What Is a Hostile Takeover?
The term hostile takeover refers to the acquisition of one company by another corporation against the wishes of the former. The company being acquired in a hostile takeover is called the target company while the one executing the takeover is called the acquirer. In a hostile takeover, the acquirer goes directly to the company's shareholders or fights to replace management to get the acquisition approved. Approval of a hostile takeover is generally completed through either a tender offer or a proxy fight.
- A hostile takeover occurs when an acquiring company attempts to take over a target company against the wishes of the target company's management.
- An acquiring company can achieve a hostile takeover by going directly to the target company's shareholders or fighting to replace its management.
- Hostile takeovers may take place if a company believes a target is undervalued or when activist shareholders want changes in a company.
- A tender offer and a proxy fight are two methods in achieving a hostile takeover.
- Target companies can use certain defenses, such as the poison pill or a golden parachute, to ward off hostile takeovers.
Understanding Hostile Takeovers
Factors playing into a hostile takeover from the acquisition side often coincide with those of any other takeover, such as believing that a company may be significantly undervalued or wanting access to a company's brand, operations, technology, or industry foothold. Hostile takeovers may also be strategic moves by activist investors looking to effect change on a company's operations.
The target company's management does not approve of the deal in a hostile takeover. This type of bid occurs when an entity attempts to take control of a firm without the consent or cooperation of the target firm's board of directors. In lieu of the target company's board approval, the would-be acquirer may then:
- Issue a tender offer
- Employ a proxy fight
- Attempt to buy the necessary company stock in the open market
When a company, investor, or group of investors makes a tender offer to purchase the shares of another company at a premium above the current market value (CMV), the board of directors may reject the offer. The acquirer can approach the shareholders, who may accept the offer if it is at a sufficient premium to market value or if they are unhappy with current management. The Williams Act of 1968 regulates tender offers and requires the disclosure of all-cash tender offers.
In a proxy fight, opposing groups of stockholders persuade other stockholders to allow them to use their shares' proxy votes. If a company that makes a hostile takeover bid acquires enough proxies, it can use them to vote to accept the offer.
The sale of the stock only takes place if a sufficient number of stockholders, usually a majority, agree to accept the offer.
Defending Against a Hostile Takeover
To deter the unwanted takeover, the target company's management may have preemptive defenses in place, or it may employ reactive defenses to fight back.
Differential Voting Rights (DVRs)
To protect against hostile takeovers, a company can establish stock with differential voting rights (DVRs), where some shares carry greater voting power than others. This can make it more difficult to generate the votes needed for a hostile takeover if management owns a large enough portion of shares with more voting power. Shares with less voting power also commonly pay a higher dividend, which can make them more attractive investments.
Employee Stock Ownership Program (ESOP)
Establishing an employee stock ownership program (ESOP) involves using a tax-qualified plan in which employees own a substantial interest in the company. Employees may be more likely to vote with management. As such, this can be a successful defense.
However, such schemes have drawn scrutiny in the past. In some cases, courts have invalidated defensive ESOPs on the grounds that the plan was established for the benefit of management, not shareholders.
In a crown jewel defense, a provision of the company's bylaws requires the sale of the most valuable assets if there is a hostile takeover, thereby making it less attractive as a takeover opportunity. This is often considered one of the last lines of defense.
This defense tactic is officially known as a shareholder rights plan. It allows existing shareholders to buy newly issued stock at a discount if one shareholder has bought more than a stipulated percentage of the stock, resulting in a dilution of the ownership interest of the acquiring company. The buyer who triggered the defense, usually the acquiring company, is excluded from the discount.
The term poison pill is often used broadly to include a range of defenses, including issuing additional debt, which aims to make the target less attractive, and stock options to employees that vest upon a merger.
Sometimes a company's management will defend against unwanted hostile takeovers by using several controversial strategies, such as the people poison pill, a golden parachute, or the Pac-Man defense.
A people poison pill provides for the resignation of key personnel in the case of a hostile takeover, while the golden parachute involves granting members of the target's executive team with benefits (bonuses, severance pay, stock options, among others) if they are ever terminated as a result of a takeover. The Pac-Man defense has the target company aggressively buy stock in the company attempting the takeover.
Hostile Takeover Examples
A hostile takeover can be a difficult and lengthy process and attempts often end up unsuccessful. For example, billionaire activist investor Carl Icahn attempted three separate bids to acquire household goods giant Clorox in 2011, which rejected each one and introduced a new shareholder rights plan in its defense. The Clorox board even sidelined Icahn's proxy fight efforts, and the attempt ultimately ended in a few months with no takeover.
An example of a successful hostile takeover is that of pharmaceutical company Sanofi's (SNY) acquisition of Genzyme. Genzyme produced drugs for the treatment of rare genetic disorders and Sanofi saw the company as a means to expand into a niche industry and broaden its product offering. After friendly takeover offers were unsuccessful as Genzyme rebuffed Sanofi's advances, Sanofi went directly to the shareholders, paid a premium for the shares, added in contingent value rights, and ended up acquiring Genzyme.
How Is a Hostile Takeover Done?
The ways to take over another company include the tender offer, the proxy fight, and purchasing stock on the open market. A tender offer requires a majority of the shareholders to accept. A proxy fight aims to replace a good portion of the target's uncooperative board members. An acquirer may also choose to simply buy enough company stock in the open market to take control.
How Can Management Preempt a Hostile Takeover?
One of the ways to prevent hostile takeovers is to establish stocks with differential voting rights like establishing a share class with fewer voting rights and a higher dividend. These shares become an attractive investment, making it harder to generate the votes needed for a hostile takeover, especially if management owns a lot of the shares with more voting rights.
Companies may also establish an employee stock ownership program. ESOPs allow employees to own a substantial interest in the company. This opens the door for employees to vote with management, making it a fairly successful defense against being acquired.
What Is a Poison Pill?
A poison pill, which is officially known as a shareholder rights plan, is a common defense against a hostile takeover. There are two types of poison pill defenses: the flip-in and flip-over. A flip-in allows existing shareholders to buy new stock at a discount if someone accumulates a specified number of shares of the target company. The acquiring company is excluded from the sale and its ownership interest becomes diluted. A flip-over strategy allows the target company's shareholders to purchase the acquiring company's stock at a deeply discounted price if the takeover goes through, which punishes the acquiring company by diluting its equity.
What Are Other Defenses to a Hostile Takeover?
Companies can use the crown-jewel defense, golden parachute, and the Pac-Man defense to defend themselves against hostile takeovers. In a crown jewel defense, a company's bylaws require its most valuable assets to be sold in the event of a takeover. This can make the company less desirable to the acquirer. A golden parachute provides the top executives of the target with substantial benefits when the takeover is completed, which can deter acquirers. A Pac-Man defense involves the target company turning the tables and aggressively purchasing shares in the acquirer's company.