With equity prices crashing in recent weeks, much of corporate America has gone on the defensive, pulling guidance, slashing costs, and seeking ways to add liquidity. For some of the most vulnerable, it has also led to a resurgence in one of the principle ways companies protect themselves from hostile takeover attempts.
The last month has seen an uptick in the adoption of so-called "poison pills," more formerly known as limited duration stockholder rights agreements. While specifics vary from company to company, the agreements are designed to prevent an activist or unwanted potential acquirer from gaining control during a time of weakness. According to Bloomberg data, poison pills are being added at the fastest pace since 2009.
Making a company hard to swallow
At its core, a poison pill, as the name suggests, is simply designed to make it more difficult for a hostile acquirer to swallow its target. Mergers and activist proposals typically require majority shareholder approval, so poison pills try to make it more difficult for the hostile party to acquire anything close to a majority stake.
Poison pills normally are triggered if a would-be acquirer amasses a predetermined stake in a company, usually between 10% and 30%. If that happens, existing shareholders -- excluding the would-be acquirer -- are entitled to buy additional shares at a discounted rate. That has the effect of diluting the interloper's stake and making the entire company significantly more expensive to buy outright.
Aerospace supplier Spirit AeroSystems (NYSE:SPR) adopted a plan Thursday night, joining a growing list of corporations, including fellow aerospace companies Hexcel (NYSE:HXL) and Woodward (NASDAQ:WWD), as well as restaurant chain Dave and Buster's Entertainment (NASDAQ:PLAY), Chesapeake Energy (OTC:CHKA.Q), e-commerce company Groupon (NASDAQ:GRPN), and Gannett (NYSE:GCI).
A number of retailers have also made the move, including Chico's FAS (NYSE:CHS), Tempur Sealy International (NYSE:TPX), and Tailored Brands (NYSE:TLRD). What all these companies have in common is a plunging share price, which makes them vulnerable to an opportunistic takeover attempt.
Sounds great. Why don't all companies have one?
Poison pills are not without their downsides. Most notably for investors, a company triggering a poison pill is typically requiring an existing holder to commit more capital to buy new shares just to retain their stake. As with any new share issuance, a poison pill is dilutive.
More broadly, in normal times a poison pill is thought to give wide leeway to management teams and could make companies less accountable to shareholders. The poison pill concept only works based on the assumption that a takeover, or activist intervention, is not in the best interest of long-term holders. But there are plenty of examples where shareholders have benefited from activists and would-be acquirers causing poorly run companies to shape up.
For that reason, proxy advisory firms -- organizations that issue guidelines to help investors vote on corporate matters -- generally take a skeptical view of poison pills. Institutional Shareholder Services (ISS), one of the largest such proxy firms, as part of a broader COVID-19 pandemic policy update said it can see the value of poison pills given what has happened to stocks during the pandemic, but advocated for pills that are short-term in nature and for the pills to be put to a vote when possible.
"A severe stock price decline as a result of the COVID-19 pandemic is likely to be considered valid justification in most cases for adopting a pill of less than one year in duration; however, boards should provide detailed disclosure regarding their choice of duration, or on any decisions to delay or avoid putting plans to a shareholder vote beyond that period," ISS wrote.
What should an investor do when a company adopts a poison pill?
It is worth noting that the vast majority of shareholder rights plans that are adopted by companies are never triggered, and in all probability, the plan will have no bearing on a stock's future performance.
If a company is subject to a hostile takeover attempt or activist intervention, investors would be wise to consider the merits of the proposal on an individual basis whether there is a pill in place or not. Proxy services including ISS and Glass Lewis, as well as websites including Fool.com, can be valuable resources to help get educated on a company and the specifics of a proposal.
I also watch for poison pills to try to gain insight into what is going on in an industry. Sometimes, admittedly, there is little insight to be gained: COVID-19 has decimated consumer spending and has made it difficult for a broad range of retailers to make money. Hence, falling stock prices and poison pills.
That's likely also the case in commercial aerospace, another sector hit hard by the pandemic, though with erstwhile merger partners Hexcel and Woodward adopting pills, followed by the recent move by Spirit, it is possible there is an opportunistic buyer or private equity firm on the prowl.
The most general of investing advice -- find strong companies and stay with them over time -- is still the best advice, and for the most part hope the stocks you own are never in a position where they need to think about a poison pill.
But there are times when good businesses with bright long-term futures see their stock prices temporarily under pressure. And in moments like those, a poison pill can be a valuable tool to protect long-term holders.