Shareholders need their wits about them during takover battles.
One thing that's all but guaranteed to give your shares a boost is if another firm makes an offer to buy the company outright. Takeover bids usually lead to some dramatic share price rises and they also generate a lot of media and investor attention, not just upon the two companies involved, but other firms which operate in the same sector.
Takeovers are usually good news for shareholders in the target company, less so for those in the bidder, and they often draw attention to the different interests of the directors and shareholders in both companies.
The takeover ritual
The behaviour of both companies during the initial phases of a takeover bid is extremely predictable. Invariably the directors of the target company call the offer "derisory" and say that it "materially undervalues the company" as they draw their shareholders attention to new developments (companies which have historically treated their shareholders as a nuisance may have problems in convincing them of this).
The bidder always highlights the premium offered to the share price before the bid announcement and often resorts to scaremongering by claiming that the price is guaranteed to fall well below the pre-bid price if the bid fails (planting negative stories with friendly journalists is a common tactic to achieve this).
Things have calmed down since the early 1980s when it was standard practice for both companies in a takeover battle to take out full-page knocking-copy adverts in the national press, accusing the other of all manner of wrong-doings and dodgy dealings.
After a series of negotiations, both directly and via the media, a formal bid may be tabled and this may be accepted by the shareholders of the target (especially if recommended by their directors) or rejected because it undervalues the business.
Occasionally a third company will become involved, either by taking a protective stake in the target company (the so-called "white knight") or even making a its own bid.
The agency problem
A well-known problem for shareholders is the agency dilemma; their interests aren't the same as those of the directors of their company. This can create a conflict of interest, particularly in companies where the directors see the business as their personal fief.
Takeovers draw attention to these differences, especially in firms where the directors own trivial shareholdings in comparison to their pay and perks. As the directors of the target company may lose their jobs if the bid succeeds a major part of the negotiations is often whether they can stay on or what payoff they will get if they "resign."
In contrast the directors of the bidding company often damage their shareholders' interests by wildly overpaying for the target, due to a mixture of ego, personal aggrandisement and their desire to show how successful they are. It also helps that if they succeed this lets them justify having an even bigger pay packet (and juicier perks) after the bid because they are managing a much bigger firm.
Shareholders should be aware that the majority of takeovers fail; the acquirer would have been better off if the bid hadn't succeeded.
A failed takeover sometimes wakes up the management of the target company, who now realise that their pay (and perks) could be under threat unless they pay more attention to their shareholders' interests. Unfortunately an all too common response to this is for the remuneration committee give the directors longer notice periods which means a bigger payoff.
Cadbury v Kraft; vegelate v stringy cheese
One of the more heated takeover battles in the last few years was Kraft Food's bid for Cadbury which completed last February. I wrote in some detail about the bid in this article from the perspective of a Kraft shareholder.
During the bid a tremendous amount of vitriol was thrown at Kraft in the British media, by journalists and politicians who pretended that national takeover policy hadn't been delegated to the European Union. Kraft was strongly derided for having the nerve to sell processed cheese products. Somehow Cadbury's use of vegetable oil as a substitute for cocoa didn't to strike a similar nerve.
It's not as if chocolate is a strategic industry, or if Kraft was trying to buy a company which has national security implications such as BAE Systems (LSE: BA). But all's fair in love, war and takeover battles and Cadbury's directors played their part to the hilt by getting Kraft to pay an extremely full price; valuing Cadbury at almost 29 times historic earnings.
Warren Buffett, whose company Berkshire Hathaway is Kraft's biggest shareholder, complained that Kraft had overpaid for Cadbury (Berkshire sold 23% of its Kraft shares soon afterwards).
Buffett also criticised Kraft for having sold a pizza business to Nestlé on the cheap to raise cash for the bid. Conspiracy theorists would point out that by doing so Kraft effectively bought off the only serious potential counter-bidder for Cadbury.
Integrating Cadbury
Many takeovers fail because the buyer has problems in integrating the new business within its existing corporate structure. The initial signs are good as Kraft figures for the first as its second-quarter profits jumped by 13% in large part thanks to Cadbury.
Kraft is now cutting costs and taking advantage of Cadbury's strong presence in developing markets, particularly former British colonies like India where chocolate sales are soaring, to sell more of Kraft's existing product range into these markets. That's where the long-term growth is going to be found.
Kraft's longer-term shareholders must be hoping that Cadbury provides a much needed boost since their shares still languish below the $31.66 set on the day when Kraft was spun off from Altria in 2001. Kraft shares currently sit on a forecast P/E ratio for 2010 of around 14.5 and yield 3.9%.
As a Johnny-come-lately I'm happy to hold on for a few years to see if they get it right.
More from Tony Luckett:
> Tony owns shares in Berkshire Hathaway and Kraft
