Project Stonebrook — Unsolicited Approach & Defense

Enhanced scrutiny of the kind associated with a sale of control applies when a board decides to sell the company, to break it up, or to enter a transaction that puts control in the hands of a single buyer, at which point the duty becomes to seek the best price reasonably available. Receiving an unsolicited proposal, however public and however well financed, does none of those things. A board that rejects a proposal and continues with its own plan is making an ordinary business decision, reviewed under the business judgment rule. Getting this backwards contaminates everything downstream: it turns a board with a real choice into a board that believes it must run an auction, and it produces materials that recommend a process nobody authorized.

The frame that does apply, and only to a defensive measure the board adopts in response to a perceived threat. It has two prongs. First, did the board have reasonable grounds for believing a danger to corporate policy and effectiveness existed — satisfied by a good-faith, reasonably informed determination of inadequacy made by a board a majority of whose members are independent, which is what the adequacy analysis is for. Second, is the response reasonable in relation to the threat: neither coercive nor preclusive, which is the refinement Unitrin added. Delaware has confirmed that a board may keep a rights plan in place against an all-cash, all-shares, fully financed offer it believes to be inadequate. The practical consequence is that the valuation work is the evidentiary basis for the first prong.

The only defensible basis for a board to say no. Not that the premium is thin, not that the timing is inconvenient, not that the process was hostile — those are preferences, and a court reads preferences as entrenchment. The claim that carries weight is that a stockholder who holds is better off than a stockholder who takes $58.00, measured against a plan the board has approved and is prepared to be judged on. That framing has a hard edge: it means the recommendation to reject is a recommendation to back the plan, and a board that does not believe its own plan cannot coherently reject on the plan's strength. A strong candidate can argue engage rather than reject on exactly the same evidence, and should be able to say which case makes each answer right.

The analysis this archetype exists for, and the reason a takeover-defense package is not just a valuation package. It answers the question a board actually faces — what will a holder who does not sell have, and when — by carrying the plan forward to a future date, valuing the company there on a forward trading multiple applied to the following year's earnings, deducting net debt at that date, and discounting the resulting share price back at a cost of equity rather than a weighted average cost of capital. Two things make it more informative than a discounted cash flow here: there is no terminal value, so the answer is not four-fifths a statement about one multiple; and deleveraging is carried explicitly, which matters for a company generating cash against a fixed debt balance. It is also the analysis that shows whether waiting is worth anything at all, which is different on a plan case and a street case.

The comparison data arrives unscreened, and the extract contains constituents that do not belong in any of the three sets — a distributor valued on working capital turns rather than proprietary content, a subcontractor whose trough earnings turn its multiple into a numerator over a hole, a business in a different growth and multiple regime entirely, a purchase of a minority stake with no control and no tender, a sale of assets out of bankruptcy, and a premium struck against a price that had already leaked. Each has a stated ground for exclusion, and the ability to name that ground is what is being tested. The trap is in how you check whether it mattered: the median of a set this size can be entirely unmoved by three bad constituents while the mean, the observed range and any range anchored on the observed range all move sharply.

The reference price behind every premium in the package, and a genuine judgment rather than a convention. The last close before the letter is the obvious candidate. The last close before an activist filed a Schedule 13D calling for a separation is the defensible alternative, on the reasoning that a price which already contains an expectation of corporate action is not undisturbed. The gap between them here is worth many points of headline premium, and the bidder will always quote the reference that makes its offer look most generous. The discipline is to choose one, disclose the reasoning on the page, print the other alongside it, and then use the same reference in every exhibit. A package that switches anchors between two pages will be caught by the first person who checks.

They measure different things against different reference points, so they agree only by coincidence. A premium is a ratio to where a minority stake traded; a multiple is a ratio to earnings, compared against where the category trades. When a company has been trading below its own peer band — for stated reasons, such as a margin well under the set median and two consecutive years of missing its own plan's margin step-up — a proposal can carry a substantial premium and still sit at an unremarkable multiple, and both numbers are correct. The useful move is decomposition: separate the part of the re-rating that is the company's own discount closing from the part that is a premium to where the category trades. A board that negotiates on premium alone is negotiating on the axis the bidder chose.

Stock-based compensation is charged here, not added back, and the earnings base has to say so. It sits inside Adjusted EBITDA in every historical and projected year, so unlevered free cash flow built from EBIT charges it, the terminal value is struck on an Adjusted EBITDA stated after it, and the peer set has to be stated on the same basis. Otherwise the same cost is charged twice: once in the cash flows and again by applying a multiple derived from an earnings figure that never bore it. The error that gets punished is silence. A reader who cannot tell which basis an exhibit is on will assume the flattering one, and a forward multiple, a terminal multiple and a trading multiple struck on three different bases produce an answer that reconciles to nothing.

A rights plan is adopted by board resolution without a stockholder vote. The flip-in feature gives every holder other than the acquirer the right to buy shares at half price once the trigger is crossed, which makes crossing it economically impossible; conventional triggers sit at 10% or 15%, and proxy advisers expect a one-year term with a qualifying-offer provision. A 4.9% trigger is a different animal: it exists to preserve material net operating losses from an ownership change under the tax rules, and a company with immaterial losses that adopts one has a plan a court will read as entrenchment rather than tax preservation. The subtler point is timing. A plan adopted before there is any accumulation to stop spends governance capital at the next annual meeting for no incremental protection, and a plan approved in form and held on the shelf delivers the same deterrence at no cost.

Most of the defensive toolkit is unavailable to a company that has not already built it. A staggered board is the only durable structural protection Delaware offers, and creating one requires a charter amendment and therefore a stockholder vote nobody will win in the middle of a bid; a company with annual elections and directors removable without cause has none of that protection. Raising a special-meeting threshold has the same problem. A prohibition on action by written consent, an advance-notice bylaw with a closed nomination window, and the Section 203 business-combination freeze are the provisions that actually bind, and every one of them is either already in the charter and bylaws or already engaged by statute. The board's real structural position was decided years before the letter arrived.

The nomination window under a standard advance-notice bylaw runs between ninety and one hundred twenty days before the anniversary of the prior annual meeting. If it closes with no nominations received, a bidder cannot put a slate on that year's ballot, and the board has bought a full annual-meeting cycle — usually the single largest asset it has, and a wasting one. Two things qualify it. Standard bylaws reopen the window if the meeting is advanced or delayed by more than thirty days from the anniversary, so the board must hold the meeting on schedule and must be told that in writing. And the window governs the annual meeting only: a special meeting called by holders at the charter threshold has no calendar gate at all, which is why the calendar buys time rather than safety.

The Delaware business-combination statute, which applies unless the company has opted out in its charter. A holder crossing 15% becomes an interested stockholder and is barred from a business combination with the corporation for three years, unless the board approved the acquisition before the holder crossed, or the acquirer reaches 85% of the voting stock in the same transaction excluding shares held by directors who are also officers and by certain employee plans. Nothing the board does can engage or disengage it during a bid; it is either in place or it is not. Its practical effect on this fact pattern is that a bidder cannot buy its way to control through the market. It can accumulate, and accumulation is pressure, but the freeze means the bought stock cannot be converted into a merger without the board.

Each step is available on its own timetable, and the board should have the whole sequence in front of it. A bear hug made public requires nothing and can be answered or ignored; there is no legal obligation to engage. Accumulation is next: a holder crossing 5% files a Schedule 13D within five business days and amends within two business days of a material change, and purchases inside those intervals are not disclosed, so a stated toehold is a floor rather than a photograph. A tender offer means a Schedule TO and an offer that stays open at least twenty business days under Rule 14e-1, with the board stating its position on a Schedule 14D-9 within ten business days under Rule 14e-2. A proxy contest needs a timely notice under the advance-notice bylaw; a consent solicitation needs written consent to be permitted at all. And the antitrust clock often paces everything: a Hart-Scott-Rodino filing carries a thirty-day waiting period for open-market or negotiated purchases and fifteen days for an all-cash tender offer.

The ceiling on any negotiation is what the bidder can fund rather than what the target is worth, and that is knowable from public filings. Build the bidder's pro forma balance sheet at a range of prices — its own net debt, the target's debt to be refinanced, the cash on both sides, fees and financing costs — against pro forma Adjusted EBITDA including whatever synergies the bidder has publicly claimed, and find the price at which its committed financing runs out. Two disciplines apply. The synergy figure is the bidder's, stated by a party with an interest in stating it, and must never be presented as a company estimate. And a bidder whose proposal is already accretive on its own numbers has a reason to persist, which is information about how long the board will be living with this, not a reason to accept.

It is a case where you advise a board that has received an unsolicited acquisition proposal — usually a bear hug, meaning a proposal made publicly and priced above the market to put pressure on the board through its own stockholders. You produce the board materials: an adequacy view measured against the company's own standalone plan, a valuation package including a present value of future share price analysis, a vulnerability assessment covering the charter, the bylaws, the calendar and the shareholder register, a menu of possible responses each priced and each marked for whether the board can execute it alone, and a recommendation. It tests corporate governance judgment and legal framing at least as heavily as valuation mechanics, which is why it shows up in later rounds and take-home exercises rather than first-round screens.

Not by itself, and this is the most commonly failed question in the archetype. The enhanced duty associated with a sale of control attaches when the board decides to sell the company, to break it up, or to enter a transaction that puts control in the hands of a single buyer. Receiving a proposal — even a public, all-cash, fully financed proposal for all the shares — does not decide anything. A board that rejects and continues with its own plan is making an ordinary business decision reviewed under the business judgment rule. What does get reviewed differently is any defensive measure the board adopts in response: that draws the two-pronged proportionality test, which asks whether the board had reasonable grounds to believe a threat existed and whether the response was reasonable in relation to it, neither coercive nor preclusive. The practical consequence is that the adequacy analysis is the evidentiary basis for the first prong.

Against the company's own standalone plan, and essentially nothing else. A board saying no is asserting that a stockholder who holds is better off than one who takes the cash, so the comparison has to be to what the company is worth on a plan the board has approved and is prepared to be judged on. That immediately raises the question of whether the plan is credible, which is why the track record of prior plans is the input that carries the weight: a plan that has repeatedly asked for margin expansion and delivered a fraction of it is a weaker foundation for saying no than one that has been delivered. Everything else — the premium, the multiple, what precedents cleared at — tells you what the market thinks, not whether the offer is adequate. Those market yardsticks and the plan-based analyses can point in opposite directions, and when they do, the board is not choosing a valuation methodology; it is deciding whether it believes its own plan.

It carries the projection case forward to a future date, values the company there by applying a forward trading multiple to the following year's earnings, deducts net debt as of that date, converts to a per-share figure, and discounts that share price back at a cost of equity rather than at a weighted average cost of capital — because what is being discounted is a share price, not an enterprise value. It uses a trading multiple rather than a control multiple, because a stockholder who does not sell owns a minority stake in a listed company. It suits a defense case better than a discounted cash flow for two reasons: there is no terminal value, so the answer is not overwhelmingly a statement about one multiple several years out; and it carries deleveraging explicitly, which matters when the plan generates cash against a fixed debt balance. It also answers the board's actual question: what a holder who waits will have, and when.

Usually not immediately, and being able to explain why is what separates a strong answer from a reflexive one. A rights plan does not create value; it buys time, and it is only worth adopting when there is an accumulation to stop. Adopting one before a bidder is buying spends the board's governance capital at the next annual meeting — particularly in front of a register with meaningful passive ownership that votes with the proxy advisers — for no incremental protection, especially where a statutory business-combination freeze already bars a holder above the statutory threshold from a merger. The stronger position is often to approve the form of a plan and keep it executable at short notice, then adopt it on the first concrete trigger: a Schedule 13D, an antitrust filing, or the commencement of a tender offer. A plan on the shelf delivers most of the deterrence and costs nothing. There is a separate point about triggers: a 4.9% threshold exists to protect material net operating losses, and adopting one where there is nothing to protect looks like entrenchment dressed as tax planning.

Read it off the calendar and the charter rather than guessing. If the advance-notice nomination window for the next annual meeting has already closed with no nominations, a bidder cannot put a slate on that ballot, which buys the board a full meeting cycle, but only if the meeting is held on schedule, since standard bylaws reopen the window when the meeting moves by more than thirty days. If the charter prohibits action by written consent, the fastest route to replacing the board is closed. What usually remains open is a special meeting called by holders at the charter threshold, which has no calendar gate, so the escalation path runs through a requisition rather than an annual meeting. Layer the securities and antitrust clocks on top — five business days to file a Schedule 13D after crossing 5%, a minimum twenty-business-day tender offer period, ten business days for the board's own response, and a thirty- or fifteen-day antitrust waiting period depending on the form of the purchase — and the answer comes out as a number of months, which is a far more useful thing to tell a board than the word 'vulnerable'.

Because every premium in the package is measured from one price, and the plausible candidates can sit far apart. The last close before the proposal became public is the conventional choice. But if an activist filed a Schedule 13D weeks earlier calling for a break-up, the price after that filing already contains an expectation of corporate action, and the last close before it is arguably the only undisturbed reference. Here that difference is worth many points of headline premium, and the bidder will quote whichever reference makes its offer look most generous. The professional answer is to choose one, print the reasoning on the page, show the alternative alongside it, and then use the same reference in the price ladder, the premiums paid comparison and the recommendation — because a package that switches anchors between exhibits invites the reader to check the arithmetic on all of them.

Budget backwards from the recommendation, because that is the page the board reads first and the one most often left unwritten. A workable split: ten minutes reading the letter, the chronology and the governance extracts and writing down the legal frame; ten fixing the unaffected date and screening the raw extract; twenty on the two plan-based analyses, which are the primary evidence; fifteen on the comparison sets and the price ladder; ten on the vulnerability assessment, which is fact assembly rather than modeling once you have the charter and the calendar; fifteen pricing the response menu and its feasibility column; and ten writing the recommendation, the reservation price and the sentence that argues against your own conclusion. That leaves nothing spare, which is the point. The failure mode is a beautiful sensitivity grid attached to a package that never answers two of the board's three questions.