Corporate Takeover Defences

A takeover process can be either hostile or non-hostile. A hostile takeover occurs when there is an attempt to take over a company without the explicit approval of the board of directors of the prey company. Since there is the lack of initial board consent, there can be hostility, hence the definition. However, if the board does not approve of a takeover, or wants to deter takeovers, then they may implement some tactics to defend themselves against a hostile bid and protect the company. There are a range of deterrents or direct defences that can be used including the Pac-Man defence, the golden parachutes method and the use of a poison pill. This tutorial will look at each of these ideas and how they work.

Method 1: The Poison Pill

The poison pill method is fairly common, with a major example being that of Netflix in late 2012; see the news headline below.

This is a defence mechanism that increases the cost of making a takeover to any party who is seeking to make an offer. In the case of Netflix, the poison pill essentially meant that if any investor bought more than 10% of the shares in issue, a raft of new shares would be injected into the market, thereby diluting their stake back down. Mylan, a pharmaceutical multinational based out of the Netherlands, recently constructed its own poison pill to fend off a potential takeover from Israel based Teva. The pill enabled an external foundation to buy enough Mylan stock to help block a takeover in the event of a takeover offer. It essentially transferred voting power across from shareholders to this external foundation.

Other poison pills may see company employees issued with generous stock options that have a takeover-conditional vesting condition. In other words, these options will only be exercisable if a company makes a takeover offer. In such a circumstance, these stock options would dilute the holders of the company. A final common type of poison pill would give shareholders the option to purchase additional shares in the company at a material discount to the prevailing market price with a similar dilutive result. The range of poison pills on offer will depend upon the jurisdiction involved; some methods may be illegal in certain jurisdictions.

Method 2: Excessive Golden Parachutes

A golden parachute is a clause in a directors contract that states how much they will be paid should, for example, a predator try to takeover the company and instigate a change of management. They are essentially compensation packages, so if they have their contracts terminated post-takeover then they would typically receive significant payments.

Golden parachutes have been criticised for mis-aligning shareholders objectives with that of management, but they can on occasion be a useful tool for deterring a takeover. Excessive golden parachute payments can increase the restructuring cost of the company being taken over. In addition, unless you intend to keep the existing senior management, the predator company will have to pay significant sums of money to eject the management from their positions, which can be a time consuming and unsettling process, especially if the takeover is hostile as suggested.

Method 3: Pac-Man Defence

The Pac-Man defence is a radical option only really open to companies that are on a relatively level playing field in terms of market cap and financial power. The strategy involves launching a counter-bid to try and takeover the predator. In other words, the prey launches a takeover of the predator! This is dubbed the Pac-Man strategy since when Pac-Man eats a 'power pellet' he is capable of chasing and eating the ghosts, when the ghosts were previously chasing him.

A high profile example of this defence in action involved Volkswagen and Porsche in a multi-year struggle of power. Initially, in 2008, Porsche launched a takeover bid of Volkswagen and acquired half of the share capital in a series of transactions. Porsche made it abundantly clear in their annual report that they were seeking to acquire Volkswagen, and the relevant excerpt from the annual report is below.

However, in 2012, after around four years of wrangling, Volkswagen and Porsche entered into a £3.6bn merger deal that saw Volkswagen acquire the remaining 50.1% of the stock that it didn't own. The Pac-Man defence is popular in certain power struggle situations because, if successful, the board of the initial prey company can seek to remove the initial predators. However, there is often little distinction between protecting shareholders and directors covering their own back in these scenarios.

Method 4: Introducing a White Knight

The white knight method tries to divert attention away from a hostile bid by introducing a white knight third party who will launch a takeover bid instead, and who will do so in a non-hostile way. Quite often the prey company will seek out a white knight if they believe it to be in the best interest of their shareholders, and that is usually done through hiring an investment bank to conduct a scan of potential suitors.

A relevant example includes a company called Allergan Inc. who were under a hostile takeover bid from Valeant Pharmaceuticals International in Q4 2014. However, white knight company Actavis stepped into the frame and hijacked the takeover with the backing of Allergan, leading to a combination of the two companies in a $23bn deal.

Method 5: Initiating a Standstill Agreement
A standstill agreement is an agreement between the predator company and the prey company that, once signed, prevents the predator from purchasing further shares in the prey company for a specified time period; the predator company enters a standstill period. This period of time enables the prey company to properly assess any alternative options, but often requires the prey company to compensate the predator for this agreement.
However, a standstill agreement can complicate proceedings and lead to shareholder value being lost of the takeover is pulled at the end of the period. A recent standstill agreement, between Intel and Altera Corp, was signed early in 2015 and expired in May. The deal, if it goes ahead, could exceed upwards of £8bn.

Alternative Methods

6.  A major capital structure change can act as a powerful deterrent against any predators looking to acquire the company. A capital structure change could involve a large share issue, a major issuance of long-term bonds or the initiation of a share buyback programme.

7.  A fire sale of the company may actually be a preferred method compared to a low-ball hostile takeover offer. A fire sale is where a company rapidly sells its assets and then seeks to distribute the cash proceeds to shareholders. This method only really works if the shareholder value gained from a fire sale is likely to exceed the takeover offer value. In reality, this method is used in times of desperation.

8.  One of the more common methods involves launching legal proceedings against the predator company in the belief that they can block the deal through an injunction. Alternatively, the prey company may appeal to the relevant competition authorities in the hope they can convince them that the deal is anti-competitive and persuade them to use their regulatory powers to block the deal.

9.  The Crown Jewels defence involves the prey company recognising what the most attractive part of their organisation is and separating it in the event of a hostile takeover offer. For example, suppose the most attractive part of a mining company is the commodities broking division. In the event that there is a hostile takeover bid, the prey company may opt to sell the commodities broking division, thereby removing the main attraction for the predator, who may then retract their offer. The 'crown jewels' of the company are sold. Again though, this may be a high price for shareholders to pay if the price achieved during the rush to sell doesn't reflect the maximum value that can be extracted.

10.  The Greenmail method involves repurchasing stock held by a predator that may be looking to initiate a hostile takeover. For example, suppose that Predator PLC holds 15% of the shares in Prey PLC. Prey PLC may choose to use the greenmail approach and buy back Predator's 15% stake at a significant premium to the prevailing market price, in order to deter any hostile takeover move. However, this is costly and may concern other shareholders.