What’s Behind Time Warner’s Response to Charter’s Offer

Time Warner’s response to Charter Communications’ $37.8 billion offer is all about subtlety.

Charter has proposed to acquire Time Warner for a price of $132.50 a share, consisting of $83 in cash and $49.50 in Charter stock. Charter went public with its offer after negotiations with Time Warner stalled.

Time Warner has not rejected Charter’s overtures, but insisted that Charter’s offer was way too low. In Time Warner’s statement announcing its board’s rejection of the Charter offer, Time Warner Cable’s chairman and chief executive, Robert D. Marcus, stated that “our Board is open to a transaction with Charter at a price of $160 per TWC share, consisting of $100 in cash and $60 per share of Charter common stock.”

That’s a pretty wide gulf between the parties, about $10 billion.

So why did Time Warner even announce a price it was willing to sell at?

This is where the subtlety comes in. Time Warner is posturing, both to set up a defense and to nudge Charter away from making a full-on hostile bid.

Or to put it another way, the Time Warner board is executing an “Airgas defense.” In 2010, Air Products made a hostile bid for Airgas. The Airgas board took the position that the Air Products bid undervalued the company, despite Airgas’ shareholders’ protests to the contrary. Air Products sued Airgas in Delaware Chancery Court seeking to force the Airgas board to accept Air Products’ takeover offer of $72 per share. Air Products claimed that since its offer fairly valued Airgas, the Airgas board was required to eliminate its poison pill and let the shareholders decide whether to accept Air Products’ bid.

The Delaware court held that the “just say no” defense by Airgas was acceptable so long as the Airgas board had a reasonable belief that the bid undervalued the company. The court thus allowed Airgas to keep its poison pill in place. It would be the board, not shareholders, that could decide whether to reject the Air Product’s offer. In the wake of this decision, Air Products dropped its bid.

The decision gives an easy avenue for boards to fight a hostile bid. Hence the term “Airgas defense.” It goes like this. A target board adopts a poison pill and makes the determination that the hostile bidder’s offer undervalues the company. Shareholders of the target company are thus stuck, unless the shareholders remove the directors. If a company’s board members serve staggered terms, as they do at Airgas, this means that a bidder has to wait two years and run two proxy contests to unseat a majority of the target’s board. That is a high barrier because few bidders are willing to spend two years on an uncertain venture like a hostile bid.

Time Warner is only partly relying on the Airgas defense, though. Certainly, Time Warner is rejecting the Charter bid in good faith and can therefore withstand a legal challenge if Charter seeks to go to court to force Time Warner to redeem its poison pill. In fact, Time Warner does not even have a poison pill in place at this time, but can adopt one in about a day or so. As in Airgas, this means that Charter will have to either persuade the Time Warner directors to accept Charter’s offer or unseat Time Warner’s directors and replace them with Charter’s nominees. In other words, the Time Warner board is saying that unless you pay our price of $160 per share, you will have to unseat us.

Here is where Time Warner’s defense differs from the one by Airgas. Airgas had a staggered board and so Air Products’ loss in court meant that it was forced to wait a second year to elect a majority of Airgas directors. In this case, all of Time Warner’s board is currently scheduled to be up for election in May 2014. The Airgas defense is really about buying time before a proxy contest can occur to unseat a majority of the target’s board. Here, though, Charter can act in the next six months. It doesn’t have to wait two years.

So why did Time Warner set a price when it didn’t need to use the Airgas defense? I suspect there are probably two reasons. The first is that setting the price allows Time Warner to claim to its shareholders that this fight is all about value and Charter is just trying to underpay. If the Time Warner board had simply rejected Charter’s bid without setting a price, Time Warner shareholders could complain that the board was simply being recalcitrant to preserve members’ jobs. Time Warner shareholders (and hedge funds that might later enter the fray) could then set the price. By setting a $160 per share price, Time Warner is trying to pre-empt the market and claims by shareholders that it should sell at a lower price.

Time Warner is also subtly trying to discourage Charter from running a proxy contest. Again, the reasons are rooted in the Airgas battle.

If Charter was able to replace a majority of the Time Warner directors, these directors would have independent fiduciary duties to assess the Charter bid. This occurred in Airgas, when Air Products succeeded in electing three director nominees to the Airgas board. But when these directors took their positions, the Air Products-selected directors promptly sided with the rest of the Airgas board in rejecting Air Products bid.

The Time Warner board is thus setting up a repeat scenario. By doing the financial and legal work to show that Charter’s bid undervalues the company, the Time Warner board is going to make it harder for Charter-nominated directors to accept a lower price. Time Warner is no doubt hoping that creating this uncertainty will push Charter to forgo the expense of a proxy contest.

Charter’s next decision is thus to decide how hard it wants to push by trying to unseat Time Warner board members. If Charter can line up 25 percent of Time Warner’s shareholders, Charter can call a special meeting of the shareholders to remove all of Time Warner’s directors. But it is easier for Charter to just put up its own nominees at Time Warner’s next annual director election in May. Time Warner’s last annual meeting was on May 17, 2013. The deadline for Charter to nominate directors to replace the Time Warner directors is at “least 90 days and no more than 120 days” before the first anniversary of that meeting. So the time for Charter to nominate directors is between now and Feb. 15. Time Warner can move the scheduled May meeting a bit to fiddle with those dates, but this is the range.

So we’ll know in short order how aggressive Charter wants to be.

Given Time Warner’s defense, any director’s contest started by Charter will really be about having shareholders put pressure on Time Warner itself to overcome this $160 per share price. In this scenario, Charter may simply nominate a short slate of two or three directors, hoping that it is enough to prod the board.

But given the board’s stance, don’t be surprised if Charter decides to nominate a full slate of independent directors and tries to push a claim that the old analysis is flawed, allowing the new directors to accept a lower price if they so choose.

This all means that Charter knows that its best chance at succeeding will probably be in persuading Time Warner’s shareholders to support its bid and pressure Time Warner into a deal, not unseating Time Warner’s directors. And that type of subtlety may take awhile.