The hostile takeover is back. Bid battles dominated 2006 – from the £10bn bid by Spanish construction company Ferrovial for BAA, owner of Heathrow, Gatwick and Stansted airports, to the all-British tussle between Lookers and Pendragon in the car showroom sector.

The list of unsolicited bids that were attempted – and most failed – in the past year was unprecedented in recent times. Figures from research firm Dealogic recorded 38 hostile bids, worth £135bn, in the first three months of 2006 alone and the flow continued throughout the year as cash-rich companies worldwide launched an extraordinary number of unsolicited bids fuelled by low borrowing costs.

Mittal Steel, owned by Lakshmi Mittal, Britain’s richest man, tried to snare Arcelor, the Luxembourg-based steel maker. Goldman Sachs, the US investment bank, tried its luck with UK broadcaster ITV, pubs and bars group Mitchells & Butler, London & Continental Railways, BAA and Associated British Ports. Meanwhile on the continent, E.On, the German utility, came to the rescue of Spain’s Endesa, which was on the receiving end of an unwanted approach from Gas Natural, its rival.

Although multi-billion pound bids grab the headlines, small and medium-sized companies are not immune from the trend towards unsolicited approaches. Indeed, while big corporations can be too big to bid for, smaller companies are vulnerable to offers from both large and small rivals.

Research conducted by Cass Business School and sponsored by Deloitte, the consultancy and accountancy group, showed that a company is at its most vulnerable in the three months after it has published its accounts. Companies that are more likely to attract a hostile bid include those whose share price undervalues the “sum of the parts” (undervalued conglomerates, for instance), those that have recently issued profit warnings or made significant share buybacks, and those with large cash balances.

Companies seeing takeover activity in their particular sector could find themselves on the receiving end of a hostile bid  – as has occurred recently in the ports industry. Penny Avis, a partner in transaction services at Deloitte, said like big companies, small and medium-sized enterprises need to prepare a defence plan in case an unexpected approach comes along. “You don’t want to be holding a beauty parade for advisers once an approach has been made; you want to be able to turn to a trusted adviser immediately,” she said.

Good preparation would also involve directors thinking about four or five key messages they would make to shareholders if they had to defend a bid and how they might support those messages. “You need the financial information to hand and you should think about what initiatives you can go public on, which will show that you are delivering shareholder value,” Avis said.

When it comes to defending a hostile bid, there is no off-the-shelf strategy: each case is different. But whether the company is large or small, defending a hostile bid will involve listening to shareholders and the market, and formulating and communicating a strategy. This is likely to include obtaining general market intelligence and reaction; visiting key shareholders; presenting the company’s case through formal communications; managing press coverage and comment; and, potentially, advertising. Tactics will vary from target to target. Depending on their investment criteria, shareholders need to be persuaded that there are good prospects for longer-term capital and, possibly, income growth if they hold on to their shares.

Sometimes defences are not solely about keeping away unwelcome bidders. The most successful defences of recent years have been those that have elicited a significantly higher offer from the acquiring company, either because there is a genuine risk that shareholders will not tender their shares or because a bid has become contested by a company prepared to pay. In a successful defence, it is important to keep your powder dry for key points in the bid – and to use the element of surprise. The prevalence of hedge funds in the market means that many defences will now try to neutralise short-term speculators as far as possible. This can be done by offering cash to remove the incentives to hedge funds to push a deal through.

A popular tactic at present is to use balance sheet strength to convince shareholders to reject the offer. A return of capital is one way of persuading shareholders and by gearing up, the company also removes one option that might have been attractive to the aggressor to improve its returns quickly after a takeover.

Finally, directors must remain flexible to the opponent’s offer – and be prepared for changes in its terms. Usually hostile bidders offer cash, but if the aggressor is offering its own paper – as in the case of Mittal Steel and Arcelor – it may be worth attacking the value of those shares and, in particular, the offerer’s own strategy and growth prospects.

One veteran of the BAA defence team said: “If it’s a cash bid, the only real defence must be to show that it significantly undervalues the company.” BAA showed, through a couple of key documents released on days 13 and 39 of the bid timetable, that the airports group was worth at least 940p a share: it was a clear line in the sand for Ferrovial and any other interested bidder to match.

Marcus Agius, chairman of BAA and the London arm of Lazards investment bank, notably did not play the nationalistic card in his armoury of defence tactics or resort to an appeal to the defending company’s government, as a number of Spanish and French companies have in recent months. One adviser believes this is a dangerous route to go down, as it irritates shareholders who are largely oblivious to national boundaries and may be foreign based themselves. If a company succeeds in defending a bid on these grounds, it also risks undermining the perceived value of the company. The market tends to discount companies that are thought to be protected from approaches by their government or are subject to regulatory or political interference. It is hardly a battle worth winning.

The question of when to open the books to an acquiring company is also critical. Most advisers would argue that allowing private records to be inspected is tantamount to raising a white flag and should not be contemplated until a deal is pretty much done. One of the hardest bids to deal with is the phantom offer, where an aggressor indicates that it will bid for a company but never goes as far as submitting one. Sir Gerry Robinson and Raphoe Management’s approach for hygiene services group Rentokil in 2005 was such a phoney bid, as was Philip Green’s attempt to get hold of retailer Marks & Spencer the previous year. However, there was nothing phoney about the defence of these two approaches. Both cost a great deal in terms of advisory fees and management time.

As a general guide, SMEs will incur defence costs in the region of 2% of their market capitalisation to defend a hostile bid, while medium to large companies will spend about 1%. However, advisory expenses can reach up to 5% of the value of a hostile bid. For most SMEs, a takeover approach is likely to be friendly and may result from a relationship built up over many years. However, approaches from private equity houses are not as friendly as they might seem. “These so-called ‘bear hugs’ are akin to a hostile takeover bid as management is under huge pressure to recommend the offer,” said Avis.

Being prepared is the best way to deal with either approach – whether it be friendly or unfriendly. At least that way you have a good chance of making sure the money on the table is the best you can possibly get. 

Biography

Angela Jameson has been The Times’s industrial correspondent for six years and writes on industry, manufacturing, transport and energy for all parts of the newspaper and Times Online. She frequently edits the award-winning business section’s Tempus investment column and oversees the weekly Powers in the Boardroom interview with Europe’s biggest business leaders.

Prior to joining, she was assistant editor of Property Week, a news magazine for the commercial property industry. Jameson joined business-to-business publisher Reed Business Information on leaving Oxford. Her first reporting job was on the leading weekly magazine for the hospitality industry, Caterer & Hotelkeeper.