Poison Pills: Keeping Predators At Bay

Poison pills have become a commonly used tool for companies to counter abusive takeover tactics and unsolicited bids   

Hostile takeovers have become a part of business life. Firms with money or credit buy up those that can no longer afford to operate independently. Large firms buy small ones at a fraction of their true value. 

Consider the case of Philippine Long Distance Company (PLDT)

The company armed itself with a “poison pill” as a defence against a possible takeover.  This was done, though is did not face any such threat. The company was vulnerable because of its weak stock price, its dominance of the domestic phone market and its easy access to credit. According to the proposal, a hostile bid would automatically trigger a rights offering. This would allow all shareholders - except the raider - to buy new shares at half the market price.

Triggers were also fixed. The rights offer would trigger when any investor acquires 10 % or more of the company's shares or makes an offer to acquire 10 %, or when an existing shareholder raises his stake by 5 %. This would have made it expensive for a prospective raider to acquire management control.

It’s a case where there was no takeover threat. Yet, the company wanted a defence mechanism that would have tied up the ownership and management for all time to come, unless somebody could overcome the prohibitive price tag that was created with the `poison pill'.

In the corporate world, companies to avert a hostile takeover create a “poison pill” that the raider will not want to swallow.

Poison Pills – the ingredients

A “Poison Pill” also known as “Shareholders Rights Plan” is designed primarily to make it difficult, time-consuming and expensive for a hostile acquirer to consummate offers that may not offer fair value to all shareholders. It is usually an issue of convertible preferred stock distributed as a dividend to current stockholders. The preferred stock is convertible into common shares equal to or greater than the number of shares outstanding. The takeover attempt becomes its own poison because it vastly increases the price to be paid for a company.

 

A “Shareholders Rights Plan” works by threatening to substantially dilute the unfriendly acquirer's equity interest. Upon the occurrence of certain takeover events, the company's shareholders (other than the acquirer) can exercise rights or warrants. On exercising this option, the shareholders can buy additional equity securities in the company or of the acquirer at a substantial discount.

The risk of dilution, combined with the authority of a target's board of directors to redeem the rights prior to a triggering event, compels the potential acquirer to negotiate with the target's board of directors, rather than proceeding unilaterally.

Steel Technologies Inc., Louisville, adopted a shareholder's right plan under which a preferred stock purchase right was distributed as a dividend on each outstanding share of common stock

The plan would protect shareholders in the event of a takeover bid by an outside company. "The company's solid increase in earnings was a factor in the board's adoption of a shareholders' rights plan,” The plan was adopted to protect the interest of shareholders and to help ensure that potential acquirers do not use coercive tactics to deprive the board and officers of the opportunity to determine the company's future and to realise the full value of shareholders' investment in Steel Technologies."

In the event that any person or group either acquires or makes a tender offer for 20 % or more of common stock, holders of the rights (other than the acquiring person) will be able to purchase a number of shares for $50 though it has a market value of $100. (50% discount to the prevailing market price in 1998).

The better Pill!

Adopting a pill is the first step to protect a company against takeovers. A poison pill makes a raider negotiate, and buy time for a target company to get a proper evaluation of the offer. It gives the company an opportunity to investigate other alternatives. Economic studies suggest that takeover premiums are higher when rights plans are in effect.

For example, Markel Corp., Glen Allen, Va., launched a $187 million bid to acquire Gryphon Holdings Inc., in October 1998; Gryphon had a "poison pill" provision that would have allowed it to issue new stock. Gryphon, however, did not activate the provision, because Markel Corp. raised its offer from $18 to $19 a share.

 

The bitter Pill!

Even though poison pills may lead to higher premiums and do not reduce bid completion rates, they still might prevent the occurrence of some bids which act against the economic interest of shareholders of the unrealised target companies.

Caution!

“Your pursuer may be squeezed by the intense competition caused by deregulation and may be desperate for a product market extension or diversification. It may consider the implementation of its strategy to be a survival issue - and acquisition of your company may be the heart of its strategy”. BEWARE!

Related reading 

“Poison pills in oil patch spawn new type of takeover insurance”: Anne De Rouffignac: Houston Business Journal

“Steel Technologies adopts shareholders' rights plan”: www.findarticles.com Issue May 4, 1998

“Pro-active measures have value”: S.Vaidya Nathan: www.hindubusinessline.com

Poison Pills: Not Too Bitter for REITs to Swallow: www.nareit.com