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. -After four months of bitter and often public disagreement, Cadbury's and Kraft's management reached a final agreement in a weekend. What factors do you believe might have contributed to this rapid conclusion?

How may golden parachutes for senior management help a target firm's shareholders? Are such severance packages justified in your judgment?

Concern about their fiduciary responsibility to shareholders and shareholder lawsuits often puts pressure on a target firm's board of directors to accept an offer if it includes a significant premium to the target's current share price.

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. -Using the information in this case study, discuss the arguments for and against encouraging hostile corporate takeovers

All of the following are true of tender offers except for

Corporate governance refers to the way firms elect CEOs.

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. -Why do the shares of acquiring companies tend to perform better when cash is used to make the acquisition rather than equity?

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 defense or tactic that is in place or is being employed by PeopleSoft. Explain how this defense or tactic is intended to discourage Oracle in its takeover effort.

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." -Discuss how changing industry conditions have encouraged consolidation within the telecommunications industry?

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 -Explain why PeopleSoft's management may have rejected Oracle's improved offer of $26 per share and why this rejection might have been in the best interests of the PeopleSoft shareholders? What may have PeopleSoft's management been expecting to happen (Hint: Consider the various post-offer antitakeover defenses that could be put in place)?

In a two-tiered offer, target shareholders typically received two offers, which potentially have different values.

Golden parachutes are employee severance arrangements, which are triggered whenever a change in control takes place. They are generally held by a large number of employees at all levels of management throughout the firm.

Inbev Acquires an American Icon For many Americans, Budweiser is synonymous with American beer and American beer is synonymous with Anheuser-Busch (AB). Ownership of the American icon changed hands on July 14, 2008, when beer giant Anheuser Busch agreed to be acquired by Belgian brewer InBev for $52 billion in an all-cash deal. The combined firms would have annual revenue of about $36 billion and control about 25 percent of the global beer market and 40 percent of the U.S. market. The purchase is the most recent in a wave of consolidation in the global beer industry. The consolidation reflected an attempt to offset rising commodity costs by achieving greater scale and purchasing power. While likely to generate cost savings of about $1.5 billion annually by 2011, InBev stated publicly that the transaction is more about the two firms being complementary rather than overlapping. The announcement marked a reversal from AB's position the previous week when it said publicly that the InBev offer undervalued the firm and subsequently sued InBev for "misleading statements" it had allegedly made about the strength of its financing. To court public support, AB publicized its history as a major benefactor in its hometown area (St. Louis, Missouri). The firm also argued that its own long-term business plan would create more shareholder value than the proposed deal. AB also investigated the possibility of acquiring the half of Grupo Modelo, the Mexican brewer of Corona beer, which it did not already own to make the transaction too expensive for InBev. While it publicly professed to want a friendly transaction, InBev wasted no time in turning up the heat. The firm launched a campaign to remove Anheuser's board and replace it with its own slate of candidates, including a Busch family member. However, AB was under substantial pressure from major investors, including Warren Buffet, to agree to the deal since the firm's stock had been lackluster during the preceding several years. In an effort to gain additional shareholder support, InBev raised its initial $65 bid to $70. To eliminate concerns over its ability to finance the deal, InBev agreed to fully document its credit sources rather than rely on the more traditional but less certain credit commitment letters. In an effort to placate AB's board, management, and the myriad politicians who railed against the proposed transaction, InBev agreed to name the new firm Anheuser-Busch InBev and keep Budweiser as the new firm's flagship brand and St. Louis as its North American headquarters. In addition, AB would be given two seats on the board, including August A. Busch IV, AB's CEO and patriarch of the firm's founding family. InBev also announced that AB's 12 U.S. breweries would remain open. -InBev agreed to name the new company Anheuser-Busch InBev, keep Budwieser brand, maintain headquarters in St. Lous, and not to close any of the firm's 12 breweries in North America. How might these decisions impact InBev's ability to realize projected cost savings?

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. -Identify the takeover defenses employed by Cephalon. Explained why each was used.

Purchasing target stock in the open market is a rarely used takeover tactic.

By replacing the target's board members, proxy fights may be an effective means of gaining control without owning 51% of the target's voting stock.

The control model of corporate governance is applicable under all of the following conditions except for

Balancing Board and Shareholder Rights: Air Products Aborted Takeover of Airgas Defining the right balance of power between corporate boards and shareholders remains elusive. The Delaware court has ruled that a board can take as long as necessary to consider a bid and can prevent shareholders from voting on takeover bids. Activist investors are increasingly urging shareholders to pressure firms to drop staggered boards because of the potential to entrench management. ______________________________________________________________________________ When, if ever, is it appropriate for a board to agree to a current bid to buy the firm if it, in good faith, believes that the bid undervalues the firm based on the board’s knowledge of the long-term outlook for the firm? When, if ever, is it appropriate for a board to prevent shareholder votes on such matters? The answers to these questions are rooted in whether boards are perceived to be acting in the interests of all shareholders or simply attempting to entrench themselves and current management. How these questions are answered will determine whether the board or shareholders will have leverage in hostile takeover negotiations. What follows is a discussion of what is an important judicial precedent pertaining to board and shareholder rights. The unsolicited offer by Air Products for Airgas on February 2, 2010, has been one of the longest-running hostile bids in U.S. history. After having revised up its offer twice, Air Products sought to bring this process to a close when it asked the Delaware Chancery Court to invalidate Airgas’s poison pill. On February 15, 2011, the court ruled that the board has the right to prevent shareholders from voting on the takeover offer as long as it is acting in good faith. In the wake of the court’s ruling, Air Products withdrew its bid. The court argued that the Airgas board determined, using a good-faith effort, that the Air Products offer of $70 per share was inadequate and allowed Airgas to use a poison pill to defeat the hostile bid by Air Products. A firm is believed to have undertaken a good-faith effort when it has exhausted all reasonable means of resolving an issue. Airgas’s board had demanded a bid of $78 per share. Because the Air Products bid was viewed as inadequate, the court ruled that Airgas could keep the poison pill in place against the will of the shareholders. The court also argued that the poison pill was not preventing Air Products from changing the composition of the board but, rather, extending the amount of time required to do so. The court also ruled that directors have the right to prevent shareholder votes if they believe that shareholders would accept a bid that undervalued the firm out of ignorance of the firm’s true value. In practice, the additional time that would have been required to change the composition of the board when the board is classified, as was the case with Airgas, is usually enough to force the bidder to walk away. Once an unsolicited bid is initiated, the composition of a target firm’s shareholders moves from its long-term investors, who often sell when the offer is announced, to arbitrageurs and hedge funds, seeking to profit from temporary differences in the offer price and the target’s short-term share price. From their perspective, the faster a deal is done, the greater their return on investment. Reflecting the change in composition of their shareholder base, target boards come under intense pressure to sell. However, the fiduciary responsibility of boards is to ensure that any bids are in the best interests of their shareholders; takeover defenses in the view of the board give them more time to evaluate the initial offer and to hold out for higher bids. The court’s decision illustrates how a poison pill can work in concert with a classified or staggered board, in which directors are elected one-third at a time. Bidders must therefore wait two years to elect a majority of the total board and force the poison pill to be rescinded. This combination has proven to be a highly potent antitakeover defense. Air Products’ bid for Airgas highlights the challenges of attempting to take control of another firm’s board. Even if Air Products had been successful in electing a majority of board members, there was no assurance the new board would have supported the $70 Air Products bid. The Airgas rejection of their bid came after three new directors nominated by Air Products had been elected to the Airgas board in 2009. Instead of campaigning for a sale, the three new directors joined the rest of the Airgas board in demanding a higher price from Air Products. The outcome of the court’s ruling has implications for future hostile takeovers. The ruling upholds Delaware’s long tradition of respecting managerial discretion as long as the board is found to be acting in good faith and abiding by its fiduciary responsibilities to the firm’s shareholders. The ruling allows target firm boards to use a poison pill as long as the board deems justified, and it is far-reaching because Delaware law governs most U.S. publicly traded firms. -Do you believe that shareholders should always have the right to vote on a sale of the firm under any circumstances? Explain your answer.

Is the highest bid necessarily the best bid? Explain your answer.

Over the years, the U.S. Congress has transferred some of the enforcement of securities laws to organizations other than the SEC such as