SPOTLIGHT ON COVID-19

The Case for Considering a Shareholder Rights Plan The Case for Considering a Shareholder Rights Plan

• COVID-19 has resulted in unprecedented disruption in global equity markets. • Opportunistic hedge funds have been building significant new stakes in publicly traded companies. • Historical precedents support expectations for a significant uptick in unsolicited M&A activity. • Boards should consider implementing short duration shareholder rights plans to prevent opportunistic share accumulations and protect valuable tax assets.

Houlihan Lokey is uniquely positioned to assist companies in the required tax and advisory services for the implementation of shareholder rights plans and in reviewing defense strategies.

As COVID-19 infections crossed the 1,600,000 mark worldwide this past week and the number of U.S. weekly jobless claims soared for the third consecutive week, investors continue to look for signals that the worst is behind for equities. Notwithstanding the recent recovery rally, valuations for many of the hardest hit companies and sectors have now dropped significantly from recent all-time highs. Capital markets continue to be under significant pressure, and the most heavily affected sectors have seen valuations cut in as much as half amid concerns that fallout from the global pandemic may be deeper and longer lasting than initially hoped for or expected.

With many parts of the economy effectively closed, boards of directors and managers continue to be focused on navigating the uncertainty in the markets they serve, ensuring the safety and well-being of their employees, the continuity of their operations, and adequate liquidity. Meanwhile, recent 13D filings and media reports suggest that opportunistic hedge funds and activists have been busy quietly building stakes in public companies as they continue to raise additional funds for new “war chests.” With most director nomination windows closed for the 2020 proxy season—and sensitivity to what might be considered “overreach” during a crisis— many activists are expected to bide their time to “go public” until after the current COVID-19 crisis abates. On the strategic side, history suggests we should also expect a meaningful uptick in unsolicited M&A in the coming months, as strategic acquirers begin to hunt for previously unattainable targets for what may be “bargain” prices. In 2008, year-over-year unsolicited M&A

2 activity doubled as a percentage of domestic dealmaking despite bear market conditions.

Moreover, with market volatility and trading volumes surging to record highs, issuers with substantial net operating losses (NOLs) and deeply depressed valuations run an increased risk of an “ownership change” for purposes of Section 382 of the Internal Revenue Code. Such a 382 ownership change could lead to a delay in the timing of the usage of such losses to offset federal income taxes, resulting in a significant loss in value for issuers.

Against this backdrop, many U.S. public companies should consider the advisability of the adoption of a shareholder rights plan (also referred to as a “poison pill”) to protect against opportunistic share purchases by would-be activists or hostile acquirers, or to protect potentially valuable NOLs from a value-destructive “change of control” under the current U.S. tax code.

A traditional, anti-takeover or defensive rights plan is designed to deter a would-be acquirer from an opportunistic acquisition of control by preventing the accumulation of a target’s shares above a predetermined threshold. Although a rights plan cannot ensure a company is takeover- proof, it encourages an interested party to approach and negotiate with a . As a result, anti-takeover rights plans provide boards of directors with time to consider potentially value maximizing alternatives which are in the best interests of all of a company’s shareholders. A NOL rights plan (or “NOL pill”), on the other hand, is designed to deter the accumulation of shares of a target company in excess of 5% that could result in an “ownership change” under the technical definitions set forth in Section 382 of the Internal Revenue Code. For an “ownership change” to be deemed to occur, an issuer must apply a fairly complex analysis under Section 382 to measure shifts in ownership of certain 5% shareholders over a three- year period. For issuers with substantial NOLs, the potential value destruction for a company associated with an ownership change can be significant under recent IRS rules.

At the end of Q1, U.S. issuers adopted 28 shareholder rights plans, an increase of 55% year- over-year.1 Given the widespread impacts of the COVID-19 pandemic, many valuations are expected to remain challenged in the near- to mid-term, and, as a result, we will continue to see rights plan adoptions of both types as the year progresses. With issuers increasingly wary of opportunistic financial and strategic investors looking to purchase stakes in quality businesses at discounts, boards and management teams increasingly look to rights plans—whether implemented or put “on the shelf” for adoption as needed—as an integral part of defense preparedness. Likewise, in light of the hit to corporate profits from global business disruptions, we also expect an increase in adoptions of NOL rights plans to protect tax assets, including those generated from losses during the current crisis.

1. Factset

3 Houlihan Lokey has a highly qualified and experienced advisory team with significant experience working with publicly traded companies to consider the many issues that have arisen in connection with COVID-19, including the potential implementation of both anti- takeover and NOL rights plans. Our firm is uniquely positioned to assist publicly traded companies not only in takeover defense strategies but also in the required tax and valuation advisory services required to implement shareholder rights plans. We stand ready to assist your company and to answer any questions you may have whether in connection with potential risks and vulnerability, or the process and best practices for working with you and your board of directors to consider the implementation of a rights plan.

Although anti-takeover rights plans and NOL rights plans ostensibly serve very different purposes, and can be tailored to meet the specific needs of an issuer, the key terms, mechanics, and effect are similar. In general, upon the acquisition of a specified threshold (a “flip-in” event), other shareholders will have the ability to exchange their rights to purchase shares of the company at a steep discount (typically 50%), resulting in massive dilution to an acquirer’s holdings. Many rights plans will also include an “exchange feature” whereby, after an acquirer exceeds the ownership level for a flip-in event, a board of directors may elect to exchange the rights pursuant to a predetermined ratio. Although the exchange feature is far less dilutive to the acquirer, it is nonetheless effective and has been the mechanism of choice in recent instances where rights plans have been triggered and not redeemed. Whether an NOL rights plan, or an anti-takeover rights plan, both are highly effective at preventing opportunistic and potentially value destructive share accumulations.

Traditionally, a major consideration for issuers considering implementing a shareholder rights plan (particularly a defensive rights plan) has been the potential for proxy advisory firms—particularly Institutional Shareholder Services and Glass Lewis—to make adverse recommendations against the issuer’s incumbent director nominees in uncontested voting situations. Although there has not been any noticeable change in policy or approach by either of the two major shareholder advisory firms on the topic of rights plans at this time, the expectation is that the “case-by-case” analyses undertaken by each in considering any shareholder rights plan adopted during the current crisis will be informed by the current global health crisis and its impacts on issuers, and the particular circumstances of the adoption. For this reason, many issuers who adopted rights plans recently have generally implemented shorter duration rights plans of less than one year to balance the need to protect shareholder value with principles of good governance. And while it is important to consider the impact of voting recommendations by these institutions, the more important consideration for boards of directors in the current environment is to make informed and well-considered decisions in light of the best interests of shareholders, whether in the context of consideration of an anti-takeover rights plan aimed at a specific or non-specific threat arising from the COVID-19 crisis, or a NOL rights plan intended to ensure preservation of potentially valuable corporate tax assets.

4 Contacts

Corporate Finance

Mark Mikullitz Rick Lacher Gary Finger Managing Director Managing Director Special Advisor Head of Shareholder Activism Services Co-Head, Board and Special [email protected] [email protected] Committee Advisory 212.497.4125 212.497.4269 [email protected] 214.220.8490

Financial and Valuation Advisory

Robert G. Rosenberg Andrew Stull Richard De Rose Managing Director Managing Director Managing Director Co-Head of Transaction Opinions and Transaction Opinions Transaction Opinions Board Advisory [email protected] [email protected] [email protected] 404.495.7020 212.497.7867 212.497.7816

Chris Glad Winston Shows Director Senior Vice President Corporate Valuation Advisory Services M&A Tax [email protected] [email protected] 312.456.4730 214.665.8652

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