22506438 Merger and Acquisition Defensive Strategies

8/8/2019 22506438 Merger and Acquisition Defensive Strategies

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Defensive Strategies (Poison Pills)

It is a term referring to any strategy, generally in business orpolitics, to increasethe likelihood of negative results over positive ones for a party that attempts anykind of takeover. It derives from its original meaning of a literal poison pill carried

by various spies throughout history, taken when discovered to eliminate thepossibility of being interrogated for the enemy's gain. In publicly held companies,various methods to deter coercive takeoverbids are called "poison pills". Takeover

bids are attempts by a bidder to obtain control of a target company, either bysoliciting proxies to get elected to the board or by acquiring a controlling block ofshares and using the associated votes to get elected to the board. Once in control ofthe target's board, the bidder can determine the target's management. As discussed

further below, targets have various takeover defenses available, and several typesof defense have been called "poison pills" because they not only harm the bidder

but the target (or its shareholders) as well. At this time, the most common takeoverdefense known as a poison pill is a shareholder rights plan.

Because theboard of directors of the company can redeem or otherwise eliminate astandard poison pill, it does not typically preclude a proxy fight or other takeoverattempts not accompanied by an acquisition of a significant block of the company'sstock. It can, however, prevent shareholders from entering into certain agreementsthat can assist in a proxy fight, such as an agreement to pay another shareholder'sexpenses. In combination with a staggered board of directors, however, ashareholder rights plan can be a defense.

Shareholder rights plans

The target company issues rights to existing shareholders to acquire a large numberof new securities, usually common stock orpreferred stock. The new rightstypically allow holders (other than a bidder) to convert the right into a largenumber of common shares if anyone acquires more than a set amount of thetarget's stock (typically 15%). This dilutes the percentage of the target owned by

the bidder, and makes it more expensive to acquire control of the target. This formof poison pill is sometimes called a shareholder rights plan because it providesshareholders (other than the bidder) with rights to buy more stock in the event of acontrol acquisition.
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Effects on shareholders

The goal of a shareholder rights plan is to force a bidder to negotiate with thetarget's board and not directly with the shareholders. The effects are twofold:

It gives management time to find competing offers that maximize sellingprice.

Several studies have indicated that companies with poison pill (shareholderrights plans) have received higher takeover premiums than companieswithout poison pills. This results in increased shareholder value. The theory

behind this is that an increase in the negotiating power of the target isreflected in higher acquisition premiums.

History

The poison pill was invented by noted M&A lawyer Martin Lipton ofWachtell,Lipton, Rosen & Katz, in 1982, as a response to tender-based hostile takeovers.

Poison pills became popular during the early 1980s, in response to the increasingtrend ofcorporate raids by businessmen such as Carl Icahn.It was reported in 2001 that since 1997, for every company with a poison pill thatsuccessfully resisted a hostile takeover, there were 20 companies with poison pillsthat accepted takeover offers. The trend since the early 2000s has been forshareholders to vote against poison pill authorization, since, despite the abovestatistic, poison pills are designed to resist takeovers, whereas from the point ofview of a shareholder, takeovers can be financially rewarding.Some have argued that poison pills are detrimental to shareholder interests becausethey perpetuate existing management. For instance, Microsoft originally made anunsolicited bid for Yahoo!, but later dropped out after Yahoo! CEO Jerry Yangthreatened to make the takeover as difficult as possible unless Microsoft raised it toUS$37 per share; one Microsoft executive commented, "They are going to burn thefurniture if we go hostile. They are going to destroy the place." The nature ofYahoo!'s poison pill was never announced. Analysts suggested that Microsoft'sraised offer of $33 per share was already too expensive, and that Yang was not

bargaining in good faith, which later led to several shareholder lawsuits and anaborted proxy fight from Carl Icahn. After Microsoft dropped their bid, Yahoo'sstock price plunged and Jerry Yang faced a backlash from stockholders that led to

his resignation.

Common types of poison pills

Preferred stockplan Flip -overrights plan Ownership flip-in plan Back-end rights plan
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Voting plan

Constraints and legal status

Following the development of poison pills in the 1980s, the legality of their usewas unclear in the United States for some time. However, poison pills were upheldas a valid instrument ofDelaware corporate law by the Delaware Supreme Court inits 1985 decision Moran v. Household International, Inc.Many jurisdictions other than the U.S. view the poison pill strategy as illegal, or

place restraints on their use.In Canada, almost all shareholders rights plans are "chewable", meaning theycontain a permitted bid concept such that a bidder who is willing to conform to therequirements of a permitted bid can acquire the company by take-over bid withouttriggering a flip-in event. Shareholder rights plans in Canada are also weakened bythe ability of a hostile acquirer to petition the provincial securities regulators to

have the company's pill overturned. Generally the courts will overturn the pill toallow shareholders to decide whether they want to tender to a bid for the company.However, the company may be allowed to maintain it for long enough to run anauction to see if a white knight can be found. A notable Canadian case before thesecurities regulators in 2006 involved the poison pill ofFalconbridge Ltd. which atthe time was the subject of a friendly bid from Inco and a hostile bid from Xstrata

plc, which was a 20% shareholder of Falconbridge. Xstrata applied to haveFalconbridge's pill invalidated, citing among other things that the Falconbridge hadhad its pill in place without shareholder approval for more than nine months andthat the pill stood in the way of Falconbridge shareholders accepting Xstrata's allcash offer for Falconbridge shares. Despite similar facts with previous cases inwhich securities regulators had promptly taken down pills, the Ontario SecuritiesCommission ruled that Falconbridge's pill could remain in place for a furtherlimited period as it had the effect of sustaining the auction for Falconbridge by

preventing Xstrata increasing its ownership and potentially obtaining a blockingposition that would prevent other bidders from obtaining 100% of the shares.In Great Britain, poison pills are not allowed under Takeover Panel rules. Therights of public shareholders are protected by the Panel on a case-by-case,

principles-based regulatory regime. One disadvantage of the Panel's prohibition of

poison pills is that it allows bidding wars to be won by hostile bidders who buyshares of their target in the marketplace during "raids". Raids have helped bidderswin targets such as BAA plc and AWG plc when other bidders were consideringemerging at higher prices. If these companies had poison pills, they could have

prevented the raids by threatening to dilute the positions of their hostile suitors ifthey exceeded the statutory levels (often 10% of the outstanding shares) in therights plan. The London Stock Exchange itself is another example of a company
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that has seen significant stake-building by a hostile suitor, in this case theNASDAQ. The LSE's ultimate fate is currently up in the air, but NASDAQ's stakeis sufficiently large that it is essentially impossible for a third party bidder to makea successful offer to acquire the LSE.Takeover law is still evolving in continental Europe, as individual countries slowlyfall in line with requirements mandated by the European Commission.Stakebuilding is commonplace in many continental takeover battles such as ScaniaAB. Formal poison pills are quite rare in continental Europe, but nationalgovernments hold golden shares in many "strategic" companies such as telecommonopolies and energy companies. Governments have also served as "poison pills"

by threatening potential suitors with negative regulatory developments if theypursue the takeover. Examples of this include Spain's adoption of new rules for theownership of energy companies after E.ON of Germany made a hostile bid forEndesa and France's threats to punish any potential acquiror ofGroupe Danone.

Other Takeover Defenses

Poison pill is sometimes used more broadly to describe other types of takeoverdefenses that involve the target taking some action. Although the broad category oftakeover defenses (more commonly known as "shark repellents") includes thetraditional shareholder rights plan poison pill. Other anti-takeover protectionsinclude:

Classified boards with staggered terms. Limitations on the ability to call special meetings or take action by written

consent. Supermajority vote requirements to approve mergers. Supermajority vote requirements to remove directors. The target adds to its charter a provision which gives the current

shareholders the right to sell their shares to the acquirer at an increased price(usually 100% above recent average share price), if the acquirer's share ofthe company reaches a critical limit (usually one third). This kind of poison

pill cannot stop a determined acquirer, but ensures a high price for thecompany.

The target takes on large debts in an effort to make the debt load too high to

be attractivethe acquirer would eventually have to pay the debts. The company buys a number of smaller companies using a stock swap,

diluting the value of the target's stock. The target grants its employees stock options that immediately vest if the

company is taken over. This is intended to give employees an incentive tocontinue working for the target company at least until a merger is completedinstead of looking for a new job as soon as takeover discussions begin.
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However, with the release of the "golden handcuffs", many discontentedemployees may quit immediately after they've cashed in their stock options.This poison pill may create an exodus of talented employees. In many high-tech businesses, attrition of talented human resources often means an emptyshell is left behind for the new owner.

Peoplesoft guaranteed its customers in June 2003 that if it were acquiredwithin two years, presumably by its rival Oracle Corporation, and productsupport were reduced within four years, its customers would receive arefund of between two and five times the fees they had paid for theirPeoplesoft software licenses. The hypothetical cost to Oracle was valued atas much as US$1.5 billion. Peoplesoft allowed the guarantee to expire inApril 2004. If PeopleSoft had not prepared itself by adopting effectivetakeover defenses, it is unclear if Oracle would have significantly raised its

original bid of $16 per share. The increased bid provided an additional $4.1billion for PeopleSoft's shareholders.

The practice of having staggered elections for the board of directors. Forexample, if a company had nine directors, then three directors would be upfor re-election each year, with a three-year term. This would present a

potential acquirer with the position of having a hostile board for at least ayear after the first election. In some companies, certain percentages of the

board (33%) may be enough to block key decisions (such as a full mergeragreement or major asset sale), so an acquirer may not be able to close anacquisition for years after having purchased a majority of the target's stock.As of December 31, 2008, 47.05% of the companies in the S&P Super 1500had a classified board

Recent Developments

Shareholder Input on Poison Pills

More companies are giving shareholders a say on poison pills. According toFactSet SharkRepellent data, so far this year 21 companies that adopted orextended a poison pill have publicly disclosed they plan to put the poison pill to a

shareholder vote within a year. That's already more than 2008's full year total of 18and in fact is the most in any year since the first poison pill was adopted in theearly 1980s.Back-end Plan

A "back-end plan" is a type of poison pill arrangement. In this plan, currentshareholders of the targeted company receive a rights dividend, which allows for
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exchange of a share ofstock(including voting rights) for senior securities or cashequivalent to the "back-end" price established by the targeted firm. As a result ofthis strategy, the takeoverbidder is unable to both 1) exercise this right, and 2)easily deter the rise in acquisition price.
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22506438 Merger and Acquisition Defensive Strategies

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