Hostile takeovers are back

The Avon lady could become the Coty lady if its competitor gets its way and forces Avon to sell.

NEW YORK (CNNMoney) -- Takeover activity may have not have picked up as quickly as investors and bankers predicted this year, but that may soon change.

Hedge funds are increasingly calling for companies to take bold action. That may push more companies to break up or announce that they are "exploring strategic alternatives" to fend off the activist shareholders.

Kenneth Squire, the founder of 13D Monitor, a research firm that follows shareholder activism said we're at the very beginning of an uptick in hostile activity.

"[Activists] are building up positions now that they'll start to follow through on," said Squire. "Activists have a lot of money that they need to put to work."

Starboard Value, Paulson & Co. and Third Point are among the hedge funds publicly pushing AOL (AOL), Hartford Financial (HIG, Fortune 500) and Yahoo (YHOO, Fortune 500) respectively to make changes, including selling off assets.

"People are getting increasingly confident and willing to do unfriendly transactions," said Arthur Crozier, chairman of Innisfree M&A, a proxy solicitation firm that advises shareholders on whether to accept or reject mergers. "Activism has really presented itself as an attractive vehicle for hedge funds to use."

At the same time, experts expect more unsolicited bids from strategic investors. Pharmaceutical company GlaxoSmithKline (GSK) made an unsolicited $2.6 billion bid for Human Genome Sciences (HGSI) Thursday morning, an 81% premium to its recent share price. Human Genome Sciences rejected the offer but said it's considering "strategic alternatives."

Investors clearly are betting that Glaxo will have to raise its bid or that another company will make an offer. Human Genome Sciences shares doubled Thursday to more than $14 a share, topping Glaxo's bid of $13 per share

And in one of the most high-profile takeover battles, privately held Coty recently made its bid for competitor Avon Products (AVP, Fortune 500) public after talks with the makeup retailer broke down.

While these potentially hostile battles are playing out in public, several investment bankers said they're also working with companies on more "bear hug" letters than they have in several years. Bear hug letters are acquisition offers that potential acquirers send to the board of a company that seems unwilling to sell.

Those bear hug letters can turn into either relatively friendly mergers or more hostile bids.

George Bason, the global co-head of the law firm Davis Polk & Wardwell's mergers and acquisitions practice, says hostile activity is heating up partly because of what he calls a "rear-view mirror problem."

Bason said that boards are often reluctant to consider bids that are at a meaningful premium to their current share price but below where the company traded several years ago. "It's hard for directors to confront that it doesn't matter to many market players where the company's stock was in 2009."

Coty's $10 billion bid for Avon came in at $23.25, a 20% premium over its previous closing price, but far below the $30 range where it traded in late 2009.

But many investors don't care about what the stock price used to be a year ago. Once it is known that one company is pursuing another, so-called merger arbitrage shareholders quickly buy up the stock.

In the case of Avon, roughly 70 million shares of the retailer changed hands immediately after the Coty bid. That's compared to 3.3 million in total over the previous 10 days.

These new shareholders often dictate the company's decision. Coty and its team of investment bankers are well aware of the power of arbitrage investors and have been holding regular calls and even a recent breakfast with them to discuss its strategy.

But some companies are able to fight back against bids they feel are inferior. On Wednesday, pharmaceutical company Roche Holding gave up a $6.8 billion hostile takeover bid for Illumina after Illumina's (ILMN) shareholders rejected Roche's choice for a new board.

Investors in water park operator Great Wolf (WOLF) also pushed that company into a bidding war after the firm's shareholders wanted it to look for a better deal than private equity firm Apollo's initial $5 bid. Private equity firm KSL made a better offer that Apollo matched. On Thursday, KSL raised its bid again ... to $7.25 a share.

And roadside restaurant chain Cracker Barrel Old Country Store (CBRL) is actively trying to thwart a hostile bid from its rival Biglari Holdings (BH), which owns restaurant chains like Steak 'n Shake. Earlier this month it adopted a so-called poison pill to make it more expensive for Biglari to buy more shares and force a sale.

The good news for shareholders of takeover targets is that many of these companies eventually see the writing on the wall and push to get the best price they can for investors. Or else.

"Investors won't let them forget that they have the opportunity to sell themselves" said Sachin Shah, a merger arbitrage strategist for Tullett Prebon.