A Poison Pill, also known as a Shareholder Rights Plan is a takeover defensive tactic used by a target company to thwart an attempted hostile takeover. This action can be preemptive in as much as the provision for adoption of the pill can be arranged by the board somewhat in advance. Alternatively, it can be invoked on an ad-hoc basis to either deter possible acquirers altogether as required or used to improve the negotiating position of the target firm. Poison Pills are not allowed in the UK under Takeover Panel rules.
A recent example of the use of the adoption of a poison pill in the U.S. is by Red Robin Gourmet Burgers (RRGB) in response to a hostile takeover approach from Vintage Capital. In addition to refusing to entertain the bid, the RRGB board adopted the pill to thwart the toe hold position of Vintage Capital increasing. This act however did not deter Vintage as more activists denounced to action by RRGB citing the destruction of shareholder value and the entrenchment of management and the board of directors. The subsequent drop in the stock price, in fact the threat of bankruptcy following the outbreak of the coronavirus has forced management to become more conciliatory. Constructive talk have since taken place between the target and the would be acquirer which resulted in Vintage being permitted to increase their position to 20% so long as the company adheres to a customary standstill agreement and no longer seeks board seats for its own associates.
In this case, the adoption of the poison pill to deter the acquirer has been rendered useless by prevailing economic conditions. Increased dialogue and a collaborative approach have been adopted as a more rewarding approach. A common element in mergers and acquisitions negotiations. However, according to figures published by Dealpointdata, March, 2020 saw a resurgence of the tactic being adopted as companies looked to defend themselves against unwanted opportunistic takeovers in light of the Covid-19 pandemic and its effect on stock prices.
Poison Pill Mechanics
Enacting a poison pill results in new stock being issued to existing shareholders providing they are below a given threshold. Usually a right to purchase a new share is distributed as a dividend to existing shareholders. A shareholder above this threshold receives nothing. Thus, the unwanted shareholder sees dilution of their larger holding. This is done to such an extent that a takeover becomes uneconomical following the losses caused as the stock price adjusts accordingly.
See our article Hostile Takeovers and Merger Arbitrage – What All Traders Should Know for a discussion on hostile takeover defense tactics.
