MF0002-Unit-07-Takeover Defenses

Unit 7 Takeover Defenses Structure 7.1 Introduction Objectives 7.2 Types of takeover 7.3 Techniques of Raid Self Assessment Questions 7.4 Defences against Takeover Bid Advance preventive measures for Defences Defence in face of Takeover Bid (Strategies) Financial Defensive Measures Self Assessment Questions 7.5 Anti Takeover amendments 7.6 Legal measures against Takeovers 7.7 Guidelines for Takeovers Self Assessment Questions 7.8 Summary 7.9 Terminal Questions 7.10 Answers to SAQs and TQs 7.1 Introduction This unit would discuss defense against the acquisition by taking over the shares listed on any stock exchanges. It explains the concept and various forms of takeover device prevailing in the corporate world and the technique of corporate raid as well. You will also understand about the various defensive mechanisms that can be adopted to face the takeover raid, which in turn focuses on corporate strategies to avoid takeover raid and the legal measures against takeovers in India. Objectives

After studying this unit, you should be able to: Discuss the various forms of takeover Describe the strategies to avoid takeover bid Discuss the defensive mechanisms to face takeover raid Discuss about the legal measures relating to corporate takeover Takeover implies acquisition of controlling interest in a company by another company by taking over of the shares listed on any stock exchange. It does not lead to the dissolution of the company whose shares are being or have been acquired. It simply means a change of controlling interest in a company through the acquisition of its shares by another group. The acquisition transactions in such shares are subject to the conditions of listing agreement. When a profit earning company takes over a financially sick company to bail it out, it is known as bail out takeover. Such takeovers are in pursuance of a scheme of rehabilitation approved by public financial institutions. Corporate takeovers in India are governed by the listing agreement with stock exchanges and the SEBI Substantial Acquisition of Shares and Takeover (SEBI Code) Code. The raid, bids and defences are the outcome of takeover. Corporates can stall such takeover through strategic defensive steps. Mergers and takeovers are motivated and negotiated under the dominance of hostility and friendliness pressure and influences and are accordingly classified as friendly mergers and hostile mergers. The raids, bids and defences are the outcome of human moods. Corporate wars and offensive postures can be avoided and can be stalled through defensive steps. 7.2 Types of Takeover There are two types of takeover bids as discussed below: Friendly Takeover - Mergers and takeovers could be through negotiations with the consent of target companys executives or Board of Directors. Such mergers are called friendly mergers. These mergers are negotiated mergers and if the parties do not reach an agreement during negotiations, the proposal stands terminated. Hostile takeover - An acquirer company may not offer the target company the proposal to acquire its undertaking, but silently and unilaterally may pursue efforts to gain controlling interest in it against the wishes of the management. Such acts of acquirer are known as raid or Take over raids. These raids when organized in a systematic way are called Takeover bids. Both the raids and bids, lead to merger or takeover. A takeover is hostile when it is in the form of raid. The forces of competition and product provide strength and weakness to the rivals in the industry, trade or commerce. 7.3 Techniques of Raid The acquirer can follow any of the following techniques to acquire control of another company:

 Takeover bid A takeover bid gives impression of the intention reflected in the action of acquiring shares of a company to gain control of its affairs. A bid has been distinguished as below: - Mandatory Bid SEBI Takeover Regulations, 1997 contain provisions for making public announcement in the following cases viz: i) For acquisitions of 15% or more of the share or voting rights. ii) For acquiring additional shares or voting rights to the extent of 10% or more shares or voting rights in any period of 12 months, if such person already holds not less than 15% but not more than 75% of the shares or voting rights in a company. iii) For acquiring shares or voting rights along with persons acting in concert, to exercise more than 75% of voting rights in a company. The following are the conditions for Mandatory Bids: i) Consideration offered should be in cash if in other securities in the same be undertaken for cash offer ii) Offer price must be highest price which offer paid in past twelve months for the same class of shares. - Partial Bids Partial bid is understood when a bid made for acquiring part of the shares of a class of capital where the offeror intends to obtain effective control of the offeree through voting powers. Such bids are made for equity shares carrying voting rights. Partial bid is also understood when the offeror bids all the issued non-voting shares in a company. Regulation 12 of SEBI Takeover Regulations, 1997, it is necessary to make public announcement in accordance with the Regulations. - Competitive Bid This can be made by any person within 21 days of public announcement of the offer made by the acquirer. Such bid shall be made through public announcement in pursuance of provisions of regulation 25 of the SEBI take over regulation 1997. Such competitive bid shall be for the equal number of shares or more for which first offer was made. Tender Offer In the earlier cases, negotiations were confined to the managements and boards of directors of the companies involved. However, the acquiring company can make a tender offer directly to the shareholders of the company it wishes to acquire. A tender offer is an offer to buy current shareholders stock at a specified price, often with the objective of gaining control of the company. The offer is often made by another company, usually for more than the present market price as an incentive to tender. Use of the tender offer

allows the acquiring company to bypass the management of the company it wishes to acquire and therefore serves as a treat in any negotiations with that management. The tender offer can also be used when there are no negotiations, but when one company simply wants to acquire another. It is not possible to surprise another company with its acquisition, however, because the SEBI requires rather extensive disclosure. The primary selling tool is the premium that is offered over the existing market price of the stock. The tender offer itself is usually communicated through financial newspapers. Direct mailings are made to the shareholders of the company being bid for, if the bidder is able to obtain a list of shareholders. Tender offer can be used in two situations: The acquiring co. may directly approach the target company for its takeover. If target company does not agree, then the acquiring co. may directly approach the shareholders by means of a tender offer. The tender offer may be used without any negotiations like hostile takeover. The shareholders are generally approached through announcement in the financial press or through direct communication individually. They may or may not react to a tender offer. The reaction exclusively depends upon difference between the market price and offered price. The tender offer may or may not be acceptable to the management of the target company. The management may use techniques to discourage its shareholders from accepting tender offer by announcing higher dividends, issue of bonus or rights shares etc., and make it difficult for the acquirer to acquire controlling shares. The target company may also launch a counter publicity programme by informing that the tender offer is not in the interest of the shareholders. As per latest SEBI guidelines, public announcement is necessary as mandatory bid for tender offer to acquire the shares or control in the target company. I. Self Assessment Questions 1. Distinguish between friendly takeover and hostile takeover _________________________________________________________ _________________________________________________________ _________________________________________________________ 2. List the various techniques of raid _________________________________________________________ _________________________________________________________ 3. Define Tender Offer

_________________________________________________________ _________________________________________________________ 4. Under what situations, can tender offer be used? _________________________________________________________ _________________________________________________________ 7.4 Defenses against Takeover Bid The following Defensive method measures can be adopted to face takeover bids: 7.4.1 Advance preventive measures for Defenses The target company should take precautions when it feels that takeover bid is imminent through market reports or available information. Some of the advance measures are discussed below: Joint Holdings or Joint Voting Agreement - Two or more major shareholders may enter into agreement for block voting or block sale of shares rather than separate voting or sale of shares. This agreement is entered into, in collaboration with or without cooperation of target companys directors who wish to exercise effective control of the company. Inter locking Share Holdings or Cross Share Holdings - Two or more group companies acquire share of each in large quantity or one company may distribute share to the shareholders of its group company to avoid threats of takeover bids. If the interlocking of share holdings is accompanied by joint voting agreement, then the joint system of advance defense could be termed as Pyramiding, the safest device of defense. Issue of Block Shares to Friends and Associates - The directors issue block shares to their friends and associates to continue maintaining their controlling interest and as a safeguard to the threats of dislodging their control position. This may also be done by issue of right shares. Defensive Merger - The directors of a threatened company may acquire another company for shares as a defensive measure to forestall two unwelcome takeover bids. For this purpose they put long block shares of their own company in the hands of shareholders of friendly to make their own company least attractive for takeover bid. Share with non-voting rights like preference shares - Non-voting shares are a convenient method of providing for any desired adjustment of control on a merger of two companies. Convertible Securities

- It is necessary that the companys capital structure should contain loan capital by way of debentures to make the company less attractive to corporate raiders. Dissemination to shareholders of favourable financial information. - The dissemination of information about the companys favourable features of operations and profitability go a long way in bringing the market price of share nearer to its true assets value. This type of behaviour on the part of the directors of the company elicit confidence of shareholders in their management and control which will in many ways help preventing any takeover bid to be in or to succeed. Making the possession of two companys asset less attractive. - This is possibly done by putting the assets outside the control of the shareholders by entering into various types of financial arrangements like sale and lease back, mortgage of assets to FIs for long term loans etc. Long Term services Assessments - Directors having specialized skills in any specific technical field may enter into contract with the company with the specific approval of shareholders or the Companies Act 1956. The prospective bidder would not be attracted due to: Fear of non-co-operation by such director High compensation for terminating the agreement. In view of these circumstances, the takeover game becomes unattractive to the bidders. Other preventive measures 1. Maintaining a fraction of share capital uncalled, which can be called up during any emergency like takeover bid or liquidation threat. Such strategy is known as Rainy day call 2. Companies may form group or cartel to fight against any future bid of takeover by way of pooling funds to use it to counter the takeover bids. 7.4.2 Defense in face of takeover bid (Strategies) A company is supposed to take defensive steps when it comes to know that some corporate raider has been making efforts for takeover. For defense against takeover bid, two types of strategies could be as below: Commercial Strategies 1. Dissemination of favourable information among shareholders. 2. Step up dividend and update share price record (i.e. pushing up share price) 3. To revalue the fixed assets periodically and incorporate them in the balance sheet 4. Reorganization of Capital structure

5. Research based arguments should be prepared to show and convince the shareholders that the offer is incapable of managing the business. 6. Trace out the various discouraging commercial features of the functioning of the acquiring company (e.g. Pending cases in labour/consumer/tax tribunal) Tactical / Defense Strategies 1. The directors of the company may persuade their friends and relatives to purchase the shares of the offeree company 2. The board may make attempt to win over the shareholders through raising their emotional attachment, loyalty and patriotism etc. 3. Recourse to legal actions In order to defuse situation of hostile takeover attempts, companies have been given power to refuse to register the transfer of shares under relevant sections of Companies Act 1956. If this is done, a company must inform the transferee and the transferor within 60 days. It is the responsibility of the directors to accept a takeover bid. A refusal to register is permitted if: - A legal requirement relating to the transfer of shares is not complied with - The transfer is in contravention of the law - The transfer is prohibited by a court order - The transfer is not in the interest of the company and public. 4. Operation White Knights - The white knight defense involves choosing another company with which the target prefers to be combined. A target company is said to use a white knight when its management offers to be acquired by a friendly company to escape from a hostile takeover. An alternative company might be preferred by the target because it sees greater compatibility, or the new bidder might promise not to break up the target or engage in massive employees dismissal. The possible motive for the management of the target company to do so is not to lose the management of the company. White knight offers a higher bid to the target company than the present predator to avert the takeover bid by hostile suitor. With the higher bid offered by the white knight the predator might not remain interested in acquisition and hence the target company is protected from losing to corporate raid. 5. White Square - The white square is a modified form of a white knight. The difference being that the white square does not acquire control of the target. In a white square transaction, the target sells a block of its stock to a third party it considers to be friendly. The white square sometimes is required to vote its shares with the target management. These transactions often are accompanied by a stand-still agreement that limits the amount of additional target stock the white square can purchase for a specified period of time and restricts the sale of its target stock, usually giving the

right of first refusal to the target. In return, the white square often receives a seat on the target board, generous dividends, and/or a discount on the target shares. Preferred stock enables the board to tailor the characteristics of that stock to fit the transaction and so usually is used in white square transaction. 6. Disposing of Crown Jewel - When a target company uses the tactics of divestiture, it is said to sell the Crown Jewel. The precious assets in the company are called crown jewel to depict the greed of the acquirer under the takeover bid. These precious assets attract the rider to bid for the companys control. The company as a defense strategy, in its own interest, sells these valuable assets at its own initiative leaving the rest of the company intact. Instead of selling these valuable assets, the company may also lease them or mortgage them to creditors so that the attraction of free assets to the predator is over. As per SEBI takeover regulation, the above defense can be used only before the predator makes public announcement of its intention to take over the target company 7. Pac-Man strategy: - It is making counter bid for the bidder. The Pac-Man defense is essence involves the target counter offering for the bidder. Under this strategy the target company attempts to takeover the hostile raider. This happens when the target company is quite larger than predator. This severe defense is rarely used and in fact usually is designed not to be used. If the Pac Man defense is used, it is extremely costly and could have devastating financial effects for both firms involved. There is a risk that under state law, should both firms buy substantial stakes in each other, each would be ruled as subsidiaries of the other and be unable to vote its shares against the corporate parent. The severity of the defense may lead the bidder to disbelieve that the target actually will employ the defense. 8. Golden Parachutes - Golden parachutes are separation provisions of an employment contract that compensate managers for the loss of their jobs under a change-of- control clause. The provision usually calls for a lump-sum payment or payment over a specified period at full or partial rates of normal compensation. When a company offers hefty compensations to its managers if they get ousted due to takeover, the company is said to offer golden parachutes. This reduces their resistance to takeover. This envisages a termination packages for senior executives and used as a protection to the directors of the company against the takeover bid. 9. Shark Repellent character - The companies change and amend their bylaws and regulations to be less attractive for the corporate raider company. Such features in the bylaws are called Shark Repellent character. Companies adopt this tactic as precautionary measure against prospective bids. Eg: Share holders approvals for approving combination proposal are fixed at minimum by 80-95% of the shareholders meeting. 10. Swallowing Poison Pills strategy - Poison pills represent the creation of securities carrying special rights exercisable by a triggering event. The triggering event could be the accumulation of a specified percentage of target shares or the announcement of a tender offer. The special rights take many forms but they all make it costlier to acquire control of the target firm. As a tactical strategy, the target company

might issue convertible securities, which are converted into equity to deter the efforts of the offer, or because such conversion dilutes the bidders shares and discourages acquisition. Another example, Target Company might rise borrowing distorting normal Debt to Equity ratio. Poison pills can be adopted by the board of directors without shareholder approval. Although not required, directors often will submit poison pill adoptions to shareholders for ratification. 11. Green Mail - It refers to an incentive offered by the management of the target company to the potential bidder for not pursuing the takeover. The management of the target company may offer the acquirer for its shares a price higher than the market price. A large block of shares is held by an unfriendly company which forces the target company to repurchase the stock at a substantial premium to prevent the takeover. The purpose of the premium buyback presumably is to end a hostile takeover threat by the large block holder or green mailer. This is an expensive defense mechanism. The large block investors involved in greenmail help bring about management changes either changes in corporate personnel, or changes in corporate policy, or have superior skills at evaluation potential takeover targets. 12. Poison Put - A covenant allowing the bondholder to demand repayment in the event of a hostile takeover. This poison put feature seeks to protect against risk of takeover-related deterioration of target bonds, at the same time placing a potentially large cash demand on the new owner, thus raising the cost of an acquisition. Merger and acquisition activity in general has had negative impacts on bondholders wealth. This was particularly true when leverage increases where substantial. 13. Grey Knight - A friendly party of the target company who seeks to takeover the predator. The target company may adopt a combination of various strategies for successfully averting the acquisition bid. All the above strategies are experience based and have been successfully used in developed nations and some of them have been tested by Indian companies also. 7.4.3 Financial Defensive Measures The firm could become a takeover target of another firm seeking to benefit from an association with highly efficient firm in terms of: High sales growth High profit margin Low stock price Highly liquid balance sheet A combination of these factors can simultaneously make a firm an attractive investment opportunity and facilitate its financing. A firm fitting the afore-mentioned description would do well to take at least some of the following steps as defensive measure against takeover: Increase debt with borrowed funds used to repurchase equity

 Increase dividends on remaining shares Structure loan covenants to force acceleration of repayment in the event of takeover Liquidate the securities portfolio and draw down excess cash Invest continuing cash flows from operations in profitable projects Use some of the excess liquidity to acquire other firms Divest subsidiaries Realize the true value of undervalued assets by selling them of or restructuring. Self Assessment Questions II 1. List the advance preventive measures for takeover Defenses _____________________________________________________________________________ _____________________________________________________________________________ _________________ 2. List the few commercial strategies for defense against takeover bid _____________________________________________________________________________ _____________________________________________________________________________ _________________ 3. List the few tactical strategies for defense against takeover bid _____________________________________________________________________________ _____________________________________________________________________________ _________________ 4. What is disposing of crown jewel? _____________________________________________________________________________ _____________________________________ 5. What is pac-man strategy? _____________________________________________________________________________ _____________________________________ 6. What is shark repellent? _____________________________________________________________________________ _____________________________________ 7. What is poison pills strategy?

_____________________________________________________________________________ _____________________________________ 7.5 Anti takeover amendments Anti takeover amendments generally impose new conditions on the transfer of managerial control of the firm through a merger or tender offer or by replacement of the board of directors. There are four major types of anti takeover amendments as below: Supermajority Amendments It requires shareholders approval by at least two-thirds vote and sometimes as much as 90 percent of the voting power of outstanding capital stock for all transactions involving change of control. In most existing cases, however, the supermajority provisions have a board-out clause that provides the board with the power to determine when and if the super majority provision will be in effect. Pure supermajority provisions would seriously limit managements flexibility in takeover negotiations. Fair-price Amendments Fair price amendments are supermajority provisions with a board-out clause and additional clause waiving the supermajority requirement if a fair price is paid for all the purchased shares. The fair price is defined as the highest price paid by the bidder during a specified period. Fair price amendments defend against two-tier tender offers that are not approved by the targets board. A uniform offer for all shares to be purchased in a tender offer and in a subsequent cleanup merger or tender offer will avoid the supermajority requirement. The fair price amendment is the restrictive in the class of supermajority amendments. Classified Board This anti takeover amendment provides for staggered or classified boards of directors to delay effective transfer of control in a takeover. The rationale here is to ensure continuity of policy and experience. For instance, a nine member board might be divided into three classes, with only three members standing for election to a three year term, each year. Thus, a new majority shareholder would have to wait at least two annual meetings to gain control of the board of directors. Under this type, a greater shareholder vote is required to elect a single director. Authorization of Preferred stock The board of directors is authorized to create a new class of securities (like preferred stock) with special voting rights. This may be issued to friendly parties in a control contest. This device is a defense against hostile takeover bids. Other anti takeover actions Other amendments that management may propose as a takeover defense include: - Abolition of cumulative voting where it is not required by state law - Reincorporation in a state with more accommodating anti takeover laws

- Provisions with respect to the scheduling of shareholders meetings and introduction of agenda items, including nomination of candidates to the board of directors. 7.6 Legal measures against Takeovers Company Act 1956 restricts individual or a company or a group of individual from acquiring shares, together with the shares held earlier, in a public company to 25% of the total paid up capital. Also the central government needs to be intimated whenever such holding exceeds 10% of the subscribed capital. The approval of the central government is necessary if such investment exceeds 10% of the subscribed capital of another company. These precautionary measures are against the takeover bids of public limited company. 7.7 Guidelines for Takeovers SEBI has provided guidelines for takeovers. The salient features of the guidelines are: Notification of Takeover - If an individual or a company acquires 5% or more of the voting capital of a company, the target company and the stock exchange shall be notified Limit to Share Acquisition - An individual or a company can continue acquiring the shares of another company without making any offer to the other shareholders, until the individuals or the company acquire 10% of the voting capital. Public Offer - If holding company of the acquiring company exceeds 10%, a public offer to purchase a minimum of 20% of the shares shall be made to the remaining share holders through a public announcement. Offer price - The offer price shall not be less than the average of the weekly high or low of the closing prices during the last six months preceding the date of announcement. Disclosure - The offer should disclose the detailed terms of the offer, identity of the offerer, details of the offerers existing holdings in the offerer company etc., Offer Documents - The offer document should contain the offers financial information, its intention to continue the offer companys business and to make major change and L.T commercial justification for the offer. III. Self Assessment Questions 1. What is anti takeover amendments?

_____________________________________________________________________________ _______________________________ 2. List the four major types of amendments _____________________________________________________________________________ _______________________________ 3. List the important guidelines as per SEBI for takeover _____________________________________________________________________________ _______________________________ 7.8 Summary In this unit, we have discussed the important elements of takeover bid strategies. Depending upon whether the bid is friendly or hostile, these strategies differ. When faced with a potential or actual hostile takeover bid, target company managers may resist the bid both for their own reasons and in order to negotiate better terms for shareholders. They can set up takeover defenses in anticipation of a hostile bid or adopt defensive tactics once the bid has been made. The pre-bid defenses are of a strategic nature. Takeover defenses and anti takeover measures have become part of managements long term strategic planning for the firm. Different legal and regulatory jurisdictions may not allow certain strategies. Bid strategies must anticipate defense strategies and prepare for different target defenses. 7.8 Terminal Questions 1. Explain the various types of corporate takeover. 2. What are the different techniques of raid? 3. Explain various defensive methods against takeover bid. 4. What are the two types of strategies for defense against takeover bid? 5. What are the three types of anti takeover amendments and how do they work to defend a target from an unwelcome takeover? 6. What are the features of the guidelines as provided by the SEBI for takeover? 7.8 Answers to SAQs and TQs SAQs I 1. Refer to Section 7.2 2. Refer to Section 7.3 3. Refer to Section 7.3 4. Refer to Section 7.3

SAQ II 1. Refer to Section 7.4.1 2. Refer to Section 7.4.2 3. Refer to Section 7.4.2 4. Refer to Section 7.4.2 (point 6) 5. Refer to Section 7.4.2 (point 7) 6. Refer to Section 7.4.2 (point 9) 7. Refer to Section 7.4.2 (point 10) SAQ III 1. Refer to Section 7.5 2. Refer to Section 7.5 3. Refer to Section 7.7 TQs 1. Refer to Section 7.2 2. Refer to Section 7.3 3. Refer to Section 7.4 4. Refer to Section 7.4.2 5. Refer to Section 7.5 6. Refer to Section 7.7

About the Author

admin Copyright 2011 SMU. Powered by WordPress.