The immediate reaction of most managements to a takeover approach is negative. Shareholders rarely share this view - and it is they who make the final decision. Sue Copeman discusses strategies for fighting a hostile bid.
The predator's first move is usually a friendly overture. A brief chairman to chairman conversation may he enough to establish that a bid will be resisted. If the bidders have anticipated this and are prepared to attack, you are likely to get a hostile bid very soon afterwards. They will have prepared the bid beforehand, done their homework and worked out what their attack strategy will be.
The initial approach will usually give some indication of whether the bidders will back out or press on with a hostile bid. Another warning sign might be some unusual share buying activity.
In the worst scenario, the first you hear of a hostile bid is at 7am one morning.
Playing for time
The takeover codes in the UK and some other European countries, such as France and Germany, lay down timetables. Once a bid is published, you have a limited lime to respond.
Debate between companies may continue for some time before the hostile bid comes in. It is a big decision for the bidder, for it is a high risk strategy involving large costs and possible loss of face in the market if the bid fails.
According to Jonathan Hinton, corporate finance, Arthur Andersen, you are often too late if you have not planned your counter strategy before the bid comes in. "Once a bid is in, you are at a disadvantage. Very rarely in these circumstances will a defence work."
Does size make a difference?
Analysts spend most of their time looking at big companies. As a result, large companies are usually accurately valued. Smaller companies, say around £100m, tend to be ignored. Predators often attack companies which they believe are under-valued.
In addition to the bargain-hunters, there are predators who want to take advantage of synergies. Potential synergies can exist in companies of all sizes. Some large predators have huge capital war chests and obtaining further financing is not a problem. This makes even the largest companies vulnerable to hostile bids.
In the UK, companies up to the lower reaches of the FTSE 100 tend to be dominated by a relatively small number of institutional shareholders, with 20 or so major institutions often holding half the share capital. "They may be prepared to let a hostile bid go down if they don't feel the price is attractive, to send a message to others. Blue Circle is a good recent example," says Jeremy Lucas, managing director, head of UK mergers & acquisitions, Deutsche Bank AC London.
Bidders have the advantage
Countries like Germany and the UK do not allow target companies to take frustrating action once a bid is on the table. Companies also have a continuing duty to disclose anything that could have a material effect on their share price. In theory, at any rate, predators need not expect any surprises.
Managements have the duty to maximise shareholder value. Doing a good job in creating a robust-defence against a hostile bid will help to achieve this if the share price rises as a result. This is true even where the defence itself is unsuccessful at the end of the day, and the hostile approach eventually ends up as an agreed bid.
Cash or paper?
You stand more chance of a successful defence if the bidder offers paper (a share-based deal) rather than cash. It can be very hard to persuade shareholders who are offered a cash price which is significantly above the current market price not to take the money and run.
"If it is a paper bid, then you have a much better chance of defending your position," comments lan Krieger of Arthur Andersen's transaction support team. "Being offered paper is more uncertain than cash. Your investors have to decide whether the bidder's management are better able to run your company than you are."
Weapons at your disposal
You need to convince your shareholders that the bid under-values your business. This means explaining to your major institutional investors why your valuation is better and how, if your company has been under-performing, the management is going to do better.
If the company is under-valued, you may be able to issue a favourable profit forecast, audited and signed by your advisers. You may be able to highlight opportunities for long-term growth.
Talking to shareholders will help you predict how they are going to react to the bid. If you are likely to lose the battle, you need to lose in the best way to maximise value.
An associated strategy in proving under-valuation is to show a favourable break-up value. This is likely only to be feasible where analysts have not been paying much attention to your business. Lucas explains: "If you think the market doesn't understand the value of an asset, you can look at sale, flotation or demerger. You might combine any of those with a return of capital to shareholders."
Once you have calculated what you would gain from this, you need to be able to show shareholders that the remainder is worth more than the balance in terms of the value of the bid. Krieger warns, "There will be general scepticism if management announces a series of strategic or restructuring actions following a bid. If shareholder value is enhanced by such actions, people will want to know why they weren't taken earlier".
Management buy outs (MBOs) can be a viable strategy for smaller under-valued companies. Indeed, Hinton suggests that most management teams should actively consider whether an MBO makes sense, particularly if there is a chance of an unwelcome bid emerging "It often makes sense, even for major corporates, to consider what price they could get from a financial buyer. It sets a base value in the event of a hostile bid being received."
It may be difficult for management to outbid a predator, as the hostile bid will often be based on perceived synergies as well as the company's value. However, Lucas points out that the larger venture capital houses may already have bought a business in a similar area, so may well have their own synergies to consider.
Most shareholders like successful bids because they make a profit on their portfolio. UK regulators don't allow US-style "poison pills" (penalties that are triggered when a takeover is announced). Neither can a company restructure after a bid in order to frustrate it.
The rules are less stringent in some countries. For example, there are no holds barred in the Netherlands, where a target company would be perfectly entitled to issue preference shares with voting rights, for example. Unsurprisingly, there are no hostile bids there.
However, you can structure your company, before a bid emerges, in a such a way that a takeover becomes more difficult, and so less likely.
Strategic alliances can be difficult to unravel. An example is Marconi (formerly GEC). In the 1980s, it established a number of joint ventures with a wide range of companies, both domestic and international. Where joint venturers have pre-emption rights, it is difficult for bidders to assess just what assets they will be able to acquire.
You can structure your balance sheet so that you are running a level of gearing which would make it difficult for someone to fund a bid by borrowing against your own balance sheet.
Alternatively, you might buy a business where a likely predator would be faced with a huge anti-trust problem.
Of course, the way you structure your company must benefit it commercially, and hence benefit your shareholders. You cannot adopt a strategy purely for takeover defence reasons.
If takeover seems inevitable but you do not like the predator involved, you may be able to find a "white knight" (alternative bidder). Your shareholders are likely to approve this strategy, as it may increase the company's ultimate price.
Most well-run companies will continually be examining other companies that are strategic fits and that may be acquisition targets, so how are you likely to find a saviour? Says Krieger: "Some white knights may previously have decided that you were not for sale. On the other hand, it may be that buying you will become a strategic imperative to prevent two of their competitors linking up to create a major force in the marketplace."
Lucas believes that only a reasonably bold company will intervene in a publicly competitive situation. "You may find you get involved in a difficult fight and that is the last thing that many public companies want to do. If you clearly have more fire power than the hostile bidder, you may have little chance of losing. But if you are the same size, even with the target board's recommendation behind you, there's no great certainty that you will win."
Challenging the hostile management's probity is when the battle gets tough - and expensive. You will need a range of advisers to investigate and refute the predator's financial returns, statements, predictions, performance, treatment of employees, perhaps even ethics. You are trying to undermine management credibility.
At the same time, they will be doing the same to you. You need to second guess what they will say and prepare your defences. Warns Hinton: "Whatever side you are on, you need to know what the other side is going to say, and you need to be able to respond quickly."
Counter attacks do the most effective damage where the bidder is offering paper. They can erode shareholders' perceptions of the value of the offer. Even in cash deals, they can create an "embarrassment" factor, according to Lucas. "Institutions may feel they really should not accept a bid from this company unless the price is very high indeed."
In the UK, the most likely targets are often companies in sectors that have become unfashionable, such as manufacturing and engineering. Frequently, continental companies take a different view. There have been a number of MBOs in these sectors, with
companies deciding to take themselves off the market before someone else does. Under-valued companies will always attract predators.
It is better to defend well than to defend successfully. By the time the bid goes through, it's usually an agreed one - at a higher price. The CEO who sells at a premium delivers value to his shareholders and gains enormous respect in the market.
Defending well requires advance planning. Regularly asking "What would happen if we got a hostile bid today?" focuses attention on what management should be doing anyway to increase value to shareholders.
Sue Copeman is editor of Strategic Risk.