Defensive Strategies (Poison Pills)

It is a term referring to any strategy, generally in business or politics, to increase

the likelihood of negative results over positive ones for a party that attempts any
kind of takeover. It derives from its original meaning of a literal poison pill carried
by various spies throughout history, taken when discovered to eliminate the
possibility of being interrogated for the enemy's gain. In publicly held companies,
various methods to deter coercive takeover bids are called "poison pills". Takeover
bids are attempts by a bidder to obtain control of a target company, either by
soliciting proxies to get elected to the board or by acquiring a controlling block of
shares and using the associated votes to get elected to the board. Once in control of
the target's board, the bidder can determine the target's management. As discussed
further below, targets have various takeover defenses available, and several types
of 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 takeover
defense known as a poison pill is a shareholder rights plan.

Because the board of directors of the company can redeem or otherwise eliminate a
standard poison pill, it does not typically preclude a proxy fight or other takeover
attempts not accompanied by an acquisition of a significant block of the company's
stock. It can, however, prevent shareholders from entering into certain agreements
that can assist in a proxy fight, such as an agreement to pay another shareholder's
expenses. In combination with a staggered board of directors, however, a
shareholder rights plan can be a defense.

Shareholder rights plans

The target company issues rights to existing shareholders to acquire a large number
of new securities, usually common stock or preferred stock. The new rights
typically allow holders (other than a bidder) to convert the right into a large
number of common shares if anyone acquires more than a set amount of the
target'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 form
of poison pill is sometimes called a shareholder rights plan because it provides
shareholders (other than the bidder) with rights to buy more stock in the event of a
control acquisition.
Effects on shareholders
The goal of a shareholder rights plan is to force a bidder to negotiate with the
target's board and not directly with the shareholders. The effects are twofold:
• It gives management time to find competing offers that maximize selling
price.
• Several studies have indicated that companies with poison pill (shareholder
rights plans) have received higher takeover premiums than companies
without poison pills. This results in increased shareholder value. The theory
behind this is that an increase in the negotiating power of the target is
reflected in higher acquisition premiums.

History
The poison pill was invented by noted M&A lawyer Martin Lipton of Wachtell,
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 increasing
trend of corporate raids by businessmen such as Carl Icahn.
It was reported in 2001 that since 1997, for every company with a poison pill that
successfully resisted a hostile takeover, there were 20 companies with poison pills
that accepted takeover offers. The trend since the early 2000s has been for
shareholders to vote against poison pill authorization, since, despite the above
statistic, poison pills are designed to resist takeovers, whereas from the point of
view of a shareholder, takeovers can be financially rewarding.
Some have argued that poison pills are detrimental to shareholder interests because
they perpetuate existing management. For instance, Microsoft originally made an
unsolicited bid for Yahoo!, but later dropped out after Yahoo! CEO Jerry Yang
threatened to make the takeover as difficult as possible unless Microsoft raised it to
US$37 per share; one Microsoft executive commented, "They are going to burn the
furniture if we go hostile. They are going to destroy the place." The nature of
Yahoo!'s poison pill was never announced. Analysts suggested that Microsoft's
raised 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 an
aborted proxy fight from Carl Icahn. After Microsoft dropped their bid, Yahoo's
stock price plunged and Jerry Yang faced a backlash from stockholders that led to
his resignation.

Common types of poison pills

• Preferred stock plan
• Flip-over rights plan
• Ownership flip-in plan
• Back-end rights plan
 • Voting plan

Constraints and legal status

Following the development of poison pills in the 1980s, the legality of their use
was unclear in the United States for some time. However, poison pills were upheld
as a valid instrument of Delaware corporate law by the Delaware Supreme Court in
its 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 they
contain a permitted bid concept such that a bidder who is willing to conform to the
requirements of a permitted bid can acquire the company by take-over bid without
triggering a flip-in event. Shareholder rights plans in Canada are also weakened by
the 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 to
allow 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 an
auction to see if a white knight can be found. A notable Canadian case before the
securities regulators in 2006 involved the poison pill of Falconbridge Ltd. which at
the 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 have
Falconbridge's pill invalidated, citing among other things that the Falconbridge had
had its pill in place without shareholder approval for more than nine months and
that the pill stood in the way of Falconbridge shareholders accepting Xstrata's all
cash offer for Falconbridge shares. Despite similar facts with previous cases in
which securities regulators had promptly taken down pills, the Ontario Securities
Commission ruled that Falconbridge's pill could remain in place for a further
limited period as it had the effect of sustaining the auction for Falconbridge by
preventing Xstrata increasing its ownership and potentially obtaining a blocking
position that would prevent other bidders from obtaining 100% of the shares.
In Great Britain, poison pills are not allowed under Takeover Panel rules. The
rights 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 buy
shares of their target in the marketplace during "raids". Raids have helped bidders
win targets such as BAA plc and AWG plc when other bidders were considering
emerging 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 if
they exceeded the statutory levels (often 10% of the outstanding shares) in the
rights plan. The London Stock Exchange itself is another example of a company
that has seen significant stake-building by a hostile suitor, in this case the
NASDAQ. The LSE's ultimate fate is currently up in the air, but NASDAQ's stake
is sufficiently large that it is essentially impossible for a third party bidder to make
a successful offer to acquire the LSE.
Takeover law is still evolving in continental Europe, as individual countries slowly
fall in line with requirements mandated by the European Commission.
Stakebuilding is commonplace in many continental takeover battles such as Scania
AB. Formal poison pills are quite rare in continental Europe, but national
governments hold golden shares in many "strategic" companies such as telecom
monopolies and energy companies. Governments have also served as "poison pills"
by threatening potential suitors with negative regulatory developments if they
pursue the takeover. Examples of this include Spain's adoption of new rules for the
ownership of energy companies after E.ON of Germany made a hostile bid for
Endesa and France's threats to punish any potential acquiror of Groupe Danone.

Other Takeover Defenses

Poison pill is sometimes used more broadly to describe other types of takeover
defenses that involve the target taking some action. Although the broad category of
takeover defenses (more commonly known as "shark repellents") includes the
traditional shareholder rights plan poison pill. Other anti-takeover protections
include:
• 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 of
the company reaches a critical limit (usually one third). This kind of poison
pill cannot stop a determined acquirer, but ensures a high price for the
company.
• The target takes on large debts in an effort to make the debt load too high to
be attractive—the 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 to
continue working for the target company at least until a merger is completed
instead of looking for a new job as soon as takeover discussions begin.
 However, with the release of the "golden handcuffs", many discontented
employees 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 empty
shell is left behind for the new owner.

• Peoplesoft guaranteed its customers in June 2003 that if it were acquired

within two years, presumably by its rival Oracle Corporation, and product
support were reduced within four years, its customers would receive a
refund of between two and five times the fees they had paid for their
Peoplesoft software licenses. The hypothetical cost to Oracle was valued at
as much as US$1.5 billion. Peoplesoft allowed the guarantee to expire in
April 2004. If PeopleSoft had not prepared itself by adopting effective
takeover defenses, it is unclear if Oracle would have significantly raised its
original bid of $16 per share. The increased bid provided an additional $4.1
billion for PeopleSoft's shareholders.

• The practice of having staggered elections for the board of directors. For
example, if a company had nine directors, then three directors would be up
for 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 a
year after the first election. In some companies, certain percentages of the
board (33%) may be enough to block key decisions (such as a full merger
agreement or major asset sale), so an acquirer may not be able to close an
acquisition 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 1500
had a classified board
Recent Developments
Shareholder Input on Poison Pills

More companies are giving shareholders a say on poison pills. According to

FactSet SharkRepellent data, so far this year 21 companies that adopted or
extended 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 18
and in fact is the most in any year since the first poison pill was adopted in the
early 1980s.
Back-end Plan

A "back-end plan" is a type of poison pill arrangement. In this plan, current

shareholders of the targeted company receive a rights dividend, which allows for
exchange of a share of stock (including voting rights) for senior securities or cash
equivalent to the "back-end" price established by the targeted firm. As a result of
this strategy, the takeover bidder is unable to both 1) exercise this right, and 2)
easily deter the rise in acquisition price.