Explained | ‘Poison pill’ and other corporate defence mechanisms to prevent hostile takeovers

Publicly listed companies are most exposed to threats of a hostile takeover. However, with time, they have come up with varied defence mechanisms to prevent such takeovers.

Tesla CEO Elon Musk’s bid to acquire Twitter was partially thwarted on Saturday with the microblogging platform deploying the ‘poison pill’ mechanism. The ‘poison pill’ mechanism is used to dilute shares of a company so that activist investors looking for hostile take-overs will incur a massive expenditure.

As part of the mechanism, Twitter put forth a shareholder rights plan that would be triggered if an entity acquires a stake of 15% or more. The plan would allow existing shareholders, excluding the acquiring entity — Mr Musk in this case — to purchase additional shares at a discounted rate, making it difficult for the acquirer to establish a majority stake in the company. The move would additionally reduce the likelihood of an entity acquiring control of the company without paying the other shareholders an appropriate premium. It was meant to buy more time as the company’s board endeavours “to make informed judgements and take actions that are in best interest of shareholders.”

Publicly listed companies across the globe often witness threats of hostile takeovers, which take place through a back-door accumulation of shares; in other words, acquiring sizeable shares from the open market than from the management.  However, with time, listed companies too have been able to come up with several defence mechanisms to prevent such takeovers. Some of them include:  

The idea here is simple: pay them to go away and stop threatening the company with hostile takeover. 

It involves the target company repurchasing its own shares at a premium and in a quantity enough to prevent a hostile takeover. The practice had once become the means for several activist investors to sell their shares at a premium by threatening a hostile takeover. 

The Wall Street Journal adds that the practice widely criticised as ‘corporate blackmail’ died down after the 1990s as “companies beefed up defences and lawmakers took steps to discourage it.” 

In 1986, broadcast company Viacom International ended a two-week long siege by repurchasing 17% of its own block of shares from prominent institutional investor Carl Icahn at $62 per share. Wall Street professionals estimated the deal helped the investor reap $21 million, as per Los Angeles Times. Mr. Icahn’s group had spent an average of $65.75 for each share, or a total of $230 million for 3.5 million shares of Viacom. However, the target company accorded it warrants priced between $65.375 and $72 for each of its common stock, which were usable for six years. Warrants are instruments that gives the holder the right, but not an obligation, to acquire the common stock of a company at any time before its expiry at a certain quantity and price. “Analysts said the warrants were attractive because of widespread predictions that Viacom stock will soar in value over the next few years,” New York Times noted in its report. Further, the publication reported, that the activist investor was given $10 million worth of free commercial air time across the company’s radio and television stations.