Lion’s Gate Take Over Bid by Icahn: Poison Pill or Just A Hard Candy?
Mad Men, Saw, Weeds, Nurse, Jackie and Kick-Ass. These are some of the shows and feature films of the Hollywood studio Lions Gate – which has just been the subject of a classic takeover attack, albeit one which eventually failed. Carl Icahn, a former green-mailer and now predator who became famous in the 1980s with his takeover bid of Texaco, often used the services of the junk-bond King Mike Milken, to raise finance. This gives a wonderful opportunity to analyse the most frequently used takeover defense, the poison pill, deployed this time by Lions Gate. It also points out how interests of majority shareholders may run contrary to interests of minority shareholders and directors. Towards the end, you shall find a part which explains what could possibly happen in India in a similar situation.
Reasons for the takeover
As a shareholder of Lions Gate (Icahn owned 18.6 percent of the shares), he was dissatisfied with the existing management of the company – the share price had touched a high of 12 US dollars in 2007, but was hovering around 6.91 presently. The figure could potentially dampen the enthusiasm of a shareholder, who is primarily interested in the increase in the value of the shares of the company he owns. Therefore, Icahn decided to stage a takeover of the company at 7 US dollars per share.
Note that whenever a person or a company attempts a takeover, the price offered by it is generally slightly over the market price. This is because transfer of a large number of shares, as compared to a smaller number, transfers the element of control, and so the additional price offered over the market price is known as the premium, which is paid for the control. In this case, Icahn was offering a premium in the range of 15 percent over the closing price. His total takeover bid amounted to 825 million US dollars, a huge amount by all standards.
The Classic Takeover Defense
As would be expected in any takeover, Lions Gate sought to protect itself and resorted to an oft used takeover defense – a poison pill. For those who are not familiar with what it is, lets just say it would have the effect that if Icahn sought to buy any more shares of the company, it would trigger an automatic grant of right to the existing shareholders to buy more shares at a cheap (discounted) price which are to be issued for that purpose specifically, thereby diluting Icahn’s acquired stake and keeping the shareholding percentage of existing shareholders either unchanged or making it higher than it could otherwise be. This doesn’t make acquisition impossible, but it means Icahn would have to buy more shares and thus shell out much more money than he would otherwise have had to, which would make it more difficult for him to gain control of the company.
Regulators in favour of the Free Market
A poison pill is implemented by the Directors to secure their employment and control over the company. A person willing to stage a takeover offers an additional amount, known as the premium (in the return of gaining ‘control’) in corporate parlance, over and above the existing market price of the shares. The British Columbia Securities Commission (the securities markets regulator in Canada), however, invalidated the poison pill, and a Canadian Court (the British Columbia Court of Appeal) upheld this ban.
The Views of the Free Market
The Court’s decision striking down the poison pill in effect gave Icahn a carte blanche to continue his onward march towards gaining control of Lions Gate. While the adoption of a poison pill by a Board is ordinarily expected to be against shareholder interest, the Board of Lions Gate then chose to go ahead and took a shareholder vote on the pill. 56 percent of the shareholders, voted in favour of the pill in this case, implying that they would not wish Icahn to gain control. That was a clear majority vote, although not by a very small margin.
How the pill works – An example
Let us assume that the acquirer has the finances needed to shell out the amount necessary to acquire the desired percentage of shareholding. Say, for example, there is a company which has two and a half million (2,500,000) shares. Now, say the acquirer wanted to attain a 40% shareholding of this company, for which he would have to purchase a million shares. After the poison pill, say, seven and a half million (7,500,000) additional shares are issued. Thus, the company now has ten million (10,000,000) shares totally, and the acquirer would require purchasing four million (4,000,000) shares to attain the desired 40% level of shareholding, which will require him to fork out four times the amount he was initially planning. With the existing level of money, he will only be able to get a 10% shareholding in the company, which would not give him the desired level of control. This is a simplistic example, in a real-life scenario issuance of a small number of additional shares can make it difficult for an acquirer to arrange additional finance.
Consequences of a poison pill – the tug of war between the Board and the Shareholders
Poison pill often reduces shareholder value. Looking at it one way, implementation of a poison pill by the Board without consent of shareholders identifies a conflict situation in corporate governance between the Board of Directors (managers) and the shareholders (owners) of a company. Ideally, the Board, or the managers are expected to act in the interest of the owners, and could be expected to be their agents. Some writers on corporate governance identify the duties of Directors as extending beyond shareholders to a wider category of stakeholders in the market, say, for example, customers. However, in either case, when the Board acts in its own interest, it can be visualised as violating such a duty.
The Tug of war between the Majority and Minority
Now, let’s look at a situation where implementation of a poison pill is approved by the shareholders. This requires a simple majority, that is, 51% of shareholders. As we saw, this shall make it difficult for the acquirer to acquire the desired level of shares. This situation is different from the one described above, as it demarcates a line of tension between the majority and the minority shareholders. In the case of Lions Gate, this line is pretty sharp – with 56% favouring the pill and 44% against it.
How the Approval of the Pill Affects the Minority
Making an open offer for shares indicates that another person wants to take control of the company, and hence presents an opportunity for them to exit from the company by selling off their shares (for consideration). Now, if no shareholder is interested in a predator gaining control over the company, he would simply not sell his share to such predator. If some shareholders want to sell their shares while the others don’t, the predator will acquire only the shares sold by existing sharheolders. Now, let’s see how this process, and the ability of the minority to sell their shares, is altered by a decision of the majority which approves the pill.
When the moolah’s just not there
In a situation where the acquirer is not able to shell out the amount that is required to attain the desired percentage of shareholding, he is likely to abandon the offer, and the shareholders willing to sell off their shares at the price offered by him (which includes the additional premium component for control) will not be able to.
When the money is arranged
Assume, in the case of the example above, a situation where the acquirer has been able to successfully accomplish the Herculean task of arranging for four times the finance required. Under certain jurisdictions, he may have the option of making his offer conditional upon a certain minimum level of acceptance. For example, under the Indian framework, he would have the option to make his offer conditional upon acceptance by a minimum 20% of the shareholders. Let us see what effect the pill would have on that.
Suppose, before the pill was issued, only shareholders holding 500,000 shares (that is, a 20% minority) wanted to sell off their shares. In such a situation, if all these offered their shares to the acquirer, he would have to purchase the 20% shares that were offered to him by the minority, even though he may not be able to attain the desired 40% shareholding. This implies that while the minority who want to sell their shares can sell them for the premium offered by the acquirer, who would have to buy all those shares, even though he would not attain the desired level of control. Of course, he needs to utilise a fraction of the finance he arranged for the entire 40% shareholding, and to that extent, some of his money is freed up.
Now, after the pill is issued, let us assume that the same 500,000 shares are sought to be sold. These represent only a tiny fraction, that is, 5% of the shareholding percentage post the pill. In such a scenario, if the acquirer made the offer conditional upon a minimum 20% acceptance, he would not be required to buy any shares from these shareholders. As a result, they would not be able to sell their shares at the premium offered by him. They would have to sell them at the open market at the price prevailing there.
The Alternatives Available to the Minority
Through the implementation of the pill, the minority cannot sell their shares anymore to the acquirer. Is this unfair? Well, they can sell it to another buyer in the stock market, at the market price. Of course, they would not stand to benefit from the premium component, or the additional price offered by the acquirer. But that should be fair, in light of the fact that it has been decided by the majority to not surrender ‘control’ in the present case.
The justifications
When the minority is not able to sell off its shares at the premium offered by the acquirer, it may not be viewed as unfair because as a general princple, a large number of the company’s affairs are expected to be governed by a majority of the shareholders, and unless there is serious mismanagement or a violation of the individual statutory rights of the minority, it doesn’t have a valid claim in Court.
Exceptions
Note that anomalous situations may occur where the news of a takeover is perceived as so beneficial for the company that the price of its shares shoots up immediately after the announcement of the acquirer to takeover the company, to a level even higher than the ‘premium’ offered by the acquirers for control.
This had happened when the US company Kraft, bid for the takeover of Cadbury. The price of Cadbury shares had risen to a higher level than that offered by Kraft. In such a case, shareholders may not sell their shares to the offeror, as the price he is willing to pay is lower than what is available in the market. This would be a signal to the offeror to increase his offer price for the shares, which is what Kraft had done. On the other hand, the offeror might decide not to buy shares at the newly reached market high, in which case it would be a signal that the acquisition is going to be called off. In such a situation, the prices could fall back to the original level.
Hence, existing shareholders who are contemplating whether to sell their shares, in such a case, have to tread this fine line by, trying to second-guess the move of the acquirer.
At the end, the game is driven by hard economics – the side which believes that the company is worth much more than what it is thought to be by the other side, wins.
Could a poison pill be issued in India?
Under Indian law, if a predator sought to acquire shares in India, the moment he reaches a 15 percent level of shareholding, he has the obligation to make an open offer to buy a minimum of 20 percent additional shares. At this point, the Board of Directors of a company cannot issue additional shares without taking the consent of shareholders. Thus, for practical purposes, a poison pill cannot be used by the Board to perpetuate its position in the company, unless the same is approved by the shareholders. In the case of Lions Gate, we see that shareholders were in favour of not letting Icahn takeover the company. Hence, if a similar occurred in India, a shareholder vote taken prior to the issuance of a pill would have sufficed to fend off a predator.
