Takeover Defence

Nov. 2006
Terminology
■ Terminology Used Reveals Hostility

• Raiders, Targets, Shark Watchers,

• Shark Repellants, Poison Pill
• Scorched Earth Policy etc.
■ Rise of Hostile Takeovers where
Bidders Approach Target Shareholders
Directly
Defences
■ General Wall Built to Make the Firm Less
Attractive to Bidders

■ Defensive Action Taken in Response to

Actual Bid Like Gathering Information on
Stock Accumulation By Someone, or
Adjustment in Asset & Ownership Structures
After the Bid Announced
• .
Attractive Target
■ An Undervalued Firm (If Markets Are
Not Efficient)
• Low Stock Price in Relation to
Replacement Cost or Earning Potential
■ A Liquid Balance Sheet With Excess
Cash, Unused Debt Capacity or
Valuable Security Portfolio
Attractive Target
■ A Good Cash Flow Relative to Current
Stock Price
■ Subsidiaries or Real Estate That Can
Be Sold Off Without Impairing Cash
Flow
■ A Small Control by Incumbent
Management
■ Government Regulation
Attractive Target
■ A Combination of These Attributes
Makes an Attractive Target and
Facilitate Financing of the Takeover

■ The Firms Assets Act as Collateral for

Bidding Firms Borrowings and Target
Cash Flows and Divestitures Can be
Used to Repay Loans
Defence
■ To Make Itself Less Attractive the Firm
May Do the Following
• Increase Debt and Repurchase Equity
• Increase Management Control
• Increase Dividends
• Loan Conditions to Provide for Immediate
or Accelerated Repayments in case of
Takeover
Defence
• Liquidate Security Portfolio
• Increase Investment or Diversify or
Takeover to Reduce Cash
• Spin-off Subsidiaries (Specially Those With
Low Impact on Cash Flow)
• Evaluate Current Operations to Eliminate
Low Return Businesses
• Realize Value of Undervalued Assets by
Sell-Off or Restructuring
Anti-Takeover Defense
- Preventive
■ Poison Pill
• Make Target Less Valuable to Buyer
• Preferred Stock (Fixed Income) to Be
Converted into x Shares of Target in
Event of Takeover
• Can Be Triggered by Board Resolution
Anti-Takeover Defense
- Preventive
■ Poison Pill -- Flip Over Rights
■ Rights that Allow Holder to Buy Stock in
the Bidding Firm at Predetermined or
Low Price
• Time Period (3-5 years)
• Trigger Mechanism
• Disarm Clause
■ Flip-In Allows Holder to Buy Shares at
Fixed Price in Target (Tata Cos)
Anti-Takeover Defense
- Preventive
■ Charter Amendments
■ Staggered Terms of Board
■ Super Majority Clause
• (Always Needed in India)
■ Fair Price Provision (Stated in Terms of
P/E Ratio or Fixed Price)
• India??
Anti-Takeover Defense
- Preventive
■ Dual Class Capitalization
• Two Class of Shareholders with Different
Voting Rights (Non Voting Shares)

■ Golden Parachute
• Contract with Top Management to Pay
Large Compensation if Managers Have to
Leave or Change in BOD
Anti-Takeover Defense
- Preventive
■ Scorched Earth Policy
• Destroy the Value of Assets
• Sell Off Attractive Parts of Business
Anti-Takeover Defense
- Active
■ Green Mail
• Share Purchase from the Acquiring Firm at
a Premium (Not to All Shareholders)

■ Stand-Still Agreement
• Pay Compensation for agreement Not to
Buy More
• Limit Ownership or No. Of Seats on BOD
Anti-Takeover Defense
- Active
■ White Knight
• Target management Seeks a Friendly
Bidder
■ White Squire
• Target May Place Shares with Friendly
Firm or Investor Who Will Not Sell or
Meddle in Management
Anti-Takeover Defense
- Active
■ Litigation
• Enter into Time Consuming Litigation with
Bidder or with Regulator

■ Capital Restructuring
• Acquire Debt or Pay High Dividends
Anti-Takeover Defense
- Active
■ Pac-man Defence
• Mount a Counter Bid for the Bidding Firm

■ Anti-Trust Shield
• Acquire Firms in Bidders Industry to Attract
Anti-Monopoly Provisions
Anti-Takeover Defense
- Good for Shareholders?
■ Some Mild Form of Defence may
Increase Shareholders Wealth
■ Given the Evidence that Target
Shareholders Gain in M&A, Severe
Resistance that Make it Impossible to
Acquire Should Lower Shareholder
Wealth
Anti-Takeover Defense
- Active

■ MV (A) =
Value of Firm With Current Mngnt +
Probability of Control Change x Change in
Value from Control Change
Anti-Takeover Defense
■ If Defense Makes it Impossible to
Change Incumbent Management, then
the Market Price of Firm May be Lower
than Firms with Less Active Defense
Consequences
■ If Mergers are value Creating Activity,
Will Not Defenses That Exclude
Potential Bidders, Reduce
Shareholders Value?