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Proxy Fights, Poison Pills and Pushy Suitors: What You Need to Know about Hostile Takeovers

Proxy Fights, Poison Pills and Pushy Suitors: What You Need to Know about Hostile Takeovers

This is the third of a three-part series on mergers and acquisitions. Click here to learn the seven things all investors should know about M&A.

Ever love someone who didn’t love you back? Public companies can be the object of unwanted affection too.

When a company says no to an unsolicited buyer, things can quickly turn “hostile.” A takeover attempt is typically deemed hostile when a public company’s board of directors rejects an unsolicited bid, but the suitor presses on nonetheless

Hostile takeovers have been around for decades, gaining notoriety in the 1980s when “corporate raiders” like Carl Icahn and Ronald Perelman used high-yield bonds to fund buyouts of such iconic companies as TWA and Revlon.

Frequently, target companies during this era that were ultimately acquired were broken up and sold off.

Today, hostile takeovers are making headlines again, though the players and the goals have changed. Now, the would-be buyers are often companies trying to swoop up their rivals, hoping tie-ups will help them grow their business. Other companies are being pushed by their shareholders to make bold moves to remain competitive.

“They’re under tremendous pressure to increase their returns,” said Donald Margotta, associate professor of finance at the D’Amore-McKim School of Business at Northeastern University.

Over the last two years, hostile acquirers have attempted to pull off megadeals involving well-known targets like pharmaceuticals giants Allergan and Mylan, and pipeline operator Williams Co. The eighth-largest announced merger and acquisition deal of 2015 was a hostile one: health insurance giant Anthem’s $55.2 billion unsolicited bid for its rival, Cigna, according to Dealogic.

The total value of announced hostile deals surged last year as would-be acquirers focused on big targets. As of December 14, 2015, there were a total of $308.8 billion in hostile deal bids during the year, more than four times the amount in 2013, Dealogic said. This giant leap in value came even though the actual number of hostile offers rose slightly, from 14 to 19, over the same period.

With hostile takeovers in the news again, it’s worth understanding how they work and what tactics targeted companies use to fend off unwanted advances.

When boards say no, what reasons do they generally give?

Boards are charged with acting in shareholders’ best interests. As such, they’re obligated to carefully consider merger or acquisition offers.

When boards recommend that shareholders vote against an unsolicited bid, they often say the bid undervalues the company.

They might feel “they can deliver more value as a standalone company or they think there are better deals out there,” said Chris Cernich, managing director of M&A and contested elections at Institutional Shareholder Services, which advises shareholders on how to vote in proxy contests.

A board might also be concerned that a deal would not make strategic sense or, if the potential acquirer proposes paying all or part of the transaction price in stock, the board might question the bidder’s long-term prospects, including calling into question how the proposed deal is financed. An initial “no” can also be a negotiating tool aimed at soliciting higher bids, either from the initial bidder or other companies.

What tactics do would-be acquirers use in hostile takeovers?

There are two main strategies buyers employ, and both strategies involve going around the board and directly to the target’s shareholders.

One mode of attack is the hostile tender offer, where a would-be buyer publicly offers to purchase outstanding shares, usually at a price above the current market value.

Acquirers must abide by certain rules in conducting hostile tender offers. Under the Williams Act, anyone who launches a tender offer is required to make certain disclosures about their offer to shareholders of the target company. The idea is to give both the prospective buyer and the target company time to present their arguments to shareholders.

A second approach used by buyers in hostile takeovers is a proxy contest. Here, the suitor’s goal is to replace members of the board or management with individuals who would support the sale of the company.

A bidder might launch a public relations campaign or run advertisements to drum up support from shareholders and bolster its chances of winning shareholders’ votes.

What do targets do to defend themselves?

There are a number of powerful defenses that companies have in their toolbox. As a result, the odds are stacked against the acquirer. Of the 205 hostile deals announced from the beginning of 2005 to December 14, 2015, just 35 were completed and 24 are pending, according to market-data provider FactSet.

Hostile buyers face “significant barriers to success,” said Marcel Kahan, a corporate law professor at the New York University School of Law.

The most famous defense in hostile takeovers is the “shareholders-rights plan,” otherwise known as the poison pill. Created by prominent corporate lawyer Martin Lipton in 1982, the poison pill makes takeovers expensive and ultimately undesirable for hostile buyers.

A poison pill is a mechanism that triggers a new class of securities to be issued by a company to its shareholders, explains Donald DePamphilis in his book “Mergers and Acquisitions Basics: All You Need to Know,” and they come in various forms.

One version, known as the “flip-in” poison pill, will kick in if a hostile bidder acquires a specific percentage of the target company’s shares. If they pass that threshold all shareholders excluding the hostile bidder have the right to buy more shares at a discounted price, which would effectively flood the market with new shares and dilute the value of the hostile investor’s position. That, in turn, would make it more expensive for that would-be buyer to get the deal done.

Putting a staggered board in place is another defensive maneuver. A company might divvy up its board members into three different groups whose election would come up at different times. By taking this approach, a company seeks to drag out the process for a hostile bidder who might have to wait years before taking control of its board since only a fraction of the board is up for re-election each year

Some hostile defenses are employed after a bid has been made. For instance, a company under attack might seek out a “white knight,” an alternative buyer deemed more desirable. The white knight generally agrees to pay more for the company than what is being offered by the hostile bidder, and to keep current management in place.

Are hostile takeovers good for investors?

The bottom line for investors: Hostile takeovers might improve stock prices for both targets and acquirers. You can read this earlier piece on M&A for more information about how a deal might impact the stock price of the target or of the acquirer.

Regardless, it’s important to do your own due diligence in assessing whether any stock meets your goals and risk tolerance.

In the end, investors should research all aspects of a company before investing. Just because someone else has fallen in love with stock – and is willing to fight for it – doesn’t mean it’s right for you.