Defense strategies adopted by companies facing the threat of takeover

Merger
Merger is defined as combination of two or more companies into a single company where one survives and the others lose their corporate existence. It is the fusion of two or more existing companies. All assets, liabilities and stock of one company stand transferred to transferee company in consideration of payment in the form of equity shares of transferee company or debentures or cash or a mix of the two or three modes.

Takeover
A takeover is acquisition and both the terms are used interchangeably. Takeover differs from merger in approach to business combinations i.e. the process of takeover, transaction involved in takeover, determination of the share exchange or cash price and the fulfilment of goals of combination all are different in takeovers than in mergers.

Purpose of merger and acquisition 1. Procurement of supplies to safeguard the source of supplies of raw material or intermediary product; to obtain economies of purchases in the form of discount, savings in transportation costs, overhead costs in buying department, etc. 2. Revamping production facilities to achieve economies of scale by amalgamating production facilities through more intensive utilisation of plan and resources;

to standardise product

specifications, improvement of quality of

product, expanding market and aiming at consumers satisfaction through strengthening after sale services. 3. Market expansion and strategy to eliminate competition and protect existing market; to obtain new market outlets in possession of the offeree; to obtain new product for diversification or substitution of existing products and to enhance the product range; 4. Financial strength to improve liquidity and have direct access to cash resources; to enhance gearing capacity, borrow on better strength and greater assets backing;

to avail of tax benefits; and to improve EPS.

5.

Corporate friendliness

Although it is rare but it is true that business houses exhibit degrees of cooperative spirit despite competitiveness in providing rescues to each other from hostile takeovers and cultivate situations of collaborations sharing goodwill of each other to achieve performance heights through business combinations. 6. Desired level of integration

Mergers and acquisitions are pursued to obtain the desired level of integration between the two combining business houses. Such integration could be operational or financial. This gives birth to conglomerate combinations.

Types of Mergers 1. Vertical Combination

A company would like to takeover another company or seek its merger with that company to expand esposing backward integration to assimilate the sources of supply and forward integration towards market outlets. The merging undertaking would be either a supplier or a buyer using its product as intermediary material for final production. 2. Horizontal combinations

It is a merger of two competing firms which are at the same stage of industrial process. The acquiring firm belongs to the same industry as the target company. Purpose is to obtain economies of scale in production by

eliminating duplication of facilities and operations and broadening the product line, reduction in investment in working capital, etc. 3. Circular Combination

Companies producing distinct products seek amalgamation to share common distribution and research facilities to obtain economies by elimination of cost of duplication and promoting market enlargement. The acquiring company obtain benefits in the form of economies of resource sharing and diversification. 4. Conglomerate Combination

It is amalgamations of two companies engaged in unrelated industries like DCM and Modi Industries. The basic purposes remains utilisation of financial resources and enlarge debt capacity through re-organising their financial structure so as to service the shareholders by increased leveraging and EPS, lowering average cost of capital and thereby raising present worth of the outstanding shares. 5. Within Stream Mergers Such mergers take place when subsidiary company merges with parent company or parent company merges with subsidiary company. The former arrangement is called down stream merger whereas the latter is called up stream merger. For example, recently, the ICICI Ltd. a parent company has merged with its subsidiary ICICI Bank signifying down stream merger

Reasons for merger or takeover (1) Synergistic operating economies

Synergy means working together. The gains obtained by working together by amalgamated undertakings result into synergistic operating gains. These gains are most likely to occur in horizontal mergers in which there are more chances for eliminating duplicate facilities. Vertical and conglomerate mergers do not offer these economies.

(2)

Diversification

Diversification caused by merger of companies does not benefit the shareholders as they can get better returns by having diversified portfolios by holding individual shares of these companies. (3) Taxation advantages

Mergers take place to have benefits of tax laws and company having accumulated losses may merge with a profit earning company that will shield the income from taxation. Section 72A of Income Tax Act, 1961 provides this incentive for reverse mergers for the survival of sick units. (4) Growth advantage Mergers and acquisitions are motivated with a view to sustain growth or to acquire growth. To develop new areas becomes costly, risky and difficult than to acquire a company in a growth sector even though the acquisition is on premium rather than investing in a new assets or new establishments.

(5)

Production capacity reduction

To reduce capacity of production merger is sometimes used as a tool particularly during necessionary times as was in early 1980 in USA. The technique is used to nationalise traditional industries. (6) Managerial motivates

Managers benefit in rank, status and perquisites as the enterprise grows and expands because their salaries, perquisites and status often increase with the size of the enterprise. The acquirer may motivate managerial support by assuring benefits of larger size of the company to the managerial staff. The resultant large company can offer better security for salary earners.

DEFENCE AGAINST TAKEOVER BID Strategies define the visions, plans, policies, and cultures of an organization over a long time period. Strategies decisions involve the future of the firm. Although the horizon is the long view, strategy also takes into account shorter-term decisions and actions. Strategies cannot be static but rather must be reassessed and reformulated continuously.

The Directors of the company hold command of the affairs of a company. Directors have been vested with powers under section 111 of the Companies Act, 1956 to refuse registration of shares in the circumstances when it is not in the interest of the existence of the company in takeover bids, etc.

Besides this, the company can take the following defensive measures to thwart away takeover bids; (1) Advance preventive measures for defence. (2) Defence in face takeover bid.

(1)

Advance preventive measures for defence

Offeree company should take precautions when it feels that takeover bid is imminent through market reports and available information so that the attempt of takeover bid by the corporate raider could be avoided successfully. Some of the prominent advance measures as derived from the experiences of the advanced nations and the prevalent laws and practices in India are discussed below.

A.

JOINT HOLDINGS OR JOINT VOTING AGREEMENT

Two or more major shareholders may enter into agreement for block voting or block sale of shares rather than separate voting or separate sale of shares. B. INTERLOCKING SHAREHOLDINGS OR CROSS

SHAREHOLDINGS Two or more group companies acquire shares of each other in large quantity or one company may distribute shares to the shareholders of its group company to avoid threads of takeover bids.

C.

ISSUE OF BLOCK OF SHARES TO FRIENDS AND ASSOCIATES

With a view to forestall a takeover bid, the directors issue block of shares to their friends and associates to continue maintaining their controlling interest and as a safeguard to the threads of dislodging their control position. D. DEFENSIVE MERGER

The directors of a threatened company may acquire another company for shares as a defensive measure to forestall the unwelcome takeover bid. E. SHARES WITH NON-VOTING RIGHTS LIKE PREFERENCE

SHARES Non-voting shares are a convenient method of providing for any desired adjustment of control on a merger of two companies. F. CONVERTIBLE SECURITIES

The capital structure should contain loan capital by way of debentures either convertible in part or full or non-convertible because any successful bidde cant acquire compulsorily convertible securities, options or warrants because liability towards repayments of principal and payment of interest discourages takeover bids.

G.

DISSEMINATION

TO SHAREHOLDERS

OF FAVORABLE

FINANCIAL INFORMATION The dissemination of information about the companys favourable features of operations and profitability go a long way in bringing the market price of share nearer to its true assets value. This type of behaviour on the part of the directors of the company elicit confidence of shareholders in their management and control which will in many ways help prevent any takeover bid to set in or to succeed.

H.

LONG-TERM SERVICE AGREEMENTS

There are two significant aspects of such an agreement viz. the prospective bidder would not be attracted due to the fear of non-cooperation by such directors if the company is acquired without personal involvement of such directors and secondly, the bidder will have to pay handsome compensation for terminating the agreement or the technical assistance or services provided under the said agreement might not be made available by any other outside party. Thus, the takeover game becomes unattractive to the bidders. J. OTHER PREVENTIVE MEASURES

The companies take various other preventive and precautionary measures to thwart away acquisition bids in future viz. (i) maintaining a fraction of share capital uncalled which can be called up during any emergency like takeover bid or liquidation threat. This strategy is known as Rainy day call, (ii)

companies may from a group or cartel to fight against any future bid of takeover against any of their member companies and maintain a pool of funds to use it to counter the takeover bids. This technique is known an antitakeover cartel. The above measures can be carefully adopted to thwart away the advances of the predators. (2) Defence in face of takeover bid

For defence against takeover bid two types of strategies could be suggested which are based on the experience of the developed nations viz. (a) Commercial strategies; and (b) tractical strategies. A. COMMERCIAL STRATEGIES (i) Dissemination of favourable information

The threatened company should keep their shareholders abreast of all latest developments particularly about the financial strength of the company as evidenced by market coverage, product demand, industry outlook and resultant profit forecast and value appreciation, etc. Disclosure of all these favourable aspects will keep the shareholders in good humour and they will always side with the existing management dislodging all the takeover bids.

(ii)

Step up dividend and update share price record

The fall in the market price of shares might occur due to restrictive dividend policy of the company. This will, automatically, bolster up the price of its shares and frustrate the takeover bid, for raising expectations for higher dividend, the company should in advance declare interim dividend and meet all statutory requirements of stock exchange of giving advance information and deciding date of closure of register of members, etc. (iii) Revaluation of Assets

Assets shown at depreciated historical costs in financial accounts understate the real value of assets. For defence strategy it is common practice to revalue the assets periodically and incorporate them in the balance sheet. Such valuation should be attested by recognized values. (iv) Capital structure reorganization

Proper capital structure is essential for enhanced profitability and brightening of the dividend prospects. Company may take suitable steps to replace preference capital by loan capital where the company has excess liquidity. It should use liquid resources for financial acquisition of assets, replacements, expansion programme, etc. and should have expert advice from financial consultants on the issue of capital restructuring before implementing any conceived plan to thwart away the takeover bid.

B. (i)

TACTICAL DEFENCE STRATEGIES Friendly purchase of shares

To stave off the takeover bid the directors of the company may persuade their friends and relatives to purchase the shares of the offeree company as they themselves cannot indulge into the game without serious violation of the existing rules and regulations or statutory prescription despite the bona fide defence against the bid. (ii) Emotional attachments, loyalty and patriotism

The board may make attempt to win over the shareholders through raising their emotions for continued association and attachment with the company as shareholder and raising fearsin their mind towards changes of the name of the company, independence of business and goodwill, etc. Takeover bid from a foreign controlled company could be warded off by invoking national interest and emotional feelings. (iii) Recourse to legal action

It is the responsibility of the directors to accept a takeover bid or thwart it away in the interest of the company. In averting the takeover bid the directors are not absolved of their liability under the law for making any wrong statements and painting in words any unrealistic position into high hopes for the future of the company.

(iv)

Operation White Knights

White knight is the term used in UK Financial markets for a bidder in acquisition pursuit. White knight offers a higher bid to the target company than the present predator who might not remain interested in acquisition and hence the target company is protected from losing to the corporate raid. (v) Disposing of Crown Jewels

The precious assets in the company are called Crown Jewels to depict the greed of the acquirer under the takeover bid. These precious assets attract the raider to bid for the companys control. The company, as a defence strategy, in its own interest, sells these valuable assets at its own initiative leaving the rest of the company intact. Instead of them or mortgage them to creditors so that the attraction of free assets to the predator is over. This defence is very much in vogue in UK but subject to regulations of City Code. (vi) Pac-man' strategy

This term was coined in America in 1982. Under this strategy the target company attempts to takeover the hostile raider. This happens when the target company is quite larget than the predator. (vii) Compensation packages viz: Golden Parachutes or First Class Passengers strategy

The term Golden Parachute is known as first class passengers in UK. The strategy is common in UK and USA and envisages a termination package for senior executives and is used as a protection to the directors of the company against the takeover bids. This strategy is adopted as a precautionary measure by the companies in USA and UK to make the takeover bid very expensive. (viii) Shark repellent character The companies change and amend their bye-laws and regulations to be less attractive for the corporate raider company. Such features in the bye-laws are called Shark Repellent character. US companies adopt this tactic as a precautionary measure against prospective bids. (ix) Swallowing Poison Pills strategy

There are many variants in this strategy. For example, as a tactical strategy, the target company might issue convertible securities which are converted into equity to deter the efforts of the offeror because such conversion dilutes the bidders shares and discourages acquisition. (x) Green mail

A large block of shares is held by an unfriendly company, which forces the target company to repurchase the stock at a substantial premium to prevent the takeover. In a takeover bid this could prove to be an expensive defence mechanism.

(xi)

Poison put

A covenant allowing the bond holder to demand repayment in the event of a hostile takeover. (xii) Grey knight A friendly party of the target company who seeks to takeover the predator. The target company may adopt a combination of various strategies for successfully averting the acquisition bid. All the strategies are experience based and have been successfully used in developed nations, and some of them have been tested in critical times by the companies in India also. In different circumstances, the scope for evolving more rapid strategies always remains for the target companies to defend their existence against takeover bids.

12.

COMBATING TAKEOVER BIDS

Indian corporates do not have adequate defense mechanism to tackle threat of a takeover bid. However, amendments in Companies Act, 1956 to effect the following changes might create factors for combating hostile takeover and also facilitate restructuring the corporates to increase global; competitiveness, viz.

(1)

Introduction of non-voting shares

Companies would be able to raise resources from the capital market without diluting the promoters stake. (2) Removal of restrictions on inter-corporate investments

Removal of restriction on inter-corporate investments and gains under sections 370 and 372 of the Companies Act, 1956 will facilitate the group companies to come to the rescue of each other in case of takeover threats. This will also help company to overcome the problem of liquidity crunch and grow vertically and horizontally. (3) Role of domestic financial institutions

In the case of hostile takeover bids, the financial institutions should adopt uniform policy to support the existing companies with good track record and help to ensure that good managements are not destabilised. (4) Safeguard new projects

Protection will be needed for small viable projects costing Rs. 5 to 10 crores during post implementation period for five years where they are subjected to hostile takeover threats for prospective higher profitability.

(5)

Threat from MNCs

To fight takeover threats from MNCs of Indian blue chip companies, the approval of Foreign Investment Promotion Board (FIPB) apart from the approval of Board and shareholders should be made compuls

STRATEGY AND M&A DECISIONS Mergers and acquisitions require changes in the organization structure of a firm. In major horizontal mergers such as Exxon-Mobil, the acquired firm is integrated into the structure of the acquiring firm. Usually one of the goals is to achieve savings by eliminating redundant facilities, officers, and employees. Sound business principles prescribe that the best facilities and the most highly qualified personnel be retained regardless of the previous company affiliation. Mergers of equals are said to protect the interests of the acquired firm. If efficiency principles are followed, no distinction should exist among mergers of equals and other kinds of mergers.