What's J.C. Penney's 'Poison Pill'?

J.C. Penney has had a rough year already, with a vague holiday sales announcement and the planned closure of 33 stores. News broke Tuesday that the company will extend its "poison pill" until 2017 and lowered the ownership threshold that would trigger dilution. Say what?

Poison pills exist as an anti-takeover strategy and commonly come into play when a company is struggling and vulnerable. J.C. Penney isn't the only retailer playing with poison; Abercrombie & Fitch announced changes to its own pill the same day.

So what's the deal with these poison pills, and what do they mean for the current health of J.C. Penney?

What the heck is a poison pill?
Despite the name, a poison pill is less like a noble movie spy taking a cyanide capsule and more like a panicked toad oozing poisonous goo to make itself seem less tasty. The corporate version involves a shareholder rights plan that caps the maximum amount of shares any one investor can own to make a potential takeover attempt less appealing.

J.C. Penney first implemented the current poison pill last summer. The pill was meant to cap the maximum holdings at 10% and expire in a year. Now the term has grown by three years and the shareholder threshold drops to 4.9%. Current shareholders with a larger stake than the threshold will for the most part only trigger the pill if they try to increase that stake. What happens if the pill triggers? J.C. Penney will flood the market with more shares to dilute the offender back under the threshold.

Why did J.C. Penney extend its poison pill?
The original poison pill was instituted last summeras the company began to undo the turnaround plan started by short-term CEO Ron Johnson. The one-year term and 10% max were too lax to begin with, however, and the company should have had better terms from the start.

The revised terms can also help J.C. Penney strengthen its carryforwards related to net operating losses (NOLs) which allow a company to use its losses to help pay off future tax bills. J.C. Penney would lose the $2 billion in carryforwards it currently has if the company underwent an ownership change.

How does J.C. Penney's pill differ from Abercrombie & Fitch's?
This one's easy: Abercrombie & Fitch's announcement differs because the company ended its poison pill to try and attract buyers. The company used the same news cycle to announce that controversial CEO Mike Jeffries was stripped of his chairman title. Jeffries has advocated against selling the company. Abercrombie's comps have slid to double-digit quarterly drops as teen shoppers turn away from the preppy styles, though, and the company would do well to consider a takeover.

Foolish final thoughts
J.C. Penney's amended poison pill still needs to go before investors at the shareholder's meeting in May for approval. That should pass, though, since the adjustment corrects an overly lax pill from last year. The company needs to take such a position to keep hostile buyers at bay and secure those carryforward tax breaks. It's less of an overall indicator of health and more a way to hold on while hoping for tailwinds.

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The article What's J.C. Penney's 'Poison Pill'? originally appeared on Fool.com.

Brandy Betz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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