March 25, 2009

Analysis: Flip-In vs. Flip-Over Pills

– by John Jenkins, Calfee Halter & Griswold

A member recently asked in the “Q&A Forum” about the rationale for including “flip-in” and “flip-over” provisions in shareholder rights plans, or “poison pills.” When a company adopts a rights plan, it typically issues of a right to purchase a fraction of a share of preferred stock as a dividend to all of the issuing company’s shareholders. The exercise price of the rights is usually based on an assessment of the price that it would be reasonable to expect the stock to achieve over the life of the rights plan. Frequently, the board receives input from a financial advisor in setting the exercise price of the rights at the time they are issued.

These rights do not become exercisable until a raider acquires beneficial ownership of a specified percentage of the target’s outstanding shares. (That percentage is usually between 10% and 20% of the outstanding shares, but in the case of NOL pills, it is typically set at 4.9 %.). When a raider crosses that threshold, the rights detach and become exercisable — except for those rights that are held by the raider, which when you get right down to it is what makes pills work in the first place.

Rights plans typically include both “flip-in” and “flip-over” features. The plan’s “flip-in” feature comes into play when a raider triggers the rights plan by acquiring the percentage of the target’s common stock specified in the plan. When this happens, each right then outstanding (other than those held by the buyer) “flips-in” and gives each holder the right to purchase shares of the target’s common stock with a market value equal to twice the exercise price of the right.

What a flip-in provision does is deter the buyer from crossing the ownership threshold that will trigger the rights plan by confronting it with the prospect of substantial dilution. Since every holder except the buyer will be able to purchase new shares at a 50% discount to current market, the buyer’s ownership interest will be diluted if the flip-in provision of the rights plan kicks in. The actual amount of that dilution will depend on the exercise price of the rights, but it is almost invariably going to be quite substantial – substantial enough to make triggering the rights economically unviable.

A “flip-over” feature is intended to protect against a second step transaction. The flip-over provision would come into play if, after the rights have been triggered, the target was sold or engaged in some other change in control transaction. Under those circumstances, each right then outstanding would “flip over” and become a right to buy shares of the raider’s common stock with a market value equal to twice the exercise price of the right.

Like the flip-in provision, the deterrent effect of the flip-over provision depends on its dilutive effect on ownership interests. However, in contrast to the flip-in provision, which dilutes the buyer’s interest in the target company, the flip-over provision dilutes the interest of the buyer’s shareholders in the buyer itself.