How Investment Banking Can Keep Your Company from Being an M&A Target - dummies

How Investment Banking Can Keep Your Company from Being an M&A Target

By Matt Krantz, Robert R. Johnson

Working with their investment bankers, corporations can take actions that make themselves less attractive to potential suitors. These actions have spawned the most colorful and descriptive language in the world of finance. In fact, the whole class of actions intended to discourage unwanted takeover overtures is sometimes referred to collectively as shark repellent, because it’s meant to ward off the sharks.

Some defense mechanisms are put into place before a hostile takeover bid, and others are enacted after a hostile takeover has been attempted. These measures include the following:

  • Poison pills: A poison pill allows shareholders the right to buy shares of the company at a substantial discount to market value if one shareholder acquires a certain percentage of a company’s stock — say, 20 percent.

    Because the entity acquiring the large position is prohibited from participating in the purchase through the poison pill, the potential acquirer would suffer substantial dilution in percentage ownership, rendering the takeover prohibitively expensive and discouraging any takeover attempt.

  • Poison puts: Poison puts are similar to poison pills, except that they grant the target firm’s bondholders the right to sell their bonds back (or put them) to the company. This discourages takeovers because it raises the cost of the transaction. Additionally, the bondholders are often entitled to a substantial premium to current market value under the terms of the poison puts.

  • Golden parachutes: Golden parachutes are compensation packages of the senior management of companies that provide for large payouts — often several times annual salary — in the event that the executive loses his job as a result of a change in corporate control. If these agreements extend further down in the organization, they’re called silver parachutes.

    Either way, they serve to make the acquisition less attractive by raising the cost of the takeover by the amount of the agreements. The proponents of golden parachutes contend that they’re necessary because corporate executives may be quick to abandon ship and seek employment elsewhere if their firm were being courted by another firm.

  • Staggered boards of directors: In lieu of electing the entire board of directors each year, a firm may arrange to have board members appointed for longer terms and have only a portion of the directors sitting for election in any given year. The effect of this is to discourage an unfriendly party from taking control of the board via a vote in any given year.

  • Supermajority voting: Firms can adopt a requirement that a higher percentage than a simple majority of shareholders must vote to approve a merger. This requirement could be as high as 75 percent or 80 percent. The provision may enact an even higher standard by precluding the hostile acquirer from participating in the vote. This makes it practically impossible for the acquirer to obtain enough votes to approve the takeover.

  • Acquiring debt: Firms can simply make themselves less attractive to potential acquirers by leveraging up their own balance sheets, or borrowing heavily. By loading up with debt, companies exhaust some of the unused debt capacity that is so highly valued by acquiring firms. If a firm has little unused debt capacity, a potential acquirer has less flexibility if the firm were to be acquired.

  • Fair price amendments: The bylaws of certain corporations require that a company seeking to acquire it must pay a “fair price” to targeted shareholders. The provisions vary from company to company, but one example is that the acquirer must pay at least as much as the highest price the target firm has traded for in the market for a given period of time.

    A second element of fair price amendments is the prohibition of a two-tiered tender offer. These tenders happen when the acquirer offers a higher price in the first tender offer and threatens a lower bid in a second step for those shareholders who fail to sell right away. This ensures that all shareholders receive the same amount per share.

  • Dual classes of shares: The shareholder base of some corporations includes two different kinds of shares, each having different voting privileges. For instance, Warren Buffett’s company, Berkshire Hathaway, has A and B shares. Berkshire Hathaway’s B shares have a market value of approximately 1/1,500 of the A shares but only have 1/10,000 of the voting rights of the A shares.

    If there are two classes of stock with different voting rights, a corporate raider would have to gain control of the shares with the greater voting power — a daunting task.

  • Greenmail: Greenmail essentially involves paying the potential acquirer to go away and not initiate a further attempt to acquire the target firm. The entity is generally paid a substantial premium for their stock, and it agrees not to try to gain control of the firm in the future. Greenmail became prevalent in the 1980s and made many corporate raiders a lot of money.

  • White knights: A proactive way to thwart a potential hostile takeover bid, or at least to make it less likely, is for the target company’s board to seek a friendly investor — a white knight — to purchase the company or to take a substantial stake in the firm to discourage a takeover attempt.

    Warren Buffett has been referred to as Wall Street’s White Knight because he has stepped in at different times and taken positions in very high-profile financial firms, including Goldman Sachs, Salomon, and Bank of America. Buffett’s infusion of capital has strengthened these firms and made their ownership structure less likely to fall into the hands of a hostile bidder.

  • Pac-Man defense: The Pac-Man defense involves the target firm turning around and making a bid to acquire the hostile bidder. This situation is fairly rare, because it generally involves a smaller company trying to acquire a larger firm.