Macaroni Defense (Hostile Takeover) - Explained
What is a Macaroni Defense?
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What is a Macaroni Defense?
A Macaroni Defense is a defensive tactic used by a company against a hostile takeover bid. During a Macaroni Defense maneuver, a corporation that is a potential takeover target, issues a large number of bonds with an exceptionally high discount on the redemption value. This essentially means that in the event of a takeover, these bonds will have to be redeemed at a much higher value. The rationale behind trying to prevent a hostile takeover or any such unwelcome merger or acquisition is that in most situations, the bids for such companies are too low. Additionally, any merger or acquisition usually evokes fears of corporate restructuring and layoffs. As such, defensive tactics such as Macaroni Defense and other similar maneuvers almost always rely on preventing the merger/acquisition by somehow manipulating the stock prices or bond prices of takeover targets.
How Does the Macaroni Defense Work?
The origin of the term Macaroni Defense can be ascribed to the similarities between the expansion of the redemption price of the bonds of the target corporation and the enlargement of macaroni (a type of pasta) in a pot full of boiling water. There is usually a twofold effect of the Macaroni Defense maneuver - on the one hand, it makes the entire takeover deal economically unappealing, while on the other, it severely limits the powers of the potential acquirer. However, even if a Macaroni Defense maneuver does lead to a successful dissuasion of a takeover bid, the corporation is still prone to being overburdened with excessive debt and the difficulties associated with making high interest payments. Often times, hostile takeover targets resort to poison pills, golden parachutes, scorched earth policies, lobster traps, green mail and leveraged recapitalization as effective anti-takeover defense mechanisms.
Illustration of a Macaroni Defense Maneuver
Let us assume that company C1 wishes to acquire company C2 via a hostile takeover. However, the management at C2 is averse to the idea of this acquisition, especially because it believes that such a move would irreparably damage the reputation of C2. As such, to dissuade C1 in its takeover efforts, the board of directors at C2 issues $100 million worth of corporate bonds that are redeemable at 165% of par value in case of a successful takeover. This means that any investor interested in acquiring $10,000 worth of such corporate bonds, for example, will gain the right to redeem the entirety of his/her investment at $16,500 post acquisition. From the perspective of C1, this additional cost of $6,500 for every redeemed corporate bond worth $10,000 is plainly too high to merit proceeding with the takeover bid. As such, C1 finally backs off from the acquisition deal.
Macaroni Defense vs. Poison Pills
Macaroni Defense maneuvers and poison pills are two popular anti-takeover defense mechanisms employed by potential takeover targets. While Macaroni Defense relies on the issuance of bonds, poison pills involve the target corporation issuing rights to all existing shareholders (except the hostile bidder) to either purchase preferred stock or common stock of the company at a predetermined price. This predetermined price usually works out to about 200% of the rights exercise price, making the entire takeover deal extremely expensive for the hostile bidder. Another similar, but much more extreme anti-takeover defense mechanism is the suicide pill, that involves the board of directors dissolving the entire company in order to prevent a hostile takeover bid.
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