July 27, 2018

Poison Pills: Uh, That’s Not How They Work. . .

In light of Papa John’s recent decision to adopt a “poison pill” rights plan targeting its founder, former chair & largest stockholder, Bloomberg’s Matt Levine has devoted a couple of columns this week to poison pills. His most recent column discusses the complexity of pills, and how that complexity has recently tripped up an investor looking to play hardball with a small cap company.

Like the Selectica situation almost a decade ago, the one Matt flagged involved an investor in a small cap company who decided to intentionally trigger the company’s pill.  Unfortunately, this press release issued by the company – Tix Corporation – suggests that he didn’t understand what he was getting himself into. After buying shares that sent him above the pill’s threshold, the investor apparently issued a statement to the effect that  “I/we dare you to proceed with the poison pill”; and, “if my estimates are correct, CEO Mitch Francis, you will dilute yourself out of control.”

This excerpt from the company’s press release points out that this isn’t how it works:

Mr. Bhakta’s correspondence clearly demonstrates no comprehension of how a shareholder rights plan operates and which shareholders risk having their ownership diluted.  Under the Shareholder Rights Plan, every shareholder EXCEPT the acquiring person and its “group” has the right to purchase a significant number of new shares at a very low price.  As a result, all shareholders who exercise their rights will protect and increase their proportionate ownership of the Company, while the acquiring person and his “group” would have their ownership percentage effectively wiped out.  The issuance of so many new shares would also ensure that the acquiring person, in this case Mr. Bhakta and his group, would suffer significant financial losses on their investment.

It is important to note that the effect of a company activating a shareholder rights plan and issuing shares is so financially devastating to the acquiring person, that it has never been done in US history.  No shareholder would ever deliberately trip a poison pill because their entire investment could be virtually wiped out.

That last paragraph is a bit of an overstatement, because people have triggered pills intentionally.  In fact, pills were deliberately triggered on at least two other occasions in addition to Selectica – although the terms of those pills weren’t as formidable as those contained in more modern versions.

Harold Simmons technically triggered the “flip-in” provisions of NL Industries’ pill in 1986, by acquiring 20% of its shares, but that poison pill did not provide that merely crossing the ownership threshold would result in the dilution to the bidder. In 1985, Sir James Goldsmith acquired a controlling position in Crown-Zellerbach and triggered its pill, but because that pill contained only a flip-over provision, he was able to avoid dilution by refraining from a second-step transaction.

What’s more, one study actually suggests triggering a pill as part of a strategy to avoid its full impact in the event of a takeover, so not everybody thinks that the idea of triggering a pill is completely nuts.  However, one thing that people didn’t really focus on until Selectica was that if you trigger a pill, the company’s not out of ammo – instead, it can just reload and blast you with round after round of dilution.

What am I talking about?  After Selectica’s pill was triggered, it essentially reloaded its pill by promptly declaring a new dividend of preferred share purchase rights. As a result, any additional purchases by the investor would trigger another round of dilution.  Since fractional preferred shares backstopped the pill, the company’s board could theoretically do the same thing over & over again. That’s the really toxic part of a poison pill.

John Jenkins