IN-DEPTH: Poison pills surge, reaction uncertain

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With share prices down and shareholder activists looking for new targets, American companies are implementing poison pills at a rate not seen in a decade. Twenty-three pills have been announced in 2020 thus far, including 17 in March alone, according to Activist Insight Governance data. By comparison, 18 pills were introduced in all of 2019.

What has struck market observers is that many of this year’s pills appear to be “preemptive,” with no immediate threat of a hostile takeover or indications that an activist shareholder is circling the business. And none of the recent rights plans are subject to a shareholder vote.

The rush to put up defenses may give activists additional ammunition for proxy fights in 2021.

Coronavirus pills

“These are like anti-Coronavirus pills,” said Professor Marcel Kahan at New York University School of Law – justified, at least in the minds of some executives, by stock market volatility and the difficulty of reacting to an emerging threat due to COVID-19 disruption.

Poison pills – formally known as shareholder rights plans – were developed in the 1980s to fend off hostile takeovers. “Triggered” when an investor goes over a certain ownership level, the plan automatically issues new shares to other stockholders, thus diluting the buyer’s stake.

Today’s flurry of pills is reminiscent of 2008, when dozens of companies threw up defensive barriers in response to that year’s financial crisis and subsequent “Great Recession.” But the new batch of pills have some key differences from earlier versions. Most notably, the average lifespan of this year’s pills is a little over one year, and in some cases can be terminated even earlier, while many 2008 pills had a 10-year lifespan.

Significant volatility

Consumer cyclical companies are the most numerous adopters of pills this year, accounting for around a quarter of the new rights plans, with energy companies and air travel firms also among those adopting the defensive measure. The majority had market capitalizations of under a billion dollars, though two large-caps and two mid-cap stocks also issued pills, according to Activist Insight Governance data.

Six Flags announced a rights plan on March 31, citing the COVID-19 pandemic and “significant volume and volatility” in the trading its stock. A day earlier Spirit Airlines launched a pill “to reduce the likelihood” that a potential acquirer could gain control via open market accumulation, while aerospace parts company AAR Corp said it needed a pill to give its board time “to make informed judgments and decisions.” None pointed to real, or even perceived takeover threats.

Some pills, however, have been the result of a clear and present threat, especially in the energy sector where habitual acquirers like Carl Icahn have been active. Both Occidental Petroleum and oil refining and distribution company Delek U.S. Holdings put in pills in reaction to Icahn buying shares. Possibly afraid of being the next target, energy infrastructure company Williams quickly followed suit.

Some pills do predict activist activity; none quicker than The Chefs’ Warehouse, which adopted a pill on March 22, a week before activist investor Legion Partners disclosed a new 5.5% stake in the food distributor.

Activist influence

Shareholder activists deserve much of the credit for shortening the durations of poison pills, according to Morton Pierce, a partner at law firm White & Case. “The activists came along (after 2008) and were taking aim at the pills, and that resonated with the shareholders base as being anti shareholder democracy.”

Fear of activism is apparent from current practices, although Pierce cautioned that, “The pill has never been a block to a proxy contest.”

Almost half the current pills have 10% trigger points, while in 2008, around two-thirds of those tracked by Activist Insight Governance had 15% thresholds (Activist Insight Governance does not guarantee the comprehensiveness of 2008 data). Since the Great Recession, some companies have also distinguished between activists, which file Schedule 13Ds, and passive investors on 13Gs, giving the latter higher thresholds. Stripping out 5% pills designed to protect net operating losses, the average trigger this year is around 14%, according to Activist Insight Governance data.

Most new pills also last for one year or less and run out before the 2021 proxy season, when issuers may hope the disruption caused by COVID-19 is over and shareholders and proxy advisors alike will take a holistic view of governance and performance.

Several of the companies with new pills are currently vulnerable on both fronts, however. Entertainment destination company Drive Shack and aerospace company AAR Corp each have staggered boards and rank as highly vulnerable on Activist Insight Vulnerability.

The reaction

Activist campaigns in the 2021 proxy season will likely center on how management teams reacted to the current crisis and whether they are perceived to have done a good job.

They may also hope to rally the governance community to come down harshly on companies that implemented pills.

Over the last decade, proxy advisory firms like Institutional Shareholder Services (ISS) and Glass Lewis have come out strongly against both poison pills and the board members who implemented them, typically recommending investors vote against an incumbent board that authorizes a long-term poison pill without subjecting it to shareholder approval.

Limiting pills to one year or less, however, makes them far more tolerable. ISS, for example, states in its 2019 proxy guidelines that it may be more lenient if that pill has a term of one year or less, and the board can offer a rationale for adopting it. Whether COVID-19 is sufficient rationale is currently unclear. Both ISS and Glass Lewis declined to comment for this story, though ISS indicated it may provide clarity in coming days.

Some advisers warn that implementing a pill should not distract directors or make them complacent, citing a March 19 note from ISS to its clients that “boards contemplating defensive maneuvers may want to consider that an effective response to the pandemic could be more advantageous than any pill.”