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Poison Put

The issuance of bonds by the target company that can be repurchased before maturity to prevent a hostile takeover attempt

What is a Poison Put?

A poison put is a takeover defense strategy that involves the issuance of bonds by the target company that can be bought back prior to the maturity date to prevent a hostile takeover attempt. The poison put defense is a pre-offer defense mechanism and can be considered a variant of the poison pill strategy.

 

Poison Put

 

However, unlike the poison pill strategy that impacts the number of shares, share price, or shareholders’ voting rights of a target company, the poison put defense does not affect the shares of the target company.

 

How Does a Poison Put Work

A target company anticipating a hostile takeover bid can create a poison put defense by incurring new debt by issuing bonds to investors. The newly issued bonds contain a provision (covenant) that grants the bondholders an option to obtain early repayment of the debt at a higher price.

The granted option can be triggered in the event of a hostile takeover bid. The primary goal of the poison put strategy is to increase the financial burden on a corporate raider at the time of a potential hostile takeover to diminish the possibility of the event.

If a target company employs the poison put defense strategy, a potential bidder must carefully assess the cost of acquisition of a controlling interest in the target company and other related costs, including the target’s debt payments, and ensure that it possesss enough cash to cover all acquisition costs.

However, the defensive strategy may not be suitable for every company that wants to prevent a hostile takeover. For example, if a company’s balance sheet is not strong and it holds a substantial amount of debt, the poison put strategy can further worsen its financial situation and can subsequently lead to financial distress. At the same time, the poison put defense limits the flexibility of the management of the target company to restructure its operations.

 

Example of a Poison Put Strategy

ABC Corp. is a medium-sized company operating in the tech industry. The company’s management recently discovered that their competitors from XYZ Corp. aim to undertake a hostile takeover of its business. ABC Corp.’s management informs the company’s board of directors of the potential bid. The company’s shareholders vote to resist the takeover bid from XYZ Corp by employing the poison put defensive strategy.

ABC Corp.’s management knows that XYZ Corp. requires $300 million to acquire a controlling interest in the former. Thus, the managers decide to incur new debt by issuing corporate bonds to investors with a value of $150 million.

The bonds will contain a covenant with a put option that will allow the bondholders to secure repayment in case of a takeover by ABC Corp. or by any company. In addition, if the bondholders exercise the option, they will be entitled to the repayment at 105% of par value (i.e., 5% above par). In other words, the total value of bonds will increase to $157.5 million.

After the implementation of the poison put defense, the total acquisition cost for XYZ Corp. will be $457.5 million ($300 million + $157.5 million).

 

Related Readings

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Bond Payables
  • Pac-Man Defense
  • Shark Repellent
  • Staggered Board

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