A corporate takeover is a complex business transaction pertaining to one company purchasing another company. Corporate takeovers typically take place for many logical reasons, including anticipated synergies between the acquiring company and target company, potential for significant revenue enhancements, likely reduced operating costs and beneficial tax considerations. In the U.S., most corporate takeovers are friendly in nature, meaning that the majority of key stakeholders support the acquisition. However, for many reasons, potential corporate takeovers can become hostile. With this in mind, some basic defense strategies can be used by the management of potential target companies to deter unwanted acquisition advances.
Overview of the Williams Act of 1968
Hostile corporate takeover attempts typically take place when a potential acquirer makes a tender offer, or direct offer, to the stockholders of the target company. This process happens over the opposition of the target company’s management, and it usually leads to significant tension between the target company’s management and that of the acquirer. In response to such practice, Congress passed the Williams Act to offer full and fair disclosure to shareholders of the potential target companies, and to establish a mechanism that gives additional time for the acquiring company to explain the acquisition’s purpose.
The Williams Act requires the acquiring company to disclose to the Securities and Exchange Commission the source of funds that will be used to accomplish the acquisition, the purpose for which the offer is being made, the plans the acquirer would have if it is successful in the acquisition, and any contracts or understandings concerning the target corporation. While the Williams Act was designed to make the corporate takeover process more orderly, the increased use of derivative securities have made the Act a less useful defense mechanism. As a result, both preemptive and responsive corporate defense strategies need to be considered by the management of companies likely to be targeted for acquisition.
Preemptive Corporate Takeover Defense Strategies
These types of strategies can be put in place by a company’s management to ward off potential takeovers before the target company is identified as a potential candidate for acquisition. A company can put in place many types of preemptive defense strategies to mitigate an attempted corporate takeover.
A first preemptive line of defense against a hostile corporate takeover would be to establish stock securities that have differential voting rights (DVRs). Stocks with this type of provision provide fewer voting rights to shareholders. For example, holders of these types of securities may need to own 100 shares to be able to cast one vote. U.S. companies that issue stock with DVRs include Viacom (Nasdaq:VIA) and News Corp (Nasdaq:NWS). It is anticipated that such securities will gain more popularity in the future, as DVRs not only help provide protection against hostile takeovers, but they typically trade at a discount relative to company stock and they pay a higher dividend. As a result, DVR shares are attractive securities to a variety of investors.
A second preemptive line of defense against a hostile corporate takeover would be to establish an employee stock ownership plan. An ESOP is a tax-qualified retirement plan that offers tax savings to both the corporation and its shareholders. By establishing an ESOP, employees of the corporation hold ownership in the company. This, in turn, means that a greater percentage of the company will likely be owned by people that will vote in conjunction with the views of the target company’s management rather than with the interests of a potential acquirer. There were 11,400 ESOPs in the U.S. in early 2009 and more than 13 million employees participating in such plans. The supermarket, construction and engineering industries are represented by many companies with an ESOP plan. A couple of America’s largest employee-owned companies include Publix Supermarkets, which employs 158,000 people, and Parsons, a construction and engineering firm, which is owned by its 11,500 employees.
Responsive Corporate Takeover Defense Strategies
These types of strategies can be implemented by a company after it has been identified as a potential acquisition target by a prospective acquirer. A company can put in place many types of responsive defense strategies to mitigate an attempted corporate takeover.
A first responsive line of defense against a hostile corporate takeover would be to establish a poison pill provision that could be used to ward off or deter prospective acquirers. One type of poison pill would allow existing shareholders, excluding the acquirer, the right to purchase the target’s stock at a price considerably below its market value. By allowing existing shareholders to purchase additional shares at a discounted price, the shares held by the acquirer would become diluted, making the takeover transaction more unattractive and expensive. In 2012, such a strategy was implemented when Carl Icahn announced that he had purchased nearly 10% of the shares of Netflix in an attempt to take over the company. The Netflix board responded by instituting a shareholder-rights plan to make any attempted takeover excessively costly. The terms of the plan stated that if anyone bought up 10% or more of the company, the board would allow its shareholders to buy newly issued shares in the company at a discount, diluting the stake of any would-be corporate raiders and making a takeover virtually impossible without approval from the takeover target.
A second responsive corporate takeover defense strategy is the alliance of a target company with an investor known as a white knight. When utilizing a white knight strategy, the target company seeks a preferred investor to acquire the company. Typically, the white knight agrees to pay a premium above the acquirer’s offer to buy the target company’s stock, or the white knight agrees to restructure the target company after the acquisition is completed in a manner supported by the target company’s management. Classic examples of white knight engagements in the corporate takeover process include PNC’s (NYSE:PNC) purchase of National City Corporation in 2008 to help the company survive during the subprime mortgage lending crisis, and Fiat’s (OTC:FNDSF) takeover of Chrysler in 2009 to save it from liquidation..
A third responsive corporate takeover defense strategy is a concept known as greenmail. This refers to a targeted repurchase, where a company buys a certain amount of its own stock from an individual investor, usually at a substantial premium. These premiums can be thought of as payments to a potential acquirer to eliminate an unfriendly takeover attempt. One of the first applied occurrences of this concept was in July 1979, when Carl Icahn bought 9.9% of Saxon Industries stock for $7.21 per share. Subsequently, Saxon was forced to repurchase its own shares at $10.50 per share to unwind the corporate takeover activity. While the anti-takeover process of greenmail is effective, some companies, like Lockheed Martin (NYSE:LMT), have implemented anti-greenmail provisions in their corporate charters. Over the years, greenmail has diminished in usage due to the capital gains tax that is now imposed on the gains derived from such hostile takeover tactics.
Corporations have many hostile takeover defense mechanisms at their disposal. Given the level of hostile corporate takeovers that have taken place in the U.S. during the first part of this century, it may be prudent for management to put in place preemptive corporate takeover mechanisms, even if their company is not currently being considered for acquisition. Such policies should be seriously pursued by companies that have a well-capitalized balance sheet, a conservative income statement that exhibits high profitability, an attractive cash flow statement and a large or growing market share for its products or services. In addition, if the company exhibits significant barriers to entry, a lack of competitive rivalry in the industry, a minimal threat of substitute products or services, minimal bargaining power of the buyers and minimal bargaining power of the suppliers, the case for implementing preemptive hostile strategies while developing a thorough understanding of responsive takeover defense mechanisms is highly advised.