Actavis, Allergan, and Ackerman's 2 Billion Dollar Day

The Allergan saga repeats many common themes of mergers:

• An activist sees ways to improve share-value and targets a company.  In this case Ackerman and Valeant thought Allergan could maximize value by slashing R&D
• The target management disagrees and then takes defensive actions including a) seeking a white knight b) threatening legal action and c) doing many of the same things the activist proposed anyway.
• A white knight arrives touting great synergies and offering more than the activist.  Shareholders of the target (Allergan) gain.   (This step is often missing and shareholder welfare might not be maximized.)
• The activist gains on increased value of the toehold position in the target.  (See Bill Ackerman's $2.2 billion day.)

Often in these situations there is another theme: the winning bidder overpays (i.e, the winner's curse).   In this case, the CEO of Activis "admitted Actavis paid up for Allergan. ‘But in the midst of doing that, we got a company and a team that shouldn’t have been up for sale,’ he said during an interview. ‘This is a once-in-a-lifetime, a unique opportunity to transform our industry.’" See Actavis Agrees)

We’ll see.  In fairness, the stock price of Activis rose on the announcement.  A win-win-win for target shareholders-activists-acquiring shareholders?  That usually doesn’t happen.

All the best,

Ralph

Hostile Takeovers: They’re Back

1H14 M&A has rebounded sharply, and along with it hostile takeover bids. This fact combined with the already robust shareholder activity present another challenge to existing firm management. This is good news to lawyers as the initial management response is to “lawyer-up”. Unfortunately, legal defenses address the symptoms not the cause of underlying performance and governance problems.

The basic problem is having survived the great recession is necessary, but not sufficient condition to performance problems. Cost cutting and share repurchases are good at preserving value, but not at growing increasing shareholder wealth. Current managers and owners may no longer be the best owners and managers of the firm’s assets. Alternative strategies and execution tactics by competitors may yield improved results in a changing market. Existing management is usually reluctant to change once successful strategies even though the market has changed. Consequently, a value gap develops between the firm’s public market and private control value, which hostile bidders will attempt to exploit. The gap needs to be significant to entice the offer given the risks involved.

Hostile activity can be viewed as a governance failure by the board to monitor and control management. Characteristics of this failure include the following:

1)     ROE lagging Ke

2)     Dividends < 50% of free cash flow resulting in a cash build

3)     Cash and marketable securities represent a significant component of overall market value

4)     The firm is under leveraged

5)     Sum of the parts is greater than the whole

Management must address the underlying performance problem or sell. Usually, the difference between a hostile and friendly deal is a higher price. In the meantime, the firm can make sure it has enough time to respond by considering the following:

	w   Tactical legal matters	w   Financial Engineering	w   Strategic Options
Proactive Measures	w   Voting provisions w   Staggered board w   Poison pill	w   Sale of block w   Joint venture w   Acquisitions w   Leveraged acq. Vehicle w   Divestitures w   Leveraged disposition	w   Monetize undervalued non-strategic assets w   Cost restructuring w   ESOP w   Spin off w   LBO w  Recapitalization –   Full or partial
Reactive Measures	w   Stock repurchase w   Block repurchase w   Voting provisions w   Poison pill	w   Divestitures w   Acquisitions w   Pac Man	w   ESOP w   LBO w   Recap w   Sale

The top portion of the above chart relates to proactive measures, while the bottom concerns reactive actions once the threat materializes. Some measures like poison pills can be used either proactively or reactively. The left column lists tactical legal matters. The middle column focuses on financial engineering, while the right pertains to strategic options. The Pac Man option was used by Men’s Warehouse to block the Jos A Bank bid. Allergan is considering a large acquisition to ward off Valeant .

The problem with defending against a hostile takeover is that you lose sight of the real objective. The key is to create shareholder value not remain independent. My concern is many management teams will lose the value creation war while winning the takeover battle. Their win will be short lived unless they add value by postponing the takeover.

There is no compelling long term defense to a well financed premium offer by a determined bidder absent real or threatened governmental interference as in AstraZeneca-Pfizer. You can buy time to improve the offer as did Jos A Bank.  Sooner or later, however, you must deal with the offer or improve performance to close the value gap.

J