Poison Pill Defense, Crown Jewels Defense, Pac-Man Defense, Greenmail Defense, and the Golden Parachute Defense. All these terms feel like they would only be used in movies! However, these are defenses against hostile takeovers. In the mergers and acquisitions world, hostile takeovers are common, or at least hostile takeover attempts are common.
These defense strategies come in handy and have saved multiple corporations from being acquired without permission. If you’re an aspiring investment banker, this article will help you understand these strategies better.
What Is A Hostile Takeover?
A takeover refers to a situation where a successful bid has been made to acquire a target company. There are friendly takeovers that can either be structured as a merger or an acquisition. When a friendly third party takes over, the board of directors and shareholders all agree to join forces.
Next are hostile takeovers. It is when one party does not want to get merged or acquired by the bidder. This potential acquirer tries to take over the target company without the permission of the board or the existing shareholders. They force their way into the target company.
The defences used by target companies to save themselves during a hostile takeover are crucial. Some of these defence strategies are:
1. Poison Pill Defence
The poison pill strategy was first used in the 80s in New York. It was devised by New York-based legal firm Wachtell, Lipton, Rosen, and Katz. It is a reference to the poison pill spies used to carry with them in case they got caught by the enemies. If they got caught, they would swallow the poison pill to avoid being questioned and tortured by their enemies.
In the business world, adopting the poison pill defence works similarly. The target company’s shareholders have distributed the rights to purchase shares of the target company at a discounted rate. When the acquirer’s shareholding in the company increases to a certain point, these rights are given to the other shareholders.
Through this defence strategy, the acquirer’s shareholding in the company is drastically decreased. This makes the takeover an unfavourable situation for the acquirer. This strategy also ensures that the management is in control and the minority shareholders are protected by the company.
There are two main types of poison pill strategies deployed by companies.
- The flip-in poison pill strategy: When this strategy is used, all shareholders, except the acquirer, are given the right to buy additional shares at a discounted rate. With every additional share bought, the acquirer’s shares are further diluted. To properly put this strategy to use, a large number of additional shares need to be bought.
- The flip-over poison pill strategy: This strategy allows the target company’s shareholders to purchase shares of the acquiring company at a highly discounted rate. The shareholders that agree to the acquiring company’s bid can exercise their rights in that company. This enables them to buy their shares as well. This is just the opposite of flip-in, as dilution is still taking place but in the acquiring company.
2. Crown Jewel Defense
This defense strategy is shown a lot in movies and TV shows. Under this strategy, the target company decides to sell its most valuable assets/branches of business. This reduces the target’s attractiveness to the acquirer.
This strategy is generally the last-ditch effort made by the target to save themselves from a hostile takeover. The company is intentionally sabotaging its business because of the circumstances.
The crown jewels of a company are the most valuable and profit-producing assets/branches. They not only create profits but also majorly contribute to the asset value of the company and have bright prospects. The crown jewels differ across industries and companies. In the manufacturing industry, factories/manufacturing techniques are generally considered the crown jewels.
In most cases, the target company sells its crown jewels to a friendly third company. This third company is often referred to as the White Knight. Once the acquirer backs off from the hostile takeover, the target buys back the crown jewel at a price that was predetermined. The crown jewel defence temporarily destroys the company until the jewel is bought back.
3. Pac-Man Defense
As the name suggests, this defense strategy is based on the video game Pac-Man. The target company tries to take over and acquire the bidder instead of letting themselves get acquired.
To implement this strategy, the target company needs to have a “war chest”. This is a large amount of cash and other assets that are kept handy with the company to deal with contingencies like a hostile takeover.
The cash is not kept idle in the company, however, it is invested in highly liquid assets like treasury bills. They can be turned into cash on demand. Assets with high liquidity are considered cash equivalents and are sometimes referred to as just cash.
A Pac-Man defence usually looks something like this:
1. The bidder is attempting a hostile takeover of the target company. They purchase large amounts of the target’s shares to secure control of the company.
2. The target realises what is happening and uses the Pac-Man strategy to prevent the hostile takeover. They deploy their war chest and purchase an even larger amount of shares of the bidder company.
3. The bidder usually abandons the hostile takeover once it sees the dilution taking place in their own company.
It is essentially a tit-for-tat situation. A hostile takeover is answered with another hostile takeover. Sometimes, the target companies also get outside funding for their hostile takeover of the bidding company.
4. Greenmail Defense
Greenmail defense is very similar to paying a blackmail ransom. A bidder buys a large number of shares of the target company and threatens a hostile takeover. It threatens the target company and forces them to buy back the shares at an exorbitant price. Greenmail is the money paid by the target to the bidder to put an end to the aggressive behaviour.
It is a measure to prevent a hostile takeover of the company.
Greenmail refers to the extra money or premium the target pays to buy back its shares. Once this payment/ransom is received, the bidder/acquirer retreats and ditches the takeover attempt.
During the 1980s, greenmail became a very common practice. Large sums of the money were being given to raiders/bidders as greenmail. However, the governments decided to step in and enforce rules, regulations, and policies.
This intervention drastically decreased such greenmail situations. Companies are now better equipped with other defence strategies like the poison pill to stop the hostile takeover.
5. Golden Parachute Defense
This defense strategy is another form of a poison pill a firm has to take to stop a hostile takeover. Under this strategy, top executives and employees are given extra benefits and severance packages in case the company gets acquired and they are terminated. These benefits act as a parachute for the employees who lose their jobs.
The benefits can range from cash bonuses and severance pays to stock options in the company. Some companies even give the employees the option of vesting previously earned compensation or even their retirement benefits.
The golden parachute strategy can be used as a defence against hostile takeovers. The bidders that are looking to take over the target company with many golden parachutes might think twice before doing so. This is because, if the takeover goes through, the bidder will have to pay all the benefits to all employees. The golden parachute benefits are given in an air-tight employment contract, so the bidder will not have any other option but to adhere to it.
The acquirers usually replace the whole management team and bring in their people to run the company. So, by implementing the golden parachute strategy, a company can make itself look less attractive to a hostile takeover.
Conclusion
Hostile takeovers are not extremely common today. This is mostly because companies can create other types of temporary associations like joint ventures in case they do not want to merge or acquire.
However, in the rare event that an attempt is made to take over a company with hostility, there are many defence strategies the target can use to save itself. Sometimes companies use a mix of strategies to get rid of the bidder at once. Some strategies are more extreme than others, like the crown jewel defence, while others are more subtle, like the golden parachute. Most companies prepare for contingencies like a hostile takeover and have plans in place in case they happen. If you’d like to further understand each of these defences and other related concepts for a job interview or since investment bankers are called upon at multiple stages of M&As, you can avail of this comprehensive course on Investment Banking.
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