On The Money

The Pellet with the Poison

9/13/2007 9:41 AM

One of the things that have been kind of glossed over amid reports last month that Charter Communications chairman, Microsoft co-founder and really big yacht owner Paul Allen was considering, among other things, taking the cable company private, was the fact that Charter deemed it necessary to create a “poison pill.”

Allen, who formed Charter in the 1990s through the strength of his considerable wallet, controls 91% of Charter’s vote and 52% of its equity. Translation: Nothing gets done, let alone a sale or hostile takeover, without Allen’s say so.

Whenever a company initiates such an action – they’re usually called shareholders rights plans – it’s usually because of a perceived threat. Remember a few years ago, News Corp. initiated its own poison pill when John Malone’s Liberty Media quietly amassed a 19% voting stake in the media giant, which he recently agreed to sell back to News Corp. for its interest in DirecTV Group and some programming assets.

But the catalyst for the poison pill was the fear that Malone could eventually amass a voting interest in News Corp. that would surpass the 30% owned by chairman Rupert Murdoch and his family.

Some analysts on Wall Street who follow Charter were a little puzzled by the poison pill, mainly because Allen has such an iron grip on Charter’s voting stock. In a recent Securities and Exchange Commission filing, Charter offered a little more insight as to why.

In a nutshell: to protect their net operating loss carry-forwards, or NOLs.

NOLs are a valuable commodity, especially in the cable industry, because they basically allow publicly held companies to use their accumulated losses over the years to avoid paying taxes in the future. So in the event that Charter starts turning a profit in the coming years, they can use their NOLs to avoid paying taxes.

NOLs are no small piece of change either. Charter, according to its 10-Q quarterly statement filed with the SEC in August had about $7.1 billion in NOLs as of June 30.

The need to protect those NOLs centers on a section of the U.S. Internal Revenue Code that deals with ownership shifts. The IRS routinely measures the number of individually managed mutual funds that own 5% or more of a stock and if that total percentage exceeds a government-set benchmark, from a tax standpoint an ownership shift has occurred. That could mean that the amount of NOLs that a company can use in one year can be limited.

So, an ownership shift doesn’t necessarily mean a takeover attempt, but could be as simple as new funds buying 5% stakes in the company or existing holders – other than large mutual funds that spread their holdings across several different funds – adding to their 5% stake. The rights plan would require board approval of any fund or individual that buys 5% or more of Charter stock or currently owns a stake of 5% or more to add to its position. The thinking is that the plan would help prevent any shareholder from inadvertently triggering an ownership shift and doesn’t have anything to do with Allen considering any particular transactions.

And a true “change of control” can only be triggered by Allen himself. Charter has about 400.4 million shares of Class A stock outstanding as of June 30 each with one vote each, and 50,000 shares of Class B stock outstanding. Allen owns directly and indirectly all 50,000 of those Class B shares. According to the filing, each Class B share is entitled to 67,836.4 votes. That means Allen’s Class B shares alone entitle him to 3.4 billion votes.

Charter admitted in the filing that the chances of a hostile takeover of the company are slim.

“…because Mr. Allen owns 90.92% of the voting power of the outstanding stock, no person could acquire a controlling interest in the company without his consent regardless of the existence of the rights agreement,” Charter said in the filing. “Furthermore, because Mr. Allen indirectly owns all of our outstanding Class B Common Stock, he has the authority to rescind the rights agreement at any time.”

It’s all very complicated and as is usual with a lot of tax issues, probably unnecessarily so. It kind of reminds me of the classic exchange in that old Danny Kaye movie, The Court Jester: “The pellet with the poison’s in the vessel with the pestle; the chalice from the palace has the brew that is true.”

Or was it the flagon with the dragon?