What is a Black Knight?
In corporate finance, a company that is offering or executing a hostile takeover of the target company is termed a black knight. A hostile takeover is an acquisition attempt by a company or raider that the target company resists.
For example, Company A is a publicly-traded company that wants to expand into a new market where Company B is already established. Company A approaches Company B with a buy offer to its Board of Directors (BoD). After consideration, Company B refuses the offer, concluding it is not in their best interest. If Company A proceeds with a takeover attempt after being rejected by Company B’s board of directors, that is deemed a hostile takeover and Company A would be referred to as a black knight.
Reasons for a Takeover
There are several factors that can influence a company to want to take over another company. Ultimately, it comes down to the long-term strategic goal of the acquirer. Below are the most common reasons why companies are acquired:
1. Enhancing business abilities
Taking over a company can improve efficiency, increase the effectiveness of marketing products and services, and increase turnover and sales.
2. Acquiring a larger market share
It is often difficult to gain a larger market share. A takeover of a competing firm is one means of garnering a substantially larger market share and reduced competition.
3. Product and service diversification
Taking over another company allows for product and service diversification and, thereby, potentially improved profitability.
4. Reducing business operational costs
If the merging companies manufacture similar products, production efficiency can be utilized to reduce production and management costs.
5. Replacing the management team
If the acquirer believes the target company is poorly run, the company can acquire the target company and replace the management team, with the goal of making the acquired company more profitable.
Hostile Takeover Strategies
There are several tactics that a black knight (acquirer) can employ to take over a target firm after the target company’s management rejects a purchase offer.
1. Tender Offer
A tender offer is an offer to purchase shares from the shareholders of the target company at a premium to the market price. The takeover company executes a tender offer directly to shareholders, thus bypassing the board of directors’ consent. The objective is to acquire enough shares to gain a controlling interest in the target company (>50%).
Example: Company A’s current stock price is $20 per share. A black knight attempting a hostile takeover of the company could issue a tender offer of $40 per share to current shareholders, with the offer contingent on being able to acquire at least 51% of the outstanding shares (controlling interest).
2. Proxy Fight
A proxy fight is when the acquirer persuades existing shareholders of the target company to vote out the board of directors. This makes the company easier to take over, as the replacement board members are expected to be more open to a control change.
Example: Company B is attempting a hostile takeover of Company A. Employing a proxy fight strategy, Company B persuades a sufficient number of the shareholders of Company A to vote out the company’s current board of directors. After the removal of the board of directors, shareholders will install new board members who are expected to respond positively to a purchase offer.
Defenses Against a Hostile Takeover
A target company can defend against unwanted hostile takeovers through several possible strategies.
1. Poison Pill
A poison pill strategy is used to make the target company less attractive to the acquirer. This strategy is employed by making buying a controlling interest in the target company’s stock a more expensive proposition.
Example: A poison pill strategy can involve giving existing shareholders the option to buy more shares of stock at a discount. This will dilute the stock, increasing the number of shares the acquirer will need to purchase to gain a controlling interest.
2. Golden Parachute
A golden parachute is a large financial compensation given to company executives if the company is taken over or if the executives are dismissed. Golden parachutes are part of employment contracts that are given to key executives.
The CEO of the target company can sign a golden parachute contract that gives him or her a huge compensation if there is a change of control in the company or if he or she is dismissed. For example, the golden parachute contract of Hewlett-Packard Enterprise CEO Meg Whitman will provide her with $91 million if the company is acquired and $51 million if she is terminated. Read more here -> http://www.businessinsider.com/whitman-gets-51-million
A supermajority amendment to the company’s voting rules can be made that requires at least 70% of shareholders to approve any acquisition. This will make it more difficult for a black knight to take over the target company, as they need to purchase more stocks to gain control.
4. The White Knight
A white knight is a friendly potential acquirer that steps in and executes a friendly takeover of the target in order to prevent a black knight from completing a hostile takeover. A white knight is deemed the rescuer of the target company because the white knight does not seek operational control of the target company, only ownership. The white knight is typically amenable to keeping current management in place and retaining the company’s core business unit (as opposed to possibly selling it off or shutting it down).
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