What is a poison pill and why have so many companies adopted it recently?
With stock prices falling in recent weeks, a large chunk of US businesses have gone on the defensive, pulling advice, cutting costs, and looking for ways to add liquidity. For some of the most vulnerable, it has also led to a resurgence of one of the primary ways companies protect themselves from hostile takeover attempts.
The past month has seen an increase in the adoption of so-called “poison pills”, more formerly known as limited-time shareholder rights agreements. While the specifics vary from company to company, the deals are designed to prevent an unwanted activist or potential acquirer from gaining control during a period of weakness. According to Bloomberg data, poison pills are being added at the fastest rate since 2009.
Make a business hard to swallow
Basically, a poison pill, as the name suggests, is simply designed to make it harder for a hostile acquirer to swallow their target. Mergers and activist proposals usually require majority shareholder approval, so poison pills attempt to make it harder for the hostile party to acquire something close to a controlling stake.
Poison pills are normally triggered if a potential acquirer accumulates a predetermined stake in a business, typically between 10% and 30%. If this happens, the existing shareholders – excluding the potential purchaser – have the right to purchase additional shares at a reduced rate. This has the effect of diluting the participation of the intruder and making the whole business much more expensive to buy.
Aerospace supplier Spirit AeroSystems (NYSE: SPR) adopted a plan Thursday night, joining a growing list of companies, including colleagues in aerospace companies Hexcel (NYSE: HXL) and Woodward (NASDAQ: WWD), as good as restaurant chain Entertainment from Dave and Buster (NASDAQ: PLAY), Chesapeake Energy (OTC: CHKA.Q), e-commerce company Groupon (NASDAQ: GRPN), and Gannet (NYSE: GCI).
A number of retailers have also taken the step, including The SAF of Chico (NYSE: CHS), Tempur Sealy International (NYSE: TPX), and Custom brands (NYSE: TLRD). What all of these companies have in common is the fall in the share price, which makes them vulnerable to an opportunistic takeover bid.
Great. Why don’t all companies have one?
Poison pills are not without their drawbacks. Most notably for investors, a company that triggers a poison pill typically requires an existing holder to commit more capital to buy new stock just to keep their stake. As with any new issue of shares, a poison pill is dilutive.
More broadly, in normal times, a poison pill would give great latitude to management teams and could make companies less accountable to shareholders. The concept of the poison pill only works on the assumption that a takeover, or activist intervention, is not in the best interests of long-term holders. But there are many examples where shareholders have benefited from activists and potential buyers to shape poorly managed companies.
For this reason, proxy advisory firms (organizations that issue guidelines to help investors vote on corporate matters) generally have a skeptical view of poison pills. Institutional Shareholder Services (ISS), one of the largest proxy firms of its kind, under a COVID-19 Pandemic Policy Update said he can see the value of poison pills given what happened to stocks during the pandemic, but advocated for short-term pills and for pills to be put to a vote when possible.
“A sharp drop in stock prices as a result of the COVID-19 pandemic is likely to be seen as a valid justification in most cases for adopting a pill lasting less than a year; however, boards should provide detailed information regarding their choice of duration, or any decision to delay or avoid submitting plans to a shareholder vote beyond that period, ”ISS wrote.
What should an investor do when a business adopts a poison pill?
It should be noted that the vast majority of shareholder rights plans adopted by companies are never triggered and in all likelihood the plan will have no impact on the future performance of a stock.
If a company is the subject of a hostile takeover bid or activist intervention, investors would be advised to consider the merits of the proposal on an individual basis, whether or not there is a pill. in place. Proxy services, including ISS and Glass Lewis, as well as websites such as Fool.com, can be valuable resources to help you learn about a business and the specifics of a proposal.
I also monitor poison pills to try to get a glimpse of what’s going on in an industry. Sometimes, admittedly, there is little information to be gained: COVID-19 has decimated consumer spending and made it difficult for a wide range of retailers to make money. Hence the fall in stock prices and the poison pills.
This is probably also the case in commercial aerospace, another sector hard hit by the pandemic, although with former merger partners Hexcel and Woodward embracing pills, followed by Spirit’s recent move, there may be an opportunistic buyer or private equity firm on the prowl.
The more general investment advice – find strong companies and stick with them over time – is still the best advice, and for the most part, let’s hope that the stocks you own will never be in a position where they need to think about. a poison pill.
But there are times when good companies with a bright long-term future see their stock prices temporarily under pressure. And at times like these, a poison pill can be a valuable tool in protecting long-term holders.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.