Poison Pills as a Defensive Tactic Against Hostile Takeovers

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Mergers and acquisitions can develop in different ways. Many M&A deals involve two amicable parties mutually interested in a merger. In other scenarios, merger attempts can be hostile. Such hostile takeovers often arise unexpectedly and catch a target company by surprise.

Poison pills, more formally known as shareholder rights plans, are defensive strategies companies deploy to thwart a hostile takeover. To fend off the hostile bidder, a target company will make itself highly unattractive in economic terms. This is often achieved by adopting poison pill measures to make the acquisition cost prohibitively expensive. The goal of the poison pill is to change the hostile bidder’s mind and to make an acquisition seem undesirable.

History of Poison Pills

Martin Lipton was a lawyer at the well-known Wall Street law firm Wachtell, Lipton, Rosen and Katz. At the time, Mr. Lipton was representing a large corporate client, General American Oil. His client faced a hostile takeover attempt from another corporation. In order to dissuade the potential acquirer, Lipton created a shareholder rights plan. The plan effectively made an acquisition of General American Oil look far less attractive.

Martin Lipton Poison Pills
Lipton in 1979. Credit: Bernard Gotfryd

The term “poison pill” originated from the poison pills used by captured spies to avoid revealing information to their enemies.

Despite being a controversial strategy, in 1985 the Delaware Supreme Court upheld the poison pill tactic. Many U.S. corporations are incorporated in Delaware. Thus, lawyers give significant deference to the rulings of Delaware courts on business law issues. Outside of the United States, many jurisdictions consider poison pills to be illegal.

Poison Pill Strategies

There are two basic types of poison pill strategies: flip-ins and flip-overs.

Flip-in poison pills are relatively common. Suppose a hostile bidder buys a large amount of company shares. The target company can employ a flip-in poison pill as a defensive tactic. A flip-in poison pill allows all the target company’s previously existing shareholders to purchase shares at a discounted price. The acquiring company may not buy shares at the discounted price. This dilutes the value of the shares purchased by the potential acquirer.

Flip-over poison pills are the opposite of a flip-in. Suppose a hostile acquiror succeeds. A flip-over plan allows stockholders of the target company to purchase shares of the acquiring company at steep discounts. This dilutes the value of the shares of the acquiror’s company. If the value is diluted substantially enough, the acquiror may become concerned at the post-acquisition company’s value. The acquisition might result in too much dilution and so that the acquirer abandons its acquisition attempt.

Real-World Examples

In 2012, Netflix was caught off guard. Carl Icahn, a well-known activist investor, acquired over 10% of Netflix’s shares without the approval of the company’s board. Activist investors typically acquire large stakes in companies with the intention of effecting changes in its corporate policies or management. In response to his threatened intervention in the company’s affairs, Netflix issued a shareholder rights plan. Their measures enabled the company to flood the market with new shares if a corporate raider acquired a large amount of Netflix shares. This use of poison pills was successful and Mr. Icahn’s stake in Netflix was significantly reduced.

More recently, in 2016, Pier 1 Imports adopted a poison pill plan to steer away a hostile acquirer. Pier 1 implemented a shareholder rights plan shortly after Alden Global Capital, a hedge fund, acquired a 9.5% stake in the company. The poison pill gave all holders of common stock the right to buy a fraction of junior preferred stock at a discounted price. The plan that Pier 1 Imports adopted made the voting rights of preferred stockholders and common stockholders similar to each other. In effect, this diluted the control rights a large shareholder could exert over the company.

Poison Pills for Pizza

As a final example, in 2018, Papa John’s Pizza chain adopted a shareholder rights plan to fend off an individual with interests adverse to its board of directors. John Schnatter, who founded Papa John’s in 1984, owned 30% of the company’s stock and was the company’s largest shareholder. The board wanted to prevent Schnatter from acquiring an even larger ownership stake in the company.

In response, Papa John’s adopted a Limited Duration Stockholders Rights plan. Papa John’s structured the poison pill measure was so that if Schnatter wanted to purchase any additional shares, he would have to pay a price that was double the price of the shares. Since he would have to pay double the value per share of the company’s common stock in order to acquire the company, the defensive tactic made Papa John’s significantly less attractive as an acquisition target.