Chapter 2 Takeover

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Chapter 2


Is a process wherein an acquirer takes over the control of the target company

Another aspect to takeover is where an acquirer acquires substantial quantity of shares or voting rights of the target company.

Is termed as substantial acquisition of interest

Acquirer may be an individual, company, any other legal entity or Persons Acting in Concert with the acquirer

Concept of takeover


Persons Acting in ConcertAre individuals or companies who act on behalf

of or in coordination with the acquirer to acquire substantial number of shares in the target company

Include holding company or subsidiary company, mutual funds with its sponsor / trustee / asset management company, etc.

May have a formal or informal agreement with the acquirer in this regard

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Bajoria – Bombay Dying Tussle:

PAC in case of Bajoria:Mega ResourcesMega StockHooghly MillsMs Pooja BajoriaMs Mohini Devi BajoriaMs Lata Devi Bajoria and Ms Meenakshi Jati


Open OfferShares of the target acquired by the acquirer

through open offer

Is a public announcement to acquire the shares of the target company

Made to ensure that the shareholders of the target company become aware of an exit opportunity available to them


Parameters of an Open Offer

Negotiated price under the agreement that triggers the open offer

Is the highest price paid by acquirer or persons acting in concert for any acquisitions

Includes shares allotted through public issue or rights issue during the 26 week period , as statutorily prescribed, prior to the date of the open offer

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Parameters…..

Average weekly high and low of the closing prices of shares as quoted on the stock exchanges, where shares of the target company are traded during 26 weeks or average of the daily high and low prices of shares during the 2 weeks prior to the date of the open offer.

Parameters such as return on net worth of the company, book value per share, EPS, etc. where shares are not listed

The Torrent group made an open offer to acquire 20% in Ahmedabad Electricity Company ("AEC") at Rs. 65 per share


Global Trends

Very common in the United States and in the United Kingdom

Very occasional and rare in Germany, Japan or China.

The reason:Germany practices dual board structureJapanese companies have interlocking sets of

ownerships known as KEIRETSU and In China most public listed companies are

state owned


Forms of Takeover


Bailout

Involves takeover of a financially sick company by a financially rich company as per the provisions of the Sick Industrial Companies (Special provisions) Act, 1985

Objective behind this takeover is to bail out the sick unit from losses


Friendly TakeoverIs one where the acquirer acquires the shares of

the target by informing the board of directors his intention to purchase the shares of the target company

If board feels the offer is worth accepting, it recommends to the shareholders that the offer be accepted

The acquirer may either acquire the assets or purchase the stock of the target


Advantages of Friendly Takeover through Purchase of Assets

Allows acquirer to purchase only those assets that it desires to purchase

Acquirer is not required to take over any contingent liabilities of the target

Provides the acquirer with an opportunity to negotiate the price with the board of directors, as the approval of the shareholders is not required.


Advantages of Friendly Takeover through Purchase of Stock

Acquirer has to assume the liabilities of the target firm

Target firm may continue to operate as an autonomous subsidiary or it may be merged with the acquiring firm

Approval of the shareholders of the target firm is needed for this type of acquisition


Hostile Takeover

One where the board of directors of the target firm disagrees to the offer of the acquirer to purchase the shares, but the acquirer continues to pursue it or makes the offer by by-passing the target company’s management

Represents an offer made by the acquirer without informing the target company’s management about their intention of acquiring stake in the company.


A Tender Offer Is an offer to buy the stock of the target firm either

directly from the shareholders or through the secondary market

Acquirer intends to buy the company's stock to the target firm’s board of directors

Proposal carries a clear indication that if the offer is turned down a tender offer shall be resorted to

Strategy expensive as the price payable is higher than the market price; also the stock price tends to rise in anticipation of a takeover


A Proxy FightHere, the acquirer approaches the shareholders

of the target firm with an objective of obtaining the right to vote for their shares

Hopes to secure enough proxies that would help in gaining control over the board of directors and replace the incumbent’s management

Are a very expensive and difficult mode of takeover for the incumbent management team can use the target firm's funds to pay all the costs of presenting their case and obtaining votes


Creeping Tender Offer

Involves purchasing enough stock from the open market to bring about a change in management.


Horizontal Takeover

Is a process where a company takes over another company from the same industry

Basic objective is to attain economies of scale and increase market share by entering into the market segments of the company taken over


Vertical TakeoverIs one where a company is taken over by any

of its vendors or customers

Can be of two types: backward and Forward

Backward is one where the business of the vendor is taken over in order to reduce costs

Forward is one where the business of the customer is taken over in order to access market directly


Conglomerate Takeover

Is one where a company takes over another company from a totally different industry

Is pursued with the objective of attaining diversification.


Reverse Takeover

Is a takeover strategy where a private company acquires a public company

Helps private company to effectively float itself and at the same time bypass the lengthy and complex process of going public by coming out with an IPO

Makes the company less susceptible to market conditions

………


Reverse......

Public company is called SHELL as all that exists of the original company is its organizational structure.

Biggest problem is that the company comes with some history, which can be bad, resulting in sloppy record keeping, pending lawsuits and contingent liabilities and some shareholders and the resulting company has to live with this history


Benefits of Takeover Helps the acquirer to attain increase in sales/ revenues Helps acquirer to venture into new business segments and

markets with ease Improves overall profitability of the entity Helps the acquirer in increasing its market share Reduces competition from the perspective of the acquiring

company Reduces overcapacity in industry Helps acquirer to expand the brand portfolio Generates benefits of economies of scale Helps attain increased efficiency as a result of corporate

synergies Helps in eliminating jobs that overlap in responsibilities


Weaknesses of Takeovers

Reduces competition and choice for consumers

Results in job cuts

Cultural differences lead to conflict

Acquirer often burdened with hidden liabilities

of the target entity

Employees of the target company work in an

environment of fear and uncertainty affecting

motivational levels.


Takeover Defences: Bank-mail

A strategy where the bank of the target firm refuses financing options to a firm that is keen on takeover.

Is done with the objective of preventing acquisition:

By depriving the merger through non availability of finance

By increasing the transaction costs of the acquirerBy delaying the takeover and permitting the target firm

to develop other anti-takeover strategies.


Greenmail

Is a practice of purchasing enough shares of another publicly traded company that poses a threat of takeover for the target company

Threat of a takeover then forces the target firm to buy those shares at a premium, in order to avoid/suspend the takeover.

Buyback is referred as the Bon Voyage Bonus for it enables the target company to be left alone by the greenmailer


Crown Jewel Defense

Is a strategy wherein a company facing a threat of takeover sells off its most attractive assets to a friendly third party or spins off its valuable assets in a separate entity

Makes the target company less attractive for the company planning a takeover, which then loses interest and defers the takeover bid.


Poison Pill/ Super Poison Put

A strategy adopted to increase the likelihood of negative results over positive ones for the company attempting a takeover

Derived from warfare terminology - Were pills laced with poison that spies used to carry and would consume when they would get discovered or captured, in order to eliminate the possibility of being interrogated for the enemy's gain

………


Represents an anti-takeover defense wherein the current management team of the target company threatens to quit en masse in the event of a successful hostile takeover

Effectiveness depends on the circumstances of the takeover - If the management team is efficient and quits en masse, the acquirer would be left without experienced leadership following a takeover. On the other hand, if the current leadership is inefficient he will get fired after the takeover making the poison pill becomes ineffective


Flip-over

Type of poison pill in which the current shareholders of the target company are given the option to purchase discounted shares/stock after the potential takeover

Strategy involves giving a dividend in the form of rights whereby the existing shareholder can purchase equity or preference shares at a value that is lower than the prevailing market price

………


Once takeover is done, the current shareholders can “flip over” the rights to purchase the shares at a discount

Strategy results in dilution and price devaluation of the shares held by the acquirer and defeats the very purpose of the takeover


Gray Knight

Is an informal and ambiguous intervener in the takeover battle that makes a counter bid for the shares of the target company

Intervener’s bid causes a lot of confusion amongst the original acquirer and the target company as the intentions behind his making a counter bid are not clear


Jonestown Defense/Suicide Pill Defense mechanism against hostile takeovers

Target firm employs tactics that might threaten the target firm’s existence, so as to thwart an imposing acquirer’s bids

Is known as Suicide Pill as it threatens the very existence of the target

Represents an extreme version of poison pill.


Killer Bees

Here the target company employs firms or individuals to fend off a takeover bid as is either is unable to do this on its own / does not want to be seen doing so.

So employs other firms or individuals to do the job for it


Leveraged Recapitalization

Is a strategy used to fend off a hostile acquisition

Here the target company adopts one of the two possible strategies: Borrow significant additional debt that facilitates

repurchase of stocks through a buyback program or Distribute a liberal dividend among the current

shareholders

…….


Leads to a sharp increase in the share price and makes target less attractive as the acquirer has to pay more for the target company minimizing the gains for the acquirer

Is a form of poison pill that serves two purposes, viz. an increase in the debt of the target making the acquisition costly and maintains shareholders interest in takeover attempts


Lock-up Provision Represents a strategy wherein an option is

granted by the seller to the buyer to purchase a target company’s stock as a prelude to a takeover.

Acquirer requires a lock up agreement before making a bid as it facilitates negotiation progress - as a result of this arrangement, the major or controlling shareholder gets effectively "locked-up" and is not free to sell the stocks to a party other than the potential buyer

……….


Lock-ups can either be:

“Soft” - one that permits the shareholder to terminate the agreement if a better offer comes along

“Hard” - one that is unconditional and cannot be terminated

Stock lock-up – Where the bidder is either allowed to purchase the Authorized but Unissued Share Capital of the controlling stockholder or the shares of one or more large stockholders.

Asset lock-up/Crown Jewel Lock up – where the target firm grants an option for the acquisition of an asset.


May take any one of the following forms:Break-up involving payment of termination fees Giving an option to the target shareholders to buy target

stock

Giving rights to target shareholders to purchase target assets

Forcing the vote provisions in merger agreements, and

Enforcing agreements with major shareholders viz. voting agreements, agreements to sell shares, or agreements to tender.


Nancy Reagan Defense

Is one where the boards of directors of the target company just say “no” to the formal bid made by the acquirer to the shareholders to buy their shares.

Board has authority of refusing the company making a takeover attempt and the matter ends there.

Constitution of the company gives them this authority.


The term refers to a catch-phrase coined by former United States First Lady Nancy Reagan advocating “abstinence from recreational drug use”.

For Example: A discussion of a takeover of the Walt Disney Company by Comcast


Non-voting Stock Are shares that provide the shareholder with very

little or no voting rights on issues such as election of the board or mergers

Issued to individuals who want to invest in the company’s profitability and success but are not interested in voting rights

Preference shares are typically non-voting shares.

Help in making the company a closely held act as a takeover defense

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For Example: Warren Buffett’s Berkshire Hathway Corporation has two classes of shares viz. Class A shares that

are voting stocks and Class B that are non-voting

shares. The Class B stocks carry 1/200th of the voting

rights of the Class A, but 1/30th of the dividends


Pac-Man Defense

Is commonly used to prevent a hostile takeover

Here the target company counters the takeover bid by trying to acquire the bidder’s company i.e. the target company makes a counter offer to purchase the business of the acquiring company

Diverts the acquirer attention as the acquirer gets busy in preventing the takeover of their own company


For Example:

The hostile takeover of Martin Marietta by Bendix Corporation in 1982. In response, Martin Marietta started buying Bendix stock with the aim of

assuming control over the company. Bendix persuaded

Allied Corporation to act as a "white knight," and the company was sold to Allied the same year.


Pension Parachute Companies often carry surplus cash in the pension

fund, which is put to use as and when companies require resources

Is a type of poison pill strategy that prevents the acquirer to go ahead with a hostile takeover by utilizing the surplus cash in the pension fund for financing the acquisition

Ensures through corporate governance practices that resources in the pension fund account do not get used for financing hostile takeover

………


The concept of pension parachute was evolved by the law firm – Kelley Dyer and Warren, which they implemented for Union Carbide. The design was upheld in Union Carbide’s litigation with GAF Corporation. GAF Corporation subsequently withdrew its hostile takeover bid, but profited $81 million from sales of Union Carbide stock.


People Pill

Is another defensive strategy adopted to ward off a hostile takeover.

Here the management of the target company threatens the acquirer that in the event of a takeover, the entire management team will resign.

This strategy is a variation of poison pill defense strategy.


Lollipop DefenseIs a strategy wherein the target creates

barriers outside its periphery to protect the company from a takeover

Called lollipop defense as the company is compared to lollipops that have a hard crunchy exterior but a soft chewy centre i.e. the takeover is made difficult by the barriers (hard crunchy exterior) but the company in general is an attractive takeover target (soft chewy centre)

……..


Target company presumes that creating a lollipop defense provides adequate security from the takeover attempt

Fact is once the acquirer is able to overcome the barriers (hard crunchy exterior), the target stands exposed (soft chewy centre) and takeover then becomes a matter of time


Macaroni DefenseIs a strategy wherein the target issues a large

number of bonds in the market carrying a peculiar condition i.e. if the company is taken over, the bonds will have to be redeemed at a very high price.

High redemption price of the bonds acts as deterrence and the acquirer may be forced to give up the takeover bid

Called Macaroni defense for the target is facing a danger of takeover and the redemption price of the bonds starts expanding like Macaroni being cooked


Lobster Trap (comparable to Chakravyuh)Is one where the target firm issues a charter

preventing individuals with more than 10% ownership of convertible securities such as convertible bonds, convertible preference shares, and warrants from transferring these securities to voting stock

Charter becomes a barrier and hostile takeover becomes difficult

Makes it becomes difficult for acquirer to exit the bid as can neither acquire controlling stake nor can it exit from the limited stake acquired


Shark Repellent/Porcupine Defense or Provision

Shark repellent is a repellent applied by deep sea divers to prevent sharks from attacking them The target company makes special amendments to its bylaws that become active only when a takeover attempt is announced

Objective of the special amendments is to make the takeover less attractive to the acquirer

In such a case, the acquirer is termed as the shark and the proposed amendments are repellents that prevent the shark from attacking ………..


May not always be in the best interest of the shareholders as may adversely affect the financial health of the company

Strategies adopted include under shark

repellent Poison pillsScorched earth policyGolden parachutes and Safe harbor


Poison Put / Event Risk Covenant

Is a strategy wherein the bondholders and stockholders are assigned a right whereby they can demand redemption of stock before maturity, at a value in excess of the par value

ORAllows the shareholders to purchase the

company’s shares at a very attractive fixed price in case of restructuring of the company, excess distribution of dividend

………


Helps the management of the company to deter the takeover attempt by making the target very costly for the acquirer

Strategy can work against the company too – during low liquidity bondholders can pressurize the company to go into reorganization or to increase the borrowing cost


Safe harbour

The target company creates barriers making it difficult for the acquirer to succeed in their takeover attempt

Barriers work as if the target is safe in the harbour and beyond the reach of the acquirer (shark).


Scorched-earth DefenseConcept originated as a military strategy

Involved a defence strategy wherein a retreating army would burn crops and trees, so that there would be no fresh supplies to the advancing army.

As an anti-defense strategy, scorched earth policy involves liquidating valuable and desired assets and assuming fresh liabilities

Makes proposed takeover becomes unattractive to the acquiring firm


Selling the Crown Jewels

Represents the most valuable unit or department of a company.

Categorized as crown jewels based on their profitability, value of assets owned, and future growth prospects

Target company creates anti-takeover clauses, whereby the company gets the right to sell off the crown jewels if a hostile takeover occurs


ShowstopperImplies inserting such a clause that imposes additional

financial burden on the acquirer in the event of a takeover

Example: Acquirer is required to pay for the offer within a stipulated

period. If the acquirer fails to pay the dues, the shareholders of the target may grant extension, subject to the acquirer agreeing to pay interest to the shareholders for the delayed payment.

Where the acquirer refuses to pay the additional amount, the agreement falls through and acquirer is required to pay compensation

………


Acquirer is the loser in either case if the deals fall throughEither pay the interestPay compensation

Creates financial burden on the acquirer


Staggered Board of Directors Is a defense wherein a certain percent of the company’s

Director are replaced every year and not the entire board being replaced annually

Makes it difficult for the acquirer to seize control over the target, as the hostile bidder has to win more than one proxy fight at successive shareholder meetings in order to exercise control over the target

In order to facilitate staggering Directors are classified into group or class and each group required to vacate their post by rotation …….


Institutional shareholders in US have been increasingly calling for an end to staggering / declassifying boards of directors so that the practice of retiring by rotation comes to an end

Reason - All desirable names drop from the list of the directors affecting investor’s confidence.


Standstill AgreementsHere an unfriendly bidder agrees to limit his

holdings of a target firm

Made possible by the target firm’s willingness to purchase the potential acquirer’s (raider ’s) shares at a premium price

Enacts a standstill or eliminates chances of a takeover attempt by the potential raider

Gives the target company time to build up other takeover defences...........


Can also take another form - wherein two or more parties agree not to deal with other parties in a particular matter for a specified period of time For Example: An agreement not to go ahead with an acquisition of other parties

Allows the concerned parties to devote more time for negotiation, due diligence, and details of a potential acquisition/defense they are currently working on


Targeted Repurchase

The target firm purchases back its own shares from an unfriendly bidder at a price well above market value

Numbers of shares re-purchased help target firm to regain controlling interest in the company by having adequate shareholders votes to prevent the hostile acquisition

Targeted repurchase considered a success if the strategy results in abandonment of the takeover attempt ……..


Not necessary that the raider company may accept the price offered

Here the raider continues with its attempt of hostile takeover and the target generally combines the targeted repurchase offer with another strategy

For Example: Setting up a holding company that receives all acquired shares and starting the process of converting the same into employee stock ownership plan (ESOPs)

……..


Defeats the very objective of pursuing a hostile takeover as raider left with no other option but to accept a market price for the shares under their control

Refusal to accept this generates risk of the shares becoming worthless, once ESOP is approved by the regulatory authorities


Top-upsIs a type of stock repurchase program

Here shares are repurchased from the existing shareholders of the company

Buyback results in immediate reduction of the voting power of the shareholders

Shareholders may however subsequently increase their holdings through additional purchases which is called a top-up

...........


For Example:Company X holds 10% shares in a company, which

implies that it has 10% voting power too. Company Y offers to purchase 5% of the shares from Company X with the latter’s consent. This purchase also reduces the voting power of Company X to 5%. If at a later date, Company X wants to increase its voting rights to say 8%, it can purchase 3% shares form the open market. This 3% purchase is called top up.

Advantage of top up strategy is that it provides the target company with time for enhancing and strengthening its takeover defense mechanism


Treasury Stock Also known as reacquired stock

Are shares/stock bought back by the issuing company with the objective of reducing the amount of outstanding stock in the open market

Is a tax-efficient tool of giving cash to shareholders instead of dividend

Strategy adopted by companies to protect the company against a takeover threat

……….


Shares repurchased either cancelled or held for reissue

Knows as Treasury shares/stock when not sold

Have the following characteristics: Do not involve payment of any dividend Have no voting rights Should not exceed the maximum proportion of total

capitalization specified by relevant legal provisionsPossession of shares does not give the company the

right to vote, rights of a shareholder, receive dividends, or to receive any part of the assets on liquidation


White KnightIs a situation where a target faces a hostile

takeover attempt from a company and is struggling to avoid the same

At the moment another company makes a friendly takeover offer to the target company in order to help the target successfully avoid the hostile takeover bid

Friendly takeover offer is to save the target from the hostile attempt and the company making a friendly offer called a white knight


White SquireIs similar to a white knight

Only difference is that a white squire exercises a significant minority stake, as opposed to a majority stake.

Does not have any intention of getting involved in the takeover battle, but serves as a figurehead in defense of a hostile takeover due to the special voting rights it holds for its equity stake holds in the company


A Voting Plan or Voting Rights Plan

Type of poison pill that the target company issues against hostile takeover attempts

Plan implemented when the company’s constitution provides for shares that carry superior voting rights compared to ordinary shares

When an unfriendly bidder acquires a substantial voting stock, it may still not be able to exercise control because the stock carrying superior voting rights will help the company fight the hostile takeover bid

…….


For Example: Asarco had a voting pattern wherein holding 99% of the company’s common stock would give the holders only 16.5% of the voting power


WhitemailIs another strategy wherein the target company

issues large number of shares to a friendly party at a price quite below the market price

Forces the acquiring company to purchase these shares from the party to complete the takeover

Strategy discourages takeover by making the deal more difficult and expensive as the corporate raider is required to purchase shares from a party that is friendly to the target company

……..


Once takeover is averted the target company may either buy back the issued shares or leave them floating in the market


Takeover Code

Takeover represented one major unhealthy practice

SEBI issued Substantial Acquisition of Shares and Takeover Regulations in 1994.

Covered both friendly and hostile takeovers

In a friendly takeover SEBI keen on making sure that the minority shareholders get fair treatment

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Concern was deeper in hostile takeover as the acquirer goes ahead with its plan without the knowledge and against the wishes of the existing management

SEBI incorporated provisions to make takeover transparent

Excluded “bailout takeover of companies” i.e. BIFR cases

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Provisions were found inadequate due to in-built ambiguity and loop-holes and failures in takeovers

Failures resulted in appointment of Justice P.N Bhagwati Committee to:Review the guidelines issued in 1994Study the effect of takeovers and mergers on

securities market To evolve appropriate provisions for regulating

takeovers and mergers ……….


Committee concluded:Strong need for takeover code to retain the

confidence of retail investors in the capital marketsNeed to provide an exit opportunity to the investors

in case they do not want to continue with the new management

Full and truthful disclosure to be made on all material information relating to the open offer to facilitate informed decision

Acquirer to ensure sufficiency of financial resources for the payment of acquisition price to the investors

Disclosures be made on all material transactions at the earliest opportunity ............


Clause 40 A and B of the Listing Agreements introduced to protect Minority Shareholders interest

Clauses prescribe a basic framework pertaining to initial disclosure before going ahead with acquisition of shares from the public

Code does not permit a "poison pill" defense, but

empowers Indian companies to block hostile takeovers by foreign companies through Press Note 18.........


Press Note 18

Is in a series of press releases issued by the Indian Ministry of Industry in 1998

Provisions include:Automatic route for FDI and/or technology collaboration would not

be available to those who have or had any previous joint venture or technology transfer / trademark agreement in the same or allied field in India

Investors of technology to the suppliers of the above category need to seek the Foreign Investment Promotion Board / Project Approval Board (FIPB/PAB) route for joint ventures or technology transfer agreements (including trademarks)

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Giving detailed circumstances in which they find it necessary to set up a new joint venture/enter into new technology transfer (including trademark).

Onus on investors/technology suppliers to provide the requisite justification and also proof to the satisfaction of FIPB/PAB that the new proposal would not in any way jeopardize the interests of the existing joint venture or technology/trademark partner or other stakeholders

Rejection or acceptance of proposal with or without conditions is the sole discretion of FIPB/PAB recording the reasons for doing so

Foreign companies wanting to set up new operations in India need to furnish a no objection certificate from Indian joint venture partners, past or present

Certificate has to be submitted to the FIPB

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Regulations are stringent but there is a strong need to keep reviewing the regulations so that they remain in tune with time.


Thank you!

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Chapter 2 Takeover