Beware of sharks.
Prominent corporate legal advisor Martin Lipton, partner of the New York City-based Wachtell, Lipton, Rosen & Katz, last week warned clients that a rash of hostile exchange offers may be an unintended consequence of the new purchase accounting rules being proposed by the Financial Accounting Standards Board (FASB).
Such activity has been dormant for quite a while. “For the first time in the United States, since the pre-Williams Act “Chinese Paper” exchange offers by conglomerates in the 1960s, it will be practical — indeed quite attractive — for acquirers to make hostile exchange offers,” writes Lipton, in his memo.
But it’s certainly not hard to see why there may be a revival. FASB’s recommended accounting changes, expected to become effective July 1, will eliminate the pooling of interest treatment in acquisitions and eliminate the amortization of goodwill in favor of periodic tests for impairment.
The purchase method, therefore, will become more attractive to potential acquirers because, as under pooling, there will be less earnings dilution. But, companies will not have restrictions against doing share buybacks and selling assets.
“Because it is (presently) so easy to kill a pooling (deal), it is not practical to attempt a hostile exchange offer that requires pooling treatment in order for it to work from an earnings dilution standpoint,” Lipton adds. “Therefore, favorable accounting treatment through pooling could only be achieved in a friendly negotiated merger. Now in many cases it will be possible to achieve accounting treatment at least as favorable as pooling through a hostile exchange offer.”
According to other pros, pooling has been an effective takeover defense tactic. For example, some target companies trying to fend off an unwanted takeover would simply repurchase its stock, issue a special dividend or change the equity structure of the company.
The elimination of pooling will remove these takeover defense weapons.
Current market conditions are also helping to feed hostile activity. Particularly in the technology, media and telecommunications (TMT) sectors, where some companies enjoy lofty share prices and others are oversold, out of favor and selling at prices significantly below value in many suitors’ and investors’ minds, he adds, there is quite a breeding ground for hostile exchange offers.
“In some ways the current situation in the TMT sector is reminiscent of the mid-70s to mid-80s in the oil and gas sector,” Lipton notes. “Then we had junk bond financed hostile cash bids. Now it may well be exchange offers.”
Lipton should know. The corporate lawyer is credited with inventing the “poison pill” takeover defense nearly 20 years ago. For advice on preparing for a hostile takeover, read his comments in “Is Your Company Shark- Proof?”
Moreover, he’s convinced that the hostile exchange offers today could be huge, citing Vodafone’s $200 billion hostile exchange offer in 1999 for Germany’s Mannesmann. He notes, “Indeed, if in a hostile exchange offer the bidder’s shares have a higher price earnings ratio and are more acceptable to investors than the target’s shares, there is no limit to the size of the hostile exchange offer.”