Decoding the Hard-To-Swallow Pill in the Business World: What Is a Poison Pill Strategy?

What Is a Poison Pill Strategy

The poison pill makes a takeover less appealing by making it more expensive.

The events following Elon Musk announcing his plans to buy Twitter in April have been quite a fiasco. Earlier this month, Musk said he was backing out of the US$44 billion bid, leading to Twitter suing him over the deal. It surely was an interesting turn of events, after Twitter imposed a “poison pill” strategy against Musk’s potential takeover in April. Back then, Musk proposed taking the company private at US$54.2 per share, which was 38% higher than Twitter’s stock value before the announcement of the plan.

The poison pill move was widely seen as a direct shot across the bow of the Tesla CEO, who has been a vocal critic of the social media platform. It stipulates that other shareholders can acquire additional shares at cheaper prices if someone holds beneficial ownership of at least 15 percent of Twitter’s outstanding common stock without the board’s authorization. This would have limited Musk’s access to control through share purchases.

Poison pills are common in the business world to fend off buyout attempts. In 2012, Netflix imposed one to foil the takeover plan of Carl Icahn, Founder of Icahn Enterprises, after he had purchased a 10% stake in the company. In 2018, Papa John’s Pizza went for a poison pill against John Schnatter, the founder of the pizza chain and former chairman. He still owned 30% of the company after resigning his post for using a racial slur during a conference call. Other big corporations, like Yahoo and Sotheby’s, have also turned to this move as well. Read on to learn more about this strategy and the different types of poison pills.

What is a poison pill?

Devised in 1982 by a mergers and acquisition lawyer in New York Martin Lipton, the poison pill, also known as the shareholder rights plan, is a defense strategy that a company utilizes to prevent or discourage a hostile acquisition. This technique makes the company seem less appealing to prospective acquirers. It became popular in the 70s during a wave of hostile takeovers raiding corporate boards by financiers, like T. Boone Pickens and Carl Icahn.

It was first tested in a lawsuit filed by oil firm General American Oil to prevent the attempted takeover by T. Boone Pickens. Lipton advised the company’s Board of Directors to dilute Pickens’ stock purchases by flooding the market with new shares. The board turned down the offer due to concerns over the strategy’s legality, and Philips Petroleum bought it out last-minute. It was not after the 1985 landmark ruling of the Delaware Supreme Court in Moran vs. Household International Inc. that the “poison pill” became famous for fighting off unwanted takeover attempts.

Two common types of poison pills

Flip-in poison pill

A flip-in poison pill, which Twitter used against Musk’s buyout, is a type of tactic which allows all shareholders (except for the acquiring company) to buy additional shares of the target company at a discounted price before the success of a takeover bid. 

Although this gives the shareholders immediate profits, the new shares will dilute the shares owned by the acquiring firm or investor, making it more difficult and costly for the acquirer to gain control. The flip-in tactic is only implemented when the acquirer has acquired at least 20–50% of outstanding shares. 

Another company besides Twitter that adopted this was PeopleSoft Inc, a company founded by David Duffield and specialized in human resource management systems. In 2004, PeopleSoft implemented the flip-in poison pill tactic against software giant Oracle Corporation, allowing new shares to flood the market. It also established a “customer assurance program”, under which it promised to reimburse customers up to five times the software costs if the company stopped developing its products after acquisition. 

Although PeopleSoft was eventually acquired by Oracle in December 2004, its anti-takeover strategy paid off for its shareholders. Oracle purchased PeopleSoft for US$10.3 billion, doubling its initial offer.

Flip-over poison pill

Meanwhile, a flip-over poison pill strategy allows existing shareholders of the target company to purchase the acquiring company’s shares at a discount if/when the takeover attempt is successful. 

Such a strategy will discourage the acquirers, as the shares of the acquiring firm’s existing shareholders become diluted with the purchase. This kind of provision intends to transfer money from the stakeholders of the acquiring firm to those of the target firm. 

In most situations, the flip-over approach does not completely prevent a takeover. Usually, it results in the acquirer canceling its hostile takeover plans to avoid stock dilution and coming up with a more friendly proposal.

Is a poison pill worth it?

While it appears that a poison pill plan can work in deterring hostile coups, it is not 100% effective and risk-free. In some cases, the strategy can backfire. 

When new shares are issued at a discount, the stock’s value is altered, forcing existing shareholders to purchase more shares in order to keep their original stake. Additionally, implementing a poison pill may be both time-consuming and costly in terms of the actual strategy and the company’s reputation. Moreover, poison pills can discourage investments from institutional investors, like Foreign Direct Investors (FDIs) and Foreign Portfolio Investors (FPIs). 

At the end of the day, a poison pill is a last resort strategy that requires thorough consideration. The outcome can be rather complicated, such as in the case of Musk’s Twitter buyout deal. Although the plan seems to be off the table now, both parties will likely to be in the headlines for a while until the legal battle between them is settled, with Twitter reportedly hiring Lipton’s firm to sue Musk.

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