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The principal aim of strategic defense is to try to eliminate, as far as possible, the attractions of the group to a would-be predator.
(a) Share price maximization
It is clear from above that a depressed share price, either from fundamental business difficulties, or where a recovery may be shortly forthcoming which has not yet been recognized by the market, is a major attraction for predators.
The fundamental causes of a depressed share price are poor or patchy profitability, however measured, and/or uncertainties about the future of the group.
Clearly a vital management objective is to maximize return on investment in whichever way this is defined. It is often possible to enhance this return by identifying assets or business units which do not conform to certain minimum profitability criteria. Elimination of such low returns can enhance the share price level substantially, and should receive priority from a management seeking a strong defensive position.
The elimination of business uncertainties is also important. These uncertainties will principally concern any area of the group’s trading – market, production, etc – where there are doubts affecting profitability. It is first of all necessary to identify the uncertainties, and then to seek to allay them, either by management action or, where the doubts are unjustified, by convincing the public that the uncertainties do not exist.
(b) The importance of group strategy
A great strength in this regard is the existence of an agreed and well-understood group strategy, complemented by divisional strategies further down the line. Provided the strategy is communicated effectively externally and is well understood, and provided group action and results can be judged in the light of its existence, it will reassure shareholder and tend to maintain the share price. Furthermore, it should nominate specifically the approach to any major ongoing uncertainties.
(c) Communication
In addition, a group may be vulnerable when recovery may be about to take place after period of low profitability or losses. It should, therefore, work hard to communicate this potential recovery whilst being careful to give accurate information and assessment Damage will be caused to the group if performance does not match the results which the outside world have been led to expect. The allaying of shareholders’ fears regarding, uncertainties, and the external communication of group strategy, both point to the importance of effective financial public relations in seeking to maximize share price. These can be cultivated in the following-ways:
(i) Use of a good external financial public relations adviser. Such a role should not i any way substitute for management’s direct communication with the media, b should complement it, where appropriate, through extending the range of contact advising on the style and method of communication, and keeping an ear close to the ground.
(ii) Development of a close relationship with the group’s stockbrokers. The latter ar usually seen as being a source of good quality information about the group, an
- they should therefore be provided with all publicly available material, and have good grasp of the strategy and current trading.
(iii) Development of a close relationship with the stock market research community ar financial press. Most research analysts have a detailed knowledge of the market they follow, and an understanding of a group’s activities and sympathy with i objectives, together with personal relationships of trust and respect – all of which can be very helpful in external communications. In addition, many journalists u research analyst contact for background material for articles.
(iv) Use of press and brokers’ results conferences. Many groups use these occasions (which usually take place on the day that the preliminary announcement of interim or final results takes place) formally to restate their aims and objectives and measure them against their actual trading results. They provide an opportunity disseminate corporate financial messages to a wide media audience.
(v) Enhancement of the quality of presentation, and depth of information, of the annual report. In particular, close attention should be paid to the clarity and content oft chairman’s statements in the annual and interim reports, and at the annual gene meeting. These are usually scrutinized and analyzed in considerable detail.
(vi) Development of direct shareholder relationships. Direct communication with many shareholders as possible should be sought, through meetings and visits to group’s facilities. Institutional shareholders, who tend to hold the majority shares, often take a very passive role but have become increasingly active in recent years.
(d) Dividend policy
The level of cash dividend is often held to influence share price. Accordingly, it is argued that an increase in dividend should cause a rise in share price. However, Chapter 4 has argued that the level of dividend, and thus dividend policy, should be based fundamentally on the cash flow generation, debt policy and returns on assets generated by the group. Thus, a change in dividend without regard to these fundamentals, or changes in them, can only be a short-term expedient towards share price maximization.
Furthermore, a high dividend payout narrows the scope for large increases in dividend in the event of a bid. Such a policy, if continued, may actually have the effect of weakening the group’s defense following a bid.
Achievement of the correct level of dividend, having regard to the fundamentals, will, however, have the most beneficial effect on share price over time, and this, in contrast to short-term changes, is of vital significance.
(e) Strategic shareholdings
Another strategic mechanism which is often used is the taking of a large strategic share stake by a friendly party, or of a cross-shareholding with that party. This has the advantage that it does, initially at least, deny any predator a major portion of the equity of the target company.
It does, however, have several disadvantages:
(i) The attitude of an initially friendly shareholder may change, and a predator may make great efforts to dislodge his shareholding. It may be more expensive to acquire, but it may prove easier for a bidder to win over than a lot of small shareholdings.
(ii) Such a shareholding or cross-shareholding may be interpreted as a sign of weakness and may actually attract predators.
(iii) It is arguable whether such a shareholding, if its object is to prevent any bid, is in the best interests of shareholders. Furthermore, a cross-shareholding is often criticized, in that it ties up significant amounts of capital in both companies.
(f) Maximization of total price payable
It is also argued that, since most predators’ resources are limited, it is worth maximizing the total price payable, either by a rights issue, or by the acquisitions of assets for shares or loan stock.
In the case of a rights issue, the value of the equity will be increased, since the proceeds will initially go to reduce the company’s borrowings in an equal and opposite amount. However, the defender’s position may be weaker, in that, if a predator bids on a share-for- share basis, the total borrowings involved (in this case the internal debt of the target company) would be less. Under-gearing may in this case prove a substantial weakness since it would make the target company more attractive.
In the case of an increase in gearing, eg, buying assets in exchange for loan stock, two negative points apply. ‘First, cash acquisitions causing an increase in gearing should be consonant with the group strategy: if not, they will become a waste of financial resource, and may lead to financial weakness which may even accelerate a bid. Second, if safe gearing limits are thereby breached, the group creates a further financial risk for itself.
However, high gearing, if within safe. limits, may constitute some form of defense, in that, in contrast to the above, it will actually increase the total cash consideration for a share-for- share bidder with limited resources.
(g) Acquisitions by the target company
Finally, acquisitions by the target company may themselves be a wise strategic defense, though again only if in accordance with group strategy. If for cash or debt they may increase group gearing, but they may also broaden the base of the group beyond areas of interest to the predator. If for shares, they may take the combined market capitalization of the company target beyond a potential predator’s reach. Further, where limited business areas of risk or uncertainty are present in group trading, they may reduce the impact of such risks/uncertainties by lowering the percentage of overall profits on which they impact.
There are four elements of good housekeeping which should be observed at all times.
First, a group should keep a close watch on its share register and share trading, in order to identify any sinister shareholding buildup at an early stage. In particular, it should note the following:
(a) Any heavy buying or selling, whether or not it affects the share price.
(b) Any change in ‘major’ shareholdings. ‘Major’ is hard to assess, but a range from 0.1% to 0.5% of total shares in issue should be considered. It is probably worth obtaining immediate details of all share transactions down to a size rather lower than 0.1%.
(c) Any large ‘Sepon’ balance or its equivalent outside the UK. The ‘Sepon’ balance measures the number of shares which have at any time recently changed hands, but which the new shareholders have not registered. Since registration may take a while to enforce, it provides a smokescreen for a would-be predator building up a quiet stake. Any balance over 1% of total shares on issue (dependent on normal turnover levels in the shares) should cause an alert.
A group should also make sure its forecasting techniques are effective and understood throughout its business units. An accurate forecast for at least the current year’s trading is a vital part of a defense document, and would normally have to be independently corroborated by a firm of accountants, so that it should stand up to rigid scrutiny.
Since a takeover offer may quickly follow the acquisition of an initial share stake as part of a predator’s tactics, it is essential to be able to draft promptly a document in response, expressing the reasons why, in the opinion of the board and its advisors, the price which might be offered in the event of a predatory bid is inadequate.
This document would, inter alia, contain the following:
(a) Comparison of offer price with recent market price of the group, comments on premium offered, and comparison with net assets. Also, comment on the disadvantages to remaining shareholders of a sizeable share stake.
(b) Details of any asset revaluation which might be appropriate.
(c) Comments on current trading, emphasizing recovery and growth situation in the light of group strategy. Particular attention should be paid to already identify areas of uncertainty, or where potential exists as yet unnoticed by the stock market; also to cash generation and gearing effects of current trading.
(d) Profit and dividend forecast.
(e) Rebuttal of commercial logic of bid, taking each point put forward by offeror. Also reference, if appropriate, to regulatory environment and national interest.
An eye should be kept on all likely predators with a view to anticipating their actions. Clearly, considerations of size (has the relevant candidate the financial resource to acquire the group?) and industrial synergies will best determine such a list.
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