VPS | Common Strategies to Combat Hostile Takeovers

What is a "hostile" takeover?

Mergers and acquisitions (M&A) activities can occur in either a "friendly" or a "hostile" manner.

A hostile takeover refers to takeover attempts that do not have the support of the target company's management. This can occur for several reasons:

- The management seeks to find the best buyer at the highest price to protect the interests of shareholders.

- The management views operating as an independent entity as a better option.

- The management aims to protect their personal interests associated with running the business.

How to defend against hostile takeovers?

To prevent unwanted takeover attempts, the management needs to create necessary barriers for  self-defense. A company with the following characteristics will be more attractive for a takeover:

- Low stock price relative to the replacement cost of assets or future earnings potential of the business, reflected through a low price-to-book value ratio.

- A large surplus of cash and untapped debt capacity.

- Stable cash flow from core operations, which can be used to pay off debts.

- A low price-to-earnings ratio relative to the overall market and industry.

- Some assets or business segments, such as real estate, that can be easily sold for cash.

- Assets that can be used as collateral for borrowing from banks.

- The management holds a small percentage of shares.

- Institutional investors are dissatisfied.

The best way for a company to protect itself from hostile takeovers is by enhancing effective management capabilities. Therefore, it is necessary to increase the value of the business and reduce its attractiveness in terms of price. Additionally, the company can implement measures to decrease its attractiveness, such as:

- Increasing financial leverage by using borrowed capital to repurchase shares, thereby increasing the company's risk level.

- Increasing the ownership ratio of shares by the management through employee stock ownership plans.

- Increasing cash dividend payments.

- Implementing provisions related to ownership changes, meaning the company must repay debts when mergers or acquisitions occur, creating pressure for the buyer.

- Implementing effective investment projects to reduce excess cash and enhance the company's scale.

In addition to the above measures, a company can apply some other strategies after being attacked by a hostile acquirer - a third-party buyer who may or may not have the support of the management. This buyer can be referred to by various names such as "white knights," "gray knights," or “black knights.”