Wednesday, December 9, 2009

Shareholder Rights? Not So Much

Sometimes, managements will adopt so-called Shareholder Rights Plans that "protect" shareholders from hostile takeovers. Often, however, such plans have negative effects for shareholders. In such cases, these plans are designed to protect managements rather than shareholders. Consider events last year at LCA-Vision (LCAV), a stock we've discussed as a potential value play.

The founders of LCAV (who left the company a few years ago) started buying up a significant number of shares, bringing their total to 11.4% of the company. Often, this type of activity suggests a takeover offer for the remaining shares may soon follow. In order to entice remaining shareholders to tender their shares, a takeover offer will ordinarily be at a price well above the current share price. Because the market anticipates an offer, the shares tend to trade higher than they otherwise would. Good for current shareholders, right? It was, until a "Shareholder Rights Plan" was adopted by management (management's description of how the plan works is available here).

The plan makes it more difficult for a group to successfully bid for and acquire the company. But even if an offer is made, shareholders are under no obligation to accept it. If they deem the offer to be unfair, they have the option to reject it. So essentially management is eliminating that shareholder option with a shareholder "rights" plan, forcing shareholders to wait until the next annual general meeting to vote the plan down.

In Security Analysis, Ben Graham asserts that shareholders do not protect themselves from managements as much as they should. This appears to be an example where management has protected itself at the expense of shareholders. Beware the Shareholder "Rights" is usually designed to protect management, not shareholders.

Disclosure: Author has a long position in shares of LCAV

This article was written by Saj Karsan of Barel Karsan. If you enjoyed this article, please vote for it by clicking the Buzz Up! button below.


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