Poison Pill Defense

Poison Pill Defense in Finance: M&A Hostile Takeover Strategy

In a hostile takeover, the target company’s board of directors expresses their clear opposition to the acquisition, yet the potential acquirer continues to pursue the acquisition.

While certain types of acquirers, most often large institutional investors such as hedge funds and private equity firms, can become disinterested in a deal should the target be in opposition to it, others, more commonly strategic acquirers, may continue their pursuit.

In a hostile takeover, defensive tactics like the poison pill may come in.

The target of a hostile takeover, in an effort to deter the bidder, can use the poison pill strategy to make itself less attractive to the acquirer due to the effects of additional dilution.

The poison pill defense — or formally referred to as the “shareholders rights plan” — is when the target’s existing shareholders are given the right to purchase more shares at a discounted price.

The ownership of the equity interest becomes effectively more diluted, making the target less attractive to the acquirer, and ideally causing them to put an end to their pursuit.

While the negative impacts stemming from equity dilution are not ideal, the ultimate goal is to disincentivize the bidder (and discourage the acquisition).

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Flip-in vs. Flip-Over Poison Pill Defense

There are two distinct types of poison pills: the “flip-in” and “flip-over”.

1. Flip-In Poison Pill: In the flip-in poison pill variation, all of the target’s shareholders, except for the hostile acquirer, are allowed to purchase additional shares at a discount. The purchase of additional shares results in instantaneous profits to other shareholders and the practice dilutes the value of the limited number of shares already purchased by the acquirer — but the catch is that those that did not opt in to purchase more shares are also diluted. The right to purchase is offered to the target’s shareholders before a takeover is finalized and is conditional on a specific “trigger”, such as when once the hostile acquirer amasses a certain threshold percentage of total shares.
2. Flip-Over Poison Pill: On the other hand, the flip-over poison pill strategy enables shareholders of the target to purchase the shares of the acquirer at a steeply discounted price if the hostile takeover ends up being successful. As an example, the target company’s shareholders can obtain the right to purchase the stock of its acquirer at a two-for-one rate, which dilutes the equity in the acquirer (and that of their shareholders).

Both the flip-in and the flip-over poison pill are more so treated as a “threat” to pressure the acquirer to avoid proceeding with the acquisition if it perceives the potential dilution post-acquisition to be too substantial.

Poison Pill Defense Twitter Example: Elon Musk Hostile Takeover (2022)

Twitter (NYSE: TWTR) is attempting to fend off a hostile takeover bid by one of its largest shareholders, Elon Musk, who happens to be the co-founder of Tesla and the world’s richest man.

Soon after, Twitter adopted a shareholder rights plan, i.e. the “poison pill” tactic, which was announced by the company after the takeover announcement by Musk became public.

Per SEC filings, Twitter’s poison pill has a stated exercise price of $210, so each shareholder can purchase shares for $210 each when “having a then-current market value of twice the exercise price.” — i.e. existing shareholders are granted the ability to purchase $420 market price shares at only $210.

Twitter Poison Pill Example

On April 15, 2022, the Board of Directors (the “Board”) of Twitter, Inc., a Delaware corporation (the “Company”), authorized and declared a dividend distribution of one right (each, a “Right”) for each outstanding share of common stock, par value $0.000005 per share (the “Common Stock”), of the Company to stockholders of record as of the close of business on April 25, 2022 (the “Record Date”). Each Right entitles the registered holder to purchase from the Company one one-thousandth of a share of Series A Participating Preferred Stock, par value $0.000005 per share (the “Preferred Stock”), of the Company at an exercise price of $210.00 (the “Exercise Price”), subject to adjustment. The complete terms of the Rights are set forth in a Preferred Stock Rights Agreement (the “Rights Agreement”), dated as of April 15, 2022, between the Company and Computershare Trust Company, N.A., as rights agent.

Source: 8-K

The board voted unanimously to adopt the plan, so the takeover offer was clearly not received well by Twitter’s board members.

But considering the lackluster performance of Twitter’s share price, the board is increasingly under pressure to sell, since they have a fiduciary duty to the shareholders to maximize the firm value of the company.

In late April, Twitter’s board eventually announced it had entered a definitive agreement to be acquired by an entity wholly owned by Elon Musk — following much scrutiny from shareholders as well as the general public.

Elon’s stake in Twitter was ~9% at the time of the announcement, and the surprise acquisition offer was swiftly met with disapproval (and shortly after, the hostile takeover began).

In terms of Twitter’s poison pill, it is triggered once Elon Musk acquires in excess of 15% of Twitter’s common shares.

The flip-in gives all the shareholders but the prospective acquirer, Elon Musk, the ability to purchase more shares at discounted pricing.

^{Flip-In and Flip-Over Trigger Provision (Source: TWTR 8-K)}

If Elon Musk, or any other stakeholder like Vanguard, accumulates 15%+ of Twitter, the option is triggered and shareholders can purchase the discounted shares, thereby diluting the hostile acquirer’s stake.

Note: Elon Musk attempted to break off the $44 billion acquisition offer, resulting in Twitter suing Musk for breaching the agreement and causing material damage to the company’s share price (and now wants to force Musk to complete the acquisition). The trial in court is scheduled to begin on October 17, 2022.