Page 49 - FINAL CFA II SLIDES JUNE 2019 DAY 6

LOS 25.f: Distinguish among pre-offer and post-offer
takeover defense mechanisms. READING 25: MERGERS AND ACQUISITIONS

Post-Offer Defense Mechanisms
MODULE 25.1: MERGER MOTIVATIONS
“Just say no” defense. If the potential acquirer goes directly to shareholders with a tender offer or a proxy fight, the target can make a public case to the shareholders
concerning why the acquirer’s offer is not in the shareholder’s best interests.

Litigation. File a lawsuit against the acquirer that will require expensive and time-consuming legal efforts to fight. The typical process is to attack the merger on anti-trust
grounds or for some violation of securities law. The courts may disallow the merger or provide a temporary injunction delaying the merger, giving managers more time to
load up their defense or seek a friendly offer from a white knight.

Greenmail. A payoff to the potential acquirer to terminate the hostile takeover attempt. An agreement that allows the target to repurchase its shares from the acquiring
company at a premium to the market price. The agreement is usually accompanied by a second agreement that the acquirer will not make another takeover attempt for a
defined period of time.

Share repurchase. The target company can submit a tender offer for its own shares. This forces the acquirer to raise its bid in order to stay competitive with the target’s
offer and also increases the use of leverage in the target’s capital structure (less equity increases the debt/equity ratio), which can make the target a less attractive
takeover candidate.
Leveraged recapitalization. The target assumes a large amount of debt that is used to finance share repurchases. Like the share repurchase, the effect is to create a
significant change in capital structure that makes the target less attractive while delivering value to shareholders.

Crown jewel defense. After a hostile takeover offer, a target may decide to sell a subsidiary or major asset to a neutral third party. If the hostile acquirer views this asset
as essential to the deal (i.e., a crown jewel), then it may abandon the takeover attempt. The risk here is that courts may declare the strategy illegal if a significant asset
sale is made after the hostile bid is announced.

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Pac-Man defense. In the video game Pac-Man, electronic ghosts would try to eat the main character, but after eating a power pill, Pac-Man would turn around and try to
eat the ghosts. The analogy applies here. After a hostile takeover offer, the target can defend itself by making a counteroffer to acquire the acquirer. In practice, the Pac-
Man defense is rarely used because it means a smaller company would have to acquire a larger company, and the target may also lose the use of other defense tactics
as a result of its counteroffer.

White knight defense. A friendly third party that comes to the rescue of the target company. The target will usually seek out a third party with a good strategic fit with the
target that can justify a higher price than the hostile acquirer. In many cases, the white knight defense can start a bidding war between the hostile acquirer and the third
party, resulting in the target receiving a very good price when a deal is ultimately completed. This tendency for the winner to overpay in a competitive bidding situation is
called the winner’s curse.
White squire defense. Target seeks a friendly third party that buys a minority stake in the target without buying the entire company. The idea is for the minority stake to
be big enough to block the hostile acquirer from gaining enough shares to complete the merger. In practice, the white squire defense involves a high risk of litigation,
depending on the details of the transaction, especially if the third party acquires shares directly from the company and the target’s shareholders do not receive any
compensation.