Think of an action thriller. The protagonist has its cover blown and is surrounded by adversaries. In a desperate move to protect key secrets, they pop a poison pill, preferring death to torture and coercion. While this sounds like a fanciful Hollywood notion, the financial world, with all its complexities and intricacies offers a similar strategy to desperate companies on the brink of an unprecedented takeover. Admitted that the business world is reputed to be shrewd and ruthless, at least no one can blame it for being dull. The bigwigs of this cutthroat powerplay toy with many financial tactics to achieve their endgame and each of these strategies are well thought out and planned to accomplish a certain objective. One such financial move is known as the Poison Pill Strategy.
Before we delve deep into the gossips of the financial world, let us first try to understand the nuances of this manoeuvre. The Poison Pill Strategy is a defensive tactic used by a target company that has reason to believe that it is being singled out for a takeover or a hostile merger. You could of course skip to the next paragraph to understand how the approach works in real life but it would serve you well to first understand what a hostile merger really is. A merger is a rational decision between two large companies to come together as one. Whether they lose their initial identities, employees or their work processes is unique to each instance and binding contracts ensure that rules of the merger are religiously followed through. When a union is mutual, it results in economies of scale, lower costs, a sharing of expertise across companies, and a generally larger share of the target market and profit pie. However, not all mergers are friendly; some are forced and sneaky too. These are called hostile mergers and many companies that are enjoying a high market share and hefty profits, or contrarily, those that are barely hanging on, are easy targets for such takeovers.
Success stories for the poison pill approach include those of Netflix in 2012, JC Penney in 2010, Yahoo in 2008 and numerous other, less illustrious names over the last few decades.
Now, let us come to the deterrent strategy and the ways in which it can be used. Companies issue shares to the general public and those who wish for more hands-on involvement in these companies can enjoy that privilege once they own a certain percentage of shares. Companies have a threshold or upper limit as to the highest percentage of shares any one individual or party can own. This can range from as low as 5% and as high as 20% of the total number of shares. If the company notices that any one individual is trying to inch closer and closer to the threshold limit, it may decide to go for one of the two types of the poison pill strategies- flip-in or flip-over in order to discourage a surprise buy-out.
A flip-in strategy is simple and used more commonly than its counterpart. Here, the company reduces share prices and decides to sell shares at a lofty discount rate to all interested buyers other than the ‘acquirer’. This way all shareholders except the aggressor would be able to double their stakes in the company and do so very profitably. The offer at once rewards older investors and dilutes profits for the acquirer, making them back off.
A flip-over strategy is a lesser used but equally effective prong of the poison pill strategy that involves increasing the number of shares issued by the company. This warrants an explanation so here we go. Let’s say Company A has 100 shares and a fixed threshold limit of 10% for any interested buyer. Acquirer X wishes to buy out Company A. They buy 10 shares, arriving at the limit. Company A does not wish to be bought out by X. It decides to increase their number of shares and releases another 25 shares into the market. It now has 125 shares and X ends up with only 8% of the total shares with their 10 shares. X must decide whether they wish to increase their expenses by continuing to buy up more and more shares to arrive at the 10% threshold or not pursue the takeover anymore. It should be kept in mind that a company has the right to release as many shares into the market as it wishes, provided it has enough buyers to lap them up.
One of the most talked about takeovers that took place last month was one where Elon Musk acquired a somewhat unwilling Twitter in a hostile buyout. For a moment it seemed as if Twitter was resisting the takeover using the Poison Pill strategy but it finally relaxed its rigid stance and gave in. Here’s a gist – for Twitter, the threshold limit for any one individual or party acquiring outstanding common stock in a transaction not approved by the board was 15%. Going for more than 15% of their stock would result in a 50% discount for all other rights holders, diluting profit share for the aggressor. When Musk acquired 9.2% of their shares, becoming the largest shareholder for the microblogging platform, he was invited to join their board of directors and agree to curb his buys to no more than 14.9%. Refusing the offer which would clearly limit his access to the company, he made his offer to buy it out in a letter addressed to the Twitter chairman, Bret Taylor. The company responded with a last-minute poison pill, attempting to water down Musk’s existing profit share and make the venture more expensive for him momentarily.
The company’s stance did not work in the end, proving that the strategy is not effective every time. A serious acquirer like Musk, who is willing to go to any lengths to woo his shareholder cohort may invariably win the hand in the long run, overturning the ruling board and taking over the new management. After all, tactics and gimmicks of financial markets, especially those operating in and for the top echelons of the business community are volatile and dynamic, and one cannot fully depend on any one survival strategy for a company that is governed by more than one governing body, i.e., the board and the shareholders.
Even if Twitter now shines as the latest feather in Elon Musk’s already overloaded hat, it in no way lessens the power of this strategy in the business world. Success stories for the poison pill approach include those of Netflix in 2012, JC Penney in 2010, Yahoo in 2008 and numerous other, less illustrious names over the last few decades. For business majors, this is a real-life example of what they had thus far learned in theory only. For Twitter and others in the similar boat, it is a rude awakening to the very real dynamics of the harsh world in which they belong.