Business Week has an article, Fighting takeovers by playing the debt card, describing Amylin Pharmaceuticals Inc.’s (NASDAQ:AMLN) attempts to fend off Carl Icahn through the use of a “Poison Put.” A poison put is a change-of-control debt covenant the effect of which is to require the borrower to pay back an outstanding loan if investors buy a sufficiently large stake in the company or elect a slate of directors. In this case, AMLN says it would be forced to pay back a $125M loan if Icahn’s slate gets control of its board, which could in turn cause it to default on up to $900M in debt. That makes AMLN an unpalatable activist target.
Business Week says the covenant is the “choice du jour” for an increasing number of companies seeking to avoid the attention of activists and raiders:
Many companies have such change of control covenants in their bond or loan agreements, among them J.C. Penney (JCP), Kroger (KR), Ingersoll-Rand (IR), and Dell (DELL). That’s not to say they would use them to ward off an Icahn. Nor is it clear how many companies are using these covenants to do so. But shareholder activists have little doubt that they have become a takeover defense. “[These change of control provisions] are designed to deter a proxy fight,” says Chris Young, director of mergers and acquisitions research for the shareholder advisory firm RiskMetrics Group (RMG).
Change in control provisions are nothing new. In fact they are a standard condition in most loan agreements:
Change of control provisions first began appearing in 1980 when corporate raiders started taking over companies and loading them up with debt. Concerned that these companies would be unable to pay back their loans, lenders insisted on covenants requiring them to repay their original lenders. These provisions became fashionable again during the private equity boom of recent years. Now, with credit tight, they have become a potent deterrent to corporate raiders leery of being forced to repay a company’s debt and then refinance the loans at higher rates.
What is new, however, is companies actively seeking the inclusion of such a covenant as a device to fend off a suitor, as Lions Gate Entertainment Corp. (USA) (NYSE:LGF) and Exelon Corporation (NYSE:EXC) seemed to do recently:
When JPMorgan Chase (JPM) extended Lions Gate’s revolving line of credit last year, the terms included a provision that triggers instant repayment if an investor buys more than 20% of the company’s stock. Since then Icahn has acquired 14% of Lions Gate. In late March, Lions Gate “strongly urged” investors-while taking no formal position-to scrutinize an offer by Icahn to buy $316 million in debt. (He could convert it into stock and boost his ownership stake.) In the same letter, Lions Gate, without mentioning Icahn, said it could be forced to repay both its bank debt and notes.
In another case, the giant electric utility Exelon (EXC) wants to buy rival NRG Energy (NRG) for $5 billion and is waging a proxy battle to elect nine members to NRG’s board. In a letter to shareholders, NRG warned that such an outcome would trigger “an acceleration” of its $8 billion of debt. Exelon General Counsel William A. Von Hoene Jr. counters that NRG is “using the debt issue as a threat” to scare off NRG’s shareholders from considering its bid.
AMLN shareholders aren’t taking it lying down. The San Antonio Fire & Police Pension Fund, an AMLN investor, has sued the company for agreeing to the poison put about the time takeover speculation began in 2007. For its part, AMLN says it has since tried unsuccessfully to get bondholders to waive a provision blocking outsiders from taking over the board and has asked its bankers for a similar waiver. Steven M. Davidoff, The Deal Professor, has a superb analysis of the issues in his NYTimes.com DealBook column, Icahn, Amylin and the New Nuances of Activist Investing. Says Davidoff:
The pension fund’s claim is mainly that these poison put provisions are void. In support of this claim, the plaintiff appears to be arguing that the provision violates the Unocal standard in Delaware, which requires that director action in response to a threat to the corporation not be coercive vis-à-vis stockholders.
In addition, the plaintiff claims that the poison put provisions violate Section 141(a) of the Delaware General Corporation Law which requires that the business and affairs of a Delaware corporation be run by the board. Here, the plaintiff claims that the poison put provisions hinder the board’s exercise of its fiduciary duties to ensure a free and fair election, since the directors cannot approve all nominees for election.
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The more problematic issue is with the language in the credit agreement for the term loan. … [If] in a two-year period the board changes control due to a proxy contest, the provision is triggered. The actions of Mr. Icahn and Eastbourne, if successful, would do the trick.
So, we are left with the issue of whether this provision violates Unocal. The answer is likely no. Delaware has broadly interpreted the doctrine, and here there is an opening for a change of control to occur – it will just take two years. This conceivably could be only two proxy contests, and therefore I suspect will likely not be found coercive. After all if Delaware tolerates staggered boards, why wouldn’t it tolerate a provision which has a similar effect?
Shareholder activist Nell Minow says companies shouldn’t use the poison put if their object is to disenfranchise stockholders:
These are shareholder rights that can’t be negotiated away by someone else.
We agree. Unfortunately, as Davidoff points out, lenders do have legitimate reasons for asking for such a provisions: they want to know who they are dealing with. This means that lenders will keep proposing poison puts and boards will “avoid resisting” them because they deter shareholder activism.
We estimate the company’s liquidation value to be around $171.6M or $5.74 per share, which is predominantly cash and equivalents in the amount of $172M or $5.75 per share. RACK’s net cash value is around $118M or $3.95 per share.
As shown in table 2, City Investing Liquidating Trust was a hodgepodge of assets. Few investors had the inclination or stamina to evaluate these assets or the willingness to own them for the duration of a liquidation likely to take several years. Thus, while the units were ignored by most potential buyers, they sold in high volume at approximately $3, or substantially below underlying value.
Greenbackd 