Poison Pill

A defensive strategy to dissuade any hostile takeovers.

What is a poison pill?

A shareholder rights plan, more commonly known as a Poison Pill, is a type of financial or structural maneuver that a company may make to frustrate an attempted takeover by a hostile bidder. Generally, this term is used to describe several approaches the target company can employ to make the potential acquisition less desirable.

If the poison pill is effective, the acquiring company may abandon its takeover and allow the target company to remain independent. However, it must be noted that poison pills are not intended as an absolute bar to takeovers. They are meant to encourage an otherwise hostile acquirer to negotiate with the directors of the target company and to dissuade the acquirer from employing abusive takeover tactics.

 

poison pill shareholder rights plan theme

 

History

The term originated from the world of espionage, where spies were instructed to swallow a poisonous pill rather than risk capture.

In corporate finance, the term “poison pill” stems from plans originally introduced in the United States, which were designed to have disastrous effects for any acquirer who attempted, by unfriendly means, to take over a target corporation which had instituted such a plan.

The term was first used by Martin Lipton of Wachtell, Lipton, Rosen, and Katz. Lipton invented the poison pill defense during a takeover battle in Texas in 1982.  At the time, T. Boone Pickens was trying to acquire General American Oil.  Lipton advised the company’s board of directors to flood the market with new shares of stock.  By diluting the stock purchased by Pickens, the company managed to discourage the unsolicited acquisition. While controversial, the tactic was ruled legal in 1985 by the Delaware Supreme Court.

 

Aims of a poison pill

Generally, a rights plan has two main aims:

#1, it is an attempt by the target corporation to ensure that all shareholders are treated equally, i.e. that a bid is made for all shares at the same time.

#2, it is an attempt by the corporation’s board to ensure that the shareholders receive the highest price for their shares.

 

Types of poison pills

Poison pills can take various forms, but the basic idea is to make it easier for current shareholders to block an outside takeover attempt. They typically discourage hostile takeovers by letting companies sell large amounts of stock to existing shareholders at cheap prices.

The two most common structures of poison pills include:

The “Flip-In” Provision

In the case of an acquisition, the flip-in strategy entitles the shareholders (other than the acquirer) to buy shares of the remaining company at a substantial discount. The right to purchase stock occurs before the merger is finalized, and the provision is usually triggered when the acquirer owns greater than a 20% share of the target’s stock. The flow of additional cheap shares into the total pool of shares greatly dilutes the acquirer’s equity, which in turn makes the acquisition costly. The shareholders are also less powerful in terms of voting, because now each share is a smaller percentage of the total.

The “Flip-Over” Provision

In the case of a merger, the flip-over strategy gives shareholders the right to buy the buyer’s common shares at a lower price than the market. While this approach is simpler to implement than a preferred stock plan, it does not prevent a company from purchasing a controlling share of the target.

Both poison pill plans enable a company to thwart all but the most determined and deep-pocketed suitors while allowing shareholders to benefit greatly if the suitor succeeds.

 

Effectiveness

No poison pill or any other type of defense is ever meant to be used. A shareholder rights plan will not generally prevent the ultimate acquisition of a corporation in the face of a persistent suitor. It will not deter acquirers from making an offer with the condition that the target board of directors redeem the rights; nor will it prevent acquirers from soliciting proxies to remove the board and redeem the rights. Their greatest utility is in their deterrent influence; a company is unlikely to launch a takeover of a firm whose defenses are sufficiently formidable.

 

Real life example

In 2012 Netflix adopted a Poison Pill (shareholder rights plan) to fend off Karl Icahn from a  hostile takeover. When Netflix learned that Karl has acquired a 10% stake in the company they immediately adopted the shareholder rights plan to prevent him from gaining a larger position.

The plan would become effective as soon as anyone tried to buy a large position without the approval of Netflix’s board. In that event, Netflix could flood the market with new shares and thus the acquirer would not be able to gain a larger percentage ownership.

 

Synopsis

Shareholder rights plans, or poison pills, are measures that a company may implement to discourage a hostile takeover by another company. Poison pills appeared in the United States as a response to the countless takeovers that occurred in the country in the 1980s, and its main purpose was to protect minority shareholders and avoid the change of control. A poison pill does not always mean that companies do not want to be acquired nor merged; sometimes they are put into effect to get more appropriate acquisition/merger conditions.

 

Additional resources

This has been a guide to a poison pill or shareholder rights plan.  To keep learning and advancing your career in corporate finance, we highly recommend these additional resources below: