Hostile Takeovers
P.V. Viswanath
Class Notes for FIN 648: Mergers and Acquisitions
Framework
 A hostile tender offer begins with an unsolicited offer by a
bidder to purchase a majority or all of the target firm’s
shares.
 The bidder will set the offer for a particular period of time,
at a price, and with a form of payment, and may attach
conditions to the offer.
 The target will ordinarily undertake evasive maneuvers.
 How to analyze a takeover scenario:
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Gain the perspective of the various players in the takeover scenario.
Master important rules and defenses that constrain the players
Anticipate the paths that outcomes may take.
P.V. Viswanath
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Profile of the target of a hostile bid
 Inefficiency Hypothesis:

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Targets of hostile bids show lower sales growth, returns
on equity, and price/earnings ratios.
They have lower insider ownership and suffer
disproportionately from entrenched management and
inefficient use of corporate assets.
They show higher liquidity and unused debt capacity.
Some studies show higher management turnover for
hostile takeover targets.
P.V. Viswanath
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Hostile Bid Targets: an alternative profile
 Investment Opportunities Hypothesis:

Targets present attractive investment opportunities owing to


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strong growth prospects or
synergies.
There is little evidence of poor performance prior to bids.
 Reconciliation:


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Not basket cases, but not stellar performers.
Mediocre performance in which the bidder sees a profitable
opportunity for takeover.
Entrenchment of target management is key: bidders resort to forceful
entry when target managers reject friendly offers.
P.V. Viswanath
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Profile of Hostile Takeovers
 Takeover attempts from 1975 to 2000.
 The odds are not good for the bidder, but the target is
unlikely to remain independent.
Total M&A done deals
Total confirmed, unsolicited
Of those that were unsolicited:
Friendly
Neutral
Hostile
Of those that were hostile:
Target sold to hostile bidder
Target sold to another bidder4
Successful defense, target not sold
P.V. Viswanath
93,312
1.20%
9.70%
58.10%
32.20%
371
24.50%
30.70%
44.80%
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After the bid
 Bidders win significantly positive abnormal returns over the
medium term.
 Target shareholders win as well, receiving higher acquisition
premiums in hostile deals.
 When a target successfully rejects a bidder, the target’s share
price falls but to a price level higher than prevailed ex ante.

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The takeover attempt stimulates a restructuring that unlocks value
for shareholders.
When the bidder offere cash, the returns are more positive still.
P.V. Viswanath
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Players in the game
 Bidder: entrepreneurs who discover profitable opportunities.
 Target: the profitable opportunity
 Free riders: other shareholders who profit by the actions of
the bidder.
 Groups within the target
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Managers vs. directors
Insiders vs. outside directors
Large shareholders vs. small shareholders
 Other potential buyers: white knights and white squires
 Arbitrageurs
P.V. Viswanath
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Estimating Return to the Arb
 The target receives a bid at $60, when its shares are trading at $40.
The price leaps to $57.
 The bidder’s share price declines $3 (from $53) upon the
announcement to close at $50.
 This price is assumed to drop further by $1.
Assumptions
Position and Payoff in Target Shares
Buy Target shares at
Value of Target Shares at End of Holding Period
Gross Spread Per Share on Target shares
Position and Payoff in Buyer Shares
Short Buyer shares at
Value of Buyer Shares at End of Holding Period
Gross Spread Per Share on Buyer shares
Total Assets of the Arbitrage Position
P.V. Viswanath
Days in Holding Period
40
20
$
$
$
57.00 $
60.00 $
3.00 $
57.00
60.00
3.00
$
$
$
50.00 $
49.00 $
1.00 $
50.00
49.00
1.00
$
57.00 $
57.00
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Estimating Return to the Arb
Short Position in Buyer Shares
Borrowed shares of Buyer
Debt @ % Assets
Capital Employed
Total Liabilities and Capital of the Arbitrage Position
Net Spread Calculation
Gross Spread
-Interest @
- Short Dividends Foregone
+ Long Dividends Received
Net spread
Results
Return on capital for holding period only
Return on capital annualized
P.V. Viswanath
$
$
70% $
$
$
50.00
(50.00)
39.90
17.10
57.00
$
$
$
$
$
50.00
(50.00)
39.90
17.10
57.00
$
10% $
4.00 $
(0.44) $
($0.20)
$0.30
3.66 $
4.00
(0.22)
($0.20)
$0.30
3.88
$
21%
195%
23%
414%
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Arbitrage Spreads
 Price offered by bidder minus market price of target
 Negative spreads imply that arbs expect a higher
offer to be forthcoming soon.
 Positive arbitrage spreads indicate that arbs think
offer is unlikely to be topped.
 A very large spread might mean that the arbs doubt
that the offer will be consummated at all.
P.V. Viswanath
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Analyzing the Arbitrage Spread
Pcurrent  (Prob x Pbid )  [(1 - Prob) x Pstand-alone ]
 Pstand-alone can be estimated as the pre-bid price of
the target
Examples: Four Pending Deals on July 18, 2003
Target's Price
Target
Bidder
Current Bid Price Pre-Bid* Probability of Closing
PeopleSoft
Oracle
$ 17.82 $ 19.50 $ 15.00
63%
Dana
ArvinMeritor
$ 15.54 $ 14.99 $ 11.50
Expect Higher Bid
Clayton Homes Berkshire Hathaway $ 13.01 $ 12.50 $ 11.00
Expect Higher Bid
Handspring
Palm
$ 0.99 $ 1.45 $ 0.85
24%
* Using the pre-bid price in this calculation assumes that it is a fair estimate of the target's
value per share if the deal does not close.
P.V. Viswanath
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Two-tier tender offers
 In 1988 Robert Campeau made a tender offer for Federated
Department Stores. Here is a simplified version.
 Suppose that the pre-takeover price of a Fed share is $100.
Campeau offers to pay $105 per share for the first 50% of
the shares, and $90 for the rest. All shares, however, are
bought at the average price of the total shares tendered. If
the takeover succeeds, the shares that were not rendered are
worth $90 each. If not, all shares are returned.
 e.g. if 75% of the shares are tendered, Campeau pays $105
to the first 50% and pays $90 to the remaining 25%. The
average price that Campeau pays is then equal to
P = 105 x (50/75) + 90 x (25/75) = 100
P.V. Viswanath
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Two-tier tender offers
 In general, if s percent of the shares are tendered the average
price paid by Campeau, and thus the price of a tendered
share, is given by
 P = 105 if s < 50 and P = 105x(50/s) + 90x(s-50/s) if s > 50
 If everybody tenders, i.e., s =100, then Campeau pays $97.5
per share which is less than the current market price. So, this
looks like a good deal for Campeau, but only if sufficiently
high number of shareholders tender.
 The question is – will target shareholders tender?
P.V. Viswanath
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Reaction of target shareholders
 The options for A & B, the two shareholders, are “Tender”
or “Hold Off.” We assume that one share (out of two) is
enough for the raider to gain control.
 The first entry is A’s payoff and the second is B’s.
A
Tender
Hold Off
B
Tender
Hold Off
97.5, 97.5 105, 90
90, 105
100, 100
 A’s optimal strategy is to tender independent of what B does.
If B tenders, then A gets 97.5; if B doesn’t tender, he gets
105, compared to payoffs of 90 and 100 for holding off.
 Since the same holds for B, they will both tender.
P.V. Viswanath
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White Knights
 So it looks like a great deal for Campeau. But there is an
incentive for a spoiler. Suppose Macy comes in and offers $102.
 We assume that both shares are needed for a takeover.
 Now the deal looks more like this.
A
Tender
Hold Off
B
Tender
Hold Off
97.5, 97.5 102, 102
102, 102 102, 102
 Now the optimal strategy is no longer to tender to Campeau.
 In fact, Macy offered substantially more and Campeau had to
bump up his offer. He ultimately won, but he paid about 2.5 times
the pre-acquisition price of Federated.
 He had to take on so much debt that he ultimately went bankrupt.
P.V. Viswanath
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Two-tier tender offers
 Coercive two-tier tender offers are not legal any
more.
 However, it’s possible to structure incentives so that
early tenders get a large and more certain payment.
 Later tenderers could be implicitly threatened by a
future “minority shareholder freeze-out.”
 Still, arbs have to assess the reaction of other
shareholders.
P.V. Viswanath
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Value of not tendering
 The arb will tender unless the expected value of not
tendering (EVNT) is greater than the dollar value of the
tender offer.
 EVNT = [Sno-competing-bid.Pr]+[Scompeting-bid.(1-Pr)]
 Hence the raider must offer a price > EVNT.
 Sno-competing-bid can be based on an assumption that the target
will not restructure or that it will try to unlock value.
 The bidder can do a sensitivity analysis and consider the
reasonableness of the various alternatives to decide how to
bid.
 The bidder can pre-emptively bid high (bear hug) or bid low,
which might lead to a longer contest.
P.V. Viswanath
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Takeover Defenses
 Decrease the perception of intrinsic value of target
to attacker.
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Spin-offs, special dividends, asset sales, options to sell
“crown jewels,” threats of union opposition or of
customer defections.
Synergies and other benefits may only become available
following a takeover of operations, restructuring and
integration with buyer.
Delay benefits of takeover by using staggered boards,
supermajority provisions, waiting periods, presenting
arguments to antitrust regulators (if target and attacker in
same industry)
P.V. Viswanath
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Takeover Defenses
 Increase the price paid by attacker.
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Golden Parachutes
Poison Puts
Topping or breakup agreements
Target management may have knowledge of hidden values not know
to the market, such as dormant land carried at cost rather than market
value on the books. Disclosure of such hidden values might help
persuade shareholders to hold out for a higher price.
Poison Pills
 Increase transactions costs of attacker by defensive litigation
and defensive appeals to regulators.
P.V. Viswanath
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