How Can a Company Resist a Hostile Takeover?

A corporate takeover is a complex business transaction that occurs when one company purchases another. Takeovers often take place for logical reasons, including anticipated synergies between the acquiring company and the target company, potential for significant revenue enhancements, reduced operating costs, and beneficial tax considerations.

But, not all takeovers are pleasant. Some can be hostile where the target doesn’t want to be acquired. There are several ways to avoid being the subject of a hostile takeover, including the poison pill and white knight defense. Keep reading to learn more about these and other anti-takeover strategies.

Key Takeaways

• A hostile takeover occurs when the acquirer takes over the target without its consent.
• Some of the strategies target companies can use to keep hostile acquirers away are the poison pill and white knight defenses.
• Setting up shares with differential voting rights or an employee share ownership plan can also keep potential acquirers away.
• U.S. Congress passed the Williams Act so shareholders are made aware of the potential target companies.

How Hostile Takeovers Work

Most corporate takeovers are friendly. This means the majority of key stakeholders support the acquisition. However, corporate takeovers can sometimes become hostile.

As noted above, a hostile takeover occurs when one business acquires another company against the management or board’s consent. The acquiring company typically purchases a controlling percentage of the voting shares of the target and, along with the controlling shares, the power to dictate new corporate policy.

There are three ways to take over a public company:

• Vertical acquisition
• Horizontal acquisition
• Conglomerated acquisition

The main reason for a hostile acquisition, at least in theory, is to remove ineffective management or board and increase future profits. With this in mind, some basic defense strategies can be used by the management of potential target companies to deter unwanted acquisition advances.

Poison Pill Defense

The poison pill defense is controversial. Also called a shareholder rights plan, its application is limited in many countries. To execute a poison pill, the targeted company dilutes its shares in a way that the hostile bidder cannot obtain a controlling share without incurring massive expenses.

A flip-in pill version allows the company to issue preferred shares that only existing shareholders may buy, diluting the hostile bidder’s potential purchase. A flip-over pill allows existing shareholders to buy the acquiring company’s shares at a significantly discounted price, making the takeover unattractive and expensive.

Netflix’s Poison Pill Defense

This type of strategy was used in 2012 when Carl Icahn announced that he purchased nearly 10% of the shares of Netflix (NFLX) in an attempt to take over the company. The company’s board responded by instituting a shareholder rights plan to make any attempted takeover excessively costly.

The terms of the plan stated that the board would allow its shareholders to buy newly issued shares in the company at a discount if anyone bought 10% or more of the company. This would dilute the stake of any would-be corporate raiders and make a takeover virtually impossible without approval from the takeover target. This plan was in place until 2015.

Note

The first poison pill defense was used in 1982 when New York lawyer Martin Lipton unveiled a warrant dividend plan.

Staggered Board Defense

A company might segregate its board of directors into different groups and only put a handful up for re-election at any one meeting. This staggers board changes over time, making it very time-consuming for the entire board to be voted out.

There are usually three classes in a staggered board defense, which is also referred to as a classified board. Board members have terms that overlap, which is why only one class is up for election at one time.

White Knight Defense

If a board feels like it cannot reasonably prevent a hostile takeover, it might seek a friendlier firm to swoop in and buy a controlling interest before the hostile bidder. This is the white knight defense. If desperate, the threatened board may sell off key assets and reduce operations, hoping to make the company less attractive to the bidder.

The white knight typically agrees to pay a premium above the acquirer’s offer to buy the target company’s stock or the white knight agrees to restructure the target company after the acquisition is completed in a manner supported by the target’s management. 

Two classic examples of white knight engagements in the corporate takeover process include PNC’s (PNC) purchase of National City Corporation in 2008 to help the company survive during the subprime crisis, and Fiat’s takeover of Chrysler in 2009 to save it from liquidation.

Greenmail Defense

Greenmail refers to a targeted repurchase. With this tactic, a company buys a certain amount of its stock from an individual investor—usually at a substantial premium. These premiums can be thought of as payments to a potential acquirer to eliminate an unfriendly takeover attempt.

One of the first applied occurrences of this concept was in July 1979, when Carl Icahn bought 9.9% of Saxon Industries stock for $7.21 per share. Saxon was then forced to repurchase its shares at $10.50 per share to unwind the corporate takeover activity.

While the anti-takeover process of greenmail is effective, some companies, like Lockheed Martin (LMT), added anti-greenmail provisions in their corporate charters. Over the years, greenmail has diminished in usage due to the capital gains tax that is now imposed on the gains derived from such hostile takeover tactics.

Stocks With Differential Voting Rights

A preemptive line of defense against a hostile corporate takeover would be to establish stock securities that have differential voting rights. 

Stocks with this type of provision provide fewer voting rights to shareholders. For example, holders of these types of securities may need to own 100 shares to be able to cast one vote.

Establish an Employee Stock Ownership Plan

Another preemptive line of defense against a hostile corporate takeover would be to establish an employee stock ownership plan (ESOP). An ESOP is a tax-qualified retirement plan that offers tax savings to both the corporation and its shareholders.

By establishing an ESOP, employees of the corporation hold ownership of the company. In turn, this means that a greater percentage of the company will likely be owned by people who will vote in conjunction with the views of the target company’s management rather than with the interests of a potential acquirer.

How the Williams Act Affects Hostile Takeovers

Hostile attempts to take over a company typically take place when a potential acquirer makes a tender offer or direct offer to the target’s stockholders. This process happens over the opposition of the target company’s management, and it usually leads to significant tension between the target company’s management and that of the acquirer.

In response to such practice, U.S. Congress passed the Williams Act to offer full and fair disclosure to shareholders of the potential target companies, and to establish a mechanism that gives additional time for the acquiring company to explain the acquisition’s purpose.

The Williams Act requires the acquiring company to disclose to the Securities and Exchange Commission (SEC) the source of funds that will be used to accomplish the acquisition, the purpose for which the offer is being made, the plans the acquirer would have if it is successful in the acquisition, and any contracts or understandings concerning the target corporation.

While the Williams Act was designed to make the corporate takeover process more orderly, the increased use of derivative securities has made the Act a less useful defense mechanism. As a result, various types of corporate defense strategies need to be considered by the management of companies likely to be targeted for acquisition.

What Happens to the Target Company’s Shares After a Hostile Takeover?

In most cases, the target’s share price increases when a hostile takeover is announced. That’s because the acquirer offers a premium above the share price. After the takeover is complete, the targets’s shares are absorbed into the acquiring company’s shares. Based on the agreement, the target’s shareholders can take cash or shares in the new company.

What Triggers a Hostile Takeover?

One of the most common ways that a hostile takeover is triggered is after talks for a friendly takeover between both the acquirer and target are unsuccessful. The board members of the acquirer generally puts an offer on the table, presenting it to the target’s board. If talks aren’t favorable, the acquirer may resort to hostile measures to take over the target.

What Is an Example of a Hostile Takeover?

InBev acquired Anheuser-Busch through a hostile takeover in 2008 after InBev offered to buy the target for $65/share. Anheuser-Busch rejected the offer, resulting in a hostile attempt by InBev. Shareholders eventually agreed after InBev raised its offer to $70/share.

The Bottom Line

Corporations have many hostile takeover defense mechanisms at their disposal. It may be prudent for a target’s management to put preemptive corporate takeover mechanisms in place, even if the company isn’t considered for an acquisition. These policies should be seriously pursued by companies with a well-capitalized balance sheet, a conservative income statement, an attractive cash flow statement, and a large or growing market share for their products or services.

If the company exhibits significant barriers to entry, a lack of competitive rivalry in the industry, a minimal threat of substitute products or services, minimal bargaining power of the buyers, and minimal bargaining power of the suppliers, the case for implementing preemptive hostile strategies while developing a thorough understanding of responsive takeover defense mechanisms is highly advised.