You can be your own white knight.

• Author: Frederick, Scott E.
• Position: Includes a related article on the resurgent mergers and acquisitions market. - Management Strategy

You can be your own white knight There's a lesson to be learned from the 1980s. Poison pills and other anti-takeover provisions may be useful roadblocks, but they can do little to stop a well-financed raider with an attractive offer for shareholders. The best protection against unfriendly acquisitions is a fully valued stock, and the key for CFOs in defending against a raid is to think like a raider and make a preemptive strike.

One popular method of maximizing shareholder value while remaining independent is to perform a leveraged recapitalization, or a recap. Recaps provide benefits to both shareholders and manegement. Shareholders receive a large, onetime dividend and an ongoing interest in the company through a remaining equity stake, known as stub equity. Management receives an increased equity stake and remains independent.

The cost of a leveraged recapitalization tends to ne lower than taking the company private in an LBO. Required rates of return on stub equities are in the 20-percent range, while professional LBO investors typically require a 30- to 40- percent return. Because the stub's value is higher, the dividend component (comprised of borrowed money) is less.

Finally, recaps solve the dilemma faced by CFOs slowly growing, mature companies: what to do with the excess cash flow that entices raiders into making a bid.

Consider several recapitalizations in recent years: Multimedia, Colt Industries, Owens Corning, FMC, Holiday Corp., Harcourt Brace Jovanovich, and USG. These recapitalizations provide examples of solid operating companies that took on huge sums of debt to maximize shareholders value and remain independent. They are also examples of how successful recaps can be, with profitable ongoing operations and investments that have generally outperformed the S&P 500. As seen in the figure on pages 50 and 51, credit statistics and the stub performance of previous recaps help illustrate the potential rewards and risks inherent in the anti-takeover measure.

CFOs can maximize shareholder value while remaining independent by using the same tools that raiders use: divestitures and high-yield bonds. Cost-cutting strategies also have to be employed, including making painful decisions like eliminating jobs.

An employee Stock Ownership Plan (ESOP) is a more benign tool that can be used in a recap to obtain tax and financial advantages. With an ESOP, CFO's may be able to obtain an interest rate approximately 20 percent below the comparable non-ESOP rate (because of the tax advantages for banks). And because the loan principal is tax deductible if a...