Gods at War: Shotgun Takeovers, Government by Deal, and the Private Equity Implosion

by Steven M. Davidoff

  Defenses

  A good hostile offer is designed from the announcement to box in a target and force it to capitulate. In setting this strategy, the timing and implementation of the offer is set by the target’s defenses. This principle was ably on display in the Yahoo and Anheuser-Busch bids. The targets’ lawyers also manipulated the process and legal institutions to buy as much time as possible and control the process. Meanwhile, the bidders clearly planned their strategies to work within the shareholder election and consent timing as set by the target’s defenses and response. Although ultimately a target may not be able to save itself through legal tactics, these legal maneuverings can certainly work to buy time. In Yahoo’s case, the extension of their meeting date and the date for director nominations functioned like Anheuser-Busch’s maneuver to postpone the record date for a consent solicitation. Both actions bought time for the target to find an alternative transaction and enhance their defenses.

  The Target

  To be victorious, a hostile bidder must win the confidence of the target’s shareholders. This is ultimately accomplished by paying the right price, but a bidder is ably assisted in this regard if there is a leadership gap at the target. Both Anheuser-Busch and Yahoo were governed by less than perfect CEOs. Anheuser-Busch, in particular, had suffered under the Busch family, and its stock had underperformed against the market and its trading peers. Meanwhile, Yahoo’s CEO, Terry Semel, had recently resigned and co-founder and then-CEO, JerryYang,was seen as an interim choice.Yahoo was also struggling and losing ever more market share to Google. In both cases, this put the targets in a significantly weakened position and made the premium offered by the bidders more acceptable. InBev succeeded, and had Microsoft more ardently pursued Yahoo, it would no doubt have completed its own deal.

  Credibility

  Larry Ellison pioneered the threatening technology hostile. He artfully maneuvered between offense and defense, backing off from a deal or otherwise lowering the consideration in successful bids for PeopleSoft and BEA Systems. Ellison also knew when to come back to the table and raise his bid to close. Microsoft initially seemed to be following the Ellison strategy but then took a wrong turn and appeared to act out of petulance. Microsoft’s strategy ultimately reduced Yahoo to begging for a deal, but this left Microsoft looking more like it was trying to get its ego massaged rather than reaching an economic bargain. In short, both Microsoft and Yahoo appeared to be incompetent, not executing a preplanned economically driven strategy.

  The Limits of Defenses

  The just say no defense can work to forestall a hostile. This may be a particularly potent defense when a company has a staggered board. In fact, I am not aware of any bidder ever successfully running a two-year proxy contest to surmount a staggered board if a board does adopt a just say no defense. Here, though, shareholder pressure and the rise of independent boards may be an increasing force working against targets where bidders actually decide to launch a bid and run a proxy contest against a staggered board.This, though, remains to be a subject of future study and events.

  For boards without a staggered structure, though, a just say no defense is at best a delaying tactic until the shareholder meeting. Against an adamant hostile bidder, this defense typically serves only to allow the target to find an alternative transaction. Quite often, this still ends in an acquisition of the company by the bidder or a white knight. In one sample dating to 2002, 66 percent of companies who do not have staggered boards do not retain their independence after a hostile bid emerges.41

  A just say no defense, though, is not without its risks and can drive away bidders and offers that in hindsight were acceptable, even at the initial price offered. In 2008, companies like Yahoo, Take-Two Interactive Software, Inc., Diebold, Inc., and Acxelis Technologies, Inc. were left with seller’s remorse as their just say no strategy worked all too well, leaving their share prices trading at historic lows. This may have been due to the disjointed market during this period. There is no doubt, though, that their share prices traded significantly down after their would-be buyers walked away from the table, and the targets were unable to find an alternative transaction.

  Flaws in takeover defenses can also work against a target. For example, in Roche Holding, A.G.’s 2008 hostile offer for Ventana Medical Systems, Inc.,Ventana’s lawyers had failed to put Ventana’s staggered board provision in the certificate of incorporation, instead placing it in the company’s bylaws. This allowed Roche to seek shareholder approval to amend Ventana’s staggered board to expand it.42 In contrast, if the staggered board is in the certificate, the board must approve its amendment.This would allow Roche to gain control of Ventana in a single year and circumvent the staggered board. Similarly, in InBev’s bid for Anheuser-Busch, the ambiguity over the state of Anheuser-Busch’s staggered board benefited Anheuser-Busch, but had it been explicitly spelled out, Anheuser-Busch would have had much more leverage with InBev. This flaw also shows that takeover defenses must be viewed in total rather than individually. The fact that Anheuser-Busch’s shareholders could act by written consent was probably satisfactory to Anheuser-Busch when its board was staggered and its directors could be removed for cause. This ability, though, would work in a very different manner once Anheuser-Busch’s board was destaggered.

  Federalism

  Yahoo and Anheuser-Busch were both incorporated under the laws of Delaware. Delaware law allows a company to just say no and refuse a hostile offer, leaving the bidder to pursue a proxy contest if it still desires to take over the target. This can be a high hurdle but a possible one to leap. Other states have much stricter antitakeover laws. Not surprisingly, the strictest are those in rustbelt states such as Ohio and Pennsylvania. Notably, studies of Pennsylvania firms have found that they declined in value in the wake of the passage of these laws.43 The reason is that these laws entrench management.The companies in these states are significantly harder to take over, and even winning a proxy contest may not be enough. This is even before any political element is accounted for. Legislatures in states other than Delaware may also be quite willing to intervene and rejigger the landscape to protect a local company. The outcome of the InBev offer may have been far different if the company had been incorporated in Missouri instead of Delaware.

  Price

  Any hostile bid will be for naught if the price offered is not acceptable to target shareholders. As the statistics show, a good price can, and historically has, overcome even the most able defenses. This has led many hostile bidders to strategically increase their bids until the target’s board breaks from the pressure. In 2008 alone, 63 percent of hostile bidders ended up increasing their original bids, and target boards responded by recommending the takeover 40 percent of the time. For hostile bidders that do not follow this advice, the results are somewhat predictable. There has been a rejection rate of nearly 100 percent, at least in almost every year since 2004.44

  The Yahoo and InBev transactions point to the future of hostile offers. These transactions will be the pinnacle of dealmaking, where tactics and strategy make a difference, and a coordinated implementing approach is a key to success. The current upward trend in hostiles is likely to continue, but hostiles will continue to remain only a minority portion, but very public, component of the takeover market. Despite their confined place in the market, these deals will also continue to be the area where dealmakers look to soar. These deals will continue to be viewed as battles, where the barbarians at the gate can surmount a target’s defenses and win the prize. Hostiles will thus be the area of takeover where personality continues to dominate and uneconomic takeovers are more likely to occur. This is particularly true because buyers have essentially unfettered freedom to engage in these takeovers. Nonetheless, the question remains whether the good governance trend and other actors such as hedge funds become a strong counteracting force to this ego.This appears to be anecdotally the case, but has yet to be confirmed empirically.

  Delaware and Hostile Takeovers

  The M
icrosoft and InBev hostiles reveal the peculiar role of Delaware law in regulating hostile takeovers. Delaware law sets forth an array of standards to review a target board’s decision when it is faced with a takeover decision. Finding a guiding point in this thicket is often hard, but these standards provide a special role for the Delaware courts to regulate takeovers. As we saw in the InBev offer, this means that litigation in Delaware is a component of most hostile offers. It allows the target and bidder to put forth both a public relations agenda and a legal defense or offense as the Delaware courts review a board’s action for compliance with its doctrine.

  Revlon Duties

  The principal standard governing a target board’s consideration of a takeover offer is Revlon. Revlon duties, as they are commonly known, were first set forth in the seminal 1986 case of Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.45 This case arose from the hostile bid by Ronald O. Perelman for Revlon discussed in Chapter 1. Revlon duties today require that a board facing the inevitable breakup or change of control of the company obtain the “highest price attainable.”46 A Delaware court will strictly scrutinize a board acting under Revlon duties. If a target board attempts to forestall a higher, competing bid, their actions will be suspect and enjoined to the extent they violate Revlon’s price-maximizing dictates.

  Revlon duties are triggered only if the board affirmatively decides to initiate a sale or breakup process. This is the part about just say no that is often thrown around in takeovers. Because Revlon applies only in this limited circumstance, a target board of a company that has not put itself into play by deciding to sell or break up the company can otherwise refuse to accept a takeover offer. Instead, it can adopt or refuse to redeem a poison pill and force the bidder into a proxy contest to acquire the company.

  The only countervailing case law is principally Chancellor Allen’s 1988 opinion in City Capital Assocs. Ltd. P’ship v. Interco.47 In that case, Allen forced a board adopting a just say no strategy to redeem its poison pill. The validity of Interco in light of subsequent Delaware decisions is probably limited applicability at best. There was a possibility, even rumor, that Vice Chancellor Strine was going to order PeopleSoft to redeem its poison pill in the Oracle battle. The case settled before a decision when PeopleSoft capitulated. But to date a just say no strategy has yet to be upended after Interco and is likely to be upheld in Delaware unless the company is simply pursuing the status quo and the shareholder ballot box is not open.48

  This does not mean that the target board can blindly ignore an offer. Rather, a board must be mindful of the procedural requisites of its duty of care and allow enough time for it and the company’s officers to consider the proposal and the board’s financial advisers to analyze the offer.49 But this is a procedural requirement that is often just a formality for a board to document its true wishes. Revlon duties, in the context of a hostile bid, thus more often come into play when a target has already agreed to a friendly transaction and a second bidder arrives to attempt a trumping bid. In the next chapter, I discuss the board’s duties in those circumstances. In that context, Delaware law has seen much movement, and market practice is actively affecting how Delaware reviews board conduct under Revlon once a trumping bid has been made. Without a sale or breakup decision, though, the validity of a just say no defense appears to be settled Delaware law.

  The Unocal Standard and Takeover Defenses

  It is because of Revlon’s limited applicability that other standards under Delaware law primarily guide a board’s conduct in their response to a hostile offer. The Delaware courts outside of Revlon duties have promulgated two standards to analyze board defensive conduct, the Unocal and Blasius standards discussed in Chapter 6. The 1985 decision of Unocal Corp. v. Mesa Petroleum Corp.50 arose out of T. Boone Pickens’s bid for Unocal. In that bid, T. Boone Pickens’s Mesa Petroleum had bought 13 percent of Unocal in the market and subsequently offered to pay $54 in cash for approximately 37 percent of Unocal’s outstanding stock, providing Mesa with majority control of Unocal. The remaining 49 percent of Unocal’s shareholders would receive debt securities and preferred stock, which Pickens claimed were worth $54 per share.

  Unocal rejected the offer and claimed that it was coercive. Shareholders would rush to bid to receive cash; if they did not, they would instead receive debt securities in the now highly leveraged Unocal. And these securities would be subordinated to $2.4 billion in debt taken on by Unocal to refinance existing debt and the initial cash purchase of Unocal shares. The battle was nasty, and at one point Pickens criticized Unocal CEO Fred Hartley for having a piano installed on one of Unocal’s corporate airplanes. Pickens would later state in his autobiography about Hartley that “never has a company been more dominated by personality.”51

  Unocal responded by launching a self-tender offer for its own stock at $72 a share in debt securities, which would be triggered only if Pickens purchased the initial 37 percent. Most shareholders would therefore not tender into Mesa’s offer and would instead wait for the richer back-end offer by Unocal itself. Moreover, if they did indeed tender, the company would be almost impossibly overleveraged with an additional $6.1-6.5 billion of debt, making an acquisition by Pickens unpalatable. To be sure that Pickens and Mesa did not attempt to take advantage of the back-end offer, Mesa was prohibited from tendering.

  Pickens and Mesa sued, challenging the board’s defensive conduct, and lost. The Delaware Supreme Court held that a target board decision to take defensive action, in light of an unsolicited takeover offer, was governed by an intermediate standard of review. This standard requires that the defensive action be “reasonable in relation to the threat posed.”52 Here, the Unocal board’s response was reasonable in light of the coercive nature of Mesa’s bid.

  Unocal, again as with Revlon, could also be painted as a crafted response to the SEC’s antitakeover stance in the 1980s. The Delaware court’s decision to regulate, and put a limit on, takeover defenses was an olive branch to prevent greater SEC action in this arena. Then in 1995, after the battles of the 1980s had passed and long after the SEC lost interest in takeover regulation, the Delaware Supreme Court relaxed Unocal’s strictures on takeover defenses in Unitrin, Inc. v. American General Corp.53 Unitrin held that a Delaware court should first ascertain whether a target board’s takeover response was preclusive or coercive. If not, then the court should review the decision under a “range of reasonableness.”54

  The true impact of Unitrin, though, was in its facts. In Unitrin, the Unitrin board had initiated a self-tender that had the effect of raising the target directors’ holdings to a blocking threshold, preventing any merger transaction with a 15 percent or greater shareholder (i.e., the hostile bidder in the case, American General). Unitrin had also adopted a poison pill with a 15 percent threshold, limiting any subsequent bidder’s acquisition of the target’s shares. The Delaware Supreme Court reversed a lower court finding that this response was unreasonable in relation to the threat posed. The Supreme Court stated: “The adoption of the poison pill and the limited Repurchase Program was not coercive and the Repurchase Program may not be preclusive.”55

  The court then remanded the case for the lower court to consider whether the program made a bid “mathematically impossible or realistically unattainable” and was reasonable in relation to the threat at hand.56 However, in other parts of the opinion, the court telegraphed the lower court’s determination by strongly implying that the Unitrin board had met this new test. The Unitrin gloss on Unocal accordingly gave target boards wide latitude in their ability to adopt strong, potentially preclusionary takeover defenses, so long as they did not completely preclude a proxy contest.

  Unocal review, as subsequently modified by Unitrin, is thus quite limited. By one count, the Delaware courts after Unitrin have overturned only four takeover defense responses as disproportionate or preclusive solely under the Unocal standard.57 All except Omnicare were decided in the Chancery Court.58 On the edges of Unocal, the courts, acting in their
takeover supervisory role, repeatedly punished target boards who completely shut off a bid’s potential for success, however remote, or who otherwise unfairly acted mid-contest to alter the rules of the game to the same effect. Thus, in two cases, Carmody v. Toll Brothers, Inc. and Mentor Graphics Corp. v. Quickturn Design Systems, Inc., the Delaware courts struck down no-hand and dead-hand poison pills.59 Then in Chesapeake Corp. v. Shore,60 the Chancery Court held that a bylaw provision adopted in the middle of a takeover battle that effectively frustrated an unsolicited bidder after its successful proxy battle was not sustainable under Unocal and Unitrin. However, these decisions were islands in a sea of permissiveness. The Delaware courts have largely upheld the vast majority of takeover defensive action, largely confining Unocal to a test of preclusiveness. In the wake of this constriction, two academics have labeled the Unocal standard as “dead.”61

  The result is twofold. First, litigation remains an element of any hostile as the potential, if not the actuality, for a violation of Unocal is present. Delaware courts thus retain their oversight review of hostile transactions. Second, given the Delaware court’s strict reading of Unocal, the defensive actions that a board can take today outside Revlon are vast.