Heads he wins. Tails he wins.
That was the situation William A. Ackman, the hedge fund manager and founder of Pershing Square Capital Management, found himself in — or perhaps more accurately, orchestrated — on Monday.
His investment partner, Valeant Pharmaceuticals International, appeared to withdraw from a hostile takeover battle to buy Allergan, the maker of Botox, when a higher rival offer emerged. Normally, Mr. Ackman and Valeant would be considered the losers, having been unable to complete the deal that they set out to clinch months ago.
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However, Mr. Ackman and, to a lesser extent, Valeant found a backdoor way to win: Having acquired 9.7 percent of Allergan's stock before they made their takeover bid — which put the company in play — Mr. Ackman's fund now stands to collect $2.6 billion. He will share 15 percent of the profits with Valeant, or $389 million, leaving him with a tidy profit of $2.2 billion.
In deal parlance, the tactic that led Mr. Ackman to his latest multibillion-dollar windfall is called a "toehold," in which a suitor takes a position in a stock before starting a takeover bid.
The "toehold" is hardly new. It was used routinely by corporate raiders in the 1980s. David Fox, a partner at Kirkland & Ellis, wrote in a memo to clients that toeholds were used "by a potential bidder to convey its serious intent or, if necessary, as a platform to quietly or publicly put the target in play." But their use slowed considerably as hostile bids fell out of favor.
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The new twist on the toehold is the idea of a company teaming up with an activist. The benefits are manifold: The activist brings financing, "a large megaphone" and a skill set "in covert accumulations," according to Wachtell, Lipton, Rosen & Katz, the law firm that specializes in mergers and acquisitions and objects to the practice.
Given Mr. Ackman's success, bankers and lawyers are anticipating a flood of similar takeover proposals. Some big companies are quietly contemplating teaming up with activist investors when only months ago such cooperation would have been considered an unholy alliance.
The question is whether this phenomenon should be a welcome part of the latest mergers-and-acquisitions frenzy or whether the toehold maneuver, as reconceived by Mr. Ackman, should be considered just the latest form of market rigging.
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Judging solely by the outcome, it is hard to fault Mr. Ackman and his toehold play. Allergan agreed to be sold for $219 a share, 48 percent more than the price less than six months ago. The buyer, Actavis, is probably the right acquirer, unlike Valeant, which had been expected to decimate Allergan's research and development budget.
The Allergan-Actavis deal would never have been possible without Mr. Ackman and Valeant showing up at the table first. And it is hard to believe that Mr. Ackman or Valeant would have had leverage with Allergan had they not found a way to control nearly 10 percent of its stock. Putting Allergan into play effectively created about $20 billion of value almost out of thin air.
So if the goal of the markets is for shareholders to be rewarded with the highest price possible, Mr. Ackman clearly succeeded. But there are other, perhaps more nuanced, views about how to define success.
Mr. Ackman's tactic worked this time. But what happens if a company falls into the wrong hands and at a much lower price as a result of pressure from the one-two punch of a large corporation teamed with an activist? Is that the price of shareholder democracy?
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And then there's the question of conflicts — and even legality.
Mr. Ackman's coalition with Valeant raised questions about whether such an alliance violated insider trading laws. At minimum, it leaves investors with a questionable taste in their mouths about fairness of the markets, given the special access certain investors — like Mr. Ackman — were able to secure by gaining advance information about a potential transaction.
Wachtell, Lipton, which defended Allergan against the hostile bid, described the maneuver as "crafty" and "one in which the strategic bidder cannot lose and the activist greatly increases its odds of catalyzing a quick profit-yielding event, investing and striking deals on both sides of a transaction in advance of a public announcement."
Allergan sued Mr. Ackman and Valeant, contending that their bid was illegal. The case is still pending, but unfortunately may never be decided because it will most likely be withdrawn, leaving other companies and investors to continue to try to test the legal limits of the courts until a definitive ruling is made.
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In the end, Mr. Ackman turned out to be right this time. But it wasn't always obvious. Early on, Mr. Ackman, frustrated that Allergan wasn't willing to negotiate, attacked the integrity of Allergan's chief executive, David E. I. Pyott.
"Allergan shareholders have also received the strong impression from Mr. Pyott that he intends to take a 'scorched earth' approach to a potential transaction with Valeant," Mr. Ackman wrote. He contended that Mr. Pyott "appears to be motivated more by personal animus than by what is in the best interest of Allergan shareholders."
Mr. Ackman was wrong about that. But he still won.