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What is a hostile takeover?

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A hostile takeover is when a company or activist shareholder tries to gain control of a target company by sidestepping the company’s management and board of directors, and going directly to its shareholders.

Hostile takeovers can be a major distraction for companies and may even lead to them taking on value-destructive maneuvers to prevent the takeover. Here’s what else you should know about hostile takeovers and how they work.

How a hostile takeover works

Hostile takeovers often begin as friendly offers. The acquiring company may make an offer to the target company while working with its board members and management to convince them of a deal’s merits. The deal turns hostile once the target company’s board members refuse, and the acquirer goes directly to the shareholders.

Hostile takeovers are typically attempted through tender offers, proxy fights or stock purchases on the open market.

  • Tender offers: The acquirer may use a tender offer to gain control of the target. Tender offers are usually an offer to purchase shares at a premium to their market price and only last for a specific time period. For the hostile takeover to be successful, the acquirer would need a majority of the shares to accept the tender offer.
  • Proxy fights: A proxy fight may also be used to replace current board members who oppose the takeover with representatives of the potential acquirer. The acquirer would make its pitch to shareholders in the hope that they vote their proxy in favor of its slate of director nominees.
  • Stock purchases: A company or group of investors may also purchase shares in the open market as a way to gain influence or control over a company. However, once a certain ownership threshold is reached, the purchases must be disclosed, which could trigger a hostile takeover defense from the target company’s management.

Hostile takeovers are more often directed at established companies with a record of underperformance. If management hasn’t taken concrete actions to correct the underperformance, outside investors or other firms may look to get involved with a hostile offer. Because of the underperformance, existing shareholders may be more amenable to accept a hostile takeover, or at least implement change at the management or board level.

Hostile takeovers can cause a lot of disruption for the target company and its employees. That’s because the takeover can lead to a significant number of layoffs, as the acquirer looks to cut costs and boost profitability. New owners could also look to spin off underperforming business units or change capital allocation priorities, and they may alter a company’s processes or products to make them more cost-effective or profitable.

Hostile takeover vs. friendly acquisition

A takeover may be friendly if the target company supports a proposed deal, but things can get ugly if a deal turns hostile.

In a friendly acquisition, the acquirer and target company may have often been in discussions and negotiations for weeks or months prior to announcing a deal. The target may agree to share certain information with the bidder to better inform the possible deal. Once a deal is reached, the two companies announce the acquisition together and often have a call with shareholders and analysts touting the benefits of the proposed deal.

In contrast, hostile takeovers often come about after a target company’s management has either rebuffed or refused to engage with the potential acquirer. The acquirer appeals directly to the target’s shareholders, typically offering a premium price for the stock and a plan to boost the company’s future prospects. Management may try to smear the reputation of the acquirer or paint a group of investors as corporate raiders in an attempt to get shareholders to reject any offers.

Hostile takeover defenses

If the directors and management of a target company want to defend against a hostile takeover bid, here are some of the most typical strategies, which sometimes may actually harm shareholders:

  • White knight: The white knight defense involves the target company finding a friendlier buyer than the potential acquirer in the hostile takeover. The white knight may be a company that agrees to acquire the target entirely, or it could be a large investor who agrees to side with the target’s existing management.
  • Greenmail: Greenmail occurs when a company agrees to buy shares at an inflated price from one of its investors. The company is willing to pay extra in order to rid itself of the investor. Some companies have adopted provisions that prevent them from paying greenmail because the move is viewed as protecting management at the expense of shareholders.
  • Stockholder rights plan: Also known as a “poison pill,” this strategy is used by target companies to make their shares unattractive to the potential bidder. They may allow existing shareholders to purchase shares at a discount in an effort to dilute its shares and limit the acquirer’s ability to gain control.
  • Staggered board: Companies may divide the service terms of their board members into different tiers  so that only a few are up for election in any given year. This makes it more difficult for a hostile bidder to win control of the board through a proxy fight in any single year.
  • Differential voting rights: Some companies have different classes of shares (dual share classes, for example) that come with different voting rights, which may limit the ability of an acquirer to accumulate voting power. A few key insiders, such as the company’s founders, may receive shares that allow their shares to have 10 times the votes of the normal shares, for example.
  • Defensive merger: When a company is concerned about a hostile takeover, it may try to acquire another company and could take on a lot of debt to do so. This move is about making itself less attractive to the potential acquirer, but is typically bad for shareholders. The company may end up saddled with too much debt and an asset that it doesn’t want or overpaid for.

Are hostile takeovers good for investors?

Hostile takeovers can be both good and bad for investors. They may allow investors to receive a premium for their shares through a tender offer or if an acquisition takes place. The mere initiation of a hostile takeover can also help to shake up management and force them to implement changes that can be shareholder friendly, such as a boost to dividends or share repurchases.

But hostile takeovers can also be major distractions to management. They take up a lot of the leadership’s time and may cause them to lose focus of their core business operations. They could also adopt defenses that destroy value for shareholders, such as overpriced acquisitions or greenmail.

Bottom line

For investors, a hostile takeover is a type of event that can create both opportunities and risks. It can be a good time to buy the stock of the target company in order to benefit from the premium the acquirer is offering to shareholders. On the other hand, investors should be aware of the fact that an acquisition of this kind can destroy value for shareholders if the acquirer is overly focused on short-term profits or management dilutes the shares to thwart the takeover.

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