Air Products Faces Modern Form of Hostile Takeover

The hunter becomes the hunted.

The announcement on Wednesday that William A. Ackman’s firm, Pershing Square Capital Management, had acquired a 9.8 percent stake worth $2.2 billion in Air Products and Chemicals no doubt elicited feelings of schadenfreude in the headquarters of Airgas. After all, only a few years ago, in 2010, Air Products made a $5.9 billion hostile offer for Airgas. Air Products’ offer failed when Airgas resisted, and then Air Products lost a court case seeking to force Airgas to redeem its poison pill and allow Air Products to acquire the company.

Now, Air Products will face a modern form of the hostile takeover, the activist investor. True to form, though, this modern Wall Street drama will begin calmly.

Mr. Ackman is likely to follow a well-worn path taken by both activist investors and his own fund, repeating the steps that Pershing Square took in its successful $1 billion investment in the Canadian Pacific Railway.

The first step is to play nice and seek to meet with company management. And this is what Mr. Ackman has already stated he wants to do. The situation will then escalate, depending on the company’s response, with the real threat being a proxy contest to unseat Air Product’s directors.

What will Mr. Ackman ask for at this meeting? Well, Air Products has lagged its peers in stock price performance in recent years. He is likely to use this underperformance to ask for some board seats and an overhaul of management. He is also likely to ask for tweaks in business direction and operations, but nothing significant.

If you need evidence for this, you need only look at the Schedule 13D for its Air Products investment filed by Pershing Square on Wednesday. Investors often scrutinize Item 4 of these schedules, which requires an investor to disclose any ”plans and proposals” for the company. Usually, the language in Item 4 is boilerplate and ignored. But in this case, it directly states Pershing Square’s intentions. It says that Pershing Square intends:

to engage in discussions with management, the board of directors, other stockholders and other persons that may relate to governance and board composition, management, operations, business, assets, capitalization, financial condition, strategic plans and the future of the Issuer. Basically this can be viewed as an escalation of priorities for Pershing Square.

There you have it. Pershing Square will first seek to reorganize the board and next deal with management. It’s a one-two punch that will directly threaten the executives at Air Products. In other words, Mr. Ackman likes the company a lot, but management not so much.

This will be the parameter of Mr. Ackman’s first conversation with Air Products. So the question now is what Air Products will do.

The company issued a statement on Wednesday, stating that it “welcomes new investors and looks forward to engaging with Pershing Square to understand its views.” In a bit of cheek, the company also began its defense. Air Products states that its 2013 “total shareholder return” was 21.6 percent as of July 24, the day before it announced adoption of a poison pill.

But this return takes into account the rise in Air Products stock as rumors spread of the Pershing Square position. According to its Schedule 13D, Pershing Square began buying in June when the stock was trading at $91 to $95 a share (it’s now above $109 on the news). Before then, the stock was only up about 5 percent for the year and lagged its peers.

Air Products is willing to speak to Mr. Ackman, and that is also the standard response of companies these days to activist investors. But it’s unclear how cooperative Air Products will be. Will the company really want to replace its directors and management, or even add Mr. Ackman or Pershing Square’s suggested directors to its board?

If there are disagreements, Pershing Square’s future conduct will be guided by the poison pill Air Products adopted. This pill is a “low threshold” poison pill. It is set off when someone acquires 10 percent or more of the company, instead of the standard 15 percent. In fairness to Air Products, though, the threshold rises to 20 percent if the buyer is a passive institutional investor, something Pershing Square is not.

Air Product’s poison pill has already worked and reportedly stopped Mr. Ackman from buying even more of Air Products. And unusually, Air Products has directly implied that the pill is aimed at activists. At the time it adopted the pill, Air Products stated that it “will help promote the fair and equal treatment of all stockholders of the company in the event of an accumulation of a substantial block of the company’s shares.”

The most important thing about the pill is perhaps not the cap it sets on Pershing Square’s ownership, but its definition of “acting in concert.” This is the standard by which investors will be grouped together for purposes of counting whether the pill has been triggered. The idea is that if parties are acting together, their ownership should be counted together for the purposes of the poison pill’s ownership limitations. The poison pill defines acting in concert to be any “agreement, arrangement or understanding” with respect to “acquiring, holding [and] voting” Air Products shares.

This is broad language and the effect is that Pershing Square will be quite limited in the types of discussions it can have with other shareholders about Air Products. Nonetheless, the low threshold here and broad definition of “acting in concert” is state of the art in defending against activist investors. And any legal challenge to this definition is unlikely to be successful. Similar “acting in concert” language was upheld by a Delaware court in the case involving Barnes & Noble and Ron Burkle’s private equity firm, Yucaipa.

The effect of this language, though, may not be the deterrent that Air Products intends. The risk of inadvertently setting off the poison pill is too great. This pill, then, will literally force Pershing Square to do a lot of its work out in the open and in public so that it cannot be accused of having any “understanding” or “arrangement” from a private meeting with other shareholders.

In the background of any disagreement looms the threat of a proxy contest by Pershing Square to unseat Air Products directors. Air Products has an 11-member board with members serving staggered terms. So only about a third of directors can be unseated in any given year. The company’s last annual meeting was on Jan. 24 and will be around the same time in 2014. Unless changed by the company, nominations for directors are not due until Oct. 26.

This all means that the next few months will be occupied by talking about management changes and perhaps fruitful attempts to make nice. But in the background, Pershing Square will have the threat until October of nominating its own directors and starting a proxy contest. And make no mistake, Pershing Square has acted on this threat before.

The paradox here is that if there is a proxy contest, it would leave the decision in the hands of Air Products’ shareholders. I use the word paradox because in 2011, Air Products criticized Airgas for using a poison pill to block its bid and stated, “It is time for the Airgas Board either to negotiate with us or terminate the company’s poison pill and let Airgas shareholders decide for themselves.”

It’s a lesson for companies that their own words and actions may be used against them. It may also be the time when we will see whether Air Products lives up to the spirit of that statement with its own shareholders.