Using active defense to deflect a hostile take-over acquisition

hostile take overAside from using pre-determined corporate policy mechanisms to protect a company from being the target of a hostile take-over, companies have access to a variety of ‘active defense’ tools that they can use to discourage a acquisition from taking place. While these mechanisms are often extremely damaging to a company’s overall share-price, they will usually allow investors with the ability to maintain proportionate control of their company, and can be useful for investors that are able to evaluate the situation from multiple angles.

The most common means of preventing a hostile take-over for a company will generally include furthering the involvement of shareholders into the decision-making process of the company, thus creating a massive corporate head-ache for potential buyers. This can include the issuance of a rights offering (also known as a ‘poison pill’), which will both dilute out the value of a company’s stock, as well require a greater volume of stock to be purchased from a proportionately more powerful equity base.

However, because of the way in which this sort of action can be highly destructive to a company’s actual share price, it is common for more benevolent management teams to instead issue policies that improve the voting power of existing shareholders, thus giving them a greater ability to veto the acquisition. This can be accomplished by either increasing the voting power of shareholders so that they have a greater quantity of votes available to them, or to institute a ‘supermajority’ clause, which requires anywhere beyond a 70% majority of shareholders to approve a potential acquisition. Given that insiders will generally own enough shares to prevent a supermajority vote, an unsupported acquisition movement cannot possibly go through with such a mechanism in place.

Rather than diluting out the value of a company’s shares through a rights issuance, a company might instead choose to protect itself from an acquisition by inflating the size of its balance sheet through some quick acquisitions of its own. For example, if a company is attempting a hostile take-over, the target company might immediately proceed to purchase a smaller company with absolutely no synergies, simply for the benefit of increasing the size of its balance sheet, and therefore increasing the fundamental price of the acquisition for the purchaser. If enough of these transactions are taken on, the target company might be able to increase its asset size to being beyond the budget of the acquiring company.

While this method has the potential to actually improve shareholder value as it is implemented, it comes with a great deal of operating risk in the way that it is often accomplished through the usage of a great deal of leverage, meaning that the company now much earn an income on its acquired assets. However, it is important to also remember how it is that the managers of the target company might also be able to bolster their variable compensation packages through aggressive acquisitions like this. This means that investors should be wary of acquisitions that are sure to implode within the company over time.

So with all of this information in mind, how does a personal investor make a decision about how it is that an acquisition will fit into their portfolio? The trick is to forget the hype, speculation, and inflation, and make sure that the fundamental value of the transaction is kept in perspective.

From Save Sonic ™ Blog

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