ANTI-TAKEOVER -1 / TAKEOVER DEFENCE 1 POISON PILLS QUESTIO) 1) ON POISON PILLS 2) ON ANTI-TAKEOVER DEFENCE 3) TAKEOVER DEFENCE BEFORE THE BID

ID 4) PRE-OFFER ANTI-TAKEOVER DEFENCES 5) PREVENTIVE MEASURES FOR TAKEOVER / ANTI-TAKEOVER 6) DO COURTS TAKE FAVOURABLE VIEW OF POISON PILLS? 7) Defenses install in advance of a takeover 8) Exercise in Wall Building 9) 1st gen poison pill (Martin Lipton), 2nd generation (Flip ov 10) er), 3rd generation (Flip in) 10) PILLS CORPORATE CHARTER AMENDMENTS Two types: Preventative Defenses install in advance of a takeover Exercise in Wall Building Active Defenses deploy during a takeover battle FT 27/4/10 - the structure of the group provides Mr Lagardre as a general partner with bullet proof anti-takeover protection. For although he owns less than 10 per cent of his group, as a general partner he can veto any change in structure.

Anti-takeover measures share two things in common. They are designed to Raise the overall cost of the takeover to the acquirers shareholders and Increase the time required for the acquirer to complete the transaction to give the target additional time to develop an anti-takeover strategy Antitakeover defenses can be divided in two categories, active and preventive defenses. Preventive measures are to reduce the likelihood of a takeover while active measures are employed when a hostile bid is made. Opponents of these measures opine that these measures reduce the value of stockholders investment. According to them the activities of raiders keeps the management honest and the threats of raiders make them work more efficiently. However the proponents of these measures argue that these prevent firm from hostile raiders who have no long term interest in the firm and are looking only for short term gains. Two hypotheses have been put forward in this regard: Management entrenchment hypothesis and stockholders interest hypothesis. Management entrenchment hypothesis proposes that shareholders experience reduced wealth effect when management takes antitakeover measures. Shareholder interest hypothesis states that stockholders wealth rises when management takes antitakeover measures. This hypothesis also shows that antitakeover measures can be used to maximize shareholders value through

the bidding process. Management can declare that it might not withdraw measures unless it receives offer in shareholders interest. The evidence from various takeovers studies is conflicting and doesnt favor any one of the hypothesis as such. Shareholder rights plans The most common form of takeover defence is the shareholders' rights plans, which activates at the moment a potential acquirer announces its intentions. The target company issues rights to existing shareholders to acquire a large number of new securities, usually common stock or preferred stock. The new rights typically allow holders (other than a bidder) to convert the right into a large number of common shares if anyone acquires more than a set amount of the target's stock (typically 15%). This dilutes the percentage of the target owned by the bidder, and makes it more expensive to acquire control of the target. This form of poison pill is sometimes called a shareholder rights plan because it provides shareholders (other than the bidder) with rights to buy more stock in the event of a control acquisition. Effects on shareholders The goal of a shareholder rights plan is to force a bidder to negotiate with the target's board and not directly with the shareholders. The effects are twofold: -It gives management time to find competing offers that maximize selling price. -Several studies have indicated that companies with poison pill (shareholder rights plans) have received higher takeover (Comment 7 Schweet 1995) premiums than companies without poison pills. This results in increased shareholder value. The theory behind this is that an increase in the negotiating power of the target is reflected in higher acquisition premiums. Poison Pills: It is a term referring to any strategy, generally in business or politics, to increase the likelihood of negative results over positive ones for a party that attempts any kind of takeover. It derives from its original meaning of a literal poison pill carried by various spies throughout history, taken when discovered to eliminate the possibility of being interrogated for the enemy's gain. In publicly held companies, "poison pills" refer to various methods to deter takeover bids. Takeover bids are attempts by a bidder to obtain control of a target company, either by soliciting proxies to get elected to the board or by acquiring a controlling block of shares and using the associated votes to get elected to the board. Once in control of the target's board, the bidder can determine the target's management. Targets have various takeover defenses available, and several types of defense have been called "poison pills" because they not only harm the bidder but the target (or its shareholders) as well. At this time, the most common takeover defense known as a poison pill is a shareholder rights plan. Because the board of directors of the company can redeem or otherwise eliminate a standard poison pill, it does not typically preclude a proxy fight or other takeover attempts not

accompanied by an acquisition of a significant block of the company's stock. It can, however, prevent shareholders from entering into certain agreements that can assist in a proxy fight, such as an agreement to pay another shareholder's expenses. In combination with a staggered board of directors, however, a shareholder rights plan can be a defence. Types Of Preventive Antitakeover Measures: 1.Poison pills: a)Preffered Stock plan: Invented in 1982 by Martin Lipton, these were the first kind of poison pill. In this target offers its shareholders preferred stocks as dividend that would be converted to some shares of bidder after the takeover takes place. This leads to dilution of bidders shareholders share. These have certain disadvantages, first they can be redeemed only after an extended period of time, which could be in excess of 10 years, preventing any friendly merger. Secondly, they add immediate long term debt (preferred stocks are considered as long term debt) to companys balance sheet making it highly leveraged and thus more risky in eyes of investors. Poison Pills Peaked in 80s in Hostile takeover period In 90s there was a major peak in Poison Pills. Number of Companies with Poison Pills: Over 1,500 corporations have poison pills (as of late December 1990) 56% of the Fortune 500 68% of the Fortune 200 52% of Business Week 1,000 Other name for Poison Pills Shareholders Rights Plans Meaning of Poison Pill name: If the acquiring company takes over the target the acquirer will have to swallow the poisonous consequences of the pill FT 28/4/10 - Lions Gate Entertainment will launch legal action against a Canadian stock market regulator on Wednesday in an attempt to overturn a ban on the poison pill defence the movie studio planned to use to block Carl Icahns $825m takeover bid. FT - 24/5/10: - Many Japanese companies adopted poison pill measures in 2007 and 2008, following a series of high-profile moves by activist shareholders, such as the Steel Partners and the Children's Investment Fund . -According to research by Nomura, 15 per cent of listed companies in Japan, or 566 companies, had takeover defence measures as of February 2010.

b) Flip over rights: This comes in form of rights offered as dividend that allow shareholders to purchase discounted stocks during specified period of time. Following the takeover the rights will flip over allowing the shareholders to buy unfriendly bidders shares below market price. A "flip-over" allows stockholders to buy the acquirer's shares at a discounted price after the merger: An example of a flip-over is when shareholders gain the right to purchase the stock of the acquirer on a two-for-one basis in any subsequent merger.

This strategy provides shareholders of the target company with the right to purchase additional stock in the target company at substantial discounts. The rights are active after some triggering event such as an acquisition of 20% of the outstanding shares by any individual, partnership, or corporation or a tender offer for 30% or more of the target corporations outstanding stock. Flip over rights were very innovatively overcome by Sir James goldsmith in 1986. Drawback of this pill is that is this is effective only when the bidder acquires 100% stock, they cant prevent bidder to have a controlling interest in the firm. c) Flip in pill: A "flip-in" allows existing shareholders (except the acquirer) to buy more shares at a discount: By purchasing more shares cheaply (flip-in), investors get instant profits and, more importantly, they dilute the shares held by the acquirer. This makes the takeover attempt more difficult and more expensive. This type of poison pill allows shareholders to purchase shares of common stock in the new company at a substantial discount after the merger. While this approach is simpler to implement than a preferred stock plan, it does not prevent a company from purchasing a controlling share of the target. Now almost always accompanies a flip-over provision: a) Occurs after similar triggering event and merger b) Allows holders to buy shares in target at 50% off c) Deals with the less than 100% controlling interest acquisition d) Back-end rights plan (like put option): Finally a back end rights plan was like a put option which allowed holders of stock can exchange their shares for a cash price or the equivalent in senior debt securities which the company's board believes is fair. This was usually a price which is above market price, and could apply to bondholders of notes as well. It is rarer now as it was typically a safeguard against two tiered offers. e) Voting Plan: First developed in 1985. Legalities of these plans have been upheld in court or Courts have upheld their legalities. A right which may avoid takeover but different from flip over or flip in is Voting Plan. Targeted companies may also implement a voting-rights plan, which separates certain shareholders from their full voting powers at a predetermined point. For instance, shareholders who already own 20% of a company may lose their ability to vote on such issues as the acceptance or rejection of a takeover bid. The presence of corporate predators may also trigger super-majority voting, which requires that a full 80% of shareholders approve a merger, rather than a simple 51% majority. This requirement can make it difficult - if not impossible - for a raider to gain control of a company. It is very difficult for management to convince shareholders that voter-rights clauses benefit them, and the addition of such clauses to the corporate charter is often followed by a drop in stock price. (For related reading, see Proxy Voting Gives Fund Shareholders A Say.) 1. Who developed poison pills and when?

They were invented by Martin Lipton in 1983 (preferred stock) and perfected with poison pill as rights in 1985. 2. What kind of financial instrument did he use as the prototype for the poison pill? The original poison pills were based on preference shares with superior voting rights. 3. What final form did the pioneer of poison pills decide upon? What was superior about the later form of poison pill? Liptons key innovation was the introduction of a right that attached to shares. Each share carried such a right. However the right was not detachable from the share until there had been a triggering event, usually a purchase of between 20% and 30% of the companys stock. Could still be redeemed at nominal value until second triggering event. A second triggering event was necessary once the right had been issued to make it excercisable. In the original flip-in plans this was when a bid was made for 100% of the firms equity The advantage of the rights approach was two-fold. Firstly, the right once triggered could be redeemed at a nominal price before the second triggering event at which the right could be exercised. With the preference share plan, the first triggering event led to the issue of the preference shares which could not be redeemed. In addition, the preference shares added to debt and leverage where the rights did not. 1st Poison Pill - Brown Forman Distillers v. Lenox Inc. 1983: Brown Forman: 4th largest distiller in the United States Brands: Jack Daniels Martel Cognacs Korbel Champagne Sales: $900 million Lenox, Inc. - major china producer Trading at $60 p/share on NYSE

Brown Forman offer $87 p/share which was more than 20 times the previous year's EPS of $4.13 - This was a high bid and difficult to fight Lipton: Suggested that Lenox offer Preferred Shares with each share convertible into 40 share of Brown Forman if Brown Forman took over Lenox. - This proved most effective since the Brown family owned 60% of Brown Forman and they would not want to lose control of Brown Forman. Problems with these first poison pills: 1. Difficult to redeem 2. Had an adverse impact on balance sheet Crown Zellerbach Poison Pills: Rights with no value at issuance Only issued when buyer acquired 20% of CZ stock or made a tender offer for 30% of CZ stock Rights allowed the holder to buy the stock of the issuer at a 50% discount off market price once merger occurs and buyer purchases 100% of the target - Allow buyer to buy $200 worth of stock for $100 Fail safe mechanism: rights could be purchased at $0.50 per right by the issuing firm These pills were flip over pills How Poison Pills Work: Shareholders receive a dividend of one right per share of common Rightsholders receive right to purchase a share at the exercise price anytime during the exercise period - Exercise period: typically 10 years - Exercise price: typically 50% off: buy $200 worth for $100 Approval: usually only need Board of Directors approval, not shareholders Triggering event: Typically purchase of 20% or offer for 30% - Until triggering event: Rights trade with the stock Not issued separately - After triggering event: Separate rights certificates mailed to shareholders They become exercisable Acquirer can't exercise its rights Redeemability: Rights redeemable until control threshold is crossed - Typically $0.02 p/right

1. Why does the empirical evidence on poison pills seem, prima facie, contradictory, and how is this contradiction resolved? The empirical evidence suggests that the announcement of a poison pill tends to depress share price and is associated with negative abnormal returns. However, the evidence also suggests that target premiums are improved by the existence of poison pills. Further research suggests that the contradiction can be explained with resort to the additional factor of managerial entrenchment (agency). The announcement of a poison pill is generally taken as a sign of entrenchment. However, evidence suggests that the overall relationship depends on the level of insider shareholding. At low levels of insider shareholding, the announcement can be positive. 2.) Corporate charter amendment: Corporate charter amendment: Changes in corporate charter are common antitakeover devices. Corporate charter changes generally require shareholders approval. The majority of antitakeover charter amendments are approved. Common antitakeover corporate charter changes are: a) Staggered board amendments: It varies the term of board of directors so that only a few, such as one third, may be elected in any year. So the incumbent board will be made up of directors who are sympathetic to the current management. - Usually 1/3 of the board is replaced every year. This means that it will take at least two years for the acquirer to place their own directors. b) Super majority provisions: It dictates the number of voting shares needed to amend the corporate charter or to improve important issues such as mergers. A supermajority provision allows for a higher than majority vote to approve a merger (typically two thirds). Supermajority charters are effective against partial offers. This is when key decisions require a support of more than 50%. e.g. 68% to 80% shareholder support may be required to approve the sale of the company or to remove a poison pill. c) Fair price provisions: It requires the acquirer to pay the minority shareholders a fair market price for the companys stock. This may be stated in terms of price or in terms of companys P/E ratio. - This is when the target companys articles specify a minimum price which must be paid to shareholders in the event of a takeover. The price is usually specified in terms of p-e ratio or price relative to medium term share price performance. d) Dual capitalization: Also called Alphabet stock. It provides equity restructuring in classes of stocks with different voting rights. They can take place only with shareholders approval. Its purpose is to give more voting rights to those who are

sympathetic to the managements view. Management often increases its voting power by dual capitalization. For this company issues shares with superior voting power which are distributed to various stockholders. Stockholders are then given a right to exchange these with common stock which are more liquid and pay more dividends. However, management who may also be stockholders may not exchange their superior voting rights with ordinary stocks. - This is when there are two classes of share. One class of shares with superior voting rights tends to be concentrated in the hands of the company founders or other insiders such as management. Many smaller shareholders are happy to hold inferior voting shares in exchange for higher dividends as any votes they might acquire would make little difference anyway. Example: -GM has class H shares (Hughes & Aircraft) & class E (EDS) shares. -Ford has A&B shares has 16.541 votes per share these are concentrated in the hands of Ford family Ford gives 40% to family voting. 3) Golden parachutes (less convincing): These are special compensation agreements which the company provides to upper management. These are highly lucrative and provide for large payments to certain senior management on either voluntary or involuntary termination of their employment. This agreement is usually effective if the termination occurs within one year of change of control. The amount of compensation is determined by employees annual compensation and years of service. A possible compensation could be a multiple of recent years annual salary, including bonuses and incentive for a certain number of years. They may be used in advance of a hostile bid to make the target less desirable but as the compensation paid is only a small percentage of total purchase price, they are not very effective. The legality of golden parachutes is questioned as they entrench management at the expense of shareholders. The system has given rise to a new breed of CEOs who join the corporation that have underperformed and tries to sell the business to a buyer. Golden Parachute Research Machlin & Choe (1993) : ~Firms with Golden parachute were target of multiple offers. ~Positive relationship between Golden agreement & Takeover Premium -Poison pills are not allowed under UK takeover rules. -Poison pills are largely US phenomena -Nevertheless in many countries market for corporate control is not seen as a good thing. -Hence, poison pills may be allowed in a country like JAPAN. Many Japanese companies adopted poison pill measures in 2007 and 2008, following a series of high-profile moves by activist shareholders, such as the Steel Partners and the Children's Investment Fund . According to research by Nomura, 15 per cent of listed companies in Japan, or 566 companies, had takeover defence measures as of February 2010.

The poison pill defence was meant to allow shareholders to buy more shares at a discount if Mr Icahn increased his stake. Shareholders were due to vote on the plan on May 4. Poison pill defences are popular but somewhat controversial. The majority of large U.S. companies had adopted them by the 1990s. Part of this popularity comes from their effectiveness in delaying a corporate takeover, during which time a target company may marshal other defenses as well. Another reason is that courts have upheld their legality. One of the first important cases in this area reached the Delaware courts in 1985 (Moran v. Household International, Inc., 500 A.2d 1346). However, some critics have argued that the strategy gives company directors power at the expense of shareholders. They maintain that it can limit shareholders' wealth by thwarting potentially beneficial takeovers and allowing bad corporate managers to entrench themselves. In the 1990s such arguments spurred some investors to attempt to repeal poison pill provisions in corporate charters. Household International Decision: November 1985: Delaware Supreme Court approved the legality of poison pills Court said the existence of poison pills does not prevent a firm from receiving a tender offer Court stated that the pills did not keep bidders away but rather helped companies get a better price when the business is sold Poison Pill Court Decisions: Unfair Use of a Poison Pill/Discriminatory Use of Pill: Maxwell vs. Macmillan - 1988 Delaware Court ruled that Macmillan unfairly used its poison pill to prevent an auction rather than promote one - Court said Macmillan was unfairly using its poison pills to favor its own restructuring plan Rales vs. Interco - 1988 Delaware Court ruled that Interco was using its poison pill to unfairly favor its own recapitalization plan Bank of New York vs. Irving Trust - 1988 - New York State Court ruled Irving Trust's pill unfairly discriminated against the Bank of New York - The court said the pill itself was not illegal but the Bank of New York which had 4.9% of Irving, should also be able to buy shares at 50% off Poison Pill Research: Georgeson & Co. examined 48 companies receiving tender offers between 1/01/86 - 10/19/87 - Looked at deals over $100 million - Found pill-protected companies received 69% higher premiums

- Protected company premiums: 78.5% above pre-announcement price - Unprotected company premiums: 56.7% above pre-announcement price 2nd Georgeson Study on Poison Pill: Premiums: November 1997: Found similar results to the first Georgeson study but the premiums were lower Premiums of pill-protected companies were eight (8%) percentage points higher than non-pill-protected companies less than first study Difference was greater for smaller capitalization companies than for large capitalization companies Poison Pill Research: Academic Research: Malatesta & Walking (1988) and Ryngaert (1988) found that the adoption of poison pills were associated with negative shareholder wealth effect Supports the management entrenchment hypothesis Comment & Schwert (1995) also found poison pills were associated with higher takeover premiums Oracle vs. PeopleSoft 2003-2005 Takeover Battle: Testimony to the power of a poison pill takeover defense Oracle kept putting on pressure to get PeopleSoft to dismantle pill defense PeopleSofts pill kept Oracle at bay until Oracle raised offer Oracle - #2 U.S. software maker after Microsoft PeopleSoft - #3 in the United States Both make back office (i.e., billing, etc.) software June 2003 Oracle makes first bid January 2005 PeopleSoft capitulates Battle became personal between CEOs PeopleSoft CEO referred to Oracles CEO Larry Ellison as the Darth Vader of the industry If an acquirer obtains 20% or more of the companys common stock then each right (other than rights owned by the acquiring person) will entitle the holder thereof to purchase, for the exercise price, a number of shares of the Companys common stock having a then current market value of twice the exercise price If, after an acquiring person obtains 20% or more of the Companys common stock, a) the company merges into another entity, b) an acquiring entity merges in the company or c) the company sells more than 50% of the companys assets or earning power, then each right (other than rights owned by an acquiring person or its affiliates) will entitle the holder thereof to purchase, for the exercise price, a number of shares of the common stock of the person engaging in the transaction having then market value of 2X the exercise price.

Poison Pills are legal in US provided the basic principles are observed:

Where they are clearly necessary to defend the genuine interests of shareholders. For example, where the current management team can demonstrate clear strategic vision by contrast with the acquirers profiteering opportunism. b. That they do not discriminate against potential acquirers without good reason. c. That they do not obstruct the potential for an auction process. Unfair Use of a Poison Pill: Bank of New York vs. Irving Trust - 1988 - New York State Court ruled Irving Trust's pill unfairly discriminated against the Bank of New York - The court said the pill itself was not illegal but the Bank of New York which had 4.9% of Irving, should also be able to buy shares at 50% off Conclusion (apparent contradiction) - Malatesta & Walking (1988) and Ryngaert (1988) found that the announcement of a poison pill tends to depress share price and is associated with negative abnormal returns. The adoption of poison pills were associated with negative shareholder wealth effect -However, the evidence also suggests that target premiums are improved by the existence of poison pills. Comment & Schwert (1995) also found poison pills were associated with higher takeover premiums -Further research suggests that the contradiction can be explained with resort to the additional factor of managerial entrenchment (agency). -The announcement of a poison pill is generally taken as a sign of entrenchment. -However, evidence suggests that the overall relationship depends on the level of insider shareholding. -At low levels of insider shareholding, the announcement can be positive. Testimony to the power of a poison pill takeover defense Oracle kept putting on pressure to get PeopleSoft to dismantle pill defense PeopleSofts pill kept Oracle at bay until Oracle raised offer Oracle - #2 U.S. software maker after Microsoft PeopleSoft - #3 in the United States Both make back office (i.e., billing, etc.) software June 2003 Oracle makes first bid January 2005 PeopleSoft capitulates Battle became personal between CEOs PeopleSoft CEO referred to Oracles CEO Larry Ellison as the Darth Vader of the industry If an acquirer obtains 20% or more of the companys common stock then each right (other than rights owned by the acquiring person) will entitle the holder thereof to purchase, for the exercise price, a number of shares of the Companys common stock having a then current market value of twice the exercise price If, after an acquiring person obtains 20% or more of the Companys common stock,

a.

a) the company merges into another entity, b) an acquiring entity merges in the company or c) the company sells more than 50% of the companys assets or earning power, then each right (other than rights owned by an acquiring person or its affiliates) will entitle the holder thereof to purchase, for the exercise price, a number of shares of the common stock of the person engaging in the transaction having then market value of 2X the exercise price. PeopleSofts Other Antitakeover Defenses: - Did 2 stock buybacks Had a staggered board Had a provision whereby shareholders cannot call special meetings PeopleSoft had not opted out of Delaware business combination statute Oracle held off buying 20% of PeopleSoft stock so that new shares are not issued via the pill Novel defense: PeopleSoft gave its customers a rebate which allowed then to receive 5 times the licensing fee in the event of a takeover PeopleSoft said it needed this as customers were afraid if PeopleSoft was taken over Oracle would discontinue the PeopleSoft software Oracle was PeopleSofts customers not its products or employees Strong Points of Poison Pill As a defensive tactic, poison pills are extremely effective. Not only do they fend off unwanted takeover bids, but boards often argue that the strategy gives the company an opportunity to find a more suitable acquiring party, a so-called white knight. Boards also favor poison pills for the leverage they bring to the bargaining table. In 2003, enterprise software giant Oracle attempted to acquire rival PeopleSoft through a $5.1 billion hostile takeover bid. But PeopleSofts poison pill was set to trigger if Oracle bought more than 20 percent of the company. After a year-long battle, PeopleSoft finally voided its poison pill and was acquired by Oracle for $10.3 billion nearly double Oracles initial offer. Weak Spots of Poison Pill Since shareholders could gain from a takeover, they often view managements adoption of a poison pill as blatant disregard of investors interests. Adopting a poison pill can really do a number on a companys corporate governance image, says Jeffrey Block, associate director for strategic research at Thomson Financial. There is a knee-jerk reaction in the marketplace against anything that dilutes the power of shareholders. Accordingly, in some cases investors send a clear message that they dont agree with managements strategy by dumping some of their shares. Consider the example of oil company Tesoro: When the company adopted a poison pill in November 2007 to defend itself against billionaire Kirk Kerkorians Tracinda Corp., its stock plummeted almost 14 percent between the week before the announcement and the week after. In March 2008, Tesoros management dropped its poison pill, with CEO Bruce Smith explaining that the company wanted to act in the best interests of our stockholders. When it comes to big institutional investors, many companies in fact dont have the choice of adopting the tactic. Market giant Fidelity Management & Research, for example, says that it

will generally vote against a proposal to adopt or approve the adoption of an anti-takeover plan. Recent Developments Shareholder Input on Poison Pills More companies are giving shareholders a say on poison pills. According to FactSet SharkRepellent data, so far this year 21 companies that adopted or extended a poison pill have publicly disclosed they plan to put the poison pill to a shareholder vote within a year. That's already more than 2008's full year total of 18 and in fact is the most in any year since the first poison pill was adopted in the early 1980s