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Letting Down Your Guard

With takeover defenses being increasingly dismantled, will a rise in hostile acquisitions be the result?
Lori Calabro, CFO Magazine
June 1, 2004

Prospective Google Inc. shareholders awaiting the much anticipated $2.7 billion initial public offering found that the company is wrapping itself in a takeover defense that keeps co-founders Larry Page and Sergey Brin firmly in control. A two-tier voting structure gives Class B stockholders — Page and Brin, for the most part — 10 votes for each share, with 1 vote for each of the Class A shares being offered.

"In the transition to public ownership, we have set up a corporate structure that will make it harder for outside parties to take over or influence Google," its Securities and Exchange Commission filing explained. That "will also make it easier for our management team to follow the long-term, innovative approach" that the company favors.

What Google was adamantly not following was the recent trend toward dismantling takeover defenses rather than initiating them. In response to shareholder demands, Goodyear Tire & Rubber Co., FirstEnergy Corp., ConAgra Foods Inc., and more than a dozen others have terminated their poison pills or agreed not to extend their current ones this year. This puts 2004 on a pace to rival 2003, when 29 companies revoked their pill provisions, up from 18 in 2002, according to Sharkrepellent.net, a mergers-and-acquisitions Website managed by New York­based TrueCourse Inc. Other companies, such as Goldman Sachs, are considering eliminating their staggered boards, while still others are opting to change their supermajority voting provisions.

Says Steve Carr, a partner at Boston-based law firm Goodwin Procter LLP: "We are witnessing what happens when you combine more-aggressive shareholders with boards that are paying more attention to corporate-governance matters."

The wisdom of eliminating traditional "porcupine" measures, now, as always, is subject to debate. While some shareholders insist that such defenses prevent them from getting the best return on their investment, "if I were a CFO of a target company, I would sure prefer to have a staggered board or a poison pill in place than not," says Carr, who is co-chair of his firm's corporate-governance and M&A group. That's especially true "since CFOs of targets often lose their jobs in a hostile takeover." (See "Acquired Tastes.")

These days, of course, CFOs have little recourse in the face of increased regulation and shareholder demands. So for some, eliminating takeover measures is simply one more reason to refocus on their businesses. Unwinding defenses "is consistent with the changing landscape of good corporate-governance practices," says FirstEnergy senior vice president and CFO Richard H. Marsh. Besides, he says, "the best defense against any hostile bid is to keep the share price growing, have a high P/E ratio, and maintain strong operations."

Bring It On
When the popularity of takeover defenses swelled in the early 1980s, porcupine amendments were aimed at repelling the efforts of such corporate raiders as T. Boone Pickens and Carl Icahn. Never guaranteed to merger-proof a company, the provisions had their highest perceived value in making a deal so difficult that raiders would look elsewhere for prey. Poison pills may trigger issuance of preferred stock with severe redemption provisions, for example, while staggered boards make winning control in one corporate meeting effectively impossible. In practice, however, the defenses often serve as leverage that target companies could use in negotiating higher offers.

Still, in recent years, a common shareholder view has evolved: that defenses are management-entrenchment tools that create barriers to increasing corporate value. "Having a takeover defense in place can reduce the playing field of potential acquirers," says Shez Bandukwala, senior vice president at Northbrook, Illinois-based Hilco Enterprise Valuation Services LLC. "So it limits the type of premium they'll be paid."

Shareholders unhappy with antitakeover provisions have targeted the best-known ones. According to Sharkrepellent.net, the number of nonbinding proposals calling for poison-pill elimination hit an all-time high of 99 last season. So far this year, some 54 similar proposals have been put forth. And poison-pill adoptions by companies have fallen sharply. (There have been noticeable exceptions, however; 3M Corp., for example, has fought to keep its pill in place.)

Staggered boards — which allow only a third of directors to stand for reelection each year — also have come under shareholder attack. Some 37 nonbinding proposals have called for their elimination so far this year, says TrueCourse vice president John Laide. There, too, not all the efforts are successful; in April, Boston-based State Street Corp. voted not to replace its staggered board, despite a concerted push from the powerful California Public Employees' Retirement System.

There are two reasons why Akron-based FirstEnergy has moved to dismantle its defenses, according to CFO Marsh, whose company's poison pill had been in place since 1997. "Shareholder proposals over the last couple of years had received increasing support — over 50 percent," he explains. Moreover, the "external environment" created by corporate scandals and the Sarbanes-Oxley Act of 2002 suggested to the company that eliminating the pill, and putting forth proposals to change its annual board elections and its 80 percent supervoting majority provision "was the right thing to do from a governance perspective."


That current external environment also includes a controversial proposal by the SEC to force firms to open their proxy ballots to shareholder nominees in the event of certain "trigger events" — such as 35 percent of shares being withheld for a sitting director (see "Proxy Fight"). The SEC is currently considering raising the threshold to 50 percent (excluding broker votes). Meanwhile, says Laide, firms that have routinely ignored nonbinding proposals to eliminate takeover defenses could find themselves subject to enough shareholder ire to trigger such a revolt.

Hardly Any Hostility
Perhaps surprisingly, there is little evidence that a proliferation of hostile takeovers will result from dismantling traditional defenses. For one thing, hostiles are a much-rarer deal than most companies realize. The high profiles of those attempted — think Comcast Corp.'s recently dropped $48 billion bid for The Walt Disney Co., and Oracle Corp.'s ongoing attempt to buy PeopleSoft Inc. — tend to magnify their apparent significance. There have been, in fact, only 49 hostile bids for U.S. companies in the past five years, according to Thomson Financial.

And with good reason. "When you do a hostile deal, it is going to take much longer and be more disruptive than if it is negotiated," says Lawrence Gennari, a partner with Boston-based law firm Gadsby Hannah LLP. Of course, such concerns are often secondary to a hostile bidder. "The real drivers of such activity are the desire for the target and the confidence of the acquirer that it's going to get it," says James Hoffman, managing director of Milwaukee-based middle-market investment bank Robert W. Baird & Co.

That confidence must be pretty high, considering that even without corporate-installed poison pills and staggered boards, many targets are protected by powerful state antitakeover laws. According to researchers at the Rochester Institute of Technology, in the past 22 years at least 38 states have written more than 65 such laws applying to companies incorporated within their borders. In 32 states, business-combination laws demand that acquirers wait up to 5 years to complete a hostile merger. Some 27 states have control-share acquisition laws, restricting a hostile acquirer's voting rights. And stakeholder laws, which guard the interests of employees and local communities, have been adopted by 29 states.

If this all suggests that the dismantling of defenses may have little impact in the M&A world, Hoffman suggests that no impact is needed. When a hostile bid is launched — whatever defenses exist — "the board [of the target] is in the best position to evaluate and negotiate prices." He thinks shareholders are misguided in "making the assumption that management is not accountable."

As for Google, while its two-tier share structure is being criticized by shareholder activists, few believe it will dampen investor enthusiasm. And only time will tell whether the structure will effectively thwart such rivals as Yahoo Inc. and Microsoft Corp. from attempting a future hostile bid — or whether Google will have to someday entrust its future to all its shareholders.

Lori Calabro is a deputy editor of CFO.




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