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The latest hostile takeover defenses defy the usual justifications.
Kris Frieswick, CFO.com | US
October 15, 2001
With stock prices down, poorly performing companies are more vulnerable to hostile takeovers. So it comes as little surprise that an increasing number are popping poison pills, a familiar takeover defense mechanism. What is surprising are the terms of some of the latest deals.
Poison-pill provisions are triggered when a hostile suitor acquires a predetermined percentage of company stock. At that point, all existing shareholders except the suitor are granted options to buy additional stock at a dramatic discount, thus diluting the acquirer's share so as to head off a change in control of the company. The measures are usually used in combination with staggered board terms so that hostile suitors can't quickly replace enough directors to revoke the provision. According to statistics from Thomson Financial Securities Data, 140 companies adopted poison pill provisions in the first half of 2001, up 45 percent from the same period last year.
PILLS FOR SALE
Patrick McGurn, vice president of Institutional Shareholder Services, a proxy advisory firm in Rockville, Maryland, isn't surprised at the burst of new activity. "When M&A activity is down, bankers and investment lawyers have to keep the fees up, so they go around and sell companies on these poison pills," he says. "Also, there's an increasing sense of insecurity out there right now. Companies are just really afraid that their stock isn't coming back up." That's especially true in the tech sector. Of the total number of pills adopted during the first six months of the year, 46 percent were put in place by technology companies, compared with just 23 percent in 1999 and 35 percent in 2000.
Among the firms that have adopted pills in the past year are Commerce One, whose stock was down to 3.1 on August 17 from a 52-week high of 84 on September 29, 2000; E-Trade, down to 6 from a high of 20 on September 6, 2000; Ask Jeeves, down to 1 from 34 on September 1, 2000; and Yahoo, down to 12 from 139 on August 25, 2000. Sixty-eight other tech companies adopted such plans in the first half of 2001.
THE WORST MESSAGE?
"Tech companies have not been an area in which there's been a lot of hostile takeover activity," says David Berger, a partner at the law firm of Wilson Sonsini Goodrich and Rosati, in Palo Alto, California. "But that's going to change in the next year or so. There's been an increasing interest in the tech sector by financial players. They're being much more aggressive. Smaller dot-coms are trading at discounts to their cash value. These companies want to make sure they have the flexibility to deal with the situation."
McGurn says that shareholder activists generally hate poison pills, complaining that they are roadblocks to lucrative buyouts. "You could make a strong argument that a takeover is the best thing for these companies," he says. "If you're an acquirer and there are five targets, and four have poison pills, which would you go after? Some say [a poison pill] is the worst possible message you could send out."
Defenders of poison pills have long claimed that they help prevent a company from being scooped up at bargain-basement prices, and thus realize more shareholder value from an acquisition. John P. Biestman, vice president of finance at Commerce One, which enacted its poison-pill plan in April, is one of the believers.
"The board of directors felt a [pill] would reduce the prospect of any coercive offers that didn't offer us a fair value," explains Biestman. "Another consideration was preserving the board's bargaining power and flexibility if we ever dealt with any [hostile] acquirers, and it was a way of mitigating" the influence of big institutions. "Plus," he adds, "at this point, poison pills are really just an established practice."
This was certainly not the case during the merger madness of the 1980s, when poison pills were first introduced. A study by J.P. Morgan Securities Inc. says that during this period, companies often experienced a stock bounce when they adopted a pill, because it sent a signal to the markets that the company might be a takeover target. If the stock price did indicate such takeover speculation, however, the potential roadblock created by the poison pill tended to push the stock back down again. In comparison, pill adoptions in the 1990s and 2000s have become so commonplace that the markets barely recognize the event, the study shows.
In fact, most poison pills are designed with the belief that they will never be triggered. Since 1997, for every company with a poison pill that successfully rebuffed an unwanted advance and remained independent, 20 pill-protected companies accepted takeover offers.
As a result, poison pills seem to have generated value at Old Economy companies as well as at some types of technology companies. A separate report by Thomson and Morgan shows that takeover premiums at nontech companies with pills are higher (an average of 35.7 percent over stock price) than they are at nontech companies without them (28.2 percent). And non-Internet tech companies with pills command higher premiums (51.1 percent) than do their nontech peers that haven't adopted such antitakeover measures (41.8 percent).
But the plans enacted by New Economy companies may undermine the notion that poison pills ultimately benefit shareholders. The Thomson-Morgan study shows that overall, Internet-related companies with poison pills command a lower premium over market value (36.3 percent) than nonpill Internet companies (45.6 percent).
One reason may be their aggressive terms. Whenever a board adopts a poison pill, it sets a "trigger," a percentage of stock that an acquirer must buy before the poison pill goes into effect. When companies first started adopting pills in the early 1980s, a 20 percent trigger was the rule, says McGurn. Today, triggers are more often set at 15 percent, and 10 percent is increasingly common.
"Boards are putting in pills that are much more toxic," says McGurn. "The last thing a big institutional investor wants is a phone call that says, 'Guess what? You just accidentally stepped over the 10 percent line at company XYZ and triggered their poison pill.' That's a nightmare call for a large institution."
To head off such problems, many companies go to some length to exempt large institutional holders from the trigger. When Coach Inc. adopted its pill this year after majority owner Sara Lee Corp. completed its spin-off, it set a 10 percent threshold. But it allowed Wellington Management Co. and Fidelity Investments, its two biggest institutional holders, to own as much as 15 percent. Still, if their stakes fall below 10 percent, the 10 percent threshold will apply.
More critically, some companies are also raising the amount of stock granted under poison-pill provisions by wildly inflating their exercise price. The exercise price of a pill usually reflects a significant premium over the market value of the company's stock, typically three to five times the current price.
Pills also usually give shareholders a 50 percent discount on the purchase price of the stock if the pill is triggered. So, for example, if a pill's exercise price was set at $60 and the stock price on the day the pill was triggered was $30, shareholders could buy $60 worth of shares at the discount and end up with four shares for each one they hold.
One company, Extreme Networks, a broadband network provider, recently adopted a poison pill with an exercise price of $150, which is more than nine times what its price was on August 31. If the company's pill were exercised that day, shareholders would have been entitled to buy nearly 20 shares for each one they held.
"We're seeing a lot of companies rushing in and amending their exercise prices," says McGurn. "They're just clearly saying, 'We don't ever want this pill to be triggered.'"
All of which suggests that at least for some types of companies, a poison pill may be an effective means of playing hard to get only if its terms are relatively moderate. Like so much else in the financial markets, however, the current trend in hostile takeover defenses runs toward the extreme.
Kris Frieswick (krisfrieswick @cfo .com) is a staff writer at CFO.