- July 28, 2022
- Posted by: Ramkumar
- Category: Posts
𝐇𝐨𝐰 𝐝𝐨𝐞𝐬 𝐚 𝐩𝐨𝐢𝐬𝐨𝐧 𝐩𝐢𝐥𝐥 𝐰𝐨𝐫𝐤
Hostile mergers and acquisitions happen when a publically listed target company performs poorly over a period and an acquirer, either within the same industry or different, intends to acquire the target company at a premium. Here, I describe how a poison pill works.
Generally, the buyer approaches the target board or CEO with an offer to acquire the firm and intends to have a friendly deal. However, when the target board refuses to accede to the buyer’s offer price, the buyer approaches the target shareholders 𝐝𝐢𝐫𝐞𝐜𝐭𝐥𝐲 𝐰𝐢𝐭𝐡 𝐚 𝐭𝐞𝐧𝐝𝐞𝐫 𝐨𝐟𝐟𝐞𝐫.
The buyer’s rationale for the bid is that they can operate the firm better than the target by investing capital in better projects, financing investments at lower costs, and returning excess cash to shareholders through dividends/buybacks.
To counter the buyer, the target firm employs pre-takeover defences. For example, the poison pill is a famous takeover defence as it raises the buyer’s acquisition cost.
For instance, let us assume the following:
CMP of target firm pre-hostile bid = $10
Target firm shares pre-deal with public = 100
Management stake = 35% and public stake = 65%
The buyer approaches the target shareholders with a tender offer with the following:
Offer price/Share = $14 for acquiring 65% stake
Fearing that the target shareholders will tender their share at a 40% premium, the target board adopts a poison pill by allowing existing shareholders to buy one additional share at a nominal price (Let us assume it as $2/share) if the target shareholders exercise, the outstanding shares double to 200, which effectively doubles the offer price for the buyer.
Though the 𝐩𝐨𝐢𝐬𝐨𝐧 𝐩𝐢𝐥𝐥 𝐢𝐧𝐜𝐫𝐞𝐚𝐬𝐞𝐬 𝐭𝐡𝐞 𝐭𝐚𝐤𝐞𝐨𝐯𝐞𝐫 𝐜𝐨𝐬𝐭, 𝐢𝐭 𝐚𝐥𝐬𝐨 𝐝𝐢𝐥𝐮𝐭𝐞𝐬 𝐭𝐡𝐞 𝐦𝐚𝐧𝐚𝐠𝐞𝐦𝐞𝐧𝐭 𝐨𝐰𝐧𝐞𝐫𝐬𝐡𝐢𝐩 𝐚𝐧𝐝 𝐭𝐡𝐞 𝐨𝐯𝐞𝐫𝐚𝐥𝐥 𝐭𝐚𝐫𝐠𝐞𝐭 𝐩𝐫𝐢𝐜𝐞. Thus, in my experience, the poison pill is a 𝐧𝐞𝐠𝐨𝐭𝐢𝐚𝐭𝐢𝐨𝐧 𝐭𝐚𝐜𝐭𝐢𝐜 adopted by a shareholder to increase the acquirer’s bid cost and not to prevent the takeover.