Exam 3: The Corporate Takeover Market:

When, if ever, is it appropriate for a board to prevent shareholder votes on matters involved in selling a firm?

If you were the CEO of a target firm, what strategy would you recommend to convince institutional shareholders to support your position in a proxy battle with the bidding firm?

A buyout involving the target firm's current management is called a management buyout. In what way do these types of deals represent agency conflicts between managers and shareholders? What board procedures can be put in place to mitigate such conflicts? How can activist investors help mitigate such conflicts?

Kraft Sweetens the Offer to Overcome Cadbury’s Resistance Despite speculation that offers from U.S.-based candy company Hershey and the Italian confectioner Ferreiro would be forthcoming, Kraft’s bid on January 19, 2010, was accepted unanimously by Cadbury’s board of directors. Kraft, the world’s second (after Nestle) largest food manufacturer, raised its offer over its initial September 7, 2009, bid to $19.5 billion to win over the board of the world’s second largest candy and chocolate maker. Kraft also assumed responsibility for $9.5 billion of Cadbury’s debt. Kraft’s initial bid evoked a raucous response from Cadbury’s chairman Roger Carr, who derided the offer that valued Cadbury at $16.7 billion as showing contempt for his firm’s well-known brand and dismissed the hostile bidder as a low-growth conglomerate. Immediately following the Kraft announcement, Cadbury’s share price rose by 45 percent (7 percentage points more than the 38 percent premium implicit in the Kraft offer). The share prices of other food manufacturers also rose due to speculation that they could become takeover targets. The ensuing four-month struggle between the two firms was reminiscent of the highly publicized takeover of U.S. icon Anheuser-Busch in 2008 by Belgian brewer InBev. The Kraft-Cadbury transaction stimulated substantial opposition from senior government ministers and trade unions over the move by a huge U.S. firm to take over a British company deemed to be a national treasure. However, like InBev’s takeover of Anheuser-Busch, what started as a donnybrook ended on friendly terms, with the two sides reaching final agreement in a single weekend. Determined to become a global food and candy giant, Kraft decided to bid for Cadbury after the U.K.-based firm spun off its Schweppes beverages business in the United States in 2008. The separation of Cadbury’s beverage and confectionery units resulted in Cadbury becoming the world’s largest pure confectionery firm following the spinoff. Confectionery companies tend to trade at a higher value, so adding the Cadbury’s chocolate and gum business could enhance Kraft’s attractiveness to competitors. However, this status was soon eclipsed by Mars’s acquisition of Wrigley in 2008. A takeover of Cadbury would help Kraft, the biggest food conglomerate in North America, to compete with its larger rival, Nestle. Cadbury would strengthen Kraft’s market share in Britain and would open India, where Cadbury is among the most popular chocolate brands. It would also expand Kraft’s gum business and give it a global distribution network. Nestle lacks a gum business and is struggling with declining sales as recession-plagued consumers turned away from its bottled water and ice cream products. Cadbury and Kraft fared relatively well during the 2008–2009 global recession, with Cadbury’s confectionery business proving resilient despite price increases in the wake of increasing sugar prices. Kraft had benefited from rising sales of convenience foods because consumers ate more meals at home during the recession. The differences in the composition of the initial and final Kraft bids reflected a series of crosscurrents. Irene Rosenfeld, the Kraft CEO, not only had to contend with vituperative comments from Cadbury’s board and senior management, but she also was soundly criticized by major shareholders who feared Kraft would pay too much for Cadbury. Specifically, the firm’s largest shareholder, Warren Buffett’s Berkshire Hathaway with a 9.4 percent stake, expressed concern that the amount of new stock that would have to be issued to acquire Cadbury would dilute the ownership position of existing Kraft shareholders. In an effort to placate dissident Kraft shareholders while acceding to Cadbury’s demand for an increase in the offer price, Ms. Rosenfeld increased the offer by 7 percent by increasing the cash portion of the purchase price. The new bid consisted of $8.17 of cash and 0.1874 new Kraft shares, compared to Kraft’s original offer of $4.89 of cash and 0.2589 new Kraft shares for each Cadbury share outstanding. The change in the composition of the offer price meant that Kraft would issue 265 million new shares compared with its original plan to issue 370 million. The change in the terms of the deal meant that Kraft would no longer have to get shareholder approval for the new share issue, since it was able to avoid the NYSE requirement that firms issuing shares totaling more than 20 percent of the number of shares currently outstanding must receive shareholder approval to do so. -Kraft appeared to take action immediately following Cadbury's spin-off of Schweppes making Cadbury a pure candy company. Why do you believe that Kraft chose not to buy Cadbury and later divest such noncore businesses as Schweppes?

Verizon Acquires MCI—The Anatomy of Alternative Bidding Strategies While many parties were interested in acquiring MCI, the major players included Verizon and Qwest. U.S.-based Qwest is an integrated communications company that provides data, multimedia, and Internet-based communication services on a national and global basis. The acquisition would ease the firm's huge debt burden of $17.3 billion because the debt would be supported by the combined company with a much larger revenue base and give it access to new business customers and opportunities to cut costs. Verizon Communications, created through the merger of Bell Atlantic and GTE in 2000, is the largest telecommunications provider in the United States. The company provides local exchange, long distance, Internet, and other services to residential, business, and government customers. In addition, the company provides wireless services to over 42 million customers in the United States through its 55 percent–owned joint venture with Vodafone Group PLC. Verizon stated that the merger would enable it to more efficiently provide a broader range of services, give the firm access to MCI's business customer base, accelerate new product development using MCI's fiber-optic network infrastructure, and create substantial cost savings. By mid-2004, MCI had received several expressions of interest from Verizon and Qwest regarding potential strategic relationships. By July, Qwest and MCI entered into a confidentiality agreement and proceeded to perform more detailed due diligence. Ivan Seidenberg, Verizon's chairman and CEO, inquired about a potential takeover and was rebuffed by MCI's board, which was evaluating its strategic options. These included Qwest's proposal regarding a share-for-share merger, following a one-time cash dividend to MCI shareholders from MCI's cash in excess of its required operating balances. In view of Verizon's interest, MCI's board of directors directed management to advise Richard Notebaert, the chairman and CEO of Qwest, that MCI was not prepared to move forward with a potential transaction. The stage was set for what would become Qwest's laboriously long and ultimately unsuccessful pursuit of MCI, in which the firm would improve its original offer four times, only to be rejected by MCI in each instance even though the Qwest bids exceeded Verizon’s. After assessing its strategic alternatives, including the option to remain a stand-alone company, MCI's board of directors concluded that the merger with Verizon was in the best interests of the MCI stockholders. MCI's board of directors noted that Verizon's bid of $26 in cash and stock for each MCI share represented a 41.5 percent premium over the closing price of MCI's common stock on January 26, 2005. Furthermore, the stock portion of the offer included "price protection" in the form of a collar (i.e., the portion of the purchase price consisting of stock would be fixed within a narrow range if Verizon’s share price changed between the signing and closing of the transaction). The merger agreement also provided for the MCI board to declare a special dividend of $5.60 once the firm's shareholders approved the deal. MCI's board of directors also considered the additional value that its stockholders would realize, since the merger would be a tax-free reorganization in which MCI shareholders would be able to defer the payment of taxes until they sold their stock. Only the cash portion of the purchase price would be taxable immediately. MCI's board of directors also noted that a large number of MCI's most important business customers had indicated that they preferred a transaction between MCI and Verizon rather than a transaction between MCI and Qwest. While it is clearly impossible to know for sure, the sequence of events reveals a great deal about Verizon's possible bidding strategy. Any bidding strategy must begin with a series of management assumptions about how to approach the target firm. It was certainly in Verizon's best interests to attempt a friendly rather than a hostile takeover of MCI, due to the challenges of integrating these two complex businesses. Verizon also employed an increasingly popular technique in which the merger agreement includes a special dividend payable by the target firm to its shareholders contingent upon their approval of the transaction. This special dividend is an inducement to gain shareholder approval. Given the modest 3 percent premium over the first Qwest bid, Verizon's initial bidding strategy appears to have been based on the low end of the purchase price range it was willing to offer MCI. Verizon was initially prepared to share relatively little of the potential synergy with MCI shareholders, believing that a bidding war for MCI would be unlikely in view of the recent spate of mergers in the telecommunications industry and the weak financial position of other competitors. SBC and Nextel were busy integrating AT&T and Sprint, respectively. Moreover, Qwest appeared to be unable to finance a substantial all-cash offer due to its current excessive debt burden, and its stock appeared to have little appreciation potential because of ongoing operating losses. Perhaps stunned by the persistence with which Qwest pursued MCI, Verizon believed that its combination of cash and stock would ultimately be more attractive to MCI investors than Qwest's primarily all-cash offer, due to the partial tax-free nature of the bid. Throughout the bidding process, many hedge funds criticized MCI's board publicly for accepting the initial Verizon bid. Since its emergence from Chapter 11, hedge funds had acquired significant positions in MCI's stock, with the expectation that MCI constituted an attractive merger candidate. In particular, Carlos Slim Helu, the Mexican telecommunications magnate and largest MCI shareholder, complained publicly about the failure of MCI's board to get full value for the firm's shares. Pressure from hedge funds and other dissident MCI shareholders triggered a shareholder lawsuit to void the February 14, 2005, signed merger agreement with Verizon. In preparation for a possible proxy fight, Verizon entered into negotiations with Carlos Slim Helu to acquire his shares. Verizon acquired Mr. Slim's 13.7 percent stake in MCI in April 2005. Despite this purchase, Verizon's total stake in MCI remained below the 15 percent ownership level that would trigger the MCI rights plan. About 70 percent (i.e., $1.4 billion) of the cash portion of Verizon's proposed purchase price consisted of a special MCI dividend payable by MCI when the firm's shareholders approved the merger agreement. Verizon's management argued that the deal would cost their shareholders only $7.05 billion (i.e., the $8.45 billion purchase price consisting of cash and stock, less the MCI special dividend). The $1.4 billion special dividend reduced MCI's cash in excess of what was required to meet its normal operating cash requirements. Qwest consistently attempted to outmaneuver Verizon by establishing a significant premium between its bid and Verizon's, often as much as 25 percent. Qwest realized that its current level of indebtedness would preclude it from significantly increasing the cash portion of the bid. Consequently, it had to rely on the premium to attract enough investor interest, particularly among hedge funds, to pressure the MCI board to accept the higher bid. However, Qwest was unable to convince enough investors that its stock would not simply lose value once more shares were issued to consummate the stock and cash transaction. Qwest could have initiated a tender or exchange offer directly to MCI shareholders, proposing to purchase or exchange their shares without going through the merger process. The tender process requires lengthy regulatory approval. However, if Qwest initiated a tender offer, it could trigger MCI's poison pill. Alternatively, a proxy contest might have been preferable because Qwest already had a bid on the table, and the contest would enable Qwest to lobby MCI shareholders to vote against the Verizon bid. This strategy would have avoided triggering the poison pill. Ultimately, Qwest was forced to capitulate simply because it did not have the financial wherewithal to increase the $9.9 billion bid. It could not borrow anymore because of its excessive leverage. Additional stock would have contributed to earnings dilution and caused the firm's share price to fall. It is unusual for a board to turn down a higher bid, especially when the competing bid was 17 percent higher. In accepting the Verizon bid, MCI stated that a number of its large business customers had expressed a preference for the company to be bought by Verizon rather than Qwest. MCI noted that these customer concerns posed a significant risk in being acquired by Qwest. The MCI board's acceptance of the lower Verizon bid could serve as a test case of how well MCI directors are conducting their fiduciary responsibilities. The central issue is how far boards can go in rejecting a higher offer in favor of one they believe offers more long-term stability for the firm's stakeholders. Ron Perlman, the 1980s takeover mogul, saw his higher all-cash bid rejected by the board of directors of Revlon Corporation, which accepted a lower offer from another bidder. In a subsequent lawsuit, a court overruled the decision by the Revlon board in favor of the Perlman bid. Consequently, from a governance perspective, legal precedent compels boards to accept higher bids from bona fide bidders where the value of the bid is unambiguous, as in the case of an all-cash offer. However, for transactions in which the purchase price is composed largely of acquirer stock, the value is less certain. Consequently, the target's board may rule that the lower bidder's shares have higher appreciation potential or at least are less likely to decline than those shares of other bidders. MCI's president and CEO Michael Capellas and other executives could collect $107 million in severance, payouts of restricted stock, and monies to compensate them for taxes owed on the payouts. In particular, Capellas stood to receive $39.2 million if his job is terminated "without cause" or if he leaves the company “for good reason." -What specific takeover defenses did MCI employ? Be specific.

A tender offer is a proposal made directly to the target firm's board as the first step leading to a friendly takeover.

Linkedin IPO Raises Governance Issues Various antitakeover defenses raise shareholder rights issues. Critics argue such measures entrench existing management. Firms employing such measures argue that they allow the founder to retain control, attract and retain key managers, and enable the firm to continue its business strategy. ______________________________________________________________________________ Investors often overlook governance structures when the prospect of future profits is high. This may have been the case when Internet social media company LinkedIn completed on May 9, 2011, the largest IPO since Google’s in 2004. With 2010 revenues of $243 million and net income of $15 million, the eight-year-old firm was valued at $8.9 billion, nearly 600 times earnings. Investors in the IPO received Class A shares, which have only one vote, while LinkedIn’s pre-IPO shareholders hold Class B shares, entitled to 10 votes each. The dual share structure guarantees that cofounder and CEO, Reid Hoffman, will own about 20% of LinkedIn and, in concert with three venture capital firms, will have a controlling interest. In contrast, public shareholders will have less than 1% of the voting power of the firm. Different classes of voting stock allow the founder’s family to preserve and protect their desired corporate culture, to preserve continuity of policies and practices, to attract and retain key managers, and to enable the current board and management to look beyond quarterly earnings pressures. The dual structure also allows founders to cash out without losing control of the companies they started. LinkedIn also adopted a staggered board, which effectively requires at least two years before a majority of the firm’s current board can be replaced. To make it more difficult to eliminate the staggered board defense, LinkedIn shareholders must vote to change the firm’s certificate of incorporation after the board recommends such a vote. Once the recommendation is made, all LinkedIn shares (Class A and Class B) have only one vote. However, the removal of the staggered board is still unlikely, because the firm’s certificate of incorporation requires that more than 80% of all shareholders approve changes in the staggered board structure. The firm also added bylaw notice provisions—to discourage shareholder activists—more onerous than would be required in SEC filings, when a shareholder has more than 5% ownership interest in a public firm. If it is later determined that the shareholder has misstated the facts in any manner, LinkedIn’s bylaws allow the board to disqualify the proposal or nomination. Finally, according to LinkedIn’s charter, any shareholder lawsuits must be litigated in the state of Delaware, where the laws are particularly favorable to corporations. These measures raise questions about the rights of pre-IPO investors versus those of public shareholders. Do they allow the firm to retain the best managers and to implement fully its business strategy? Do they embolden management to negotiate the best deal for all shareholders in the event of a takeover attempt? Or do they entrench current management intent on maintaining their power and compensation at the expense of other shareholders? Discussion Questions: Mittal Acquires Arcelor—A Battle of Global Titans in the European Corporate Takeover Market Ending five months of maneuvering, Arcelor agreed on June 26, 2006, to be acquired by larger rival Mittal Steel Co. for $33.8 billion in cash and stock. The takeover battle was one of the most acrimonious in recent European Union history. Hostile takeovers are now increasingly common in Europe. The battle is widely viewed as a test case as to how far a firm can go in attempting to prevent an unwanted takeover. Arcelor was created in 2001 by melding steel companies in Spain, France, and Luxembourg. Most of its 90 plants are in Europe. In contrast, most of Mittal's plants are outside of Europe in areas with lower labor costs. Lakshmi Mittal, Mittal's CEO and a member of an important industrial family in India, started the firm and built it into a powerhouse through two decades of acquisitions in emerging nations. The company is headquartered in the Netherlands for tax reasons. Prior to the Arcelor acquisition, Mr. Mittal owned 88 percent of the firm's stock. Mittal acquired Arcelor to accelerate steel industry consolidation to reduce industry overcapacity. The combined firms could have more leverage in setting prices and negotiating contracts with major customers such as auto and appliance manufacturers and suppliers such as iron ore and coal vendors, and eventually realize $1 billion annually in pretax cost savings. After having been rebuffed by Guy Dolle, Arcelor's president, in an effort to consummate a friendly merger, Mittal launched a tender offer in January 2006 consisting of mostly stock and cash for all of Arcelor's outstanding equity. The offer constituted a 27 percent premium over Arcelor's share price at that time. The reaction from Arcelor's management, European unions, and government officials was swift and furious. Guy Dolle stated flatly that the offer was "inadequate and strategically unsound." European politicians supported Mr. Dolle. Luxembourg's prime minister, Jean Claude Juncker, said a hostile bid "calls for a hostile response." Trade unions expressed concerns about potential job loss. Dolle engaged in one of the most aggressive takeover defenses in recent corporate history. In early February, Arcelor doubled its dividend and announced plans to buy back about $8.75 billion in stock at a price well above the then current market price for Arcelor stock. These actions were taken to motivate Arcelor shareholders not to tender their shares to Mittal. Arcelor also backed a move to change the law so that Mittal would be required to pay in cash. However, the Luxembourg parliament rejected that effort. To counter these moves, Mittal Steel said in mid-February that if it received more than one-half of the Arcelor shares submitted in the initial tender offer, it would hold a second tender offer for the remaining shares at a slightly lower price. Mittal pointed out that it could acquire the remaining shares through a merger or corporate reorganization. Such rhetoric was designed to encourage Arcelor shareholders to tender their shares during the first offer. In late 2005, Arcelor outbid German steelmaker Metallgeschaft to buy Canadian steelmaker Dofasco for $5 billion. Mittal was proposing to sell Dofasco to raise money and avoid North American antitrust concerns. Following completion of the Dofasco deal in April 2006, Arcelor set up a special Dutch trust to prevent Mittal from getting access to the asset. The trust is run by a board of three Arcelor appointees. The trio has the power to determine if Dofasco can be sold during the next five years. Mittal immediately sued to test the legality of this tactic. In a deal with Russian steel maker OAO Severstahl, Arcelor agreed to exchange its shares for Alexei Mordashov's 90 percent stake in Severstahl. The transaction would give Mr. Mordashov a 32 percent stake in Arcelor. Arcelor also scheduled an unusual vote that created very tough conditions for Arcelor shareholders to prevent the deal with Severstahl from being completed. Arcelor's board stated that the Severstahl deal could be blocked only if at least 50 percent of all Arcelor shareholders would vote against it. However, Arcelor knew that only about one-third of shareholders actually attend meetings. This is a tactic permissible under Luxembourg law, where Arcelor is incorporated. Investors holding more than 30 percent of Arcelor shares signed a petition to force the company to make the deal with Severstahl subject to a traditional 50.1 percent or more of actual votes cast. After major shareholders pressured the Arcelor board to at least talk to Mr. Mittal, Arcelor demanded an intricate business plan from Mittal as a condition that had to be met. Despite Mittal's submission of such a plan, Arcelor still refused to talk. In late May, Mittal raised its bid by 34 percent and said that if the bid succeeded, Mittal would eliminate his firm's two-tiered share structure, giving the Mittal family shares ten times the voting rights of other shareholders. A week after receiving the shareholder petition, the Arcelor board rejected Mittal's sweetened bid and repeated its support of the Severstahl deal. Shareholder anger continued, and many investors said they would reject the share buyback. Some investors opposed the buyback because it would increase Mr. Mordashov's ultimate stake in Arcelor to 38 percent by reducing the number of Arcelor shares outstanding. Under the laws of most European countries, any entity owning more than a third of a company is said to have effective control. Arcelor cancelled a scheduled June 21 shareholder vote on the buyback. Despite Mr. Mordashov's efforts to enhance his bid, the Arcelor board asked both Mordashov and Mittal to submit their final bids by June 25. Arcelor finally agreed to Mittal's final bid, which had been increased by 14 percent. The new offer consisted of $15.70 in cash and 1.0833 Mittal shares for each Arcelor share. The new bid is valued at $50.54 per Arcelor share, up from Mittal's initial bid in January 2006 of $35.26. The final offer represented an unprecedented 93 percent premium over Arcelor's share price of $26.25 immediately before Mittal's initial bid. Lakshmi Mittal will control 43.5 percent of the combined firm's stock. Mr. Mordashov would receive a $175 million breakup fee due to Arcelor's failure to complete its agreement with him. Finally, Mittal agreed not to make any layoffs beyond what Arcelor already has planned. -Identify the takeover tactics employed by Mittal. Explain why each was used.

Despite the pressure of an attractive purchase price premium, the composition of the target's board greatly influences what the board does and the timing of its decisions.

Federal and state laws make it extremely difficult for a bidder to acquire a controlling interest in a target without such actions becoming public knowledge.

What do you believe are the primary factors a target firm's board should consider when evaluating a bid from a potential acquirer? Explain your answer.

Pfizer Acquires Warner-Lambert in a Hostile Takeover In 1996 Pfizer and Warner Lambert (Warner) agreed to co-market worldwide the cholesterol-lowering drug Lipitor, which had been developed by Warner. The combined marketing effort was extremely successful with combined 1999 sales reaching $3.5 billion, a 60% increase over 1998. Before entering into the marketing agreement, Pfizer had entered into a confidentiality agreement with Warner that contained a standstill clause that, among other things, prohibited Pfizer from making a merger proposal unless invited to do so by Warner or until a third party made such a proposal. In late 1998, Pfizer became aware of numerous rumors of a possible merger between Warner and some unknown entity. William C. Steere, chair and CEO of Pfizer, sent a letter on October 15, 1999, to Lodeijk de Vink, chair and CEO of Warner, inquiring about the potential for Pfizer to broaden its current strategic relationship to include a merger. More than 2 weeks passed before Steere received a written response in which de Vink expressed concern that Steere’s letter violated the spirit of the standstill agreement by indicating interest in a merger. Speculation about an impending merger between Warner and American Home Products (AHP) came to a head on November 19, 1999, when an article appeared in the Wall Street Journal announcing an impending merger of equals between Warner and AHP valued at $58.3 billion. The public announcement of the agreement to merge between Warner and AHP released Pfizer from the standstill agreement. Tinged with frustration and impatience at what Pfizer saw as stalling tactics, Steere outlined in the letter the primary reasons why the proposed combination of the two companies made sense to Warner’s shareholders. In addition to a substantial premium over Warner’s current share price, Pfizer argued that combining the companies would result in a veritable global powerhouse in the pharmaceutical industry. Furthermore, the firm’s product lines are highly complementary, including Warner’s over-the-counter drug presence and substantial pipeline of new drugs and Pfizer’s powerful global marketing and sales infrastructure. Steere also argued that the combined companies could generate annual cost savings of at least $1.2 billion annually within 1 year following the completion of the merger. These savings would come from centralizing computer systems and research and development (R&D) activities, consolidating more than 100 manufacturing facilities, and combining two headquarters and multiple sales and administrative offices in 30 countries. Pfizer also believed that the two companies’ cultures were highly complementary. In addition to the letter from Steere to de Vink, on November 4, 1999, Pfizer announced that it had commenced a legal action in the Delaware Court of Chancery against Warner, Warner’s directors, and AHP. The action sought to enjoin the approximately $2 billion termination fee and the stock option granted by Warner-Lambert to AHP to acquire 14.9% of Warner’s common stock valued at $83.81 per share as part of their merger agreement. The lawsuit charged that the termination fee and stock options were excessively onerous and were not in the best interests of the Warner shareholders because they would discourage potential takeover attempts. On November 5, 1999, Warner explicitly rejected Pfizer’s proposal in a press release and reaffirmed its commitment to its announced business combination with AHP. On November 9, 1999, de Vink sent a letter to the Pfizer board in which he expressed Warner’s disappointment at what he perceived to be Pfizer’s efforts to take over Warner as well as Pfizer’s lawsuit against the firm. In the letter, he stated Warner-Lambert’s belief that the litigation was not in the best interest of either company’s stockholders, especially in light of their co-promotion of Lipitor, and it was causing uncertainty in the financial markets. Not only did Warner reject the Pfizer bid, but it also threatened to cancel the companies’ partnership to market Lipitor. Pfizer responded by exploiting a weakness in the Warner Lambert takeover defenses by utilizing a consent solicitation process that allows shareholders to change the board without waiting months for a shareholders’ meeting. Pfizer also challenged in court two provisions in the contract with AHP on the grounds that they were not in the best interests of the Warner Lambert shareholders because they would discourage other bidders. Pfizer’s offers for Warner Lambert were contingent on the removal of these provisions. On November 12, 1999, Steere sent a letter to de Vink and the Warner board indicating his deep disappointment as a result of their refusal to consider what Pfizer believes is a superior offer to Warner. He also reiterated his firm’s resolve in completing a merger with Warner. Not hearing anything from Warner management, Pfizer decided to go straight to the Warner shareholders on November 15, 1999, in an attempt to change the composition of the board and to get the board to remove the poison pill and break-up fee. In the mid-November proxy statement sent to Warner shareholders, Pfizer argued that the current Warner Lambert board has approved a merger agreement with American Home, which provides 30% less current value to the Warner-Lambert stockholders than the Pfizer merger proposal. Moreover, Warner shareholders would benefit more in the long run in a merger with Pfizer, because the resulting firm would be operationally and financially stronger than a merger created with AHP. Pfizer also argued that its international marketing strength is superior in the view of most industry analysts to that of American Home and will greatly enhance Warner-Lambert’s foreign sales efforts. Pfizer stated that Warner Lambert was not acting in the best interests of its shareholders by refusing to even grant Pfizer permission to make a proposal. Pfizer also alleged that Warner Lambert is violating its fiduciary responsibilities by approving the merger agreement with American Home in which AHP is entitled to a termination fee of approximately $2 billion. Pressure intensified from all quarters including such major shareholders as the California Public Employees Retirement System and the New York City Retirement Fund. After 3 stormy months, Warner Lambert agreed on February 8, 2000, to be acquired by Pfizer for $92.5 billion, forming the world’s second largest pharmaceutical firm. Although they were able to have the Warner poison pill overturned in court as being an unreasonable defense, Pfizer was unsuccessful in eliminating the break-up fee and had to pay AHP the largest such fee in history. The announced acquisition of Warner Lambert by Pfizer ended one of the most contentious corporate takeover battles in recent memory. -What factors may make it difficult for this merger to meet or exceed industry average returns? What are the implications for the long-term financial performance of the new firm of only using Pfizer stock to purchase Warner Lambert shares?

The target firm's bylaws may provide significant hurdles for an acquiring firm.

Verizon Acquires MCI—The Anatomy of Alternative Bidding Strategies While many parties were interested in acquiring MCI, the major players included Verizon and Qwest. U.S.-based Qwest is an integrated communications company that provides data, multimedia, and Internet-based communication services on a national and global basis. The acquisition would ease the firm's huge debt burden of $17.3 billion because the debt would be supported by the combined company with a much larger revenue base and give it access to new business customers and opportunities to cut costs. Verizon Communications, created through the merger of Bell Atlantic and GTE in 2000, is the largest telecommunications provider in the United States. The company provides local exchange, long distance, Internet, and other services to residential, business, and government customers. In addition, the company provides wireless services to over 42 million customers in the United States through its 55 percent–owned joint venture with Vodafone Group PLC. Verizon stated that the merger would enable it to more efficiently provide a broader range of services, give the firm access to MCI's business customer base, accelerate new product development using MCI's fiber-optic network infrastructure, and create substantial cost savings. By mid-2004, MCI had received several expressions of interest from Verizon and Qwest regarding potential strategic relationships. By July, Qwest and MCI entered into a confidentiality agreement and proceeded to perform more detailed due diligence. Ivan Seidenberg, Verizon's chairman and CEO, inquired about a potential takeover and was rebuffed by MCI's board, which was evaluating its strategic options. These included Qwest's proposal regarding a share-for-share merger, following a one-time cash dividend to MCI shareholders from MCI's cash in excess of its required operating balances. In view of Verizon's interest, MCI's board of directors directed management to advise Richard Notebaert, the chairman and CEO of Qwest, that MCI was not prepared to move forward with a potential transaction. The stage was set for what would become Qwest's laboriously long and ultimately unsuccessful pursuit of MCI, in which the firm would improve its original offer four times, only to be rejected by MCI in each instance even though the Qwest bids exceeded Verizon’s. After assessing its strategic alternatives, including the option to remain a stand-alone company, MCI's board of directors concluded that the merger with Verizon was in the best interests of the MCI stockholders. MCI's board of directors noted that Verizon's bid of $26 in cash and stock for each MCI share represented a 41.5 percent premium over the closing price of MCI's common stock on January 26, 2005. Furthermore, the stock portion of the offer included "price protection" in the form of a collar (i.e., the portion of the purchase price consisting of stock would be fixed within a narrow range if Verizon’s share price changed between the signing and closing of the transaction). The merger agreement also provided for the MCI board to declare a special dividend of $5.60 once the firm's shareholders approved the deal. MCI's board of directors also considered the additional value that its stockholders would realize, since the merger would be a tax-free reorganization in which MCI shareholders would be able to defer the payment of taxes until they sold their stock. Only the cash portion of the purchase price would be taxable immediately. MCI's board of directors also noted that a large number of MCI's most important business customers had indicated that they preferred a transaction between MCI and Verizon rather than a transaction between MCI and Qwest. While it is clearly impossible to know for sure, the sequence of events reveals a great deal about Verizon's possible bidding strategy. Any bidding strategy must begin with a series of management assumptions about how to approach the target firm. It was certainly in Verizon's best interests to attempt a friendly rather than a hostile takeover of MCI, due to the challenges of integrating these two complex businesses. Verizon also employed an increasingly popular technique in which the merger agreement includes a special dividend payable by the target firm to its shareholders contingent upon their approval of the transaction. This special dividend is an inducement to gain shareholder approval. Given the modest 3 percent premium over the first Qwest bid, Verizon's initial bidding strategy appears to have been based on the low end of the purchase price range it was willing to offer MCI. Verizon was initially prepared to share relatively little of the potential synergy with MCI shareholders, believing that a bidding war for MCI would be unlikely in view of the recent spate of mergers in the telecommunications industry and the weak financial position of other competitors. SBC and Nextel were busy integrating AT&T and Sprint, respectively. Moreover, Qwest appeared to be unable to finance a substantial all-cash offer due to its current excessive debt burden, and its stock appeared to have little appreciation potential because of ongoing operating losses. Perhaps stunned by the persistence with which Qwest pursued MCI, Verizon believed that its combination of cash and stock would ultimately be more attractive to MCI investors than Qwest's primarily all-cash offer, due to the partial tax-free nature of the bid. Throughout the bidding process, many hedge funds criticized MCI's board publicly for accepting the initial Verizon bid. Since its emergence from Chapter 11, hedge funds had acquired significant positions in MCI's stock, with the expectation that MCI constituted an attractive merger candidate. In particular, Carlos Slim Helu, the Mexican telecommunications magnate and largest MCI shareholder, complained publicly about the failure of MCI's board to get full value for the firm's shares. Pressure from hedge funds and other dissident MCI shareholders triggered a shareholder lawsuit to void the February 14, 2005, signed merger agreement with Verizon. In preparation for a possible proxy fight, Verizon entered into negotiations with Carlos Slim Helu to acquire his shares. Verizon acquired Mr. Slim's 13.7 percent stake in MCI in April 2005. Despite this purchase, Verizon's total stake in MCI remained below the 15 percent ownership level that would trigger the MCI rights plan. About 70 percent (i.e., $1.4 billion) of the cash portion of Verizon's proposed purchase price consisted of a special MCI dividend payable by MCI when the firm's shareholders approved the merger agreement. Verizon's management argued that the deal would cost their shareholders only $7.05 billion (i.e., the $8.45 billion purchase price consisting of cash and stock, less the MCI special dividend). The $1.4 billion special dividend reduced MCI's cash in excess of what was required to meet its normal operating cash requirements. Qwest consistently attempted to outmaneuver Verizon by establishing a significant premium between its bid and Verizon's, often as much as 25 percent. Qwest realized that its current level of indebtedness would preclude it from significantly increasing the cash portion of the bid. Consequently, it had to rely on the premium to attract enough investor interest, particularly among hedge funds, to pressure the MCI board to accept the higher bid. However, Qwest was unable to convince enough investors that its stock would not simply lose value once more shares were issued to consummate the stock and cash transaction. Qwest could have initiated a tender or exchange offer directly to MCI shareholders, proposing to purchase or exchange their shares without going through the merger process. The tender process requires lengthy regulatory approval. However, if Qwest initiated a tender offer, it could trigger MCI's poison pill. Alternatively, a proxy contest might have been preferable because Qwest already had a bid on the table, and the contest would enable Qwest to lobby MCI shareholders to vote against the Verizon bid. This strategy would have avoided triggering the poison pill. Ultimately, Qwest was forced to capitulate simply because it did not have the financial wherewithal to increase the $9.9 billion bid. It could not borrow anymore because of its excessive leverage. Additional stock would have contributed to earnings dilution and caused the firm's share price to fall. It is unusual for a board to turn down a higher bid, especially when the competing bid was 17 percent higher. In accepting the Verizon bid, MCI stated that a number of its large business customers had expressed a preference for the company to be bought by Verizon rather than Qwest. MCI noted that these customer concerns posed a significant risk in being acquired by Qwest. The MCI board's acceptance of the lower Verizon bid could serve as a test case of how well MCI directors are conducting their fiduciary responsibilities. The central issue is how far boards can go in rejecting a higher offer in favor of one they believe offers more long-term stability for the firm's stakeholders. Ron Perlman, the 1980s takeover mogul, saw his higher all-cash bid rejected by the board of directors of Revlon Corporation, which accepted a lower offer from another bidder. In a subsequent lawsuit, a court overruled the decision by the Revlon board in favor of the Perlman bid. Consequently, from a governance perspective, legal precedent compels boards to accept higher bids from bona fide bidders where the value of the bid is unambiguous, as in the case of an all-cash offer. However, for transactions in which the purchase price is composed largely of acquirer stock, the value is less certain. Consequently, the target's board may rule that the lower bidder's shares have higher appreciation potential or at least are less likely to decline than those shares of other bidders. MCI's president and CEO Michael Capellas and other executives could collect $107 million in severance, payouts of restricted stock, and monies to compensate them for taxes owed on the payouts. In particular, Capellas stood to receive $39.2 million if his job is terminated "without cause" or if he leaves the company “for good reason." -Do you believe that the potential severance payments that could be paid to Capellas were excessive? Explain your answer. What are the arguments for and against such severance plans for senior executives?

Which of the following is true about so-called shark repellants?

Teva Acquires Cephalon in a Hostile Takeover Friendly approaches are most commonly employed in corporate takeovers. Hostile takeovers may be employed by the bidder to break an impasse. Unplanned events often are a deciding factor in the timing of takeovers and the magnitude of the winning bid. ______________________________________________________________________________ Discussions about a possible merger between Israel’s mega generic-drug maker Teva Pharmaceutical Industries Ltd. (Teva) and a specialty drug firm, Cephalon Inc. (Cephalon), had been under way for more than a year. However, they took on a sense of heightened urgency following an unexpected public announcement on March 29, 2011, of an unsolicited tender offer for U.S.-based Cephalon by Canada’s Valeant Pharmaceuticals International Ltd. (Valeant). The Valeant offer was valued at $5.7 billion, or $73 per Cephalon share. Cephalon had already rebuffed several friendly merger proposals made privately from Valeant earlier in 2011. Valeant, known for employing aggressive takeover tactics, decided to break the impasse in its discussions with Cephalon’s board and management by taking its offer public. Valeant argued publicly that their offer was fair and that the loss of patent protection for Cephalon’s top-selling sleep-disorder drug, Provigil, in 2012 and the tepid adoption of a new version of the drug called Nuvigil would make it difficult for Cephalon to prosper on its own. Cephalon responded that the Valeant offer had undervalued the company. Valeant coupled its hostile offer with the mailing of a proposal to Cephalon shareholders to replace Cephalon’s board with its own chosen directors and to have the new board rescind Cephalon’s shareholder rights plan. Shareholders only had to sign and return a response card to Valeant giving the firm the right to vote their shares in support of the proposal to change the composition of the Cephalon board. Cephalon distributed their own candidates for the Cephalon board to the shareholders. Valeant had a reputation for aggressive cost cutting and improving earnings performance by paring back its own internal R&D activities and acquiring new drugs through the acquisition of other pharmaceutical companies. This was in marked contrast to the more traditional approach taken by many pharmaceutical companies, which involved heavy reinvestment in internal research and development to develop new drugs. Valeant’s approach has been to cut R&D costs ruthlessly, seek undervalued targets, set aggressive timeframes for integrating acquisitions, and to use cash rather than equity. This set Valeant apart from many other pharmaceutical firms, which have commonly used equity to make acquisitions, despite the research showing that equity-financed deals tend to underperform those in which the purchase price was mainly cash. Given its reputation, attempts to get an agreement between Valeant and Cephalon were in trouble from the outset. Valeant was not interested in Cephalon’s oncology products and even proposed buying only the firm’s non–oncology drugs. Cephalon’s board and management showed little interest in dismembering the firm and proceeded to acquire U.S.-based Gemin X Pharmaceuticals Inc. for $225 million on March 21, 2011, and to buy up the outstanding shares of ChemGenex Pharmaceuticals Ltd of Australia for $175 million. The use of cash for these purposes substantially reduced the firm’s cash balances. Teva had significantly greater appeal to the Cephalon board, since it had expressed interest in the entire company. Teva also was willing to pay a substantially higher purchase price because of the greater perceived synergy between the two companies. To understand the source of this synergy it is important to recognize that Teva has historically been viewed by investors as primarily a manufacturer of low-margin pharmaceuticals. Profit margins on such drugs tend to be substantially less than those of branded drugs and were likely to continue to decline due to increased competition and government and insurance company pressure to reduce selling prices. Teva did have its own blockbuster branded drug, Copaxone, which accounted for 21% of the firm’s $16.1 billion in 2010. However, the drug was going to lose patent protection in 2014. Teva needed to achieve a better balance between branded and generic products. Acquiring Cephalon, with its strong drug pipeline and fast-growing cancer drug Treanda and pain medicine Fentora, offered the potential for offsetting any loss of Copaxone revenue and of expanding Teva’s offering of high-margin branded drugs. These drugs would complement Teva’s own portfolio of drugs, serving therapeutic areas ranging from central nervous system disorders to oncology to pain management, that generated $2.8 billion in 2010. With Cephalon, branded drugs would account for 36% of the combined firms’ revenue. Together, the combined firms would have 30 pharmaceuticals at least at the mid-development stage. Teva believed the deal would be accretive immediately, with $500 million in annual cost savings and synergies realized within three years. Although the deal did offer cost-cutting opportunities, the ability to broaden the firm’s product offering was a far greater attraction. With this in mind, Teva lost little time in exploiting Cephalon’s efforts to ward off Valeant’s March 29 unwanted takeover bid by moving aggressively to trump Valeant’s offer. Teva’s all-cash bid of $81.50 per share represented an approximate 12% premium to Valeant’s $73 per share offer and a 39% premium to Cephalon’s share price the day after Valeant’s announced its bid. The deal, including the conversion of its convertible debentures and stock options, is worth $6.8 billion to Cephalon’s shareholders. The purchase agreement included a breakup fee of $275 million, about 4% of the purchase price. Having publicly stated that they thought their offer fully valued the business, Valeant withdrew its offer after the joint Cephalon–Teva announcement on May 2, 2011. Valeant could not continue to pursue Cephalon unless it was willing to run the risk of being publicly perceived as overpaying for the target. Investors reacted favorably, with Cephalon’s stock and Teva’s rising 4.2% and 3.5%, respectively, on the announcement. Expressing their disappointment, investors drove Valeant’s share price down by 6.5%. Valeant would still profit from the 1 million Cephalon shares it had acquired prior to Teva’s and Cephalon’s public announcement of their agreement. These shares had been acquired at prices below Teva’s winning bid of $81.50 per share. The acquisition of Cephalon marks the third major deal for Teva in four years as it continues to implement its business strategy of broadening its product portfolio by diversifying between generic-drug offerings and higher-margin branded offerings through acquisitions. This strategy is designed to reduce the firm’s reliance on any single drug or handful of drugs. -What does the reaction of investors tell you about how they valued the combination of either Valeant or Teva with Cephalon? Be specific.

Verizon Acquires MCI—The Anatomy of Alternative Bidding Strategies While many parties were interested in acquiring MCI, the major players included Verizon and Qwest. U.S.-based Qwest is an integrated communications company that provides data, multimedia, and Internet-based communication services on a national and global basis. The acquisition would ease the firm's huge debt burden of $17.3 billion because the debt would be supported by the combined company with a much larger revenue base and give it access to new business customers and opportunities to cut costs. Verizon Communications, created through the merger of Bell Atlantic and GTE in 2000, is the largest telecommunications provider in the United States. The company provides local exchange, long distance, Internet, and other services to residential, business, and government customers. In addition, the company provides wireless services to over 42 million customers in the United States through its 55 percent–owned joint venture with Vodafone Group PLC. Verizon stated that the merger would enable it to more efficiently provide a broader range of services, give the firm access to MCI's business customer base, accelerate new product development using MCI's fiber-optic network infrastructure, and create substantial cost savings. By mid-2004, MCI had received several expressions of interest from Verizon and Qwest regarding potential strategic relationships. By July, Qwest and MCI entered into a confidentiality agreement and proceeded to perform more detailed due diligence. Ivan Seidenberg, Verizon's chairman and CEO, inquired about a potential takeover and was rebuffed by MCI's board, which was evaluating its strategic options. These included Qwest's proposal regarding a share-for-share merger, following a one-time cash dividend to MCI shareholders from MCI's cash in excess of its required operating balances. In view of Verizon's interest, MCI's board of directors directed management to advise Richard Notebaert, the chairman and CEO of Qwest, that MCI was not prepared to move forward with a potential transaction. The stage was set for what would become Qwest's laboriously long and ultimately unsuccessful pursuit of MCI, in which the firm would improve its original offer four times, only to be rejected by MCI in each instance even though the Qwest bids exceeded Verizon’s. After assessing its strategic alternatives, including the option to remain a stand-alone company, MCI's board of directors concluded that the merger with Verizon was in the best interests of the MCI stockholders. MCI's board of directors noted that Verizon's bid of $26 in cash and stock for each MCI share represented a 41.5 percent premium over the closing price of MCI's common stock on January 26, 2005. Furthermore, the stock portion of the offer included "price protection" in the form of a collar (i.e., the portion of the purchase price consisting of stock would be fixed within a narrow range if Verizon’s share price changed between the signing and closing of the transaction). The merger agreement also provided for the MCI board to declare a special dividend of $5.60 once the firm's shareholders approved the deal. MCI's board of directors also considered the additional value that its stockholders would realize, since the merger would be a tax-free reorganization in which MCI shareholders would be able to defer the payment of taxes until they sold their stock. Only the cash portion of the purchase price would be taxable immediately. MCI's board of directors also noted that a large number of MCI's most important business customers had indicated that they preferred a transaction between MCI and Verizon rather than a transaction between MCI and Qwest. While it is clearly impossible to know for sure, the sequence of events reveals a great deal about Verizon's possible bidding strategy. Any bidding strategy must begin with a series of management assumptions about how to approach the target firm. It was certainly in Verizon's best interests to attempt a friendly rather than a hostile takeover of MCI, due to the challenges of integrating these two complex businesses. Verizon also employed an increasingly popular technique in which the merger agreement includes a special dividend payable by the target firm to its shareholders contingent upon their approval of the transaction. This special dividend is an inducement to gain shareholder approval. Given the modest 3 percent premium over the first Qwest bid, Verizon's initial bidding strategy appears to have been based on the low end of the purchase price range it was willing to offer MCI. Verizon was initially prepared to share relatively little of the potential synergy with MCI shareholders, believing that a bidding war for MCI would be unlikely in view of the recent spate of mergers in the telecommunications industry and the weak financial position of other competitors. SBC and Nextel were busy integrating AT&T and Sprint, respectively. Moreover, Qwest appeared to be unable to finance a substantial all-cash offer due to its current excessive debt burden, and its stock appeared to have little appreciation potential because of ongoing operating losses. Perhaps stunned by the persistence with which Qwest pursued MCI, Verizon believed that its combination of cash and stock would ultimately be more attractive to MCI investors than Qwest's primarily all-cash offer, due to the partial tax-free nature of the bid. Throughout the bidding process, many hedge funds criticized MCI's board publicly for accepting the initial Verizon bid. Since its emergence from Chapter 11, hedge funds had acquired significant positions in MCI's stock, with the expectation that MCI constituted an attractive merger candidate. In particular, Carlos Slim Helu, the Mexican telecommunications magnate and largest MCI shareholder, complained publicly about the failure of MCI's board to get full value for the firm's shares. Pressure from hedge funds and other dissident MCI shareholders triggered a shareholder lawsuit to void the February 14, 2005, signed merger agreement with Verizon. In preparation for a possible proxy fight, Verizon entered into negotiations with Carlos Slim Helu to acquire his shares. Verizon acquired Mr. Slim's 13.7 percent stake in MCI in April 2005. Despite this purchase, Verizon's total stake in MCI remained below the 15 percent ownership level that would trigger the MCI rights plan. About 70 percent (i.e., $1.4 billion) of the cash portion of Verizon's proposed purchase price consisted of a special MCI dividend payable by MCI when the firm's shareholders approved the merger agreement. Verizon's management argued that the deal would cost their shareholders only $7.05 billion (i.e., the $8.45 billion purchase price consisting of cash and stock, less the MCI special dividend). The $1.4 billion special dividend reduced MCI's cash in excess of what was required to meet its normal operating cash requirements. Qwest consistently attempted to outmaneuver Verizon by establishing a significant premium between its bid and Verizon's, often as much as 25 percent. Qwest realized that its current level of indebtedness would preclude it from significantly increasing the cash portion of the bid. Consequently, it had to rely on the premium to attract enough investor interest, particularly among hedge funds, to pressure the MCI board to accept the higher bid. However, Qwest was unable to convince enough investors that its stock would not simply lose value once more shares were issued to consummate the stock and cash transaction. Qwest could have initiated a tender or exchange offer directly to MCI shareholders, proposing to purchase or exchange their shares without going through the merger process. The tender process requires lengthy regulatory approval. However, if Qwest initiated a tender offer, it could trigger MCI's poison pill. Alternatively, a proxy contest might have been preferable because Qwest already had a bid on the table, and the contest would enable Qwest to lobby MCI shareholders to vote against the Verizon bid. This strategy would have avoided triggering the poison pill. Ultimately, Qwest was forced to capitulate simply because it did not have the financial wherewithal to increase the $9.9 billion bid. It could not borrow anymore because of its excessive leverage. Additional stock would have contributed to earnings dilution and caused the firm's share price to fall. It is unusual for a board to turn down a higher bid, especially when the competing bid was 17 percent higher. In accepting the Verizon bid, MCI stated that a number of its large business customers had expressed a preference for the company to be bought by Verizon rather than Qwest. MCI noted that these customer concerns posed a significant risk in being acquired by Qwest. The MCI board's acceptance of the lower Verizon bid could serve as a test case of how well MCI directors are conducting their fiduciary responsibilities. The central issue is how far boards can go in rejecting a higher offer in favor of one they believe offers more long-term stability for the firm's stakeholders. Ron Perlman, the 1980s takeover mogul, saw his higher all-cash bid rejected by the board of directors of Revlon Corporation, which accepted a lower offer from another bidder. In a subsequent lawsuit, a court overruled the decision by the Revlon board in favor of the Perlman bid. Consequently, from a governance perspective, legal precedent compels boards to accept higher bids from bona fide bidders where the value of the bid is unambiguous, as in the case of an all-cash offer. However, for transactions in which the purchase price is composed largely of acquirer stock, the value is less certain. Consequently, the target's board may rule that the lower bidder's shares have higher appreciation potential or at least are less likely to decline than those shares of other bidders. MCI's president and CEO Michael Capellas and other executives could collect $107 million in severance, payouts of restricted stock, and monies to compensate them for taxes owed on the payouts. In particular, Capellas stood to receive $39.2 million if his job is terminated "without cause" or if he leaves the company “for good reason." -What alternative strategies could Verizon, Qwest, and MCI have pursued? Was the decision to acquire MCI the best alternative for Verizon? Explain your answer.

A no-shop agreement prohibits the takeover target from seeking other bids.

Alcoa Easily Overwhelms Reynolds’ Takeover Defenses Alcoa reacted quickly to a three-way intercontinental combination of aluminum companies aimed at challenging its dominance of the Western World aluminum market by disclosing an unsolicited takeover bid for Reynolds Metals in early August 1999. The offer consisted of $4.3 billion, or $66.44 a share, plus the assumption of $1.5 billion in Reynolds’ outstanding debt. Reynolds, a perennial marginally profitable competitor in the aluminum industry, appeared to be particularly vulnerable, since other logical suitors or potential white knights such as Canada’s Alcan Aluminum, France’s Pechiney SA, and Switzerland’s Alusuisse Lonza Group AG were already involved in a three-way merger. Alcoa’s letter from its chief executive indicated that it wanted to pursue a friendly deal but suggested that it may pursue a full-blown hostile bid if the two sides could not begin discussions within a week. Reynolds appeared to be highly vulnerable because of its poor financial performance amid falling aluminum prices worldwide and because of its weak takeover defenses. It appeared that a hostile bidder could initiate a mail-in solicitation for shareholder consent at any time. Moreover, major Reynolds’ shareholders began to pressure the board. Its largest single shareholder, Highfields Capital Management, a holder of more than four million shares, demanded that the Board create a special committee of independent directors with its own counsel and instruct Merrill Lynch to open an auction for Reynolds. Despite pressure, the Reynolds’ board rejected Alcoa’s bid as inadequate. Alcoa’s response was to say that it would initiate an all cash tender offer for all of Reynolds’ stock and simultaneously solicit shareholder support through a proxy contest for replacing the Reynolds’ board and dismantling Reynolds’ takeover defenses. Notwithstanding the public posturing by both sides, Reynolds capitulated on August 19, slightly more than two weeks from receipt of the initial solicitation, and agreed to be acquired by Alcoa. The agreement contained a thirty-day window during which Reynolds could entertain other bids. However, if Reynolds should choose to go with another offer, it would have to pay Alcoa a $100 million break-up fee. Under the agreement, which was approved by both boards, each share of Reynolds was exchanged for 1.06 shares of Alcoa stock. When announced, the transaction was worth $4.46 billion and valued each Reynolds share at $70.88, based on an Alcoa closing price of $66.875 on August 19, 1999. The $70.88 price per share of Reynolds suggested a puny 3.9 percent premium to Reynolds’ closing price of $68.25 as of the close of August 19. The combined annual revenues of the two companies totaled $20.5 billion and accounted for about 21.5 percent of the Western World market for aluminum. To receive antitrust approval, the combined companies were required divest selected operations. -Describe the various takeover tactics Alcoa employed in its successful takeover of Reynolds. Why were these tactics employed?

Linkedin IPO Raises Governance Issues Various antitakeover defenses raise shareholder rights issues. Critics argue such measures entrench existing management. Firms employing such measures argue that they allow the founder to retain control, attract and retain key managers, and enable the firm to continue its business strategy. ______________________________________________________________________________ Investors often overlook governance structures when the prospect of future profits is high. This may have been the case when Internet social media company LinkedIn completed on May 9, 2011, the largest IPO since Google’s in 2004. With 2010 revenues of $243 million and net income of $15 million, the eight-year-old firm was valued at $8.9 billion, nearly 600 times earnings. Investors in the IPO received Class A shares, which have only one vote, while LinkedIn’s pre-IPO shareholders hold Class B shares, entitled to 10 votes each. The dual share structure guarantees that cofounder and CEO, Reid Hoffman, will own about 20% of LinkedIn and, in concert with three venture capital firms, will have a controlling interest. In contrast, public shareholders will have less than 1% of the voting power of the firm. Different classes of voting stock allow the founder’s family to preserve and protect their desired corporate culture, to preserve continuity of policies and practices, to attract and retain key managers, and to enable the current board and management to look beyond quarterly earnings pressures. The dual structure also allows founders to cash out without losing control of the companies they started. LinkedIn also adopted a staggered board, which effectively requires at least two years before a majority of the firm’s current board can be replaced. To make it more difficult to eliminate the staggered board defense, LinkedIn shareholders must vote to change the firm’s certificate of incorporation after the board recommends such a vote. Once the recommendation is made, all LinkedIn shares (Class A and Class B) have only one vote. However, the removal of the staggered board is still unlikely, because the firm’s certificate of incorporation requires that more than 80% of all shareholders approve changes in the staggered board structure. The firm also added bylaw notice provisions—to discourage shareholder activists—more onerous than would be required in SEC filings, when a shareholder has more than 5% ownership interest in a public firm. If it is later determined that the shareholder has misstated the facts in any manner, LinkedIn’s bylaws allow the board to disqualify the proposal or nomination. Finally, according to LinkedIn’s charter, any shareholder lawsuits must be litigated in the state of Delaware, where the laws are particularly favorable to corporations. These measures raise questions about the rights of pre-IPO investors versus those of public shareholders. Do they allow the firm to retain the best managers and to implement fully its business strategy? Do they embolden management to negotiate the best deal for all shareholders in the event of a takeover attempt? Or do they entrench current management intent on maintaining their power and compensation at the expense of other shareholders? Discussion Questions: Mittal Acquires Arcelor—A Battle of Global Titans in the European Corporate Takeover Market Ending five months of maneuvering, Arcelor agreed on June 26, 2006, to be acquired by larger rival Mittal Steel Co. for $33.8 billion in cash and stock. The takeover battle was one of the most acrimonious in recent European Union history. Hostile takeovers are now increasingly common in Europe. The battle is widely viewed as a test case as to how far a firm can go in attempting to prevent an unwanted takeover. Arcelor was created in 2001 by melding steel companies in Spain, France, and Luxembourg. Most of its 90 plants are in Europe. In contrast, most of Mittal's plants are outside of Europe in areas with lower labor costs. Lakshmi Mittal, Mittal's CEO and a member of an important industrial family in India, started the firm and built it into a powerhouse through two decades of acquisitions in emerging nations. The company is headquartered in the Netherlands for tax reasons. Prior to the Arcelor acquisition, Mr. Mittal owned 88 percent of the firm's stock. Mittal acquired Arcelor to accelerate steel industry consolidation to reduce industry overcapacity. The combined firms could have more leverage in setting prices and negotiating contracts with major customers such as auto and appliance manufacturers and suppliers such as iron ore and coal vendors, and eventually realize $1 billion annually in pretax cost savings. After having been rebuffed by Guy Dolle, Arcelor's president, in an effort to consummate a friendly merger, Mittal launched a tender offer in January 2006 consisting of mostly stock and cash for all of Arcelor's outstanding equity. The offer constituted a 27 percent premium over Arcelor's share price at that time. The reaction from Arcelor's management, European unions, and government officials was swift and furious. Guy Dolle stated flatly that the offer was "inadequate and strategically unsound." European politicians supported Mr. Dolle. Luxembourg's prime minister, Jean Claude Juncker, said a hostile bid "calls for a hostile response." Trade unions expressed concerns about potential job loss. Dolle engaged in one of the most aggressive takeover defenses in recent corporate history. In early February, Arcelor doubled its dividend and announced plans to buy back about $8.75 billion in stock at a price well above the then current market price for Arcelor stock. These actions were taken to motivate Arcelor shareholders not to tender their shares to Mittal. Arcelor also backed a move to change the law so that Mittal would be required to pay in cash. However, the Luxembourg parliament rejected that effort. To counter these moves, Mittal Steel said in mid-February that if it received more than one-half of the Arcelor shares submitted in the initial tender offer, it would hold a second tender offer for the remaining shares at a slightly lower price. Mittal pointed out that it could acquire the remaining shares through a merger or corporate reorganization. Such rhetoric was designed to encourage Arcelor shareholders to tender their shares during the first offer. In late 2005, Arcelor outbid German steelmaker Metallgeschaft to buy Canadian steelmaker Dofasco for $5 billion. Mittal was proposing to sell Dofasco to raise money and avoid North American antitrust concerns. Following completion of the Dofasco deal in April 2006, Arcelor set up a special Dutch trust to prevent Mittal from getting access to the asset. The trust is run by a board of three Arcelor appointees. The trio has the power to determine if Dofasco can be sold during the next five years. Mittal immediately sued to test the legality of this tactic. In a deal with Russian steel maker OAO Severstahl, Arcelor agreed to exchange its shares for Alexei Mordashov's 90 percent stake in Severstahl. The transaction would give Mr. Mordashov a 32 percent stake in Arcelor. Arcelor also scheduled an unusual vote that created very tough conditions for Arcelor shareholders to prevent the deal with Severstahl from being completed. Arcelor's board stated that the Severstahl deal could be blocked only if at least 50 percent of all Arcelor shareholders would vote against it. However, Arcelor knew that only about one-third of shareholders actually attend meetings. This is a tactic permissible under Luxembourg law, where Arcelor is incorporated. Investors holding more than 30 percent of Arcelor shares signed a petition to force the company to make the deal with Severstahl subject to a traditional 50.1 percent or more of actual votes cast. After major shareholders pressured the Arcelor board to at least talk to Mr. Mittal, Arcelor demanded an intricate business plan from Mittal as a condition that had to be met. Despite Mittal's submission of such a plan, Arcelor still refused to talk. In late May, Mittal raised its bid by 34 percent and said that if the bid succeeded, Mittal would eliminate his firm's two-tiered share structure, giving the Mittal family shares ten times the voting rights of other shareholders. A week after receiving the shareholder petition, the Arcelor board rejected Mittal's sweetened bid and repeated its support of the Severstahl deal. Shareholder anger continued, and many investors said they would reject the share buyback. Some investors opposed the buyback because it would increase Mr. Mordashov's ultimate stake in Arcelor to 38 percent by reducing the number of Arcelor shares outstanding. Under the laws of most European countries, any entity owning more than a third of a company is said to have effective control. Arcelor cancelled a scheduled June 21 shareholder vote on the buyback. Despite Mr. Mordashov's efforts to enhance his bid, the Arcelor board asked both Mordashov and Mittal to submit their final bids by June 25. Arcelor finally agreed to Mittal's final bid, which had been increased by 14 percent. The new offer consisted of $15.70 in cash and 1.0833 Mittal shares for each Arcelor share. The new bid is valued at $50.54 per Arcelor share, up from Mittal's initial bid in January 2006 of $35.26. The final offer represented an unprecedented 93 percent premium over Arcelor's share price of $26.25 immediately before Mittal's initial bid. Lakshmi Mittal will control 43.5 percent of the combined firm's stock. Mr. Mordashov would receive a $175 million breakup fee due to Arcelor's failure to complete its agreement with him. Finally, Mittal agreed not to make any layoffs beyond what Arcelor already has planned. -Identify the takeover defenses employed by Arcelor? Explain why each was used.

The threat of hostile takeovers is a factor in encouraging a firm to implement good governance practices.