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Case
study adapted by Prof. Ian Giddy, New York University Primer on pills Poison pills are the most effective corporate anti-takeover device. They were invented by securities lawyer Martin Lipton in 1982 and upheld by Delaware courts (Moran v. Household International) in 1985 and federal court (Moore Corp. v. Wallace Computer Services) ten years later. In the 1990s corporations successfully lobbied states to repeal existing legislation that forbade poison pills and, in some cases, actually insert provisions that effectively mandated pills. A typical pill is triggered when any individual or group acquires or offers to acquire 15 percent of the company’s voting stock. The pill gives every other shareholder the right to double their share holdings for a nominal sum of money. Consider for example, a company with 100 million shares selling at $50 each. Someone buys 15 million shares for $750 million. She owns 15 percent of the company, for a short while anyway. The pill is triggered and holders of the other 85 million shares get the right to buy 85 million newly issued shares for $850 (one penny per 1,000 shares). With 185 million shares outstanding, the price per share is now $27 instead of $50. The acquirer’s 15 million shares are worth only $405 million versus the $750 million she paid, and she only has 8 percent of the voting shares instead of 15 percent. Other shareholders gain, they now have two $27 shares instead of one $50 share, and slightly increased voting rights as well. Studies have consistently shown that poison pills reduce shareholder value significantly (Malatesta, Paul H., and Ralph A. Walkling [1988]. “Poison Pill Securities: Stockholder Wealth, Profitability, and Ownership Structure,” Journal of Financial Economics, 20, 347-376; Brickley, James A., Jeffrey L. Coles, and Rory L. Terry [1994]; “Outside Directors and the Adoption of Poison Pills,” Journal of Financial Economics, 35, 3, 371-391; Ryngaert, Michael [1988]; “The Effects of Poison Pill Securities on Shareholder Wealth,” Journal of Financial Economics, 20, 377-417). Moreover the pills are not aimed at hostile acquirers, but at any shareholders who challenge management. Only 15 percent of hostile bidders acquire a stake in the target before announcing, so the pill is irrelevant to 85 percent of hostile bidders. Zero percent of hostile bidders acquire enough shares to trigger the pill. But any group of shareholders that gathers enough votes to make a difference risks being labeled a group and having half the value of their investment eliminated. Simpler evidence that pills are bad is that even supporters dare not speak their name. Poison pills are universally, and cynically, called “shareholder rights plans” by companies that adopt them. The name comes from the fact that “rights” to buy additional shares are distributed to shareholders if the pill is triggered. But it’s clearly meant to suggest something that increases shareholder rights. Poison pills don’t. Without a pill, shareholders can sell their shares or not at whatever price they choose. With a pill, shareholders can be prevented from selling at above-market prices to hostile bidders. If supporters believed these plans were good, they would name them honestly, for example “anti-takeover dilution plan.” Shareholders have consistently fought pills. Today about 3,000 public companies have pills, and 200 new ones adopt them each year. On the other hand, activists such as Providence Capital have forced a handful of companies to eliminate or water down pills. 22 of 29 anti-pill shareholder resolutions passed last year, and several more were withdrawn when companies voluntarily eliminated pills. Shareholder approval of poison pills is not required in the US, but is in Canada. Poison is good for you There are two theories advanced in defense of poison pills. The first is that they prevent two-tier tender offers. This is Goldfield’s line. CEO John Sottile said, “The Rights Plan is meant to help insulate the company from abusive takeover tactics designed to gain control of the company without paying a full, fair price to all of the stockholders.” Suppose an unscrupulous person wanted to buy the company above with 100 million shares selling for $50 each. He might announce that he would buy 50 million plus one shares at $40 each, then use his voting control of the company to merge it with his own company, paying remaining shareholders $1 per share. Although shareholders believe the company is worth $50, some of them are frightened enough at the prospect of getting only $1 that they sell for $40. The more than sell, the more pressure to sell. The acquirer ends up buying a $5 billion company for $2 billion. Such a nakedly abusive offer would be illegal on a number of grounds but someone might try to so something similar. She could start false negative rumors about a company and buy up stock, then use her voting influence to make the company worse. As soon as she got control, which might take much less than 50 percent of the stock given diffuse ownership, she could start running the company to benefit herself (say by buying raw materials from her private company at above market prices). The more she did this, the lower the price would fall, until she could get shareholder agreement on a lowball sale to her own company. There are plenty of legal protections to prevent this kind of attack. If they are inadequate then it’s easy to design defenses that prevent them, without giving the board the ability to reject a legitimate tender offer in shareholder interest, and without chilling all shareholder activism. Moreover the poison pill allows the board to neglect value-enhancing defenses like getting the stock price up, communicating better and building credibility with shareholders, structuring the balance sheet for maximum shareholder return, actively seeking investors and acquirers, and simply running the company well. The second justification of poison pills is that they increase the board’s clout in takeover negotiations. Suppose an acquirer offers 20 percent above market price. Enough shareholders might accept this offer that the acquirer gets the power to install its own board. With a poison pill, the board can block that attempt, and insist on a 25 percent premium. It is true that for completed takeovers, poison pill company shareholders enjoy a larger increase from the initial offer than at non-poison pill companies. But the flaw of that argument is easy to see. Most poison pill companies don’t get tender offers in the first place. When they do, the offers are lower for two reasons. First, the stock’s market price is lower due to the drag of the poison pill. Second, the acquirer will make a smaller initial premium offer, because it expects to have to raise it. Instead of starting with the best price, it will bid low in order to have negotiating room. It is clear that the advantage of greater price increases from initial bid is far outweighed by the disadvantages of lower initial bids and offers that are never made. A more basic objection is a study of the use of poison pills shows the board is more likely to use its negotiating power to ensure jobs or cash payments to itself than to get more money for shareholders. Anything the board gets for itself comes out of money that would otherwise be paid to shareholders. Grading Goldfield’s pill In recent years, pills have gotten friendlier. This is why Sottile can say, “The Board of Directors has determined to institute a Rights Plan in accordance with good corporate governance practices.” Although I oppose all poison pills, some are more toxic than others.
These twelve provisions are the most important for evaluating a pill. The recommended principles are compiled from lists from Institutional Shareholder Services, California Public Employees’ Retirement System, educational pension fund TIAA-CREF, and Ontario Municipal Employees Retirement System. The modern practice is my impression of the usual practice for pills adopted in the last three years, older pills are generally worse. I gave Goldfield a grade based on A (meets recommendation although most modern pills don’t), B (meets recommendation along with most modern pills), C (doesn’t meet recommendation, but most modern pills don’t) and D (doesn’t meet recommendation although most modern pills do). Plusses and minuses were awarded for intermediate cases. Although these provisions are not equally important, Goldfield’s average of 2.6, or B–, seems about right. Triggers, flips, TIDEs and sunsets The trigger is the percentage of stock that must be acquired by a person or group before the pill is triggered. Out of ten pills, about eight use 15 percent, one uses 10 percent (called a “hair trigger” pill), and one uses 20 percent, the minimum recommended by governance groups. Other thresholds are rare: there are a few pills between 15 percent and 20 percent, a few at 25 percent and a few at 30 percent. Goldfield gets a plus here because with cumulative voting, 12.5 percent is enough to elect a director. Therefore, a group can get board representation without coming close to the pill trigger. The flip-in amount is the number of new shares issued for each old share not held by the acquirer. The standard is one new share for each old share. Goldfield’s plan calls for 11 new shares for each old share at the current price ($0.40 per share). The rule is $4.40 worth, so if the stock price goes down, the flip-in amount increases. The effect of this is mitigated by the real money provision below. The board has reserved the right to eliminate the real money provision and change the flip-in amount to one-to-one. This doesn’t improve the grade since the board will select the option most unfavorable to the acquirer. Since good governance recommends as low a flip-in amount as possible, Goldfield earns a D. Goldfield’s flipover provision says that the poison pill also applies to the stock of any company that merges with Goldfield or buys more than half its assets. This is an obnoxious provision that shareholders hate and most new plans omit. At first glance, flipovers seem silly. No one can merge with Goldfield or buy half its assets without board approval, and if the board likes the deal it can cancel the pill. Even if an acquirer found a way around board approval, say by shareholder consent action or legal challenge, that same means could be used to eliminate the pill. But let’s say General Electric offers to buy Southeast Power for $50 million. Since this is almost $2 per share, the board would be hard pressed to turn down the offer. A refusal would certainly provoke a shareholder lawsuit. The flipover pill means the board can approve the sale, knowing that GE will never give GV shareholders the right to buy its stock at half price. Flipover provisions are no additional protection, they are just a way of giving a board cover to ignore shareholder interests. TIDE stands for Three-year Independent Director Evaluation. CalPERS waged a mostly successful campaign to get these included in poison pills. It means that at least every three years the independent directors must review the pill and decide if it is in shareholder interest. Their conclusion is not binding on the rest of the board, but it would be hard for the insiders to ignore it. Goldfield gets a minus for using an old-fashioned, weak definition of independent. Only employees, spouses and people “substantially dependent on” Goldfield for their livelihoods, are deemed to be dependent. The modern definition excludes anyone who receives significant compensation from the company plus a wider assortment of relatives and other indirect dependents. Sunset provisions are another CalPERS reform. Poison pills should expire at a set date, within ten years of adoption. Of course, the term can be extended or a new pill adopted, but the provision is still valuable. Chewable pills and jawbreakers Chewable pills are invoked by shareholders rather than the board. It is difficult for even the most hardened pill apologists to argue against this. After all, if the pill is really for shareholder protection, why not let shareholders decide whether or not to invoke it. If someone makes an offer that shareholders like, they can cancel the pill. If someone makes an abusive offer, shareholders can use the pill as a defense. Therefore, most pills today claim to be chewable, but they are in fact jawbreakers. That is, they contain clauses that make them impossible to chew in practice. Goldfield’s is a tough chew, like a frozen Tootsie Roll, but not a jawbreaker. Suppose a potential acquirer makes an offer. This would automatically trigger a nonchewable pill, unless the board of directors had previously agreed not to do it. With a chewable pill, the board instead calls a shareholder vote. If shareholders like the deal, they cancel the pill. If they don’t, they leave the pill in force. In principle that could mean the pill gets triggered, but the bidder would most likely withdraw the offer instead. The catch is that the offer must meet certain conditions before the board will allow a shareholder vote. That’s offensive as a matter of principle. If it’s almost impossible to meet the conditions, the pill is a jawbreaker. Good practice allows the board to require an offer to be open for 60 days, plus at least 10 days after any change in terms. The board can ask for proof that the buyer has, or has commitments for, 50 percent of the cash value of the outstanding shares. The buyer can be required to offer at least the current market price of the stock. A majority vote of shareholders should be enough to cancel the pill. The vote should be held within 60 days of the receipt of the offer. Goldfield requires the offer to be open for only 20 days, plus the 10 days after changes in terms. In that respect it does better than the standard. It adheres to the market price and majority rule provisions. But it requires proof or firm commitments for 80 percent of the cash, rather than 50 percent, and allows up to 120 days between offer and vote. Goldfield imposes some additional conditions. The offer must be for all shares and at least 80 percent in cash. It must be accompanied by a fairness opinion and half the costs of the vote. The buyer must agree to buy all non-tendered shares on the same terms as the offer for 30 days afterwards. Even if all these conditions are met, the board reserves the right to declare the offer unfair. Although these conditions are too restrictive, most serious buyers could meet them (except, possibly, the board veto). Many pills require offers to have huge premiums over market and require supermajorities, as high as 90 percent, to cancel the pill. Other pills require unreasonable certifications and conditions. So Goldfield gets an A–, but only because I’m grading on a curve. The algebra Good pills require shareholders to put up real money to exercise their poison pill rights. This requires a little algebra to demonstrate, so mathphobes will have to take my word for it. Let’s go back to our example of the company with 100 million shares selling at $50 each. Let’s say the stock would be worth $80 per share with good management. Without a pill, lots of people would bid for the assets, and shareholders would walk away with something close to $80. Suppose someone offers to buy all the shares at some price. With a normal pill, shareholders who don’t sell double their number of shares for nominal cost. Let’s say that X shares are tendered and 100 million minus X are not. After the offer 100 million minus X new shares will be issued, but the company will not take in significant new money. The bidder will wind up with X/(200 million – X) of the company. That will make each purchased share worth $80 times X/(200 million – X), assuming the bidder winds up with control (if not, the bidder will wind up with less). A shareholder who does not tender will end up with $100 times X/(200 million – X) if the bidder does not win control, and more otherwise. No bidder will offer more than $80 times X/(200 million – X), because this is the most the shares can be worth, and no shareholder will accept less than $100 times X/(200 million – X), because this is the least the shares can be worth. So no deal is possible regardless of expectations for X, even though the bidder would be happy to pay, and the shareholders would be happy to accept, $65 per share. Now consider the real money version of the same pill. A shareholder must pay $50 to receive two new shares for each share owned. It’s the same half-price bargain, but shareholders must write checks. In this formulation there will be 200 million – 2X new shares issued, because two new shares are issued for each nontendering shareholder. The bidder will end up with X/(300 million – 2X) fraction of the company, but the company value will be increased by $50 times 100 million – X as a result of the new capital raised. The bidder’s shares will be worth [$80 times X + $50 times (100 million – X)]/(300 million – 2X) or ($5 billion + $30 times X)/(300 million – 2X) if it gains control of the company. Suppose, for example, that 80 million shares are tendered. The tendered shares will be worth $7.4 billion divided by 140 million or about $53 per share. So an acquirer will bid more than the market price of $50 per share if it is confident of getting enough shares tendered. Now consider the shareholders. If they hold, they must put up $50 in cash to get two new shares. If the acquirer fails, each new share will be worth [$5 billion + $50 times (100 million – X)]/(300 million – 2X) or ($10 billion – $50 times X)/(300 million – 2X). Suppose that 10 million shares tender. The people who don’t tender will pay $50 and own three shares worth $9.5 billion divided by 280 million (about $34) each. A shareholder would rather tender at $53 than pay $50 to end up with $102 worth of stock. So shareholders will tender if they are not confident the bidder will succeed. This is a theoretical calculation. In reality shareholders are even more likely to tender because they will figure management is likely to treat the new capital as badly as the old, so the value is less than $34 per share, and because people prefer getting checks to writing them. Therefore, real money poison pills allow the possibility that an acquirer will succeed even if the pill is triggered. In this case, the bidder would offer a high price, to ensure success, and set a high minimum, say 80 percent of shares must be tendered for the offer to be effective. Most shareholders would grab the high price, $70 in hand for a $50 stock is better than gambling, especially because the high minimum makes success unlikely. Insiders would be able to watch the tenders and invoke the pill for the benefit of themselves and their options. In effect, they could sell out for about double the tender price that ordinary shareholders get. That’s unfair, but at least a deal is possible. Voting One of OMERS’ poison pill principles is “protection for normal corporate governance activities is important.” It recommends that the terms “beneficial ownership” and “acting jointly or in concert” be based solely on ownership and not on voting rights or agreements. It’s also important that normal organizing tactics such as group meetings, fund raising and committee formation be protected. Of course, no one does this, because the real purpose of pills is to entrench board power rather than prevent takeovers. Of course, boards claim the pill will not to be used against dissident shareholders, but none will put it in writing (we will be putting Goldfield’s board to this test, asking them to write a letter that the pill will not be invoked against shareholders merely for voting against the board’s recommendation, but no eRaider target has yet complied). Without written assurances, many shareholders will not oppose management. Goldfield gets a C here because no one provides this protection. Another good governance recommendation is that poison pills be put to shareholder vote. Goldfield doesn’t do this. Since a few companies do, Goldfield gets a C–. Dead hand provisions allow the incumbent board and their approved successors to control the pill even after they have been voted out of office. TIAA-CREF led the effort to eliminate these, and they are rare today (partly because they have been found illegal in Delaware and New York, two popular states for incorporation, though they have been found legal in Georgia and anti-shareholder states have passed legislation to allow them). Related provisions like slow hand (newly elected board members get control of the pill only after a period of time) and no hand (no one can cancel the pill) are also dying out. Goldfield does not have any of these distasteful provisions. If pills are bad, it might seem that cancellation is always good. But that’s not the case. If boards can cancel the pill for some bidders but not others, it can be the worst situation for shareholders. For example, boards can block an outside bidder in favor of a management buyout at a lower price, a practice that is not unheard of. Therefore, good pills require that shareholders vote on cancellation as well as activation of pills. But no one allows this, so Goldfield’s sin only merits a C. Finally, the best pills have fixed rules everyone knows and honors. Goldfield’s, like all plans, allows the board to change almost any aspect at any time for any reason. All the protections can be swept away in a secret vote. This also gets a C. What do we do about it This is eRaider, not eWhiner. Our first step will be to lobby the board to rescind the pill and, failing that, put in some improvements. If that fails, we will sponsor a shareholder resolution to eliminate it. We are looking into a binding by-law amendment. We will certainly oppose re-election of any director who does not work to eliminate the pill. This pill shatters the truce that we have honored since we, along with other shareholders, ran a dissident director slate in 2001. Goldfield has made many positive changes since then, and we felt that it was on track to realize shareholder value. The pill destroys any hope of institutional purchase, reduces the chance of a favorable buyout or asset sale and ties our organizing hands. We have to fight it or give up on this company. Originally posted: September 24, 2002 Questions 1.
Why is Goldfield so keen to avoid a takeover? See the Goldfield Case. |