A notable historical example illustrates how the poison pill strategy is applicable in practice: Oracle’s attempt at acquiring PeopleSoft. Although Oracle bid $5.1 billion initially, the use of the people soft forced them to negotiate a much higher price of $10.3 billion. This case study serves as a clear illustration of how powerful the poison pill can be if effectively employed by a board of directors to resist unwanted takeovers and obtain more favorable terms for shareholders.
In this blog, we will get a comprehensive guide on what exactly a poison pill strategy is, its types, and its usage. Along with that, we will also discuss how this strategy is employed in the real world, why it is used, and some of its advantages and disadvantages.
Table of Contents:
Check out this Investment Banking Online Course video to learn more about the concepts of Investment Banking:
What is a Poison Pill Strategy?
Definition: A poison pill strategy is a defensive tactic employed by a company’s management to discourage or prevent hostile takeovers. The strategy involves implementing measures that make the target company more difficult to acquire. A typical approach is to provide fresh shares to current shareholders to increase their ownership and weightage of their voting rights. This will also reduce the hostile acquirer’s ownership position and raise the cost of the data acquisition. This strategy seeks to financially exclude potential buyers by making a purchase unappealing.
Example: A real-world example of a Poison Pill Strategy occurred in 2012 when Yahoo implemented a shareholder rights plan to fend off a hostile takeover by Microsoft. Yahoo issued additional shares to existing shareholders, making the acquisition more challenging and less appealing for Microsoft. Poison Pill Strategies are controversial and often spark corporate governance and shareholder rights debates. This actual case highlights how controversial Poison Pill Strategies are and how they fit into the larger picture of business law.
Sign up for your Investment Banking Course today and start your journey to success!
History of Poison Pill Strategy
The poison pill strategy, invented by Martin Lipton in 1982, was developed as a countermeasure against the wave of hostile takeovers by corporate raiders. Named after the historical practice of spies using lethal pills to evade capture, this tactic aims to deter unwanted takeovers by making them financially unattractive.
Initially, its legality was uncertain until the Delaware Supreme Court upheld its validity in 1985. While widely used in the U.S., its application is restricted or banned in many foreign jurisdictions. Critics argue it can entrench management, while supporters see it as crucial for protecting companies from opportunistic takeovers.
Types of Poison Pills
Poison pills come in various forms, each with its own strengths and weaknesses. Here are some of the most common types:
In a flip-in poison pill, current shareholders are given the right to purchase extra shares at a discounted rate in the event of a hostile takeover attempt. This dilutes the shares held by the acquiring company, making the takeover more expensive.
Instead of allowing shareholders to buy discounted shares, a flip-over poison pill allows existing shareholders to purchase the acquiring company’s shares at a discounted price after the completion of a merger. This benefits shareholders by providing them with shares in the merged entity at a lower cost.
This type of poison pill allows only the current board (or a portion of it) to redeem the rights, preventing a new board, installed by the acquirer, from redeeming them.
Explore the Investment Banking Career Path and get some good initiatives for becoming an investment banker.
How Do Poison Pills Work?
The board of directors of a company may use a poison pill as an obstacle against hostile takeover attempts. It typically involves the application of specific terms or procedures that increase the difficulty and financial appearance of the target company’s acquisition for the hostile acquirer.
ImagePoison pills are resistant measures set up by companies to put off hostile takeovers. The “flip-in” provision is an anti-takeover defense mechanism that allows existing shareholders to purchase additional shares at a discounted price if a hostile bidder accumulates a specified percentage of the total shares of the company, thereby diluting his stake. On the other hand, under the same circumstances, the acquirer’s financial stability can be affected by “flip-over”, where the target company’s shareholders purchase the acquirer’s shares at a reduced cost. The “dead hand” provision seeks to prolong the period during which poison pills will be operative even when their original principal is gone, thus extending their deterrent effect against hostile takeovers. These strategies allow time for the evaluation of alternative options or improved terms through bargaining on behalf of target companies’ boards, which may likely discourage such bids.
Why is the Poison Pill Strategy Used?
The term “poison pill” suggests that the strategy is unappealing or harmful for the party trying to take control. Here are some reasons why companies might employ the poison pill strategy:
- Hostile Takeover Deterrence: The primary purpose of a poison pill is to make a hostile takeover financially unattractive or difficult. By triggering certain provisions in the poison pill, such as issuing new shares at a discount to existing shareholders, the target company can dilute the acquirer’s (an “acquirer” refers to an individual, company, or entity that takes steps to acquire or purchase another company) ownership stake, making the acquisition more expensive.
- Protecting Shareholder Interests: Poison pill advocates argue that the purpose of the policy is to safeguard stockholders’ interests. The goal of the poison pill is to prevent a hostile takeover and guarantee that shareholders make important decisions about the company’s future.
- Time for Evaluation: Poison pills give the targeted company’s management more time to think about and respond to a takeover offer. This extra time allows the board to consider other strategies, look for different potential buyers, or think about restructuring options without feeling rushed into making a decision.
- Encouraging Fair Value: Poison pills can be structured to encourage a fair value for the company. If an acquirer is genuinely interested in acquiring the target, they may be more willing to negotiate a fair price rather than face the obstacles posed by the poison pill.
- Protecting Employees and Corporate Culture: The management of a target company may be concerned about the potential impact of a hostile takeover on employees and the existing corporate culture. Implementing a poison pill can help to maintain stability and continuity in these areas.
Check out these Top 35 Investment Banking Interview Questions to ace your interview.
Examples of Poison Pill Strategy
Below are some examples of the Poison Pill Strategy.
- eBay and Craigslist (2005)
In 2005, eBay, the online auction giant, faced resistance from Craigslist, a classified advertisement website, regarding eBay’s minority stake in the company. eBay had acquired a minority interest in Craigslist with the hope of acquiring a more significant share. However, when tensions rose and eBay attempted to sell its stake, Craigslist enacted a poison pill provision. This move restricted eBay from selling its shares to an outside party without the approval of Craigslist’s board, effectively blocking eBay’s takeover aspirations.
- Hewlett-Packard (HP) and Xerox (2019)
In 2019, Xerox launched a hostile takeover bid for Hewlett-Packard (HP), proposing a merger between the two technology companies. HP’s board rejected the offer, stating that it significantly undervalued the company. In response to the hostile takeover attempt, HP implemented a poison pill strategy, allowing existing shareholders to purchase additional HP shares at a discounted price. This move aimed to thwart Xerox’s bid by diluting the value of the shares and making the acquisition less attractive to Xerox and its shareholders.
- Pfizer and AstraZeneca (2014)
In 2014, Pfizer, a pharmaceutical giant, pursued a hostile takeover of AstraZeneca, a British-Swedish multinational pharmaceutical company. AstraZeneca resisted the acquisition, arguing that Pfizer’s offer undervalued the company. To fend off the hostile takeover, AstraZeneca’s board implemented a poison pill strategy. The provision allowed existing shareholders to purchase additional AstraZeneca shares at a discounted price, making the acquisition more challenging and financially less appealing for Pfizer. The poison pill, along with regulatory concerns, eventually led to the collapse of the takeover attempt.
Advantages and Disadvantages of Poison Pill Strategy
This strategy involves implementing measures that make the target company less attractive or more difficult to acquire. While it can be an effective tool for protecting a company’s interests, it also has its advantages and disadvantages.
Advantages of Poison Pill Strategy
- Poison pills discourage hostile takeovers by increasing acquisition difficulty and reducing financial security.
- It grants shareholders the option to buy discounted shares, making takeovers more costly for acquirers and securing better deals for shareholders.
- It enhances the target company’s negotiating power, potentially resulting in more favorable terms for both shareholders and the company.
- It provides management and the board with time to evaluate takeovers, explore alternatives, and seek a more favorable merger partner.
Disadvantages of the Poison Pill Strategy
- Critics argue poison pills can protect management, hindering adaptability to market changes and response to poor performance.
- The strategy may lead to a stock price decline, signaling to investors a resistance to value-creating transactions. In light of this, accurate stock market predictions become crucial for investors to navigate potential risks and make informed decisions regarding their investment portfolios.
- Poison pills may face legal scrutiny for obstructiveness, requiring companies to navigate legal requirements carefully.
- Implementing a poison pill incurs legal and administrative expenses for companies.
Conclusion
We hope this article helps you gain knowledge of Investment Banking course online. If you are looking to learn best Investment Banking course in a systematic manner from top faculty & Industry experts then you can enrol to our Investment Banking course.
For getting solutions to any queries related to this topic, visit us on our !
FAQs
How does the implementation of a poison pill affect the company's stock price in the short term?
Introducing a poison pill can cause the stock price of the company to go down in the short term because of uncertainty in the market and apprehension about the firm’s defensive position against possible takeovers. By accepting a poison pill, investors may perceive it as an indication that resistance to change is being demonstrated. Such can affect investor sentiment adversely and confidence in the capacity of the company to adjust for market changes.
Can a poison pill be used defensively in friendly takeover situations?
Yes, poison pills may be used as defense mechanisms during friendly takeover scenarios. It prevents unfair negotiation, ensuring that both sides have an equal say on what they want. The target firm will either strike a better deal by making it more expensive for the acquiring party or ensure that such an acquisition shall serve all stakeholders’ interests.
Are there any legal precedents that have upheld the use of poison pills as a legitimate defense against hostile takeovers?
Yes, there are previous court cases that have supported using poison pills as legitimate defenses against hostile takeovers. Poison pills are seen as consistent with directors’ fiduciary duty to shareholders and as a way to counteract unfairness committed by bidders seeking control over corporate assets. However, judicial treatment and authorization of anti-takeover measures like these depend on the laws of different jurisdictions and specific circumstances surrounding each case.
How do institutional investors typically respond to the presence of a poison pill in a company they invest in?
The presence of a poison pill may evoke mixed feelings among institutional investors. Some of them may see it as a means to safeguard the rights of shareholders, while others perceive it as negative evidence that the company is not open to negotiations or cannot easily embrace change. Investors’ response depends on their assessment of how the company is structured and whether integration will be facilitated after the takeover.
What role do proxy fights play in the context of a company with a poison pill strategy?
When there is a disagreement among shareholders about either the appropriateness of this strategy or where the business should go, proxy battles can be relevant in companies with poison pills. A possibility arises where shareholders vote on whether to remove board members or make changes to poison pills, leading to heated battles influencing decisions made by management in relation to governance within an organization.
How do poison pills impact the dynamics between the target company's management and its shareholders?
In fact, poison pills have far-reaching implications for relationships between a corporation’s top executives and its stockholders. Although aimed at shielding stockholder interests, incorporating a poison pill into corporate policy frequently appears as an exercise favoring management over stakeholders, especially if used by executives for managerial entrenchment or slowing down necessary alterations. This brings in tensions and conflicts, which eventually affect performance and relations with those who own shares in such firms.