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- What is a poison pill?
- What types of poison pills are there?
- What are the disadvantages of poison pills?
- What if shareholders don’t want a poison pill?
- Where does this leave Elon and Twitter now?
Poison pill swallowed
*TWITTER ADOPTS LIMITED DURATION SHAREHOLDER RIGHTS PLAN
— zerohedge (@zerohedge) April 15, 2022
By now you may have heard that after Elon Musk made an unsolicited offer to buy all the shares of Twitter, and in response, the Twitter Board of Directors adopted what is call a poison pill defense to prevent the takeover.
But what exactly is a poison pill, and how can it stop Elon from taking over the company?
Let’s break that down here, shall we?
💊 What is a poison pill?
In essence, a poison pill is a shareholder rights plan that restructures the change of control (takeover) provisions for a target company which has received an unsolicited or hostile takeover offer from an acquiring party.
Referring to the suicide or L-pill filled with cyanide that World War II era spies used in the event they were captured, the adoption of a poison pill by the target makes the company much less desirable to acquire and effectively prevents the unwanted takeover.
The premise, of course, is that the poison pill is meant to protect the shareholders, the actual owners of the company from the big bad hostile buyer.
But how exactly does a new shareholder rights plan or poison pill do this?
That depends on the pill and its mechanism, of course. So, let’s walk through those next.
📜 What types of poison pills are there?
There are numerous types of poison pill plans, but the most popular and effective ones are: preferred stock plan, the flip-in, the flip-over, the back-end rights plan, and golden handcuffs.
In preferred stock plans, the company issues a special dividend of preferred voting shares to the current shareholders of the company, in effect giving them special voting rights if an outsider suddenly bought a large block of shares. This is sort of a pre-emptive poison pill and would be difficult to adopt amidst a current hostile takeover. Frequently used before the LBO days of KKR and Bain, the preferred stock plan is rarely used as a poison pill defense now.
The flip-in poison pill is the most common of defenses, and it is where the current shareholders receive the right to buy a large number of shares below the market price, locking in an immediate profit and diluting the hostile acquirer’s shares significantly. The rights are triggered when any non-approved acquirer purchases too much of the target company shares, say 15% or 20% (set by the board), and triggers the flip-in. After the new shares are issued, the acquirer must then pay a much higher price in order to complete the takeover, now at an extremely unattractive cost.
The flip-over poison pill mirrors the flip-in approach and allows stockholders of the target company to purchase the shares of the acquiring company at a deep discount price if a hostile takeover is completed. This only works, of course, when there is a stock for stock purchase from another company and does not prevent a cash tender or offer from an individual or private company.
In a back-end rights plan, a poison pill is similarly triggered when the acquirer buys a certain percentage of outstanding shares of the target company. The back-end rights plan typically gives current shareholders the right to exchange their shares of stock for cash or preferred stock attached with super voting rights. The idea here is that the acquirer may be able to buy a large number of shares in a public offer, but would be unable to complete the acquisition at a desirably low price. That said, if the acquiring company then offers a price higher than the back-end plan offer, then this poison pill tactic will fail.
Another anti-takeover provision that is sometimes used is a twist on golden handcuffs. You may have heard the term referring to high-level executives receiving performance-based compensation or stock, keeping them tethered to the company while these options or the deferred compensation vests. But golden handcuffs can also be used in a poison pill type of defense by the target company. By triggering an immediately vested windfall of stock options or compensation, thereby removing the key employees’ golden handcuffs, the acquirer most likely loses the most important leaders of the company. This is only effective, of course, when the key employees are vital to the performance or success of the company going forward.
👎 What are the disadvantages of poison pills?
You may have already realized that there are some major disadvantages of poison pills. First and foremost, there’s a large amount of dilution that occurs with most of the strategies, forcing current investors to invest more into their holdings just to retain their current percentage of ownership.
Think of it this way: say you own the right to eat one piece of a cake that the baker has agreed to split evenly into eight pieces. Then the baker decides to split the cake into sixteen pieces instead, but keeps the same price per piece. You now have to buy an additional piece to have the same amount of cake you originally paid for and you wind up paying twice as much. This is dilution.
Secondly, the company itself becomes a less attractive investment for institutions, as any type of takeover premium the shares may enjoy in the market is now tempered by the poison pill. This has the effect of holding the shares below a price they may normally achieve without a poison pill in effect.
Lastly, of course, poison pills can be a self-serving defense for poor management to remain in place, regardless of ineffectiveness or incompetence. This last one often leads to shareholder lawsuits and drags the company through months or years of underperformance before it can right itself and perform optimally for the shareholders. Kind of like squatters refusing to leave your rental house, always late and low on rent, egregiously using the utilities, and letting the house fall into disrepair.
Poor management can destroy a company.
🚫 What if shareholders don’t want a poison pill?
So, let’s say the shareholders recognize the above drawbacks and want to prevent the adoption of a poison pill. Often, if a flip-in or flip-over approach is used, the board of directors adopt the measure in an emergency midnight meeting and shareholders have no opportunity to prevent it.
So what can they do?
There are basically two actions shareholders can take if they would like to reverse a poison pill tactic. The first is a large shareholder or group of shareholders can seek to install a new set of board members in order to vote on removing the newly adopted poison pill. This, however, takes time and requires a special shareholder meeting to be called with the agenda of proposing a new slate of directors. Problem is, most boards are staggered, and members’ terms end on different dates over the course of a number of years. By the time the shareholders install a new board, the point is often moot, as the acquirer has left the building and has no interest in pursuing a merger or takeover any more.
The second and most American thing the shareholders can do is, of course, sue. By launching a shareholder lawsuit, they can seek to have executives or board members removed from the company due to what they argue is a breach of fiduciary duty. By claiming the executives are not acting in the best interests of the shareholders and they have not been good fiduciaries for the company, the shareholders argue they should be removed by a court of law.
You may be thinking, well, this would take as long or even longer than proposing a new slate of directors and it’s probably difficult to even prove a breach of fiduciary duty. And you are correct. It is an exceedingly difficult and long process and not often effective.
🍿 Where does this leave Elon and Twitter now?
While I won’t even try to speculate what Elon Musk is thinking and what his response will be, let’s review exactly where things sit with Twitter and what his options are, as he has been quoted as having a Plan B in the works.
First, on April 4th, Elon disclosed he had bought 9.2% of the outstanding shares of Twitter. Then on April 14th, Elon sent a letter to the Twitter Board of Directors offering to buy the rest of the company for $43 billion or $54.20 per share. The offer was said to be subject to due diligence and certain terms to be agreed to before a definitive agreement would be signed and the offer officially launched.
Twitter’s response, as you may know, was to adopt the flip-in version of a poison pill. The special shareholder rights plan is exercisable if a party acquires 15% of Twitter stock without prior approval. Shareholders can buy additional shares at a deep discount to the price of the stock at the time the plan is triggered. The plan is set to expire on April 14th, 2023. Massively dilutive poison pill, ruining the takeover offer from Elon.
Possible options going forward for each party are:
Twitter, who is reportedly working with JP Morgan and Goldman Sachs investment bankers, could find a white knight suitor. This would be someone to take the company private with the assurance that the current executives and a number of the current board members would stay in place going forward. Otherwise, with the poison pill already in place, the company would likely remain as is until at least April 14th, 2023.
Elon has a few options and is reportedly working with Morgan Stanley bankers to explore them. First, he could seek to install a new slate of directors by calling a special meeting, but as the board is staggered with varying terms and lengths, this would be an uphill battle. Second, he could initiate a lawsuit on behalf of the shareholders, claiming breach of fiduciary duty by the board members for not accepting his offer which represented a ~42% premium to the shares before he disclosed his 9.2% stake. Third, Elon could find a partner company to join his bid, one that the board may be open to working with, and seek to strike a friendly agreement in lieu of a hostile takeover at close to current prices. Not likely.
And finally, Elon could just dump his 9.2% Twitter holding, most likely pushing the share price lower to spite the board of directors, and simply walk away with a modest profit.
What happens next is anyone’s call, but this is what makes situations like this fascinating and a great learning experience for all.
So, grab your popcorn and let’s see what happens next.
That’s it. I hope you feel a little bit smarter knowing about poison pills, how they work, and what may happen in the Twitter battle with Elon.
As always, feel free to respond to this newsletter with questions or future topics of interest!