What is a Hostile Bid?

Hostile takeovers happen when an acquiring entity looks to purchase a public company without the blessing of the Board of Directors or executive management. The would-be acquirer instead makes an offer for shareholders to tender their shares to them or starts a proxy fight to boot off the current recalcitrant Board to commence a friendly takeover. A friendly takeover has the approval of the Board.

Hostiles were made famous in the 1980’s, synonymous with private equity firms having cheap access to debt to fund leveraged buyouts, but are still relevant today – albeit with a much smaller debt load than what was possible in the past.

Hostile bids can be made by strategic or financial acquirers. From the strategic side, the rationale generally stems from:

1. the company has excellent assets owing to market intelligence and access to information in the sector and is undervalued;
2. there are obvious synergies to combining the two businesses whether through economies of scale or other factors;
3. the target is poorly run and the acquirer’s management can run it much more efficiently.

So an example would be Home Depot, with very robust operating margin, making a bid for a large, inefficient home improvement chain focused in a geography that it wants to expand in and has seen its stock trade sideways for a while.

These factors will entice Home Depot to pay up for the share price.

Private Equity Firms and Hostile Takeovers

In the past, financial buyers or private equity firms would simply punch in numbers on Excel (and prior to that mapping them out on actual paper spreadsheets) – if the IRR makes sense, launch a hostile bid.

Today’s market is much more efficient and banks are not only loathe, but unable to owing to regulatory hurdles, to provide the amount of off-market leverage required to get the IRR to an acceptable level for most PE funds. The market will generally have a stock trade at a floor (assuming that it generates relatively stable free cash flows) value where a leveraged buy out makes sense. So PE firms are priced out from just tinkering around with financial engineering.

As such, these days there is always an operational angle to leveraged buyouts. Either the PE fund feels that they can install a better management team or has some sort of synergy with its other portfolio companies. For example if they have a company that leases railcars and they buy a logistics firm, this could make sense.

The alternative is that the PE firm feels that the stock is just undervalued – although when marketing their hostile takeover campaign they have to argue that shareholders are getting great value and the current management team is weak.

Hostile Bid Vulnerability

Who are obvious targets for a hostile bid? Companies that have:

1. balance sheet stress (more likely to be acquired by a strategic buyer as financial buyers can no longer really use leverage to juice their returns);
2. seen their share price underperform peers (easier to tap into shareholder dissatisfaction); and
3. seen their share price decline precipitously, whether or not in line with market (allows for an opportunistic bidder).

If combined with other elements such as a management team that is perceived to have excessive compensation structures, this makes them an obvious target.

Ironically, these are the targets that are most likely to not negotiate a friendly transaction and force an acquirer to go hostile. Management in this case is reluctant to negotiate unless they get a very high takeout price or have some agreement where they are paid to ride off into the sunset or are allowed to keep their seats. This is a cost for the acquirer, either via a higher equity cheque or a flaw in the plan in terms of installing its perceived superior management team.

If a company has undergone a recent review of “Strategic Alternatives” – which in the corporate finance world generally involves hiring an investment banker to evaluate how to crystallise value for the company – that has gone nowhere, this makes them even more vulnerable to a hostile bidder.

Limitations of a Hostile Transaction

Hostile bids are cool – they generally are a top business news item and come with squabbling due to the antagonistic nature of the process.

However, to the extent possible, acquirers will generally approach the target’s board first to attempt a friendly transaction.

The main constraint is that without the approval of the target’s management, the acquirer does not have access to a data room and commercial information that is required to have a thorough due diligence process. As such, it makes sense when they have high confidence from the market intelligence they have plus any public financial disclosures and investor presentations.

Additionally, hostile transactions raise costs – the management spends time waging a PR campaign, which takes away time from the business.

The premium to current share price will usually (but not always) be more compelling to get more passive investors who are on the fence to tender.

Takeover Defense Strategies

There are a number of actions that the target of a hostile bid can undertake that would deter the bidder. However, many of these tactics are arguably not in the best interests of shareholders at the firm (including not agreeing to be acquired in itself) – the Board of Directors and Management have a fiduciary duty to shareholders.

The first action is to retain an investment banker and start presenting marketing materials where the bid is opportunistic and does not reflect the true intrinsic value of the target. However, this may not elicit a strong reaction especially if the target has underperformed or a recent strategic alternatives process has yielded no logical results.

Actions that may be beneficial to shareholders include looking for a white knight. This means trying to get a rival bidder in to pay a higher price. These potential white knights will have access to a data room, but the balance of power is tilted to their favor due to the existential overhang for the target company.

Other actions include poison pills/shareholder rights plans, Pac Man defenses (making a bid for the acquirer instead – obviously this does not work for private equity firms), mergers and asset sales assuming that they are not restricted by debt documents and do not require shareholder approval by regulation (smaller transactions), putting on undue leverage and golden parachutes for management (offering them huge sums of money should there be a takeover).

The problem with these aforementioned actions is that they blatantly do not serve shareholders – they only ensure that the takeover does not happen. This may encourage a proxy fight so that cetain actions can be repealed.

VWAP and Shareholder Analysis in M&A

For acquirers, there has to be some preliminary analysis conducted on how the target share price has moved over time and who the main shareholders are.

Generally, M&A bankers love VWAP – volume weighted average price – how does the bid compare to where the stock has traded. If the bid is high versus a depressed share price from market gyrations and there is no change in the underlying story of the stock (things are not going badly), a higher premium may be required to entice shareholders.

Looking at the BLoomberg screen Ownership History is also important. If shareholders are largely transient or and less institutional, the premium may be enough to get people to move quickly. If the shareholder base is largely institutional with a long term thesis and can ride out short term vagaries int he market, the premium will have to be much higher to be compelling.

Looking at the weighted average entry cost of major investors in the Target can give a read through as to their eagerness to transact – no one wants to take a quick loss. Conversely, a dog that has been sitting in the books for some time may cause some asset managers to just lock in a lower loss and get rid of it.

For shareholders betting on a very particular thesis at the TargetCo, if the acquirer is a strategic buyer and the share price has done poorly over time, they may want a stock element to the purchase consideration so that they can continue to bet on this upside.

If there is no shared shareholder base between the two companies, the share offer may be less attractive and the acquirer may want to consider cash – otherwise there will be a decline in both companies’ share prices and large shareholder churn if the transaction is consummated (which leads to selling pressure and depresses the stock price).

If the acquirer thinks that the shareholders of the target will not be receptive, they should issue external equity via equity capital markets instead (albeit at a small commission).