Exam 3: The Corporate Takeover Market:

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. -Why did the Cadbury common share price close up 38% on the announcement date, 7% more than the premium built into the offer price?

Which of the following factors influences corporate governance practices?

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 other defenses do you think Warner could or should have employed? Comment on the effectiveness of each alternative defense you suggest Warner could have employed?

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." -How did the actions of certain shareholders affect the bidding process? Be specific.

In your opinion, did the Dell Inc. board of directors act in the best interests of the Dell shareholders? Cite examples to support your position.

Tender offers always consist of an offer to exchange acquirer shares for shares in the target firm.

Which of the following are common takeover tactics?

The final outcome of a hostile takeover is rarely affected by the composition of the target's stock ownership and how stockholders feel about management's performance.

A proxy contest is one in which a group of dissident shareholders attempts to obtain representation on a firm's board by soliciting other shareholders for the right to vote their shares.

Oracle Attempts to Takeover PeopleSoft PeopleSoft, a maker of human resource and database software, announced on February 9, 2004 that an increased bid by Oracle, a maker of database software, of $26 per share made directly to the shareholders was inadequate. PeopleSoft’s board and management rejected the bid even though it represented a 33% increase over Oracle’s previous offer of $19.50 per share. The PeopleSoft board urged its shareholders to reject the bid in a mailing of its own to its shareholders. If successful, the takeover would be valued at $9.4 billion. After an initial jump to $23.72 a share, PeopleSoft shares had eased to $22.70 a share, well below Oracle’s sweetened offer. The rejection prolonged a highly contentious and public eight-month takeover battle that has pitted the two firms against each other. PeopleSoft was quick to rebuke publicly Oracle’s original written offer made behind the scenes to PeopleSoft’s management that included a requirement that PeopleSoft respond immediately. At about the same time, Oracle filed its intentions with respect to PeopleSoft with the SEC when its ownership of PeopleSoft stock rose above 5%. Since then, Oracle proposed replacing five of PeopleSoft’s board members with its own nominees at the PeopleSoft annual meeting to be held on March 25, 2004, in addition to increasing the offer price. This meeting was held about two months earlier than its normally scheduled annual meetings. By moving up the schedule for the meeting, investors had less time to buy PeopleSoft shares in order to be able to vote at the meeting, where the two companies will present rival slates for the PeopleSoft board. Oracle seeks to gain a majority on the PeopleSoft board in order to lift the company’s unique “customer assurance” anti-takeover defense. PeopleSoft advised its shareholders to vote no on the slate of potential board members proposed by Oracle. PeopleSoft also announced that it would buyback another $200 million of its shares, following the $350 million buyback program completed last year. Oracle has said that it will take $9.8 billion (including transaction fees) to complete the deal. The cost of acquiring PeopleSoft could escalate under PeopleSoft’s unusual customer assurance program in which its customers have been offered money-back guarantees if an acquirer reduces its support of PeopleSoft products. Oracle repeated its intention to continue support for PeopleSoft customers and products. The potential liability under the program increased to $1.55 billion. In addition, Oracle will have to pay PeopleSoft’s CEO Craig Conway a substantial multiple of his current annual salary if he loses his job after a takeover. This could cost Oracle an additional $25 to $30 million. Meanwhile, the Federal Trade Commission is reviewing the proposed acquisition of PeopleSoft by Oracle and has expressed concern that it will leave to reduced competition in the software industry -Identify at least one takeover tactic being employed by Oracle in its attempt to acquire PeopleSoft. Explain how this takeover tactic(s) works.

TYCO Rescues AMP from Allied Signal In late November 1998, Tyco International Ltd., a diversified manufacturing and service company, agreed to acquire AMP Inc., an electrical components supplier, for $11.3 billion. In doing so, AMP successfully fended off a protracted takeover attempt by AlliedSignal Inc. As part of the merger agreement with Tyco, AMP rescinded its $165 million share buyback offer and its plan to issue an additional 25 million shares to fund its defense efforts. Tyco, the world’s largest electronics connector company, saw the combination with AMP as a means of becoming the lowest cost producer in the industry. Lawrence Bossidy, CEO of AlliedSignal, telephoned an AMP director in mid-1998 to inquire about AMP’s interest in a possible combination of their two companies. The inquiry was referred to the finance committee of the AMP board, which expressed no interest in merging with AlliedSignal. By early August, AlliedSignal announced its intention to initiate an unsolicited tender offer to acquire all of the outstanding shares of AMP common stock for $44.50 per share to be paid in cash. The following week AlliedSignal initiated such an offer and sent a letter to William J. Hudson, then CEO of AMP, requesting a meeting to discuss a possible business combination. Bossidy also advised AMP of AlliedSignal’s intention to file materials shortly with the SEC as required by federal law to solicit consents from AMP’s shareholders. The consent solicitation materials included proposals to increase the size of AMP’s board from 11 to 28 members and to add 17 AlliedSignal nominees, all of whom were directors or executive officers of AlliedSignal. Within a few days, the AMP board announced its intentions to continue to aggressively pursue its current strategic initiatives, because the AlliedSignal offer did not fully reflect the values inherent in AMP businesses. In addition, the AMP board also replaced Hudson with Robert Ripp as chair and CEO of AMP. The AMP board also authorized an amendment to the AMP rights agreement dated October 25, 1989. The amendment provided that the rights could not be redeemed if there were a change in the composition of the AMP board following the announcement of an unsolicited acquisition proposal such that the current directors no longer comprised a majority of the board. A transaction not approved by AMP’s board and involving the acquisition by a person or entity of 20% or more of AMP’s common stock was defined as an unsolicited acquisition proposal. By early September, AlliedSignal amended its tender offer to reduce the number of shares of AMP common stock it was seeking to purchase to 40 million shares. AlliedSignal also stated that it would undertake another offer to acquire the remaining shares of AMP common stock at a price of $44.50 in cash following consummation of its offer to purchase up to 40 million shares. In concert with its tender offer, AlliedSignal also announced its intention to solicit consents for a proposal to amend AMP’s bylaws. The proposed amendment would strip the AMP board of all authority over the AMP rights agreement and any similar agreements and to vest such authority in three individuals selected by AlliedSignal. In response, the AMP board unanimously determined that the amended offer from AlliedSignal was not in the best interests of AMP shareholders. The AMP board also approved another amendment to the AMP rights agreement, lowering the threshold that would make the rights redeemable from 20% to 10% of AMP’s shares outstanding. AlliedSignal immediately modified its tender offer by reducing the number of shares it wanted to purchase from 40 million to 20 million shares at $44.50 per share. AMP announced a self-tender offer to purchase up to 30 million shares of AMP common stock at $55 per share. The AMP self-tender offer was intended to provide AMP shareholders with an opportunity to sell a portion of their shares of common stock at a price in excess of AlliedSignal’s $44.50 per share offer. Also, on September 28, 1998, AMP stated its intention to create a new ESOP that would hold 25 million shares of AMP common stock. Allied Signal indicated that if the self-tender were consummated, it would reduce the consideration to be paid in any further Allied Signal offers to $42.62 per share . Credit Suisse, AMP’s investment banker, approached a number of firms, including Tyco, concerning their possible interest in acquiring AMP. In early November, Tyco stepped forward as a possible white knight. Based on limited information, L. Dennis Kozlowski, Tyco’s CEO, set the preliminary valuation of AMP at $50.00 per share. This value assumed a transaction in which AMP shares would be exchanged for Tyco shares and was subject to the completion of appropriate due diligence. In mid-November, Ripp and Bossidy met at Bossidy’s request. Bossidy indicated that AlliedSignal would be prepared to increase its proposed acquisition price for AMP by a modest amount and to include stock for a limited portion of the total purchase price. The revised offer also would include a minimum share exchange ratio for the equity portion of the purchase price along with an opportunity for AMP shareholders to participate in any increase in AlliedSignal’s stock before the closing. The purpose of including equity as a portion of the purchase price was to address the needs of certain AMP shareholders, who had a low tax basis in the stock and who wanted a tax-free exchange. Ripp indicated that the AMP board expected a valuation of more than $50.00 per share. Tyco indicated a willingness to increase its offer to at least $51.00 worth of Tyco common shares for each share of AMP common stock. The offer also would include protections similar to those offered in AlliedSignal’s most recent proposal. On November 20, 1998, the AMP board voted unanimously to approve the merger agreement and to recommend approval of the merger to AMP’s shareholders. They also voted to terminate the AMP self-tender offer, the ESOP, and AMP’s share repurchase plan and to amend the AMP rights agreement so that it would not apply to the merger with Tyco. In early August, AlliedSignal filed a complaint against AMP in the United States District Court against the provisions of the AMP rights agreement. The complaint also questioned the constitutionality of certain anti-takeover provisions of Pennsylvania state statutes. Concurrently, AMP shareholders filed four shareholder class-action lawsuits against AMP and its board of directors. The suits alleged that AMP and its directors improperly refused to consider the original AlliedSignal offer and wrongfully relied on the provisions of the AMP rights agreement and Pennsylvania law to block the original AlliedSignal offer. In late August, AMP filed a complaint in the United States District court against AlliedSignal, seeking an injunction to prevent AlliedSignal from attempting to pack the AMP board of directors with AlliedSignal executive officers and directors. The complaint also alleged that the Schedule 14D-1 SEC filing by Allied-Signal was false and misleading. The complaint alleged that the filing failed to disclose that some of AlliedSignal’s proposed directors had conflicts of interest and that the packing of the board would prevent current board members from executing their fiduciary responsibilities to AMP shareholders. In early October, the court agreed with AMP and enjoined AlliedSignal’s board-packing consent proposals until it stated unequivocally that its director nominees have a fiduciary duty solely to AMP under Pennsylvania law. The court also denied AlliedSignal’s request to deactivate anti-takeover provisions in the AMP rights agreement. The court further held that shareholders might not sue the board for rejecting the AlliedSignal proposal. AlliedSignal immediately filed in the United States Court of Appeals for the Third Circuit. The court ordered that although AlliedSignal could proceed with the consent solicitation, its representatives could not assume positions on the AMP board until the court of appeals completed its deliberations. The district court ruled that the shares of AMP common stock acquired by AlliedSignal are “control shares” under Pennsylvania law. As a result, the court enjoined AlliedSignal from voting its AMP shares unless AlliedSignal’s voting rights are restored under Pennsylvania law. AlliedSignal was able to overturn the lower court ruling on appeal. -What anti-takeover defenses were in place at AMP prior to AlliedSignal's offer?

TYCO Rescues AMP from Allied Signal In late November 1998, Tyco International Ltd., a diversified manufacturing and service company, agreed to acquire AMP Inc., an electrical components supplier, for $11.3 billion. In doing so, AMP successfully fended off a protracted takeover attempt by AlliedSignal Inc. As part of the merger agreement with Tyco, AMP rescinded its $165 million share buyback offer and its plan to issue an additional 25 million shares to fund its defense efforts. Tyco, the world’s largest electronics connector company, saw the combination with AMP as a means of becoming the lowest cost producer in the industry. Lawrence Bossidy, CEO of AlliedSignal, telephoned an AMP director in mid-1998 to inquire about AMP’s interest in a possible combination of their two companies. The inquiry was referred to the finance committee of the AMP board, which expressed no interest in merging with AlliedSignal. By early August, AlliedSignal announced its intention to initiate an unsolicited tender offer to acquire all of the outstanding shares of AMP common stock for $44.50 per share to be paid in cash. The following week AlliedSignal initiated such an offer and sent a letter to William J. Hudson, then CEO of AMP, requesting a meeting to discuss a possible business combination. Bossidy also advised AMP of AlliedSignal’s intention to file materials shortly with the SEC as required by federal law to solicit consents from AMP’s shareholders. The consent solicitation materials included proposals to increase the size of AMP’s board from 11 to 28 members and to add 17 AlliedSignal nominees, all of whom were directors or executive officers of AlliedSignal. Within a few days, the AMP board announced its intentions to continue to aggressively pursue its current strategic initiatives, because the AlliedSignal offer did not fully reflect the values inherent in AMP businesses. In addition, the AMP board also replaced Hudson with Robert Ripp as chair and CEO of AMP. The AMP board also authorized an amendment to the AMP rights agreement dated October 25, 1989. The amendment provided that the rights could not be redeemed if there were a change in the composition of the AMP board following the announcement of an unsolicited acquisition proposal such that the current directors no longer comprised a majority of the board. A transaction not approved by AMP’s board and involving the acquisition by a person or entity of 20% or more of AMP’s common stock was defined as an unsolicited acquisition proposal. By early September, AlliedSignal amended its tender offer to reduce the number of shares of AMP common stock it was seeking to purchase to 40 million shares. AlliedSignal also stated that it would undertake another offer to acquire the remaining shares of AMP common stock at a price of $44.50 in cash following consummation of its offer to purchase up to 40 million shares. In concert with its tender offer, AlliedSignal also announced its intention to solicit consents for a proposal to amend AMP’s bylaws. The proposed amendment would strip the AMP board of all authority over the AMP rights agreement and any similar agreements and to vest such authority in three individuals selected by AlliedSignal. In response, the AMP board unanimously determined that the amended offer from AlliedSignal was not in the best interests of AMP shareholders. The AMP board also approved another amendment to the AMP rights agreement, lowering the threshold that would make the rights redeemable from 20% to 10% of AMP’s shares outstanding. AlliedSignal immediately modified its tender offer by reducing the number of shares it wanted to purchase from 40 million to 20 million shares at $44.50 per share. AMP announced a self-tender offer to purchase up to 30 million shares of AMP common stock at $55 per share. The AMP self-tender offer was intended to provide AMP shareholders with an opportunity to sell a portion of their shares of common stock at a price in excess of AlliedSignal’s $44.50 per share offer. Also, on September 28, 1998, AMP stated its intention to create a new ESOP that would hold 25 million shares of AMP common stock. Allied Signal indicated that if the self-tender were consummated, it would reduce the consideration to be paid in any further Allied Signal offers to $42.62 per share . Credit Suisse, AMP’s investment banker, approached a number of firms, including Tyco, concerning their possible interest in acquiring AMP. In early November, Tyco stepped forward as a possible white knight. Based on limited information, L. Dennis Kozlowski, Tyco’s CEO, set the preliminary valuation of AMP at $50.00 per share. This value assumed a transaction in which AMP shares would be exchanged for Tyco shares and was subject to the completion of appropriate due diligence. In mid-November, Ripp and Bossidy met at Bossidy’s request. Bossidy indicated that AlliedSignal would be prepared to increase its proposed acquisition price for AMP by a modest amount and to include stock for a limited portion of the total purchase price. The revised offer also would include a minimum share exchange ratio for the equity portion of the purchase price along with an opportunity for AMP shareholders to participate in any increase in AlliedSignal’s stock before the closing. The purpose of including equity as a portion of the purchase price was to address the needs of certain AMP shareholders, who had a low tax basis in the stock and who wanted a tax-free exchange. Ripp indicated that the AMP board expected a valuation of more than $50.00 per share. Tyco indicated a willingness to increase its offer to at least $51.00 worth of Tyco common shares for each share of AMP common stock. The offer also would include protections similar to those offered in AlliedSignal’s most recent proposal. On November 20, 1998, the AMP board voted unanimously to approve the merger agreement and to recommend approval of the merger to AMP’s shareholders. They also voted to terminate the AMP self-tender offer, the ESOP, and AMP’s share repurchase plan and to amend the AMP rights agreement so that it would not apply to the merger with Tyco. In early August, AlliedSignal filed a complaint against AMP in the United States District Court against the provisions of the AMP rights agreement. The complaint also questioned the constitutionality of certain anti-takeover provisions of Pennsylvania state statutes. Concurrently, AMP shareholders filed four shareholder class-action lawsuits against AMP and its board of directors. The suits alleged that AMP and its directors improperly refused to consider the original AlliedSignal offer and wrongfully relied on the provisions of the AMP rights agreement and Pennsylvania law to block the original AlliedSignal offer. In late August, AMP filed a complaint in the United States District court against AlliedSignal, seeking an injunction to prevent AlliedSignal from attempting to pack the AMP board of directors with AlliedSignal executive officers and directors. The complaint also alleged that the Schedule 14D-1 SEC filing by Allied-Signal was false and misleading. The complaint alleged that the filing failed to disclose that some of AlliedSignal’s proposed directors had conflicts of interest and that the packing of the board would prevent current board members from executing their fiduciary responsibilities to AMP shareholders. In early October, the court agreed with AMP and enjoined AlliedSignal’s board-packing consent proposals until it stated unequivocally that its director nominees have a fiduciary duty solely to AMP under Pennsylvania law. The court also denied AlliedSignal’s request to deactivate anti-takeover provisions in the AMP rights agreement. The court further held that shareholders might not sue the board for rejecting the AlliedSignal proposal. AlliedSignal immediately filed in the United States Court of Appeals for the Third Circuit. The court ordered that although AlliedSignal could proceed with the consent solicitation, its representatives could not assume positions on the AMP board until the court of appeals completed its deliberations. The district court ruled that the shares of AMP common stock acquired by AlliedSignal are “control shares” under Pennsylvania law. As a result, the court enjoined AlliedSignal from voting its AMP shares unless AlliedSignal’s voting rights are restored under Pennsylvania law. AlliedSignal was able to overturn the lower court ruling on appeal. -What options did AlliedSignal have to neutralize or circumvent AMP's use of the Rights Agreement?

According to the management entrenchment hypothesis, takeover defenses are designed to protect the target firm's management from a hostile takeover.

Studies show that which of the following combinations of corporate defenses can be most effective in discouraging hostile takeovers?

Which of the following are the basic principles on which the market model is based?

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 were the motivations for Valeant and Teva to be interested in acquiring Cephalon? Be specific.

Hewlett-Packard Family Members Oppose Proposal to Acquire Compaq On September 4, 2001, Hewlett-Packard (“HP”) announced its proposal to acquire Compaq Computer Corporation for $25 billion in stock. Almost immediately, investors began to doubt the wisdom of the proposal. The new company would face the mind-numbing task of integrating overlapping product lines and 150,000 employees in 160 countries. Reflecting these concerns, the value of the proposed merger had sunk to $16.9 million within 30 days following the announcement, in line with the decline in the value of HP’s stock. In November 2001, Walter Hewlett and David Packard, sons of the co-founders, and both the Hewlett and Packard family foundations, came out against the transaction. These individuals and entities controlled about 18% of HP’s total shares outstanding. Both Carly Fiorina, HP’s CEO, and Michael Capellas, Compaq’s CEO, moved aggressively to counter this opposition by taking their case directly to the remaining HP shareholders. HP management’s efforts included a 49-page report written by HP’s advisor Goldman Sachs to rebut one presented by Walter Hewlett’s advisors. HP also began advertising in national newspapers and magazines, trying to convey the idea that this deal is not about PCs but about giving corporate customers everything from storage and services to printing and imaging. After winning a hotly contested 8-month long proxy fight by a narrow 2.8 percentage point margin, HP finally was able to purchase Compaq on May 7, 2002, for approximately $19 billion. However, the contentious proxy fight had lingering effects. The delay in integrating the two firms resulted in the defection of key employees, the loss of customers and suppliers, the expenditure of millions of dollars, and widespread angst among shareholder. -In an effort to combat the proxy contest initiated by the Hewlett and Packard families against the merger, HP's board and management took their case to the shareholders in a costly battle paid for by HP funds (i.e., HP shareholders). Do you think it is fair that HP's management can finance their own proxy contest using company funds while dissident shareholders must finance their effort using their own funds.

The size of the target firm is the best predictor of the likelihood of being taken over by another firm.

TYCO Rescues AMP from Allied Signal In late November 1998, Tyco International Ltd., a diversified manufacturing and service company, agreed to acquire AMP Inc., an electrical components supplier, for $11.3 billion. In doing so, AMP successfully fended off a protracted takeover attempt by AlliedSignal Inc. As part of the merger agreement with Tyco, AMP rescinded its $165 million share buyback offer and its plan to issue an additional 25 million shares to fund its defense efforts. Tyco, the world’s largest electronics connector company, saw the combination with AMP as a means of becoming the lowest cost producer in the industry. Lawrence Bossidy, CEO of AlliedSignal, telephoned an AMP director in mid-1998 to inquire about AMP’s interest in a possible combination of their two companies. The inquiry was referred to the finance committee of the AMP board, which expressed no interest in merging with AlliedSignal. By early August, AlliedSignal announced its intention to initiate an unsolicited tender offer to acquire all of the outstanding shares of AMP common stock for $44.50 per share to be paid in cash. The following week AlliedSignal initiated such an offer and sent a letter to William J. Hudson, then CEO of AMP, requesting a meeting to discuss a possible business combination. Bossidy also advised AMP of AlliedSignal’s intention to file materials shortly with the SEC as required by federal law to solicit consents from AMP’s shareholders. The consent solicitation materials included proposals to increase the size of AMP’s board from 11 to 28 members and to add 17 AlliedSignal nominees, all of whom were directors or executive officers of AlliedSignal. Within a few days, the AMP board announced its intentions to continue to aggressively pursue its current strategic initiatives, because the AlliedSignal offer did not fully reflect the values inherent in AMP businesses. In addition, the AMP board also replaced Hudson with Robert Ripp as chair and CEO of AMP. The AMP board also authorized an amendment to the AMP rights agreement dated October 25, 1989. The amendment provided that the rights could not be redeemed if there were a change in the composition of the AMP board following the announcement of an unsolicited acquisition proposal such that the current directors no longer comprised a majority of the board. A transaction not approved by AMP’s board and involving the acquisition by a person or entity of 20% or more of AMP’s common stock was defined as an unsolicited acquisition proposal. By early September, AlliedSignal amended its tender offer to reduce the number of shares of AMP common stock it was seeking to purchase to 40 million shares. AlliedSignal also stated that it would undertake another offer to acquire the remaining shares of AMP common stock at a price of $44.50 in cash following consummation of its offer to purchase up to 40 million shares. In concert with its tender offer, AlliedSignal also announced its intention to solicit consents for a proposal to amend AMP’s bylaws. The proposed amendment would strip the AMP board of all authority over the AMP rights agreement and any similar agreements and to vest such authority in three individuals selected by AlliedSignal. In response, the AMP board unanimously determined that the amended offer from AlliedSignal was not in the best interests of AMP shareholders. The AMP board also approved another amendment to the AMP rights agreement, lowering the threshold that would make the rights redeemable from 20% to 10% of AMP’s shares outstanding. AlliedSignal immediately modified its tender offer by reducing the number of shares it wanted to purchase from 40 million to 20 million shares at $44.50 per share. AMP announced a self-tender offer to purchase up to 30 million shares of AMP common stock at $55 per share. The AMP self-tender offer was intended to provide AMP shareholders with an opportunity to sell a portion of their shares of common stock at a price in excess of AlliedSignal’s $44.50 per share offer. Also, on September 28, 1998, AMP stated its intention to create a new ESOP that would hold 25 million shares of AMP common stock. Allied Signal indicated that if the self-tender were consummated, it would reduce the consideration to be paid in any further Allied Signal offers to $42.62 per share . Credit Suisse, AMP’s investment banker, approached a number of firms, including Tyco, concerning their possible interest in acquiring AMP. In early November, Tyco stepped forward as a possible white knight. Based on limited information, L. Dennis Kozlowski, Tyco’s CEO, set the preliminary valuation of AMP at $50.00 per share. This value assumed a transaction in which AMP shares would be exchanged for Tyco shares and was subject to the completion of appropriate due diligence. In mid-November, Ripp and Bossidy met at Bossidy’s request. Bossidy indicated that AlliedSignal would be prepared to increase its proposed acquisition price for AMP by a modest amount and to include stock for a limited portion of the total purchase price. The revised offer also would include a minimum share exchange ratio for the equity portion of the purchase price along with an opportunity for AMP shareholders to participate in any increase in AlliedSignal’s stock before the closing. The purpose of including equity as a portion of the purchase price was to address the needs of certain AMP shareholders, who had a low tax basis in the stock and who wanted a tax-free exchange. Ripp indicated that the AMP board expected a valuation of more than $50.00 per share. Tyco indicated a willingness to increase its offer to at least $51.00 worth of Tyco common shares for each share of AMP common stock. The offer also would include protections similar to those offered in AlliedSignal’s most recent proposal. On November 20, 1998, the AMP board voted unanimously to approve the merger agreement and to recommend approval of the merger to AMP’s shareholders. They also voted to terminate the AMP self-tender offer, the ESOP, and AMP’s share repurchase plan and to amend the AMP rights agreement so that it would not apply to the merger with Tyco. In early August, AlliedSignal filed a complaint against AMP in the United States District Court against the provisions of the AMP rights agreement. The complaint also questioned the constitutionality of certain anti-takeover provisions of Pennsylvania state statutes. Concurrently, AMP shareholders filed four shareholder class-action lawsuits against AMP and its board of directors. The suits alleged that AMP and its directors improperly refused to consider the original AlliedSignal offer and wrongfully relied on the provisions of the AMP rights agreement and Pennsylvania law to block the original AlliedSignal offer. In late August, AMP filed a complaint in the United States District court against AlliedSignal, seeking an injunction to prevent AlliedSignal from attempting to pack the AMP board of directors with AlliedSignal executive officers and directors. The complaint also alleged that the Schedule 14D-1 SEC filing by Allied-Signal was false and misleading. The complaint alleged that the filing failed to disclose that some of AlliedSignal’s proposed directors had conflicts of interest and that the packing of the board would prevent current board members from executing their fiduciary responsibilities to AMP shareholders. In early October, the court agreed with AMP and enjoined AlliedSignal’s board-packing consent proposals until it stated unequivocally that its director nominees have a fiduciary duty solely to AMP under Pennsylvania law. The court also denied AlliedSignal’s request to deactivate anti-takeover provisions in the AMP rights agreement. The court further held that shareholders might not sue the board for rejecting the AlliedSignal proposal. AlliedSignal immediately filed in the United States Court of Appeals for the Third Circuit. The court ordered that although AlliedSignal could proceed with the consent solicitation, its representatives could not assume positions on the AMP board until the court of appeals completed its deliberations. The district court ruled that the shares of AMP common stock acquired by AlliedSignal are “control shares” under Pennsylvania law. As a result, the court enjoined AlliedSignal from voting its AMP shares unless AlliedSignal’s voting rights are restored under Pennsylvania law. AlliedSignal was able to overturn the lower court ruling on appeal. -Why did AlliedSignal, after announcing it had purchased 20 million AMP shares at $44.50, indicate that it would reduce the price paid in any further offers it might make?

Institutional activism has assumed a larger role in ensuring good corporate governance practices in recent years.