Poison Pill– Ultimate Weapon Against Hostile Takeovers, Corporate Raiders: Raise Defenses, Hostiles are Coming…

Poison pill is a company’s ultimate doomsday weapon against hostile takeovers, corporate raiders… The poison pill is designed to make a hostile takeover transaction very unattractive by diluting the value of a hostile takeover investor’s share of the company…

A poison pill strategy is also known as a ‘shareholder rights plan’, which forces potential hostile takeover investors to negotiate with management/ board of directors rather than directly with shareholders… As such, it’s more of a ‘management rights plan’ as it empowers management/ board of directors at the expense of shareholders…

Hence, there is a growing apathy among shareholders against poison pills because of its potential to block all hostile takeovers, irrespective of the merit… However, despite being one of the more effective anti-takeover tools; there is increasing shareholder activism against poison pills… Also, there is an increasing trend by large companies to shed their poison pills; but in contrast there is an increasing trend by smaller companies to adopt the practice…

According to Martin Lipton, who developed the concept of poison pill in 1982; the purpose of ‘poison pill’ was to give shareholders more time to evaluate the proposed hostile bid and to give management the opportunity to make a better business decision… Two of the most common poison pill strategies include: Flip-over: Existing investors are given options to purchase bidder’s shares at a premium… Flip-in:

Existing investors are given options to purchase additional shares in the company at a premium… Both strategies dilute the company’s stock, thus making a hostile takeover more expensive and less attractive… However, the use of poison pills as a takeover defense is highly controversial, and at the core of the controversy is the question: Whether adoption of poison pills is in the best interest of shareholders or an attempt by management to entrench themselves?

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According to Anna Maria Galinska; now, the question is whether the old legal cases upholding poison pill tactics can also apply to ‘shareholder activism’… There are two arguments on this issue and they revolve around definition of– threat and control… and, the question: Does shareholder activists pose such a serious threat to a corporation that it justifies the adoption of poison pill? Or, does a shareholder activist’s motivation differs from incentives of a hostile bidder?

Here, the primary shareholder activists argument is that they focus on the future strategy of the company and seek alternative solutions to improve the company growth, profitability… rather than, to takeover or destroy the company… On the flip side, there are those that say shareholder activism, especially hedge fund activism, creates only short-term gains, which harms the company long-term… According to Activist Insight; shareholder activism is gaining momentum both in U.S. and EuropeThey points out that 13 European companies are publicly targeted by activists in 2014, so far; while in 86 companies activists have sought board representation worldwide, in 2014…

In recent research by Ed Hammond and Arash Massoudi; the value of global mergers and acquisitions (M&A) hit $1.75 Trillion in first six months of 2014, a 75% rise on the same period last year and highest since 2007. The increase highlights a shift in thinking in the U.S., Europe and Asia… Now it seems, risk aversion and organic expansion are being pushed aside, with the belief that– improved financial returns and company growth can be more easily ‘bought’ than ‘built’… Although 95% of M&A deals are very friendly, some 5% are hostile takeovers, in which one party fights to gain control of a firm against the wishes of existing management…

Although poison pills are generally on decline in large-cap companies; smaller firms are increasingly taking up the strategy both to ward off unsolicited bids and drive-up price of the company should takeover develop. According to Keith Gottfried; small-cap companies are more likely to perceive themselves as under-valued targets as the stock market fluctuates… Smaller companies are also cheaper to acquire, especially in a downturn, which makes the tactic more attractive to them…

Basically, a hostile takeover is launched in one of two ways; ‘tender offer’ or ‘proxy fight’. In ‘tender offer’, the raider offers to buy a certain number of shares of stock in the corporation at a specific price. The price offered is generally more than the current stock price so that shareholders are motivated to sell. The raider hopes to get enough shares to take control of the corporation and replace existing board of directors and management.

In ‘proxy fight’, the raider launches a public relations battle for shareholder votes, hoping to enlist enough votes to oust the board of directors and management… In defenses against hostile takeovers– corporate boards and executives devised number of schemes to defend themselves against hostile takeovers… ego, the poison pill

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In the article Companies Use Shareholder Rights Plan–Poison Pills by Kalen Smith writes: Essentially, poison pills are used to dilute the acquiring company’s ownership. This is conducted by issuing stocks, warrants, or options to existing shareholders and it exercisable once takeover company acquires fixed percentage of the target company’s stock (often at a significant discount to current price). Poison pills are usually triggered when investor obtains ownership interest of  20%…

While there are a variety of ways poison pills may be constructed, one common way is to make the long-term director’s options immediately exercisable, thereby diluting the potential hostile’s ownership, and alternatively, current shareholders may be given rights to purchase additional shares at a deep discount, making it much more expensive for the target company to get acquired…

Poison pills may be used in different scenarios, for example; management may want to deter a hostile takeover in order to preserve their jobs… Or, sometimes, a company doesn’t mind being bought out, but is not interested in the specific company that is attempting to do so. In the latter case, using a poison pill can be a delaying tactic to give the company more time, while they search for a more favorable acquisition partner…

In the article Poison Pill’s Relevance in Age of Shareholder Activism by Steven Davidoff Solomon writes: Poison pills were invented to fight off hostile raiders intent on taking control of a company, and so just as the hostile raiders are reinventing themselves, these same tools that were invented for hostile raiders are being reworked and used to fight off activists…

Most U.S. corporations are incorporated in State of Delaware and the Delaware courts have repeatedly held that poison pill is a valid response to a hostile takeover bid… The court reasoned that Delaware law gives boards of directors the power to make such judgments, and if shareholders don’t like it, they can simply replace the directors… In effect, the channel for company change of control is through board of directors…

But in shareholder activism situation, the motivations are different from a hostile takeover. In a hostile takeover, there is a change of control– new management and new board of directors… But with shareholder activism, main issues are about– how to steer the future direction and improve the company…

Shareholder activism is as debated now as takeovers were in 1980s. Critics of shareholder activists argue that they force companies to take short-term actions that hurt the long-term interests of both the shareholders and the companies… A number of studies have found that this is not true in many cases, and that activism does create long-term shareholder value…

Clearly, though, there is still questionable corporate activism like the proposals by Mr. Icahn, David Einhorn’s hedge fund Greenlight Capital on what Apple should do with its cash hoard… Most studies are not definitive and debate continues over whether activism poses same threat as hostile takeovers… However, there is a difference; activism enhances shareholder value; in hostile takeover, shareholders are being taken advantage of…

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In the article Absurdity of The Poison Pill by Carl Icahn writes: Public companies refer to a poison pill as a ‘shareholder rights plan’. Does anyone else find that amusing? If anything, it undermines shareholder rights rather than supporting them… A poison pill actually creates an unmitigated ban on acquiring more than certain percentage of stock. A purchaser who desires to buy and the seller who wishes to sell are simply out of luck.

Board of directors should not be allowed to hide behind a poison pill indefinitely… all parties should operate under a more rational system… There are myriad of solutions that could be legislatively enacted short of absolute prohibition on poison pills. The solutions should create a balance between rights of shareholders to buy and sell shares and the desire of management to have meaningful input in a change of control situation…

However, the future of poison pills depends on much wider issues involving corporate governance…  According to Profusek; corporate governance is going thru a transition … the ultimate question is where to strike the balance of power between the board of directors and the shareholders…Despite uncertainty regarding the future of poison pills, there is no doubt that they are experiencing a resurgence in the current market, particularly as a means of protecting a company’s ‘net operating loss’ (NOL) carry forwards…

According to Mike Armstrong; new poison pills are being put in place to protect something that all companies find very valuable– their ‘net operating loss’ (NOL) carry forwards… Nobody likes to lose money, but one good thing about the new pills for companies is they can use their losses to offset future income tax liabilities, once they’re in the black again… So while traditional poison pills is aimed to protect an entire company, NOL poison pills are designed to shield single line on company’s balance sheet…

According Thomson Financial; there are over 1,500 poison pills in place at public companies today, with nearly 35% set to expire over the next few years. That means that hundreds of companies will have to decide whether to placate shareholders– let them expire or renew them and risk angering corporate investors, and the increasingly influential private equity market. Some companies will put the decision to shareholder vote, but the majority don’t require shareholder input for renewal of a poison pill…