Trilogy to the Rescue
First published in The National Post
By: Anita Anand
The hottest takeover bid in Canada right now is the hostile bid launched by Trilogy Retail Enterprises for Chapters Inc. Chapters' board opposed the original $13-per-share offer as unfair and inadequate. Trilogy subsequently raised its bid to $15. Even at the original offer price, the Trilogy bid is an attractive offer for Chapters shareholders. However, the bid is certainly not a slam- dunk.
The most recent skirmish in the battle for Chapters took place this week when Chapters argued before the Ontario Securities Commission that Trilogy should release more financial information and details regarding any possible merger between Chapters and Indigo, headed by Heather Reisman, spouse of Gerald Schwartz. The OSC yesterday made the right decision when it declined to force additional disclosure.
The commission rejected Chapters' view that information such as composition of management following a merger, timing of a merger, estimates of merger costs etc. should be disclosed now. Trilogy did release some additional information regarding a possible merger. All of this is unnecessary, however, since a merger between Chapters and Indigo is not being negotiated at this stage.
As Brian Steck, former vice-chairman of the Bank of Montreal, testified in an affidavit before the Commission, Indigo's financial information is not necessary for shareholders to make a decision on the Trilogy bid. "If I have learned anything in my 29 years as an investment banking professional, it is that a transaction is consummated and concluded only when its terms have been agreed to by the appropriate parties," said Mr. Steck. A later merger would only happen following approval by independent directors of the two companies, subject to valuations and negotiations. That's when disclosure should occur.
Moreover, if a merger were negotiated after the completion of the bid, minority shareholders of Chapters would be protected because they would approve the merger under a separate vote. Thus, while there is an appearance of conflict because of the fact that Schwartz's spouse heads Indigo, the bottom line at present is that there is no definite merger on the table.
The Commission hearing is just one attempt by Chapters' management to persuade shareholders that the Trilogy bid is unfair. Indeed, Chapters' management would like to think that shareholders have already decided to reject the offer and therefore extending the bid is futile. However, a more realistic view of the situation is that individual shareholders are unsure whether to accept the Trilogy bid or wait for a sweetened offer. Although shareholders may not be giving a second thought to the fact that a shareholders' rights plan or "poison pill" is in place, theories underlying pills highlight why Trilogy should be considered a saviour and not a raider of Chapters.
The "management entrenchment view" of pills is premised upon the notion that in the takeover bid situation, management stands to lose employment, compensation, power and/or prestige. Pills are invoked as deterrents to hostile bids in order to insulate management. Even if the proposed change of control would add future value to target shareholders, management (including inefficient management) can insulate itself by invoking a pill, thereby potentially thwarting hostile bids.
The management entrenchment view is front and center in the Trilogy strategic plan. Trilogy points to the fact that the price of Chapters stock fell from $36 in 1999 to $8.62 over the 20-day period prior to the announcement of the Trilogy offer. In Trilogy's view, this drop in share price is indicative of bad decision-making by inefficient management. As Trilogy head Gerald Schwartz explained in a letter to Chapters' shareholders, "It is clear that Chapters' current senior management and board are not acting in the best interests of Chapters shareholders and should not be permitted to continue making costly errors at the expense of shareholders."
On the other side of the coin is the "shareholders' interest view" which posits that pills have the effect of adding value for shareholders by preventing hostile bidders from coercing them to tender their shares at a low price. Thus, by adopting a pill, management can increase the target company's leverage. The hostile bidder knows that the target has the time to search for a white knight and negotiate a higher premium for its shareholders. The target can in fact look for a white knight or simply play stubborn and try to persuade shareholders that the bid is opportunistic and inadequate. To reject the bid, shareholders must be convinced that the share price will rise from its temporarily depressed levels to a price well above the offer price.
Chapters' management is convinced that the Trilogy offer is too low and that the bid has nothing to do with the fact that Chapters shares are trading above the offer price. In addition, Chapters has been trumpeting that sales in December 2000 were up 5% since December 1999 and that its EBITA will be $60.8-million for its next fiscal year. As Chapters CEO Larry Stevenson recently stated, "Share value has been increasing since the announcement of the [Chapters] reorganization efforts undertaken by current Chapters' management."
Chapters also sees the Trilogy bid as coercive since it is a partial bid or a bid for less than 100 % of the shares. Target shareholders may feel compelled to tender to the offer since they face the risk of illiquidity and potentially lower share prices if the takeover is completed. In Chapters' view, Trilogy is not saving Chapters' shareholders from inefficient management but is simply making an opportunistic bid at a time when Chapters' share price is temporarily depressed. Further, Chapters' management sees this offer as little more than a stepping-stone towards the ultimate goal of a merger between Chapters and Indigo.
So, why should shareholders believe the management entrenchment view in this case? First of all, since the Trilogy offer is not a "permitted bid" under the terms of the pill, the offer is conditional on Chapters' terminating application of the pill in this instance. But Chapters' board has advised shareholders to reject the Trilogy offer, stating that it is pursuing initiatives to maximize shareholder value. If and when Trilogy receives the requested number of shares under the bid, any refusal by the Chapters board not to terminate the application of the pill would be objectionable regardless of the "initiatives" that Chapters' management is undertaking. Once shareholders have spoken by tendering, there would seem to be little reason for Chapters to deny them the opportunity to exit the company via the Trilogy bid.
Chapters' claim that the recent rise in its share price is due to the reorganization efforts undertaken by current management is suspect. It is very common in the context of a takeover bid for the target's share price to rise (at least temporarily) after the announcement of the bid. In addition, some retailers (including booksellers) have seen their share prices rise recently. Although the U.S. book giant Barnes & Noble is not fending off a bid, its share price has risen nearly 50% from the lows in October 2000. The conclusion seems warranted that Chapters' management deserves little credit for the recent rise in its share price.
At the end of the day, Chapters' shareholders may decide to hold on to their shares. But whatever option they choose, Trilogy has been a saviour for them. If the bid succeeds, tendering shareholders will receive a significant premium to the share price which immediately preceded the bid. Remaining shareholders will benefit from new management which has a record of success. They will also be able to participate in a decision regarding the potential merger with Indigo. If the bid does not succeed, Chapters' shareholders will at least benefit from a revived management that received a wake- up call from Trilogy to turn the Chapters' ship around.
The OSC has appropriately decided to let the bid proceed on its own terms and let shareholders decide.