Vienna MBA
Mergers & Acquisitions
Hostile Transactions I
1
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.)
2
Tender Offers
Tender Offer (takeover bid) -- buying shares directly from
shareholders, at a specified price
• 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
3
Tender offer example: Alcoa bids for Alcan
$58 + 0.4 shares = $73.25 at announcement
Alcoa
May 7, 2007
Alcan
1 share
32% premium
• 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
5
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
6
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
7
Number of Tender Offers in US 1980-2007
250
200
150
100
50
0
80
82
84
86
88
90
92
94
96
98
00
02
04
06
Source: Thomson Financial
8
Tender Offers in Europe 1980-2007
Number of deals
600
500
400
300
200
100
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006
Source: Thomson Financial
9
Tender Offers in Asia 1985-2007
Number of Tender Offer
300
250
200
150
100
50
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007
Source: Thomson Financial
10
Tender Offers vs. Merger (U.S.)
2500
Deal Number
2000
1500
1000
500
0
Tender
Merger
Source: Betton, Eckbo, and Thorburn (2005)
11
Tender Offers vs. Merger (U.S.)
1800
Average Deal Value $M
1600
1400
1200
1000
800
600
400
200
0
Tender
Merger
Source: Betton, Eckbo, and Thorburn (2005)
12
Target return in successful tender offer
Paul Asquith, “Merger Bids, Uncertainties, and Stock Returns”, Journal
Financial Economics
13
Target return in failed tender offer
Paul Asquith, “Merger Bids, Uncertainties, and Stock Returns”, Journal
Financial Economics
14
Bidder return in successful tender offer
Paul Asquith, “Merger Bids, Uncertainties, and Stock Returns”, Journal
Financial Economics
15
Bidder return in failed tender offer
Paul Asquith, “Merger Bids, Uncertainties, and Stock Returns”, Journal
Financial Economics
16
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?
17
The “free-rider” problem
• 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
18
Two-Tier Tender Offer
Two-tier Tender Offer – bidder offers a higher price for the first
x% shares and a lower price for the remaining shares.
•
Increases the likelihood of success in tender offer
•
Benefits those who tender “early.”
In U.S.: Two-tiered offers require pro rata distribution of firsttier, and standard 20-day opening requirement.
In Canada: CBCA requires that all shareholders must receive
identical consideration. This provision deters two-tiered offers
19
Role of large shareholders
In 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)
Tender
Small
Tender
Not Tender
Large shareholder
Not tender
15, 15
10, 10
20, 15
10, 10
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”?
20
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%
23
Frequency of Toehold
(Betton, Eckbo and Thorburn 2008)
Approaches to the target
Casual Pass
– The bidder uses an informal (often anonymous or thirdparty) 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
25
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
26
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
27
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
28
Vienna MBA
Mergers & Acquisitions
Hostile Transactions II
29
Takeover Defenses - Greenmail
Greenmail– A premium paid to a bidder to get him/her to
terminate a takeover attempt.
• 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
30
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)
31
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
32
Strategic defensive measures
• Pac Man
• White knight
• White squire
33
Pac Man: eat or be eaten
Pac Man: Target initiates takeover of acquirer
$700 M
Chesapeake
Sherwood
In 1999
$740 M
Sherwood
Chesapeake
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.
34
White Knight
White knight: Management chooses an acquirer it prefers
Yahoo seeks help from Time Warner / AOL in the Microsoft-Yahoo
takeover battle (March 5, 2008)
35
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)
36
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
37
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.
38
Shareholder Amendments
• The corporate charter establishes the conditions
that allow a takeover.
• Target firms frequently amend corporate
charters to make acquisitions more difficult.
29-39
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.
40
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
41
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
42
Poison pill: Definition I
Technical 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
43
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.
44
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
45
Frequency of poison pills
Number of Deals
900
800
700
600
500
400
300
200
100
83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
Source: Thomson Financial Securities Data
46
Takeover premium and poison pills
41%
45%
40%
35%
32%
30%
31%
25%
25%
20%
15%
10%
5%
0%
Large Cap with
Poison
Large Cap
without Poison
Small Cap with
Poison
Small Cap
without Poison
Large Cap >=$1B; small cap< $1B
Source: Poison Pills and Shareholder Value, Georgeson&Company
47
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
48
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
49
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)
50