Hedge Fund Targets Try New Flavor of Poison Pill

December 04, 2012  

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So-called specific-purpose pills are gaining popularity among companies that are finding themselves on the business end of hedge fund activist campaigns.

Poison pills, used by companies since the 1980s to fend off the unwelcome advances of corporate raiders, have been employed less and less frequently in recent years. But a new kind of pill strategy has lately gained interest among the targets of so-called shareholder activist investors, including hedge funds.

A growing number of companies have instituted what are called specific-purpose poison pills. Unlike standard poison pills, these newer pills are generally adopted in response to a specific event, such as the public disclosure of a sizable stake by an apparent activist investor, an unsolicited takeover offer or simply after heavy volume of trading in a stock. The goal of the target companies is to retain control of the company, or at least control the process for a potential sale or restructuring.

Poison pills, also called shareholder rights plans, essentially give all shareholders —except the one the company doesn’t like and feels threatened by — the right to buy more shares at deep discounts under certain circumstances. A rights plan generally stipulates that the pill would be triggered when the hostile investor accumulates somewhere between 15 and 20 percent of the shares. The goal is to make the company prohibitively expensive for the unwanted investor to acquire control of the company without management or board support.

The latest company to adopt one of these specific-purpose pills was SandRidge Energy. It instituted the plan on November 19 after hedge fund TPG-Axon Capital — which recently raised its stake to 6.5 percent — and hedge fund Mount Kellett Capital Management publicly urged the energy company to review strategic alternatives. Both also called on the company to change its CEO. The pill is triggered if an individual or some other investor acquires just 10 percent of the stock or an institutional investor filing as a passive investor owns 15 percent.

Also in November, Netflix adopted a rights plan after Carl Icahn reported a 9.98 percent stake and said he believed that Netflix held significant strategic value for several larger companies. It also set a threshold of just 10 percent for outside investors and 20 percent for institutional investors.

So far this year, 28 specific-purpose pills have been adopted. This compares with 34 for all of last year, 39 in 2010 and 56 in 2009, when many stocks were down significantly and perceived to be very vulnerable following the global stock market meltdown, according to FactSet SharkRepellent, a data and research firm. In contrast, during the period leading up to the financial crisis there were only 17 of these kinds of pills instituted in 2007 and 19 the previous year.

The pills adopted in response to a specific event are usually stricter than most others. For example, FactSet found of the 28 companies that adopted a poison pill in response to a specific threat or to assure a friendly merger, half set the trigger threshold for when the pill goes into effect below 15 percent of total shares owned by the outside investor and only three companies used what FactSet deems to be a more shareholder-friendly 20 percent limit.

In contrast, only 15 percent of the routine adoptions used a low trigger threshold (below 15 percent) and 30 percent included a trigger of 20 percent or more, allowing an investor to take a bigger stake in the company, according to FactSet.

Specific-purpose pills also typically have short terms, of a year or less. By contrast, 50 percent of this year's routine adoptions don’t expire for 10 years, according to FactSet.

Pill proponents assert that the weapon gives the incumbent management more time to mull a decision and get the highest possible price for the company. Opponents — activist investors and their supporters — argue that pills entrench management teams who feel it is in their best interest to retain control rather than make the changes requested or sell the company outright.

So are these specific-purpose pills effective? So far, results are mixed. Investors in Netflix have not benefited from the specific-purpose pill; the stock is down about 50 cents since it was adopted. SandRidge’s stock, however, is up 4 percent since the pill was adopted.

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