Corporate Raiders Beware: A Short History of the “Poison Pill” Takeover Defense

Since the heyday of corporate raiders in the 1980s, so-called poison pills have been a standard – and powerful -- corporate defense against hostile takeovers. So what exactly are they?

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On Halloween, infamous corporate raider Carl Icahn showed up on Netflix’ doorstep with something designed to truly frighten those in charge of the troubled DVD-and-streaming-video giant: an announcement that he’d taken a nearly 10% share in the company, the opening move in a possible hostile takeover — or at least some sort of big shakeup — that would likely leave a lot of the current execs looking for new jobs.

The Netflix board responded, predictably, with something other than a treat, announcing on Monday that it had instituted a “shareholder-rights plan” — known colloquially as a “poison pill” — intended to make any attempted takeover costly indeed for any takeover artist.

The terms of the plan are simple: If anyone buys up 10% or more of the company — only a smidgen more than the 9.98% Icahn has already accumulated — the board will allow shareholders to buy newly issued shares at a discount, diluting the stake of any would-be corporate raiders like Icahn and making takeovers virtually impossible without approval from the takeover targets.

(MORE: Raiders of the Lost Stream: Netflix Fight with Carl Icahn Escalates over ‘Poison Pill’)

While Icahn quickly denounced Netflix’ action as “an example of poor corporate governance,”  it’s safe to say that Icahn is no more shocked by Netflix’ poison pill than Captain Renault was “shocked, shocked” to discover gamblers in Rick’s Café Americain in Casablanca.  Indeed, since the heyday of corporate raiders in the 1980s, poison pills have been a standard — and powerful  — corporate defense against hostile takeovers.

The poison pill — the name is a reference to the cyanide capsules spies are supposed to take when they are captured — was invented in 1982 by famed corporate lawyer Martin Lipton, and came into widespread practice after the Delaware Supreme Court affirmed its legality in a landmark 1985 case.

Literally thousands of companies have adopted poison pill plans in the years since then, either as a general policy or in response to takeover threats from “activist shareholders” like T Boone Pickens, Ron Perelman and, of course, Icahn himself.

While not as common as they were in the 80s, in part because hostile takeovers aren’t as common as they were in the 80s, poison pills are likely to remain a part of the business landscape for some time. Indeed, in the last decade, they’ve been invoked (with varying degrees of success) by an assortment of well-known companies facing takeover bids, including Yahoo, News Corp, and JC Penney.

(MORE: Netflix Horror Show: The Real Reason Shares Plunged by 17%)

Netflix’ poison pill is what’s known as a “flip-in” plan, which offers shareholders the opportunity to buy discounted shares once a hostile shareholder has gobbled up a certain percentage of shares, usually 15%. But over the years companies have adopted a wide assortment of tactics to protect themselves from takeovers by making themselves unattractive targets. In 2003, for example, Peoplesoft tried to protect itself against a takeover by rival Oracle offering customers fat refunds (worth several times more than what the customers had originally paid) if Peoplesoft were to be acquired.

Proponents of poison pills say that they protect companies from slash-and-burn corporate raiders more interested in making a quick buck than in nurturing a long-term strategy that will enable companies to reach their full potential.

If nothing else, they force hostile takeover artists to negotiate with boards, and put pressure on potential buyers to increase their bids. One 2005 study by FactSet found that companies using poison pills were able to raise their price tag 24% higher than companies without such plans. In the case of Peoplesoft, the takeover target only agreed to rescind its poison pill provisions and allow itself to be bought by Oracle after the larger company more than doubled its bid from an initial $5.1 billion to $10.3 billion.

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Critics of poison pills, like Icahn, describe these supposed “shareholder-rights plans” as inimical to real shareholder rights. Poison pill provisions, he complains in a post on his blog (yes, Carl Icahn has a blog), “can be put in place and removed by the directors as they please whenever they please without a shareholder vote.” Pointing out that other countries put many more restrictions on companies instituting poison pill plans, he argues that the boards of American companies “should not be allowed to hide behind a poison pill indefinitely.” Shareholder “activists” like Icahn claim that they help to shake out bad management and unlock value in troubled companies. Shareholders frustrated with management often welcome the attention of shaker-uppers like Icahn.

In the case of Netflix, there are certainly plenty of shareholders less-than-thrilled with the management of CEO Reed Hastings. We’ll just have to see how many of them are willing to cozy up the notorious Icahn.

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