Poison Put

What Is A Poison Put?

A takeover defense tactic known as a "poison put" involves the target company issuing a bond that investors can redeem before the bond's maturity date. Its purpose is to raise the price a company will pay to acquire the target company.

A hostile takeover defense tactic makes it more difficult for an acquiring company to take over a target company. As part of the strategy, the target company's executives must issue bonds with a poison-put covenant.

The covenant provides that bondholders may redeem their bonds early and receive full payment if they take over the company. However, it is an additional cost the acquiring company must cover to purchase the target company.

Unlike poison pills, which affect shares and voting rights, poison puts have no such effect. Executives can use various tactics when defending their business against a hostile takeover bid. 

One such tactic is "poison pills," which aim to increase costs and decrease the likelihood of acquiring a company through a takeover bid. Although company executives are still responsible for acting in the shareholders' best interest, this takeover defense is legal.

Understanding Poison Put

A poison pill defense, known as a "poison put," gives bondholders a chance to get their money back if a hostile takeover occurs before the bond's maturity date. The takeover triggers the early repayment right stipulated in the bond covenant.

A target company that anticipates a hostile takeover offer may use new debt to issue bonds to investors as a poison pill defense. 

In the event of a hostile takeover offer, the recently issued bonds contain a clause (covenant) that gives the bondholders the option to receive an early repayment of the debt. This sum can be significant if the interest rate is high, the bond's term is long, or both. 

The strategy's main objective is to make a corporate raider face a heavier financial burden during a hostile takeover attempt.

A potential bidder must carefully evaluate the cost of acquiring a controlling interest in the target company and other related expenses, such as the target's debt payments, and make sure it has enough cash on hand to cover all acquisition costs if the target company uses the poison put defense strategy.

Not every company should use this strategy. For instance, if the target company's balance sheet is weak and it already has a sizable amount of outstanding debt, the strategy may worsen its financial situation and result in financial distress.

Example Of Poison Put

PBH Corp. is a medium-sized business operating in the tech sector. The company's management recently learned that MBC Corp., a rival, intends to launch a hostile takeover of their company. 

PBH Corp.'s management alerts the prospective offer's board of directors. As a result, the company's shareholders decided to use the poison-put defensive tactic to reject the takeover offer from MBC Corp.

The management of PBH Corp. is aware that MBC Corp. needs $300 million to acquire a controlling stake in PBH. Therefore, the board decided to issue new debt from $150 million worth of corporate bonds.

If PBH Corp. issues the bonds, a covenant with a put option will guarantee immediate repayment in the event of a takeover. In addition, the bondholders will be qualified for reimbursement at 105 percent of par value if they exercise their early payment option (i.e., 5 percent above par). 

Therefore, the total bond value will rise to $157.5 million.

The total acquisition cost for MBC Corp. will now be $457.5 million ($300 million + $157.5 million) following the implementation of the poison put defense. The high cost may effectively deter MBC from pursuing the takeover.

Now, let's look at another example. When the board of directors of a company thinks a bigger rival may try to buy it in the future, the business issues corporate bonds as a form of defense, adding to its debt load. 

The board decided to include a poison put covenant in the recently issued bonds, which states that if a triggering event, like a hostile takeover, bondholders will be entitled to early repayment of their debt.

The bonds have a $50 million market value. Therefore, the competitor must be able to afford the purchase of a controlling interest in the company's shares and the potential immediate repayment of millions in interest to bondholders to acquire it successfully.

The poison-put strategy worked well for the target company. It forced the acquirer to abandon their hostile takeover attempt as they lacked the funds to cover the additional acquisition cost.

Benefits Of Poison Put

When used as a preventative measure against hostile takeovers, the poison put technique has many advantages. The main benefits are as follows:

1. Prevents hostile acquisitions: A poison put effectively discourages hostile takeover bids by making it much more expensive for an acquirer to proceed with the takeover. It triggers the prompt repayment of bonds following a change in ownership.
2. Preserves Current Management and Strategic Initiatives: The company's present management is able to carry out its strategic plans without the disruption that frequently follows a hostile takeover thanks to the poison put.
3. Offers Bondholders Early Repayment: The option of early repayment benefits bondholders by lowering investment risk and giving them access to liquidity and security before the scheduled maturity date.
4. Maintains Value for Shareholders: The poison put protects shareholder value and voting power by not reducing the value of shares or changing voting rights, in contrast to other defensive strategies.
5. Increases Power in Negotiations: If a takeover does move forward, the target business may be able to negotiate better terms or a more advantageous agreement with the potential acquirer if a poison put clause is included.
6. Increases Market Self-Belief: By using a poison put, a firm can communicate to the market that it is ready to fight off hostile takeovers, which will increase investor confidence and possibly improve the company's reputation.

Drawbacks of Poison Put

Poison puts have substantial administrative, legal, and financial costs even though they can be a useful protection against hostile takeovers. Businesses who are thinking about using a poison put strategy must carefully assess these possible drawbacks versus the advantages.

Limitations of a poison put approach:

1. Financial Pressure on the Business: When a poison put is activated, the company must pay back its outstanding bonds right away, which puts a heavy burden on cash flow and could potentially reduce liquidity.
2. Bankruptcy Risk: The company runs the danger of going bankrupt if it does not have enough liquid assets to cover the bond obligations, especially if it already has a lot of debt or little assets.
3. Harmful Effect on Credit Score: Poison put activation can have a detrimental effect on a company's credit rating by alerting investors and credit rating agencies to financial instability, which can raise borrowing rates in the future and restrict access to capital markets.
4. Minimal Effect on Owners: Because the poison put has no direct effect on trading volume or share value, it may not have a favourable effect on stock prices or give owners instant rewards, which could negatively affect market perception.
5. Potential Obstacles in the Law and Regulation: Poison put clauses can be implemented and activated to protect the company against legal challenges from bondholders or shareholders as well as regulatory attention and costs associated with legal and compliance.
6. Intricacy and Administrative Stress: Poison put clauses can be difficult to draft, implement, and maintain administratively and legally. They also need a substantial financial and legal investment to ensure ongoing management and compliance with evolving circumstances.

Alternatives to a Poison Put

When a publicly traded company faces a hostile takeover attempt, its board of directors has several strategic options to protect the company's interests and fend off the unsolicited bid.

While the poison put strategy is one such defense mechanism, there are several other effective alternatives. The alternatives are:

1. Crown Jewel

The crown jewel defense is when a company sells off its most priceless assets, also referred to as the crown jewels, to appear less desirable to the acquiring company. The assets that generate revenue are a company's crown jewels.

The target company sells its assets to a white knight to implement the crown jewel defense. This third party purchases a company on more benevolent terms than the adversarial black knight. 

When using this strategy, the white knight typically consents to return the assets to the target business after the hostile takeover has been stopped.

Let's take a closer look at a more effective crown jewel defense tactic where Company Y sells its assets to a reliable third party:

Company X makes a bid to buy Company Y. Company Y declines the offer. However, company X goes ahead with the acquisition anyway, proposing to pay a 10% premium for Company Y's stock. 

To buy Company Y's assets for $100 million, Company Y contacts Company Z, a trusted business. A contract between Company Y and Company Z states that Company Y will repurchase its assets from Company Z at a slight premium after the hostile bidder leaves. 

Company X withdraws its hostile bid because Company Y's most valuable assets are no longer there. Company Y repurchases its assets from Company Z at the predetermined price after the hostile bidder withdraws.

2. Stock Acceleration

Stock acceleration, also referred to as triggered-option vesting is used to fend off hostile bidders by making the company less desirable and more expensive to acquire. It is similar to the poison put option in this regard. 

This strategy requires the acquiring company to pay the employee's unvested stock options when a specific event occurs. The acquisition is what causes the accelerated vesting to happen. Therefore, the vesting schedules remain in place if the sale doesn't appear.

If the acquisition goes through, the business might have trouble keeping talented workers whose continued employment might have relied heavily on their vesting percentage.

Companies may decide to speed up the regular vesting schedule for highly valued employees, which increases the present value for the workers. 

The company may face problems due to the employee benefit, including the possibility that the employee will take the money and leave the organization soon after. For both the employer and the employee, vesting changes have tax ramifications.

3. Pac-Man Defense

When a hostile bidder attempts to acquire a target company, the target company can use the Pac-Man defense. 

The acquiree becomes the hostile bidder by acquiring most of the acquirer's shares. This puts the acquirer's business and the acquisition at risk.

The Pac-Man strategy allows the target company to hunt down and consume those initially targeting them for consumption, just like its arcade game namesake. 

The target company must have sufficient resources to take over the adversarial company for the strategy to be successful.

Let's look at an example.

Internationally, the Porsche and Volkswagen Group case may be the most well-known. Porsche, led by Wendelin Wiedeking, orchestrated a hostile takeover of the much larger Volkswagen Group. 

It did this by gradually increasing its stake in Volkswagen until Porsche eventually owned over 75% of the company in 2008. Banks were reluctant to lend Porsche any more money during the financial crisis of 2007–2008. They wanted their loans paid back immediately. 

By October 2008, Porsche was experiencing record profitability but suddenly ran out of money.

Ferdinand Pich was the chairman of Volkswagen and a member of Porsche's board of directors. He was also the grandson of Ferdinand Porsche, the company's founder and a co-founder of what would become Volkswagen.

He chose to loan Porsche the money necessary to pay off their debts. This turned Volkswagen—which Porsche had tried to acquire—into the rescue, effectively taking control of Porsche. 

The battle between the Porsche and Pich families (both descendants of Ferdinand Porsche) for control of Porsche and Volkswagen finally ended. 

The historical ties between Porsche and the Volkswagen Group contributed significantly to the peculiar circumstances. Volkswagen was identified as the surviving partner when the two businesses announced their official merger later that year.

Conclusion

Although the poison put is a useful defence tactic that places a heavy financial burden on prospective buyers by enabling bondholders to redeem their bonds before they expire, it is not without problems.

The poison pill can place pressure on a business's finances and increase the likelihood of bankruptcy, particularly for businesses that are already heavily indebted. In light of these obstacles, it is imperative that businesses think about other defensive strategies.

The three strategies—stock acceleration, Pac-Man defense, and crown jewel defense—offer different ways to discourage hostile bidders by either decreasing the company's appeal or raising the price and complexity of the acquisition.

These tactics have their own benefits and drawbacks despite being very successful. The defence mechanism selection should be in line with the company's financial standing, strategic objectives, and the particulars of the takeover threat.

Companies can choose the best course of action to protect their independence and shareholder value by carefully weighing these variables, assuring stability and future expansion in the face of any acquisition attempts.

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Asset Acquisition
• BATNA
• Letter of Intent
• Mergers & Acquisitions
• Pitchbook