Poison Pills Haven’t Lost Their Potency

Although poison pills have decreased in popularity, companies are still using them at the first sign of a takeover attempt.
Sarah JohnsonMarch 10, 2011

Last week Family Dollar Stores joined the handful of companies this year that have implemented a shareholder rights plan — aka poison pill — to fend off a takeover. The retailer’s board rejected an unsolicited $7 billion bid by hedge fund Trian Group, saying the offer “substantially undervalues the company.” At the same time, Family Dollar’s board announced it was adopting a rights plan that would make further takeover attempts prohibitively expensive.

Once viewed as long-term insurance policies against corporate raiders, shareholder rights plans are more commonly used today as short-term stopgaps against a threat. For example, J.C. Penney implemented a one-year plan last fall after hedge-fund manager William Ackman upped his stock stake in the retailer above 15%. This year, 8 of the 11 poison pills implemented between January and March were adopted in response to an activist investor’s acquisition offer or to preserve the value of net operating loss carryforwards (which, for tax purposes, could be reduced when ownership of a company changes), according to research firm FactSet Research Systems.

Shareholder rights plans are designed to thwart unfriendly acquirers by making it more costly for them to accumulate stock over a specified threshold without board approval. In Family Dollar’s case, its board will intervene if anyone acquires at least 10% of the company’s common stock in the next year. The trigger enables other shareholders to buy additional voting stock at a discounted price, in effect diluting the acquirer’s dominance.

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Although investor groups have long decried their use, poison pills can be beneficial for both companies and shareholders when used properly, according to David Grinberg, a partner at law firm Manatt, Phelps & Phillips. The plans “allow the board to disseminate information about the value of the company to the stockholders, give its recommendation, seek other strategic alternatives, and negotiate with the hostile bidder to raise the price,” he explains.

Still, poison pills give boards all the power in making decisions about takeover bids. That power was reaffirmed last month in a closely watched case in Delaware Chancery Court, when the court upheld the poison pill used by Airgas to spurn a $70-per-share offer by rival Air Products and Chemicals. “The power to defeat an inadequate hostile tender offer ultimately lies with the board of directors,” wrote Chancellor William Chandler in his opinion. Still, he emphasized that boards cannot “just say no” to an offer without doing a proper investigation and using outside advice on which to base their denial. Air Products has since announced it will drop its fight for Airgas, which lasted for more than a year.

Although poison pills have lost favor in the past decade, they may regain popularity among companies that weathered the recession but are still seeing low stock prices, says Robert Schreck, a partner at law firm McDermott Will & Emery. Such companies may turn to rights plans under the attitude of “We’re not going to allow the arbitrageurs to take away from us or allow some private-equity guy to buy stock at a low price and close us out,” he says.

Boards that do consider rights plans will have to carefully weigh the reputational risk involved. “Companies still have to deal with the negative PR and shareholder relations that come with routine poison-pill adoptions,” says John Laide, senior product manager at FactSet.