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Fighting Takeovers by Playing the Debt Card


"Change of control" provisions are making outsiders leery of takeovers that could force them to refinance debt at higher rates

When Carl C. Icahn and other investors launched a proxy battle earlier this year against Amylin Pharmaceuticals (AMLN), the San Diego biotech company unsheathed a tactical weapon that has become the choice du jour for a growing number of companies eager to ward off corporate raiders.

The tactic might well be called "the banker made me do it" defense. Amylin has in place a "change of control" debt covenant that requires it to pay back an outstanding loan if investors buy a large stake in the company or elect a block of board members. Amylin says it would be forced to pay back a $125 million Bank of America (BAC) loan if outsiders wrested control of its board, which in turn could force it to default on up to $900 million in debt. That could make Amylin unpalatable as a takeover target.

Many companies have such change of control covenants in their bond or loan agreements, among them J.C. Penney (JCP), Kroger (KR), Ingersoll-Rand (IR), and Dell (DELL). That's not to say they would use them to ward off an Icahn. Nor is it clear how many companies are using these covenants to do so. But shareholder activists have little doubt that they have become a takeover defense. "[These change of control provisions] are designed to deter a proxy fight," says Chris Young, director of mergers and acquisitions research for the shareholder advisory firm RiskMetrics Group (RMG).

Change of control provisions first began appearing in 1980 when corporate raiders started taking over companies and loading them up with debt. Concerned that these companies would be unable to pay back their loans, lenders insisted on covenants requiring them to repay their original lenders. These provisions became fashionable again during the private equity boom of recent years. Now, with credit tight, they have become a potent deterrent to corporate raiders leery of being forced to repay a company's debt and then refinance the loans at higher rates.

Is the movie studio Lions Gate Entertainment (LGF) using a loan covenant to fend off Icahn? When JPMorgan Chase (JPM) extended Lions Gate's revolving line of credit last year, the terms included a provision that triggers instant repayment if an investor buys more than 20% of the company's stock. Since then Icahn has acquired 14% of Lions Gate. In late March, Lions Gate "strongly urged" investors—while taking no formal position—to scrutinize an offer by Icahn to buy $316 million in debt. (He could convert it into stock and boost his ownership stake.) In the same letter, Lions Gate, without mentioning Icahn, said it could be forced to repay both its bank debt and notes.

In another case, the giant electric utility Exelon (EXC) wants to buy rival NRG Energy (NRG) for $5 billion and is waging a proxy battle to elect nine members to NRG's board. In a letter to shareholders, NRG warned that such an outcome would trigger "an acceleration" of its $8 billion of debt. Exelon General Counsel William A. Von Hoene Jr. counters that NRG is "using the debt issue as a threat" to scare off NRG's shareholders from considering its bid.

Companies using change of control provisions this way are taking heat. Last month the San Antonio Fire & Police Pension Fund, an Amylin investor, sued the company for "embedding" its covenant about the time takeover speculation began in 2007. Amylin says it has since tried unsuccessfully to get bondholders to waive a provision blocking outsiders from taking over the board and has asked its bankers for a similar waiver. Shareholder activist Nell Minow says companies shouldn't use such loan covenants if they disenfranchise stockholders. She says: "These are shareholder rights that can't be negotiated away by someone else."

Grover is Los Angeles bureau chief for BusinessWeek.

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