All you wanted to know about poison pills

It is not just governments that are worried about foreigners swooping in to buy the nation’s assets for cheap, when stock prices are down and out. Companies are worried too. In order to protect themselves from hostile takeovers during these testing times, many companies across the world are taking ‘poison pills’ to ward off hostile takeovers. Some US companies who recently resorted to poison pills include Hexcel Corp, Woodward Inc, Dave and Buster’s Entertainment Inc, CommVault Systems Inc and Tempur Sealy International.

A poison pill is a defensive tactic used by companies, which makes it difficult for a hostile acquirer to buy out a majority stake in the company, given the acquirer control over its management and shareholding. The typical poison pill is structured as a shareholder rights agreement, where the existing shareholders of the target company get rights to buy additional shares the moment a takeover is announced. These shares may carry a steep discount to the market price or additional voting rights.

A takeover is a bid by a potential acquirer to obtain a block of shares in a company, that can give it a controlling stake in the target company. A hostile takeover is a situation where such takeover bids are mounted without the consent of the incumbent management.

The intent of poison pills is to make the acquisition a costly affair for acquirers, thereby discouraging the takeover decision. The potential acquirer is compelled to negotiate with the target’s board of directors, rather than proceed unilaterally. An example of this was Yahoo’s actions in 2000: when confronted with the possibility of takeover by Microsoft, it allowed the board to issue up to 10 million new shares in the event of an acquisition offer on the table. The board also announced unlimited voting power for each share held and allowed all directors to cash in on all of their outstanding stock options, amounting to about 16 million potential new shares.

Though the poison pill has been used for over four decades now in the stock markets, it has gained importance in the recent months due to the havoc wreaked by Covid. Companies are reeling due to wage cuts, furloughs and the market carnage has eroded their valuations. This can render otherwise sound companies vulnerable to hostile takeovers at beaten down valuations, by cash-rich rivals or vulture funds. Plummeting stock prices explain the sudden resurgence in the adoption of poison pills.

Incumbent managements may fear takeovers, but takeovers are not altogether bad for shareholders of listed companies, who may get an attractive exit if there’s a hostile takeover attempt. The adoption of a poison pill is often a decision of the board which often carries a potential conflict of interest.

This is one reason why many companies do not have provisions for poison pills. Apart from being dilutive in nature, poison pills also require the commitment of a significant amount of capital from existing shareholders. Since most poison pills adopted till date have not been triggered, no direct link can be established to stock performance as well. Investors should therefore scrutinise poison pill proposals put to them objectively before voting them in, as they could prove detrimental to their interests. If allowing such tactics, it may be best to stick to short duration measures rather than allow them for good.

Rather than protect shareholders, an overdose of poison pills can be toxic for them.

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