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M&A: Behind the Boom in Unsolicited Bids


Although merger and acquisition activity has fallen significantly since the start of the credit crisis in 2007, one corner of M&A seems rather busy these days: unsolicited takeover bids. The recent increase in the size and number of these offers has been perceptible even to the casual observer. Moves by household names Kraft Foods Kraft Foods (KFT) and PepsiCo PepsiCo (PEP) are just the latest examples of blue-chip companies pursuing unsolicited acquisition proposals.

Other big names have done the same. Despite the severity of the credit crunch in 2008, InBev, Roche, Microsoft (MSFT), Samsung, BHP Billiton (BHP), and Electronic Arts (ERTS), a veritable who's who of multinational companies, were just a few who went public with unsolicited bids.

To be sure, these are not your father's hostile bids. The nomenclature that developed around the unsolicited bids of the 1970s and '80s justifiably evoked the imagery of pirates and raiders. Although the nature, tactics, and objectives of strategic buyers have little in common with those employed by the greenmailers and corporate bust-up artists of that bygone era, many of the same terms continue to be used—hostile bidder, bear-hugs, poison pills, and white knights. While the terminology may have remained the same, little else has.

Corporate Cash on the Rise With the continuing trend towards global consolidation, the precipitous drop in share prices from all-time highs in 2007, the strengthening economy, and the growing respectability of unsolicited bids, there will likely be a steady stream of such proposals in the months and years to come. Indeed, a recent Citigroup report projects that unsolicited M&A activity will increase further over the next year.

So why, in a period of declining M&A activity, are we seeing a pick-up in unsolicited activity? Although each situation is unique, the availability of cash to financially strong strategic buyers and weakened takeover defenses at target companies appear to be common denominators in recent unsolicited bids.

Cash, and the availability of additional credit if necessary, clearly is key. Following the collapse of Lehman Brothers last September, most businesses responded quickly and made significant cost cuts. Many companies went into survival mode, conserving cash in any way possible. Even as share prices decreased significantly, companies opted to retain cash rather than continue shareholder buyback programs. As a consequence of these actions, the aggregate cash held by the Standard & Poor's 500-stock index companies has risen from roughly $600 billion a year ago to over $700 billion today, according to ThomsonReuters.

Depleted Anti-takeover Arsenals This cash, together with the ability to borrow more at historically low interest rates, means that healthy companies can now turn their attention to long-term growth and implementation of their strategic plan. If a target company fulfills a potential bidder's strategic needs but is not for sale, an unsolicited bid often becomes the only alternative. Increasingly, strategic buyers view unsolicited bids as just another means to achieve their strategic objectives.

And while would-be strategic buyers have the means and the motive to make their approach, many target companies find themselves vulnerable to unsolicited bids. This vulnerability is a result of a combination of low stock prices, which may not reflect the intrinsic value of the business enterprise, and depleted anti-takeover arsenals.

That last point is worth examining in detail. Most U.S. public companies have far weaker anti-takeover defenses than in years past. Shareholder activism over the past decade has been marked by shareholder resolutions to eliminate key takeover defenses—namely, shareholder rights plans (or "poison pills"), and classified, or staggered, boards of directors.

Fewer Shareholder Rights Plans Shareholder rights plans are designed to ward off unsolicited bids by severely diluting any shareholder who acquires more that a specified percentage of the target company's shares without prior Board approval. Staggered boards, in which different groups of directors have terms expiring in different years, are intended to prevent a hostile bidder from replacing a company's entire board of directors with the acquirer's own candidates in any one year.

Responding to shareholder opposition, many companies simply let their rights plans expire and some companies even terminated their shareholder rights plans. The result: Less than 30% of the S&P 500 companies have a shareholder rights plan today, as compared to 60% in 2002.

The same trend is mirrored with respect to staggered boards. They are now found at less than 35% of the S&P 500 companies, as compared to 60% in 2002. While rights plans and staggered board do not ultimately prevent the success of hostile bids, they do provide the target's board with both leverage and the time to assess options.

Greater Director Pressure While your view of any particular bid is likely to be dependent upon which side you are on, unsolicited bids are clearly gaining respectability—if not with target company boards and managements, at least with their institutional shareholders. As Diane Garnick, investment strategist for INVESCO, bluntly concluded, "institutional investors are focused on maximizing returns, we are more concerned with the acquirer's price and long-term prospects of the combined company than whether the bid is solicited or unsolicited." Since institutional shareholders own more than 60% of the shares of U.S. public companies, they are likely to have considerable leverage in determining the outcome of almost any takeover battle.

Whatever position institutional shareholders may have in a particular company before the bid, that position, and the leverage which comes with it, increases once an unsolicited acquisition proposal becomes public. The shareholder base changes, often rapidly, following the public announcement of an unsolicited proposal. In some cases, the long-established composition of the shareholder base of a target company can actually change dramatically in just a few trading days. Target company shares move from the company's traditional, long-term shareholders into the hands of arbitrageurs, hedge funds, and other short-­term holders who seek to profit on the spread between the offer price and the current trading price. From the perspective of these holders, the faster a deal is done, the greater their return on investment.

Faced with a rapidly changing shareholder base lobbying for a quick deal, directors often come under intense pressure to negotiate or capitulate. Despite the pressure, boards of directors must act in the best interests of all shareholders. Target company boards must insure that despite the pressure resulting from a rapid change in shareholder base, the company does not get sold at less than full value. The proper use of takeover defenses, consistent with the board's exercise of their fiduciary duties, should successfully enable the board to reject an inadequate price or negotiate a price that represents a full and fair value for the company.

When Opportunity Knocks While not every unsolicited proposal should be accepted simply because its offer price is at a premium to the target's pre-offer share price, neither should every unsolicited proposal be summarily rejected on the basis that the offer is "hostile." Every change-of-control proposal, solicited or unsolicited, requires a thorough evaluation by the board of directors taking into account all appropriate considerations. Management and directors of a company on the receiving end of an unexpected takeover bid must become immediately—and thoroughly—engaged in the process in order to achieve a resolution that is in the best interests of the company and its shareholders, whatever that resolution may ultimately be. After all, "unexpected" does not always mean "negative." When opportunity knocks, sometimes it's a surprise.
Frank_aquila
Aquila is a partner in the Mergers & Acquisitions Group of Sullivan & Cromwell LLP.

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