Concept: Poison Pill

#20

What?

• Counter to Greenmail
• Defense strategy used by a target firm to prevent a hostile takeover by another company via diluting its shares

Concept

• Poison pill: something that's difficult to swallow or accept
• Allows existing shareholders to purchase additional shares at a discount and thus diluting the ownership interest of the hostile party
• This process raises the acquisition costs thereby deterring takeover attempts

Origin

• Devised by Wachtell, Lipton, Rosen, and Katz (legal firm in NY)
• Been around since the 1980s 
• Spies used to carry poison pills to avoid being questioned by their enemies when captured

Types

• Flip-in, flip-over (among others)
• Flip-in is more commonly followed

Flip-in Strategy

• Allows shareholders (except for the acquirer) to purchase additional shares at a discount before the takeover is finalized
• Though purchasing additional shares provides shareholders with instantaneous profits, the practice dilutes the shares already purchased by the acquiring company
• Provisions of flip-in usually in the company's bylaws or charter itself

Flip-over Strategy

• Allows stockholders of the target company to purchase the shares of the acquiring company at a deeply discounted price if the hostile takeover attempt is successful
• A target company shareholder may dilute equity by buying the stock of its acquirer at a two-for-one rate
• The acquirer may thus avoid the acquisition in the case it perceives a dilution of shares after the acquisition

Examples

• 2012: Netflix (NFLX) announced a shareholder rights plan after investor Carl Icahn acquired a 10% stake
• Any new acquisition of 10% or more, any Netflix merger, sales, or transfer of more than 50% of assets would enable existing shareholders to purchase two shares for the price of one
• Icahn criticized this move as "an example of poor corporate governance"
• Netflix shares soared to $304 by July 2011
• The poison pill would allow the stock to reach a price of $350 per share
• July 2018: Papa John’s (PZZA) adopted a poison pill to prevent ousted founder John Schnatter (30% stakeholder) from acquiring the company
• The company enforced a Limited Duration Stockholders Rights plan aka the wolf-pack provision, which doubled the share price for those who tried to buy a large stake (31% or more for Schnatter and 15% for others) without the board's approval
• It thus deterred Schnatter from a hostile takeover

Disadvantages

• Stock values become so diluted that even shareholders need to purchase new shares just to keep even
• Institutional investors are discouraged from buying into corporations that have aggressive defenses
• Ineffective managers can stay in place through poison pills, else VCs might buy the firm and improve its value with better managing staff

Example

• In 2008, Microsoft offered Yahoo! shareholders $31 per share at a 62% premium
• They pulled out after Yahoo! launched a poison pill
• Yahoo's share price took a nosedive leading its Head Jerry Pinto to step down