Yesterday, Iconix Brand Group (SYMBOL: ICON) announced that it was announcing a short-term shareholder rights plan (known as a poison pill) to deter companies' from accumulating a controlling stake in the company at a price it considers too low.
Poison pills are implemented when a company whose stock is trading at depressed levels wants to prevent other companies from acquiring it through a hostile takeover for less than it is worth. Poison pills do this by triggering a new, prohibitive cost the acquirer would need to pay if it takes over the company.
In one type of poison pill, known as a "flip-over," stockholders are allowed to buy the acquirer's shares at a discounted price after the merger. In another type, called a "flip-in," existing shareholders (except the acquirer) are allowed to buy more shares at a discount. This is the type Iconix approved.
Iconix adopted the poison pill on the heels of Sports Direct International accumulating over 14.4% of the company's shares within a short time period. Sports Direct first began buying shares in mid-November for about $6.91 and moved to accumulating large quantities when the stock dropped below $6, including 1,350,000 shares on December 28 for an average of $5.67.
The Iconix plan and the announcement of it have several positives for shareholders and a couple of potential disadvantages. First the positives.
1) If Sports Direct accumulates more than 20% of Iconix on the open market, it would be a clear sign it's planning a hostile take-over. If it or any other company does cross the threshold, in effect Iconix shareholders will be able to buy preferred shares of the company at a 50% discount, but the takeover company won't be able to (their rights to buy would be voided if they're over 20%). That means the acquirer would lose a lot of money (the "poison"), as its position would become very diluted and shareholders would gain because their positions would become somewhat more concentrated relative to the acquirer being diluted.
Often when poison pill plans refer to giving rights to preferred shares, they're not actually talking about creating a whole new class of shares for the long-term. Rather, the preferred shares are shares that allow shareholders to buy common shares at a discount. Sometimes, they allow shareholders to buy more than one common share at a discount for each preferred share they own. For example, one preferred share gives the shareholder the right to buy 5 common shares at a discount.
It's not clear from the press release if the preferred shares will work similar to that, but I forecast they will because the company said that preferred shares would be valued at $30 and buyable by shareholders for $15, yet the stock price was only about $6.50 when they announced the plan. So giving shareholders the right to buy only 1 share of common stock for $15 wouldn't make sense. It wouldn't poison the takeover shark and wouldn't help shareholders. If however, shareholders can buy 5 common shares per preferred share, they'd get 4 for only $15, or $3.75 each and that would poison the takeover shark.
2) As I understand the summary of the plan in the press release, if the poison pill is activated, Iconix would raise cash from it through the issuance of the new preferred shares, which it can use to buy back their 2018 debt at low prices. The debt is currently trading for about 45 cents on the dollar, so if this scenario occurs and Iconix for example brings in $100 million in cash, they could use it to buy back over $220 million in debt, saving about $120 million.
$120 million is far more than a full year of earnings, so would be a major gain for the company and stockholders. For this reason, I think the stock price would rise significantly if the poison pill were activated because the company's balance sheet would be greatly improved without any dilution to shareholders' positions.
3) It will most likely prevent a company from doing a hostile takeover and acquiring Iconix for less than its worth. The consensus price target of analysts that cover Iconix is $19.33.
Many investors who have bought shares have done so with the aim of the stock reaching $15 to $20. If Sports Direct acquires the company through a hostile takeover at current prices, shareholders would receive far less than that.
In a press release, Iconix said the plan "is intended to protect the interests of the Company and Iconix shareholders by reducing the likelihood that any person or group gains control of Iconix through open market accumulation or other tactics without paying an appropriate control premium and by providing the Board and shareholders with time to make informed decisions. "
Ultimately, the poison pill should result in a potential acquirer paying a fair price and shareholders receiving a fair price.
4) Iconix stated that it's not against selling the company for a fair price. The company said the plan "is not intended to deter offers that are fair and otherwise in the best interests of the Company and its shareholders."
I view this as a positive because it indicates the board is open to reasonable offers, and is not inherently against selling if it would benefit shareholders.
5) It shows competence on the part of CEO Peter Cuneo and CFO David Jones. They monitored the situation of Sports Direct relatively rapidly accumulating a large number of shares on the open market, realized it might be a hostile takeover, and moved fairly quickly to put a plan in place.
6) The news will bring greater attention to the fact that Sports Direct feels strongly that the company is worth more than $6. This should help put a floor on the price. Sports Direct is Britain's largest sportswear retailer with over 500 stores across Europe and has at a market cap of about $2.5 billion. Besides owning stores, Sports Direct owns and licenses brands such as Dunlop to other companies.
So, it's in the same business as Iconix, and knows better than anyone what Iconix's earnings, brands and relationships/contracts with retailers are worth. Over time, that should boost investor sentiment that the company is valuable.
7) The board and management feel strongly that the price is "depressed," and that Iconix is a serious takeover target at current prices. They would not spend money on the legal fees needed to create a poison pill if they thought the stock was only worth $8 per share.
If you crunch the numbers, Sports Direct probably would have needed to spend an average of over $8 per share to do a hostile takeover in the open market. Viewing their purchase prices for the first 14.4% and how much another 5.4% would cost at current prices, I estimate their first 20% would have cost about $6 per share.
Then, since they're required to disclose additional accumulations of shares to the SEC, the public would find out by the time they got to 20 or 25%. The media and investors would know it was a hostile takeover and shares would shoot up 30% right away to about $8 and then to $12 by the time Sports Direct reached over 50%. So if they were able to get 20% at $6 average, 10% at $8, 10% at $10 and 10% at $12, the average price would be $8.4.
If Sports Direct tried to rush to accumulate enough shares in the short time windows between the required SEC filings, it would also drive the price up quickly because of too much demand.
If Iconix is putting time and money into a poison pill to prevent a company from taking it over for $8.4 average, it clearly has strong conviction the company is worth more than $8.4.
I think $8.4 is conservative because while some shareholders would sell for $8 or $10, many wouldn't sell for less than $12 to $15. And some won't sell for less than $20. For example, I know one investor who owns 300,000 shares who won't sell for less than $30 a share. I personally would probably take $13 if it were today because my basis is only about half that. I think the stock will be over $15 in a year, but I would take $13 to lock in profits right away and be able to invest the money in other places. The difference between $13 and $15 is 15.38%, so taking a 100% profit and giving up 15% (and be able to re-invest elsewhere) is a deal I'd be open to taking. I'm probably not going to want to give up more than 15%.
Anyway, this move demonstrates Iconix strongly believes it's worth at least $8 because if it were ok with $8, they wouldn't implement a poison pill. $8 is about 31% higher than the current price. And if you asked them, they'd probably say it's worth much more than $8.
There are two potential disadvantages of the plan, though I don't think they'll come into play:
1. If an acquirer passes the 20% level and the poison pill occurs, it would require a little additional effort for shareholders to purchase the preferred shares. Still, with the gain to the company and the stock, I think this would be worth it, and I'm completely fine with it.
2. Some shareholders might not have enough cash to buy the additional shares. I'm guessing many of the shareholders without enough cash could use margin to get the preferred share. Even if their margin is close to the maximum, as described above, a poison pill being activated will send the stock price higher, which should improve people's margin buying power.
Likewise, perhaps third parties can set up a mechanism that would allow shareholders to sell their shares (with the rights to the preferred shares) for a small discount to the combined value of the common shares and the rights. So the shareholder would still realize nearly all of the gains of the poison pill. I figure the company would be in favor of this because it would allow Iconix to still achieve its goal of diluting the acquirer's stake while raising more cash.
Iconix said additional details will be included in a Form 8-K it will file with the SEC.
A question I have is: is this poison pill strong enough that it will definitely prevent a hostile take-over? Because CEO Peter Cuneo has successfully turned around 7 companies, I'm fairly sure he's familar with how to ward off hostile takeovers, so my bet is that management designed it so it's very poisonous. If yes, then neither of the potential disadvantages would matter and the stock will probably rise some when the 8-K is released and investors see there's enough poison in the pill to protect the stock's long-term value. When the 8-K is released, if you have the time to do the calculations of how much an acquirer would probably lose via a poison pill, please let us everyone know what you come up with in the Comments below.
From my reading of it, the higher the stake a company takes above 20%, the bigger the size of the poison pill. If they go all the way to 51%, then all of those shares would be subject to the dilution of the poison pill.
Also, at this point now that the cat is out of the bag, Sports Direct is definitely not going to be able to accumulate 51% on the open market for less than $8.50 average. If they try to do it in small portions each day, it will take them weeks to reach 51%. And their required SEC filings will reveal what's going on and sellers will hold out for higher prices.
If they try to do it all in one week, the massive demand would also drive the price up. Plus, people will notice high volumes and a rapidly rising stock price and now know what's taking place.
Another question is: why the date of February 12, 2016? The possible reasons I can think of are: a) Give investors enough time buy shares and lock in their preferred share rights; b) Perhaps they were concerned that Sports Direct may have already reached 20% and wanted to give them plenty of time to get below 20%; c) Maybe they expect to have the refinancing closed by then, at which point the stock price will jump high enough that a takeover is undoable.
While a few details of the plan need to be made more clear, I think the core parts of it and the news surrounding it (Sports Direct buying a large stake and Iconix being a potential takeover target) are very good for shareholders.
Disclosure: I am/we are long ICON.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.