Monday, March 25, 2013

Are You a Takeover Target?

An improving economy and favorable financial markets have renewed interest in acquisitions as a growth option. We can expect increasing shareholder pressure to grow earnings, or return excess cash to them. The pressure can trigger a hostile bid or shareholder activism. Either you develop options, or you become one.

Targets include both firms suffering from poor performance like HP or well performing firms with large and growing cash holdings such as Apple. Both HP and Apple may be somewhat protected from a hostile bid given their size. They are not, however, immune from shareholder activism as recent events have shown.

Characteristics that will land you on someone’s takeover or activism target list include the following:

1)     Slow earnings growth but profitable cash positive operations
2)     Returns on equity lagging the cost of equity
3)     Depressed stock price multiples-especially market to book and price to earnings ratios
4)     Growing cash and marketable securities holdings constituting a large portion of your market value
5)     Relatively low dividend payout ratio e.g. less than 30%
6)     Low leverage with debt/cap ratios e.g. below 20%
7)     Multiple SBUs with the sum of the parts value, break-up value, exceeding the current market value of the whole firm
8)     Problematic organic and M&A growth results

So what do you do if you have one or more of these characteristics? Consider the following:

1)     Explore alternative strategic options-code for putting yourself up for sale. Probably not your first choice.
2)     Contact your lawyers to ensure takeover and shareholder activism defenses are in order. This only buys you time. It does not solve the underlying performance issue.
3)     Sell assets and SBUs better owned by someone else. This involves a periodic product portfolio review to transfer those units which have passed their sell by date.
4)     Return excess cash to shareholders through a special dividend or share repurchase
5)     Increase the dividend payout ratio to reduce the future build up of cash
6)     Increase leverage and use the proceeds to fund a special dividend or share repurchase. Probably want to maintain an investment grade rating of at least BBB to ensure financial flexibility. This translates into a maximum debt to capital ratio of around 50% for nonfinancial companies.
7)     Consider taking the firm private-possibly via a management lead LBO
8)     Develop new shareholder friendly organic and M&A growth strategies

As I've written before, the key is to Do Onto Yourself before someone else does onto you. We may be early in the cycle. 

Nonetheless, it never hurts to be prepared.


P.S. (See also, Ralph's post on The Best Takeover Defense: Don't Leave Money on the Table.)

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