takeovers; these factors can leave companies vulnerable to hostile takeovers.
In addition to the above areas, companies should pay attention to the specific hostile takeover patterns in the market. Many times, these are early warning signs of emerging hostile takeovers.
A non-exhaustive list is as follows:
- Massive increase in number of small stock transactions
- Company executives or board become victims of negative publicity
- Sudden increase of minority shareholders seeking documents
- Other companies have faced hostile bids or dawn raids
- Increase in unsolicited offers to sell shares
- Random rise in inspections seeking customer, creditor, and shareholder information
- Specific activity in activist investor circles, well known Raiders etc.
Hostile takeover defense
In general, there are fewer companies that embark on hostile takeover attempts than companies who have been on the receiving end; therefore, there are historically more avenues to deploy towards defending against these attempts.
Defense mechanisms are designed and deployed by organizations by using specialty killer bees and testing periodically.
There are multiple kinds of defensive strategies and tactics deployed in tandem or independently; they can be categorized into preventive defense, active defenses, evasive maneuvers, suicidal defenses, and offensive defenses.
While each one has varying degrees of risk, impact, and survival odds, organizations often enlist a combination of these.
1. Preventive defense
Preventive defenses are designed to reduce the likelihood of a financially successful hostile takeover, making it more difficult.
They are a combination of early warning signs, tight controls or agreements, and event-based triggers called poison pills. Let us examine a few of them in a bit more detail to understand them better.
1.1 Corporate charter amendments
- Use staggered board agreements, outlining provisions whereby only one third of the board of directors may be elected each year. This requires shareholder approval to implement and classified directors cannot be removed before their term expires.
- Design supermajority provisions requiring at least 80% of voting shareholders to approve the takeover, as opposed to a simple 51% majority. This is effective as it can make hostile takeover an uphill battle for predators.
- Use a fair price provision as a weaker defense through a modification of a corporation’s charter, requiring the Acquirer to pay minority shareholders at least a fair market price for the company’s stock, typically as P/E ratio.
1.2 Tight controls
- Use clauses called “shark repellents” to trigger change control on stock exchanges as a deterrent.
- Manage and monitor shareholder mix and trading patterns or anomalies as an early warning sign.
- Deploy tighter controls on register and debt.
- Design golden parachutes i.e., change of stock ownership triggers benefits for executives.
- Deploy dual cap structure, i.e. different voting rights for different types of stock
1.3 Poison pills
These are designed by corporations to “poison” the deal and discourage hostile Acquirers by making stock less attractive to Acquirers.
Poison pills were first invented in 1982 to defend El Paso Electric from General American Oil; in fact, the first pill was used by Brown Forman against Lenox in 1983. Subsequently, many variants of poison pills have evolved and been deployed.
The below table outlines key characteristics, execution conditions and impact of these pills.
2. Active Defense
The active defenses are triggered only after the bid has been made. With this timing in mind, they are more reactive, expensive, and risky.
Active defenses also come with higher opportunity costs, making them a significant distraction for executives and boards.
Initiate court proceedings against the hostile Acquirer to stall the bid, increase bid costs, and buy more time to activate other defenses.
To deploy this active defense,Targets must find skeletons in the Acquirer’s closet related to legal, regulatory or securities laws.
Activate media to trigger public sentiment around opposition rationale; this helps create negativity around the Acquirer’s takeover tactics. We suggest highlighting your country/region specificity and any grey areas as you bring in the media.
Self-Tender is, as the name describes, the Target purchasing paid up shares from other shareholders by sums exceeding share capital to increase the relative voting power of friendly shareholders.
2.4 Scorched Earth
Scorched earth is a self-tender offer by the Target, burdening itself with debt.
Greenmail refers to the payment of a substantial premium for large shareholder stock in return for not initiating a bid for company control. The tax aspects present obstacles for this, as the statute also warrants shareholder approval to repurchase beyond a certain number of shares.
2.6 Standstill Agreement
Standstill agreement is an undertaking by the Acquirer not to acquire any more shares of the Target within a certain time. It should be noted the Standstill Agreement is usually deployed with Greenmail.
3. Evasive Maneuvers
The evasion and negotiation techniques are usually applied along with active defenses; some literature even considers them a subset of active defenses. However, they are applied differently and need bidders, allies, and favorable scenarios to play out. Let us explore the theory of Knights below.
3.1 White Squire
A White Squire is a company consenting to purchase a large block of the Target company’s stock. White Squires are typically not interested in acquiring management control of the Target, but are interested in the Target either as an investment or to gain board seats at the Target company.
3.2 White Knight
A company which is a more favorable Acquirer compared to the Hostile company (Dark Knight).
3.3 Yellow Knight
A company once attempting a takeover, but comes back discussing a merger with the Target company.
3.4 Grey Knight
New entrant hostile takeover candidate in addition to the Target firm and first bidder, perceived as more favorable than the Black Knight (remember Black Night = unfriendly bidder), but less favorable than the White Knight (friendly bidder).
3.5 Lady Macbeth
A corporate-takeover strategy by which a third party poses as a white knight to gain trust, but then turns around and joins with unfriendly bidders.
These sort of poison pill defenses are used as deterrents, but are rarely deployed. You can think of suicidal defenses as part of the arsenal, but seldom executed given their destruction of value.
- People Mail. A blackmail strategy where executives of the Target threaten to resign together if the Raider takes over the company.
- Crown Jewel Defense. A strategy where the Target company sells off its most attractive assets to a friendly third party or spins off the valuable assets in a separate entity, thus reducing interest of the hostile entity.
- Jonestown Defense. In this extreme version of the “poison pill,” also called the “suicide pill,” the Target undertakes activities that might threaten its own existence to fend off the hostile takeover.
These are counterattack moves from the Target aimed at the hostile Acquirer to surprise the Acquirer and thwart its intention.
- Pac Man Defense. As the name implies, this defense is based on the game “Pac Man” and the theme of “eat or be eaten.” It occurs when the Target makes an offer to buy the hostile company in response to the hostile bid for the Target.
- Fat Man Defense. Here the Target company acquires a third company to make the hostile Acquirer’s bid more expensive.
- Capital Structure Clog. With this strategy, the target corporation initiates various changes to its capital structure to ward off a hostile bidder, e.g. recapitalization, assuming more debt (bonds or bank loans), issuing more shares (ESOP, general shares, white squires) and/or initiating buybacks (self-purchase or open market).
While most, if not all, defenses can counter deals driven by power and greed, they do not necessarily create shareholder value.
If outright hostile takeover has grey areas and questionable ethics, so do many of the defenses involved. I have outlined a select few, which are met with stronger resistance than the others.
- Capital Structure Clog. High leverage can stress the cash flows of the company, depriving it of financial resources needed to counter unexpected situations, invest in growth, or return shareholder value.
- Supermajority Provisions. Although they can help in fending off hostile bids, supermajority provisions can also apply to friendly acquisitions, making them difficult to discern; therefore, special clauses need to be built to ease this form of defense.
- Golden Parachutes. These are usually met with strong shareholder resistance as they are uncovered through compensation disclosures. Pac Man Defense. A key downfall of this strategy is that it creates no premium to original Target’s shareholders. Moreover, it is very expensive and can even damage the company.
- Crown Jewel Defense. Finally, here you might cause courts to disfavor an asset or crown jewel, locking it up, which will impact the bidding process.
There are many examples of hostile takeovers; in some cases, the bids were successful, while others were fended off due to good defense strategy and execution.
Listed below are some prominent hostile transactions in the history of M&A.
- Xerox and HP Inc. In November 2019, Xerox (a much smaller company) commenced its hostile takeover bid on HP Inc (considered competition). Xerox made its hostile takeover intention public to confirm its seriousness; HP Inc rejected this offer in March 2020, stating uncertainties and unacceptable conditions. Xerox also stepped back due to the COVID-19 situation; this situation will likely play out sometime in future.
- AOL and Time Warner. Generally considered the poster child of failed M&A from every standpoint. The hostile takeover was consummated in 2000 (valued at $164 billion), but the subsequent dot com and telecom bubble bursting led the company to lose $200 billion in value within 24 months.
- Air Products & Chemicals Inc. and Airgas Inc. The hostile takeover attempt commenced in 2009 and dragged on for two years with Air Products & Chemicals finally ending their attempt in 2011. The court upheld Airgas’s use of a poison pill, but the onus shifted to Airgas to prove it was indeed worth the valuation it claimed. Its performance waned during the great recession and came under considerable media fire. Airgas ultimately exited for 2X the value offered by the hostile bid. Wall Street now holds Airgas as one of the best arguments for management’s right to defend its company.
- Sanofi Aventis and Genzyme. In 2010, Sanofi’s bid for Genzyme turned hostile after the latter’s board refused the initial terms. Sanofi tendered > $237 m worth of Genzyme shares, resulting in equity ownership of 90%. The deal was eventually consummated in 2011.
- KKR and RJR Nabisco. This transaction occurred in 1988 and, at the time, was the largest hostile takeover bid at $25 billion. The fight was bitter and made media headlines regularly; this was also a leveraged buyout adding to the deal’s complexity. With the takeover, the company was saddled with a huge debt load on their balance sheet.
- Other notable hostile takeovers in the history of the M&A landscape would be Kraft Foods/Cadbury, InBev/Anheuser-Busch, Icahn Enterprises/Clorox, RBS/ABN Amro amongst others.
There is a new trend with activist investors taking on companies which have been relatively under delivering vis-à-vis their peers, and there are multiple recent examples: Symantec, Citrix, Cognizant, Autodesk, and the likes.
These have a slightly different acquisition approach, which will be further investigated in a separate article.
While many acquisitions of Big Tech from Silicon Valley cannot be categorized as hostile because they are executed in a friendly manner, the primary goal is to remove any possible competition thus leaving limited room for targets.
Enterprise defense architecture
A good defense is built on high valuation, engaged shareholders, and an active board with competent management.
However, there are times even in these cases when systems get out of sync, creating vulnerabilities and distractions.
Hostile takeover attacks or defenses are expensive, time consuming, resource intensive and distracting. The art and science of effective defense is to create more impact or deterrence with limited effort.
A modular defense architecture always helps scale your defenses, one layer at a time. A company should always evaluate the risks, opportunities, and tradeoffs before treading from one layer to the other since both the stakes and risks increase as you go up the stack.
Companies also fall prey to the classic dilemma that hostile takeovers are not frequent events and hence not worth investing time or money into robust defense mechanisms to combat them.
However, hostile takeover defenses cannot be built or strengthened overnight; rather, this is an ongoing process given the dynamic business environment.
Based on experience, observation, and analysis, I have developed a framework architecture for defending against hostile takeovers.
While this architecture will not perfectly fit every scenario, it generally works well and is flexible enough to respond to differences within a process given the proper rigor and structure.
I have had the good fortune to implement and test this framework through wargaming at a few corporations in the United States and Canada; however, I believe it can also be adapted to other parts of the world.
Each layer can be considered a standalone lever to employ, or can be used interdependently with other incremental steps towards creating more rigorous defensive positions against hostile takeover intent.
As one moves from the independence layer towards the offensive layer, the process gets more complicated, expensive and resource consuming.
Hostile takeovers: ethical considerations
The hostile M&A actions and consequences have multiple grey areas and require tighter scrutiny with respect to ethics.
A few (non-exhaustive list) ethical considerations are:
- All forms of suicidal defense result in destruction of shareholder value and are considered unethical
- Fiduciary duties of the Target board must always be respected
- All decisions must be taken in good judgment and only to protect or enhance shareholder value
- One must abide by all laws and regulations, be they corporate, environmental, labor, or international
- The board of directors may not receive any form of payment or unjustified benefits of tangible or intangible monetary value
- The board should not obtain golden shares
Hostile takeovers are here to stay, and businesses need to understand the drivers behind them and invest in proactive management of shareholder value, assessing their vulnerabilities and investing in their defense mechanisms.
Decimating smaller companies for power, greed and growth will always remain questionable, and many corporations will likely succumb to these.
Not all hostile takeovers are bad, some of them do return higher shareholder value, and it is important to separate the value creating ones from the ones trying to destroy value.
Appendix A: rapid response process
Hostile Takeovers responses need to be rapid, methodical, and timed- they must be undertaken with all stakeholders involved and the first phase of these responses occur within 24 hours.
It is also important that the first few steps of response are not necessarily aimed at defense but acknowledgement.
The first line of approach is the investor relations who will then rally the executives, board, and other supporting professionals.
The above example is merely aimed at education on how a rapid response process works within hours of receiving a bear hug.
A more elaborate response ensues, typically along the layers of the defense architecture outlined before running for weeks, months or even more.
Appendix B: integration of hostile takeovers
However hostile the intent and the transaction process, post-deal is a whole different ball game. The shareholders from both sides want the company to work and generate value.
The new board and shareholders want to create a good foundation for the future. Given the above there are select differences on where integration efforts focus to generate value.
A non-exhaustive list is outlined below:
- Lack of sufficient pre-deal due diligence presents unknown risks, a rigorous confirmatory due diligence process is a very important step
- The focus is on generating shareholder value rather than just synergies. While focus on traditional cost and revenue synergies is a given, integration teams must focus on Beta synergies i.e., those value drivers directly impacting the stock price
- Executive and employee engagement become much more critical than friendly acquisitions; all aspects from training, communication, incentives, retention must have adequate rigor, KPIs and be very outcome focused
- Communication workstreams need to focus 360 degrees i.e., employees, customers, shareholders, partners, regulators etc.
- All KPIs and metrics are execution oriented rather than financial e.g., synergies should be tracked on run rate costs rather than EBIT given the former is much more execution oriented
- When it comes to the integration, prioritize first, stabilize next, revitalize thereafter and continuously evangelize
- M&A integration efforts are geared towards rigor and execution rather than just speed. For example, one does not measure time to full integration, but KPIs are oriented towards time to shareholder value
More on this topic to come in a separate article, highlighting the difference in approach by deal type and deal phase when it comes to hostile takeovers.