What is a poison pill? What does this have to do with investing? For those who have been following the Elon Musk and Twitter saga, this is very relevant. Elon Musk is currently attempting a hostile takeover of Twitter for $54.20 per share. Twitter’s board is not accepting Musk’s takeover and they are defending themselves and their shareholders with a poison pill defence also called a shareholder rights plan. What exactly is it, has it been used before and who is this actually protecting? All these questions and more will be answered below.
What Is a Poison Pill?
To begin with, what is a poison pill? The poison pill defence has been around since the 1980s. The term was coined by a New York legal firm called Wachtell, Lipton, Rosen, and Katz.
When spies were captured, they carried a poison pill to avoid revealing any kind of information to their enemies. Nowadays, It is a very effective way to prevent a hostile takeover of a company.
In a nutshell, existing shareholders are given the right to purchase shares at a discounted price. The hostile party’s ownership effectively decreases.
This makes it more expensive for the potential new owner since they must purchase more shares to take over the company. The hostile takeover immediately becomes less attractive.
Types of Poison Pills
There are two types of poison pills. The first is the flip-in poison pill. Only existing shareholders, not the acquirer, are allowed to purchase discounted shares. This effectively dilutes the hostile party’s stake in the company and makes it more expensive to succeed in the takeover.
The second type is the flip-over poison pill. Existing shareholders can only purchase discounted shares if the takeover attempt is successful. This can be perceived as a last effort attempt to dissuade the party from taking over the company if a dilution occurs after the takeover.
Effects of a Poison Pill
A poison pill can lead to many different outcomes regarding the stock price, management, hostile takeover and the shareholders. A poison pill is only triggered if the hostile party purchases a certain percentage of shares. This percentage differs for every company.
What Is a Poison Pill With Stock Price
If there is dilution created by releasing outstanding shares to prevent the takeover, the price of the stock will decrease. Existing shareholders have no choice other than to purchase cheaper shares to stay even.
Since the price of the stock already rose due to more stock being purchased by the hostile party, it can quickly decrease if the same party decides to change their mind and sell their stake in the company. This can leave shareholders in a precarious place.
On the other hand, the stock price can go even higher. The hostile party might double down on their decision and buy even more shares. If the takeover is beneficial for the future of the company, institutional investors can also join the fun. Ultimately, this will benefit shareholders. This depends on how willing is the hostile party to purchase the company.
There are different reasons why a hostile takeover is initiated. In some cases, it is to combine different businesses. It can also be done to replace incompetent management and to change the direction of a company. We will take a look at specific examples for Papa John’s, Netflix and Twitter. Each has its own particularities.
Historical Use of the Poison Pill Defence
To better understand the effects and actions undertaken during a poison pill defence, we will take a look at a few examples over the last years, and one that is happening as we speak.
Netflix (NASDAQ: NFLX)
In 2012, Netflix was nowhere near as successful as it is today. Its streaming service was in the early stages of development and its stock was less than $10.
Activist investor and billionaire Carl Icahn decided to undertake a hostile takeover of Netflix. The company’s stock was falling, subscribers were decreasing and its streaming business wasn’t growing as expected.
Icahn saw great potential in Netflix and wanted to shake things up. Other tech companies were also interested in a Netflix takeover but didn’t act on it.
In November 2012, Icahn disclosed he owned 9.98% of the company. In response, Netflix announced it would adopt the poison pill defence if Icahn reached the 10% threshold. Their plan included a 2-for-1 discount on shares if a successful takeover was underway (flip-over poison pill). Netflix successfully convinced Icahn to retreat and look where it is now.
Fun fact: Netflix released their Q1 earnings after-hours this April 19th. This was the first time the company lost subscribers since this hostile takeover attempt in 2012, one decade later. Netflix lost 200k subscribers in Q1 and is expecting another 2M by July. To prevent this, they are cracking down on password sharing. The next few months will be interesting for them.
Papa John’s (NASDAQ: PZZA)
In the summer of 2018, the news of Papa John’s founder, John Schnatter, being ousted as chairman for using a racial slur and then trying to undertake a hostile takeover made the news.
Back then, Mr Schnatter already owned 30% of the company. He was the largest shareholder. This was a rare occasion when a company founder wanted to take control of the company, but wasn’t allowed to by the board and shareholders.
Papa John’s shareholders voted to undertake a poison pill defence if Mr Schnatter moved his stake in the company to 31% or if anyone bought 15% of the company without the board’s approval.
Under these circumstances, existing shareholders could purchase discounted shares to dilute anyone interested in the takeover. It would effectively become more expensive to increase ownership in Papa John’s. Schnatter was also excluded from any dividend distributions. The hostile takeover attempt ended there. Since the stock has been performing well.
Twitter (NYSE: TWTR)
To conclude this section, our main story. Elon Musk recently submitted a bid to buy Twitter. Musk’s motives for this takeover have little to do with money.
He is targeting this social media giant for its part in the free speech movement and the spread of misinformation. He says it is a turning point for our civilization.
Musk already invested $2.64B, which represents a 9.2% stake in Twitter and proposed to spend $43B more for its purchase. He is currently worth more than $250B. Twitter’s board responded with a poison pill, which will come into effect if anyone succeeds in acquiring more than 15% of the company.
If Musk receives 51% of the shareholder’s votes, he can replace the current board and enact his master plan. One of Twitter’s biggest shareholders is Mohammed Bin Salman. He is the Saudi crown prince and deputy prime minister. He strongly opposed Musk’s plan.
This led to many questions about the Saudi government’s use and influence of Twitter. Musk’s plan to promote free speech and remove misinformation is a double-edged sword.
Many view it as dangerous to our society, while others are tired of being censored. He also has very little experience in this industry other than tweeting about absolute randomness. Who will win this battle?
Now You Know What a Poison Pill Is
To conclude, a poison pill is a very effective strategy to prevent a hostile takeover from an inside or outside investor. Shareholders can easily find themselves on the winning or losing side. In the first two examples, the stock rose after the proposal. As for Twitter, it is too early to know.
After Musk’s initial purchase, it rose over 25%. The next weeks will dictate the future of Twitter and maybe of free speech and misinformation. Apart from Twitter, the poison pill defence has been very successful for other companies with little damage done to the core of the business.
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