Sunday, November 15, 2009

Takeover defenses: How effectively have Indian companies used them?

As the Indian economy moves towards greater competitive edge both in domestic and foreign markets, the internal structuring and bearings of the Indian companies are also undergoing a sea change. Such changes are usually wrought about by corporate maneuvers like merger, demerger, takeover, alliances, privatization of public sector undertakings etc. Takeover can be formally defined as ‘acquisition of a certain block of equity capital or controlling interest in a company which enables the acquirer to exercise control over the affairs of the company’ and can be categorized broadly into two types a hostile takeover in the former case and a friendly takeover in the latter.

As a company sitting over a pile of cash becomes a target of hostile takeover raids, the managers of the targets and sometimes a resourceful attorney start to devise plans in order to thwart the raiders ambition, sometime the defenses are questionable at best and methodology were unethical to say the least, however nonetheless any effective counter either using a loophole in law or by milking the system is seen as a victory for the defense as the raiders are always at a comparative advantage than the target as they can choose the time of raid which is mostly at the time the defenses are at the ebb. As obvious from the discussion in the paragraphs above a takeover is hostile when the target does not want to be acquired and rejects, if any, offer of ‘friendly’ takeover.
Takeover defense can be categorized into four broad segments, firstly to make the target look unattractive which can be achieved by Poison Pill, Crown jewel defense, Scorched earth defense, leveraged recapitalization, poison put, shark repellant, secondly to counterattack the raider by bidding to takeover the raider it includes Pac man defense, killer bees, thirdly to negotiate with the raider to call off the raid usually at a premium this may include Greenmail, targeted repurchase and fourthly ask for third party help like in white knight, black knight, white squire, bankmail, whitemail etc. This post will discuss the various strategies in brief and then would try to find out how wisely and effectively have the Indian companies used such defensive strategies wither knowingly or unknowingly to beat back the raiders.
Now let us discuss the various takeover defense strategy in brief and see how effective they have been when used in Indian scenario, before we venture we must however remember that most Indian companies are family owned business entities where they are themselves the promoters and hold more than 50% of the shares thereby making hostile takeover impossible, also the silent creeping acquisition of shares by raider route has also been blocked by SEBI through its mandatory disclosure by acquirer and other policies:
Poison Pill – This strategy involves issue of low price preferential shares to the existing shareholders to enlarge their capital base. This will make hostile takeover too expensive. Wikipedia says that it was invented by an US attorney to defend the El Paso Natural Gas takeover. This can also take shape of a special issue share which on completion of a hostile takeover entitles the holder to buy two shares at the price of one, thus increasing the price cost of acquisition. A variation would include a lobster trap is an anti-takeover strategy used by target firms. In a lobster trap, the target firm issues a charter that prevents individuals with more than 10% ownership of convertible securities (includes convertible bonds, convertible preferred stock, and warrants) from transferring these securities to voting stock. Other variations include flip in, flip out etc.
Crown jewel defense – When a company is threatened with takeover, the crown jewel defense is a strategy in which the target company sells off its most attractive assets to a friendly third party or spin off the valuable assets in a separate entity. Consequently, the unfriendly bidder is less attracted to the company assets. Other effects include dilution of holdings of the acquirer, making the takeover uneconomical to third parties, and adverse influence of current share prices.
Leveraged buy outs - In corporate finance, a leveraged recapitalization is a strategy often used to fend off a hostile acquisition. Under this strategy, a company incurs significant additional debt to repurchase stocks through a buyback program or distributes a large dividend among the current shareholders. This will cause the share price to increase significantly, making the company a less attractive takeover target. Following a leveraged recapitalization, a raider would pay more, thus minimizing any gains and acting as a deterrent. Download and try reading 'Barbarians at the gates' for more perspective in LBO.
Shark repellent – Amending the memorandum or articles of the company to make the takeover complex and costly and thereby making the target unattractive.
The scorched-earth defense – It is a form of risk arbitrage and anti-takeover strategy. When a target firm implements this provision, it will make an effort to make it unattractive to the hostile bidder. For example, a company may agree to liquidate or destroy all valuable assets, also called "crown jewels", or schedule debt repayment to be due immediately following a hostile takeover. In some cases, a scorched-earth defense may develop into an extreme anti-takeover defense called a "suicide pill"
The Pac-Man defense – It is when a company that is under a hostile takeover attempts to acquire its would-be buyer. The most quoted example in U.S. corporate history is the attempted 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. The incident was labeled a "Pac-Man defense" in retrospect.
Killer bees – This defense uses firms or individuals that are employed by a target company to fend off a takeover bid; these include investment bankers (primary), accountants, attorneys, tax specialists, etc. They aid by utilizing various anti-takeover strategies, thereby making the target company economically unattractive and acquisition more costly.
Greenmailing – It is a variant of the corporate raid strategy of asset stripping. However, once having secured a large share of a target company, instead of completing the hostile takeover, the greenmailer offers to end the threat to the victim company by selling his share back to it, but at a substantial premium to the fair market stock price. Whilst benefitting the predator, the company and its shareholders are impoverished. From the viewpoint of the target, the ransom payment may be referred to as a goodbye kiss. The origin of the term as a business metaphor is unclear, although it will certainly be understood in context as kissing the greenmailer and, certainly, a few million dollars goodbye. A company which agrees to buy back the bidder's stockholding in the target avoids being taken over. In return, the bidder agrees to abandon the takeover attempt and may sign a confidential agreement with the greenmailer who will agree not to resume the manoeuvre for a period of time.
Lock-up provision - is a term used in corporate finance which refers to the option granted by a seller to a buyer to purchase a target company’s stock as a prelude to a takeover. The major or controlling shareholder is then effectively "locked-up" and is not free to sell the stocks to a party other than the designated party (potential buyer). Typically, a lockup agreement is required by an acquirer before making a bid and facilitates negotiation progress. Lock-ups can be “soft” (shareholder permitted to terminate if superior offer comes along) or “hard” (unconditional). These provisions may take the form of (i) break-up/termination fees, (ii) options given to target shareholders to buy target stock, (iii) rights given to target shareholders to purchase target assets, (iv) force the vote provisions in merger agreements, and (v) agreements with major shareholders (voting agreements, agreements to sell shares or agreements to tender). In a stock lock-up, the bidder is able to either purchase 1) authorized but unissued shares of the major or controlling stockholder, or 2) the shares of one or more large stockholders. The acquirer holds the option to exercise the shares at a higher price in the event of sale to a higher bidder, or to vote in favor of the acquirer’s bid. An asset lock-up occurs when the target firm grants an option for the acquisition of an asset. This is also known as a crown jewel lock-up. In many cases, lock-up provisions may impede “free competition”, and thereby restrict the market from acting naturally by preventing rival bids for the target company. Courts will approve lockups if they find that the lockup was used to encourage a bidder to make an offer and not as a device to end an auction or bidding process. Asset lock-ups, however, discourage other bidders, and are generally discouraged by the courts.
Targeted repurchase – It is a technique used to thwart a hostile takeover in which the target firm purchases back its own stock from an unfriendly bidder, usually at a price well above market value. In the event of a hostile takeover attempt, a target company can use a top-up to increase time for enhancing takeover defenses. Stock repurchases are often used as a tax-efficient method to put cash into shareholders' hands, rather than pay dividends. Sometimes, companies do this when they feel that their stock is undervalued on the open market. Other times, companies do this to provide a "bonus" to incentive compensation plans for employees. Rather than receive cash, recipients receive an asset that might appreciate in value faster than cash saved in a bank account. Another motive for stock repurchase is to protect the company against a takeover threat.
Bankmail – In a bankmail engagement, the bank of a target firm refuses financing options to firms with takeover bids. This takeover tool serves multiple purposes, which include 1) Thwarting merger acquisition through financial restrictions, 2) Increasing the transaction costs of the competitor’s firm to find other financial options, and 3) to permit more time for the target firm to develop other strategies or resources.
White knight – It may be a corporation, a private company, or a person that intends to help another firm. There are many types of white knights. Alternatively, a gray knight is an acquiring company that enters a bid for a hostile takeover in addition to the target firm and first bidder, perceived as more favorable than the black knight (unfriendly bidder), but less favorable than the white knight (friendly bidder). The first type refers to the friendly acquirer of a target firm in a hostile takeover attempt by another firm. The intention of the acquisition is to circumvent the takeover of the object of interest by a third, unfriendly entity, which is perceived to be less favorable. The knight might defeat the undesirable entity by offering a higher and more enticing bid, or strike a favorable deal with the management of the object of acquisition. The financial standing of the struggling firm could prevent any other entity being interested in an acquisition. The firm may already have huge debts to pay to its creditors, or worse, may already be bankrupt. In such a case, the knight, under huge risk, acquires the firm that is in crisis. After acquisition, the knight then rebuilds the firm, or integrates it into itself.
White Squire – A white squire is similar to a white knight, except that it only exercises a significant minority stake, as opposed to a majority stake. A white squire doesn't have the intent to take over a company, but rather serves as a figurehead to a defense to a hostile takeover. The white squire may often also get special voting rights for their equity stake.
Whitemail – It is an anti-takeover arrangement in which the target company will sell significantly discounted stock to a friendly third party. In return, the target company helps thwart takeover attempts, by raising the acquisition price of the raider, diluting the hostile bidder’s number of shares, and increasing the aggregate stock holdings of the company.


  1. This comment has been removed by a blog administrator.

  2. thank you..,im doing my mba project on take overs..., this is realy usefull for me..

  3. thanks...great article...helped me in my exams


  4. I am really impressed along with your writing skills and also with the format on your blog.