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How to Handle a Hostile Takeover.

Shareholders in Allergan Inc. and Hillshire Brands Co. have faced a big dilemma in the past month: Each company is the subject of hostile takeover bids.

In the case of Hillshire, the first hostile bid by Pilgrim’s Pride Corp. at US$45 per share set off a bidding war, with Tyson Foods Inc. following up with a US$50 per share offer, which Pilgrim's topped with a revised offer of US$55. Hillshire is trading near US$60, as investors bet on a continuation of the takeover battle.

In the case of Allergan, Valeant Pharmaceuticals International Inc. has already changed its bid twice (increasing the cash portion of the offer) to try to get the company into the fold.

If you are lucky enough to own one of these targets, or any other target of a hostile bid, it may be tempting to just sell right away into your new windfall. But here are five things to do first in any hostile takeover before you push the sell button.

  • Take a deep breath

Like negotiating for a house — or, more appropriately, betting in a poker game — the buyer never puts its final offer out first. There is always wiggle room and the chance of a higher bid from the first bidder is always very high. Any increase might be small, or it could be big, but the key is that time is on your side.

Your target company will react to bids, not the market. You now have a security that might act differently or even be negatively correlated to the market, which can help your portfolio. Giving the bid some time also allows new buyers to emerge, as evidenced by Osisko Mining Corp.’s recent takeover.

  • Take a look at the industry/regulations/government

As investors in Potash Corp. of Saskatchewan Inc. know only too well, a government can cause plenty of interference in a potential takeover, whether it is hostile or not. The last thing you want is a deal stopped by the regulators.

Ainsworth Lumber Co. Ltd. recently had its takeover, albeit not a hostile one, thwarted by regulators, as Louisiana-Pacific Corp. did not like the conditions attached to the deal’s approval.

After the first bid is made, ask yourself if the government or regulators have the power to stop it.

  • Look at the premium in a different way

A hostile bid will be at a premium to the market. If not, well, the buyer is not really trying, is it?

There may be a nice premium of, say, 35%. That sounds good, but make sure you look at the history of the company’s share price. Maybe that's a good premium now, but the buyer is trying to get the company at a fraction of what it used to be. This occurs often in the resource sector.

Take a look at the long-term trading price of the target. Is the buyer trying to buy a cyclical company at the bottom? If so, it probably has more room in its offer price, as it would be buying for the next up cycle.

  • Take a look at your new portfolio weighting

Everyone likes to see a takeover bid, but you do not want your whole portfolio to be heavy on one stock. On occasion, takeovers fail, and stocks collapse as a result. With a premium bid, the target company’s weighting in your portfolio may have increased beyond your comfort zone. It is always okay to sell a bit for portfolio management reasons.

  • Differentiate between cash and stock bids

Cash is better, especially in a hostile deal. Shareholders in a target company almost never like stock of the bidder, because of its aggressive nature. A cash bid eliminates this issue.

However, many hostile deals are for stock, or a combination of cash and stock, such as the Allergan bid.

If the bid is for stock (or part thereof), you now need to examine another company. Would you want to own shares in the acquirer? Are the shares reasonably priced on a valuation basis? Are they volatile? Does the company have a lot of debt? Baggage? Good management?

If you do not want anything to do with the acquirer's stock, then you have less time. You may still want to wait a bit to see what happens, but you will want to sell before the deal is completed.

Because stock bids are less attractive, though, there is more chance of a sweetened offer. This is one area you need to be very careful with.

Finally, keep in mind that while such bids are deemed hostile, 95% of the time they are very friendly towards your portfolio’s net value.

Peter Hodson, CFA, is CEO of 5i Research Inc., an independent research network providing conflict-free advice to individual investors (www.5iresearch.ca).

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