Swallowing the Poison Pill - A bitter taste or a sweet escape?


In today's world of business, mergers and acquisitions are an indispensable part of the corporate strategy. However, not all mergers and acquisitions are welcoming with public listed companies being most exposed to threats of a hostile takeover. The coronavirus outbreak has undisputedly pushed corporate entities to vulnerable positions wherein entities have become attractive targets for hostile acquisitions because of the plummeted stock prices. However, with time, they have come up with varied defence mechanisms to prevent such hostile takeovers. Amongst other anti-takeover strategies, the ‘poison pill strategy’ is being advocated as a successful mechanism to combat hostile takeovers which is potent enough to ward off the bidder or acquirer but in doing so caused harm to their company as well. Hence, the name 'poison pill'.

Decoding the poison pill
A poison pill is a manoeuvre that typically makes a company less palatable to a potential acquirer by making it more expensive for the acquirer to buy shares of the target company above a certain threshold. In its simplest form, the poison pill is a shareholders' rights plan, which excludes the acquirer. The purpose of this move is to devalue the stock worth of the target company and dilute the percentage of the target company equity owned by the hostile acquirer to an extent that makes any further acquisition prohibitively expensive for him.

Of the many variants of the poison pill, the flip-in and the flip-over types are the most common. The board of directors can adopt these pills at any point in time without the shareholders’ approval. On adoption, the rights get attached to the shares and are traded along with the shares. The mechanism protects minority shareholders’ and avoids the change of control of company management. Implementing a poison pill may not always indicate that the company is not willing to be acquired. At times, it may be used as a negotiating ploy enacted to get a higher valuation or more favourable terms for the acquisition.

Many companies in the past have adopted this strategy. An example of this was Yahoo’s actions in 2000 wherein when confronted with the possibility of takeover by Microsoft, it allowed the board to issue up to 10 million new shares in the event of an acquisition offer on the table. In 2012, Netflix announced that a shareholder rights plan was adopted by its board just days after investor Carl Icahn acquired a 10% stake. The new plan stipulated that with any new acquisition of 10% or more, any Netflix merger, sales, or transfer of more than 50% of assets, allows for existing shareholders to purchase two shares for the price of one. In July 2018, the board of restaurant chain Papa John’s voted to adopt the poison pill to prevent ousted founder John Schnatter from gaining control of the company. Recently, in news is Twitter which has 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 (Elon Musk) 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.

In India too, the Software company Mindtree tried to protect themselves by a hostile takeover attempted by the cash-rich L&T by adopting the poison pill strategy which didn’t go much to their recourse. The founders and family purchased the stake of VG Siddhartha (founder of Café Coffee Day) which he had in Mindtree to collectively hold a 20% stake which earlier was only 13%. However, L&T went on to buy another 25% stake from the open market and lastly gave an open offer to the major shareholders of Mindtree to sell their stake to L&T for Rs. 980 per share. Finally, Mindtree became a Larsen & Turbo company on June 27, 2020.

Despite the solidification of the fact that the poison pill is an effective anti-takeover mechanism in sophisticated jurisdictions, the validity of the poison pill defence is yet to be tested in the Indian corporate regime. More importantly, L&T’s successful takeover of Mindtree in 2020 garnered significant attention from the stakeholders regarding the need for poison pills, and the economic fallout of the pandemic has provided an ancillary push to explore the application in the Indian regime.

Other strategies available to avoid hostile takeover
Greenmail defence: 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.

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.

Pac-man defence: It involves the target company making an offer to the acquirer 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.

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.

The most popular defence used in India has been the White Knight defence. In 2010, veteran hotelier PRS Oberoi had brought in Mukesh Ambani as a white knight to thwart a hostile takeover by ITC, then headed by the legendary YC Deveshwar. In 1987, when a Dubai-based businessman named Manu Chhabria bought a 1% stake in L&T, to defeat the Black Knight and save the company from a foreign takeover, NM Desai, the former chairman of L&T, approached business tycoon Dhirubhai Ambani to acquire more stakes than Chhabria in the company. Mr. Dhirubhai Ambani came as a White Knight and saved L&T by acquiring an 18.5% stake for approx Rs. 190 Cr over the next 2 years.

Indian legal perspective: To pop the pill or not
In India, the convergence of numerous factors like an uptick in cross-border M&A, shareholders being replaced by domestic/foreign institutional investors and resurgence in unsolicited takeover due to the pandemic, demands contemplation for popping the poison pill.

The law pertaining to takeovers is embodied in the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997, commonly referred as the Takeover Code which subtly provides safeguards to make sneaking up on the target company difficult for an acquirer. As per the Takeover Code, an acquirer is required to make a mandatory open offer upon gathering 25% shares (or voting rights). Even after triggering the mandatory offer thresholds, an acquirer may make a voluntary offer and consolidate stakes. They also impose several restrictions on the preferential allotment of shares and/or the issuance of share warrants by a listed company. In 2011, SEBI declared an overhaul SEBI (Substantial Acquisitions of Shares and Takeover) Regulations 1997 by introducing the 2011 regulations which adopted various measures and established certain regulations drafting an easy way for hostile takeovers. Since the extant framework does not strictly prohibit hostile takeovers, it becomes pertinent to explore defences like the ‘poison pill’.

The SEBI (Disclosure & Investor Protection) Guidelines 2000 require the minimum issue price to be determined with reference to the market price of the shares on the date of issue or upon the date of exercise of the option against the warrants. Such issue must also be approved by shareholders. Without the ability to allow its shareholders to purchase discounted shares/options against warrants, an Indian company would not be able to dilute the stake of the hostile acquirer and seeking shareholder approval in the event of a takeover attempt is a very time-consuming process, thereby making impossible poison pills to operate within the existing Indian legal framework. Apart from this, in the event of a takeover bid, all the directors of the target company may be removed in a single shareholders meeting, as permitted under the Companies Act, 2013, thus making futile the Staggered Board defence available to foreign companies. To this end, the Indian legal framework does not expressly bar the poison pill, but in tandem, does not facilitate its adoption by the entities.

In today’s world, the shareholders are determined to get the best value for their investment at any cost, thus, the negative image of 'hostile acquirer' amongst the shareholders of the target company seems to be a thing of the past. However, since the poison pill can be termed as a necessary evil in an age of rising mergers and acquisitions and the pandemic which is making the companies vulnerable to potential unsolicited acquirers, the time is ripe for India to calibrate the poison pill strategy in the corporate world to pre-empt hostile takeovers. By opening this window, Indian companies need to shift from desperate defensive play to sitting ready on the offensive because by deploying strategies to only protect its shareholders can lead to overdose of the poison pill which would be toxic for them.

Swallowing the Poison Pill A bitter taste or a sweet escape | The coronavirus outbreak | Decoding the poison pill | Greenmail defence | White Knight defence | Indian legal perspective | Substantial Acquisition of Shares and Takeovers | Disclosure & Investor Protection


Devika Rana