What's in a Poison Pill?

Avici is the latest equipment maker to adopt a shareholder rights plan to protect itself against unwanted takeovers

December 10, 2001

3 Min Read
What's in a Poison Pill?

With a stock price down to a level that may tempt hostile suitors, Avici Systems Inc. (Nasdaq: AVCI; Frankfurt: BVC7)is the latest networking company to file a shareholder rights plan, commonly referred to as a “poison pill.”

The plan, adopted last week, allows a company’s existing shareholders to buy new shares at a deep discount, diluting the number of shares outstanding. It is designed to thwart takeovers and is typically triggered when a hostile suitor owns 15 percent of the stock. The pill is not invoked if board members agree a proposed merger is friendly.

A spokeswoman confirmed that Avici’s shareholder rights plan could be triggered at the 15 percent threshold. But she added that there have been no major stock purchases or takeover attempts that hastened Avici’s board of directors to adopt the pill.

Instead, a languishing stock price may have prompted the pill. The terabit router maker’s stock closed Monday down 17 cents (5.72 percent) to 2.80, giving the company a $140 million stock market value. Although Avici’s stock has been trading in the low single digits in recent months, its 52-week high last December was $43.81.

Other networking companies to recently adopt poison pills include Redback Networks Inc. (Nasdaq: RBAK) and Extreme Networks Inc. (Nasdaq: EXTR).

Experts say that depressed stock values may create an environment for hostile takeovers, causing companies to protect themselves in such events.

“It’s a standard housekeeping thing,” says Diane Frankle, an attorney with the Silicon Valley firm of Gray Cary Ware & Friedenrich, who is not affiliated with Avici. “If the market is as volatile as it has been recently, boards will think about it in the normal course of business.”

Lawyers note several poison pill benefits. “If someone makes a hostile offer, it gives you time to shop around for another offer,” says Greg Gallo, also a securities lawyer with Gray Cary. “It gives you time to find a white knight and get the best price.”

The pills are an effective deterrent against hostile takeovers. Of the 2,500 public companies that have adopted poison pills since the 1980s, none has been taken over by a hostile bidder.

The pill’s purpose is not always intended to prevent hostile suitors, however. It’s often used merely to get a better price in the event of any potential takeover.

“The poison pill forces someone who wants to take over a company to negotiate with the board,” says Don Reynolds, a lawyer with Wyrick Robbins Yates & Ponton. “Studies show that companies with them do get a better price when they’re acquired.”

But other studies have shown a drawback to poison pills. They can slightly depress a company’s stock price because some institutional buyers may be less inclined to buy a stock if there is any provision that can thwart a takeover.

Boards often adopt poison pills after a big drop in the stock price that is disproportionate to any change in a company’s fundamentals.

— Tom Davey, special to Light Reading, http://www.lightreading.com

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