Poison Pill

Equity markets have seen quite some turmoil lately. There was high volatility coupled with plunging stock prices, since the markets witnessed a downfall, as COVID-19 started to afflict the global economy with a looming negative outlook towards recovery. This apparent undervaluation, caused by shrunken market cap, of companies makes them more vulnerable to hostile takeovers, without the consent of target company, at attractive prices. This prompts companies to issue what’s notoriously called Poison Pills.

Also called the Shareholder Right Plan, a Poison Pill is a corporate maneuver to prevent hostile takeover attempts. In literal terms, it implies a way to make it more difficult for the acquirer to swallow the target or to enact a hostile takeover of the target. Poison pills appeared in the United States as a response to the numerous hostile takeovers that occurred in the 1980s.

Poison pills are triggered when a potential activist shareholder attempts rapid share accumulation and acquires a certain percentage of stake, usually 5% to 20%, thus ringing a warning bell pertaining to some hostile activity. Most commonly, poison pills allow existing shareholders, excluding the acquirer, the right to purchase additional shares of the company, at a discounted price, with an aim of diluting the ownership of the hostile investor. This reduces percentage stake corresponding the shares bought by the acquirer, thus decreasing its value and making it a costly bid, much difficult to execute than before. Sometimes the additional shares issues also come with additional voting rights, so as to keep the decision-making power with the existing shareholders. They can be issues either as a prophylactic / preventive measure or in response to a specific threat from an opportunistic buyer.

For instance,

• Hexcel and Woodward issued poison pills in April 2020, each triggering at 15% stake acquired, after their announced $6.4bn merger consensually fell through and their stock price tumbled, reflecting market dislocations resulting from COVID-19.

• Spirit Airlines adopted poison pill in March 2020, triggering if an active investor acquires 10% of shares outstanding, as airlines industry was decimated by the travel restrictions owing to coronavirus pandemic and spirit lost nearly 80% of its value in less than a month.

• HP issued poison pill in February 2020, after Xerox up the ante to takeover HP, exercisable if one entity acquires more than 20% stake in the company.

• Netflix in 2012 adopted a shareholder rights plan after investor Carl Icahn acquired 10% stake. The new plan stipulated that with any new acquisition of 10% or more, any Netflix merger or transfers of more than 50% of assets, existing shareholders can purchase two shares for the price of one.

Two leading proxy advisory firms - ISS and Glass Lewis – have also been more receptive to the idea of poison pills adoption in the wake of COVID-19 pandemic and macroeconomic volatility as reasonable context, provided that the reasons for the pill are clearly communicated to the shareholders, as should the intention of the board to continue to evaluate its necessity, as well as other steps to protect the company’s stockholders from opportunistic behavior.

Although this tactic does help discourage monopolistic takeovers and protect the long-term interests of company and existing shareholders, but it makes it even existing shareholders dole out more money to keep up their stake because of dilutive nature of poison pills. Companies might also resort to this method of defense, when they have cues of some specific opportunistic buyer attempting an acquisition. Albeit, it can lead to ineffective managers staying put to due to existence of such defensive measures through poison pills, not giving an opportunity to an incoming investor to scrutinize and change the company for the good and improve its value. So varied viewpoints have always made poison pill defenses somewhat controversial, ergo not encouraged as the best-fit defense strategy.

Write-up by: Anmol Arora