TRW Fights a Hostile Offer With a Nuanced Breakup

A traditional but seldom-used fixture in the anti-takeover textbook – the breakup defense – was rolled out by TRW Inc. in its effort to fend off a $6 billion-plus hostile bid by Northrop Grumman Inc. TRW proposed spinning off its automotive operations into an independent company and keeping its aerospace, defense, and systems businesses. Behind the move was an intricate web of strategic, legal, tax, shareholder value, and m&a market competition issues, any of which packed the potential to determine the outcome of the scrap. The fencing match got underway in February when Northrop Grumman mounted a bid of $47 a share in stock, sued in the federal courts to overturn Ohio’s tough anti-takeover law – a first line of protection for Cleveland-based TRW – and said it would consider raising the offer if TRW opened its books. TRW shot back that the bid had been adjudged inadequate by advisers Goldman, Sachs & Co. and Credit Suisse First Boston and suggested that shareholders sit tight while it shed the auto components business in a tax-free deal over a span of six to nine months. The bid was later raised to $53 per share. Neither TRW nor Northrop Grumman have been enthralled by the automotive business, which is in a state of turmoil as a result of economic pressures and a restructuring to get in line with demands of the big auto manufacturers. Auto parts represented TRW’s largest business, accounting for about $10 billion of the company’s $16 billion in 2001 sales, but it was less profitable than the higher tech pieces most coveted by Northrop Grumman. TRW said that the spin-off had been under consideration even before the Northrop Grumman bid was uncorked. On a strategic basis, the split made sense. Joe Martha, who follows manufacturing and supply chain developments at Mercer Management Consulting, says that an independent auto parts business can put more focus and resources into its development at a critical time. In a two-level company, he says, “Usually the one that is more technically oriented tends to get more of the attention because it might be a more glamorous business.” Martha also says that the TRW auto parts unit has the size and breadth of product lines to become a Tier 1 supplier to the Big Three auto assemblers, who are requiring their largest vendors to serve as coordinators and distributors for the myriad components they use. “They are looking for someone to act more in a total distribution role and come in with solutions rather than individual products.” A spin-off also has the potential to become a tax-based poison pill. In a recent written analysis, Robert Willens, managing director and tax expert at Lehman Brothers, painted a scenario for using the tax angles of spin-offs as defensive weaponry, although he did not specifically cite TRW. If the spin-off is engineered deftly in the face of a hostile bid, he said, it could trigger a huge and unpalatable tax bill for a buyer. In Willens’ example, a company with two operations – one with great growth, the other with flat sales – receives a hostile offer from a bidder that really wants the hot business. He said that the typical spin-off now includes an indemnity agreement requiring the parent or a successor to pay any federal taxes resulting from the split. The ploy is to spin off the high-growth business. If it is purchased inside the first six months of independence, the deal, under federal rules, will create a huge tax bill that must be paid by the hostile buyer. TRW has other angles However, TRW, according to a March 13 news release, was planning to spin off the automotive business and not the higher-growth technology operations. Other language in the release suggested why it chose that route. TRW said it received “unsolicited indications of interest” from third parties for the company as a whole, without the auto business, and for specific parts of the entire company. Once rid of the auto parts business, then, TRW could have cleared the way for an auction designed to generate the highest possible price for its remaining technology assets and presumably pit Northrop Grumman against the unidentified “third parties.” That approach probably would relieve the successful acquirer of a big tax bill as well.