Companies build up defences to keep raiders at bay

MUMBAI: Some Indian companies are considering measures to protect themselves from hostile takeovers as L&T’s Mindtree bid puts the spotlight on weak corporate defences in place to thwart raiders. These companies are seeking legal opinion, consulting lawyers and discussing ways of countering a hostile takeover in case one materialises.

ET has learnt that a Gujarat based consumer goods company, an auto ancillary company, and an information technology firm based in the South are among others who have spoken to their lawyers and are considering measures to shore up their defences, lawyers privy to the development said.

The prominent strategies being recommended by lawyers include maximising of share value, keeping promoter holdings higher, and giving different tenures for each board member. Inserting restrictive clauses such as high severance packages for promoters, restrictions on brand usage in case of hostile takeovers could also be powerful deterrents, said experts.

While hostile takeovers are common in developed markets, India has seen very few cases. But the trend could change as the promoter shareholding in several listed entities is being diluted while the institutional shareholding is on rise. The issue is relevant in the context of several mid-cap companies that are suffering due to overleveraging and high promoter pledging.

“We have received preliminary queries from few corporates about strategies that can be adopted to deter any of their competitors from undertaking a hostile takeover,” said a source privy to the development. “Most of the companies who have raised the queries are the ones whose stocks have been beaten down badly in the recent mid-cap meltdown,” he added.

One of the key strategies is maximising the share value, say legal experts. This would need the companies to keep their minority shareholders happy. Acquirers typically target those companies for hostile takeover which have sound business but their shares are trading cheaper.

“Markets typically give premium valuations to the stocks with clean governance structures; hence the stocks are too expensive for hostile takeovers. Acquirers typically target companies whose stocks are trading cheap on account of governance issues but business is solid,” said Mohit Saraf, senior partner, Luthra & Luthra. “Promoters should also keep leveraging in check since higher promoter shareholding or lower promoter leverage makes hostile takeovers difficult,”

Also, in order to maximise the share value, the companies could also use the means such as steep dividend payouts. Experts say this strategy should be used in very early stages so that it has maximum impact on the share prices.

“However, attempts to raise share prices are not always successful if the increase in share price is not significant as is evident from the dividend declaration by Mindtree, arguably, to ward off L&T’s hostile bid,” said a discussion paper released by law firm Khaitan & Co.

Another effective strategy is what is popularly known as ‘staggering boards’ where the board is divided into different groups or classes with each class having a different tenure.

For instance, consider company ‘A’ has a board of nine who have been divided into three classes ‘X’, ‘Y’ and ‘Z’. While class X could have a term of one year, members of class Y could have two-year terms and members of class Z could have tenure of say three years. Hence, at no point of time would the complete board of a company would be up for election. In order to gain board control, potential acquirers will have to wait for a long time.

“This is an effective method to keep hostile acquirers at bay,” said Sandeep Parekh, founder, Finsec Law Advisors. “However, such mechanisms cannot happen overnight, they have to be provided for in the articles of association,”

There are also clauses that companies could incorporate in articles of association to deter raiders such as a poison pill. For instance, it is a common practice in US based companies to include excessive compensation packages for top employees in case of a hostile raid. Some companies are also known to link employee stock option plan to takeover with the ESOPs vesting only if the buyout is friendly.

Also the company could place restrictions on acquirers from using the brand-name or trademark of the target company in case of a hostile takeover. For instance, salt-tosoftware conglomerate Tata Sons has put a clause in its articles that a successful hostile buyer will not be permitted to use the Tata brand name. This is a disincentive especially in consumer industries where the brand is popular.