Forget poison pills and golden parachutes – it’s starting to seem that the best form of anti-takeover protection may be the change of control provisions that tend to accompany (over-)leverage.  Look no further than several proxy battles, currently underway, to recognize their importance.  The hostile acquirors in each may have figured out how to best the traditional defenses used by companies, but some have been most slowed by the target’s lenders, threatening to pull loans or put bonds.  While these contractual clauses, found in a target’s credit agreements or debt indentures, seemed innocuous during boom times, today they seem to be anything but.

As background, change of control is considered an “event of default” under many credit agreements, accelerating debt repayment among other things.  These clauses are purposefully inserted, to allow banks to re-evaluate credit risk or worse, in the event of a change. This is necessary – banks evaluate credit risk on an individual basis and the emergence of a new owner or management team can lead many a banker to second thoughts.  True at any point, banks can be especially standoffish in the case of hostile takeovers during economic downturns. 

Several proxy fights underway today make this risk clear, at times painfully so.  The battles underway between energy companies Exelon/NRG, Hedge Fund SRM/Hudbay, and Icahn Associates/Lions Gate Entertainment each play out around credit issues.  These concerns can lead banks to pull credit lines.  No surprise, these same concerns can also lead aggressive suitors to back down or seek alternative financing.  Cautionary tales in their own right, they should be carefully regarded by others, including the fund bidding for Target Corp, Pershing Square Capital. 

The extreme of bank pull-back is playing out in Hudbay’s proxy war with SMR.  This fight is illustrative of how lenders react to drawn out proxy contest when they have the choice of renewing or allowing credit lines to lapse. Hudbay, a Canadian base metals miner, got into a proxy contest with an activist hedge fund because it entered into a $525-million merger with Lundin Mining Corp. SRM, a hedge fund, called a special meeting to remove the entire board of directors.  The transaction with Lundin was dealt a serious setback on January 23, 2009 when the Ontario Securities Commission (OSC) set aside the Toronto Stock Exchange’s earlier decision granting conditional approval for the listing of the HudBay shares,which were supposed to be issued as consideration in the Lundin transaction. The OSC also ordered that the shareholders should be given an opportunity to vote on the deal. Hudbay called off the merger before shareholders ever voted, but SRM has continued its proxy contest to replace the board.

The proxy contest, and the uncertainty that it is causing, led lenders to not renew a $65 million credit facility to the Hudbay.  Management doesn’t believe the revocation will be material, given their deep pockets, but the situation is living proof of why banks write change of control provisions into contracts.  The special meeting is set for March 25, 2009 and several major proxy firms have all recommended against the disruptive board ouster.  That said, the SRM hedge fund seems intent on performing a massive share buyback with the firm’s capital in order to satisfy redemption requirements.

Looking to avoid that outcome is energy company NRG, which has an $8 billion debt overhang acting as its defense.  Ironically, they have a staggered board, but the thing that seems to be really hindering Exelon’s hostile takeover bid is change of control provisions on credit facilities and debt documents. The staggered board provision is arguably dysfunctional and allows it is to be expanded by a simple majority vote shareholders.  Would-be acquirer Exelon was well aware of this chink in NRG’s armor when it decided to launched a hostile takeover campaign. To get around the classification of the board, it initiated an exchange offer for all the company’s outstanding shares, submitted a shareholder proposal to expand the NRG’s 12 seat board to 19, and nominated a slate of nine directors. Still, Exelon was aware of NRG’s $8 billion or so in total debt would require refinancing in the event of a change in control and decided to try any way.

Alternative debt financing is the other way to go. Lion Gate doesn’t have any antitakeover protections drafted into its articles of incorporation, but the change of control provisions on its credit facility is forcing an activist hedge fund to structure its deal differently. Carl Icahn’s High River recently increased its stake in the studio to 14.5%. Icahn already announced his intentions to possibly agitate for expanding the size of the board or removing directors and that he might call a special meeting for these purposes. The media company was in the process of negotiation a stand-still agreement with Ichan until talks broke down on certain terms. Still, the activist funds can’t go too far. Lions Gate has a change of control provision in its $340 million five-year senior secured revolving credit facility.  It is set to trigger when any person or group acquires ownership greater than 20% of voting shares (not merely beneficial ownership).  Icahn doesn’t seem cowed – he recently launched a tender offer to purchase $325 million convertible notes.  This debt position will give him additional leverage without pushing him over the 20% voting limit but isn’t seen as a trigger pull. 

All of this should serve as fodder in the strategy of hedge fund Pershing Square, attempting to take over Target Corp.  That company has multiple takeover defenses in place, along with its secret weapon: a $2 billion credit facility (yet to be drawn).  It has a motivated opponent, too: Pershing has an entire fund that is dedicated solely to investing in retail giant Target and owns 9.97%.  Pershing Square is now nominating 5 members to Target’s classified board (yet the retail also has a poison pill). If Pershing gets through the poison pill and waits out 2 voting cycles, it should hope that credit markets are open for business again because the company has that $2.0 billion credit facility, with a change of control trigger attached. In sum, the facility would expire as soon as the majority of its directors are not made of members solicited by the Board of Directors. Considering all of this, it seems that Target is actually not an easy target…but is any company really a fortress in today’s depressed equity markets?

In today’s depressed equities market, no one can be too careful. So while poison pills and staggered boards are excellent anti-takeover devices, perhaps the more mundane credit facilities and their change of control provisions are important contract terms that can help to ward off unwanted attention. Getting a credit line pulled while the end of the credit crisis isn’t yet quite in sight is a factor that will cause even the most implacable of hostile acquires to think twice.

Published: March 19, 2008