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Routing

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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flanker 12/4/2012 | 7:27:40 PM
re: What's in a Poison Pill? It's a little strange that upstart LightReading would publish a story whitewashing poison pills. Poison pills do one thing and one thing only: they protect the jobs of senior management.

They acquired a really bad reputation in the 1980s because incompetent managers put them in place to prevent their firms from being taken over during the late 1980s LBO craze.

Some academic studies were done in the aftermath and they concluded the effect of poison pills was

1) to depress stock prices because it reduced management and board accountability

2) it denied investors an option to exit or liquidate holdings via a tekover.

3) the prime beneficiaries were managers and board members, not shareholders.

Poison pills are the work of incompetent managers, not depressed share valuations. There are other ways to short circuit a takeover besides poison pills.

iptwister 12/4/2012 | 7:27:38 PM
re: What's in a Poison Pill?
> Poison pills are the work of incompetent
> managers, not depressed share valuations.
> There are other ways to short circuit
> a takeover besides poison pills.

What are these other ways?

Poison Pills are only instituted by the Board of Directors, which generally represents the shareholders. Therefore, your comments are logically false and irrational, it seems to me.

ipt
iptwister 12/4/2012 | 7:27:37 PM
re: What's in a Poison Pill? > Also anyone who thinks Boards of Directors
> look after shareholders, has never been on
> a board..

For what it's worth, I'm on the Board of Directors of two technology venture funded companies, and I can assure you that at least I look after the interest of the shareholders. Additionally, the other members of the boards I'm on look after the shareholders as well.

Sometimes there is a conflict between the 'greater shareholders' and the shareholders that I (or others) represent.

However, your comments are patently false, because I think that, and I am on a board (2).

ipt
Sparxe 12/4/2012 | 7:27:37 PM
re: What's in a Poison Pill? I do not think AVICI did this to avoid a takeover. I think after seeing what happened at Exodus, Enron, Excite, Covad, and PSInetworks, Managment at AVCI knows that shareholders are going to bolt, drive the shares down and sue their asses off. The new "thing" is not takeovers, but getting shakey companies to declare Chapter 11, rip-off the shareholders and buy the company for dirt. Most takeovers make money for shareholders of the target company. I think AVCI may be telling shareholders that they are above that.

Also anyone who thinks Boards of Directors look after shareholders, has never been on a board..

Sparxe Nj
iptwister 12/4/2012 | 7:27:36 PM
re: What's in a Poison Pill?
Typically, in a pre-ipo company, each traunch of investments has 1 or more directors. So typically a first round funding will have 1 or 2 'founder' board seats, and 1 or 2 (depending upon how many major investors) 'investor' board seats. Subsequent rounds of funding may or may not have a board seat, this is negotiated as part of the investment.

I am less familiar with public companies, which AVCI is, but I'm almost certain the board seats are wholely elected by the shareholders, typically coming from one class, common. Sometimes the board members themselves are influenced by personal stock, certain vesting considerations, etc... For further study of a bad situation, read about the RJR takeovers and arguably corrupt board in _Barbarians at the Gate_ by Bryan Burrough and John Helyar.

Since different rounds of funding may have different rights, the series A shareholders and board representatives may want to do something different than the series C sharedholders.

Also, the 'founder representative' may want something different than the venture investor.

In this way, the good of the whole can be at odds with the good of the few.

Let me give you a quick example. A friend of mine is the Series C board seat for a company. In the series-C funding they had a liquidation preference and ratchet on their stock price. So, if the D (next) round was done at a price lower than what they paid, the C round folks got their stock price reduced, and got more stock. So, the C round folks are kinda sorta inclined to want the D round done at a lower valuation, while the A and B round folks, and especially the 'founder' board members are not. There's a general 'good' of the group, and then a particular good of a class or shareholders. In this context, the only people they could find to invest in a series D round wanted to pay less than the series C price. So the Series C folks would get more stock. This was negotiated in at the last round, and was part of the investment. However, the founders, series-A and series-B folks said "look series-c folks, waive this right and take no increase in stock or we'll refuse this funding". Kinda like holding your breath till you get what you want, ala @home.

Another example would be when considering selling the company. Some shareholders might be in it for the short term cash, sometimes the founders, while another group may be in it for the long term.

All of this stuff is very complex, and certainly there are times when people get screwed, and boards act unethically. I don't argue that. However the broad statements in previous posts are wholely inaccurate.

Hopefully, through this discussion, we can see why AVCI is doing what they're doing, and learn about the different motivations that board and investor folks have.

ipt
rjmcmahon 12/4/2012 | 7:27:36 PM
re: What's in a Poison Pill? Sometimes there is a conflict between the 'greater shareholders' and the shareholders that I (or others) represent.
________________________

I am confused. What distinguishes a "represented shareholder" from a "greater shareholder"? And how do the "greater shareholders" get their interests represented in such a conflict?
flanker 12/4/2012 | 7:27:35 PM
re: What's in a Poison Pill? Poison Pills are only instituted by the Board of Directors, which generally represents the shareholders. Therefore, your comments are logically false and irrational, it seems to me.

I'm not so sure. A board meember from any given round may represent several investors that participated in that round. I know from experience that board members face a FOUR-WAY conflict between a) the interests of the firm the board member works for, b) not wanting to piss off the exec. team by asking tough questions or insisting on a course of action the mgmt. team does not want to take, c) the interests of other investors in the board member's round, and d) the interests of investors from other rounds of investment. All these interests do not neatly overlap.

Weak board oversight is a trademark of some large publicly traded companies (Enron?), but strong VC represented oversight can be bad too. Look at the VCs that drove Tachion into the ground. The MIB/CEO came from their lead investor.


As for poison pills, yes their are other dirtier ways to prevent a takeover. They include litigation and using the regulatory process to slow down an aquisition by a public-traded company. The number of regulatory complaints that could theoretically be filed is almost infinite, but this assumes the board would back management in a fight, and not the acquiror during the hostile bid.













What are these other ways?
steve 12/4/2012 | 7:27:32 PM
re: What's in a Poison Pill? jeez, whats all the fuss about? Poisen pills
have been a completely standard part of
corporate governance for 10 or 15 years. They used to be controversial for tech companies, but that was primarily because the venture capital board members didnt understand how they worked and there were very few hostile takeovers of tech companies. Without a pill a bad guy can do a proxy solicitation and own the company within about 30 days - which does not give the board time to figure out alternatives. As has been noted repeatedly, all the pill does is force the acquiror to deal with the board to get the best price. Studies (Georgeson) show that companies with pills get higher prices than those without. The naysayers will now say that the existence of the pill detered someone from showing up with a bid at all. Since overwhelming evidence shows that a board just redeems the pill when they have an attractive deal, that just isnt true.
vengance 12/4/2012 | 7:27:29 PM
re: What's in a Poison Pill? Generally, takeovers are a good thing for shareholders because of the takeover premium paid by the acquiring company. Thus, poison pills are bad for shareholders because they deter takeovers.

However, once the acquisition process is started, poison pills can be a good thing because they give management a chit in the negotiation process during a takeover/generally increasing the takeover price.

The real issue is that if you take a start up public too soon, market volatility can ruin a firm with no operating income. VC's goal is to get their money back with a hefty return to offset their risks. Some of the most successful (based on IPO revenue) VC started firms underperform the market post IPO.
opticalwatcher 12/4/2012 | 7:27:29 PM
re: What's in a Poison Pill? I once worked for a company that had artifically depressed stock (we'd spent a lot on R&D for a new product that wasn't out yet and the old product was showing its age).

A company tried to buy us out for nothing. It was a competitor that would have fired everyone and sold off the assets.

The poison pill led to a court battle that we lost.
Still, the company managed to fight them off. Within a year the stock was at least double what they offered.

So the employees, the stockholders, the customers, and yes, the management all got their respective asses saved by the poison pill. Not necessarily a bad thing.

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