Scorched Earth Policy
What Is a Scorched Earth Policy?
A scorched earth policy is an aggressive defense strategy used by a target company to deter endeavors of a hostile takeover by an acquirer. Named after the guerrilla warfare strategy of obliterating anything of possible use to a foe while withdrawing from a position, this course of action generally requires the company targeted for a takeover to do its best to make itself less alluring.
How a Scorched Earth Policy Works
A scorched earth policy is a last resort strategy. In both the military and corporate world, it tends to be considered a last, frantic endeavor to battle off the advances of a hostile, undesirable predator.
The goal here is to start activities that damage the company, undermining its value and future earnings potential. Strategies used to arrive at this objective incorporate selling off valued assets, piling up heaps of unpaid liability due to be reimbursed when the hostile takeover is complete, and establishing provisions that give senior management substantial payouts, for example, golden parachutes, on the off chance that another management team is brought on.
No company, or its shareholders, is probably going to need to participate in such actions except if it is completely fundamental. As a matter of fact, while seeking to ruin a hostile bid, it is more normal for target companies to start other, less harming anti-takeover measures. One model is a flip-in poison pill. This specific strategy enables shareholders, other than the acquirer, to buy extra stock in a company targeted for takeover at a discount.
Flooding the market with new shares dilutes the value of the shares previously purchased by the securing company, decreasing its percentage of ownership and making it harder and more exorbitant for it to gain control. However, this option isn't available to everybody. Poison pills must be used assuming present in the target companies standing rule or charter, implying that a scorched earth policy is at times the main viable solution left to battle off hostiles.
Types of Scorched Earth Policy Strategies
Businesses can carry out scorched earth policies in a wide assortment of ways. They can remember taking for extra debt, adopting golden parachutes for senior executives, selling off valued assets, or rescheduling debt repayment for after the proposed takeover.
All in all, every one of these defense strategies expects to make the target company less alluring to a likely hostile acquirer.
We should investigate a few specific types of scorched earth actions.
Make the Price Expensive
Perhaps of the least complex way a target can battle off a hostile takeover is by embracing a "poison pill," which offers current shareholders the chance to purchase shares at a discount.
A poison pill really weakens the ownership stake of an expected hostile acquirer and makes the target firm nonsensically costly. In December of 2020, for instance, activewear retailer Foot Locker announced the adoption of a poison pill to make preparations for a takeover endeavor by holding company Vesa Equity. Vesa Equity is controlled and run by activist investor Daniel Kretinsky, a Czech billionaire legal counselor.
Foot Locker management was put on alert when Vesa Equity purchased a 12.2% stake in the company, buying up a total of 153,730 shares. Foot Locker's poison pill was carried out to keep Vesa Equity and Kretinsky at bay. The plan terminates on Dec. 7 of 2021 and as per Foot Locker ought to reduce "the probability that any person would gain control of the Company through open market accumulation or different strategies."
Poison pills are officially known as shareholder rights plans.
Sell off Key Assets
A big justification for why hostile takeovers happen is that a potential acquirer needs to get their hands on a specific "crown gem" asset owned by a target company. However, in the event that the target company can sell off its most appealing assets to a friendly outsider, it can make a potential takeover ugly.
For instance, a core or crown gem asset can be a proprietary technology, customer database, or even a fleet of vehicles. Of course, the big difficulty with this approach is that selling off key assets can permanently damage the company. It's anything but an irreversible action. Hence, selling core assets will in general be a strategy of last resort as it were.
Get the Acquirer
In this method of defense, otherwise called the "Pac-Man Defense," the target company looks to completely make something happen by endeavoring to assume control over the acquirer. It's an aggressive strategy yet has a similar purpose as any defensive strategy: make a hostile takeover extremely hard for the acquirer and force them to abandon the endeavor.
As such, in a Pac-Man Defense, a target company answers a hostile takeover endeavor with a hostile takeover endeavor of their own.
For a Pac-Man Defense to work, the target needs critical resources. Since the Pac-Man Defense includes buying the hostile acquirer, the target company needs an adequate number of financial resources to be viewed as a trustworthy threat.
To raise the funds required for a Pac-Man defense, the target can sell off its non-core assets, sell non-core business units, borrow cash, or tap its own cash balance.
One of the most mind-blowing instances of this strategy being utilized in real life comes from 1982 while engineering and manufacturing company Bendix attempted to obtain building materials specialist Martin Marietta. Bendix managed to snatch a 70% controlling stake in Martin Marietta shares.
To battle off a complete takeover, Martin Marietta sold off several non-core business sections and borrowed $1 billion to get a half stake in Bendix. The gigantic measures of cash required to fight each other hurt the two companies. Eventually, Allied Corporation acquired Bendix.
Reactions of a Scorched Earth Policy
It is highly dangerous to Engage in these practices. The goal is to prevent a hostile takeover from occurring. A scorched earth policy is deadly to such an extent that it could prevail with regards to achieving this. The problem is that it could likewise leave the acquiree, or target company, in such a wreck that its freshly discovered freedom is brief.
A ton relies upon what measures were utilized to scare off the admirer. On the off chance that extreme advances were taken, for example, important assets being sold and heaps of debt being acquired, it might just involve time before the target company goes under.
Important
In extreme cases, a scorched earth policy could turn out to be a "self destruction pill."
Committing suicide is a high price to pay for freedom and one that will most likely lead to a revolt from shareholders, regardless of the fact that they are so against being gobbled up by another company. In the event of a takeover, cash or shares in the new company will be coming their direction. Bankruptcy, then again, will probably leave them with essentially nothing.
Limitations of a Scorched Earth Policy
If all the board of directors (B of D) do some way or another concur that a scorched earth policy is worth carrying out, they actually must conquer a few possibly troublesome obstructions. The hostile company might look for a injunction against the company's defensive actions and could possibly prevent the board from stopping the takeover bid.
For instance, a steel company could threaten to purchase a manufacturer entangled in lawsuits for making poor quality parts.
In this case, the target company would try to purchase the future liabilities associated with any claim settlement with an end goal to burden the new, combined company with those liabilities, making it ugly to hostile bidders.
However, the option to possibly ruin itself isn't in every case completely at the target company's prudence. The hostile bidder in this scenario might have the option to secure a court injunction to stop this acquisition, which, if fruitful, would successfully foil the steel company's scorched earth policy.
Scorched Earth Policy FAQs
What Is a Scorched Earth Political Policy?
A scorched earth political policy is pointed toward obliterating either the opposition party or the system itself with the goal that it can't proceed.
Has a Scorched Earth Policy Been Used in Business?
Indeed. Businesses have consistently executed scorched earth policies as means to shield against or put hostile takeovers down. For instance, computer monster HP adopted a poison pill in February of 2020 to battle off Xerox's hostile takeover bid.
Highlights
- Quite possibly of the easiest way a target can fight off a hostile takeover is by embracing a "poison pill," which offers current shareholders the chance to purchase shares at a discount; really weakening the ownership stake of the likely acquirer.
- The fundamental problem with scorched earth policy is that it could leave the acquiree, or target company, in such a wreck that its recently discovered freedom is brief.
- Once in a while, hostile bidders secure injunctions to prevent the target company from implanting a scorched earth policy.
- In a "Pac-Man Defense," the target company answers a hostile takeover endeavor with a hostile takeover endeavor of their own.
- A scorched earth policy is a last-ditch endeavor to dissuade a hostile takeover by making the target company ugly to the expected acquirer.
- Strategies incorporate selling off valued assets, piling up heaps of unpaid liability, and promising management substantial payouts if they are one day excused.
- The price to pay for freedom could be leaving business as many scorched earth measures are difficult to recuperate from.
