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What Is a Poison Pill?
by Marie C. Baca

http://www.bnet.com/2403-13238_23-215585.html

Created in the 1980s by M&A lawyer Martin Lipton, the so-called “poison pill” is a tactic public companies use to thwart hostile takeovers. In effect, it is an agreement adopted by a company’s board of directors that makes the target’s stock prohibitively expensive or otherwise unattractive to an unwanted acquirer. To date, no takeover bid has ever seen a poison pill fully executed — management teams typically have used the strategy as a deterrent and negotiation tool, buying their company time to bargain for a better purchase price.

But shareholders often rail against the tactic, arguing that they don’t always have the right to vote on the bid, and that a takeover bid that management finds unwanted could actually be in their best interest. Consequently, many public companies that become acquisition targets face the awkward decision to either appease investors or lose one of their most effective weapons against hostile takeovers.

Who coined it: Mergers and acquisitions lawyer Martin Lipton
Also known as: Shareholder rights plan, “shark repellent”
How long a poison pill lasts: About 10 years, unless the board decides to cancel it before the expiration date. However, now that shareholders are increasingly hostile to poison pill tactics, the current trend is to adopt more palatable pills that have a lifespan of just a few years.


How It Works
Most poison-pill agreements are triggered when an outside company or individual — think Carl Icahn, for example — acquires enough stock to gain a controlling interest in the target company. The term is often used as a catch-all for a variety of antitakeover measures, but in its most common form there are two primary tactics:


Flip-over: If a hostile takeover occurs, investors have the option to purchase the bidder’s shares at a discount, thereby devaluing the acquirer’s stock and diluting its stake in the company.

Flip-in: Management offers shares to investors at a discount if an acquirer merely purchases a certain percentage of the company. The discount is not available to the acquirer, and so it becomes extremely expensive for that acquirer to complete the takeover. Experts estimate that it would cost an unwanted bidder, on average, four to five times more to “swallow” a poison pill in order to acquire a target.

Although state courts have generally upheld the validity of poison pills since the 1980s, judges have recently leaned toward limiting their scope in order to protect shareholders. Currently, a target company can still legally keep its poison pill in place and accept an offer from another bidder, as long as the final acquisition price is higher than the original hostile bid. In the mid-1980s Revlon tried to skirt this legal requirement because its directors favored a deal with a private equity firm. But the courts eventually invalidated the company’s poison pill because Revlon repeatedly rebuffed higher offers from a grocery chain called Pantry Pride.

Why It Matters Now
According to research firm Thomson Financial, there are currently over 1,500 poison pills in place at public companies today, with nearly 35 percent set to expire over the next two years. That means that hundreds of companies will have to decide whether to placate shareholders and 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 a shareholder vote, but the majority don’t require investor input for renewal of a poison pill.

Poison pills are generally on the decline in large-cap companies, with the notable exception of Yahoo, which has one in place that will be triggered if Microsoft or any other potential suitor buys more than 15 percent of the company without board approval. These days, it’s smaller firms that are increasingly taking up the strategy, both to ward off unsolicited bids and to drive up the price of the company should a takeover become inevitable. “Small-cap companies are more likely to perceive themselves as undervalued when the stock market fluctuates,” says Keith Gottfried, a partner at Blank Rome LLP who specializes in shareholder activism and corporate governance. Smaller companies are also cheaper to acquire, especially in a downturn, which makes the tactic more attractive to them.

Foreign companies are also turning to poison pills more frequently, particularly in Canada and Japan, where hostile bids are on the rise. According to Thomson Financial, overseas firms now account for nearly 70 percent of first-time pill adopters. In the U.S., hostile takeovers are fairly rare. There have been only 12 hostile bids exceeding $20 million in value in the U.S. since 2005. Historically, hostile bid activity decreases sharply during periods of recession.

Strong Points
As a defensive tactic, poison pills are extremely effective. Not only do they fend off unwanted takeover bids, but boards often argue that the strategy gives the company an opportunity to find a more suitable acquiring party, a so-called “white knight.”

Boards also favor poison pills for the leverage they bring to the bargaining table. In 2003, enterprise software giant Oracle attempted to acquire rival PeopleSoft through a $5.1 billion hostile takeover bid. But PeopleSoft’s poison pill was set to trigger if Oracle bought more than 20 percent of the company. After a year-long battle, PeopleSoft finally voided its poison pill and was acquired by Oracle for $10.3 billion — nearly double Oracle’s initial offer.

Weak Spots
Since shareholders could gain from a takeover, they often view management’s adoption of a poison pill as blatant disregard of investors’ interests. “Adopting a poison pill can really do a number on a company’s corporate governance image,” says Jeffrey Block, associate director for strategic research at Thomson Financial. “There is a knee-jerk reaction in the marketplace against anything that dilutes the power of shareholders.”

Accordingly, in some cases investors send a clear message that they don’t agree with management’s strategy by dumping some of their shares. Consider the example of oil company Tesoro: When the company adopted a poison pill in November 2007 to defend itself against billionaire Kirk Kerkorian’s Tracinda Corp., its stock plummeted almost 14 percent between the week before the announcement and the week after. In March 2008, Tesoro’s management dropped its poison pill, with CEO Bruce Smith explaining that the company wanted to act in “the best interests of our stockholders.”

When it comes to big institutional investors, many companies in fact don’t have the choice of adopting the tactic. Market giant Fidelity Management & Research, for example, says that it “will generally vote against a proposal to adopt or approve the adoption of an anti-takeover plan.”

How to Talk About It
Here are poison pill-related terms:

Activist shareholder: An investor who uses his stake in a company to influence the management and direction of that company. The rise in shareholder activism is one reason why many large companies have eschewed poison pills in recent years due to their “shareholder-unfriendly” reputation.

“Chewable” pill: A modified poison pill that can appease investors by permitting them to ask for a special shareholder vote to determine whether or not a specific bid can be exempt from triggering the pill. Such policies prevent companies from automatically discouraging takeover bids that may be lucrative for shareholders.

Black knight: A company that makes an unsolicited, hostile takeover bid on a target company.

White knight: A company that saves a target from a hostile takeover by acquiring it under more favorable terms and a better price per share.

Proxy contest: A technique used by a hostile bidder to rally a group of shareholders and their proxies (authorized representatives) to vote out the target company’s incumbent management and replace them with managers who will be more likely to accept the bid.