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'Poison Pill' Defense

Updated: Jun. 16, 2023By: Kent Thune

A poison pill is a shareholder defense that a target company can use to prevent a hostile takeover from an acquirer. See examples of poison pills, how they work, and how a shareholder rights plan can help to enact these defense strategies.

The business term "Poison Pill" defined in dictionary or encyclopaedia

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What Is a Poison Pill?

A poison pill, or a shareholder rights plan, is a defense tactic enabling shareholders of a corporation to protect against a hostile takeover from an acquiring company or investor. Typical poison pills are enacted when shareholders are given the right to buy additional shares at a discount, which can make a takeover less financially unattractive to an acquirer.

As the name suggests, the poison pill name for the shareholder rights plan comes from the tactic a spy might use to prevent being captured and questioned by an enemy. Similarly, in a hostile takeover, the target company often quite opposed to being taken over by the acquiring company or investor.

Other types of poison pills are possible, such as golden parachutes, which is the trigger of large severance packages to senior executives who are likely be removed from their roles following an acquisition from another party.

Poison pills are typically triggered when an investor reaches a certain percentage threshold of share ownership.

How the Poison Pill Defense Works With Investing

Let's say that a target company's board of directors wants to prevent a hostile takeover. The poison pill defense could be triggered if one shareholder buys 10% or more of the target company's shares. If the threshold is met or exceeded, the poison pill is triggered.

When the poison pill is enacted, every other shareholder, with exception of the one who owns 10%, would have the right to buy newly issued shares at a discount. When other shareholders buy new shares at lower prices, this dilutes the shares of the 10% owner, making it difficult for a takeover to occur without the board's approval.

Flip-In vs Flip-Over Poison Pills

There are different poison pill defense strategies that targeted companies can enact to prevent a hostile takeover from an acquiring company or investor. The two primary types of poison pill defense strategies are the flip-in strategy and the flip-over strategy.

  • Flip-in poison pill strategy: Enables shareholders, except for the acquiring company or investor, to purchase newly issued shares at a discount. The new shares dilute the shares held by the acquiring company or investor, which can prevent the takeover by making it more difficult and less attractive for the acquirer.
  • Flip-over poison pill strategy: Opposite of a flip-in poison pill strategy, enables the target company shareholders to buy shares of the acquiring company at a discount. This strategy occurs when a hostile takeover is imminent and the defense provision may prevent the acquirer from completing the takeover if it feels that a dilution of value would occur post-acquisition.

Note: Dilution occurs when a company issues new shares of stock, which reduces the proportional ownership value and the voting power of existing shares.

Poison Pill Restrictions & Disadvantages

A poison pill defense, which is part of a shareholder rights plan to defend against hostile takeover, can be effective in thwarting a hostile takeover. However there are some poison pill disadvantages, such as share dilution, that can be drawbacks to the maneuver.

  • Dilution of shares: A key defense aspect of a poison pill, dilution may also negatively affect existing shareholders because the issuance of new shares reduces proportional value of the shares, thus buying more shares is required to maintain their prior ownership percentage.
  • Discourages institutional investors: Institutions and large investors may be hesitant to buy into a company that aggressively defends against potential suitors.
  • Poor corporate governance: Ineffective managers and board directors looking to defend their positions can retain power through a poison pill defense plan, even without a vote from shareholders who may benefit from an acquisition.

Poison Pill Examples

There are multiple poison pill examples in market history, most recently the Twitter poison pill enacted to defend against Elon Musk's original takeover attempt in April of 2022. Other examples of shareholder rights plan enactments include Netflix, Pier 1 Imports, and Papa John's.

Netflix Poison Pill: November 2012

The Netflix poison pill was enacted in November 2012 against the notorious corporate raider, Carl Icahn, when he purchased a 10% stake in Netflix (NFLX). When Icahn publicly suggested that NFLX could be attractive to a larger tech firm, Netflix CEO and co-founder, Reed Hastings, enacted the shareholder rights plan as a defense.

Since Netflix was beginning to see competition from other streaming services, such as Hulu, Icahn's suggestion that Netflix could be ripe for takeover was arguably correct. However, the Netflix poison pill would prove effective and NFLX would go on to see exponential growth in the years to follow.

Papa John’s Poison Pill: July 2018

In July 2018, John Schnatter, the founder of Papa John's (PZZA) and its largest shareholder, attempted to gain control of the company. To defend against a takeover, the company's board of directors enacted a shareholder rights plan, or a poison pill provision.

At the time of the attempted takeover, Schnatter owned 30% of PZZA. The poison pill defense, according to The New York Times, the defense plan would be implemented if Schnatter increased his ownership in the company to 31%, or if anyone purchased 15% of the company's stock without board approval.

Twitter Poison Pill: April 2022

The Twitter poison pill defense occurred in April 2022, when the founder of Tesla (TSLA), Elon Musk, bought a 9.2% stake in Twitter (TWTR). Shortly following this purchase, Musk announced an offer to buy Twitter outright at a price of $54.20 per share. Twitter's board of directors then announced the poison pill shareholder defense.

The poison pill provision put in place by Twitter's board would allow for shareholders to buy newly issued shares in the market at a discounted price. This would effectively dilute Musk's shares, which would reduce and weaken his ownership stake, meaning he would have to pay more to buy Twitter.

Bottom Line

A shareholder defense plan, known as a poison pill provision, can be an effective measure to protect a target company against a hostile takeover from an acquiring company or investor. While poison pills can be an effective defense tactic, they are not always beneficial to shareholders, as share ownership is diluted.

This article was written by

Kent Thune profile picture
Kent Thune, CFP®, is a fiduciary investment advisor specializing in tactical asset allocation and portfolio management with a focus on ETFs and sector investing. Mr. Thune has 25 years of wealth management experience and has navigated clients through four bear markets and some of the most challenging economic environments in history. As a writer, Kent's articles have been seen on multiple investing and finance websites, including Seeking Alpha, Kiplinger, MarketWatch, The Motley Fool, Yahoo Finance, and The Balance. Mr. Thune's registered investment advisory firm is headquartered in Hilton Head Island, SC where he serves clients all around the United States. When not writing or advising clients, Kent spends time with his wife and two sons, plays guitar, or works on his philosophy book that he plans to publish in 2024.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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