Twitter Adopts 'Poison Pill' Defence Against Musk's Takeover – But Does It Work?

A poison pill is used to dissuade an outside player from taking over by making the deal unduly expensive to them.

Musk, who currently owns about 9 percent of Twitter's shares, had offered to buy all its shares for $43 billion and take it into the private sphere.

(Photo: Altered by The Quint) 

Twitter announced on Friday, 15 April, that its board of directors had unanimously adopted a "poison pill" defence strategy after it received an "unsolicited, non-binding proposal" from billionaire Tesla CEO Elon Musk to purchase the company.

In a statement, Twitter said that the poison pill defence or "The Rights Plan" was being adopted to enable all stakeholders to realise the full value of their investment in the company.

But what is the poison pill strategy?

What is a 'Poison Pill'? 

A poison pill defence is sometimes undertaken by a company in the event of a potential hostile takeover, which implies that a player on the outside stakes their claim on the company by urging major stakeholders to sell their shares without the approval of the company's board of directors.

"The Rights Plan will reduce the likelihood that any entity, person or group gains control of Twitter through open market accumulation without paying all shareholders an appropriate control premium or without providing the board sufficient time to make informed judgements and take actions that are in the best interests of shareholders," Twitter said in a statement.

The poison pill strategy is used to dissuade the outside player from taking over by making the deal less attractive and unduly expensive to them.

The strategy allows shareholders to buy additional shares at a discounted price. The more shares they purchase, the more watered down the ownership status of the hostile player becomes, i.e. the value of the shares owned by the entity reduces.

In response to Musk's bid, Twitter announced on Friday that it would permit its shareholders to buy discounted shares if an entity owns more than 15 percent of the stock in the company without taking the approval of its board of directors.

Musk, who currently owns about 9 percent of Twitter's shares, had offered to buy all its shares for $43 billion and take it into the private sphere.

Recent Instances of Its Use

Previously, a poison pill strategy was adopted by United States (US)-based fast-food chain Papa John's in 2018. The entity undertook the move to block its founder, John Schnatter. Schnatter owned around 30 percent of the company's shares at the time, as per a report by The New York Times.

Over-The-Top (OTT) giant Netflix had also adopted a poison pill strategy in 2012 to prevent billionaire businessman Carl Icahn from taking over.

The company attempted to make it harder for Icahn to assert his claim on the company by ensuring that purchasing more shares of the company would inconvenience him. Netflix set into motion a contingency plan in case of an entity owning more than 10 percent of the company without taking the board's approval.

Companies like McDonald's and The Walt Disney Company, among others, have also adopted this strategy to fend off hostile investors.

2 Types of Poison Pills

There are two kinds of poison pills used by companies. One is called the "flip-in" pill, while the other is called the "flip-over" pill.

Flip-in permits stakeholders apart from the outside entity – who is staking claim on the company – to buy extra shares at discounted prices if the company's board is against the outside player taking over. The poison pill adopted by Twitter against Musk is a flip-in.

The flip-over is adopted in the event that an outside entity takes over the company. The flip-over permits stakeholders to purchase stocks of the new owner after the takeover occurs.

Both types are meant to reduce the value of shares owned by the outside entity and make a potential takeover highly inconvenient – mostly financially – by a hostile player.

Do They Work? 

Poison pills are quite successful. No potential buyer has ever taken the pill after it was put up by a company's board as a defence tactic, as per The Conversation.

However, such strategies are usually not encouraged as they tend to compromise a company's value. They are often viewed as a means to protect the top echelons of the company – such as its board, rather than its smaller shareholders.

However, there is one way a poison pill could benefit the company as a whole: by generating an even higher bid from a potential buyer. If the bid is high enough, the board may rethink their whole position on using the pill, and consider selling.

What may also trigger the board to rethink its poison pill defence if offered a higher price is that these pills usually come with expiration dates. The one being used by Twitter, for instance, will expire after one year.

(With inputs from The New York Times, The Conversation.)