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AlliedSignal Takes Over AMP
AMP was the world™s largest producer of cables for computers and other electronic
equipment. Its performance had disappointed investors, and the company was widely
viewed as ripe for change in operations and management.
AlliedSignal believed that it could make these changes faster and better than AMP™s
incumbent management. So in summer 1998, when AMP announced that its quarterly
profits were down 50 percent, AlliedSignal declared that it would bid $44.50 per share
for AMP™s stock. AMP™s stock price immediately bounded by nearly 50 percent to about
$43 per share.
AMP at first seemed impregnable. It was chartered in Pennsylvania, which had
passed tough antitakeover laws. Pennsylvania corporations could “just say no” to
takeovers that might adversely affect employees and local communities. AMP had also
protected itself against takeover by establishing a poison pill. This gave its sharehold-
ers the right to buy more shares at a bargain price if there was a bid.
taken by a target firm to
AlliedSignal held out an olive branch, hinting that price was flexible if AMP was
avoid acquisition; for
ready to talk turkey. When its proposal was rebuffed, Allied decided to go ahead with
example, the right for
its offer and 72 percent of AMP shareholders accepted. However, there was still the
existing shareholders to buy
problem of the poison pill, and AlliedSignal™s offer stated that it was not obliged to buy
additional shares at an
any shares until the poison pill was removed. This was not something that AMP™s man-
attractive price if a bidder
agement was likely to do voluntarily.
acquires a large holding.
AMP fought back vigorously. It announced a plan to borrow $3 billion to repurchase
its shares at $55 per share”its management™s view of the true value of AMP stock. At
the same time it asked the Pennsylvania legislature to pass a law that would effectively
bar the merger. The governor gave his support and in October the bill was approved in
the Pennsylvania House of Representatives and sent to the Senate for consideration.
6 The principal federal act regulating takeovers is the Williams Act of 1968.

An Italian Takeover Battle
possibility was for Telecom to borrow a large amount of
Hostile takeovers were almost unheard of in Italy” that
cash and use it to buy back some of its shares. In-
is, until 1999 when Olivetti made a takeover bid for Tele-
vestors would then know that Telecom had every incen-
com Italia. What made this bid even more remarkable
tive to cut costs and generate the extra cash to pay off
was the fact that Telecom was seven times the size of
this debt. Another potential defense was for Telecom to
look for a “ white knight” that would make a more con-
The recently privatized Telecom was Italy™s principal
genial partner.
fixed-line telecommunications firm. Its performance,
In the business plan that it sent to shareholders,
however, had been lackluster and Olivetti saw plenty of
Telecom stated that it was proposing to acquire the re-
room for improved efficiency. Therefore, in November
mainder of TIM shares and also to buy back some of its
1998 Olivetti set about appointing advisers for a possi-
shares. Soon afterwards it announced that it had found
ble bid. These consisted of the Italian investment bank
a white knight in the form of a German company,
Mediobanca and three American firms, Chase Manhat-
Deutsche Telekom, and would shortly submit the pro-
tan, Lehman Brothers, and Donaldson, Lufkin & Jen-
posal to shareholders. Investors were not convinced
rette (DLJ).
that a takeover with Deutsche Telekom would make
Everybody agreed that Olivetti would have to offer
sense, and The Wall Street Journal likened the prospect
mainly cash to Telecom shareholders rather than
to two elephants mating. There was a further potential
Olivetti™s shares. The company would need to borrow
problem with such a merger. The German government
this cash, and to pay it back it would have no choice
retained a large holding in Deutsche Telekom and would
but to run a tight ship and keep costs under control.
therefore be the dominant shareholder in a merged firm.
Chase, therefore, set about signing up a syndicate of 25
The Italian government retained the right to veto any
major banks that would be prepared to lend 22.5 billion
merger involving Telecom Italia. It was unlikely to object
euros, equivalent to nearly $24 billion.
to Olivetti as a merger partner, but it might be unhappy
Olivetti made its takeover bid for Telecom in Febru-
to see the country™s principal telecommunications com-
ary 1999. The bid was worth over 50 billion euros and
pany largely controlled by another government. So al-
the cash would come from a mixture of the syndicated
though Deutsche Telekom™s offer was more generous
bank loan, an issue of bonds, and an issue of shares.
than Olivetti™s, investors were far from certain that it
Investors™ initial response to the offer was lukewarm.
would be allowed to proceed.
Some doubted whether a minnow like Olivetti could
In March Olivetti upped its bid for Telecom by 15
successfully swallow a whale like Telecom. Although
percent. The new bid was worth 58 billion euros and of-
the offer price was more than a third higher than Tele-
fered Telecom investors a profit of over 50 percent on
com™s market price before the bid, many investors re-
the January stock price. In May 1999 Telecom Italia™s
garded it as too low.
shareholders began to respond to Olivetti™s bid. At first
Telecom began to prepare its defenses. It too ap-
there was only a trickle of acceptances, but by the time
pointed three advisers” Banca IMI, J. P. Morgan, and
the offer closed 3 weeks later, the trickle had become a
Credit Suisse First Boston (CSFB). They ran through a
flood and it was clear that Olivetti had won.
number of possible measures that the company could
take. One possibility was for Telecom to turn the tables
Source: The bid for Telecom Italia is described in M. Walker, “The
by making a bid for Olivetti. Another idea was that Tele- Sack of Telecom Italia,” Euromoney, July 1999, pp. 30“46. A record
com should buy the remaining shares of TIM, a com- of the offer, together with copies of press releases and other informa-
pany in which it already had a holding. This would make tion, is provided on www.olivetti.com/press/.
Telecom a still larger bite for Olivetti to swallow. A third

Meanwhile AlliedSignal was discovering that it too had powerful allies. About 80
percent of AMP™s shares were owned by mutual funds, pension funds, and other large
investors. Many of these institutions publicly disagreed with AMP™s stubbornness. The
College Retirement Equities Fund (CREF), one of the largest U.S. pension funds, then
took an extraordinary step: it filed a legal brief supporting AlliedSignal™s case in the


federal court. Then the Hixon family, descendants of AMP™s co-founder, made public a
letter to AMP™s management expressing “dismay” and asking, “Who do management
and the board work for? The central issue is that AMP™s management will not permit
shareholders to voice their will.”7
As the weeks passed, AMP™s defenses, while still intact, did not look quite so strong.
By mid-October, it became clear that AMP would not receive timely help from the
Pennsylvania legislature. In November, the federal court gave AlliedSignal the go-ahead
to ask shareholders to vote to remove the poison pill. Remember, 72 percent of its stock-
holders had already accepted AlliedSignal™s tender offer.
Then, suddenly, AMP gave up: management had found a white knight when Tyco
Friendly potential acquirer International came to its rescue. Tyco was prepared to offer stock worth $55 for each
sought by a target company AMP share. AlliedSignal dropped out of the bidding; it didn™t think AMP was worth
threatened by an unwelcome that much.
suitor. What are the lessons? First, the example illustrates some of the stratagems of merger
warfare. Firms like AMP that are worried about being taken over usually prepare their
defenses in advance. Often they will persuade shareholders to agree to shark-repellent
Amendments to a company changes to the corporate charter. For example, the charter may be amended to require
charter made to forestall that any merger must be approved by a supermajority of 80 percent of the shares rather
takeover attempts. than the normal 50 percent.
Firms frequently deter potential bidders by devising poison pills, which make the
company unappetizing. For example, the poison pill may give existing shareholders the
right to buy the company™s shares at half price as soon as a bidder acquires more than
15 percent of the shares. The bidder is not entitled to the discount. Thus the bidder re-
sembles Tantalus”as soon as it has acquired 15 percent of the shares, control is lifted
away from its reach.
The battle for AMP demonstrates the strength of poison pills and other takeover de-
fenses. AlliedSignal™s offensive still gained ground, but with great expense and effort
and at a very slow pace.
The second lesson of the AMP story is the potential power of institutional investors.
The main reason that AMP caved in was not failure of its legal defenses but economic
pressure from its major shareholders.
Did AMP™s management and board act in the shareholders™ interests? In the end, yes.
They said that AMP was worth more than AlliedSignal™s offer, and they found another
buyer to prove them right. However, they would not have searched for a white knight
absent AlliedSignal™s bid.

Is it better to own shares in the acquiring firm or the target? In general, shareholders of
the target firm do best. Franks, Harris, and Titman studied 399 acquisitions by large
U.S. firms between 1975 and 1984. They found that shareholders who sold following
the announcement of the bid received a healthy gain averaging 28 percent.8 On the other
hand, it appears that investors expected acquiring companies to just about break even.

7 S. Lipin and G. Fairclothy, “AMP™s Antitakeover Tactics Rile Holder,” The Wall Street Journal, October 5,
1998, p. A18.
8 J. R. Franks, R. S. Harris, and S. Titman, “The Postmerger Share-Price Performance of Acquiring Firms,”

Journal of Financial Economics 29 (March 1991), pp. 81“96.
Mergers, Acquisitions, and Corporate Control 585

The prices of their shares fell by 1 percent.9 The value of the total package”buyer plus
seller”increased by 4 percent. Of course, these are averages; selling shareholders
sometimes obtain much higher returns. When IBM took over Lotus, it paid a premium
of 100 percent, or about $1.7 billion, for Lotus stock.
Why do sellers earn higher returns? The most important reason is the competition
among potential bidders. Once the first bidder puts the target company “in play,” one or
more additional suitors often jump in, sometimes as white knights at the invitation of
the target firm™s management. Every time one suitor tops another™s bid, more of the
merger gain slides toward the target. At the same time the target firm™s management
may mount various legal and financial counterattacks, ensuring that capitulation, if and
when it comes, is at the highest attainable price.
Of course, bidders and targets are not the only possible winners. Unsuccessful bid-
ders often win, too, by selling off their holdings in target companies at substantial prof-
its. Such shares may be sold on the open market or sold back to the target company.10
Sometimes they are sold to the successful suitor.
Other winners include investment bankers, lawyers, accountants, and in some cases
arbitrageurs, or “arbs,” who speculate on the likely success of takeover bids.
“Speculate” has a negative ring, but it can be a useful social service. A tender offer
may present shareholders with a difficult decision. Should they accept, should they
wait to see if someone else produces a better offer, or should they sell their stock in
the market? This quandary presents an opportunity for the arbitrageurs. In other words,
they buy from the target™s shareholders and take on the risk that the deal will not go

Leveraged Buyouts
Leveraged buyouts, or LBOs, differ from ordinary acquisitions in two ways. First, a
large fraction of the purchase price is debt-financed. Some, perhaps all, of this debt is
junk, that is, below investment grade. Second, the shares of the LBO no longer trade on
the open market. The remaining equity in the LBO is privately held by a small group of
(usually institutional) investors. When this group is led by the company™s management,
the acquisition is called a management buyout (MBO). Many LBOs are in fact MBOs.
In the 1970s and 1980s many management buyouts were arranged for unwanted di-
visions of large, diversified companies. Smaller divisions outside the companies™ main
lines of business often lacked top management™s interest and commitment, and divi-
sional management chafed under corporate bureaucracy. Many such divisions flowered
when spun off as MBOs. Their managers, pushed by the need to generate cash for debt
service and encouraged by a substantial personal stake in the business, found ways to
cut costs and compete more effectively.
During the 1980s MBO/LBO activity shifted to buyouts of entire businesses,
including large, mature public corporations. The largest, most dramatic, and best-

9 The small loss to the shareholders of acquiring firms is not statistically significant. Other studies using dif-
ferent samples have observed a small positive return.
10 When a potential acquirer sells the shares back to the target, the transaction is known as greenmail.

11 Strictly speaking, an arbitrageur is an investor who makes a riskless profit. Arbitrageurs in merger battles

often take very large risks indeed. Their activities are sometimes known as “risk arbitrage.”

documented LBO of them all was the $25 billion takeover of RJR Nabisco in 1988 by
Kohlberg Kravis Roberts (KKR). The players, tactics, and controversies of LBOs are
writ large in this case.

RJR Nabisco12
On October 28, 1988, the board of directors of RJR Nabisco revealed that Ross John-
son, the company™s chief executive officer, had formed a group of investors prepared to
buy all the firm™s stock for $75 per share in cash and take the company private. John-
son™s group was backed up and advised by Shearson Lehman Hutton, the investment
bank subsidiary of American Express.
RJR™s share price immediately moved to about $75, handing shareholders a 36 per-
cent gain over the previous day™s price of $56. At the same time RJR™s bonds fell, since
it was clear that existing bondholders would soon have a lot more company.
Johnson™s offer lifted RJR onto the auction block. Once the company was in play, its
board of directors was obliged to consider other offers, which were not long coming.
Four days later, a group of investors led by LBO specialists Kohlberg Kravis Roberts
bid $90 per share, $79 in cash plus preferred stock valued at $11.
The bidding finally closed on November 30, some 32 days after the initial offer was
revealed. In the end it was Johnson™s group against KKR. KKR offered $109 per share,
after adding $1 per share (roughly $230 million) at the last hour. The KKR bid was $81
in cash, convertible subordinated debentures valued at about $10, and preferred shares
valued at about $18. Johnson™s group bid $112 in cash and securities.
But the RJR board chose KKR. True, Johnson™s group had offered $3 per share more,
but its security valuations were viewed as “softer” and perhaps overstated. Also, KKR™s
planned asset sales were less drastic; perhaps their plans for managing the business in-
spired more confidence. Finally, the Johnson group™s proposal contained a management
compensation package that seemed extremely generous and had generated an avalanche
of bad press.
But where did the merger benefits come from? What could justify offering $109 per


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