Stories of World War II espionage are thrilling, whether they are biographies, novels, big-budget films, or documentaries. Spies faced unimaginable danger as they smuggled government secrets to aid the war effort. The consequences of discovery were interrogation, torture, and execution.
Skilled spies prepared for the worst-case scenario with poison pills that could be taken when capture was imminent. They chose instant death over the possibility of being forced to divulge information to the enemy.
The term “poison pill” might have originated in espionage, but it took on a new meaning in the 1980s. Over the course of that decade, corporate America was drowning in a tsunami of hostile takeovers. So-called “corporate raiders” swooped in to acquire companies that had no interest in being acquired – and those corporate raiders built sizable personal fortunes along the way.
Some of the most well-known corporate raiders include Carl Icahn, Robert M. Bass, Sir James Goldsmith, and Asher Edelman – and of course, there were fictional versions brought to life on the big screen. Pretty Woman’s Edward Lewis and Wall Street’s Gordon Gekko are iconic examples of the cutthroat world of big business in the 1980s.
Hostile takeovers peaked in 1988 when 160 separate attempts were made to buy companies without the consent of their leadership teams. A New York legal firm, Wachtell, Lipton, Rosen, and Katz, took a page from the spy handbook to create an effective defense against corporate raiders – the business equivalent of a poison pill.
What Is A Poison Pill In Business?
In the business world, a poison pill gives special purchasing rights to existing shareholders – everyone except the individual or entity attempting the hostile takeover. The most common poison pill strategy is to allow shareholders to purchase additional stock at deeply discounted prices.
The goal of a poison pill in business is to reduce the appeal of a company in danger of being involuntarily acquired. Also known as shareholder rights plans, poison pill strategies make the purchase far more costly and complex for the acquirer.
This often serves to deter the individual or company attempting a takeover, as well as to persuade current shareholders that keeping existing management is in their best interests.
Are Poison Pills Good For Shareholders?
The trouble is that poison pills in business, like the original version used in espionage, can cause damage to the company employing the strategy. That’s the point – to make acquisition less attractive for the potential buyer and position the board’s offer of discounted shares as a better option for shareholders than whatever they would receive from the acquiring company. However, from a shareholder’s perspective, the poison pill strategy is not necessarily a win.
Yes, poison pills strategies allow shareholders to enjoy immediate profits when they purchase new stock at a discount. However, poison pills result in diluted stock values, so if shareholders want to maintain proportionate ownership in the company, they must buy additional stock to keep up. Institutional investors tend to avoid companies that adopt a poison pill strategy for this reason.
Companies with ineffective managers are tempting targets for hostile takeovers, which creates a problem for shareholders. In such cases, managers may deploy a poison pill to remain in their positions, despite the fact that a new, more skilled management team could grow the company and deliver improved returns.
It is worth noting that prevention of a hostile takeover isn’t the only use of a poison pill strategy. In some cases, the strategy is employed in an effort to increase the valuation of the targeted company or improve the terms of the acquisition for the acquired company’s shareholders. In such cases, poison pills are good for shareholders.
Types of Poison Pills
There are two types of poison pills used to discourage hostile takeovers: the flip-in and the flip-over. The more common flip-in poison pill strategy gives shareholders the opportunity to purchase new shares at discounted prices – for example, two shares for the price of one or new shares at 50 percent of their market value.
Assuming shareholders exercise this right, they are able to do so before the deal is finalized. That dilutes the acquirer’s stake in the company, which makes it more expensive to complete the takeover.
A flip-over poison pill strategy works a bit differently. It gives shareholders of the target company the right to buy shares of the acquiring company at a discounted price after the transaction is finalized. This strategy does nothing to damage the target company pre-takeover, but it can deter an acquisition if the post-acquisition consequences appear too costly.
Poison Pill Example
Wall Street history is full of poison pill examples, including some that successfully prevented unwanted acquisitions and some that failed to achieve their objective. In 2012, Netflix saw a threat when Carl Icahn purchased a ten percent stake in the company. Netflix responded with a shareholder rights plan or poison pill that permitted shareholders to buy two shares for the price of one if there was any new acquisition of ten percent or more, any sale or transfer of more than half of Netflix’s assets, or any Netflix merger.
A more recent poison pill example occurred when Elon Musk acquired nearly ten percent of Twitter’s common stock. Twitter enacted a poison pill to prevent Elon Musk from taking over the company without the board’s consent.
Essentially, the Twitter shareholder rights plan stated that shareholders would have the opportunity to buy Twitter stock at half price if any individual or business reached the threshold of 15 percent ownership or more without board approval.
In the end, the Twitter board voted unanimously to accept Elon Musk’s offer to buy the social media platform for approximately $44 billion. Even co-founder and former Twitter CEO Jack Dorsey, who is still a member of the board, voted in favor of the transaction, so the Twitter poison pill strategy was never deployed.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.