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What Is Poison Pill Strategy?

Created on 04 May 2022

Wraps up in 5 Min

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Updated on 10 Sep 2022

If (some) people are here because the phrase 'Poison Pill' has a certain connotation attached to it, you should see a therapist or psychiatrist.

In the 1st week of November 2012, billionaire Carl Icahn acquired a 9.98% stake in the streaming giant Netflix. This investment was a big red flag for the streaming company. This sounds familiar, doesn’t it?
Yes. Elon Musk and his Twitter acquisition.

Elon acquired a 9% stake in the company. He was also offered the Board of Director (BOD) seat, which Elon jilted. He then started to contemplate opening a new social media company but instead, he decided to just purchase Twitter. Ha!
But Twitter didn't accept Elon's offer. You'll ask how Twitter can reject Elon's purchase offer? Oh! This is exactly what we are going to talk about today but we will get to that spicy bit in a bit. 

Twitter's BOD decided to avail the 'poison pill' strategy to fend off Elon Musk.

But, we already know how efficient that was, given Elon has acquired Twitter despite the strategy. So today, we are going to talk about the 'poison pill' strategy and its previously used instances.

What is a 'Poison Pill'?

Poison pill or Shareholder's Rights Plan refers to a deterrent strategy used by a company to protect itself from getting surly acquired completely. The victim company uses this tactic to look less attractive to the potential acquirer. 

There are 2 types of poison pill strategy - 'flip-in' and 'flip-over'. The 'flip-in' poison pill strategy is the most commonly used strategy. This allows the existing shareholders to buy the newly issued shares at a discount. Except for the acquirer, the new shares can be bought by any other existing shareholder. This acts lucrative for the old investors and loss for the acquirer as their shareholding gets diluted.

On the other hand, 'flip-over' strategy permits the existing shareholders to purchase shares at discount rates after the company has been acquired. The traditional poison pill (flip-in) strategy revolves around flushing of new shares into the public. This shareholder rights plan would flood the market with newly issued shares if anyone buys more than 10% of the firm. This 10% threshold varies from company to company.

Twitter's Poison Pill for Musk

For Twitter, the threshold was 15%. Twitter’s rights plan becomes exercisable if any entity, person, or group acquires beneficial ownership of 15% or more of Twitter’s outstanding common stock in a transaction not approved by the Board. If the 15% threshold is crossed, rights holders would then be able to purchase Twitter stock for a 50% discount.

This means that to prevent some entity from acquiring a company, the company issues more shares to the existing shareholders for a massive discount. This entices shareholders to buy more shares. This leads to more supply of shares, and the company's share capital increases, thus diluting the aggressor's shareholding.

For example - let's say there are 100 shares of Twitter. Elon lands on Earth and purchases ten shares of the company. Now his stake is 10%. Twitter sees this as a threat. "It's a takeover", screams Parag Agarwal (CEO). 

So twitter decides to issue more shares. They issue 25 new shares. This increases the total number of shares to 125 from 100. Now, Elon had 10 shares out of 100. After this change, Elon will hold 10/125 which is 8% of the company. Now, if he has to buy more stake, he has to purchase more new shares. This would cost him more money, and the dupe here is that Twitter can increase its share capital as much as they want. This dilutes the aggressor's shareholding and thus prevents a hostile takeover.

Is there any other major instance where the poison pill strategy was used? Oh, yes! Just as juicy as this one. 

The mega Netflix-Carl Icahn dispute

Source: Forbes India

Who is Carl Icahn?

Carl Icahn is believed to be the most feared and ruthless investor Wall Street has ever confronted. Carl Icahn has been an activist and aggressive investor. He has been a person with bold decision-making. As of 2021, its estimated Icahn is worth $23 billion. Carl Icahn was born on February 16, 1936 in Brooklyn, New York. 

Despite having a vile childhood engulfed with negativity, Car Icahn climbed the success ladders to become one of the legendary investors of all time. The 86-year-old billionaire is the founder of Icahn Enterprises, which holds $15-20 billion in assets, and Carl Icahn holds 88% of the conglomerate.

On 31st October 2012, the shares of Netflix skyrocketed as Carl Icahn invested $321m to acquire a 9.98% stake in the streaming company. The stock price soared by 15% after the announcement broke out.

Everyone knows about Netflix. The internet movie streaming giant recently lost 2 Lakhs subscribers after 10 years. Thanks to the pandemic, Netflix was the one that helped us pass our entire day. After the pandemic got abated, things started to get normal and people were off to their offline jobs. People started to spend less time hovering over web series and shows. This impacted the growth of online movie streaming companies. Netflix lost subscribers, and even worse, their customers were sharing their account passwords, thus impacting their revenues and profits. Netflix wasn't chill anymore!

The worse had happened during 2010-12, when Netflix shares had lost 3 quarters of their value since peaking in July 2011. During that time, the company was oscillating between aborted DVDs services and streaming services. Netflix decided to commence a DVD rental model to entice tight-budget customers. This decision cost Reed Hastings a fortune. 

This hassle created some headwinds for the company's increasing profits. The company was also looking at a drop in its subscriber base. Due to a decline in its subscriber base and vile policy adoption like movie home delivery option, the company's shares fell from $300 to $58 per share, losing 80% of their value.

As every crisis brings an opportunity, Carl decided to take a 9.98% stake in the streaming company. He bought 5.5 million shares at $58 per share, for a total investment of $321 million. But Netflix was not willing to give their company to any other entity. So, Netflix decided to adopt the 'poison pill' policy to deter the aggressive investor. 

The policy stated that any new acquisition of 10% or more permitted existing shareholders to purchase shares at a 50% discount. It was surprising that Netflix fixed the benchmark to 10% which was sporadic for most companies. Usually, companies fix a threshold of 20% and more. Maybe Netflix knew that they were dealing with the 'real lone wolf of the wall street'.

Netflix was successful in fending off the billionaire investor. The poison pill strategy was victorious and helped the company to maintain its independent identity.

Conclusion

Twitter was not able to optimize the efficiency of this strategy and failed miserably. The Netflix-Carl Icahn case showcased how corporates use the poison pill strategy to save  their interest. But it's not always good for any firm to not get acquired by other firms. Maybe getting acquired could help both parties grow exponentially. 

The poison pill strategy has proven to be effective in most cases. The only dilemma the company faces is whether the acquisition will work out in favor of the company's growth or decline.

​Till we meet again and hear the next gossip! Happy investing. 

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Akshat Yadav

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Akshat is a finance enthusiast. Loves to read and write about it. Being passionate about investing, he believes any layman could excel in this subject. From companies and industries to individual stocks, he shares his thoughts on finance, stocks, and investing.

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