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William W. McGinnis, CFA Securities & Investments Expert |
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William W. McGinnis, CFA Securities & Investments Expert |
| Hostile Takeover Acquisition Offers - Article |
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Hostile Acquisition Offers – The
Responsibilities of the Target Board A Case Study of the AirTran Offer for By Report as of May 11, 2007 Summary Shareholders are at a distinct
disadvantage in deciding whether to accept a hostile acquisition offer.
They often lack the training, experience and information
necessary to make the best decision for themselves.
Therefore, shareholders of a target company are highly dependent
on the recommendations of their Board of Directors.
The Board has a more thorough understanding of the company and
its competitive position, access to information about the company that
is not publicly available, and the counsel of outside professionals who
assist in assessing the offer. In
developing their recommendation to shareholders, a Board should consider
a number of specific issues in order to appropriately represent the
shareholder base. The The Purpose of This Study When a hostile acquisition offer is announced, shareholders of the target company are generally left wondering what to do – tender their shares to the potential buyer or reject the offer. Hostile offers, by their very nature, are played out in the media. The views of the potential buyer and the target are in conflict. The only thing clear to shareholders is that the price offered by the potential buyer appears to be higher than the recent share price of their company. This report will help shareholders understand some of the issues that are typically evaluated by the management and Board of Directors of a target company – issues that are of significant importance to the shareholders. This should better-position shareholders to make a good decision in these matters. Definition: Unsolicited Acquisition Offer vs. Hostile Acquisition Offer What is the difference between the two? An unsolicited acquisition offer is an offer received by a company when the company isn’t seeking offers. The target company may decide to ignore the offer, reject the offer, enter into discussions with the potential buyer, or accept the offer. While not necessarily desired by the target company, an unsolicited offer does not have to be unfriendly. A hostile acquisition offer is an unsolicited offer that the potential buyer makes public by informing the media and the target’s shareholders. The buyer does this to pressure management and the Board to accept the offer or at least enter into negotiations. While hostile offers are always unsolicited, the reverse is not true. Beyond Cynicism When a public company is faced with a hostile takeover bid, it is the Board of Directors’ responsibility to look out for the interests of the shareholders. Boards are elected by shareholders as the shareholders’ representatives in corporate governance. However, as Directors are normally nominated for their positions by management of the company, there can be a tendency to believe that Boards are more loyal to management than to the shareholders they represent. While it is not unusual for Directors to have loyalties to management, most Boards are well-informed of their legal responsibilities to shareholders. Given the legal and regulatory scrutiny under which Boards have operated in the last 10 years, most Directors take their responsibilities to shareholders very seriously. In addition, many companies have a policy that only non-management Board members can participate in votes regarding acquisition offers, thereby allowing greater independence from management. Even the most diligent efforts of Directors will leave some shareholders dissatisfied. This occurs because it is almost impossible that all shareholders would agree on any single issue. Thus, regardless of the decision that is made, some shareholders are going to be unhappy. The best Directors can do is to attempt to represent the majority of shareholders. Background
of Our Case Study – AirTran Targets Potential Buyer - AirTran Holdings, Inc. (NYSE: AAI)
AirTran
An airline company based in Target Company - Midwest Air Group, Inc. (Amex: MEH)
Midwest or
Parent of
According to a published
report, AirTran first approached What
Factors Should a Board Consider? When a company receives any acquisition offer, the Board of Directors clearly has an obligation to safeguard the interests of shareholders. Accepting an offer simply because the “offered price” is higher than the recent share price, does not safeguard shareholder interests. In order to appropriately protect and represent shareholders, Boards must weigh many factors in determining how to respond to such an offer. In this manner, they may arrive at a decision that, while not intuitively obvious to outsiders, is indeed in best interest of the shareholders.
1.
Is the potential buyer trying to buy the company at a
bargain price? In most cases, the obvious answer is “Yes.” While there may occasionally be circumstances when a buyer would offer a fair or above-value price for competitive reasons, this is not the norm. This is particularly true when an unsolicited offer becomes a hostile offer. If the price offered were “more than fair,” most Boards of Directors would have a difficult time rejecting such an offer. From a legal perspective, it would be a very risky move. Thus, for an offer to become hostile, the Board generally has some reason to believe that they are on solid legal ground in spurning the potential buyer. What do we mean by “bargain price?” There is a common misperception that the stock market efficiently prices stocks. Efficient Pricing Theory suggests that all relevant “known” information is included in a stock’s price at all points in time. There has long been significant debate regarding the validity of the theory. Regardless, the more immediate point is that the theory only accounts for “known” information. If “all information” known and unknown was always correctly factor into stock prices, stocks would never be over-valued or under-valued. One only has to look at the tech-stock-bubble of several years ago to know with certainty that stocks can become over-valued. Why is the market inefficient? Several factors account for potential mispricings including: a lack of insight into non-public information, the inability to properly assess potential future results, investor fear and greed, and disparate shareholder goals. Using Midwest Airlines as an example, the airline industry has been under pressure due to rising fuel prices. This has lowered earnings and, consequently, stock prices throughout the industry. Some airlines have either entered or approached bankruptcy. The airline industry has a long history of cyclicality. One can easily argue that the industry is currently in a down-cycle. All of this has put pressure on stock prices of these companies. Every
investor knows the old maxim – Buy Low / Sell High.
Acquiring companies know the maxim as well.
It’s easy to guess that AirTran is indeed trying to buy low.
That would seem to leave
2.
Might the share price rise to higher levels without an
acquisition? Often, when there is hostile acquisition interest, things are already improving within the target company and /or industry. The problem is that outsiders (investors for example) cannot yet see these improvements. We’ll provide a couple of examples to demonstrate this phenomenon. a.
AirTran’s initial offer When
AirTran first approached Midwest with an unsolicited acquisition offer
in July of 2005,
b.
A hypothetical hostile offer for Kohl’s We’ll use another Milwaukee-based company – the Kohl’s Corporation – to further demonstrate the difficulty of assessing future opportunities. In early in 2006, Kohl’s shares traded as low as $42.78 per share. At this price, the shares were down 46% from their all-time high of $78.83 in 2002. There had been a series of earnings and revenue growth disappointments and there was talk of growing competitive challenges. It was not uncommon to hear comments questioning management’s ability and the company’s future. This would have been a very opportune time for a competitor to make a hostile acquisition offer. While no hostile takeover of Kohl’s was attempted, for illustration purposes, we are going to assume that a hostile offer was made under price parameters that parallel the AirTran offer for Midwest. Potential Buyer - Hypothetical Retailer H-Retailer A major retailer interested in expanding its business Hypothetical Target - Kohl’s Corporation (NYSE: KSS)
Kohl’s
A national retailer based in AirTran’s
first offer for Midwest Airlines was 25.3% above the share price at the
time of the initial offer. Assuming
a pre-offer price of $42.78 for Kohl’s, if it had received a
similarly-priced offer from H-Retailer, it would have come in at $53.60
per share as shown in Table 2. The
second, higher offer would have risen to $63.14 or 47.6% above the
pre-offer price. The third
offer would have risen to $71.48 or 67.0% above the pre-offer price –
the same percentage as in
Now, obviously, this would have appeared to be a very attractive offer. With a share price that had been in distress for over three years and significant concerns about the future of the company, how could the Board of Directors have refused such an offer? What’s missing in the scenario outlined above is an understanding of ongoing events and the future opportunity for shareholders. For instance, the Board of Directors knew at the time that Kohl’s management had already initiated many changes focused on improving operations, competitive positioning and profitability. As shown in Table 2, less than one year later, the share price had risen to $75.54, a 76.6% increase from the $42.78 level and 40.9% above the original hypothetical acquisition price and 5.7% above the second increase of the hypothetical offer. Thus, Kohl’s shareholders ended up better off than if the company had been sold under a hypothetical scenario similar to the hostile offer for Midwest Airlines by AirTran. Within 15 months of the “offer date” the share price reached $79.55. The shares had climbed 86.0% on the success of the company. The hypothetical acquisition would have brought shareholders only a 67.1% increase. Are
we suggesting that the same will hold true for Midwest Airlines?
We can’t know that – just like Midwest’s shareholders, we
lack access to the more substantial information and resources available
to It is clearly difficult for shareholders to accurately assess the current value of a company’s shares. If it had been possible for investors to foresee even the relatively near future, Kohl’s shares certainly would not have been trading as low as $42.78 per share in early-2006. Obviously,
3.
Is it a cash offer? When someone offers you a $20 bill, you know exactly what it is worth. Yes, it’s worth $20. But what if someone offers you 7 ham sandwiches? What are they worth? Obviously, you need more information – you need to know how big they are, the quality of the ingredients, whether they’re fresh, who made them and much more. Even then, can you really determine what they are really worth? Possibly, the bigger question is “Do you really want 7 ham sandwiches?” What is the point of all this? Well, in a hostile acquisition offer, it is not uncommon for all or a portion of the offer to be shares of the potential buyer. As every investor knows, stocks don’t have a fixed value – the price changes on a daily basis. What happens if the share price of $20 today falls to $10 in the future? As discussed in the previous section, it is difficult for investors to correctly value the shares of a company they own. This problem is compounded when they are offered shares in another company. Now they need to assign a value to the shares of the potential buyer as well as their own company. Compounding difficult processes rarely leads to improved results. If AirTran had made a
cash offer of $15.00 per Midwest share, the decision for the Board, as
representatives of However, AirTran’s
combination stock-cash offer creates a more complex decision – “Do
we believe While AirTran might be
willing to share selected non-public information with In fairness to As
AirTran’s offer is comprised of approximately 40% AirTran shares, it
would only be prudent for 4.
What is the value of the offered shares? Potential buyers would like target shareholders believe that the buyer’s share price will stay the same or rise in the future. The reality is that sometimes share prices decline. One of the most memorable and dramatic examples of a substantial price decline following a merger was the acquisition of Time Warner Inc. by America Online Inc. in 2001. America Online paid for the purchase of Time Warner by exchanging its own shares for those of Time Warner. Time Warner shareholders received shares equivalent to approximately 45% of the combined companies. The shares closed at $46.30 on January 11, 2001, the day of the acquisition. Over the next four months, the shares rose to $56.11 and then began a substantial decline. The shares had fallen to only $9.45 by July 25, 2002 – an 80% decline from the acquisition date. Since that time, the highest close for the shares was $22.90 on January 18, 2007 – still a decline of over 50%. While this is a disturbing scenario, there have been many cases of companies being acquired for stock only to have the acquiring company end up bankrupt and the shares worthless. That is truly the worst case scenario and something that frequently crosses the mind of a target Board. In the Midwest case,
AirTrans’ most recent offer is $9.00 dollars of cash and 0.5842 shares
of AirTran per To see the flaw in this
view, consider AirTran’s first public offer to Based on the AirTran share price of $12.35 at the time, the offer was valued at “$11.25” per share. This is the figure that is still printed in recent newspaper articles. However, using AirTran’s share price on May 11, 2007, the value of the original offer has declined to “$10.83” or 3.7% below the originally stated amount. That’s because the AirTran shares have declined 5.9% during the period. This exemplifies the point that share-based offers can vary in value. Between the time an investor agrees to sell their shares to a potential buyer and the closing of the transaction, it is common for several months to pass. Obviously, if the acquiring company’s shares rise in price, the acquisition value would also rise. However, as explained later in this report, there are often selling pressures following a stock acquisition, making price increases more difficult. As
should every Board, it is reasonable that
5.
Would our shareholders want to own the offered shares? If an investor wanted to own shares of a potential buyer, why wouldn’t they just go out and buy them in the open market? Investors end up owning shares of companies for a wide variety of different reasons. However, one of the worst reasons is “because I received them in an acquisition.” Suddenly, the investor is holding shares of a company that they likely know very little about. That is one reason that a Board’s endorsement of an acquisition is so important. There is an implied endorsement of the acquiring company and its future. However, a shareholder needs to understand that the endorsement is actually only as of a moment in time. Circumstances are always in a state of change. The Board cannot continue to monitor the performance of the new company, the product cycle, the economy, competitive situations and all of the other factors that result in the relative level of success of a company. As a result, soon after an acquisition, many shareholders decide to sell their shares. This is particularly true in the case of hostile acquisitions because many times speculators have purchased the shares with the hopes of reaping a short-term gain. What happens when there is a significant increase in the number of shares of a stock available for sale? It puts downward pressure on the share price. This is not to suggest that share prices always decline following an acquisition, but the pressure is frequently there. It
is reasonable for Midwest’s Board to be concerned about the potential
for significant selling of AirTran shares if an acquisition of 6.
What are the potential tax consequences for shareholders? Tax issues are always an important consideration in assessing an acquisition offer. While some acquisitions do not constitute taxable events for shareholders, many do. The issue becomes quite confusing because some investors hold their shares in tax-exempt accounts, while others are taxable. To further confuse the matter, the taxable investors have a wide variety of tax situations. The great challenge for Boards is that they generally have now way of knowing the tax status and situation of their investors. Thus, they are left to consider all possibilities and make some form of determination. It is almost certain that the interests of some shareholders will be in direct conflict with the interests of other shareholders. For
a Board of Directors it is easy to view potential tax implications of an
acquisition as a negative. 7.
Should the Board represent investors or speculators? An interesting phenomenon often occurs when a company receives a hostile offer – many of its shareholders decide to sell their shares in the open market, rather than wait to see whether the acquisition will actually take place. This may happen even after the shares have increased by 30% to 40% in a relatively short period of time. Who would buy the shares after they have already increased by 30% to 40%? Speculators! These new shareholders are speculating that the shares will rise even higher due to a bidding war or higher offers from the potential buyer. These shareholders are not interested in the long-term prospect of the company – they are seeking short-term gains. In addition, they often promote the acquisition by planting comments favorable to the acquisition in the media, pressuring the Board and threatening or filing lawsuits. As shareholders of the company, shouldn’t they expect to be represented by the Board of Directors? Shouldn’t their wishes count? We believe the answer is “No.” The Board of Directors was elected by the old shareholders – the ones expecting the company to be well-managed and successful in the long-term. Companies, by their very nature are long-term in focus. They compete in environments where success is most accurately measured in periods exceeding one year – and often significantly longer. Thus, it seems reasonable to expect that, under normal circumstances, a Board would take a long-term view. In recent years, Google Inc. has been recognized for its rather aloof approach to Wall Street. Management avoids earnings predictions and has clearly stated that short-term performance is not its focus. Prior to its IPO, Google actually published an “Owner’s Manual” for shareholders, spelling out what shareholders should expect. While most companies haven’t published their own “Manual,” it seems fair to expect that management and the Board of Directors will take a long-term view. To do otherwise, would certainly be viewed as poor management. If the new shareholders want to sell the company, they should maintain their holdings at least long enough to elect a new slate of Directors. Yes, the ironic thing is that most Boards have staggered terms, typically with 3-year terms. Thus, it could take two years or more to elect enough Board members to trigger a sale of the company. However, most speculators won’t remain shareholders nearly that long. They are frequently operating on a very short time horizon – looking only for the short-term gain. If an acquisition doesn’t happen quickly, they will generally sell the target’s shares and move on to the next target. What about the normal,
long-term shareholders who would like to take advantage of the price
increase offered in the unsolicited offer?
How can a company take care of their interests?
The interesting thing is that, following the announcement of a
hostile acquisition offer, the share price often approaches or exceeds
the amount of the offer price. This
occurs because the aforementioned speculators quickly purchase the
shares, hoping a bidding-war will ensue or that a higher price will be
offered. Most shareholders
will have an opportunity to sell their shares to these speculators, thus
capturing most, if not all, of the acquisition price being offered.
In It is important to note
that, by selling their shares in the open market, these shareholders
would be foregoing any potential increase in the offer should Given
the long-term nature of companies, we understand why Conclusion Boards of Directors have significant responsibilities when confronted with a hostile acquisition offer. These offers are generally high profile and highly contentious, resulting in legal and ethical challenges for Boards in protecting the interests of their shareholder base. As
shown by the Disclosure:
Neither W. McGinnis Advisors, LLC nor the preparer of this report,
William W. McGinnis, CFA, hold any investments related to either Source:
W. McGinnis Advisors, LLC, Contact: Media Inquiries, Bill McGinnis, 414-228-1888, bill@wmcginnisadvisors.com About W. McGinnis Advisors, LLC specializes in providing expert witness testimony and opinions worldwide in investments and securities cases. The firm, headed by William W. McGinnis, CFA, assists plaintiffs or defendants in cases relating to mergers & acquisitions, stock and business valuations, investment suitability and investment research issues. William McGinnis, a Chartered Financial Analyst, has worked in investment analysis, portfolio management, mergers & acquisitions and the provision of professional opinions on such matters for over 25 years.
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