Barbarians at the gates of tech?

NetCap Securities analyst Tom Taulli writes that hostile takeovers may soon become an increasingly familiar part of the technology horizon.

3 min read
Corporate raiders, white knights, poison pills, breakup values...

This was the vocabulary of the decade of greed during the 1980s. The theme of greed was so prevalent that one of the top movies was "Wall Street," which involved the consummate, amoral corporate raider Gordon Gekko. One of his most memorable quotes: "Greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the U.S.A."

In a way, tech is similar to the "malfunctioning" companies that lagged the 1980s. Tech companies need lots of work and restructuring. If done successfully, there is a tremendous amount of profit potential.

Interestingly enough, hostile takeovers have been quite rare in tech. A big reason is valuation. In a hostile deal, you want to buy a company that is selling at a cut-rate price and then do a turnaround.

This is not to say there have been no hostile deals in tech. Charles Wang, the chairman of Computer Associates, is a notable exception, having done more than 200 acquisitions since 1976. He believes that successful tech deals require a unified management voice; it is not uncommon for him to fire most of the top management team of a target. He has no fear of firing programmers, as well.

Tech companies need lots of work and restructuring. If done successfully, there is a tremendous amount of profit potential. Then again, CA is in a maturing tech marketplace of lumbering mainframes. Basically, it is easier to pull off hostile deals when the growth rate has stabilized and the valuations are muted.

To launch a big trend, you need a top company to take the lead. With hostile tech deals, it looks like the lead is Yahoo. The company recently closed a hostile deal to buy HotJobs.com for $436 million in stock and cash. In fact, Yahoo's unsolicited offer broke up an already signed deal for TMP Worldwide to purchase HotJobs.com.

In all, Yahoo paid more than $80 million than TMP was willing to shell out. Why the high price? Apparently, Yahoo saw that it could monetize the asset better. Moreover, Yahoo would become a big hitter in the lucrative online job market. Why build it when you can buy it (yes, another mantra from the 1980s)?

Tech companies are realizing that the environment is likely to become more hostile. But a potential target is not left without any recourse. A company can take a variety of measures to ward off a hostile takeover. One is a poison pill, which dilutes an acquirer's stake and makes it prohibitively expensive to buy the company. Tech companies are now scrambling to set up such anti-takeover measures.

However, the adoption of such anti-takeover defenses is not necessarily an attempt to prevent a deal from closing. Rather, it can be an effective way to boost the ultimate price tag of a deal.

It looks like the planets are aligned for a major trend in hostile deals. But there are other trends that bode well for hostile deals. For example, the current administration in the White House is certainly pro-business and will likely be amenable to hostile deals.

Something else important to consider is a significant change in accounting rules. Typically, in a high-tech deal a company will have a low book value. The difference between the book value and the purchase price is considered goodwill. This can be a big number, such as was the case with many mega-acquisitions in tech during the late 1990s. But a change in the accounting rules means there is no need to expense the goodwill. Thus, a hostile acquirer will not take a big hit to the financials.

Finally, tech companies traditionally avoided hostile deals because they may have scared away employees. However, with the increased unemployment in tech, this concern is quickly fading.

It looks like the planets are aligned for a major trend in hostile deals: pro-business politics, favorable accounting, rising unemployment and low valuations. No doubt, Gordon Gekko would be salivating.