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

Greenmail Defence  

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.

Crown Jewel defence 

The mechanism involves the target company spinning-off its crown jewel unit, or its most valued asset, in order to make the acquisition less desirable for the acquirer. The asset could be the unit that is most profitable unit in the company, or is important for future profitability, or produces the flagship product of the company.  

In September 2020, France-based Veolia Environnement SA initiated a bid to acquire 30% of utility company Suez SA from the state-backed utility company, Engie. Financial publication Bloomberg reported that the acquirer was opportunistically exploiting a depressed COVID-19 situation. It had reported, “Suez’s justified outrage at this move, which would put Veolia boss Antoine Frerot in pole position to swallow the entire company, hasn’t been backed up by a convincing alternative, however.” 

The defence was centred around Suez’s French water business. News agency Reuters reported in April 2021 that in an effort to force Veolia to negotiate, Suez set up a Dutch foundation to prevent the sale of the water business deemed essential for its rival to divest and thereby, receive the antitrust approval to buy Suez. The Dutch foundation was meant to ensure that would own a symbolic but a powerful piece of the company and does not split from the group. In turn, this would make Suez unbuyable.

Pac-man defence 

The idea is simple: prevent a hostile takeover by initiating a reverse takeover. It involves the target company making an offer to the acquire the company that commenced the takeover bid. The target company could make use of its ‘war chest’ or securing finances from outside for the reverse takeover bid.

Pac-Man was a popular yesteryear video game. The player is required to gulp all the power pills escaping the ghosts that are chasing the Pac-Man character. Once the player has acquired all the pills, the ghosts turn blue, allowing ‘Pac Man’ to eat them and acquire bonus points. 

In 1999, Richmond-based paper-recycling company Chesapeake Corp launched an unsolicited bid for Shorewood Packaging. The latter had previously tabled an offer to purchase the former Chesapeake for $480 million at $40 for each share. In response, Chesapeake upped its bid to acquire Shorewood at $17.25 per share from an initial $16.50 per share, reported CNN Money. Shorewood rejected the offer and after three months it was acquired by North America-based company, International Paper.  

White Knight defence  

In case a company’s board finds itself in a situation that it cannot prevent a hostile takeover, it seeks a more accommodative and cordial firm to acquire a controlling stake from the hostile acquirer. The ‘White Knight’ agrees to restructure the company adhering largely to the desires of the target company’s board, also providing a fair consideration.

Automobile maker Fiat bailing out Chrysler from a liquidation crisis in 2009 is a case in point.

Chrysler, like many other automobile manufacturers at the time was witnessing a downswing in sales following the global economic crisis of 2008. It had to initiate bankruptcy proceedings in April 2009. This initiated a search for a potential buyer to bail it out from the crisis by infusing some cash into the company. Chrysler was previously endowed $4 billion from the U.S. Treasury Department in December 2008 and another $4 billion in 2009 to keep the company afloat. But the other overall macroeconomic downturn did not help its revival ambitions. Its near deals with Nissan and Kia Motors collapsed because of the same reason. Additionally, the companies were believed to be unwilling to infuse cash into the beleaguered company.

It was later that Fiat emerged as the white knight. The terms of the deal held that Fiat would not immediately infuse cash into the company, but as The Wall Street Journal reported, obtain a stake in exchange for covering the cost of retooling a Chrysler plant to produce Fiat models in the United States and provide engine and transmission technology.