Macaroni Defense

What Is the Macaroni Defense?

The macaroni defense is one of many approaches a company may adopt to prevent an unwanted acquisition, or a hostile takeover. In the macaroni defense, the target company issues a large number of bonds with the condition that they must be redeemed at a high price if it is ever taken over. 

Understanding the Macaroni Defense

When a company wants to acquire control of another company, it will usually begin by making a friendly approach to its board of directors (B of D). After weighing up its options, the target may respectfully decline, perhaps because it believes the bid is too low or for other reasons.

At that stage, the prospective buyer can either walk away or put up a fight. Instead of respecting management’s resistance, it could attempt to bypass it by presenting its bid through a tender offer to shareholders.

Should takeover advances turn unfriendly or hostile, the target company's board has several tools at its disposal to make life difficult for the prospective buyer and thwart its advances. One of these options is the macaroni defense.

The target company issues a huge amount of corporate bonds that must be repaid at a mandatory higher redemption value in the event that the company is taken over. In other words, if the hostile bidder succeeds in acquiring the company, it will be forced to pay back the money investors lent the previous regime plus quite a bit extra, effectively raising the overall purchase price.

Example of the Macaroni Defense

Company XYZ is having some difficulty preventing Company ABC from taking it over. Management rejected an initial bid because it fears ABC is not a good fit and plans to layoff lots of staff, but ABC is refusing to give up and has been able to drum up support for its cause from some of XYZ’s shareholders, many of which are tempted by the substantial premium price being offered.

In response, and after consulting with its advisers, XYZ opts for the macaroni defense. Corporate bonds are issued to raise $250 million, with a condition that they must be redeemed, or paid back early, at 200% of their par value in the event of a takeover. What this means is that if ABC succeeds in acquiring XYZ, it will suddenly find itself having to foot a $500 million bill. 

Criticism of the Macaroni Defense

Bonds with these types of conditions attached might be enough to put off a raider from buying the target company. However, like most other anti-takeover measures, securing freedom from unwanted predators tends to come at a cost.

The most obvious downside of this strategy is that the company will still have to repay the principal of the bond at some point, and until then will be obligated to fork out the periodic interest payments attached to it. Should the company be saddled with lots of debt, it might have difficulty honoring these liabilities and become financially crippled for years to come.

Special Considerations

The macaroni defense is just one of several anti-takeover defenses that a company might choose to utilize. Other methods include leveraged recapitalization, a golden parachute, greenmail, and a poison pill.