Updated: May 11, 2020
Pac-Man. Golden Parachutes. Greenmail. These are probably three terms or phrases that you didn’t expect to see at the beginning of an investment article. But, throughout the course of this post, you’ll be acquainted with these terms and learn exactly what they mean and how they’re relevant in the world of investment, and, in particular, in Mergers and Acquisitions (M&A’s).
Last time out, we discussed the nature of M&A transactions, and the reasons why they can become hostile. Before continuing, if you haven’t already read that article, I highly recommend that you check it out here. Today, however, we’re going to be talking about some of the defence mechanisms and strategies that target firms can put into place to stop themselves from being the subject of a hostile takeover – which is also known as ‘Shark Repellent.’ There are numerous strategies employed and enacted by companies to carry out this function, but in this article, I’m going to focus on three that I find most interesting. Enjoy!
A golden parachute is not exactly what you might think. Rather, it is a term used to refer to significant financial benefits given to senior executives or management officials at a company when it is acquired by another firm, and the contracts of these managing directors are terminated as a consequence of the M&A transaction. Generally speaking, golden parachutes provide a firm with away to repel the sharks and ward off an unwanted takeover attempt.
How do they work?
Let’s take the following example. Kraft Foods Inc. wanted to acquire Cadbury’s PLC in 2009. Had Cadbury’s wanted to prevent this hostile takeover, they could have used golden parachutes. This would have meant that their senior managing executives would have been given lucrative contracts, most likely with extremely generous severance pay*, so that, if Kraft wanted to implement its own management team after the deal, it would have to pay a substantial amount of money to remove the initial Cadbury’s employees from their positions. Golden parachutes are therefore given their name because they are supposed to offer executives a ‘soft landing’ when they lose their jobs.
A real-life example of a soft (well, extremely soft) landing, can be found in the June 2012 deal that saw Duke Energy take over Progress Energy. In a bid to prevent the takeover, Progress Energy offered their then-CEO, William (Bill) D. Johnson a golden parachute compensation package. However, this didn’t phase Duke Energy, and they still completed the M&A. Yet, after just short of an hour on the job as the new CEO of Duke Energy, Bill Johnson decided to resign, due to a clash of leadership ideals. Due to his golden parachute, he earned $44.4 million USD, which isn’t too shabby.
*Please note that benefits tied to golden parachutes do not only entail generous severance payments. Sometimes, a golden parachute will detail in the contract that, if terminated, the company will still have to cover the employee’s medical, dental or other types of insurance and legal fees, as well as offer them cash bonuses and stock options.
Further Examples of Golden Parachutes
Below we have included some notable Golden Parachute examples that have been taken from the Investopedia web page:
Meg Whitman, chief executive officer (CEO) of Hewlett-Packard Enterprise, stands to receive almost $9 million if there is a change of control at the company, and more than $51 million if she is terminated.
Until a federal court blocked it in May 2016, Staples Inc. and Office Depot Inc. were exploring a merger. Had they merged, the CEO of Office Depot would have collected $39 million under the terms of his golden parachute.
Dell Inc. is in the process of merging with storage giant EMC Corporation. Per the terms of his golden parachute, EMC’s CEO will receive compensation worth $27 million.
Imagine the following scenario: The supermarket company, Sainsbury’s, wants to acquire its rival, Tesco. Sainsbury’s might start to buy shares in Tesco, as it would give it a larger shareholding majority. But, Tesco doesn’t want to deal with Sainsbury’s – it is unwilling to be part of an M&A. Consequently, Tesco might greenmail Sainsbury’s. This essentially involves Tesco buying back its shares from Sainsbury’s at a significant premium (at a much higher price than what it sold them for originally), as long as Sainsbury’s agree not to attempt a takeover of Tesco again the future. It may also be the case that Tesco prohibits Sainsbury’s from buying its shares for a certain period of time.
In this case, both Tesco and Sainsbury’s come out as winners. Tesco are protected from a future takeover from Sainsbury’s, and can continue to function as normal. Likewise, Sainsbury’s make a large profit from the greenmail payment, and can put it towards investing in their own business development, instead of taking over another.
Greenmail, conceptually similar to blackmail (although the former involves legitimate money), is outlawed now by many regulatory bodies across the world as an anti-takeover practice, but, particularly in the 1980s, was a very common occurrence. Investors known as corporate raiders would invest in a company, threatening a hostile takeover, and then sell the shares back at a profit, just to make a bit of money. Pretty cheeky right?
I can hear you all calling out for a real-life example, so here it is:
Sir James Goldsmith was a well-known corporate raider in the 1980s. Most famously, he masterminded two greenmail campaigns against St. Regis Paper Company and Goodyear Tire and Rubber Company. From these, Goldsmith raked in a hefty combined sum of $144 million USD, in only a matter of months. How did he do this? Read on to find out!
In October 1986, Goldsmith bought an 11.5% stake in Goodyear at an average cost of $42 a share. He threatened a hostile takeover, but Goodyear said no, and so Goldsmith offered, in what is know as a ‘goodbye kiss,’ to sell back his shares to the company for $49.50 per share. As you can imagine, this returned Goldsmith a large profit.
Remember when you were younger and computers had only three interesting features – Paint, Pinball and Pac-Man. You probably haven’t heard of the latter since then, but the formerly popular arcade game has fascinating ties to the investment world. You might be wondering how, so, let me explain:
In the arcade version of Pac-Man, a little figure would go around eating yellow dots while avoiding four ghosts in an enclosed maze. However, if your Pac-Man ate a power-pellet, it could turn around and chase the ghosts. Companies around the world have copied this strategy, in a bid to prevent a hostile takeover.
How does it work?
In the above example, Sainsbury’s wanted to acquire Tesco (very unrealistic, but go with it!), and so we will adopt this example again. Sainsbury’s may be persistent, and try to find ways to make Tesco susceptible to a takeover, whether it be by making a tender offer, or by purchasing a majority stake in the company. However, if Tesco is unwilling to talk, it can employ the Pac-Man’s Defence, in which it might turn around and make a bid to acquire Sainsbury’s! Tesco could try to buy back some of its shares, or even attempt to buy equity in Sainsbury’s. Whilst quite rare, it can happen, although usually, it will involve a smaller firm trying to acquire a larger one.
Will Kenton says the following:
“For some companies, the Pac-Man defense is one of the few options available when faced with a hostile takeover attempt. Without getting aggressive and fighting back, the company may have no chance of surviving. However, on the downside, the Pac-Man defense can be an expensive strategy that may increase debts for the target company. Shareholders may suffer losses or lower dividends in future years.”
A real-life example? Go on then…
It’s 1982. Michael Jackson’s Thriller has just been released, Italy have won the FIFA World Cup, Argentina are invading the Falklands, and Prince William was born. But, over in the corporate world, Bendix, an American manufacturing and engineering company, has just made an offer to buy Martin Marietta Corporation, a supplier of aggregates and heavy building materials. Bendix buys the majority of Martin Marietta’s shares, and has effective control over the company. What happens next? Well, in short, Martin Marietta does something completely unprecedented, and carries out the first known Pac-Man’s defence. It sold its non-core businesses and orchestrated its own hostile takeover of Bendix!
Please show your support for the blog by adding your email to the subscription list below. You will only receive emails when a new article is posted, and that way, you can stay up-to-date with the latest news.
Thanks for reading!