Hostile Takeover

Definition Of Hostile Takeover

A hostile takeover is the acquisition of one organization by another. A hostile takeover occurs by approaching a company’s shareholders directly or fighting to substitute the management and get the acquisition approved. In a hostile takeover, the target company’s management does not wish the takeover to go through. The buyer takes control of the target company and forces them to agree to the sale. Therefore hostile takeover takes place only in publicly traded companies.

Further on, we will see the methods enabling hostile takeovers.

Methods of Hostile Takeover

The two primary methods in which a hostile takeover takes place are:

Tender Offer

The tender offer is a public bid made by the acquiring company for a large segment of the target company’s stocks at a fixed price. The price quoted is usually higher than the market value of the stock. They offer a premium price to convince the shareholders to sell their shares. The bid holds a specific time limit and may have conditions that the target company must follow if the offer gets approval. The acquiring company must file required documents with the regulatory body and should disclose its plans for the acquired company. Sun Pharma’s attempt to acquire Israel Company Taro is an example of a tender offer method.

Proxy Fight

In the proxy fight method, the buyer tries to influence the shareholders to vote out the current management in favor of the team that will support the takeover. Proxy is the term that defines the ability to let someone else vote on behalf of the shareholders. Thus the buyer uses the proxy method to vote for the new board. Usually, managers and displeased shareholders within the company attempt to change ownership by getting the confidence of the remaining shareholders. The defense strategies that may be applied to prevent the takeover may not be strong enough for the proxy fight method of a takeover. Hewlett-Packard’s hostile takeover of Compaq was conducted by the proxy fight method.

Hostile Takeover

Bear Hug

A bear hug is a type of takeover in which the buying company offers a price higher than the target company’s market price. This higher price is for the target company’s unwillingness to get acquired.

After understanding the methods of a hostile takeover, let’s look into the reasons for the same.

Reasons For Hostile Takeover

There can be numerous reasons why a company may desire to take over another company, such as to gain majority market share, cheap valuations with low promoter stake, etc. The company may want to take over and use the acquired firm as cash flow for the benefit of the primary company.

Reasons For Opposing Takeover

Not all target companies agree with such takeovers. This may lead to a hostile takeover instead of the approach of friendly acquisition. The other primary reasons for the reluctance of the target company are:

  • It may be that a company wants to stay independent and have complete control over its operations.
  • The members of the management are trying to protect their jobs. They realize that the acquiring company will replace them soon after completing the buyout.
  • The shareholders and board of directors might fear the reduction in the company’s value as an aftermath of the buyout. This will also put the company in the danger of running out of business.

These are a few of the reasons why a target company opposes the takeover.  These reasons induce the acquiring company to commence a hostile takeover.

Now let’s look at the defense mechanisms that the target company can use in case of hostile takeovers.

Defensive Measures

The target company can put defensive measures into action either before or after the hostile offer. The uses of defensive measures are:

  • Delaying the transaction.
  • Negotiating a better deal.
  • Keeping the target company independent.

Defensive measures can be of two types:

  • Pre-offer Takeover Defence Mechanism
  • Post-offer Takeover Defence Mechanism

Generally, the experts recommend setting up pre-offer defensive measures as they are less scrutinized in the court than the post-offer defense measures.

Pre-offer Takeover Defence Mechanism

These are the following types of pre-offer defensive measures:

Poison Pill

The target company gives its shareholders the right to buy the target company’s stocks at a large discount to the stock’s market price.

For more information about this, read our detailed article on Poison Pill.

Poison Put

The target company gives its bondholders the right to sell the bonds back to the company at a pre-determined redemption price, which is generally above or at the par value.

For more, read Poison Put.

Restrictive Takeover Laws

The companies can incorporate themselves in the states where the law helps them defend against hostile takeovers.

Staggered Board

Under this strategy, the target company’s board of directors is divided into three groups of equal sizes. Each group can be elected in a staggered way for the three-year term. This arrangement will deter an acquirer as he can win only one-third of the directors in a year.

For more, read Staggered Board.

Restricted Voting Rights

Under this measure, shareholders who have recently acquired a large percentage of stocks are restricted from voting.

Refer to Restricted Stock.

Supermajority Voting Provisions

Through this provision, a higher majority, say 85%, of the shareholders, need to approve the transaction instead of the standard 51%.

For more about it, read Supermajority.

Fair Price Amendments

Through such amendments, the target company does not allow mergers where an offer is below a threshold value.

Golden Parachutes

Compensation arrangements are made between the target and the senior management. The managers have the right to leave the company with huge exit payouts if there is any change in the corporate control.

To know more about it, read – Golden Parachute

Scorched Earth Policy

In this strategy, the target company spoils its own image to protect itself from a hostile takeover.

Read more at Scorched Earth Policy.

Post-Offer Takeover Defence Mechanism

These are the following types of post-offer defensive measures:

‘Just Say No’ Defence

The easiest way is to decline the offer. Suppose the acquiring company tries the bear hug or even a tender offer. In that case, the target company’s management should explain to the shareholders and the board of directors why the deal is not the best for the company.

Litigation

The management can allege the violation of securities law and file a court case against the acquirer.

Greenmail

The target company makes an agreement with the acquirer to buy back its own shares from the acquirer at a premium. This is mostly accompanied by another clause prohibiting the acquirer from making another attempt for a specific time period.

Read more about this – Greenmail.

Share Repurchase

The target company can acquire its stocks from any shareholders by using a share repurchase. This can lead to an increase in the cost for the acquirer.

Leveraged Recapitalization

The target company uses a huge amount of debt to finance the share repurchases. However, they do not repurchase all the shares.

‘Crown Jewel’ Defence

The target company’s management can identify the major motivation behind the deal, i.e., a specific subsidiary or an asset, and sell it off to another party.

‘Pac-man’ Defence

The target company can make a counter-offer to take over the acquiring company and defend itself. However, other defensive measures can’t be used later if the company decides to use this strategy.

White Knight Defence

The board of the target company looks for a third party that has a better fit with the company to buy the target company in place of the hostile acquirer. This third party is the ‘White Knight.’

White Squire Defence

The board of the target company asks a third party to buy a substantial but a minority stake in the target company. This stake would be enough to obstruct the takeover with no need to sell the company.

Example Of Hostile Takeover

After gaining an insight into the concept of hostile takeovers, let’s look at an example to have a clearer view of the same.

AOL and Time Warner, $164billion

One of the classic examples of a hostile takeover is the takeover of Time Warner by AOL in the year 2000. AOL announced its plan to take over the much larger and more successful firm, Time Warner. However, Time Warner was resistant to the takeover and wanted to commence functioning as an independent entity. This pushed AOL to opt for the hostile method of the takeover. This deal was termed the deal of the millennium.

Conclusion

The term ‘hostile takeover’ turns the boardroom into a battlefield—a takeover results in volatile stock prices and lost jobs in the corporate world. The hostile takeovers damage a firm’s reputation and affect the lives of all those associated in the years to come. There are various defensive measures available to the managers to avoid getting acquired involuntarily. They can use these before or after making the offer. It is important that managers know these measures in detail and makes provisions. A target company needs to have its defenses strong if they do not want to be acquired forcefully.



Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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