Poison pill and its effectiveness in thwarting hostile takeovers

A nickname for shareholder rights plan, the term ‘poison pill’ refers to a defence tactic used by a target company to prevent or discourage a potential hostile takeover. The origin of the term can be attributed to espionage, where spies are instructed to swallow cyanide (poison) pills rather than face capture by enemy/hostile forces. The term eventually made its way to the business world, especially in mergers and acquisitions in the 1980s.

Poison pill is primarily of two types: flip-in and flip-over. A widely-used strategy, ‘flip-in’ allows existing shareholders (except the acquirer) to buy more shares in the target company at a deep discount when the potential acquirer’s holding in the company reaches a certain limit. While this offers instant profit to investors, it also dilutes the shares held by the acquirer, making the takeover attempt more expensive and difficult. A flip-over strategy allows shareholders to buy the deeply discounted stock after successful hostile takeover.

The poison pill is generally very effective in warding off any hostile takeover bids by making the deal less attractive for the acquirer. However, the tactic can also be harmful to the target company and hence the macabre sounding name.

Why is it in the news now?

It has been in the news or ‘trending’ for the last few days after Tesla, and SpaceX CEO Elon Musk made a $43 billion unsolicited bid to take over the social media giant Twitter last week. The billionaire, who currently owns a 9.2 per cent stake in the social media platform, offered to buy the company for $54.20 a share to take it private and build it into a platform for ‘free speech’.

The social-media giant immediately responded by adopting a ‘poison pill’ to prevent the unsolicited takeover. The plan would prevent Musk, or any other shareholder, from increasing their stake in Twitter beyond 15 per cent without the board’s approval. If any shareholder reaches the threshold, all others would be allowed to purchase additional shares at a deep discount, diluting the acquirer’s stake in the company.

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What are the other major instances when this policy has been used?

The poison pill strategy was originally conceived by Martin Lipton, a renowned takeover attorney and co-founder of the New York City firm Wachtell Lipton Rosen & Katz. In 1982, Lipton introduced the shareholder rights plan defending El Paso Corp from a hostile takeover by Burlington Northern Railroad.

A year later, ceramics manufacturer Lenox used this strategy to defend against a hostile takeover by Brown-Forman Distillers, producers of Jack Daniel’s whiskey. Lenox offered a special dividend to its shareholders, giving them the right to purchase half-price shares in Brown-Forman if the takeover was successful. The defence was successful as Brown-Forman was forced to increase its takeover offer and enter into a negotiated agreement before acquiring the company. Lenox’s lead investment banker, Martin Siegel, was credited with coining the term ‘poison pill’.

Over the years, several companies used the strategy to defend themselves from hostile takeover bids. Some famous ones include internet major Yahoo, which used a poison pill plan in the 2000s to prevent Microsoft from acquiring it.

In 2012, Netflix implemented a poison pill after billionaire investor Carl Icahn purchased a 10 per cent stake in the company. American pizza restaurant chain Papa John’s used a poison pill to thwart an attempt by ousted founder John Schnatter to regain control.

How successful has it been in the past?

Although there are no recent studies, a 2001 report found that since 1997, for every company with a poison pill successfully resisted a hostile takeover, there were 20 companies that accepted the offers. Also, shareholders are increasingly averse to using poison pills because not all takeover offers are hostile and some can be financially rewarding to the shareholders as well as the company.

For instance, Yahoo prevented a takeover by Microsoft, despite the latter offering a 62 per cent premium to acquire the internet giant. Microsoft eventually withdrew its bid as the poison pill made the deal ‘expensive’. It led to a sharp crash in the stock price of Yahoo, followed by a spate of lawsuits against the company for undermining shareholders’ interests. Jerry Yang, then CEO of Yahoo, faced a backlash from shareholders which eventually led to his resignation.

Will it help Twitter thwart Elon Musk’s bid?

It could. Musk offered to acquire Twitter for $43 billion, or $54.20 per share. But Twitter’s poison pill includes both a flip-in and flip-over trigger, allowing other shareholders to purchase shares at half price, thereby increasing the number of shares in circulation and reducing his stake considerably. It would be nearly impossible for Musk to take control of the company without shelling out significantly more than what he had initially planned. However, media reports have since emanated that the Twitter Board is considering the offer made by Musk.

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