Corporate Instruments to Fend Off Unwanted Shareholders

Table of contents

Tables and Figures

List of abbreviations

1. Introduction
1.1. Problem definition
1.2. Procedure

2. Takeover motives
2.1. Strategic Motives
2.1.1. Market Motives
2.1.2. Capacity Motives
2.1.3. Risk Motives
2.2. Financial Motives
2.2.1. Capital market related motives
2.2.1.1. Access to capital markets
2.2.1.2. Undervaluation and restructuring
2.2.2. Motives of balance and tax policy
2.2.2.1. Balance sheet policy
2.2.2.2. Tax policy
2.3. Personal Motives

3. Techniques of a hostile takeover
3.1. Tender offer
3.2. Dawn Raid

4. Takeover defence instruments
4.1. Important legal restrictions and frameworks
4.2. Preventive measures
4.2.1. Poison Pill
4.2.2. Golden Parachutes
4.2.3. Golden Shares
4.2.4. Share Buyback
4.2.5. White Squires
4.3. Reactive Measures (ad-hoc measures)
4.3.1. White Knight
4.3.2. Crown Jewels
4.3.3. Investor Relations

5. Cases
5.1. ABN Amro
5.1.1. Background
5.1.2. Motives
5.1.3. Offer
5.1.4. Takeover Defence
5.1.4.1. Share buyback
5.1.4.2. White Knight
5.1.4.3. Crown Jewels
5.1.4.4. Investor Relations
5.1.5. Empirical analysis of stock prices
5.1.6. Conclusion
5.2. Endesa
5.2.1. Background
5.2.2. Motives
5.2.4. Takeover Defence
5.2.4.1. Golden Shares
5.2.4.2. White Squires
5.2.4.3. White Knight
5.2.5. Empirical analysis of stock prices
5.2.6. Conclusion
5.3. Bayerische HypoVereinsbank
5.3.1. Background
5.3.2. Motives
5.3.3. Offer
5.3.4. Takeover Defence
5.3.3.1. White Squire
5.3.3.2. Golden Parachutes
5.3.5. Empirical analysis of stock prices
5.3.6. Conclusion
5.4. Mannesmann
5.4.1. Background
5.4.2. Motives
5.4.3. Offer
5.4.4. Takeover Defence
5.4.4.1. Investor Relations
5.4.4.2. Poison Pill
5.4.4.3. White Knight
5.4.4.4. Golden Parachutes
5.4.5. Empirical analysis of stock prices
5.4.6. Conclusion

6. Conclusion

Bibliography

Tables and Figures

Table1: Conclusion of takeover defences in ABN Amro-case

Table 2: Conclusion of takeover defences in Endesa-case

Table 3: Conclusion of takeover defences in HVB-case

Table 4: Conclusion of takeover defences in Mannesmann-case

Figure 1: Worldwide M & A transactions 2000 – 2007

Figure 2: Buyer's motives for M&A decisions

Figure 3: The Pentagon Concept to assess the maximum increase in value potential through restructuring

Figure 4: Performance of stock prices in ABN Amro-case

Figure 5: Performance of stock prices in Endesa-case

Figure 6: Performance of stock prices in HVB-case

Figure 7: Performance of stock prices in Mannesmann-case

List of abbreviations

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1. Introduction

1.1. Problem definition

As today’s markets mostly develop and change faster than companies can organically grow, the option of taking over other companies has become core to strategic management seeking to expand the company’s business and to create value for both customers and stakeholders (Achleitner 2005). So Mergers & Acquisitions have experienced an enormous boom in today’s business world of fast changing global markets and emerging competition, as shown in figure 1.

illustration not visible in this excerpt

Source: Available from: Spiegel Online (2007).

Figure 1: Worldwide M & A transactions 2000 – 2007.

On the other hand, this development forces target companies to take measures to protect themselves against hostile takeovers, as the purpose of these kinds of acquisitions is to get control of a strong competitor or even to eliminate him by selling out its assets after a successful acquisition (Achleitner 2005).

So in order to determine an appropriate defence strategy against takeover attempts of an unfriendly nature and to apply the appropriate anti-takeover instruments, many aspects such as motives and practical approach of the attacking company have to be taken into account as well as a variety of legal frameworks and shareholder interests and rights.

The present assignment’s authors’ intent is to provide an overview on this complex field. It does not stake out the claim of textual completeness, but rather intends to deliver a concentrated guideline through the topic’s most important aspects; leading to a description of some of the most commonly used instruments to fend off unwanted shareholders. A particular focus is thereby dedicated to these instruments’ impact on stock prices – and thus on shareholder value – of both the attacking and the target company, which is substantiated by a significant amount of empirical evidence delivered by real cases, where the respective defence instruments have actually found their application.

1.2. Procedure

The present assignment consists of 6 chapters. Chapter 1 covers the problem definition, delivering an overview on worldwide M & A activities and this trend’s impact on takeovers as an important strategic instrument for management. Secondly, the authors’ procedure with this assignment is covered. Chapter 2 covers the different motives for takeovers and analyses them more into detail with regards to their economical benefit for the merging organizations. What is also shown in this context is the contrast of takeover motives that are indeed sensible and to the economical benefit of all stakeholders and rather problematic or questionable motives such as some financially motivated takeovers or takeovers motivated by the hybris of some managers. Now that the various motives for takeovers have been clarified, the two commonly used techniques of a hostile takeover are discussed in chapter 3 – the more official tender offer and the rather sneaky dawn raid. With the so forth given background on a potential hostile attacker’s motives and his possible technical approach, the reader is taken to chapter 4 introducing some of the most commonly used takeover defence instruments. Because almost all anti-takeover instruments are subject to legal limitation and regulation, these legal restrictions and frameworks are covered in the first place before the authors go more into detail on the instruments themselves. The chapter then distinguishes between preventive measures to be taken before the actual takeover offer is brought to the attention of a target company’s management and shareholders and reactive (ad-hoc) measures which are to be considered after the offer has been delivered. Chapter 5 finally picks up on the above theoretically explained instruments and shows their application in four selected cases. All cases are presented in a certain pattern allowing the reader to capture the background and motives of the respective takeovers, the course of the offer stage, the applied takeover instruments and the development of stock prices, substantiated by empirical evidence. The authors conclude each case with an individual appreciation taking the effect of the applied anti-takeover instruments on value and stock price and their defence effectiveness as a whole into account. Chapter 6 covers the authors’ final conclusion.

2. Takeover motives

Mergers and acquisitions can be considered as a form of corporate strategy to enable management to react on a changing economical environment, which of course implies specific risks and opportunities for the parties involved (Wirtz 2003). From a buyer’s perspective, the various motives for a takeover are, by that definition, linked to its chances and can be categorized in strategic, financial and personal purposes. These are shown in figure 2 and shall be discussed as follows.

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Source: Modelled after: Wirtz, B. (2003), p. 58.

Figure 2: Buyer's motives for M&A decisions.

2.1. Strategic Motives

Strategic Mergers & Acquisitions describe those mergers that express or execute a corporate strategy, whereby the primary objective is the realization of synergy effects. A synergy within the context of M & A can be assumed if an additional value is created by the merger of two companies (Achleitner 2005). Generically speaking, this adopts the concept of 2 + 2 not being 4, whereby the utility generated through the cooperation of multiple factors is unequal to the sum of utility generated by the factors alone. Sandler (1991 cited Wirtz 2003) stated that in capital market terminology, a synergy effect can be assumed if the following formula applies to two different investment objects

illustration not visible in this excerpt

At and Bt thereby describe the return on each of the two investments at the moment of t, while (A + B)t describe the total return generated through A and B together at the moment of t.

2.1.1. Market Motives

Locating such synergy potentials and implementing them into a company’s business strategy is essential today in order to defend its market position against a completely new dimension of competition driven by competitors from other nations and industry branches. Within that context, mergers & acquisitions often have a significant effect on a company’s procurement and distribution markets, as Wirtz (2003) said.

While the avoidance of bottlenecks in the supply chain, warranty of higher quality standards or a stronger bargaining power through the purchase of higher volumes are typical motives in the procurement markets on the one hand, we find motives such as pooling of sales activities and strengthening market position and bargaining power against competitors and customers on the distribution markets on the other hand (Kogeler 1992). It is important to mention that changing buying behaviour of customers and their increasing demand for integrated, systematic and individualized solutions and services is also a strong driver for M & A activities with the purpose to serve this trend (Wirtz 2003).

2.1.2. Capacity Motives

Capacity synergies arise, when functional units along the supply chain are united in order to provide more efficiency through a common use of resources and knowledge. Wirtz (2003) talks about capacity motives in M & A, when the purpose of the merger seeks to use synergies in core value creating activities such as research & development, production or distribution.

2.1.3. Risk Motives

Another strategic motive for M & A activities is managing enterprise risks. Based on the portfolio theory, mergers & acquisitions within that context especially aim at diversifying enterprise risk by entering new (lateral) industries. This makes the buyer company more independent from stagnating core markets or enables it to balance different developments of single branches or products and thereby maintain stable yields. To ensure that strategic objective, companies would choose M & A targets with revenue streams that correlate negatively with their own, e. g. an oil company merging with an airline (Wirtz 2003).

2.2. Financial Motives

While strategically motivated M & A target at the creation of the above described synergy effects, financially motivated ones are executed independently from long-term considerations of value creation and market position but with the objective to increase profitability in the short- and mid-term. Achleitner (2005) distinguishes between two characteristics in this context: Capital market related motives and motives of balance and tax policy.

2.2.1. Capital market related motives

2.2.1.1. Access to capital markets

Mergers tend to open up new and often improved options for a company to raise capital; meaning that from a financing perspective the company’s enhanced assets may now exceed a certain critical dimension that makes the purchase of bonds attractive and the related transaction costs more reasonable for the addressed stakeholders. This also applies to the investor perspective, whereat the newly acquired return potential through the merger may justify a financial engagement with and the granting of equity to a company (Achleitner 2005).

2.2.1.2. Undervaluation and restructuring

A value-driven acquisition can be presumed if the buyer’s intents are influenced by the market’s subjective perception of an undervaluation of the target company (Achleitner 2005). The acquisition is then exclusively motivated by the profits to be made through re-selling the target and thereby benefit the most from its undervaluation. Usually a series of restructuring measures are undertaken before the resale in order to either sell the whole company or single parts of it at an increased value. The Pentagon Concept from Copeland, Koller and Murrin illustrates the scope within these measures can be assessed. The concept’s objective is to determine the enterprise value after the restructuring measures and thereby the so called Maximum Raider Opportunity which is defined as the difference between the present market value and the value after restructuring (Achleitner 2005 and Copeland, Koller and Murrin 1993).

illustration not visible in this excerpt

Source: Modelled after: Achleitner, A.-K. (2003), p. 67.

Figure 3: The Pentagon Concept to assess the maximum increase in value potential through restructuring.

2.2.2. Motives of balance and tax policy

2.2.2.1. Balance sheet policy

There are not many events that have such a significant impact on a company’s balance sheet as M & A. A fact that many buyers take advantage of, as the incorporated transactions and their consequences are relatively inscrutable to external analysts. Depending on whether the target’s assets are taken over in the balance sheet (Asset Deal) or whether they are booked into shares (Share Deal), the acquirer’s financial statement can be positively influenced by making us of available balance policy suffrage. For example, a company can use its too high cash or security paper reserves to finance an acquisition. This may lead to lower cash positions and to a shifting within the acquirer’s financial and – if applicable – it’s fixed assets. According to Achleitner (2005), this can be considered an effective measure especially for very liquid companies seeking to prevent a hostile takeover.

2.2.2.2. Tax policy

Another fact that companies are able to benefit from in M & A are the tax advantages that occur with such transactions; meaning that on the one hand side, gains and losses of the merging companies can regularly be netted out. On the other hand side, significant tax savings can also be achieved by taking into account the transaction’s financing costs as deductible operating costs, as Wirtz (2003) said.

2.3. Personal Motives

While strategic and financial motives exclusively describe economical intents to take over a target company, personal motives need to be considered in a psychological context. It is with no doubt of great importance to have highly professional and personally skilled people involved in order to successfully manage an M & A process. However, in situations where company ownership and its management are separated, conflicts of interest may occur when it comes to an M & A transaction. This so-called Hybris-Hypothesis describes that the takeovers are quite often (if not mostly) motivated by personal objectives of company’s management such as an increase of personal status or wealth through higher revenues, which of course, will mostly not meet the interests of the company’s shareholders (Gaughan 2007).

3. Techniques of a hostile takeover

According to Picot (2005), the two potentially most promising techniques for a company to successfully perform a hostile takeover are considered to be the so called:

- Tender Offer and
- Dawn Raid

3.1. Tender offer

A tender offer is a public offer by the alienee to the target company’s shareholders, whereby the transaction can either be subject to a purchase or to a trade of stocks. As for Germany, tender offers are regulated in the Wertpapierübernahmegesetz, stating that the offer’s public character is determined by an unlimited circle that is addressed to sell its shares. An offer that is only addressed to a limited number of shareholders would therefore not hold the characteristics of a public offer (Hölters 2005).

3.2. Dawn Raid

Picot (2005) described the dawn raid technique as the secret attempt to gain control over the target company by purchasing big equity stakes that would give the alienee a majority in voting power in the General Assembly. Again, the German Wertpapierübernahmegesetz constrains this quite common technique with certain regulations. First, overrides in voting power of 5%, 10%, 25%, 50% and 75% have to be reported to both the target company and the Federal Supervisory Office (the ‘Bundesaufsichtsamt’) within seven days, which will most likely result in an increase of the target company’s stock price – and therefore to higher transaction costs. Second, the Wertpapierübernahmegesetz obliges the bidder to offer a cash deal if he has acquired more than 5% of the shares or voting rights within the preceded three months. However, the dawn raid will then only be constrained if the target company’s stock price has dropped in the meanwhile, which will most likely not be the case after the takeover plans have been publicly noticed (Achleitner 2005).

4. Takeover defence instruments

Takeover defences are measures performed by a target company’s management that aim at prevention or delay of the (hostile) takeover, whereby the bidder either is forced to improve his takeover proposal or is tried to be kept away completely from gaining control over the target company (Kuhner and Schilling 2002). According to Hölters (2005) takeover defences can be classified into two principal categories:

- Preventive measures and
- Reactive measures (ad-hoc measures)

4.1. Important legal restrictions and frameworks

The application of takeover defences is exposed to a variety of interests, such as those of management, shareholders, employees and sometimes politics (Hölters 2005). As a result, managers are on the one hand side faced with legal frameworks that provide them with the entrepreneurial freedom to take preventive action to the company’s benefit – such as Germany’s § 93 Stock Law (Aktiengesetz or AktG) that applies to the time before submission of a hostile takeover bid. On the other hand, they are obliged to the so called commandment of neutrality, as defined in both national and international legislation such as in § 33 of Germany’s Security Paper Takeover Law (Wertpapierübernahmegesetz or WpÜG) and the European Takeover Directive 2004/25/EG (regulating international capital mobility), whereby management must not undertake any action that is suitable for impeding the takeover bid (Picot 2005). Since 2006, German companies can chose to either exclude § 33 WpÜG or to opt-in according to the recently levelled law (Albersmeier 2007).

4.2. Preventive measures

4.2.1. Poison Pill

The concept of the Poison Pill strategy implies an automatically initiated conditioned legal act or transaction in the case of a hostile takeover attempt. The most commonly used variant of Poison Pill in the Unites States of America is an option given to shareholders to buy additional shares at conditions far below market price. Alternatively, convertible bonds that would be due with submission of a hostile tender offer can be offered. Another quite creative variant is to grant the target’s shareholders the option to swap their shares against those of the alienee at a far too inexpensive exchange rate – a measure that is not allowed in Germany, as it would advantage the target’s shareholders against those of the bidder and thus violate national laws (Achleitner 2005).

Thus, according to Picot (2005), the sole Poison Pill variant that is probably possible in Germany is an increase of capital under the exclusion of the shareholders’ reemptive rights within the approved capital. But with regards to § 33 of the German security paper takeover law, this measure requires the approval of the shareholders’ general meeting or of an extraordinary meeting held with the intent to approve a defence against the takeover.

4.2.2. Golden Parachutes

The Golden Parachute strategy seeks to impede the hostile takeover through causing additional financial stress to the alienee subsequent to dismissing the target company’s management after the completed takeover (Achleitner 2005). This method is originated in the 1980’s and finds its application in contractual agreements between the target company and its managers determining extraordinary (and often inappropriately) high compensations for the event of a premature retirement (Kraft and Jaeger 2003). Golden Parachutes are also mainly used in the USA and have increasingly been criticized in the last years. Even falling stock prices could be observed in the respective companies after a Golden Parachute agreement was brought to the attention of the public (Achleitner 2005). German legislation allows only limited application of Golden Parachutes, as payments to the Board of Directors must by law be in an appropriate relation to the Board’s tasks and the company’s general situation. Additionally, German law obliges the Supervisory Board to provide and monitor the adequacy of the top management’s payments; it can even be held liable for inappropriately high compensations (Kraft and Schilling 2003).

4.2.3. Golden Shares

Golden Shares, however, is a defence instrument that is also applied in Germany. This strategy is defined as methods that give influential power on shareholder structure and corporate strategy decisions to Government. Golden Shares are typically developed as veto rights, rights to reservations and rights to staff committees and could for example imply that Government as one of the dominant shareholders has to approve important corporate decisions such as disposal of fixed or capital assets (Gaughan 2007).

The most recent jurisdiction of the Court of Justice of the European Union will surely give a very interesting drive to European companies with Golden Shares strategies in place, as most of these strategies most likely won’t comply with the European policy of free flow capital (Picot 2005). The first result could already be observed with German car manufacturer Volkswagen, who was now forced to dissociate itself from its Golden Shares strategy that had been in place for decades (Sueddeutsche Zeitung 2007).

4.2.4. Share Buyback

This instrument leads to stringency with the available shares in the market and thus to an increase of the takeover costs, said Achleitner (2005). As for Germany, the ultimate objective to make the acquisition financially unattractive to a hostile bidder does, however, also comprise considerable risk, as the company loses its voting rights on the bought back shares. And as the number of circulating shares decreases at the same time, buying back own shares might even ease the gain of control for unwanted shareholders if the increase of the stock price turns out be not high enough (Hölters 2005). So the only way to prevent this scenario when using share buy back as a preventive anti-takeover measure is to be safeguarded by a friendly shareholder who gains additional control through the stringency of available shares (Kraft and Schilling 2003).

But the German Aktiengesetz delivers additional constraints to share buy back as an effective instrument to fend off a hostile takeover: First, German law does not define a hostile takeover a ‘serious and immediate threat’ to the target company, which is the legal precondition to allowing management to buy back own shares. In fact, a takeover is being considered as an option that the target company’s shareholders might possibly even be in favour of. Second, the maximum buy back volume is limited to only 10% of the company’s original capital by law. And last but not least, a buy back program of own shares requires approval by the General Assembly. Due to these facts, the instrument of buying back own shares cannot be considered an adequate strategy to effectively protect a company from a hostile takeover – at least in the case of Germany, said Hölters.

4.2.5. White Squires

Companies implementing the so called White Squires strategy as a preventive instrument against unwanted shareholders and hostile takeovers seek to take influence on the shareholder structure by having friendly companies hold a certain number of its shares and vice versa. The objective is to reduce its easy acquirable diversified holdings, said Herrmann (1993 cited Kraft and Schilling 2003). Thus, the company seeks to distribute voting power in a way that circles supporting the company and its management’s strategy can exercise a predominant influence – and are able to financially benefit from it adequately (Kraft and Schilling 2003).

Kraft and Schilling (2003) also said that the German Aktiengesetz holds one principal restriction that has to be taken into account when the White Squires strategy is to be applied successfully: The shareholding structure must not comply with §§ 19, 328 AktG whereby a holding of more than 25% would lead to a loss of voting rights of the shares beyond that threshold.

4.3. Reactive Measures (ad-hoc measures)

Once that preventive measure did not lead to the desired success or the risk of a hostile takeover has been assessed incorrectly, the target company’s management encounters the question how an unwanted acquisition can be impeded. One of the most common instruments, which is also explicitly permitted by the otherwise so restrictive German law and does not necessarily require approval by the Supervisory Board (Kraft and Schilling 2003), is called

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