Some hostile takeovers develop a life of their own, whisking the parties into undreamed-of territory as each side reacts to the unexpected. But when BASF pulled off the largest-ever unsolicited European takeover of a US company, it owed much to painstaking preparation and accurate anticipation of the target’s every move.
The German chemicals conglomerate finally completed its $5bn (€3.98bn) merger with Engelhard Corporation, the US catalyst and pigments manufacturer, in early June. But BASF had made its initial approach before Christmas 2005 and there had been lengthy manoeuvrings as Engelhard tried in vain to command a much higher price.
BASF’s sole corporate finance adviser was Lehman Brothers. “In the summer of 2005, we undertook an assignment to look at a number of potential opportunities for BASF,” remembers Carlos Fierro, Lehman’s co-head of European M&A and the man who led the deal’s execution. “Based on the results, a decision to pursue Engelhard was taken in the autumn.”
With Lehman’s help, BASF had been contemplating acquisitions in general for a couple of years. Its principal strategic agenda was to expand into areas that were either non-cyclical or had a different cycle to the chemicals industry, that had high technological content and were closer to the end-consumer.
Complementary purchase
It did not have to be catalysts, but catalysts fitted the bill, not least because BASF already had a chemical catalysts business of its own.
Engelhard was an industry leader in the attractive automotive catalysts sector and produced catalysts for the chemical and petroleum industries. “It also had an interesting pigments business, which played a part in the decision,” says Jan-Philipp Pfander, the coverage banker who leads Lehman’s relationship with BASF. “It was a somewhat sleepy company, with a good collection of businesses.”
Engelhard’s share price had underperformed, hovering between $25 and $30 for some years. It was over 90% institutionally-owned, with the top 10 shareholders owning about 50% of the company. With the founding family no longer on the share register, this all made it an easier target.
The company’s takeover defences included a shareholder rights agreement, a staggered board of directors and a supermajority voting provision in its charter. “But it did have one vulnerability: its charter allowed for shareholder action by written consent,” Mr Fierro says. “That meant that at any time you could go straight to the shareholders and get them to take action.”
The big question was whether to go for a friendly agreement or to make an unsolicited offer. “We decided to plan for a friendly deal, but to prepare for the option of going unsolicited,” says Dr Pfander. “And the timetable was driven by the unsolicited option.”
Expert timing
One of the traditional tactics employed in hostile bids is to combine them with a proxy fight, with the bidder nominating its own directors for election at the annual general meeting (AGM). Engelhard’s charter decreed that any such nominations for its 2006 AGM had to be submitted by January 28 – and this became key to the timing.
At a meeting just before Christmas, BASF offered Engelhard $37 a share – the stock was trading at just over $30. “To its credit, Engelhard mobilised very quickly,” Mr Fierro recalls. The board was summoned, lawyers and bankers hired. Merrill Lynch was appointed adviser, to be joined later by JPMorgan.
BASF had asked for exclusive negotiating rights. “[Engelhard] responded very quickly that it needed more money, somewhere in the $40s, but that was not where BASF was prepared to go,” Mr Fierro says. On the first business day of the year, January 3, BASF publicly announced its $37 all-cash offer, having told Engelhard that, if due diligence justified additional value, it would pay an extra $1.
The reaction in Germany was electric. It was a major news story: the first German hostile bid for a US company. So, apart from communicating the virtues of the offer to Engelhard shareholders, the bid team had to conduct an information exercise on a number of other fronts. “The German press had no feeling for US poison pills and how one might succeed against them,” Dr Pfander points out. “And we had to make sure that BASF shareholders were happy – there were concerns that BASF might be enticed to overpay.”
As soon as the offer went public, the shares shot up to $38, rising over the next few weeks to more than $40, as arbitrageurs and hedge funds climbed in on the act. The offer entered its riskiest phase. Would it flush out another bidder? Here, too, the team had done its homework.
Before deciding to go hostile, the Lehman team had reasoned that the two obvious direct competitors – both European – would be ruled out of bidding on anti-trust grounds. “We also concluded that other strategic buyers – other chemical companies – would be unlikely for various reasons to bid at the price we were offering,” says Mr Fierro. “And we calculated that financial sponsors wouldn’t bid because they couldn’t achieve the returns they require.”
That reasoning was spot on, and proved crucial to the eventual outcome. In the meantime, Engelhard quickly realised – as the team had done – that its governance structure made it vulnerable, allowing a bidder to use written consent and to start a proxy fight. So instead of sitting pat, it effectively put the company up for sale or, as they say in the trade, to “review strategic alternatives”.
Engelhard canvassed the market to solicit interest either in the complete company or in parts of it. It signed confidentiality agreements with standstill provisions with various parties, including BASF, and set a bid date of April 14. “It tried to give us the impression that a robust auction was under way,” Dr Pfander says. “If you read between the lines – well, maybe, but most likely not.”
BASF did its due diligence and, on the bid date, duly raised its bid to $38. For Engelhard, the bid date was put-up-or-shut-up time and, as it was clear that there was not going to be another bid, it had to propose something else to show that the business was worth more.
That something came in the form of a, not unexpected, leveraged recapitalisation and share buyback plan. Engelhard proposed buying back 20% of its stock at $45 a share. To ward off the written consent threat, it also proposed increasing its board from six to nine members, electing five at the June AGM.
“So the AGM would become a referendum for the shareholders,” Mr Fierro explains. “If their five were elected, they would implement the recapitalisation plan. If the BASF nominees were elected, they would presumably approve the BASF offer.”
So decision-making had shifted from management to the shareholders, and both sides stepped up their efforts at persuasion. Engelhard based its valuation on projected forecasts for 2007 and, pivotally as it turned out, on the share prices of its direct competitors. The BASF team had not spoken to shareholders earlier on.
“We didn’t want to engage in dialogue until we knew what we were fighting against,” says Thomas Ehlke, a Frankfurt-based banker who led Lehman’s day-to-day work on the transaction. But the team began chipping away at the assumptions underlying Engelhard’s forecasts, insisting that there would not be another bidder.
Market assistance
No hostile bid ever goes exactly according to plan and, in this case, the unexpected turned out to be the killer blow. On March 9, the equity market had turned down with a vengeance. Instead of continuing to rise, as Engelhard had predicted, the share prices of its competitors traded down. “That was the fatal flaw in their value proposition, which turned out to be a one-legged stool,” says Mr Fierro.
Engelhard’s stock had slipped on the recapitalisation news to just over $38. Knowing that arbitrageurs do not like selling at a discount, BASF added one last and final dollar, raising to $39 and swearing there was not another cent to come. That was the knockout. The merger agreement was signed on May 30.
Thorough preparation meant not only winning the prize, but doing so at a very tight premium to the initial offer. “In unsolicited offers in the US, the bidder always increases its bid, typically by 20% or more,” says Dr Pfander. “We did it by 5%.”
