For nearly a year now, Air Products has been fighting to buy industrial gases and hardgoods distributor Airgas. The fight has prompted the question: How likely is it that Air Products will succeed?
To learn more about the mechanics of undertaking a hostile takeover bid, MDM spoke with Jim Hill, executive chairman of Ohio-based Benesch and chairman of the law firm’s private equity practice. Hill provided background on the topic, examples of other deals, and the challenges inherent with this approach.
MDM: How common are hostile takeovers?
Jim Hill: Hostile takeovers are not that common because there are a lot of cards stacked against you if you are the hostile offeror, as evidenced by the Airgas-Air Products hostile takeover bid.
A lot of companies have “poison pills,” which means as the hostile offeror is buying up stock of the target company, in order to get beyond 15 percent they have to get approval from the target board. In the old days, people could just buy up stock on the market and ultimately get close to a number that was so meaningful that the target company would have to deal with you.
Over the years, poison pills have evolved. A number of large public pension plans – take the California Public Employees’ Retirement System (CalPERS) for instance – have significant ownership in a number of public companies and have demanded that boards basically extinguish those poison pills because it is clearly a management entrenchment tool.
Another mechanism used very often – it’s being used by Airgas and was used in the CF-Terra situation (CF Industries, a Deerfield, IL-based fertilizer distributor launched a hostile takeover bid in 2009 for Terra Industries, Sioux City, IA, that took more than a year to resolve) – is staggered board of directors elections, so you’re never electing your entire board in any given year. Airgas has a nine-member board, so they elect three members every year.
If you’re a hostile offeror, even if you get your three directors elected over the three directors proposed by the target company, you’re still facing a minority situation. And you can only have a proxy contest once a year.
And then there’s another wild card. In the CF-Terra proxy battle, CF actually did get three of the directors elected in the annual election. But, they actually ended up voting against the CF proposal. To their credit, they looked upon themselves as independent, and they looked upon themselves as having fiduciary duty to the company.
Hostile takeovers in general are very expensive to mount because there is no guarantee at the end of the day that you’re going to win.
MDM: With all the potential negatives, what benefits are there for a company who engages in a hostile takeover attempt?
Hill: A long time before venturing into the market, the offeror should be looking at the company very carefully and thinking about where real efficiencies are, what markets the target is in that the hostile company isn’t in, etc. It’s the same reasons for buying a company on friendly terms. It’s not just about revenues.
And sometimes, just as in a typical acquisition setting, you undertake a takeover bid to add really good management that you may not have in certain areas of your company.
You really have to net out all the expense, all the PR, all the distraction to management before starting the process. And that’s a lot for a board to do, part of why it’s not that common.
MDM: Once the decision to go ahead is made, do most hostile takeover bids succeed?
Hill: It would be an interesting statistic to look at. My own observation is that a majority of them fail because the people that are on the other side are well advised. They have smart lawyers, they have smart financial advisors, and there are a simply lot of things you can do – the poison pill, the staggered board, etc. – to fend off the offeror.
Having said that, if the offeror comes in with a gargantuan price – say it’s a 40 percent premium to your stock price – it’s a lot harder to say no. Can you really say to your shareholders, we’re going to stay the course, and we’re going to be able to create that value anyway?
Board members don’t really want to spend a lot of time in litigation. They don’t want to spend their lives being deposed. It’s an unpleasant, unsettling situation to suddenly be subpoenaed by lawyers representing shareholders who are saying, you know Jim Hill, you rejected an offer that created substantial value for shareholders and you guys really have no plan to create that kind of value. You’ve breached your fiduciary duty to us.
So if you’re an independent director, I think you have to think long and hard about the offer because you don’t want to be in a position where the 30 percent premium comes and goes, and your stock continues to go sideways or starts to go down from where it was before the offer was made.
MDM: So if a hostile takeover bid succeeds, are there integration challenges that come up because it is a hostile takeover? Are there challenges that arise because the employees in the company may have been opposed?
Hill: Sure, no question about it. You like to think when people launch hostile bids that they’ve thought through all of that. How would we integrate the company? Have we been such bitter competitors for so many years that some of the inside people just hate our people, and vice versa?
The easier takeovers to do are the ones where you are in effect not buying a competitor, but you’re buying something complementary to your own business, something that you think will fit in very well.
In those where you’ve been going to head, if you succeed, you’re challenged with the cultural integration and the residual scars from the hostile takeover itself. All of that is surmountable but it’s difficult. You may have won the battle but lost the war.
MDM: Are there options for a target company after a hostile bid has been made?
Hill: One of the things you will see often in a hostile takeover situation is the target company will look for a “white knight” to come in who is more “management friendly.” Someone who would be more likely to leave the management in place and not make significant changes to how the company operates.
The problem with seeking a white knight is that you are no longer just saying no. Now you’re actually putting the company into play. You’re saying, we are willing to sell the company, we just think someone else would be a better fit. And that opens up the floodgates for a battle that will continue to distract management and can be very expensive.
MDM: Looking specifically at the Airgas-Air Products situation, why do you think Airgas is so resistant to the takeover bid?
Hill: I think there are a few reasons. First, the management believes they can create that kind of value themselves. And I think it’s also the board and the management saying they know if the acquisition happens that management’s not going to be around anymore and that has its own implications. I’m not saying that’s necessarily a selfish perspective. The board and management may feel they can run their company better than anybody else could.
In any company, anytime somebody starts asking about buying you, whether on a hostile basis or on a friendly basis, the initial reaction is: What kind of value is going to be created? After that, is it really good for our shareholders? And then it’s a question of, at the end of the day, where are we?
As much as we’d like to say otherwise, we’re not totally altruistic, and everyone thinks about their position and where they will be at the end of the day.
Over the years, you’ve seen a lot of things written very negatively about corporate takeovers where finally the target management team just acceded to the offer and walked away with huge compensation packages. And that’s something that I think is scrutinized a lot more closely today than ever in the past.
But they could make an argument, and maybe it’s the right argument, that yes we did receive financial benefit, but we also got a 35 percent premium from what the stock was trading at so everybody won.
But the thing you always have to be thinking about as a director is can I justifiably create this kind of value that’s being offered if we reject the offer? And that’s a dice roll because this isn’t a great economy, as we all know. They have to be asking, are we really going to be able to create the kind of earnings per share over the next year or two where we’d be at that same place?
MDM: Is that the time frame in which you think shareholders expect to see that value created?
Hill: Yes. You have to be able to present this fairly cohesive plan, show that you’re operating on this plan, and that you are going to get there fairly quickly.
If you’re a company that has been dropping its earnings per share significantly over the past three or four years – even considering the recession – you don’t have a real organic or acquisitive growth plan that’s working.
It becomes a lot harder to just say no, because at that point if I’m an independent director, I’m really feeling the heat. It would be hard for me to sit up in a deposition when I really don’t have anything other than, well we’re going to sell more, and we’re going to be smarter.
That plays into the whole hostile takeover situation. If you were trying to takeover a company that was executing on a plan, and was showing to the analysts over the quarters that it really was hitting its numbers, its plan was succeeding both on an organic and an acquisitive basis, I think that’s a tough company to ever takeover.