There is something innate in the makeup of most CEOs, as if it’s embedded deep within their DNA: they want the company they head to keep getting bigger.
Author and investment great, Ben Graham, called this characteristic aggrandisement. It’s an effort to extend one’s power, influence and reputation; to build an empire. Sometimes the empire is strong but sometimes it’s built on sand.
The main vehicle for this aggrandisement is the corporate takeover, and the fuel of takeovers is bank-supplied credit and shareholder-supplied equity. Beneath all this corporate activity there is something you, as a shareholder, need to realise: it might be the CEO playing the game, but it’s the shareholders who are placing the chips on the table.
This article looks at the takeover process: what should you do when a takeover looms and, most importantly, when is the takeover in your best interests or is it simply a CEO’s folly?
The takeover process
In common usage, takeover means acquiring control of a publicly listed company. Control typically describes when a bidder acquires all or a majority of the voting shares in the target company, with the target then becoming a subsidiary of the acquirer.
Takeovers can be friendly or hostile and are typically undertaken via a takeover bid or a scheme of arrangement. Let’s look at the differences.
Takeover bid
This is where individual offers (to each shareholder) are made in order to purchase the target securities at a specified price. Bids can be friendly (where the acquired is happy to be taken over) or hostile (where the target usually resists). A bid can be made off-market (not using the sharemarket) or via a market.
Most takeover bids are made off-market because this allows conditions to be included in the offer. When a bid is made, shareholders of the target company will receive a written offer to buy their shares.
Scheme of arrangement
This is where all shareholders vote on the offer first and their shares are acquired only if the resolution is passed. Therefore schemes of arrangement are used only for friendly acquisitions and are often used where 100 per cent of the target is being acquired.
All shareholders in a scheme of arrangement must singularly abide by the vote, because it ultimately becomes a court-approved statutory arrangement and is therefore binding by law.
Regulatory requirements
Takeovers in Australia are regulated by a combination of legislation, government policy and stock exchange rules. The main takeover rules are spelt out in the Corporations Act and are administered by the Australian Securities and Investments Commission. If a dispute arises, it is managed by the Takeovers Panel. There are many rules covering takeovers but let’s look at one of the main ones — the 20 per cent rule.
This states that a person cannot acquire more than 20 per cent of a company unless via a specified exception, which includes takeover bids and schemes of arrangement. So when the 20 per cent threshold is hit, the takeover machinery is triggered.
Response to a hostile takeover
When an off-market bid is launched for shares you own, you will receive letters from both sides of the battle. The first, describing the details of the offer, will be from the bidder. The second will be from the directors of your company, who are obligated to respond to the bid by issuing a target’s statement.
The directors’ statement will usually advise that the offer significantly undervalues your shares and you should reject it. This will be backed by an “independent valuation” from a financial house acting on your company’s behalf. Company valuations are pretty rubbery beasts at the best of times, so the “independent valuation” can be any figure the appointed adviser wants it to be. A financial house employed to defend against a hostile takeover is unlikely to conclude the initial offer is a fair one.
Cynicism aside, the directors, in rejecting the initial offer, are usually acting in the best interests of the shareholders – they are seeking a higher bid from the initial bidder or new offers from elsewhere.
That said, sometimes management’s judgement about the adequacy of the initial offer can be clouded because, price aside, they are usually defending their jobs and their pride.
What you should be doing
1. Read the documents
Once a takeover bid is announced, the bidder must make an offer to buy your shares within two months. Don’t act immediately, but wait until you have also read the target company’s statement before responding.
For schemes of arrangement, you will receive a scheme booklet from the company in which you own shares. Because of additional requirements involved with schemes, receiving the booklet could take a few months. It will describe the nature of the arrangement and typically include an independent expert’s report outlining whether or not the offer is fair and reasonable and in your best interests.
Because this is a vehicle reserved for friendly acquisitions, you are likely to be told by the directors that it is fair and reasonable. You can vote either in person at the scheme meeting or send a proxy form.
2. Look out for ASX announcements and monitor the financial press
After the announcement of a takeover bid or scheme, the situation can change quickly. The price offered may increase, or the period for accepting the bid may be extended. Watch the media for updates and also check the ASX website regularly for any announcements. Sometimes information will be found in ASX announcements rather than sent to you directly.
3. Determine value and keep an eye on the share price
Whether a takeover or scheme of arrangement makes sense is usually a value-versus-price decision so determine for yourself whether the prices being thrown around seem fair. This applies whether you own shares in the acquirer or the to-be-acquired.
The corporate graveyard is littered with companies that overpaid for acquisitions. Get a handle on value to judge whether your CEO is a genius or a megalomaniac.
I appreciate that not everyone can independently undertake corporate valuations, so look to the share price action for a guide. This can provide a clue as to the general thinking. Typically, when the bid or scheme is announced, the share price will move closer to the offer price. It might be higher if the market expects a better offer could emerge. If the market thinks the offer is likely to fail, the share price could be lower than the offer price.
Armed with all this information, you have the following choices:
1. Sell on-market before the offer expires if you are happy with the current market price.
2. Wait and accept the best offer. This means you will ultimately sell your shares directly to the highest bidder without paying any brokerage costs. You will receive payment in cash and/or shares as set out in the bidder's statement. But this begs the question, how often does another (better) offer arise after the first bid has been made? Logic suggests the first offer will not necessarily be the last.
3. You could reject the offer altogether. Generally you don’t have to sell your shares to the bidder. But remember, if the bidder acquires a significant parcel of shares, control of the company will shift in its favour. So understand what its intentions are with the company, because they might not be aligned with yours or other small shareholders.
Remember also that a large number of shares held by one owner can result in reduced daily trading volume in the shares of that company, making buying and selling more difficult. And when the acquirer obtains 90 per cent or more of the company, it can generally compulsorily acquire your shares anyway.
Expand
