Conventional Wisdom

Over the last month, each of the major stock market indices has experienced extreme volatility and a broad-based decline in value, largely in response to the coronavirus pandemic. The bellwether Dow Jones Industrial Average has declined 34%, while the S&P 500, the Nasdaq Composite and the Russell 2000 indices have experienced declines of 32%, 29% and 40%, respectively. The hospitality, retail, transportation and oil and gas industries have been hit particularly hard, with the oil and gas industry confronting a second issue with Saudi Arabia initiating an oil price war with Russia and the subsequent price of oil and oil-related stocks plummeting.

Conventional wisdom would suggest a resulting increase in hostile M&A activity is likely to occur, as opportunistic acquirors take advantage of companies that are undervalued and, in some cases, particularly vulnerable due to liquidity concerns. During the financial crisis of 2008, the number of unsolicited public offers for U.S. targets spiked 54% from 41 to 63 over the prior year (and then dropped to normalized historical levels in the mid-30s for each of the next three years).[1] Similarly, activist shareholders were emboldened to launch 126 and 133 proxy fights in 2008 and 2009, respectively, against U.S. companies – more than in any year since.[2]

Number of Unsolicited Public U.S.-Target M&A Deals

We note in this regard that U.S. corporations may be more vulnerable to opportunistic hostile bids than at any time in recent history, with many companies having dismantled valuable takeover defenses over the last two decades. For example, 10% of S&P 500 companies currently have classified boards, down from 39% in 2010 and 60% in 2000.[3] Likewise, relatively few companies now have “poison pill” shareholder rights plans in place (although many companies have poison pills “on the shelf” and ready to be deployed). At the same time, other companies have built up massive cash balances over the course of the economic expansion of the last decade and are capable of deploying that cash toward acquisitions. Private equity funds have also built up lots of dry powder, with the industry holding a total of $1.5 trillion in unspent capital available for acquisitions at the end of 2019.[4]

For those funds who view the current decline in the markets as temporary, the current situation offers a tremendous opportunity to advance investment objectives. For example, Carl Icahn has increased his stake in (1) Hertz Global Holdings Inc. (HTZ) to 38.9% after purchasing 11.4 million shares at $7.43/share,[5] (2) Newell Brands Inc. (NWL) to 10.7% after purchasing 2.58 million shares at 13.41/share,[6] and (3) Occidental Petroleum Corp. (OXY) to 9.9% from 2.5% at a range of $17.11 – $12.68/share.[7] To put those purchases in context, at market close on January 31, 2020, HTZ was priced at $15.76/share, NWL at $19.53/share and OXY at $39.72/share.

Indeed, several companies have already adopted poison pills following the plunge in their stock price over the last couple of weeks, resulting in stock prices they believe do not nearly reflect their companies’ intrinsic value. Some of these companies, such as Delek US Holdings, Inc., have already been grappling with shareholder activism, while others, such as The Williams Companies, Inc. and Dave & Buster’s Entertainment, Inc., have adopted poison pills proactively to fend off opportunistic bidders and activist hedge funds. All of these poison pills have terms of no longer than one year, a term that qualifies for less restrictive treatment from the proxy advisory firms.[8]

Countervailing Considerations

At least in the short term, there may be some countervailing considerations that could dampen or delay the otherwise expected wave of shareholder activism and unsolicited M&A.

• In times of unprecedented uncertainty and volatility, shareholders may favor stability, continuity and institutional knowledge, and defer their interest in shaking things up to a later time. Shareholders may focus more on value preservation than value creation in the short term.
• It may be more difficult to get shareholders focused on activist campaigns, particularly those focused on longer-term governance concerns rather than board and management under-performance. In addition, it may be difficult to get face-to-face or even telephonic meetings organized with large shareholders, given social distancing requirements and the fact that many investor representatives are working remotely.[9]
• Tried and true activist strategies may be less attractive in the current climate. For example, returning cash to shareholders through special dividends or share buybacks is not likely to be a compelling idea at a time when fundamental business uncertainties suggest that most companies would be prudent to conserve a sizable cash cushion and companies without sufficient liquidity begin to fail.
• The optics are bad. Given the concerns we are all grappling with about the health and safety of our families and friends and the threat of a long-term downturn in the economy, an activist campaign seeking short-term profits or a hostile bid may seem opportunistic and particularly unseemly at this time.
• A hostile bid at a time of a rapid market downturn, particularly one that may not reflect weakness in a company’s underlying business, long-term prospects or the overall economy, may give the board of directors more leverage to employ strong tactics to defend against the bid. The Delaware law standard for the evaluation of takeover defenses, Unocal v. Mesa Petroleum, requires the board, when taking defensive actions, to identify a legally cognizable threat to corporate policy and effectiveness and to demonstrate that the defensive actions employed are reasonable in relation to that threat.[10] It has been well settled for decades under Delaware law that an offer that the board, in the exercise of due care, determines to be inadequate, constitutes a legally cognizable threat justifying continued deployment of a poison pill and potentially other steps.[11] It is also well settled that the greater the threat, the more aggressive the board can be in repelling it.[12] As a result, Delaware courts may provide additional latitude to boards protecting against inadequate hostile offers in the current environment.
• The uncertainty of the availability and cost of debt financing during this time of market disruption has had a clear impact on private M&A already, and will certainly have an adverse impact on the ability of many acquirors to pursue hostile bids for cash consideration. In addition, private equity sponsors will need to decide where best to allocate their time and resources – whether to pursue new deals or to focus on their portfolio companies, which are themselves experiencing unprecedented challenges.
• Many potential strategic acquirors may themselves be distracted by addressing the impact of the COVID-19 outbreak on their own businesses. Despite the potential benefits of attractively priced acquisitions, hostile M&A is expensive, time-consuming and risky, and strategics will need to consider whether their time is better spent with their own customers, employees and shareholders than with aggressive expansion. And companies may be incentivized to hoard cash rather to use it for acquisitions, even at attractive valuations.
• The COVID-19 outbreak also raises logistical issues that could impact shareholder activism and hostile M&A in the short term. For example, it may be more difficult to identify and engage with director nominees, and director nominees may take longer to provide the required responses to director nominee questionnaires or to consult with their current employers or other companies on whose boards they serve in order to get clearance to be a nominee. In addition, the process of moving shares from street name into record name, so that a shareholder is recognized as a record owner and can directly exercise shareholder rights, may take longer than usual with brokers operating with reduced staffs.

Conclusions

There is little doubt that hostile M&A and shareholder activism will increase if stock prices remain at the current depressed levels. While there may be good reason to believe that a new wave of hostile M&A and shareholder activism will be delayed until current healthcare and market conditions stabilize, we can be certain that internal M&A and corporate development departments, investment bankers and other industry participants are already working to identify potential acquisition targets. While this bodes well for a return to heightened activity levels in the broader M&A market, it also may portend a wave of hostile M&A once the time is right. Company boards and management would be well advised to get out in front by reviewing their takeover defenses with counsel, reconsidering their plans for maximizing shareholder value and considering proactive outreach to their shareholders.

[1] Thomson Reuters.

[2] FactSet.

[3] Deal Point Data; ISS Analytics.

[4] “[Private equity firms] have amassed almost $1.5 trillion in unspent capital, the highest year-end total on record, according to data compiled by Preqin.” See Melissa Karsh and Benjamin Robertson, Private Equity Is Starting 2020 With More Cash Than Ever Before, Bloomberg (Jan. 1, 2020), available at: https://www.bloomberg.com/news/articles/2020-01-02/private-equity-is-starting-2020-with-more-cash-than-ever-before.

[5] TipRanks, Billionaire Carl Icahn Picks up These 2 Stocks on the Dip, Yahoo! Finance (Mar. 15, 2020), available at: https://finance.yahoo.com/news/billionaire-carl-icahn-picks-2-115019189.html?mod=article_inline.

[6] Id.

[7] “‘I’m just glad I can afford to quadruple down,’ Mr. Icahn said.” Cara Lombardo, Carl Icahn Boosts Occidental Stake to Almost 10% as Shares Plummet, Wall Street Journal (Mar. 11, 2020), available at: https://www.wsj.com/articles/carl-icahn-boosts-occidental-stake-to-almost-10-as-shares-plummet-11583969050.

[8] Proxy advisory services, such as Institutional Shareholder Services Inc. (ISS), may recommend a vote against or withhold from directors who adopt a poison pill without stockholder approval. However, ISS also will consider votes on a case-by-case basis if the poison pill has a term of one year or less, depending on the disclosed rationale for the adoption and other factors (such as a commitment to put any renewal to a stockholder vote). ISS United States Proxy Voting Guidelines Benchmark Policy Recommendations, published Nov. 18, 2019, pp. 12-13.

[9] However, this doesn’t necessarily cut in favor of management, as the retail shareholder base – which tends to support incumbent management – may experience a higher percentage of distracted shareholders than large institutional shareholders, giving the large institutional shareholders even more weight than they otherwise have in the outcome of the contest. See Alon Brav, Matthew D. Cain, Jonathon Zytnick, Retail Shareholder Participation in the Proxy Process: Monitoring, Engagement, and Voting, European Corporate Governance Institute – Finance Working Paper No. 637/2019 (Nov. 6, 2019), at 22, 43, available at: https://ssrn.com/abstract=3387659 (Reporting that in a survey of proxy votes in U.S. companies from 2015-2017, retail shareholders supported 94% of management sponsored proposals and noting that, “The support rates measured at the retail account level are higher than those reported when support is measured at the shareholder level.”); see also Gretchen Morgenson, Small Investors Support the Boards. But Few of Them Vote., New York Times (Oct. 6, 2017), available at: https://www.nytimes.com/2017/10/06/business/small-investors.html.

[10] Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 954-955 (Del. 1985).

[11] Air Prods. & Chems., Inc. v. Airgas, Inc., 16 A.3d 48, 124 (Del. Ch. 2011); Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d 1361, 1384 (Del.1995).

[12] Stahl v. Apple Bancorp, Inc., 579 A.2d 1115, 1124-1125 (Del. Ch. 1990) (“The essence of the Unocal form of review is a judicial assessment of the proportionality of a response to a threat.”).

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