Vienna MBAMergers & Acquisitions

Hostile Transactions I

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Hostile Transactions Outline

• Takeover strategies– Tender offers

• Definition and details• Examples• The free rider problem

– Toeholds and disclosure requirements– Other strategies (casual pass, bear hug)

• Defensive tactics (white knights, poison pills, etc.)

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Tender Offers

• Can be either hostile (not recommended by target management) or friendly (recommended by target management– If hostile, a way of bypassing target management

• Bidder will still often continue to negotiate with target management, and seek to gain approval (transition from hostile to friendly)

– If friendly, a tool for carrying out a purchase of shares• “Self-tenders” are one way of carrying out a share repurchase

Tender Offer (takeover bid) Tender Offer (takeover bid) -- buying shares directly from shareholders, at a specified price

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Tender offer example: Alcoa bids for Alcan

Alcoa Alcan

$58 + 0.4 shares = $73.25 at announcement

32% premium

1 share

May 7, 2007

• Largest hostile bid in Canada in 2007 ($33 billion)

• The proposed acquisition would create the world’s largest producer of aluminum metal

• Launched after two years of failed negotiations for a merger of equals, where neither side wanted to give up control (Link)

• Alcan was finally acquired in a friendly deal by Rio Tinto. Rio Tinto offered $101 in cash in a deal that would keep Alcan’s CEO (Link)

Legal Structure of Tender Offers • In the U.S., tender offers are governed by the Williams Act (1968).

Some state legislation also applies.– A tender offer must be open for at least twenty days– If a new offer arrives, any existing offers must be extended to 10+ days from the

date of the new offer– Extensive disclosure requirements covering intentions and financing, and making

it difficult to surprise the target– The tender offer must be communicated to all shareholders, usually through

financial newspapers and direct mailings

• In Canada, the primary legislation governing takeovers is the Canada Business Corporations Act. Provincial legislation also applies. link

– A takeover bid is defined as a bid for 20% or more of the outstanding shares– Bids must be open for twenty-one days– Financing conditions on tender offers are prohibited

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Characteristics of a tender offer (U.S.)

These characteristics define a situation that requires a formal tender offer in the U.S. (based on case law – not explicitly defined in Williams Act)

1.Active & widespread solicitation of target shareholders for shares

2.Solicitation for a substantial percentage of shares

3.Offering a premium price

4.Not negotiated with target management

5.Subject to a fixed number to be purchased

6.Offer opens for only a limited time

7.Pressure on the target shareholders to sell

8.Public announcement

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Types of Tender Offers

• “Conditional” offer: stipulates that the tender offer will proceed only if a certain number of shares are tendered, or some other conditions are met

• “Restricted” offer: limits the number of shares that the acquirer will accept

– Shares must be taken on a pro rata basis if oversubscribed

• “Any or all” offer: both unconditional and unrestricted

 

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Number of Tender Offers in US 1980-2007

Source: Thomson Financial8

Tender Offers in Europe 1980-2007

Source: Thomson Financial9

Tender Offers in Asia 1985-2007

Source: Thomson Financial10

Tender Offers vs. Merger (U.S.)

Source: Betton, Eckbo, and Thorburn (2005)11

Tender Offers vs. Merger (U.S.)

Source: Betton, Eckbo, and Thorburn (2005)12

Target return in successful tender offer

Paul Asquith, “Merger Bids, Uncertainties, and Stock Returns”, Journal Financial Economics

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Target return in failed tender offer

Paul Asquith, “Merger Bids, Uncertainties, and Stock Returns”, Journal Financial Economics

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Bidder return in successful tender offer

Paul Asquith, “Merger Bids, Uncertainties, and Stock Returns”, Journal Financial Economics

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Bidder return in failed tender offer

Paul Asquith, “Merger Bids, Uncertainties, and Stock Returns”, Journal Financial Economics

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The “free-rider” problem in tender offers

Suppose a firm is worth $10 per share under current management, and $20 per share to an acquirer

The acquirer offers $15 per share, conditional on receiving a majority of shares

The target shareholder decision (for a small holder)– Tender: receive $15 if deal closes, $10 otherwise– Don’t tender: shares worth $20 if deal closes, $10

otherwise– What should a small shareholder do?

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• If the offer price is below the expected after-merger price, small shareholders will not tender – Individual decision to accept or reject tender offer does not affect

success of the offer for small shareholders– If the offer succeeds, small shareholders fully share in the

improvement brought by takeover

• Two ways to solve free-rider problem:1. Two-tier offers or other pressure to tender;

2. Presence of a large shareholder

The “free-rider” problem

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Two-Tier Tender Offer

• Increases the likelihood of success in tender offer

• Benefits those who tender “early.”

Two-tier Tender OfferTwo-tier Tender Offer – bidder offers a higher price for the first x% shares and a lower price for the remaining shares.

In U.S.: Two-tiered offers require pro rata distribution of first-tier, and standard 20-day opening requirement.

In Canada: CBCA requires that all shareholders must receive identical consideration. This provision deters two-tiered offers

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Role of large shareholdersIn the previous free-rider case. • There is a big shareholder holding 99% target shares. • A small shareholder holds 1% of target shares.

(current price =$10, offer price =$15, after-merger price=$20)

15, 15 10, 10

20, 15 10, 10

Large shareholder Tender Not tender

Tender

Not TenderSmall

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The large shareholder internalizes the impact her decision will have on outcome

How important is the “free-rider” problem in practice?What is another form of “pressure to tender”?

Early warning for target shareholders

• The accumulation of large blocks of shares in the hands of a potential acquirer is potentially important information for target shareholders– The U.S., Canada, and other jurisdictions require potential

acquirers to disclose certain information publically.

Disclosure requirements

In the U.S., Williams Act requirements:• Schedule 13D must be filed when a 5% ownership threshold is passed

and the acquirer has obtained 2% or more in the past year or has intentions of acquiring the target

• Individuals acting in concert are treated as a single entity for the purposes of this section

– Applies to “stock parking” carried out by brokers acting in the interest of an acquirer, e.g., Ivan Boesky

• Filers must provide an update after a material change.• “5% beneficial owners” have not acquired more than 2% in the last year

and have no interest in taking over the company. Instead file 13G.

In Canada, the CBCA requires a very similar warning system, but the initial threshold is 10% rather than 5%.

Toehold acquisition

• Toehold: target’s shares owned by the bidder before the deal announcement– Lowers acquisition cost – Establishes fiduciary duty of target management to

acquirer– With 10 days to report reaching 5% threshold,

purchaser can potentially accumulate a large position before being revealed

– Only used in 15% of hostile deals– Average toehold level is well below 5%

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Frequency of Toehold (Betton, Eckbo and Thorburn 2008)

Approaches to the target

Casual Pass– The bidder uses an informal (often anonymous or third-

party) overture to target management to gauge interest Bear Hug

– Bidder writes a public letter to target CEO, friendly on the surface, but expressing a strong commitment to complete a deal, friendly or not. Releases it to the WSJ, etc.

– Arbitrageurs get involved– Puts pressure on target manager and board to respond

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Other hostile strategies

• Proxy fight

• Open market purchase / street sweep / creeping tender offer

• “Three-piece suitor”– Toehold purchase– Tender offer to gain majority– Freeze-out merger

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Creeping Tender Offer Example

• Porsche : 34th largest auto firm, 0.1 M employees, 0.1 M vechiles

• VW: 4th largest auto firm, 0.3 M employees, 5.7 M vehicles

• Porsche begins to accumulate shares of VW from 2005 up to 30% before a formal acquisition announcement

• Creeping tender offer– Porsche continues to acquire shares in VW over an extended period of time– On Sunday, October 26, VW announces that it has acquired 42.6% of the company, and

has acquired options on another 31.5% of the shares, totalling 74.1%– The other main shareholder is the state of Lower Saxony (20%)– The effective free float is thus less than 5%– Short-sellers panic (short-squeeze)– Briefly, on October 28, the share price exceeds $1200 per share, and VW is the most

valuable company in the world– The state still has a “golden share” allowing it to block a takeover of the board, and this

will likely be challenged in the near future

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Related Events

• Kraft makes $16.3 billion hostile bid for Cadbury– Cadbury rejects Kraft bid– Ferraro ponders offer for Cadbury– Hershey may launch bid for Cadbury

• Cadbury sweet on Hershey takeover

Vienna MBAMergers & Acquisitions

Hostile Transactions II

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Takeover Defenses - Greenmail

• Extortion Vs. fair compensation for efficiency increasing monitoring activities

• Usually accompanied by a standstill agreement, requiring the bidder to refrain from further purchases for a period of time

• Example: Boone Pickens (a greenmailer) activities with Mesa Petroleum

GreenmailGreenmail– A premium paid to a bidder to get him/her to terminate a takeover attempt.

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Greenmail• Wealth effects: significant loss of 2-3% on announcement of

greenmail (target firm)

• Even with standstill agreements, 40% of firms are acquired within 3 years of greenmail

• Anti-greenmail measures– 50% excise tax on greenmail imposed in 1986 in U.S.

– Antigreenmail charter amendments require a majority or supermajority of nonparticipating shareholders to approve

– Greenmail has been prohibited in Canada due to the equal treatment requirements of the Canada Business Corporations Act (CBCA)

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Financial defensive measures

1. Increase debt / remove financial slack

2. Repurchase shares

3. Increase insider holdings

4. Reduce cash and marketable securities

5. Increase dividends

6. Spin-off subsidiaries that operate independently (no lost synergies)– Preferable to sell-off because it doesn’t generate cash

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Strategic defensive measures

• Pac Man

• White knight

• White squire

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Pac Man: eat or be eaten

Pac Man: Target initiates takeover of acquirer

Sherwood Chesapeake$700 M

In 1999

Sherwood Chesapeake$740 M

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After several rounds of bidding, International Paper eventually bought Sherwood for $875 million.

More recently, after the hostile offer from Alcoa to Alcan (June, 2007), there was discussion in the Canadian financial press about a possible Pac Man defense. A nice article about the strategy and summary of its history is here.

White Knight

White knight: Management chooses an acquirer it prefers

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Yahoo seeks help from Time Warner / AOL in the Microsoft-Yahoo takeover battle (March 5, 2008)

White squire

• Management seeks a large blockholder that it considers somewhat friendly

• Often will be accompanied by a standstill agreement and restrictions on stock sales, e.g., right of first refusal to target

• Squire may get discount on shares, large dividends, or seats on the board

• Example is Warren Buffett with Champion International– “selling protection to nervous companies at a handsome premium

to himself.” (NY Times)

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Defensive restructuring and reorganization

• Target makes a defensive acquisition of other firms– With equity: dilutes acquirers shareholding– With cash or debt: makes financing more difficult for

acquirer– Can create antitrust problems, e.g., Mannesmann

acquisition of Orange

• “Scorched earth” policy (suicide pill)• Dual-class recapitalization – establish different

classes of shares with different voting rights

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Defensive restructuring and reorganization

• Leveraged recapitalization – repurchase shares and issue debt

• MBO

• ESOPs (Employee stock ownership plans)– Funding the pension plan with stock can make it more

difficult for acquirer to gain control– Example: Polaroid in 1988 creates ESOP that

purchases 14% of Polaroid stock to defeat Diamond Shamrock.

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Shareholder Amendments

• The corporate charter establishes the conditions that allow a takeover.

• Target firms frequently amend corporate charters to make acquisitions more difficult.

Types of Shareholder Amendments• Supermajority amendment

– Requires two-thirds or more vote to approve transactions involving change of control

– Typically gives board discretion for when this rule is in effect (board-out clause)

• Fair-price amendment– Usually the acquirer must pay all shareholders the highest

price paid for any shares over some period – rules out two tier offers. May also have other minimum requirements related to book value.

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Types of Amendments• Staggered (classified) board amendment

– Prevents replacement of entire board at once– E.g., nine seats with three up for election every year

• Adopt straight rather than cumulative voting – More difficult for minority shareholders to acquire seats

• Authorization of blank-check preferred stock– Directors are free to determine voting, dividend, and conversion

rights without further stockholder approval– Can be issued to friendly parties in a control contest– Used by over 90% of companies at the end of 1998– A discussion of legality in the context of banks is here

• Reincorporate in jurisdiction with stronger anti-takeover laws

• Lock-in amendments make it difficult to void previous antitakeover amendments

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Impact of Shareholder Amendments

• Shareholder amendments usually make takeovers more difficult.

• All charter amendments must be voted on and approved by shareholders.

• Most antitakeover amendments have negative effect on share price when announced

• Antitakeover amendments also tend to be adopted by underperforming firms

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Poison pill: Definition ITechnical definition (“shareholder rights plan”): • “Rights” to purchase additional shares at a given price are attached

to each share of stock (like a warrant but not separately tradeable)• In a poison pill type of rights plan, the rights are exercisable at a

very low price ($.01), and only if a certain triggering event or events occur (e.g., an acquirer gains more than xx% of the firm’s shares without board approval).

– Another type of “rights” plan is used simply to issue new shares – e.g. a seasoned equity issuance can be carried out by issuing “rights” to all existing shareholders to purchase additional shares at a given price, usually only a small discount to current price.

• The key is that the “rights” are canceled for any shareholder who triggers exercisability, i.e., the acquirer who fails to gain board approval, causing dilution

Examples: Suncor shareholder rights plan (with link to the plan details)IMS Health shareholder rights plan policy

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Shareholder Approval and Legality of Poison Pills

Shareholder Approval• In the U.S., most states do not require explicit shareholder approval

for rights plans– Nonetheless, many corporations seek shareholder approval as it is considered

good corporate governance practice to do so• In Canada, rights plans must be approved by shareholders

Legality• In U.S., courts have generally upheld rights plans so long as they

– Do not appear to favor management interests over shareholders– Provide a means to seek out a better deal, but do not provide an absolutely

insurmountable obstacle to acquisition• In Canada, rights plans are used, but generally have more

restrictions– Again, the goal should be to slow the process down and give management time

to seek alternatives, rather than absolutely blocking the possibility of acquisition.

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Variants of poison pill plans

• Chewable pills– Can be removed by the board under certain circumstances, or alternatively by

shareholders under circumstances (e.g., 2/3 vote)

• Dead hand pill– Can be removed only by the board that initially approved, rendering proxy

contests useless (ruled illegal, absolutely prevents takeover)

• Slow hand pill– Can only be removed by new board after a period of time, e.g., six months

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Frequency of poison pills

46Source: Thomson Financial Securities Data

Takeover premium and poison pills

47Source: Poison Pills and Shareholder Value, Georgeson&CompanyLarge Cap >=$1B; small cap< $1B

Wealth effects of poison pills

• The probability of takeover is generally reduced by the presence of a poison pill plan

• Targets protected by poison pill plans have higher takeover premia

• Good for shareholders, or a means of entrenching poor management?– On adoption of a poison pill plan, about a 2% wealth loss on

average to shareholders

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Poison pill: Definition II

In common usage (e.g., newspapers), the term “poison pill” is often used more loosely simply to indicate something that makes a takeover more difficult.

Example: Yahoo’s poison pills against MSFT– Yahoo’s compensation plan gave any employee

accelerated vesting rights in the event of a merger.

Example: PeopleSoft’s poison pills against Oracle– PeopleSoft gives its customer rebate up to 5 times of

software price, in the event of a takeover

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Poison puts

• A bond may have attached a covenant that gives the bond holder the right to “put back” the bond to the firm in the event of certain types of change of control transactions

• These are also called “event risk covenants”

• Until the 1980’s, not very common, as lenders had not experienced changes in control radically changing borrowing structures and risk

• The LBO wave of the 1980’s motivated poison puts after defaults and downgrades of unprotected debt– Can serve a dual purpose: hostile takeover deterrence

• Empirical evidence: poison puts reduce borrowing costs (25 to 50 basis points)

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