TAKE OVER STRATEGIES

by Meenakshi Valliappan on Friday 9 September 2011, 5:28 AM | Category: Strategy| View: 2762 views
 
 
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 In business, a takeover is the purchase of one company (the target) by another (the acquirer, or bidder)

Friendly Takeovers

Before a bidder makes an offer for another company, it usually first informs the company's board of directors. If the board feels that accepting the offer serves shareholders better than rejecting it, it recommends the offer be accepted by the shareholders.

In a private company, because the shareholders and the board are usually the same people or closely connected with one another, private acquisitions are usually friendly. If the shareholders agree to sell the company, then the board is usually of the same mind or sufficiently under the orders of the equity shareholders to cooperate with the bidder. This point is not relevant to the UK concept of takeovers, which always involve the acquisition of a public company.

Hostile takeovers

A hostile takeover allows a suitor to take over a target company's management unwilling to agree to a merger or takeover. A takeover is considered "hostile" if the target company's board rejects the offer, but the bidder continues to pursue it, or the bidder makes the offer without informing the target company's board beforehand.

A hostile takeover can be conducted in several ways. A tender offer can be made where the acquiring company makes a public offer at a fixed price above the current market price. Tender offers in the United States are regulated by the Williams Act. An acquiring company can also engage in a proxy fight, whereby it tries to persuade enough shareholders, usually a simple majority, to replace the management with a new one which will approve the takeover. Another method involves quietly purchasing enough stock on the open market, known as a creeping tender offer, to effect a change in management. In all of these ways, management resists the acquisition but it is carried out anyway.

The main consequence of a bid being considered hostile is practical rather than legal. If the board of the target cooperates, the bidder can conduct extensive due diligence into the affairs of the target company. It can find out exactly what it is taking on before it makes a commitment. But a hostile bidder knows only publicly-available information about the target, and so takes a greater risk. Also, banks are less willing to back hostile bids with the loans that are usually needed to finance the takeover. However, some investors may proceed with hostile takeoversbecause they are aware of mismanagement by the board and are trying to force the issue into public and potentially legal scrutiny.

Reverse takeovers

reverse takeover is a type of takeover where a private company acquires a public company. This is usually done at the instigation of the larger, private company, the purpose being for the private company to effectively float itself while avoiding some of the expense and time involved in a conventional IPO. However, under AIM rules, a reverse take-over is an acquisition or acquisitions in a twelve month period which for an AIM company would:

§  exceed 100% in any of the class tests; or

§  result in a fundamental change in its business, board or voting control; or

§  in the case of an investing company, depart substantially from the investing strategy stated in its admission document or, where no admission document was produced on admission, depart substantially from the investing strategy stated in its pre-admission announcement or, depart substantially from the investing strategy.

An individual or organization-sometimes known as corporate raider-can purchase a large fraction of the company's stock and in doing so get enough votes to replace the board of directors and the CEO. With a new superior management team, the stock is a much more attractive investment, which would likely result in a price rise and a profit for the corporate raider and the other shareholders.

Backflip takeovers

A backflip takeover is any sort of takeover in which the acquiring company turns itself into a subsidiary of the purchased company. This type of a takeover rarely occurs.

Financing a takeover

Funding

Often a company acquiring another pays a specified amount for it. This money can be raised in a number of ways. Although the company may have sufficient funds available in its account, remitting payment entirely from the acquiring company's cash on hand is unusual. More often, it will be borrowed from a bank, or raised by an issue of bonds. Acquisitions financed through debt are known as leveraged buyouts, and the debt will often be moved down onto the balance sheet of the acquired company. The acquired company then has to pay back the debt. This is a technique often used by private equity companies. The debt ratio of financing can go as high as 80% in some cases. In such a case, the acquiring company would only need to raise 20% of the purchase price.

Strategies

There are a variety of reasons why an acquiring company may wish to purchase another company. Some takeovers are opportunistic - the target company may simply be very reasonably priced for one reason or another and the acquiring company may decide that in the long run, it will end up making money by purchasing the target company. Other takeovers are strategic in that they are thought to have secondary effects beyond the simple effect of the profitability of the target company being added to the acquiring company's profitability. For example, an acquiring company may decide to purchase a company that is profitable and has good distribution capabilities in new areas which the acquiring company can use for its own products as well. A target company might be attractive because it allows the acquiring company to enter a new market without having to take on the risk, time and expense of starting a new division. An acquiring company could decide to take over a competitor not only because the competitor is profitable, but in order to eliminate competition in its field and make it easier, in the long term, to raise prices. Also a takeover could fulfill the belief that the combined company can be more profitable than the two companies would be separately due to a reduction of redundant functions.

Takeovers may also benefit from principal-agent problems associated with top executive compensation. For example, it is fairly easy for a top executive to reduce the price of his/her company's stock - due to information asymmetry. The executive can accelerate accounting of expected expenses, delay accounting of expected revenue, engage in off balance sheet transactions to make the company's profitability appear temporarily poorer, or simply promote and report severely conservative (e.g. pessimistic) estimates of future earnings. Such seemingly adverse earnings news will be likely to (at least temporarily) reduce share price. (This is again due to information asymmetries since it is more common for top executives to do everything they can to window dress their company's earnings forecasts). There are typically very few legal risks to being 'too conservative' in one's accounting and earnings estimates.

A reduced share price makes a company an easier takeover target. When the company gets bought out (or taken private) - at a dramatically lower price - the takeover artist gains a windfall from the former top executive's actions to surreptitiously reduce share price. This can represent tens of billions of dollars (questionably) transferred from previous shareholders to the takeover artist. The former top executive is then rewarded with a golden handshake for presiding over the fire sale that can sometimes be in the hundreds of millions of dollars for one or two years of work. (This is nevertheless an excellent bargain for the takeover artist, who will tend to benefit from developing a reputation of being very generous to parting top executives). This is just one example of some of the principal-agent / perverse incentive issues involved with takeovers.

Similar issues occur when a publicly held asset or non-profit organization undergoes privatization. Top executives often reap tremendous monetary benefits when a government owned or non-profit entity is sold to private hands. Just as in the example above, they can facilitate this process by making the entity appear to be in financial crisis - this reduces the sale price (to the profit of the purchaser), and makes non-profits and governments more likely to sell. It can also contribute to a public perception that private entities are more efficiently run, reinforcing the political will to sell off public assets.

Perceived pros and cons of takeover

While perceived pros and cons of a takeover differ from case to case, there are a few worth mentioning.

Pros:

1.     Increase in sales/revenues (e.g. Procter & Gamble takeover of Gillette)

2.     Venture into new businesses and markets

3.     Profitability of target company

4.     Increase market share

5.     Decrease competition (from the perspective of the acquiring company)

6.     Reduction of overcapacity in the industry

7.     Enlarge brand portfolio (e.g. L'Oréal's takeover of Bodyshop)

8.     Increase in economies of scale

9.     Increased efficiency as a result of corporate synergies/redundancies (jobs with overlapping responsibilities can be eliminated, decreasing operating costs)

Cons:

1.     Goodwill, often paid in excess for the acquisition.

2.     Reduced competition and choice for consumers in oligopoly markets. (Bad for consumers, although this is good for the companies involved in the takeover)

3.     Likelihood of job cuts.

4.     Cultural integration/conflict with new management

5.     Hidden liabilities of target entity.

6.     The monetary cost to the company.

7.     Lack of motivation for employees in the company being bought up.

Takeovers also tend to substitute debt for equity. In a sense, government tax policy of allowing for deduction of interest expenses but not of dividends, has essentially provided a substantial subsidy to takeovers. It can punish more conservative or prudent management that don't allow their companies to leverage themselves into a high risk position. High leverage will lead to high profits if circumstances go well, but can lead to catastrophic failure if circumstances do not go favorably. This can create substantial negative externalities for governments, employees, suppliers and other stakeholders.

 

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