What is a ‘poison pill’ and why is Twitter swallowing one?

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It’s been a wild ride for Twitter investors recently, to say the least.

In just two weeks, Elon Musk became one of the social media giant’s largest shareholders, said he was joining the board, backed out of joining, and then launched a hostile takeover bid.

Now, Twitter is fighting back, hoping to maintain its independence. On Friday, management enacted a limited duration shareholder rights plan, also called a “poison pill,” in case it wants to ward off Musk’s unwelcome $43 billion “best and final” offer.

But what is a so-called corporate poison pill, and why would Twitter take one?

The corporate defense tactic dates back to the early 1980s and the dawn of the “corporate raider,” a type of investor who used inventive financing to pursue takeover targets that would have previously been too expensive.

Raiders would buy a significant portion of a company’s stock, then threaten to take over the whole company. If the takeover succeeded, they would often end up selling parts of the business to pay for their buyout, firing workers, or splitting up the firm into different entities.

Enter the “poison pill,” named after the deadly pills used by spies to avoid interrogation if they were captured. One of the 1980s’ most prominent M&A lawyers came up with the go-to defense against the feared corporate raider, even if that raider is the world’s richest person.

How do “poison pills” work?

As conceived by Martin Lipton, a partner at the white-collar law firm Wachtell, Lipton, Rosen & Katz, the poison pill is used to do one thing: make a proposed acquisition less appealing for the acquirer.

The tactic comes in two forms—called the flip-in and flip-over strategies. The flip-in strategy allows current shareholders, except for the acquirer, to purchase additional shares at a discount. This results in immediate profits for shareholders and a diluted ownership stake for the acquirer, making the deal less appealing.

A flip-over strategy, on the other hand, lets shareholders of the target company purchase shares of the acquiring company at a discount if the takeover is successful. This, in turn, dilutes the equity in the acquiring company and, again, makes the deal less appealing for the company threatening a hostile takeover.

In 2012, Netflix successfully used a poison pill to fend off a takeover bid from Carl Icahn, one of the most famous corporate raiders of the 1980s who is now worth over $16 billion. The company flooded the market with shares, making it excessively costly for Icahn to complete an acquisition.

Now Twitter is following suit, enacting a flip-in poison pill strategy in an attempt to prevent Musk from acquiring the company.

Under the new plan, which is set to expire on April 14, 2023, if any person or group acquires at least 15% of Twitter’s common stock without the board’s approval, current shareholders will be allowed to purchase additional shares at a discount.

“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 judgments and take actions that are in the best interests of shareholders,” Twitter’s board said in a press release.

It appears Elon Musk’s 1980s-style corporate raider tactics have triggered an equally retro defense strategy from Twitter, and the Twitter buyout plot continues to thicken.

The poison pill isn’t the only strategy Twitter is using to counter Musk’s offer. It may also look for a so-called white knight to counter Musk’s offer and buy the company instead, according to well-known investor Mark Cuban. “Every major tech company, Google, FB, et al is on the phone with their anti-trust lawyers asking if they can buy Twitter and get it approved. And Twitter is on the phone with their lawyers asking which can be their white knight. Gonna be interesting,” Cuban wrote in a tweet on Thursday.

This story was originally featured on Fortune.com





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