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Hostile Takeover

This article has been published in ‘Sanhita’ - a corporate issues magazine - by the Pune Chapter of The Institute of Company Secretaries of India (ICSI) in July 2008


What is meant by Hostile Takeover?


Hostile Takeover is a type of acquisition in which, the company being purchased (Target Company) does not want to be purchased at all, or does not want to be purchased by a particular buyer (Acquirer) that is making a bid. In other words, the Acquirer intends to gain control of the Target Company and force it to agree to the sale. The word ‘hostile’ in dictionary means ‘unfriendly, aggressive’.


Hostile Takeovers is a type of method used for Corporate Restructuring. There are other methods like Mergers & Acquisitions, Leveraged Buyout, Spin offs, etc. through which Corporate restructuring may be done.


In India, hostile takeover is a dreaded word, may be since it is a method used which is not democratic in nature and somewhat unpleasant for the management of a target company.


Why a hostile takeover?


There are several reasons why a company might want or need a hostile takeover. The major reason may be of financial gain instead of economic or business gain.


The acquiring company may think that the target company can generate more profit in the future than the selling price. E.g. If a company can make $100 million in profits each year, then buying that company for $200 million makes sense. That is why it is observed that so many corporations have subsidiaries that do not have anything in common -- they were bought purely for financial reasons.


Legal Angle:


Companies Act 1956 does not expressly mention about takeovers or acquisitions. It primarily, only talks about Mergers & Amalgamations through Section 391-396.


SEBI (Substantial Acquisition of Shares & Takeovers) Regulations, 1997 has been enacted by the Securities and Exchange Board of India which deals with acquisition of shares, takeovers, etc.


Neither the term ‘takeover’ nor the term ‘hostile’ has been expressly defined under the said Regulations, the term basically envisages the concept of an:


[i]) taking over the control

[ii]) or management of the target company

[iii]) acquires substantial quantity of shares or voting rights of the target company.


Here the term ‘substantial acquisition of shares’ attains a very vital importance, irrespective whether the corporate restructuring is through merger / acquisition / takeover.


The said SEBI Regulations have discussed this aspect of ‘substantial quantity of shares or voting rights’ separately for two different purposes:


(I) For the purpose of disclosures to be made by acquirer(s):


(1) 5% or more shares or voting rights:


A person who, along with ‘persons acting in concert’ (PAC), if any, acquires shares or voting rights (which when taken together with his existing holding) would entitle him to more than 5% or 10% or 14% shares or voting rights of target company, is required to disclose the aggregate of his shareholding or voting rights to the target company and the Stock Exchanges where the shares of the target company are traded within 2 days of receipt of intimation of allotment of shares or acquisition of shares.


2) More than 15% shares or voting rights:

An acquirer, who holds more than 15% shares or voting rights of the target company, shall within 21 days from the financial year ending March 31 make yearly disclosures to the company in respect of his holdings as on the mentioned date. The target company is, in turn, required to pass on such information to all stock exchanges where the shares of the target company are listed, within 30 days from the financial year ending March 31 as well as the record date fixed for the purpose of dividend declaration.


(II) For the purpose of making an open offer by the acquirer:

(1) 15% shares or voting rights:


An acquirer, who intends to acquire shares which along with his existing shareholding would entitle him to more than 15% voting rights, can acquire such additional shares only after making a public announcement (“PA”) to acquire at least additional 20% of the voting capital of the target company from the shareholders through an open offer.


(2) Creeping limit of 5%:

An acquirer, who is having 15% or more but less than 75% of shares or voting rights of a target company can consolidate his holding up to 5% of the voting rights in any financial year ending 31st March. However, any additional acquisition over and above 5% can be made only after making a public announcement.

However in pursuance of Reg. 7(1A) any purchase or sale aggregating to 2% or more of the share capital of the target company are to be disclosed to the Target Company and the Stock Exchange where the shares of the Target company are listed within 2 days of such purchase or sale along with the aggregate shareholding after such acquisition / sale. An acquirer who has made a public offer and seeks to acquire further shares under Reg. 11(1) shall not acquire such shares during the period of 6 months from the date of closure of the public offer at a price higher than the offer price.


(3) Consolidation of holding:

An acquirer who is having 75% shares or voting rights of a target company can acquire further shares or voting rights only after making a public announcement specifying the number of shares to be acquired through open offer from the shareholders of a target company.


Methods of hostile takeover:


Tender offer and Proxy fight are the two primary methods of conducting a hostile takeover.


A tender offer is a public bid for a large chunk of the target's stock at a fixed price, usually higher than the current market value of the stock. The purchaser uses a premium price to encourage the shareholders to sell their shares. The offer has a time limit, and it may have other provisions that the target company must abide by if shareholders accept the offer. The bidding company must disclose their plans for the target company and file the proper documents with the SEBI as explained above.


In a proxy fight, the buyer doesn't attempt to buy stock. Instead, they try to convince the shareholders to vote out current management or the current board of directors in favor of a team that will approve the takeover. The term "proxy" refers to the shareholders' ability to let someone else make their vote for them -- the buyer votes for the new board by proxy.


Often, a proxy fight originates within the company itself. A group of disgruntled shareholders or even managers might seek a change in ownership, so they try to convince other shareholders to band together. The proxy fight is popular because it bypasses many of the defenses that companies put into place to prevent takeovers. Most of those defenses are designed to prevent takeover by purchase of a controlling interest of stock, which the proxy fight sidesteps by changing the opinions of the people who already own it.


Case Law:


The most famous proxy fight was Hewlett-Packard's takeover of Compaq. The deal was valued at $25 billion, but Hewlett-Packard reportedly spent huge sums on advertising to sway shareholders. HP wasn't fighting Compaq -- they were fighting a group of investors that included founding members of the company who opposed the merger. About 51 percent of shareholders voted in favor of the merger. Despite attempts to halt the deal on legal grounds, it went as planned.


Defending a hostile takeover:


If we consider the global practices, there are several ways to defend against a hostile takeover. The most effective methods are built-in defensive measures that make a company difficult to take over. These methods are collectively referred to as "shark repellent." Here are a few examples:


1. The Golden Parachute is a provision in a CEO's contract. It states that he will get a large bonus in cash or stock if the company is acquired. This makes the acquisition more expensive, and less attractive. Unfortunately, it also means that a CEO can do a terrible job of running a company, make it very attractive for someone who wants to acquire it, and receive a huge financial reward.


2. The supermajority is a defense that requires 70 or 80 percent of shareholders to approve of any acquisition. This makes it much more difficult for someone to conduct a takeover by buying enough stock for a controlling interest.


3. A staggered board of directors drags out the takeover process by preventing the entire board from being replaced at the same time. The terms are staggered, so that some members are elected every two years, while others are elected every four. Many companies that are interested in making an acquisition don't want to wait four years for the board to turn over.


4. Dual-class stock allows company owners to hold onto voting stock, while the company issues stock with little or no voting rights to the public. Investors can purchase stocks, but they can't have control of the company.


5. One of the more common defenses is the poison pill. A poison pill can take many forms, but it basically refers to anything the target company does to make itself less valuable or less desirable as an acquisition.


6. The people pill - High-level managers and other employees threaten that they will all leave the company if it is acquired. This only works if the employees themselves are highly valuable and vital to the company's success.


7. The crown jewels defense - Sometimes a specific aspect of a company is particularly valuable. For example, a telecommunications company might have a highly-regarded research and development (R&D) division. This division is the company's "crown jewels." It might respond to a hostile bid by selling off the R&D division to another company, or spinning it off into a separate corporation.


8. Flip-in - This common poison pill is a provision that allows current shareholders to buy more stocks at a steep discount in the event of a takeover attempt. The provision is often triggered whenever any one shareholder reaches a certain percentage of total shares (usually 20 to 40 percent). The flow of additional cheap shares into the total pool of shares for the company makes all previously existing shares worth less. The shareholders are also less powerful in terms of voting, because now each share is a smaller percentage of the total.



Why is it a dreaded one?


A target company may not want to be acquired at the first place, upfront, through a friendly manner. Members of management might want to avoid acquisition because they are often replaced in the aftermath of a buyout. The board of directors or the shareholders might feel that the deal would reduce the value of the company, or put it in danger of going out of business. Simply put, the target company gets scared by the very thought of ‘being acquired’.


In this case, a hostile takeover will be required to make the acquisition. In some cases, purchasers use a hostile takeover because they can do it quickly, and they can make the acquisition with better terms than if they had to negotiate a deal with the target's shareholders and board of directors.


Some analysts feel that hostile takeovers have an adverse effect on the economy, in part because they often fail. When one company takes over another, management may not understand the technology, the business model or the working environment of the new company. The debt created by takeovers can slow growth, and consolidation often results in layoffs.


Another cost of hostile takeovers is the effort and money that companies put into their takeover defense strategies. Constant fear of takeover can hinder growth and stifle innovation, as well as generating fears among employees about job security.



Who Benefits?


Promoters typically defend their opposition to hostile takeover proposals on the ground that they are not in the best interests of the shareholders.


However, shareholders usually see an immediate benefit when their company is the target of an acquisition because the acquiring company pays for stocks at a premium price. Conversely, the acquiring company often incurs debt to make their bid, or pays well above market value for the target company's stocks.


But numerous empirical researches abroad has proved that stock prices rise just as much in response to a hostile offer as they do on announcement of a friendly bid. In fact, over the short term, the returns from a hostile offer are much better than in a friendly offer. The premiums are comparable. In other words, hostile offers are hostile only to the promoter-managers and not to the shareholders.


Ultimately, we must measure the costs of mergers and acquisitions on a case-by-case basis. Some have been financial disasters, while others have resulted in successful companies that were far stronger than their predecessors were.


Case Law:


India Cements takes over Rassi Cements in 1998


ITC Ltd takes over East India Hotels Ltd in 2000


Unsuccessful hostile takeovers:


Sterlite Industries & Indal (Indian Aluminium)



Anand Arvind Wadadekar

M.Com, M.A Economics, MBA Finance, AMFI, DIT, GCIPR

Pune, Maharashtra

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