In recent years, contests for control usually have taken the form of cash tender offers, a far less cumbersome takeover mechanism than engaging in proxy contests or offering to acquire target companies’ common stocks in exchange for the acquiring companies’ securities. Corporations that are candidates for contested takeovers are those with the following conditions: the companies are incorporated and domiciled in states where there are no strong anti-takeover statutes;⁹⁶ share ownership is widespread or there are blocks that may be tied up via private transactions;⁹⁷ there is a possible low will of the management to resist a takeover attempt; there is a general absence of impediments to the takeover, such as a company’s being in a regulated industry (say, insurance, commercial banking, or aviation); there do not appear to be antitrust problems; and there do not appear to be important people or institutions, such as customers, employees or suppliers, who could harm the takeover target by terminating relationships with the company. One example of a contested tender offer is the November 1975 cash tender by Babcock International, a subsidiary of Babcock and Wilcox, for all the shares of the American Chain and Cable Company at 27 net per share, in cash. Prior to the tender offer, the shares had traded in 1975 in a range between 14 and 20. American Chain was a New York corporation, its management held little stock and it was not in a regulated industry. Initially, American Chain and Cable resisted the offer, but when Babcock raised the price to 32 in December, the new offer was approved by the American Chain and Cable management, several members of which obtained employment contracts. There have been scores of contested cash takeovers in the period 1975-78, including those for the common stocks of Allied Thermal, Husky Oil, Apco, Otis Elevator, ESB, Aztec Oil and Gas, Sea World, Babcock and Wilcox, Marcor, Royal Industries and Carrier Corporation.

Going Private

Many companies that are attractive under the financial-integrity approach and that are nonregulated are also candidates for going private, as was Barbara Lynn Stores. In mid-1974, its stock was trading at 2 to 2½, although the company had a highly liquid book value of 8. The insiders proposed a merger at 4, which was voted on favorably. There was a stockholder suit opposing the merger, but the suit was settled when it was agreed that the cash merger price would be increased. In early 1975, all public shareholders received $4.40 per share, or virtually double the market value before the going-private transaction.

POSTARBITRAGE

Postarbitrage situations are created after an asset-conversion event has taken place and securities owned by public shareholders remain outstanding. Usually these holdings are minority interests in companies. Postarbitrage investment opportunities seem to be present on a reasonably regular basis for outside investors in postarbitrage periods. In order to understand why, it may be profitable to simulate the thinking processes of professional arbitrageurs, who are acutely conscious of the time value of money and who are inclined to acquire securities in concert for the same reason. Thus, when offers to acquire securities occur and less than all the shares tendered are accepted (a so-called partial offer, or partial), arbitragers tend to dispose of the masses of stock they have accumulated shortly after the conclusion of an offer. This, of course, depresses market prices.

In addition, conventional stockholders are frequently reluctant to hold the shares of common stocks in postarbitrage situations, because the shares at that point may not be marketable, are delisted and, occasionally, if there are less than three hundred shareholders of record for an over-the-counter issue, are even deregistered with the Securities and Exchange Commission. Thus, in post-arbitrage markets equity securities may sell at ultradepressed prices. As a group, these securities then become highly attractive holdings. For example, in November 1974 Loew’s acquired control of CNA Financial Corporation by a partial tender offer for CNA common stock at 5. Immediately after the conclusion of the tender offer, in December 1974 and January 1975 CNA common traded in volume on the New York Stock Exchange between 2½ and 3. At this writing in early 1978, CNA common is selling around 11.

In August 1974, Mobil Oil sought through a cash tender offer at a price of 35 a majority of the outstanding common stock of Marcor Corporation. The cash tender was oversubscribed, with Mobil receiving far more stock than it had sought. Purchases were made on a pro-rata basis, and unpurchased shares were returned to share owners. Subsequent to the tender, the shares were available for a protracted period at prices ranging between 15 and 17 per share. Within a year after the tender offer expired, however, Mobil proposed a cash merger at a price of 35. Eventually all shareholders received 35. Similar profit opportunities for outsiders after control was acquired through partials occurred in, among others, the common stocks of American Medicorp, Signal Company, and Veeder Industries.

Another postarbitrage opportunity existed for Indian Head debentures. There had been a cash tender in 1974, which would have resulted in a value for the debentures of $70.12. After the tender offer, the debentures sold at prices well below 70.12—as low as 48. Eventually, there was a cash merger in 1976 at a price that resulted in debenture holders having the right to receive $84.14 in cash.

Postarbitrage positions do not, of course, always work out. An example of an unprofitable postarbitrage investment for outsiders is provided by Schenley Industries common stock. Control of Schenley was obtained in 1968, when there were both private purchases and an exchange offer that had a market value of around 54. After control had been obtained, the Schenley business prospered. Nonetheless, in 1971 a merger force-out at a price of about 29 occurred—in perspective, a very modest price, even though it represented the highest price at which Schenley common stock sold in the two years before the February 1971 vote on the merger.

In postarbitrage investing, it is very important to avoid managements that seem to have predatory predilections. Again, the public record, through proxy statements or Part II of the 10-K, gives indications of which managements might be predatory. Postarbitrage activities have significant disadvantages, especially where there is no know-who. It is usually impossible to determine when a so-called mop-up merger might occur; indeed, a mop-up merger might never happen (though it is our experience that the vast majority of controlling shareholders prefer 100 percent ownership rather than less). Finally, postarbitrage securities tend to be relatively unmarketable, and are sometimes not marketable at all.

One important rule of thumb we tend to follow in postarbitrage investing is to acquire positions in securities at prices two thirds or less than control shareholders paid in the recent past to obtain control. The postarbitrage world is such that equity securities often sell for 50 percent or less of the price paid for control.

In general, purchases based on this approach have worked out well in recent years, as witnessed by profits that were realizable, inter alia, on postarbitrage investments in CNA Financial, Marcor, Transocean Oil, Indian Head, American Medicorp, and Veeder Industries. However, this rule of thumb is far from a panacea and an investment technique that will always prove successful. In some instances, control buyers will be able to mop up public stock at prices well below those paid for control, even though the controlled business prospers in the interim between the acquisition of control and the buy-out of the public. For one thing, controlling stockholders may succeed in forcing out public stockholders at prices well below control prices (as per the Schenley situation discussed previously). After all, the timing and conditions for proposing a force-out merger are within the control of insiders. However, closing the transaction is not something wholly within the insiders’ province, because of the probability of stockholder suits to improve prices paid in force-out mergers. Second, there are times when acquirers overpay to obtain control of basically sick businesses; in those instances, the minority stockholder is unlikely to fare well. One example is Commonwealth Refining, in which Tesoro Petroleum acquired a controlling interest in 1976 by paying $13.50 per share. In 1978, Commonwealth sought protection of the bankruptcy courts by filing a petition for an arrangement under Chapter XI of the bankruptcy statutes. At this writing, Commonwealth common stock is quoted at around $.50 bid.

In sum, though, we think an investment program based on acquiring issues in postarbitrage markets at prices well below those paid by controlling shareholders for the same security should work out well. Where this approach is further limited by applying financial-integrity standards, we think prospects are that such investments ought to work out exceptionally well.