Management Needs New Strategy to Protect Company's AssetsBy: Andy Marken
The price tag for the leveraged buyout of RJR Nabisco was higher than the gross national income of many of the world's smaller countries. The $24 billion tab proved that no company, no matter how big, is entirely safe from corporate takeover artists.
AT&T has made an aggressive series of acquisitions. Financial institutions are buying other financial institutions. The petroleum, pharmaceutical and distribution industries are all consolidating.
While highly visible, the latest round of deals weren't isolated events. For the first ten months of 1998, more than 5,550 similar transactions were completed. There were 750 LBOs (leveraged buyouts), including divestitures as well as friendly and unfriendly takeovers in the United States and abroad.
That's almost 18 per day -- a leveraged buyout nearly every hour!
Corporate mergers as well as friendly and unfriendly takeovers are reaching epidemic proportions and they are draining management's time and company resources. In the long run, many companies are exhausted by takeovers that provide a quick profit to purchasers, but leave the company devastated or divided.
Most company stock (public and private) is grossly undervalued -- the stock market created a rich-feeding ground for financial sharks, as well as for public firms and organizations anxious to place their initial public offering (IPO).
Most merger targets are companies churning out record earnings, which makes them tempting prey for LBOs. Institutional stockholders see these companies as an opportunity to improve their portfolio performance.
The same is true of pension fund managers. Investment bankers and lawyers have large sums of money available from deregulated banks that want to improve their return on deposits. European and Pacific Basin raiders are mounting an aggressive invasion of the U.S. marketplace to gain a stronger foothold in the American economy.
Meanwhile, the M&A (merger & acquisition) specialists are standing on the sidelines smiling--they take a cut from both sides of the deal.
When companies are churning out record earnings, their stocks remain dramatically undervalued. The value of a company's assets will often continue to rise while its stock value remains stagnant or declines. At the same time we have Internet-based firms that bleed red ink and garner spectacular multiples when the founders determine it’s time to cash in.
The disparity represents a juicy potential for profit through resale of company stock, and it's too much for many to resist. Raiders buy on the basis of earnings/potential and sell on the basis of assets. And to protect themselves in these deals they have begun to hunt in packs.
Tearing Firms Apart
The objective of most corporate raiders is to reap high returns by tearing apart the company and selling off its parts. If any vestige of the original firm remains, it is so laden with debt that management is forced to focus on short-term survival, rather than long-range competitive strategies.
It's relatively simple to rape a company. All management needs to do is eliminate investments in R&D, marketing and promotion, then pay the savings to the moneychangers. No need for any special concern about the people who made the company a going concern -- after it is stripped of its productive potential, they will be gone anyway.
It's little wonder that today's executives spend fitful, sleepless nights. Rather than focusing on building their organizations in a healthy, profitable manner, they're often forced to fight off corporate buccaneers who want to dismantle and sell off the organization.
At first glance, recent defensive moves by corporate management seem to run counter to sound management practice. Rather than retaining earnings for future growth, management is extending leveraged debt as much as possible to make their firms less desirable for takeover.
New Team Players
To help fend off unwelcome advances, boards of directors, company presidents and officers are adding new members to their teams. Today, these teams include takeover lawyers, investment bankers, proxy solicitors and PR counsel. These new players are added because hungry (some might say greedy), smart and very well-paid people around the globe are spending all of their time developing ideas for the potentially lucrative take-over deals.
M&A activities used to be carried out on a target-of-opportunity basis. But today, they are an integral part of the organization's long-range, growth-planning strategy.
Unfortunately, few corporate heads have received training or education in such activities as mergers, acquisitions, takeovers or LBOs -- and trial by fire is the most difficult way to gain such expertise.
Since management is often ill-equipped to handle these problems, it generally relies on defensive moves, rather than offensive and preemptive measures. While most of these efforts have negative side effects and are ultimately fruitless, their goal is to make the firm unattractive, difficult or too expensive to acquire.
When unfriendly or undesirable overtures are sounded, the most common response is to run to legal counsel and put together a defensive plan.
Often, this includes incorporating provisions requiring majority shareholder approval of mergers and liquidations, acquisition of properties that create regulatory barriers, preparation of "black books" with defensive contingency plans, incorporating cumulative voting requirements and/or reclassification of the board of directors.
Public relations activities (on both sides) can play a crucial role, as both sides carry out campaigns to persuade shareholders to give their proxies to either management or the prospective buyer.
For the most part, such activities are carried out like the 1996 presidential campaign--black hat/white hat, character assassination and guilt by association. It includes scores of news releases and position statements, a myriad of phone calls and urgent, hasty decisions regarding what should and shouldn't be said.
To avoid being put on the defensive, management needs to develop offensive and strategic plans to address the critical questions that arise in a takeover situation. These questions include, "What are the maximum capital and earnings values of the company's assets?" and "Who can best manage them to provide the best return for the investors?"
To add credibility and viability to their firms, management needs to aggressively posture and "sell" the company to the financial community, even if the organization is not publicly held.
These activities include an aggressive, prompt disclosure program on new products and services, research breakthroughs and contracts, as well as sales and earnings results. The annual report should be more than a simple report to the investors -- it should be an important source of information on the company. The annual report can serve as an effective selling tool throughout the year.
Management should develop fact files or "white paper" kits for the press and financial community; they should have meetings with brokers, funds and analysts; a concerted publicity program should be carried out in the business and financial press, and pulse-taking efforts should be made with shareholders and industry analysts.
Such activities allow management to tell how well it is managing company assets, and to address issues such as asset values and management. By taking these measures, management adds credibility to its position, making unwelcome tender offers more expensive and proxy fights more difficult.
These activities are well within management's control. Another activity management can undertake individually, or in organized groups, is aggressively lobbying Washington to take action dampening merger mania through tax legislation.
If Congress passes proposed legislation to eliminate "mirror" transactions, it will eliminate a loophole that lets highly leveraged buyers avoid taxes by creating and then selling subsidiaries. Elimination of the deduction for interest on acquisition debt is another way for the Federal Government to discourage non-productive mergers.
Drawing Battle Lines
In taking these and similar actions, management, investors and the government all share a common understanding and long-range goal. The investor will receive a framework for projecting earnings and return on investment. Management will give investors a sound platform for showing that proposed offers may be inadequate or against the best long-term interest of their company.
Today's frenzied M&A activity is the commercial equivalent of war. As in war, no one can (or should) rely on defensive weapons alone. Instead, the strongest weapons--including an aggressive, offensive strategy--must be used to preserve management control of events.
Hostile takeovers are battles that require a dramatic improvement in management's planning and strategic thinking. By taking appropriate actions at the outset, the managers of takeover target companies can stave off many hostile takeovers, or at least negotiate terms that are favorable for all concerned ... management, shareholders, employees, customers, suppliers and the industry.
© Copyright 1999, G.A.Marken, Marken Communications
The author assumes full responsibility for the contents of this article and retains all of its property rights. MarcommWise publishes it here with the permission of the author. MarcomWise assumes no responsibility for the article's contents.