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Friendly Takeover
When takeover offer is from a perspective acquirer who is not on the negative list of the target company, the process for friendly takeover begins. In a friendly takeover, there is cooperation between the target company and acquirer company. The target company shares critical information required for valuation of the company, facilitates in the due diligence by the acquirer and cooperates in carrying out legal formalities. In such cases, chances of better consideration are also high and sometimes the acquirer may allow the promoters/management of the target company to continue having important role even after the takeover. For example, Mr. Manvinder Singh was allowed to continue as CEO of Ranbaxy Labs. Ltd. even after friendly takeover by Daiichi Sankyo In India, most of the takeovers are friendly. Even in US, most the takeovers are friendly, though, in wave IV, (1981-1989) there were many hostile takeovers. During the remaining waves 1893-1903 (I), 1919-1929 (II), 1945-1973(III) and 1992-2000(V), most of the takeovers were friendly.
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Hostile takeover
Sometimes, the promoter group receives an offer from a perspective acquirer whom they donot want to sell out. It is also possible that some of the entities in the promoter group are against the sell out. On such occasions, the hostile takeover battle follows: A typical example Indian Aluminum Co. Ltd. was strongly against selling out to Sterlite Industries ltd, though was willing to be taken over by Hindalco. Sterlite had to resort to hostile takeover in 1998 and made an open offer to acquire the shares of Indian Aluminium at a premium. In case of hostile takeover, potential acquirer company resort to takeover tactics while target company may follow Defence tactics
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Takeover Tactics
Some of the commonly used takeover tactics are as follows: Dawn Raid Bear Hug Saturday Night Special Proxy Fight
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Dawn Raid
In this tactics, brokers acting on behalf of acquirer/raider buy, in the morning at the time of opening of the trading session, all target companys shares available on the stock exchanges where the shares are listed. Because this is done early in the morning, the target firm usually doesn't get informed about the purchases until it is too late, and the acquirer now has controlling interest. Such a tactics has many disadvantages: The acquirer may not be able to buy large number of shares The market price of target companys share may shoot up in the light of aggressive buying In view of the aggressive buying, shareholders may hold back shares and dawn raid may fail. SEBIs takeover code prohibits the acquirer, along with persons in concert with him, from acquiring 15% or more shares or voting capital ( included the shares already held), without making an open offer. Open offer price is related to the past prices and thus dawn raid will push up the open offer price. It is more prudent to gradually acquire upto 15% over a period of time and then make an open offer
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Bear Hug
In order to limit the options available to management of target company, a bidder may make very attractive offer to the management. The formal letter of offer may also contain implied intention to go directly to the shareholders with the tender offer if they dont receive a positive response from management of target company. Though, such an offer is unsolicited, the board of directors is bound to consider impartially in the interest of the shareholders. If the board does not consider it favourably some shareholders can file suit against the management for ignoring the interest of shareholders, if premium is high. It is a deadly hug, that is why it is called bear hug
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Proxy Fight/Contest
In this tactic, the acquirer convinces the majority shareholders to issue proxy rights in his favour, so that he can remove the existing directors from the board of the company and appoint his own nominees in place. This is acquiring control without investment and thus cannot sustain for long. It requires a sound reason for removal of existing team and also effort and costs to collect proxies from geographically spread shareholders. Generally, this tactics is used to replace those directors who are against the merger with those who are more willing to vote for merger.
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Takeover Defenses
Many promoters/managements create defenses against takeovers so as to make the company less attractive to raiders or more difficult to takeover. This helps in discouraging and attempt to takeover. Such attempts may be preventive or active. Preventive anti-takeover defenses are taken in order to discourage and thus taken before any takeover bid is made. Active anti-takeover defenses are deployed after the hostile attempt has been made.
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1. 2. 3. 4.
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b. Classified Boards
A company may delay effective transfer of control in a takeover, by amending its M/A or Articles of Association to provide for having staggered or classified board of directors. Under this strategy, a board of directors is divided into 2-3 classes, with only one of the class of directors contesting for elections for a say 3 year term. In such as case, only a class of directors will retire ( and contest for re-election) at any point of time and directors of the other classes will continue even when the ownership has changed after takeover bid. The acquirer shall have to wait for atleast 2 annual general meetings to gain control over the management of the company.
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d. Dual Capitalization
This strategy is useful in case of hostile takeover bid. Using this amendment, the Board of Directors is authorised to create a new class of securities with special voting rights. A typical dual capitalization involves the issuance of another class of shares that have superior voting rights to all the current outstanding stockholders. The stockholders are then given the right to exchange these shares for ordinary shares. Shareholders prefer ordinary shares because the special class of shares lack marketability and also fetch low dividends. Management retain the special voting stocks in order to retain control over the company.
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2. Poison Pill
The term poison pill refers to any strategy which upon successful acquisition by the acquirer, creates negative financial results (poison) and leads to value destruction. It involves creation of securities called poison pills. These securities provide their holders with special rights exercisable only after sometime ( for example 15 days) following the occurrence of a triggering event such as tender offer for control or the accumulation of specified percentage of shares in the target company. These special rights are the economic poison Poison pills make takeovers more expensive and thus discourage takeovers. However, they donot prevent takeovers as the acquirer may be willing to bear the cost of poison pill if there are expectations of high synergy effects.
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e. Voting Plans
Under the voting plans, the company declares a dividend of preference shares with voting rights. In some cases, if a party acquires a substantial block of a companys voting stock, preference shareholders become entitled to super voting rights. This makes it difficult for acquirer to obtain voting control.
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3. Poison Put
The quality of debentures issued by the company is subject to deterioration in case of change in control, as it may involve restructuring of the capital. Poison put provides the holders of corporate bonds a protection from the risk of takeover related credit deterioration. Under this plan, the bond holders are given the put option ( right to sell) which is triggered by a unfriendly change of control. The exercise price is generally set at 100 or 101 percent of face value of the bond Exercise of put after unfriendly takeover can be very costly to the bidder and thus it discourages takeover.
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4. Parachutes
Parachutes are employee severance agreement are triggered when a change in control of management takes place. It serves as a protection to key employees who may feel threatened by the potential acquisition. It also serves as deterrent to takeover as it makes it expensive to change the key employees after takeover. Such agreements do not require the approval of the shareholders as the management can enter to agreement with its employees. Primarily, parachutes may be of three types, namely Golden Parachute, Silver Parachute and Tin Parachute
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Types of Parachutes
Golden Parachute a an agreement that provides contractual guarantee of fairly large sum of compensation to top and/ or senior executives of the target company whose services are likely to be terminated in case of takeover. Such an agreement is usually enforceable if the termination occurs within one year after the takeover. Funds may also be put aside for such payment in separate accounts called rabbi trusts. Rabbi trusts provide assurance to the managers that the sufficient funds would be available for this purpose at the time of takeover. These agreements help in retention of key employees and help these employees remain objective during the process of takeover and not be afraid of the acquirer. These parachutes also increase costs and thus discourage takeovers. Silver Parachutes are similar to golden parachutes except that in case of silver a larger portion of employees may be covered by such agreement. The compensation is lower and is generally equal to one years salary Tin Parachutes are agreements that generally cover almost all the employees of the target company but the compensation is not very high (generally 1-2 weeks of salary for every year of service put in by the employee)
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The defenses discussed earlier are used before the hostile acquisition bid is made. There are a number of defenses that could be used after the acquisition bid has been made. These include: 1. Share Repurchases 2. Standstill Agreements 3. Green Mail 4. White Knight 5. White Squire 6. Recapitalization 7. Employee Stock Option Plans (ESOPs) 8. Litigation 9. Pac-Man Defense 10. Just Say No 11. Crown Jewels
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1. Share Repurchases
A company may buy its own shares from public and reduce capital. In India, this is governed by Section 77 A of the Companies Act 1956. The Act permits buy back of own shares out of free reserves, securities premium account or the proceeds of specified securities except out of the proceeds of issue of same kind of securities or equity shares. Share Buy-backs or share repurchases reduce the number of floating shares in the market available for purchase by acquirer. It also increases the share of promoters in the total capital of the company as the total capital is reduced by share repurchases. For example, if promoters hold 24000 shares out of 1,00,000 total shares of the Co, their share is 24%. After repurchase of 40,000 shares, the share of promoters will increase to 40% ( 24,000/60,000).
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b. Dutch Auctions
In a Dutch auction, the company may declare the number of shares it will buy and the price band in which shareholders may offer shares in a specified time period. For example, the company may offer to buy 2 lakh shares with market price of Rs. 15, in the price range of Rs 17 to Rs. 22. At the offer price that results in 2 lakh shares being offered, all shares offered at or below that price will be purchased at the highest of the price. Thus, if 1 lakh shares were offered at Rs. 17, another 1 lakh shares were offered at Rs. 18 and 50,000 shares were offered at Rs. 20. The company will buy the first 2 lakh shares at Rs. 18, although one lakh shares were offered at Rs. 17 as well. In case of oversubscription, pro rata purchase may take place.
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2. Standstill Agreements
Standstill agreements are agreement between the target company and the potential acquirer who has already acquired a significant shares in the company, not to increase its shareholding further during a specified period. Since the number of shares purchased by the potential acquirer are enough to pose a serious takeover threat to the the target company, the management is willing to pay a significant amount as consideration to the potential acquirer for putting the takeover process on hold. Meanwhile, the company may send an offer to the potential acquirer to sell these shares. Thus, standstill agreements are generally followed by green mail The agreement may also be to restrict the potential acquirer not to buy shares beyond a specified percentage
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3. Green Mail
Greenmail is an agreement offer in the form of a targeted share repurchase from specified shareholders, at a premium, in order to prevent a hostile takeover. Under this arrangement, the promoters of the target company agree to buy back the shares accumulated by the raider at a substantial premium. In return, the raider agree that neither he nor any of his associates shall acquire any sizable stake in the target company for a stipulated period. The use of greenmail involves ethical issues as using greenmails the managers pursue their personal agendas ( to remain in control of the company) at the cost of the shareholders wealth.
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4. White Knight
When faced with the threat of hostile takeover, a target company may approach a white knight, another company that would be more acceptable as acquirer to the target company, to takeover the target at more favourable terms. These favourable terms may include higher price, promise not to lay-off management or other key employees, not to disassemble/break the company. However, white knight may also also request for favourable terms or other considerations.
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White Squire
Squire refers to a man who escorts knight and carries his shield or other items. In the context of M&A, white squire is portfolio investor ( who holds shares to make profit and is not interesting in gaining control of the company). The company may issue a large shares to a white (friendly) squire so as to dilute the percentage holding of the hostile bidder. The deal with white squire is structured in a manner that the white squire cannot sell these shares to hostile bidder. Since the white squire is not interested in takeover, it is different from the white knight that takes over the company. Warren Buffett has been the most renowned white squire for the last two decades. Many banks and mutual funds act as white squires
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Recapitalization
Leveraged recapitalization is basically a defensive tactics and is of recent origin. Under the leveraged recapitalization, shareholders are offered with a super cash dividend (that is funded through a substantial debt. (so called leveraged cash out or LCO). This increases the debt equity ratio of the company, charge on the assets of the company andthus discourages the takeover attempt. Many a times, bonus shares ( stock dividend) are also issued and shareholders receive the share certificates as dividend. These share certificates are called stub and they are sometimes priced high as hostile bidder is looking for buying more shares. Most Recapitalization plans require shareholders approval and also subject to national laws of the country.
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8. Litigation
After a hostile bid has been received, the target company can challenge the acquisition through litigation. The litigation may be based on anti-competition effects of acquisition, inadequate disclosure by the bidder or other securities laws violations. The target company may seek injunction to prohibit the bidder from further purchase of shares until the court has have given its ruling. The time taken in the litigation gives time to the target company to seek white knight or white squire. Such as litigation is also used as a bargaining point for getting better deal as the target company may agree to drop the litigation if the acquirer accepts terms favourable to target company. Such a tactics is very useful in countries in India where litigation takes quite a long time to settle.
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9. Pac-Man Defense
A Pac-man defense is an extreme step wherein the target company or its promoters start acquiring sizeable holdings in the acquirer/raiders company. This results in a threat to the the potential acquirer and makes the acquirer run for cover and forces him to hammer out a peace pact. This tactics is possible in India prior to the acquirer hitting the trigger for open offer and making the public announcement thereof. This tactics is effective when the original acquirer is smaller than the original target company. The target company needs to take care that it does not trigger the open offer for the acquirers company. If both the company finance acquisition through debt, they may take borrow huge sums and become highly leverage and thus financial risk increases. This could be disastrous for both the companies.
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Takeovers are usually suffered by winners curse. Common value auctions are those in which value of the object being competed for is the same for all bidders but their valuations (estimates of the value) differ . The winners curse hypothesis states that the winners of a sealed bid common value auction tends to be one who most over estimates the true value of the auctioned object. Thus the winner is likely to be cursed by overbidding. To avoid the winners curse in common value auctions, bidders should scale down their estimates to form their bids. Optimal bidding strategies in common value auctions call for a decrease in the bid with an increase in the no. of competing bidders and the degree of uncertainty about the true value. Therefore a friendly takeover bids are usually inflated by managers hubris.
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Following are topics are to be done from the book Contemporary Issues in Mergers and Acquisitions by Dr. Manju Gupta 1. Leverage Buy Out (from page 151 -162) 2. Management Buy Out (from page 162 -165)
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