2022 saw one of the most valuable acquisition deals in history: Elon Musk acquired Twitter Incorporated for an equivalent of ₹36 lakh crores. In the early days of Musk's takeover bid, the board enacted what is colloquially known as the "poison pill" strategy.
This strategy allows a company's board to avoid a hostile takeover where a third party attempts to acquire most of its shares from the open market. In this scenario, the board dissuades the takeover attempt by diluting the stake of the acquirer.
The idea is to make the company unpalatable to the acquirer, hence the name "poison pill".
Types of Poison Pills
Let's understand the different kinds of poison pills through an example where Pineapple Incorporated, a prominent institutional industry stalwart, is attempting to take over Berry Incorporated, a small but valuable startup poised for growth.
If Berry Incorporated has enacted any of the following "poison pills", Pineapple will have a hard time:
Preferred stock plans
Berry Incorporated can issue dividends of a special type of stock, "a preferred stock", to common shareholders that will grant them voting rights. These "preferred" stakeholders will then be able to exercise their special voting rights when an outsider suddenly buys a large chunk of shares.
Flip-in
Suppose Pineapple Incorporated bought more than 15% of Berry Incorporated's shares. In response, Berry allows its shareholders to buy many of its shares at a discounted rate to counter the offer. The greater the number of shares purchased by stakeholders, the more Pineapple's stake gets diluted. This can even force Pineapple to spend more on the bid, discouraging them from pursuing their takeover attempt.
Back-end rights plan
Using this strategy, Berry can design its employee stock option plan (ESOP) to become effective in case of hostile takeovers. This includes giving employees the right to obtain shares with a higher value if an acquiring company takes a majority stake. This way, Pineapple cannot quote a lower price for the shares than those mentioned in the plan. The only way for the deal to move forward would be for Pineapple to increase its bid.
Golden handcuffs
Like the above strategy, this one also involves the creative use of ESOPs. Berry Incorporated, a smart and savvy company, awards restricted stock to its most valued workers, which can be obtained once the person meets a predetermined level of performance. However, this poison pill gets triggered when Berry is in danger of a hostile takeover. Its valuable employees become vested in stock options, and they are freed from the "performance threshold" limitation. When Pineapple finally completes its bid, there is no guarantee that the people who made Berry amazing would stick around.
Advantages of the "Poison Pill" Strategy
- Protects the interests of minority stakeholders from being jeopardized by takeovers based on majority stock control
- Discourages bids based on a temporary decline in share price
- Companies with "poison pill" defences tend to gain higher takeover premiums
Limitations of the "Poison Pill" Strategy
- In the event of a failed takeover bid, the strategy can still leave the value of a company's stock lower than before
- Can shield underperforming management from shareholder efforts to find replacements. However, most "poison pill" strategies have sunset protocols built in to prevent this from being a lasting problem.
- Lastly, a "poison pill" strategy cannot dilute the stake of an activist investor that was acquired before the strategy was adopted.
Examples of the "Poison Pill" Strategy
Papa John's
To deter the ousted founder John Schnatter from gaining control of the company in July 2018 with his 30% stake, the board adopted a strategy that would let Papa John's sell its stock to shareholders for half the market price if Schnatter and his associates increased their stake to 31%, thereby effectively diluting their stake. While Schnatter filed a suit over some of the provisions of this strategy, the takeover was averted, and John would later reduce his stake in the company to less than 4% in 2020.
Netflix
When billionaire investor Carl Icahn and his affiliates disclosed a stake of nearly 10% in 2012, Netflix adopted a "poison pill" strategy that would dilute the stake of anyone acquiring more than 10% of the company by allowing shareholders a two-for-one stock deal.
GAIN Capital
In 2013, FXCM Incorporated was planning to acquire GAIN Capital Holdings Inc. In response, GAIN determined that rights would be allocated to the company's common shares at a ratio of one-to-one. Upon the takeover, each right would allow stockholders to buy one-hundredth of a share in a new series of participating preferred stock.
"Poison Pill" Strategy in India
A series of provisions drafted by the Securities & Exchange Commission of India to regulate takeovers restricts the use of "poison pills" in the country.
According to the SEBI (Substantial Acquisitions of Shares and Takeovers) Regulations, 2011, the acquirer is mandated to make a public announcement once it obtains 25% of the target company's share. This is the only major obligation for the acquirer to undertake a takeover.
Paragraph 26(c) of the code states that the target company can not issue any securities which entitle the holder to voting rights, thereby negating any "poison pill" strategies. Furthermore, paragraph 26(d) refrains the target company to "implement any buy-back of shares or effect any other change to the capital structure".
Discount warrants less than the pricing structure prescribed are also restricted by paragraph 13.1.2, chapter 13 of the SEBI (Disclosure and Investor Protection) Guidelines. Therefore, once the acquirer publicly announces their takeover bid, there is relatively little action the target company can take to stop it.