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  Date:14^th August 2010

 Compiled by: M Sathya Kumar  

Protecting against takeover attempts

Under the new regulation, the cost of taking over a company could go up steeply as the acquirer has to make an offer for the entire public holding.

The Achuthan Committee Report on Takeover Regulations was released recently and it is likely that SEBI will accept most of the recommendations. Once enacted, the new takeover code will provide a legal environment that would facilitate fair and transparent M&A (mergers and acquisitions) activities.

There is now an expectation of an increase in takeover bids, some of them hostile, for listed companies, especially those with smaller promoter holdings. Company managements should take proactive measures to counter this emergent threat.

Obvious mechanism

The most obvious defence mechanism is to shore up promoter holding as quickly as possible provided the promoter has adequate funds.

Even so, it is a somewhat suboptimal fix as it does not create wealth. Another, and very negative, remedy is to commit the company to onerous covenants that get triggered when there is a takeover bid.

Called ‘poison pills', their aim is to make a takeover prohibitively expensive. But this practice is not in vogue as the markets do not take kindly to it.

A positive way to find a remedy is to first understand what would drive maximum takeover activity in the future. Post the implementation of the new regulations, the cost of taking over a company would go up substantially as the acquirer has to make an offer for the entire public holding.

Therefore, more takeover attempts would be spurred by the valuation arbitrage available in the target rather than strategic considerations. So a good defence would be to take steps to eliminate this incentive to arbitrageurs.

The new takeover code is likely to attract a class of investors who specialise in taking a company private, reconfigure its business model and balance-sheet to make it more efficient and then float it back in a new avatar. Why cannot the promoters themselves take measures to give their companies a makeover, even whilst being listed, thereby pre-empting these takeover specialists?

Ten steps

The following are 10 positive measures that promoters could adopt to help them thwart takeover threats.

The first and, perhaps the most clichéd, step is to tidy up one's governance practices. There is now clear empirical data to prove the high correlation between governance and valuation.

Continuously benchmark company performance with domestic and global peers.

Admit a poor investment decision and exit from it at the earliest. Do not get sentimentally attached to a business.

Divest dormant assets, especially land. Whilst the share price does not adequately factor these, an acquirer would certainly see value in them.

Monetise some of the value hidden in unlisted, fully gestated, subsidiaries as soon as possible. More so in the case of overseas entities.

Keep the lenders on your side. Loan agreements generally require lenders' approval for a change in management unless the loan is paid off forthwith. If a lender feels his loan is safer with the existing management, he may ask the acquirer to prepay it. This would increase the takeover cost.

Large cash balance with the company is viewed by the market as an underperforming asset. On the other hand, an acquirer finds it attractive as it can be used, post acquisition/merger, to reduce the debt, if any, taken for the takeover. So minimise this component of the balance-sheet.

Share the company's windfall gains with shareholders. Shareholders have a tendency to stay invested in a company which has a history of making extraordinary payouts. This helps keep the share price firmer than otherwise.

Quickly build up size through expansion. If possible, become an acquirer and look for takeover targets.

And, lastly, keep on standby a friendly company (known as white knight in M&A parlance) with deep pockets to come in support in case of a crisis.

To conclude, existing promoters of listed companies would be able to defend their companies under the proposed new takeover regulations.

The name of the game is to identify value creators and eliminate value destroyers.

A game which can be played better by the promoters themselves as they know their companies and businesses better than any outside acquirer.

(The author is the founder of NeoCFO.)

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