John A. Moran gives every indication of having been drawn reluctantly into a dirty fight. “We like to keep a low profile,” he said recently in the sedate offices of Dyson-Kissner-Moran Corp., the little-known investment company he chairs.
That DKM relishes its privacy is evident from the absence of any identifying plaque on its front door. It also values its reputation as a company that never engages in hostile takeovers and offers quietly responsible advice to the many companies in which it holds significant interests.
But the outside world has a way of penetrating even the men’s-club composure of companies such as DKM as surely as the clamor of traffic intrudes through the curtained windows of its conference room. At Household International, where DKM is the largest shareholder, John Moran had never voted against management in his four years on the board. That all changed Aug. 14. Now he finds himself shunned by his fellow directors and dropped from the management slate for reelection at next month’s annual meeting.
The reason is that Moran is the plaintiff in a lawsuit that has one of the highest profiles of any corporate litigation now before a U.S. court.
The suit is now being heard on appeal by the Delaware Supreme Court, after an initial ruling in Household’s favor by the state Court of Chancery. Moran filed suit to challenge Household’s enactment in that Aug. 14 vote of a stock dividend known as a “poison pill.”
The poison pill is a takeover defense so potent that some merger and acquisition professionals, including lawyers for the Securities and Exchange Commission, believe companies can use it to stop all hostile tender offers.
In its basic form, the poison pill is the issue of a dividend to shareholders consisting of a warrant, or right, to buy an additional share of common or preferred stock. The right may only be exercised in the case of a “triggering event"--typically the acquisition of 20% of the company’s shares or voting rights or a tender offer for 30%.
Even then, the warrant is designed to discourage shareholders from exercising it. Household’s warrant allows a shareholder to buy 1/100 of a preferred share with the same annual dividend, $1.75, as Household common--but is priced at $100 while Household common has not traded above $40 in the last 15 years.
Its real purpose emerges if and when an acquirer seeks to absorb Household in a merger, the presumed goal of any bidder planning a major tender offer. In that event, each warrant would give the Household shareholder the right to buy $200 worth of the acquirer’s stock for $100--making the merger prohibitively expensive.
“I call them atomic bomb warrants because they really destroy everyone but the pilot,” remarked Alan C. Greenberg, chairman of Bear, Stearns & Co. and a famously blunt observer of Wall Street shenanigans, in his testimony in the Delaware case. “Any prospective suitor would have to have his head examined to get involved with this.”
Usurp Holders’ Right
Moran sees the poison pill as a “very subtle” attempt by the management of Household--the Chicago-based parent of Household Finance Corp. and Von’s Supermarkets, among other companies--"to usurp what I consider to be a fundamental shareholder right, the right to vote on an offer.”
Responds Donald C. Clark, Household’s chairman and chief executive: “John was outvoted on the merits of the plan. There are 15 responsible board members trying to do what’s in the best interests of the shareholders, and one individual who suggests he knows better than the 15.”
The passion that Moran’s lawsuit has excited reflects the constantly seesawing balance between shareholder and management, bidder and target, that defines the universe of corporate takeovers.
The case is a battle over the loftiest principle of corporate America, the notion of shareholder democracy, fought by executives ascribing the basest personal motives to each others’ actions. While Moran has suggested that the Household board and management created the pill to entrench themselves in office, Clark has been spreading the word that Moran had been planning a hostile takeover of the company behind the backs of the other directors. Moran denies this.
As the most substantive legal test of the poison pill--a state judge in Nevada and a federal judge in New York have upheld it without examining the legal issues--Moran’s lawsuit is being closely watched by the corporate bar.
Has Other Uses
“If the (Delaware) Supreme Court upholds the chancery court,” said Arthur Flesicher Jr., a New York takeover lawyer, “the only limit will be the breadth of a lawyer’s imagination.” The warrants in a poison pill can theoretically be devised to trigger anything from the forced divestiture of a company’s subsidiary to mandated pay-outs of stock or other assets.
The poison pill is a device so complicated that takeover veterans disagree whether it is a cure for hostile takeovers or a therapy worse than the disease; whether it discourages proxy contests or invites them, and whether it entrenches management comfortably against all assailants or forces them to consider all offers much more responsibly.
The brainchild of New York takeover lawyer Martin Lipton, the poison pill is the fastest-spreading takeover defense on the corporate scene. At least 13 public companies have installed it, according to the Investors Responsibility Research Council, a nonprofit shareholder-rights lobbying group. The IRRC estimates that at least 300 more corporations, many of which are undoubtedly awaiting the outcome of Moran’s challenge, have the implicit authority in their bylaws to join the bandwagon without seeking shareholder permission.
The reason for this interest is obvious. A company board’s exclusive right to cancel the poison pill gives directors virtually unassailable veto power over all offers, friendly and unfriendly, for their companies. How one views this power depends on how one assesses a board’s discretion and its willingness to sacrifice self-interest for the good of the shareholders.
Raises Stakes Sharply
One key to the pill’s potency is that it raises the stakes so high in a takeover that it is assumed that no would-be acquirers would be willing to execute a merger in order to test it in court. “No one has a way around it, and no one would risk the dilution (of stock) to test it,” Moran says.
Were all the Household rights outstanding at the time of such a merger, the acquirer would have to pay an extra $6 billion for the company ($100 times 60 million, the number of Household shares). That is three times the company’s entire market value of $1.8 billion.
As Delaware’s chancery court found, the impact of this right on the capital of the acquirer “is immediate and devastating.”
A bidder might try to acquire the rights to prevent them from being exercised later. But it is unlikely that a bidder could acquire all of them. Even if 5% remained outstanding, the dilution from those would be $300 million, pricing Household well beyond the willingness of any buyer to pay.
The pill’s inventor, Lipton, appears uncomfortable with the more grandiose claims for the pill, perhaps because the more powerful it is thought to be, the more likely it is that a court will strike it down.
“It’s been blown far out of proportion by exaggeration and nonsense,” Lipton said in an interview. “The pill does not prevent takeovers. It does not discourage proxy fights. It simply increases the negotiating strength of the board of directors of target companies. It restores to a level playing field a situation where the raider has all the negotiating power.”
Created as Antidote
Lipton says he created the pill as an antidote to what he considers a baleful development, the rise of the “two-tier, front-end-loaded, junk-bond, bust-up takeover.” That is his description of the methods of today’s corporate “raiders” such as T. Boone Pickens and Carl Icahn.
Pickens and Icahn, the argument goes, attack a company by offering shareholders a lush cash premium for a majority stake. They fund their early acquisitions by floating so-called junk bonds, high-yielding bonds that the rating companies consider extremely speculative. Once the shares flow in, they offer a much smaller premium, often in subordinated debt, for the balance. To pay off the acquisition’s heavy debt, they break the company up and sell the pieces.
“The myth is that the takeover entrepreneur is going about the country doing good,” Lipton says. “In fact, we’re mortgaging our future. They say, ‘We’ll stop spending the assets on research and development and we’ll devote all the revenues to repaying the debt that’s necessary to buy the companies in the first place.’ There’ll be no new wells drilled, no plants built.”
Lipton made this case to the Household board, but Moran contends that it was overwrought.
“There was sort of a blanket interpretation that anyone who might want to make a legitimate offer to the shareholders was a ‘raider,’ ” he testified in chancery court. “In spite of all the characterization of the raiders and the bust-ups and the two-tiered offers, looking right through it, it was a plan that would preclude the shareholders from having an opportunity to receive and consider offers at a premium price without board approval.”
Can Subvert Pill
There are some, however, who believe that any serious acquirer can subvert the poison pill simply by conditioning a bid on its withdrawal. Others argue that a poison pill can place more pressure on a board, not less, because its triggering can damage the issuing company in the long term.
These theories may be tested this month in the course of the battle by Sir James Goldsmith, a British financier, for Crown-Zellerbach Corp., a forest-products company that installed the first real poison pill last July. In the event of a merger, the provision allows Crown holders to buy $200 of stock in the acquiring company for $100.
Goldsmith, who is the first bidder for any company with a poison pill, has offered $42.50 per share for at least 51% of the shares but has conditioned his offer for the entire company on the Crown board’s withdrawal of the warrants.
His investment banker, Robert Pirie of Rothschild Inc., leaves no doubt that Goldsmith is willing to play a kind of arms-race brinksmanship with the Crown board, believing that the board would not want to trigger poison-pill rights that would make Crown too expensive for any buyer for the 10 years that the warrants would remain in effect.
“Once we have the irrevocable right to buy 30% of the stock"--which would occur April 29, when tenderers’ withdrawal rights expire--"the pill explodes,” Pirie said. “Then they’ve wrecked the company. There ought to be some very nervous directors as that date approaches. I think Marty Lipton has created a monster. It’s a contemptible scheme to protect management and the board from any outside interference.”
Board Opposes Offer
So far Crown hasn’t blinked; the board on Thursday recommended that shareholders reject Goldsmith’s offer, but said it would withdraw the pill in the event of a bid for the entire company at $60 per share.
Most existing poison pills have another element that promotes the notion that they are favored by company managements distrustful of shareholders. Because the rights kick in whenever a shareholder accumulates 20% of the company’s stock or stock voting rights, they could have a depressing effect on proxy contests, battles in which insurgent shareholders challenge the decisions of management.
Forcing proxy fighters to do battle with less than 20% of a stock, according to chancery court testimony, sharply reduces their prospect of victory. John C. Wilcox, managing director of the proxy solicitation firm of Georgeson & Co. and a witness for Household, testified that in 96 proxy contests between 1981 and 1984 studied by his firm, insurgents won in 76.2% of the cases where they held 20% or more of a company’s stock, but only 50.6% when they owned less than 20%. In the few cases where the insurgents held more than 30%, Wilcox allowed, management won no victories.
Lipton argues that the vast majority of proxy contests are waged with less than 20%, so the limit ought not to be a bar to insurgents. He and other lawyers suggest, furthermore, that a poison pill’s enactment may focus the discontent of shareholders of under-performing companies, providing insurgents with a needed platform and precipitating, rather than discouraging, proxy contests. Parker G. Montgomery, chairman of Cooper Laboratories, is currently waging a proxy battle over exactly this issue with the management of Rorer Group, a Fort Washington, Pa. health-care products company which installed a poison pill on Feb. 7.
Can Muffle Shareholders
Still, that poison pills might appeal to executives who consider shareholders a burdensome constituency is not lost on investment bankers. Salomon Brothers promotes its version of the plan with a letter to corporate clients that notes that companies can often impose poison pills “without a time-consuming and potentially disruptive shareholder vote.”
At Household, the poison pill plan was enacted soon after management discovered that shareholders would be barely receptive to an anti-takeover amendment at the 1984 annual meeting. A “fair-price” amendment had been proposed to require that any bidder offer the same price to all shareholders. Proxy solicitors Georgeson & Co. had concluded that the vote might be as slim as 50.8% in favor. Household Chairman Clark decided not to risk a vote, and a few months later proposed the poison pill.
Throughout this period, testimony indicates, Clark harbored a strong dread of a hostile takeover although none had actually surfaced. In the spring of 1984, Moran and Clark had discussed a DKM-sponsored management buy-out of the company involving the spinoff of Household Finance Corp. for $2 billion, a price that would have made acquisition of the remainder cost-free.
But Clark, who had just become chairman, grew nervous that the plan might inadvertently deprive him of control; after one meeting he took Moran aside and pressed on him a copy of a July, 1984, Fortune magazine article titled “Oops! My Company is on the Block.” The article described how some companies had been taken over by acquirers who outbid management groups trying to arrange a leveraged buy-out.
Clark was also edgy about the problems experienced by Avco Corp., a competing company that was fighting off a hostile approach by Leucadia Corp. And there were rumors of other buyers interested in Household, including San Francisco-based First Nationwide Financial Corp.
The result, Moran contends, was that Clark met with most of the directors in a rump session Aug. 13, the day before the formal board meeting, to campaign for the new provision and suggest that Moran was plotting a hostile takeover.
“He knew which directors to go to. I wasn’t invited,” Moran says.
Household says all directors were invited who were able to make it to Chicago that day. In the event, the poison pill passed with a 14-2 board vote the next day. Joining Moran in opposition was John C. Whitehead, chairman of Goldman, Sachs & Co., Household’s investment bank. Whitehead later said he did not want to focus attention on Household as only the second company to install the provision. Since Moran’s suit has had the same effect, he testified, he would support the pill today.
Moran filed suit three days later, asserting that the board and management were seeking to entrench themselves. He acknowledged in testimony that he knew that the action would “make me a pariah, if you will, in the eyes of people that had formerly been friends of mine.” In fact, Moran found the next month’s board session, Sept. 10, to be “a very, very chilly meeting.” He moved to submit the poison pill to a shareholder vote, in which case he would withdraw his lawsuit; the motion died for lack of a second.
Dropped From Slate
Since then Household has disclosed its slate for election of directors at this year’s annual meeting: Moran has been dropped.
“It’s one thing to challenge a board action on a legal basis,” Clark explains. “It’s another to ascribe personal motives to a very dedicated board.”
And Clark suggests that, although Household’s institutional investors are solidly in opposition to the pill, Wall Street has supported the board.
“Its opponents argued that it would depress the value of our stock,” he says. “But just the opposite has happened. The board’s action has been vindicated.” (Household shares, priced at about $25 when the poison pill was implemented last summer, is currently trading at about $35 on the New York Stock Exchange.)
Replies Moran: “In 1974, Household stock was $40 a share. It’s never been that high since.”