Every company would like to thwart any takeover attempt at any cost and uses various strategies to stall that. One of the strategies used is a Poison Put. Thus, a Poison Put is a defense mechanism used by a target company to avoid a hostile takeover. In this, a target company issue bonds that need to be redeemed before maturity, in case of a takeover. This means the bondholders will have to be redeemed before the completion of the takeover. The whole idea and objective while following this strategy is to increase the cost of take over or the debt burden for the corporate raider.
In the world of mergers and acquisition, most takeovers are after a mutual agreement between the two companies. Some takeovers, however, are by force where the existing shareholders and management are not willing to acquisition by another entity. In some cases, the target company’s management adopts poison pill strategies to avoid the takeover. And, one such strategy is a poison put.
This strategy is a type of poison pill strategy. However, unlike the poison pill strategy, this strategy doesn’t affect the stock price, the number of stock, or the voting rights of the shareholders. Rather, it throws a challenge to the bidding company to come up with enough cash to pay for all the acquisition costs, including for the redemption of the new bonds, before their maturity.
Such types of defense strategies are legal.
How Poison Put Work?
In this, a company witnessing a hostile takeover issues additional debt to make itself less attractive to the bidder. The target company takes more debt by issuing bonds to the investors. Moreover, these bonds carry a provision that gives holders an option to get the payment early if the company faces a hostile takeover bid. It may also carry a provision to redeem the bonds at a premium.
After a target company uses this strategy, the bidding company needs to carefully assess the acquisition. This is because the target company becomes much more expensive after using this defensive strategy. Secondly, apart from that, it needs additional cash flow immediately to pay off those bonds.
A point to note is that such a strategy may work against the target company as well. If the target company already has too much debt on its balance sheet, then using this strategy, may weaken its financial position. And if somehow even they are able to stall the hostile take over, the financial burden will still be there to be cleared off.
Example of Poison Put
Company A is a small tech company, and comes to know that rival Company B may attempt a hostile takeover with a $20 million bid. The management and shareholders doesn’t want this takeover. Thus, Company A issues corporate bonds with a value of $10 million.
These bonds come with a provision that bondholders will get immediate payment in case of a takeover by any entity. Moreover, the bondholders will also get 105% of the par value in case of a takeover.
This means, in case of a takeover, the value of bonds will be $10.5 million. Or, Company B will have to pay $10.5 million more to acquire Company A. It is possible that this hefty tag discourages Company B from taking over Company A. In such a case, Company A’s use of Poison Put strategy will be successful.
Poison Put is an effective defense strategy in case of a hostile takeover. We can say that it is the best poison pill strategy because it has no impact on the shareholding pattern and the number of shares. It is simple to implement and is very straightforward. However, the target company must work to ensure that adopting this strategy does not make its financial situation worse.
Frequently Asked Questions (FAQs)
A Poison Put is a defense strategy that a target company uses to avoid a hostile takeover.
Poison put strategy prevents hostile takeovers. Also, it does not affect the stock price, the number of stock, or the voting rights of the shareholders.