Background: Cumulus is the second largest radio operator in the U.S., with over 400 stations. Although it makes a modest operational profit, it is drowning in debt of about $2 billion. One review of the stock said it was “priced for bankruptcy”, since, even after an 8 to 1 reverse split, it has trending downward and currently lists at about 50 cents a share.
The former president, Lew Dickey, was forced out a couple of years ago, but there are rumors that a new company he formed recently will mount a hostile takeover of his old company. It apparent response to this, Cumulus has adopted what one analyst describes as a “poison bill” to forestall any unwanted actions. The details are covered in: Is Cumulus Worried About A Hostile Takeover?
My problem is that the description of the company’s actions are completely incomprehensible to me. So, could someone explain what the following entails and is designed to do? Thanking you in advance, here’s what the review states:
As the 8K explains, all of the shareholders of record on June 5 get the new rights issued as part of the dividend. Under the rights plan, certain shareholders will be allowed under certain conditions to buy new Class A shares at a 50% discount or, instead, the company can choose to redeem the rights by giving those certain shareholders an additional Class A share of stock for free.
The kicker is that the rights are only triggered if an “Acquiring Person” (or a group of people) acquires 4.99% or more of Cumulus’s stock. That means, the rights aren’t triggered until someone, perhaps the former president, accumulates a large block of stock, likely with the intent to take over the company.
The second issue is that the Acquiring Person (or group) that bought the 4.99% stake in Cumulus can’t exercise the rights. That means, in the event an Acquiring Person buys 4.99% of Cumulus, the company would either be cheaply selling or giving away stock to every shareholder other than the Acquiring Person trying to take it over. Accordingly, the Acquiring Person needs to come up with even more money to buy half of those new shares under the rights agreement and get control. The poison pill thus makes a hostile takeover less likely by making it much more expensive.
As described, that doesn’t seem like a major deterrent.
The key flaw is that the more shares you issue (regardless of who you give or sell them too) the less each other share is worth.
So let’s suppose the hostile buyer announces that they have 5% of the stock. In response, the company issues zillions of new shares and gives them to other shareholders. The 95% of the company already held by those other shareholders is only going to be worth marginally more than it’s already worth (it would slightly increase, since the hostile buyer is being diluted but the other shareholders are not). So at that point, the hostile buyer can continue to buy up shares, now needing to buy up twice as many shares, but each share being roughly half the old price.
To the extent that the new shares are sold rather than just given away, then the old shares are not diluted to the same extent, but that also means that the company has that much more cash, and is that much more valuable.
Fotheringay-Phipps, I probably didn’t explain it very well.
Consider this hypothetical using the transaction structure from the 8K but entirely made up numbers. A company has 100 million shares outstanding. Each is worth $1. The former president starts a hostile bid by spending $10 million on the public market to buy 10 million shares equal to 10% of the company. How much should half company cost in your view? $50 million?
Under the rights plan, the holders of the other 90% of the company get an option to buy shares at a 50% discount to the market price. If the rights are triggered, they will have the right (and the incentive) to exercise their rights and buy 90 million shares of stock for just $45 million. The hostile takeover bidders cannot participate in this. Thus, the company now has 190 million shares outstanding. The hostile bidder’s 10 million shares now represent only a bit more than 5.26% of the company due to dilution from the rights offering (10 million shares/190 million outstanding). The market value of the company has also gone up. It was worth $100 million, but now it’s worth $145 million due to the extra cash it received from the rights offering. Each share is worth approximately $0.763 accounting for both the new cash and the new shares issued ($145 million/190 million shares).
In order to go from 5.26% ownership to 50% ownership, the bidder must buy 85 million more shares. This will now cost an additional roughly $64.9 million (~$0.763/share * 85 million shares). Thus, including the cost of the first 10 million shares, the rights offering has pushed up the cost to acquire half the company to $74.9 million. This is considerably more than the bidder would have needed if there had been no rights offering.
Alternatively, the company can elect to give each shareholder (other than the hostile bidders) an extra share. This might be preferable because the board doesn’t need its shareholders to exercise their options and invest more money in the company. It can do this entirely on its own. In that case, each shareholder other than the hostile bidder gets extra shares, 90 million in total. The company is still worth just $100 million but it has 190 million shares outstanding. Accordingly, each share is worth approximately $0.526 ($100 million/190 million shares).
The hostile bidder’s $10 million for 10 million shares has still got him only 5.26% of the company. In order to go from 5.26% of the company to 50%, the hostile bidder still needs to buy 85 million more shares. Under this alternative, these shares will cost approximately $44.7 million (~$0.526/share * 85 million shares) more than the $10 million he has already spent. Even in this scenario, the bidder’s cost of the deal has gone up by $4.7 million and, by acquiring the shares and triggering the rights plan, the hostile bidder has cut the value of his initial shares nearly in half. That’s a lot of risk and a big discouragement to mounting the hostile takeover bid in the first place. That’s the whole idea of the poison pill.
I covered this in my prior post (final paragraph).
It’s true that the guy would have to spend an extra $24.9M if the company did this. But remember - the company is now worth $45M more than previous, due to the extra cash from selling the new shares. When the hostile takeover guys get to 50% their portion of this is $22.5M. So it only cost them an extra $2.4M, or about 5% over their original plan. Most hostile takeovers have more margin than that.
Agreed. As I wrote in my prior post, “the hostile buyer is being diluted but the other shareholders are not”. (Another way to look at your numbers is that the cost to the hostile takeover guy is simply the dilution of his shares = $10M * 90M/190M = $4.7M.
I suggested that the takeover people would announce at 5%, making the dilution of their shares half as damaging as in your scenario where it happens at 10%. If in theory the target company could trigger it at 49%, that would be more damaging yet. I assumed that there’s some notification at 5% which is why it was used and beyond that point it would be dangerous to wait, but possibly not.