The $45.6 billion unsolicited offer for Allergan by Valeant Pharmaceuticals and William A. Ackman’s hedge fund is many things, including bold, novel and mega in all ways. It is a new twist in the war between companies and shareholder activists, most likely changing everything and igniting a furious battle not just for Allergan but over the laws governing takeovers and activism.
The pairing of an activist and a corporation in a hostile takeover is no doubt novel. As Michael de la Merced, David Gelles and Alexandra Stevenson wrote in The New York Times on Tuesday, the offer is a sharp turn in how inimical activists and corporations interact.
Valeant has now disclosed to the world that hedge fund activist funds are a ready arsenal of capital that can be used to aid hostile takeovers by corporations. It’s not just capital, either. Activist hedge funds are experts at pushing corporations into adopting entirely new strategies and pushing out old directors. Their expertise will be invaluable to companies on the hunt for takeovers, perhaps supplanting the investment banks who now advise on such situations.
Only a few hostile takeovers have taken place over the last few years while activism has become the norm. But this deal may give a real boost to hostile takeovers. By establishing an early 9.7 percent stake, Mr. Ackman’s hedge fund, Pershing Square Capital Management, and Valeant are buying insurance for a failed hostile takeover. If the bid fails or Allergan is sold to another party, the two can instead reap the profits of their significant stake to cover their costs and perhaps make much more money. Previously, hostile bidders had been reluctant to purchase these stakes â€" called toeholds â€" but now have a clear route to do so and to limit their downside if the bid fails. This may spur more hostile deals.
This may mark not only the fusing of the two corporate tactics but also a Faustian bargain between hedge funds and corporations. I say Faustian because Valeant may have unleashed a monster. Activists and corporations may team up on hostile takeovers, but the companies who join with activists may soon discover they are targets themselves.
The teaming of Pershing Square and Valeant will also increase pressure on private equity firms to become more like the hedge fund activists. The bid for Allergan is larger by multiples than any private equity deal since the financial crisis. It shows the potential for these private equity firms and their hundreds of billions of dollars in unspent capital. If private equity is to stay in the game, it will have to find a way to compete.
Whether this comes to pass, the Allergan bid is yet another sign that activism is more mainstream than ever and here to stay. These funds have too much money to go away and will continue to innovate.
The Allergan offer not only has the potential to upend how the takeover market works, unleashing a powerful new force in the pairing of hedge funds and corporations, it will also most likely spur a subset of corporations to push even harder for a reform of the takeover rules. These companies will cite the way that Valeant and Pershing Square accumulated their stake in Allergan to highlight the need to change the laws.
The reason is that Valeant and Pershing Square bought their 9.7 percent stake in a way designed to keep it secret until that number was reached.
A new entity formed by Pershing Square and Valeant bought 4.99 percent of Allergan in the market from February through April 10. Of that stake, 96 percent was composed not of actual shares but of options to buy Allergan stock. Most of the capital appears to have been put up by Pershing Square, with Valeant contributing only about $75 million.
Then on April 11, Valeant and Pershing Square increased their stake above 5 percent. Under the so-called 13D rules, named after the provision in the federal security rules that require a filing, once their holding exceeded 5 percent, Valeant and Pershing Square were required to publicly disclose their ownership in a filing with the Securities and Exchange Commission. But a so-called 13D filing is only required to be made within 10 calendar days.
This creates a window of time for a bidder or activist to buy even more shares, something Pershing Square did with a vengeance. In this 10-day period, Valeant and Pershing Square bought an additional 4.7 percent stake in Allergan, all in call options. At the end of the period, the two bidders filed their 13D and disclosed an offer to buy Allergan for $48.30 in cash and 0.83 share of Valeant common stock.
Previously, the law firm Wachtell Lipton, among others, had called for a reduction in the 10-day period. The S.E.C. has responded by saying it would review the rules, and it appeared that some reform was coming to shorten then period.
Pershing Square’s move will no doubt increase these calls. It will also fuel the debate more generally about reforming the takeover laws to limit activism, combining old arguments that activist hedge funds are focused solely on short-term goals with fresh arguments that hostile takeovers shortchange shareholders.
This will be a long fight that will become more heated and break new ground, but the more immediate battle for Allergan will most likely turn into a typical hostile takeover.
Allergan does not have a poison pill in effect, but expect it to fix that problem in the coming days by adopting one to cap Valeant and Pershing Square’s stake at its current size.
After that, Allergan will assess the offer and decide whether to negotiate or reject it. Interestingly, Allergan has a provision in its governing documents called a constituency provision, which allows its board to take into account interests other than shareholders â€" like workers â€" when considering an offer. Allergan will most likely rely on this provision to give it latitude to reject Valeant and Pershing Square’s bid, perhaps even raising the fact that Valeant is Canadian. Even without this defense, though, the law is pretty clear that Allergan’s board can turn down this offer if it wants on the grounds that it undervalues the company.
Allergan will most likely resist for a while to buy time to find another deal or force Valeant and Pershing Square to pay a higher price, but the defense may be ultimately futile if Valeant and Pershing Square continue their pursuit.
The reason is that Allergan has a clear hole in its takeover defenses.
If Allergan does adopt a poison pill, then the only route to push Allergan to remove it is for Valeant and Pershing Square to go fully hostile, which includes a proxy contest to unseat Allergan’s directors, who can be removed without cause at a shareholder meeting. Allergan’s annual meeting is scheduled for May 6, and the date for nominating directors has passed, so Valeant and Pershing Square have missed that window.
There is still that hole, however. Allergan’s organizational documents allow for 25 percent of shareholders to call for a meeting. The provision will allow for Valeant and Allergan to call for a shareholder meeting to remove and replace Allergan’s directors. They can easily convert their options into stock, making their 9.7 percent stake real and making the 25 percent hurdle relatively easy to reach.
Allergan knows all this, of course, and it will now set off a dance as Allergan looks for other suitors and Pershing Square and Valeant begin to tighten the screws. Over the next few weeks, the two sides will circle and test each other to determine how far Allergan is willing to go in its defense. In the wings will be the threat of a proxy contest.
It is a historic moment to be sure.
