Takeovers: Defensive mechanisms against a hostile takeover
In recent times, mergers, acquisitions and take-overs have assumed prominence in the Nigerian corporate sector. The global economic recession has led to the distress of many companies especially relatively small and medium-size companies that are finding it increasingly difficult to survive the hard times. Many hypothesis and theories have been tested with a view to finding a suitable recipe for sustenance and improvement. Mergers, acquisitions and take-overs have emerged as a popular option and have become the subject of concern of business executives who are looking for either survival or/and increased profitability for their enterprises.
A Takeover as defined by the Investment & Securities Act (‘ISA’), 2007 is “the acquisition by one company of sufficient shares in another company to give the acquiring company control over that other company”. Conceptually a takeover is a change in the control structure of one company (the target) by another company (the acquirer, or bidder) that assumes control of the target. Under Nigerian Law, a takeover is for public companies.
A takeover may be friendly or hostile. A friendly takeover occurs where there are no objections from the Board/management or dissents from the shareholders of the target company, hence leading to a consummation with express endorsement from the Board or Management of the target company without any heated negotiations or litigation. A hostile takeover on the other hand, occurs where the Board or Management of the target company expressly rejects an acquisition offer from an acquirer, and this often leads the acquirer into making a direct ‘takeover bid’ to the shareholders, bypassing its Board/Management. It may be material to note that the ISA does not expressly distinguish between a friendly and a hostile takeover.
All bids that are made between companies are, as mentioned not always welcome with open arms. In the event that a target company recognises a bid as hostile, and is trying to protect itself from a hostile takeover, as with any cases, it can be said that preventive measures are more effective than reactive measures implemented once the takeover attempts have already been launched. The first step in a company’s defence, therefore is for management and controlling shareholders to begin their preparations for a possible fight long before the battle is joined. There are various preventive and reactive measures. This article aims to discuss a few preventive measures.
This defence tactic involves strategies of buying new assets with an underlying purpose of forcing the growth of the company. What this leads to, is that the value of the company increases at the same time as the liquid assets decreases. The reason behind this defence tactic is that the increased value will intimidate acquiring companies with limited financial resources to place a bid. The reduced financial resources of the target company acts as a secondary effect, reducing the acquiring company’s incentives even more for a takeover.
This is one of the most used and controversial defence strategies. This defence strategy was first introduced in 1982 by the New York Layer Martin Lipton under the name “warrant dividend plan” but was later changed to poison pill when he mentioned it in an article in the Wall Street Journal. The expression ‘poison pill’ comes from the domains of espionage, referring to back in the days when agents were instructed to swallow a cyanide pill instead of being captured or as in the case of a company, overtaken. In the corporate world, the effect of the cyanide pill is similar. Shareholder rights, preferred shares, stock warrants or options, which the target company offers and issues to its shareholders are classified as poison pills in a takeover situation. Once implemented, the shareholder rights and preferred stock, can only be redeemed by the board of directors. These rights are inactive until they are triggered when an unwanted shareholder acquires a pre-specified amount of outstanding stocks which has been agreed on by the board of directors. Once triggered the poison pill can only be redeemed in a short period of time by the board of directors.
The logic behind the poison pill is to dilute the acquiring company’s stocks in the target company so much that the bidder never manages to acquire the requisite quantum of shares for control without the consensus of the board of directors, and thus loses both time and money on their investment.
This is the main use but not the only use of the poison pill, as it has other implications. The pill can be used as a tool to create more time to reflect over the actual bid and maybe start some sort of negotiation process between the target and the acquirer with a view to determining if they can agree on some terms or even to determine if the target can put some pressure on the acquirer to raise its premium offer to further serve the shareholders’ wealth. The poison pill although implemented after the bid has been presented, serves as a preventive measure because, its features can be categorized as acquisition cost enhancers that force the acquiring company to pay more for the stocks and in return, making the target company look less attractive to acquire.
The poison pill can be categorized into two types. The flip-in pill and the flip-over pill. A flip-in pill makes it possible for the targeted company to issue preferred shares which only existing shareholders have the rights to buy. Hence if they chose to exercise their rights, they will get the opportunity to buy additional shares in the company for a price often far beneath the market value of that share. On the other hand, a flip-over pill gives the existing shareholders in the target company the right to buy the acquiring company’s shares for a discounted price in the event of a total merger or acquisition. This raises the risk of the company’s financial leverage and thus seen as very unattractive for an acquirer who has to inherit these debts. If a target company is seeking to defend against a full acquisition, this poison pill is very effective.