Dr. Robert Grossman founded Electro Cardio Systems Inc. (ECS) in 2001. The principal purpose of the firm was to engage in the research and development of heart pump devices. Although the firm did not show a profit until 2006, by 2010 it reported after-tax earnings of $1,200,000. The company had gone public in 2004 at $10 a share. Investors were initially interested in buying the stock because of its future prospects. By year-end 2010, the stock was trading at $42 per share because the firm had made good on its promise to produce lifesaving heart pumps and, in the process, was now making reasonable earnings. With 850,000 shares outstanding, earnings per share were $1.41. Dr. Grossman and the members of the board of directors were initially pleased when another firm, Parker Medical Products, began buying their stock. John Parker, the chairman and CEO of Parker Medical Products, was thought to be a shrewd investor and his company’s purchase of 50,000 shares of ECS was taken as an affirmation of the success of the firm. However, when Parker bought another 50,000 shares, Dr. Grossman and members of the board of directors of ECS became concerned that John Parker and his firm might be trying to take over ECS. Upon talking to her attorney, Dr. Grossman was reminded that ECS had a poison pill provision that took effect when any outside investor accumulated 25 percent or more of the shares outstanding. Current stockholders, excluding the potential takeover company, were given the privilege of buying up to 500,000 shares of ECS at 80 percent of current market value. Thus, new shares would be restricted to friendly interests.
The attorney also found that Dr. Grossman and “friendly” members of the board of directors currently owned 175,000 shares of ECS.
a. How many more shares would Parker Medical Products need to purchase before the poison pill provision would go into effect? Given the current price of ECS stock of $42, what would be the cost to Parker to get up to that level?
b. ECS’s ultimate fear was that Parker Medical Products would gain over a 50 percent interest in ECS’s outstanding shares. What would be the additional cost to Parker to get 50 percent (plus 1 share) of the stock outstanding of ECS at the current market price of ECS stock? In answering this question, assume Parker had previously accumulated the 25 percent position discussed in a.
c. Now assume that Parker exceeds the number of shares you computed in part b and gets all the way up to accumulating 625,000 shares of ECS. Under the poison pill provision, how many shares must “friendly” shareholders purchase to thwart a takeover attempt by Parker? What will be the total cost? Keep in mind that friendly interests already own 175,000 shares of ECS and to maintain control, they must own one more share than Parker.
d. Would you say the poison pill is an effective deterrent in this case? Is the poison pill in the best interest of the general stockholders (those not associated with the company)?