On Monday, Hertz Global Holdings (HTZG.Q) publicly announced the implementation of a "shareholders rights plan." Also known as the "poison pill defense," the plan, which received the approval of the company's board of directors, aims to prevent any individual shareholder from gaining too much control over the company. The announcement comes as the company has seen a stellar year of performance. While management said the poison pill defense is not in response to a known takeover attempt, is it possible that management is gearing up for some unwanted company from activists?
Hertz has performed strongly over the past few years
Although Hertz may not come across as the ideal investment for some investors, its operating results over the past four years have been impressive. From 2009 through 2012 revenue at the largest publicly traded car-rental business has grown by 27% from $7.1 billion to $9 billion.
Over the same time-frame, the company's net income has done even better. The company's annual bottom line has improved, rising from -$126 million to $243.1 million. The primary reason for the increase in net income over time was that the company's costs increased at a far slower rate than its revenue. In fact, the company's cost of goods sold rose by only 17.4% over that time horizon, while its operating expenses rose 18.4%, both nearly 10% less than the company's revenue growth.
On top of seeing revenue and net income improve, the company also experienced an increase in its free cash flow. Between 2009 and 2012, the company saw its free cash flow rise 51% from $1.6 billion to $2.4 billion, primarily attributable to increases in both net income and depreciation/amortization.
What the poison pill means
In essence, a company decides to adopt a poison pill defense whenever it believes that it may be subject to an unwanted takeover attempt or interference from outside investors. In the case of Hertz, the company only claimed that it was initiating the provision because it "observed unusual and substantial activity" in its shares throughout the year.
According to the announcement, the company will issue rights to all shareholders on record as of Jan. 9, 2014. For each share held, investors will be given the right to buy one-ten thousandth of a preferred share in the company for a price of $115, with the total purchase price of a preferred share equaling $1.15 million. In sum, this would imply that 44,898 preferred shares will be outstanding, with a total value of $51.6 billion (far higher than the $11.6 billion that Hertz is currently worth).
The purpose of this is that the preferred shares will make any sort of takeover or forced dividend demanded by an outside party nearly impossible. Also, in the event that a takeover bid is announced for the company at, say, $30 per share, the entity that made the bid would have to agree to pay 10,000 times more for each preferred share.
Hertz isn't alone!
Initially, this kind of move by a company's board of directors may seem a bit off-kilter. However, a number of companies in the past have employed the poison pill defense to stave off unwanted investors. One of the most recent examples involves J.C. Penney (JCPN.Q).
For the past few years, J.C. Penney has been struggling to stay afloat. Due to a shift in consumer preferences away from brick and mortar retailers combined with a failed turnaround plan, the company's operating results have deteriorated drastically. Between 2009 and 2013, the company's revenue fell 29.8% from $18.5 billion to $13 billion. Due to declining revenue, the company's net income of $572 million gradually turned into a net loss of $985 million.
Seeing an opportunity to effect change and profit in the process, activist investor Bill Ackman initiated an 18% stake in the company and gained himself a seat at the board. Seeing other investors like George Soros and Kyle Bass flowing in, the company initiated a poison pill that shared some traits with that of Hertz.
For starters, like Hertz, J.C. Penney's poison pill would initiate when an activist investor acquired at least a 10% stake in the company or bought additional shares if the stake was already above 10%. Similarly, the rights lasted for a year and were allocated one to each common share.
Unlike Hertz, however, J.C. Penney's poison pill wasn't as extreme in protecting the company. While each right made it more difficult for investors to take over J.C. Penney, the rights were only worth $55 apiece and they each represented one-one thousandth of a preferred share instead of the one-ten thousandth that each right represents at Hertz.
As we can see, Hertz is serious about maintaining its course. In an effort to protect itself from unwanted parties who might try to intervene and demand a hefty dividend like Carl Icahn did at Apple, or try to otherwise change the company like Bill Ackman did at J.C. Penney, the board of directors felt that a poison pill defense would be appropriate. Irrespective of what happens with the company, Hertz shareholders should not become terribly excited about the announcement because it only adds value if a shareholder buys too much of the company's shares. Absent this, there is no real value added by the transaction and, therefore, not much reason to celebrate.