At a recent meeting of the Houston chapter of the National Association of Corporate Directors (NACD), one of the speakers on a panel dealing with enterprise risk issues to be considered by corporate directors highlighted energy industry takeovers as a possible emerging risk. William Gutermuth from the Houston office of Bracewell & Giuliani LLP discussed unfriendly takeovers as an enterprise risk and the role of poison pill defensive plans. Changes in attitudes toward poison pills in recent years coupled with the dramatic decline in energy company share prices during the past 12 months presents an environment that is ripe for a possible increase in the number of unfriendly takeover attempts in this industry.
Poison pills are essentially plans, generally approved by shareholders, which lay out a pre-determined course of defensive action against an unwanted takeover attempt that is triggered by a hostile offer. Most plans involve the sale to existing shareholders of additional shares at a nominal value designed to significantly increasing the cost of a hostile takeover for the acquirer. The hostile acquirer is confronted with having to buy a substantially greater number of shares than he originally anticipated in his bid, presumably increasing the acquisition cost to a point he may consider abandoning the effort. The plans have various time periods of restrictions against the hostile acquirer moving forward and when the additional shares may be issued. The ultimate purpose of the poison pill is to provide the board of directors with a period of time to hire legal and financial advisors and to begin an orderly defense against the hostile bid, while also providing time for other suitors, or possibly "white knights," to get involved in the bidding process.
In recent years, poison pills have fallen into disrepute. The idea being that from a good governance viewpoint, having poison pill plans in place discourages possible acquisition approaches to the detriment of shareholders and possibly to the enhancement of directors and management. The belief is that if an unfriendly takeover offer is received, poison pill plans can still be put into place and activated with sufficient time to prevent a steamrolling by the acquirer of the board of directors, whose obligation is to ensure that if the company is sold it is to the highest offer. As a result, there has been a trend in recent years to allow existing poison pills to expire. Mr. Gutermuth presented data showing that in 2007 and 2008, 60% and 71%, respectively, of poison pill plans scheduled to expire were allowed to naturally end.
After presenting this information, Mr. Gutermuth presented data designed to highlight the possible enterprise risk that directors need to consider as part of their obligation for overseeing the governance of their companies. Between 2004 and 2008, data from SharkRepellent.net shows that there has been roughly a tripling in the number of unsolicited/hostile takeover transactions and an equally large increase in the number of proxy fights.
According to the FactSet MergerMetrics report for 2008, unfriendly transactions represented 23% of all announced deals involving full acquisitions of U.S. public companies. This was well above the percentage of unfriendly deals witnessed in the past five years where 2006 saw the next highest percentage of just 14%.
What Mr. Gutermuth then showed was a chart based on his office's examination of 10-Q corporate filings with the Securities and Exchange Commission for the period ending September 30, 2008, showing the average market capitalization of the top 250 U.S. based exploration and production and oil field service companies and their cash balances and available credit lines divided into quartiles. The amazing point is that the average cash and available credit total for the top quartile companies exceeded the average market capitalization of all the companies in the three remaining quartiles. It is also important to note, the top quartile cash and available credit total was determined after excluding the huge cash hoards of ExxonMobil, ConocoPhillips and Chevron. In fairness, today, given the recent rally in stock prices and the drop in revenues and profits for energy companies, their financial resources have probably shrunk. The credit crisis has resulted in many company lines of credit being reduced or cancelled. As a result of the changed business environment, this analysis is likely not completely valid. But the point is that the U.S. energy industry is under significant stress and many valuable companies potentially are at risk of being purchased in a hostile takeover. So what should directors do?
According to Mr. Gutermuth, there are four points that need to be considered to make sure that a company is not swooped up on the cheap in a hostile takeover. Even though share prices for energy companies are well off their 2008 highs, a fully-financed cash offer at a premium to the current market price has to be considered by the board. It cannot fall back on the "Just Say No Defense" anymore since according to Mr. Gutermuth, the courts will not respect that defense. He also said that when confronted with a hostile takeover attempt, boards are entitled to consider a range of alternative actions beyond merely the sale of the corporation. They may also demonstrate how a corporate strategy can reasonably be expected to create a higher value than that received in the takeover attempt. A way to provide the directors with the opportunity to evaluate the alternatives is to have a shareholder rights plan (poison pill) in place. This would insure that the board can control the evaluation and sale process. Mr. Gutermuth's last point was that the process should be controlled by the independent directors on the board along with professional advisors.
Sharkrepellent.net reported that in 2008 there was a late-year surge in poison pill adoptions. The 28 poison pill adoptions in December were the most in any month since October 2001. There were 127 total adoptions in 2008, the most in any year since 2002 shortly after the tech-stock collapse. The 76 first-time poison pill adoptions in 2008 was the most in three years, a dramatic reversal from 2007's total of only 42, which was the lowest total since the early 1980s. It would appear that the stock market fall and the rise in hostile takeover attempts is motivating companies to adopt poison pill defenses.
G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.
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