Portfolio Magazine: Going Hostile

Going Hostile
by Charles P. Wallace Nov 11 2009

Hostile deals are traditionally viewed as risky and difficult to pull off, but some acquirers, such as Kraft, are giving it a shot as the odds shift.

While British candy producer Cadbury rejected a hostile $17 billion takeover offer from America’s Kraft this week, it does not have history on its side.

In recent years, changes in laws and an absence of buyers in today’s market have made it easier for buyers to prevail in hostile takeovers.

“We advise clients that if there is a hostile attempt, the odds are pretty good you’ll be sold, maybe not to that company and most definitely not at the initial price, but once a company is in play, it’s very hard to come out of that as a standalone company,” says Marilyn Sonnie, a partner at law firm Jones Day who specializes in mergers and corporate governance. Frequently, Sonnie says, companies trying to avoid a hostile takeover end up in the arms of a white knight, a company more amenable to the takeover target’s needs.

Sonnie says that is likely a result of shareholder pressure in recent years. Activists such as Carl Icahn have put pressure on management to defer to the interests of shareholders. “The courts aren’t going to let you resist forever and at any price,” she says.

According to Sonnie, it’s harder for companies to resist a determined takeover attempt. “A lot of the traditional takeover defenses have been diluted to a great extent,” she says. “Most of the takeover defenses that are permissible are ways to gain bargaining power, not to completely block it.”

For example, she said one common takeover defense was to have board members serve staggered terms so that the entire board can’t be replaced all at once. Under shareholder pressure, many companies now make all directors stand for election each year. Many so-called poison-pill defenses have been curtailed, such as requiring a supermajority of votes to approve a merger or replace directors. That won’t help Cadbury because poison-pill defenses are not generally allowed in the U.K.

Corporate buyers also have more leverage now because there are fewer players. “The buyer is now in the driver’s seat,” says Roger Aguinaldo, CEO of M&A Advisor, an organization that facilitates connections between players in the mergers and acquisition business. In fact, there have not been many takeovers at all this year, in large part because financial players like private equity firms have stayed on the sidelines because of the lack of available financing. According to Dealogic, the Kraft-Cadbury merger would be the largest hostile takeover of the year after a British attempt to acquire miner Anglo American plc was withdrawn.

“Financial buyers, who typically make up 30 to 40 percent of all transactions, are absent from the market, not that they don’t have money but they can’t raise financing to make their transactions work,” says Aguinaldo. “If you take out one-third to 40 percent of the financial buyers, you really have only 30 to 35 percent of the market out there looking for transactions.”

Even in good years, Aguinaldo says, hostile takeovers are not very common. “It is like forcing someone to a shotgun wedding,” he says. “You want both parties to be happy because they are going to be married after this.”

Another reason buyers have an advantage is the valuation of many firms remain depressed despite the recent rise in stock markets. A large firm may go in and make an offer, and when it is rejected they will go hostile. “There may be an incentive to go hostile now rather than wait until the company’s share price recovers,” Aguinaldo says.

Why are such deals so hard? Transatlantic hostile deals are not very common because of the possibility of a culture clash. According to the Financial Times, the last transatlantic hostile takeover for more than $1.7 billion occurred in 2006, when Goldman Sachs led a consortium to buy Associated British Ports. Even friendly cross-border mergers are difficult to pull off: The memory of Daimler’s acquisition of Chrysler is only one example of deals that failed for cultural reasons.

Sonnie says it is usually hard for companies to do a hostile takeover using all stock as the currency to fund the transaction. “There are institutional and other shareholders who would just as soon take a premium to the trading price in cash and move that money on to the next company,” she says. “But where it’s all stock, there’s not as much reason for investors to support the deal.”

Cadbury’s problem is that since Kraft’s offer was first made in September, a number of other potential suitors such as America’s Hershey have looked at the chocolate maker, but no company came forward to make a rival offer. Cadbury may have rejected the current Kraft offer on the table, but it may prove impossible to reject an improved offer.