The Hostile Takeover

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When a company is either placed on the market voluntarily, or becomes the target of hostile or other acquisitive activity, the company is in a precarious state. Rapidly, any outstanding shares of the company are acquired by what are known as “risk arbitrageurs” or “arbs” who are betting on whether or not the deal will close. At this point, the company is said to be “in-play”, and it is only a matter of time either before a deal is completed or the company will be forced to overhaul its management.

White Knight: 
A "white knight" is a colloquial term for an investor, or group of investors, that is contacted by management to help support its reorganization goals and oppose those of a hostile bidder. Typically, management will seek a “white knight” who is willing to leave the current board and management in position, and allow them control over the company’s future.

A “13-D” is a regulatory filing required by section 13(d) of the Securities and Exchange Act of 1934 (currently codified as 15 USCS § 78m(d)) for the acquisition of any publicly traded company). Once an individual (or associated group) of shareholders has acquired more than 5% of the outstanding shares of a public company, that shareholder is required to file a “13-D,” which discloses the size of the holding, identifies the shareholder, and discusses the shareholder’s plans and interests in acquiring such a large stake.

A company may choose to expand its debt load by “leveraging” its debt. “Leveraging” means that a company has certain amounts of cash on hand and is able to use that cash and the company’s assets to secure high levels of borrowing. Typically, in a leveraged transaction, the goal of the leverage is to acquire sufficient capital to buy out shareholders and to give the company a new start with the primary goal of smoothing operations while quickly paying off the company debt.

Introduction to Hostile Takeovers

Corporate legal professionals, as you may have previously discovered, don’t necessarily get a great deal of excitement in their professional career. Negotiating deals and working out tax beneficial strategies may be exciting to some - but not too many. However, when it comes to legal excitement, it is only the rare courtroom drama that can compare with the thrill of a hostile takeover transaction. 

The hostile takeover is not a unique type of business combination. It will either take on one of the business combinations that we have studied previously in this chapter or it will be a simple stock transaction, which we will discuss more in the following chapter. Regardless of the form of the transaction, the thing that adds special flavor to a hostile takeover is the fact that, as the name implies, it is hostile. In other words, a hostile takeover is the result of a situation where the incumbent board of the company, and some percentage of its shareholders, are refusing to sell the company to a would-be buyer. The existing board works to maintain its control over the company, while the hostile bidder positions itself to accomplish its goal of acquiring control over the company.

What might be interesting here are real-world examples of hostile takeovers.

Setting the Scene- The Recent History of the Hostile Takeover

EXAMPLE: Imagine the setting. The directors of Happy Co. are busily operating its business when they discover that a single individual or company has acquired a significant percentage of the company’s stock. Happy Co.’s board had failed to notice the sizable acquisition right up until the point when the SEC informed them that Acquire Co., a known “corporate raider”, had filed its "13-D," a form that Acquire Co. is required to file with the SEC once its holding reaches greater than 5% of Happy’s outstanding stock.

As a member of Happy Co.’s board, how do you respond?

The scenario described above, which we will follow to its conclusion below, was fairly typical throughout the 1980’s. Essentially, an environment of relatively cheap and available capital created a situation where small organizations – often styling themselves as Leveraged Buyout (LBO) Firms or alternatively, “vulture investors” – would raise large pools of capital that they would subsequently use as a means of acquiring various operating companies. 

In such an environment, two opinions generally emerged during the process of a takeover bid. Many investors in the target companies joined the various investment firms that were financing these corporate takeovers. From these investors’ perspectives, their corporations' management had been acting too conservatively and failing to work aggressively to make the company more profitable. From this point of view, investors felt that corporate raiding was a good thing that took companies and assets out of the hands of poor managers and placed them in the hands of aggressive, talented managers who were prepared to work hard to make companies realize their full potential. 

From the perspective of incumbent management and often the corporate employees as well, hostile takeovers simply represented greed run rampant. As these investors acquired their target companies, they typically would cut the firm’s operating expenses aggressively – slashing overhead and cutting jobs in the process. Moreover, the transactions structured by these investors in acquiring the companies often included adding a great deal of debt to the acquired company’s balance sheet in order to finance the transaction of acquiring the company. 

Ultimately, the likely result was that all parties involved – management, the employees, and the interceding investors – had varying opinions as to how to manage the company and often led to chaos within the ranks of the corporation. Time has shown that such transactions rarely netted investors huge profits, but they often did have the effect of streamlining management and trimming corporate “fat” from the target companies. There is no question that some of the transactions structured during the “takeover craze” of the 1980’s were financially unsound and more about short-term gain than for the long-term growth of the companies and the economy. However, not nearly as many jobs were lost as had been feared would result from these transactions, and many employees found themselves working for much more capable management than they worked for before the takeovers.

EXAMPLE: Happy Co’s board initially responds with a media blitz describing the solid nature of the firm and its management. The Board cites the company’s long tradition of treating employees with respect and it points to the accolades that management has received. Concurrently, Acquire Co. has begun lining up other investors and speaking with financial experts to determine the nature and amount of any bid it should make for Happy.

The reason why we are studying hostile takeovers, despite the fact that hostile takeovers are not longer as common, is that such transactions continue to occur. While excessive leverage is no longer common in such deals, it continues to be the case that hostile transactions do occur and it is important to understand both the lingo and options that will be discussed in such a situation.

Management’s Reaction

Faced with a hostile bidder, management has a handful of options at its disposal to consider as possible responses to the hostile offer. The list that follows provides brief summaries of those responses. Keep in mind, however, that a creative management team may develop means of its own to respond to a bid, or combine any or all of the methods below as a method of stopping or stalling the hostile suitor.

1. Propose a Management Plan
When putting forth a hostile bid, the incoming bidders typically will disclose – either of their own free will or because they are required to do so by the SEC – their plan for reforming the firm. However, even if the buyer does not disclose its plans, management may themselves propose a slate of changes that they feel will win the approval of shareholders and provide the same beneficial changes as those suggested by the hostile bidder.

Depending on the perspective of the shareholders and the price that is offered by the buyer, management’s proposing its own plan may be greeted in any of a number of ways. In a situation where the proposing buyer is viewed as not only hostile, but potentially destructive of corporate value (such as when the buyer has a track record of dissolving companies quickly for its own benefit), then management’s plan may be welcomed by the shareholders and the employees of the company. On the other hand, it’s also possible that management’s plan may be viewed with disdain by the shareholders. Such a response is usually combined with the observation that management is offering “too little, too late.” If management could have put the plan forward before, why did they fail to do so? Was it because they were protecting their jobs? Finally, and most likely, shareholders often view management presenting its own plan as simply a negotiating tactic that calls for the hostile suitor to   raise its bid in response. 

EXAMPLE; With its media campaign underway, the Board of Happy Co. now begins to look for other options. Having received a copy of Acquire’s “13-D” filing and having some insight as to what the buyer’s plans for the firm are, Happy’s board now begins to formulate its own strategy for revamping the firm. Their plan includes a major reorganization, the sale of some non-core assets, and the curtailing of many executive perks. The plan is viewed by shareholders and the general market with mixed emotions. While the sale of assets and the cuts on executives’ perks are well received, the media is calling into question why the assets were purchased in the first place and how management was allowed to accumulate so many benefits. Moreover, if these changes were in the best interest of the company, ask Happy’s shareholders, why were they not instituted before?

2. Find a White Knight
Management may also respond to a hostile suitor by finding an alternative bidder that it finds to be less threatening. Typically, when faced with a hostile bidder, management will look to other potential buyers – including other major shareholders, other investment funds, or even competitors in the industry – that management would prefer to see assume control of the company, rather than the hostile bidder. 

In a situation involving a new bidder – the so-called “white knight” – management is taking some risks. By involving multiple bidders, the company is inviting itself into a situation where it may be required to either auction the company to the highest bidder, or to enter into a scenario where a host of additional bidders might enter the fray, since, by soliciting bids, the company has placed itself, at least in the public’s mind, “in-play.”

EXAMPLE: Management’s next step is to begin searching for another buyer. In the process, they speak to Compete Co., a competitor of Happy’s that had, in the past, indicated an interest in acquiring Happy. Management offers Compete favorable deal terms in return for adopting a portion of management’s plan and retaining the current executives. Compete takes the offer into consideration, but voices a concern that it does not want to enter an “auction” scenario where the price of Happy is bid on by multiple suitors until the company is sold to the highest bidder – not necessarily the bidder best equipped to run the firm.

3. Stagger the Board
We already discussed the staggered board before. A "staggered" board provides that only a certain percentage of the board of directors is elected during each year. A staggered board creates a situation where an incoming buyer who is attempting to take over the company by way of a proxy solicitation leading to election of their own slate of directors, will require several years to complete the acquisition.

EXAMPLE: Happy’s board also quickly produces a board initiative to require that the board be staggered. The new board, which is to consist of nine members rather than the current 5, is to be staggered over three years, with three directors elected per year.

4. Adopt a Poison Pill
In the final section of this chapter, we will discuss the “poison pill” as a tool used by companies to protect themselves from hostile buyers. For now, keep in mind that a poison pill serves to discourage a hostile takeover attempt and/or to help insure that management has additional leverage in negotiating with the incoming bidder.

The Buyer’s Perspective

Like the incumbent management, the bidder also has a certain set of options for initiating and completing the takeover bid. The list that follows is a sample listing of such maneuvers.

1. Buy 
The easiest way that an acquirer can gain control of a target company is to simply acquire a large percentage of the company and thus secure actual control of the firm. While this is the easiest method in form, it is often the hardest to put into practice. The SEC has some very specific limits as to the acquisition of shares by a bidder after initiating a bid. See 15 USCS § 78n(d). In most cases, such a buyer is not allowed to purchase shares except through the bid itself, and cannot circumvent the process for any reason. [As an aside, you may notice that the statutory citations in this area are federal, not state. It is federal regulation, not state law, that deals with the takeover process. The Supreme Court has ruled that the states may not promulgate rules that restrict or regulate takeovers because that would be too great an infringement on interstate commerce, which is the federal government’s job to regulate and control. See Edgar v. MITE Corp., 457 U.S. 624 (1982).] Additionally, the sheer cost of acquiring a control position in a large company may be difficult or impossible for a single bidder to raise sufficient funds to accomplish the takeover.

EXAMPLE: Acquire, anticipating Happy’s move, has assembled a “syndicate” – a group of investors in addition to itself, who are willing to help finance Acquire’s plan – to complete the deal. However, as the price of Happy’s shares continues to climb because of speculation as to the possibility of the takeover bid, it is not clear if the syndicate will be able to raise sufficient funds to finance the transaction.

2. Proxy Contest
As we discussed previously, a proxy contest is where an incoming bidder offers its own slate of directors at the annual election and solicits proxies from other shareholders to get that slate elected. This can be an efficient way of effecting a takeover. The problem with such a plan is that it is inherently unstable, as voters can switch sides without notice and can be lost quickly.

3. “Bear Hug”
Another technique, employed less frequently but effective when executed properly, is for the incoming bidder to offer a price that is simply too good for the target company to pass up. Such a scenario is generally only used in small acquisitions where a large firm is acquiring a small firm, typically because it wishes to acquire an asset or customer from the small firm. In a “bear hug,” the buyer offers a price that is so high that no other buyer is likely to match the offer. The Board, based on the desire of the shareholders to maximize their investment return, is, in essence, "forced" to accept the bid. 

EXAMPLE: Having added several new investors to the syndicate, and before any other bidder – including Compete Co – is able to make an offer, Acquire substantially raises its offer. The new level of the offer, in addition to the fact that the syndicate is quite large and has involved most of the major funding banks for such transactions, makes Happy’s board face the fact that their options are limited, and it may be time to consider maximizing shareholder value, rather than protecting their own jobs. Therefore, the option of accepting Acquire’s bid becomes the best, and perhaps only realistic, option.

The Outcome

Once a hostile takeover, or any change of control transaction, has begun, there is usually no way to reverse it. After a company has been placed on the market, the inevitable outcome is such that it will ultimately be either acquired by another firm or be forced to markedly change its operations and management. The problem with such situations is that they are inherently unpredictable as buyers enter and leave the fray based on the prospects of the deal closing in their favor. Such transactions represent the best “show” in the corporate legal practice and provide ample opportunity for any legal professional to learn how businesses are bought, sold, and changed.