Beware the Bargain Hunter. Are You Prepared for a Possible Takeover Approach? Public Company Boards Should Check What Defenses They Have, What's Available, and What Best Protects Long-Term Investors in Today's Uncertain Market


Corporate & Finance Alert

June 2, 2009

Merger and acquisition (M&A) activity hit its lowest monthly level for almost five years in April, underlining how tough deal making remains despite rising stock markets and the often repeated phrase that there are “green shoots of a recovery.”

Thomson Reuters recently released data that highlighted that globally announced M&A volumes were at their lowest monthly total since September 2004. In the first four months of the year, M&A fell 35 percent compared to the same period in 2008. The year-to-date decline was led by a near-halving of European M&A deals, down 49 percent, and a 59 percent drop in the Asia-Pacific region. In the United States, year-to-date M&A held up somewhat better, down 22 percent. However, the U.S. numbers were boosted by a number of multi billion-dollar deals announced on “Merger Monday” (April 20), which included proposed acquisitions by Oracle, GlaxoSmithKline and PepsiCo Inc.

Although M&A activity has been stymied by a gloomy and unclear economic outlook, scarce debt financing, and sometimes unbridgeable differences between buyers and sellers over asset prices, unsolicited or hostile transactions increased dramatically in 2008 and are likely to feature significantly in 2009.

According to Thomson Financial, there were 17 large-cap (+$1 billion) hostile takeover attempts in 2008 compared to only 5 in 2007. This trend has continued into the 2009. Recent large-cap examples include Roche Holding’s $42.5 billion all-cash bid for Genentech and Exelon’s $6.2 billion all-stock offer for NRG Energy. Mid-cap companies have also got in on the unsolicited bid scene, for example Mill Road Capital’s $78 million cash bid for R.G. Barry and Knowledge Learning’s $141 million bid for Nobel Learning.

The recent financial crisis has left many public companies’ market capitalizations at 10-year lows, but with the Dow up more than 30 per cent and NASDAQ up more than 35 per cent from troughs on March 9, sentiment has improved somewhat recently and some commentators suggest that the continued depressed share prices will continue to attract acquisitive companies looking for a bargain.

Indeed, the dramatic decline in market capitalization has potentially made it easier for predators to position themselves to make a successful hostile approach. The “early warning” benefits of the Hart-Scott-Rodino minimum reporting threshold – just increased to $65.2 million, effective February 12, 2009 – have been eroded. An acquiror can accumulate 15-20 percent of a mid-cap target’s shares before an HSR filing is triggered. Thus, a hostile party could quietly, without notice or warning, accumulate a substantial block in the 10 days leading up to a Schedule 13D filing obligation, leaving no meaningful opportunity for the target to react forcefully, for example by implementing a poison pill.

In light of the recent hostile trend, directors of public companies should consider undertaking a thorough review and assessment of their likely exposure to a hostile approach and any perceived weaknesses. There are a number of practical steps to better prepare for, and respond to, a hostile bid. Taking these practical steps will provide target companies with more flexibility to better defend against any unsolicited offer.

We discuss below several structural and procedural defenses that have been highlighted in recently announced deals and should be considered by all public companies.

Advance Notice Bylaws

Poor stock performance provides shareholder activists with a simple battering-ram to push boards to complete business combinations not otherwise contemplated, to sell divisions for less than inherent long-term value, and to obtain board representation disproportionate to their holdings.

In light of this, careful attention should be paid to the company’s existing advance notice bylaw provisions. These usually require a shareholder seeking to propose nominations or have other business considered at a meeting of shareholders to submit information to the company about the nominations or business by a specified date prior to the meeting. Recent Delaware court decisions (for example, CNet Networks and Office Depot – where shareholder nominations for board seats were permitted to be presented after the apparent deadlines set out in the bylaws) have demonstrated that a lack of clarity in these provisions can render them inapplicable in certain circumstances leading to devastating effect.

These decisions highlight the need for companies to identify and amend ambiguous advance notice bylaw provisions to make clear that they apply both to company and non-company proxy materials and the nomination of directors. It is also becoming common for companies to enhance protections afforded by the advance notice bylaws by requiring a dissident’s notice to elaborate on matters that might not otherwise come to light, for example requiring the disclosure of hedging and other synthetic and temporary holding techniques.

Shareholder Rights Plans/Poison Pills

2008 was a popular year for adopting a poison pill, an increase of nearly 50 per cent over 2007. According to FactSet SharkRepellent, 127 poison pills were adopted in 2008, the most in any year since 2002, with 76 of these as first-time pill adoptions. The vast majority being implemented by companies with market capitalizations of less than $500 million.

Companies should ensure that the rights plan they have adopted incorporates the latest technical improvements and is appropriately tailored.

Companies considering the adoption of a shareholder rights plan (and those considering enhancing an existing plan) will need to weigh this against the potential adverse investor and public relations implications. However, any confrontation with proxy advisory firms can be avoided if companies choose to have a rights plan “on the shelf” for adoption at a future date if needed.

Recent plans have sought to catch previously undisclosed equity derivative positions that may not have been caught under traditional “beneficial ownership” definitions when determining whether the applicable threshold has been crossed.

Debt Arrangements

Companies should look to review their existing debt agreements paying particular attention to any repayment obligations on a “change-of-control”. While the credit markets continue to be constrained, the consent or waiver of an existing lender group may not be easily obtained. As a result your existing lenders may well play a much greater role in any potential takeover than might previously have been the case.

Be Prepared – Have a Takeover Tool Kit

In preparation for a hostile takeover, directors should diligently and continually monitor the value of their company, so that they are in a position to quickly judge whether a bid is too low and requires defensive measures. In addition, companies should constantly refresh their shareholder lists and contact information so that the board can be aware of shareholder changes. Some companies even periodically organize town hall meetings with their shareholders to improve communication with shareholders and discuss corporate governance issues.

In this uncertain environment, directors should undertake a thorough review and assessment of the takeover defense weapons at their disposal including their company’s charter, by-laws, compensation program, and director and officer insurance coverage. Being prepared is all about having a carefully crafted tool kit of options and available defense tools, including poison pills, carefully reviewed and understood by the board prior to receipt of any unsolicited offers. This will provide the board with greater flexibility if defensive steps are later needed in response to hostile action.