Of poison pills and white knights! - Views on News from Equitymaster

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Of poison pills and white knights!

Aug 22, 2006

Wait! These words are not from the plot of a James Bond flick, neither they form part of the Superman's dictionary. Rather, they are part of daily parlance for M&A executives - a breed that is involved in leading the consolidation process across industries, across the global economy. As investors in equities, you are in fact part owners of companies you invest in. And as India Inc. sees greater consolidation across sectors, these are key terms that you should be aware of. Consolidation generally happens through mergers, takeovers and acquisitions by companies. Those of you who tracked the recent consolidation deal in the steel industry, between Arcelor and Mittal Steel, a few of these terms came to the forefront. In this article, we dicsuss the two most classical ways of disrupting a takeover threat - poison pill and white knight.

Poison pill
This is one of the classic anti-takeover strategies adopted by the target company. Through this strategy, the target company aims at making its own stock less attractive to the acquirer, who attempts to obtain a controlling stake in the former, and thereby gain control of the board and, through it, the company's management. In the initial stages of their parleys, in order to fend off Mittal Steel's takeover bid, Arcelor tried to use this strategy. It involved the Canada based Dofasco Group, one of the Arcelor companies. In order to prevent Mittal Steel's sale of the firm following any takeover, Arcelor had transferred ownership of Dofasco to a Netherlands-based trust.

In its most original avatar, the poison pill strategy allows existing shareholders (except the bidding company) to buy more shares at a discount. This is by way of making a rights issue of stock to existing stakeholders. The main goal of this kind of a poison pill is to dilute the holdings of the bidder and make the takeover bid more difficult and expensive.

In its most effective use, a poison pill is intended to increase the cost of negative outcome for the acquirer, thus making its target look effectively a lot pricier than what it was in its original state.

White knight
This is a company that makes a friendly takeover offer to a target company that is facing a hostile takeover from another party, which is indeed called a 'black knight'. The white knight offers the target firm a way out with a friendly takeover. Severstal of Russia was supposed to be the 'white knight' for Arcelor against the takeover pitch of Mittal Steel. As per the arrangement, Arcelor purchased the 90% stake of Severstal owned by its CEO, plus all of his other steel and mining assets. Severstal's CEO, in return, received Arcelor shares and purchased more with cash, ultimately giving him a 32% stake in the world's second largest steel maker.

While these anti-takeover tactics have borne fruit in many instances in the past, they have failed in several cases as well. Arcelor's attempts to ward off the takeover are the recent examples of failed anti-takeover strategies. However, it is still to be noted that the entire exercise definitely increases the effective cost of acquisition for the acquirer company. In the above example, Mittal Steel paid almost 80% more (US$ 50 per share) in June 2006 than its initial proposal for the acquisition of Arcelor in January 2006. Also, while the Mittal family will be by far the largest shareholder in the combined entity, people associated with Arcelor will remain highly influential in the company (12 out of 18 board members are from Arcelor).

Conclusion
Consolidation is the name of the game, be it in 'old economy' industries like steel and automobiles, or in 'new economy' growth industries like technology and telecommunications. So, the next time you read a release that says that your (invested) company is using a poison pill or a white knight strategy to ward off a takeover attempt, you will definitely know what it is actually up to. More importantly, you may then have the opportunity to purchase more shares at cheap prices!

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