Hostile Takeover

What is a Hostile Takeover?

A hostile takeover occurs when an acquirer scrutinizes a company's shareholders or contests with management to obtain approval for the takeover. Such a takeover can be completed through a proxy contest or a takeover bid.

This takeover occurs when an organization fails to obtain the consent or approval of the target company's management and attempts to take control of that company.

Instead of obtaining the approval of the target company's board of directors, the acquirer may purchase the target company by making a tender offer, participating in a voting contest, or otherwise attempting to acquire the required number of shares.

The main characteristic is that the target company's management does not want the takeover. 

In some cases, the target company's management tries to fend off hostile takeovers with what they consider to be controversial tactics, such as golden parachutes, Pac-Man defenses, crown jewel defenses, and poison pills.

What is a 'Poison Pill' defense?

The poison pill strategy has been used since the 1980s and was developed by New York-based law firms Wachtell, Lipton, Rosen, and Katz.

This name comes from the spies who used to keep poison pills with them in the past to prevent being questioned if the enemies captured them.

Shareholders' rights plans, also known as the poison pill strategy, were developed in the 1980s. It is a defensive strategy that companies use to prevent hostile takeovers.

Such a takeover occurs when one company acquires another - usually by going directly to the company's shareholders or competing to replace management - to get approval for the purchase.

The poison pill makes businesses less attractive to hostile buyers by raising prices and preventing takeovers or creating economic consequences for buyers.

A poison pill is a strategy that often makes a company less susceptible to potential acquirers by making it more expensive for the acquirer to buy shares of the target company above a certain threshold.

The poison pill typically works very well at deterring hostile takeover attempts by decreasing the deal's value for the potential acquirer. The strategy, however, can also be destructive to the intended organization.

How does a poison pill work?

A Poison pill, formally known as a shareholder rights plan, can be found in a company charter or shareholder agreement. There are various poison pills, but they generally allow some shareholders to buy more shares at a discount.

The only shareholder who abstained from buying shares at a discount is the one who activated the poison pill. It is activated when a person, usually a buyer, reaches a threshold number of shares they own. 

If they reach this threshold, the value of their shares is suddenly diluted as other shareholders make discounted purchases. 

There are some examples where poison pills have been used.

• In the case of the Netflix saga. Netflix was forced to implement a poison pill strategy when it got a hostile bid from Carl Icahn.
• Carl Icahn, a famous investor, and a corporate raider, caught Netflix off guard in November 2012 by buying a 10% stake. Netflix responded by announcing a shareholder rights plan as a "poison pill," a decision that angered Carl Icahn without end. 
• Carl wanted to take over the company and Make it alluring for more giant video conglomerates like Microsoft, Apple, Verizon, and Comcast. Still, he failed to do so when Netflix opted for a 'shareholders rights plan,' also known as a poison pill.
• A year later, Carl reduced its stake to 4.5%, and Netflix ended plans to release the rights in December 2013.
• The Poison pill would have allowed shareholders to buy shares at a steep discount if Carl had raised his stake beyond 10% without the board's approval.

Another recent example is Twitter, where The poison pill would have flooded the market with new stock had Elon Musk or any other individual or group working together bought 15% or more of Twitter stock.

This would have immediately diluted Musk's stake and made it much more challenging to acquire a significant portion of the business. Musk currently owns more than 9% of the company. 

Limitations of Poison Pill

Poison pill has their disadvantages.

Some of the disadvantages are:

1. An essential aspect of the poison pill is dilution which can also negatively affect existing shareholders because the issuance of new shares reduces the corresponding value of the stock. 
2. The purchase of additional shares is necessary to maintain their prior ownership ratio.
3. It can also discourage institutional investors, Institutions, and large investors who may be reluctant to buy a company that shows a combative attitude against potential suitors.

Even without the consent of the shareholders who stand to gain from the purchase by potential suitors, ineffective management and directors looking to safeguard their jobs can continue to stay in power through a poisoned pill strategy.

Poison pills can be used in many different scenarios. For example, management may want to prevent hostile takeovers from saving their jobs, Or maybe they are happy to sell the company but not to the company that has made the bid.

In these cases, poison pills buy companies time to find a suitable acquirer.

What is a 'Golden Parachutes' defense?

As the name suggests, the golden parachute is a last-minute financial backup created for senior executives. These contracts are triggered in the event of a hostile takeover bid or when executives are fired following a merger or takeover.

Here, executives receive lucrative severance packages that include bonuses, stock compensation, insurance, retirement benefits, and more. This strategy can also be used in case of unjust dismissal.

Golden parachutes don't precisely protect executives from getting fired, but they indeed take care of their financial health. So, if they can't command the ship anymore, they can at least get there safely with a golden parachute.

It also makes sense to distinguish between a golden parachute and a regular retirement allowance. Generally, employees who are dismissed for severe reasons do not receive severance pay.

The same is true if this employee voluntarily resigns. However, C-level employees who are dismissed for good cause or leave may receive a golden parachute, depending on the terms of their employment contract.

Primarily the Golden parachute is only included in the contracts for C-level executives like chief executive officers, chief financial officers, and chief legal officers. 

Sometimes even executive vice presidents and other top officers receive the Golden parachute.

How does a golden parachute work?

To better understand how this works, let's look at an example.

• Assume the CEO of company "A" has worked with ABC Company and has been instrumental in its success. However, his employment contract includes a golden parachute.
• Industry leader XYZ is trying to play dirty and acquire ABC by force. After receiving it, their first decision was to fire CEO A. 
• But fortunately for him, he has a golden parachute in his contract that provides him with a $50 million severance package under the circumstances. This ensures that it is supported in such a situation.
• These clauses can specify lucrative benefits an employee will receive if terminated. Severance packages in cash, special bonuses, stock options, or disputes over previously awarded compensation are all examples of golden parachutes. 
• The employment contract specifies the circumstances under which this clause is effective. Many talented top executives are attracted to jobs because of the golden parachute clause in employment contracts. 
• At the time of the takeover, this clause served as a safety net for the top executives. In addition, it raises their morale and motivates employees to remain with the business for a long.
• During the acquisition process, the acquiring company compensates the departing employees and appoints new hires in their place. 
• The top executives' employment contracts contain a "Golden Parachute" clause that makes things expensive for the acquiring company.

What is a 'Pac-Man' defense?

The Pac-Man defense is a strategy used by the company that is subject to a hostile takeover. The Pac-Man defense strategy involves a target company attempting to buy a company that has launched an aggressive takeover against it.

Essentially, the company that was initially the subject of the initial takeover attempt will reverse positions by attempting to take over the acquiring company instead. 

The acquiring company can proceed with a large-scale purchase of shares of the target company, but this can be countered by having the target company buy back those shares and then buy the claims of the acquiring company and turn the tables.

In other words, a defensive strategy in which the company, facing the threat of a hostile takeover, "turns the table around" by acquiring its potential buyer. 

The purchase frequently proves too much for the acquiring corporation to handle if they have to cope with their attempt to acquire another company and the prospect of being caught.

This defense strategy takes its name from the popular video game Pac-Man, where Pac-Man's initial goal is to escape the ghosts chasing him; however, once he consumes the power pill, he can turn around and eat the ghosts that try to eat it. 

This strategy may also prove challenging for the target company, as acquiring a hostile takeover company may require extensive resources and must be arranged from other sources.

How does a Pac-Man defense work?

Suppose a company makes an aggressive or hostile bid against another publicly traded company, which the target company does not accept. In that case, the company can use any method to take control of the acquiring company. 

For example, the target company could buy shares of the acquiring company using its cash reserves.

An excellent example of Pac-Man defense is when Porsche made several offers to repurchase Volkswagen in 2005 but failed to do so. 

But after the 2008 financial crisis, Volkswagen began buying back Porsche shares when Porsche's share price fell, and in 2012, Volkswagen took over 100% of Porsche's shares.

Another example of Pac-Man defense strategy is the oil company TotalFina, which in 1999 made a $48 billion takeover bid for Elf Aquitaine. In response, Elf Aquitaine submitted his $50.97 billion counteroffer. 

Finally, TotalFina Elf acquired Aquitaine after making a $54 billion bid.

Bendix Corp., in 1982 Bid for Martin Marietta, an aggregates and heavy construction materials company. To block the takeover, Martin Marietta sold many businesses and took on more than $1 billion in debt.

Bendix Corp. held more than 70% of Marietta's shares, and Marietta had more than 50% of Bendix's shares. This egoistic battle destroyed the finances of both companies. And competitors took advantage of this situation by acquiring Bendix Corp.

What is a 'Crown jewel' defense?

Protecting the crown jewel is an anti-takeover strategy applied during mergers and acquisitions by a target company by selling its most valuable assets to reduce the attractiveness of a target company. This is the last strategy to use to prevent a crisis.

The target company's valuable assets are sold to a third party, dubbed the "white knight ."This strategy forces the hostile bidder to withdraw from the bid. 

The crown jewel strategy is a self-destruct strategy, and after the hostile bidder withdraws from the auction, the target company buys back the asset from a third party at a predetermined price.

To understand how the crown jewel strategy works. First, you need to know the meaning of crown jewel. Crown Jewels are the company's most essential and valuable asset in terms of profitability, future business prospects, and asset value.

Selling the crown jewels is thought to be a dangerous procedure. Experts claim that organizations often kill their businesses by selling off their assets at a fixed price and then repurchasing them at a higher price to insulate themselves from takeover. 

Additionally, the corporation implicitly discloses its private information to another company by selling off its intellectual property and trade secrets, which hurts its status and reputation in the business world. 

This tactic should be applied with the utmost care and prudence to avoid hurting the business.

How does the 'Crown-Jewel' defense work?

This strategy aims to prevent the hostile company from gaining control of the target company. As a result, the target company sells crown jewels and other valuable assets that depreciate the company's market value.

One of the recent examples of crown jewel defense is French companies Suez and Veolia. These are two of France's leading water and waste management companies.

In 2020, Veolia made a hostile takeover by acquiring his 29.9% stake in Suez. At that time, Suez used the crown strategy to block the takeover.

Another good example is Sun Pharma and Taro. In 2007, Sun Pharma and Taro (an Israeli company) agreed to merge. However, due to some violations, the contract was unilaterally terminated by Taro.

However, Israel's Supreme Court issued an injunction against Sun Pharma for failing to complete the contract. Taro took advantage of the Crown Jewel defense at the time by selling the Irish unit to keep Sun Pharma out.

Another example can be a telecommunication company that might sell its R&D department, which is its most valuable asset, or the crown jewel in the hope that the aggressor might lose interest in the company since it has already sold its crown jewel.

Researched and authored by Rishabh Bhoria| Linkedin

Reviewed and Edited by Krupa Jatania I LinkedIn

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