Would Yahoo! have Swallowed the Poison Pill?

We recently saw that Yahoo had removed the so called “Severance Benefits” that it had planned to implement were it ever subject to a hostile takeover. In this article, we take a closer look at this mechanism as well as how effective “Poison Pills” like this can be.

A Poison Pill is a strategy employed by companies to ensure that the existing managment is not harmed by a hostile takeover. We know that takeovers can be accomplished by more ways than one. In the recent interactions between Yahoo! and Microsoft, there was a threat in the air that Microsoft would either replace Yahoo!’s board members with those more sympathetic to it at the AGM, or buy up a dominating percentage of Yahoo! share.

Image Credit: Steven Fernandez

Poison Pill Suicide

Yahoo! management has every right to be afraid of something like this since it would be quite likely that Microsoft would want to replace a number of Yahoo! managers with their own people. In order to prevent this from happening (After all, no one likes to lose their jobs), Yahoo! enacted a clause that in the event of a hostile takeover, Yahoo employees could avail themselves of massive benefits by walking away.

These massive benefits would of course financially harm the company effectively raising the cost of the takeover by hundreds of millions of dollars. This “Poison Pill” is like a suicide attempt. The threat is, don’t try and take me over, otherwise I’ll self destruct.

The question is, is this threat credible? In Game theory, a credible threat is one where the person who is making the threats actually benefits by carrying out the said threat. By this logic, if a robber takes hostage a single victim, threatening to shoot him if the police came in, would he actually do it? After all, killing the hostage provides him with no protection afterwards and will probably only increase his sentence! The only reason why he would ever carry out his threat and kill the hostage, was if he was insane. A perfectly rational robber would never kill a single hostage. This is why it is sometimes best to be insane.

The situation is strikingly similar when discussing corporate Poison Pills. It’s reasonable to assume that Yahoo! management holds a considerable stake in the company, and harming the company will harm them too. Moreover, the Poison Pill will be swallowed only if the hostile takeover succeeds. Assuming that the Pill is swallowed, this cannot reverse the acquisition. What then is the purpose of swallowing the pill? It is just a threat, and not a very credible one. The managment doesn’t gain anything by swallowing a pill that hurts the company after the acquisition has taken place.

One can devise a Poison Pill in such a way that it reduces the effectiveness of a hostile takeover by allowing existing shareholders (But not the acquirer) to purchase shares at a discount. This means that having bought a certain percentage of Yahoo! (in this case, 15%), Yahoo! shareholders can then get more shares at a huge discount. This means that the percentage of shares owned by Microsoft will come be less than 15% and may not be enough for a takeover. This is called a Dilution Poison Pill.

Will this be effective? Let’s say that Microsoft has bought 15% of Yahoo! stock for tens of billions of dollars. That money is a sunk cost. Once they’re bought, they’re bought. Microsoft must treat this as a sunk cost, and continue to buy up more Yahoo! shares to gain a controlling interest since the additional cost of buying the shares is much less than the amount already sunk in. So this Poison Pill holds no threat either.

The only way that the management can effectively threaten to swallow the pill, was if they were considered insane. Unfortunately, the Insane argument doesn’t really work in a corporate environment. In fact, an insane management has no right to run the company at all. And thus the Poison Pill threat is negated.

2 comments to Would Yahoo! have Swallowed the Poison Pill?

  • Edward Sheedy

    I think this relates to the case of Jeff Jagodzinski at Boston
    College. He will be fired by the Athletic Director if he takes an interview with the New York Jets. There is little to no benefit of firing him (at the very least it is a net loss). If Jagodzinski is a good enough coach to warrant consideration from an NFL team the BC AD should want to keep him on staff for as long as possible. Firing him will not make the BC Athletic Department better off. According to game theory and the article, Jagodzinski should consider to threat hollow. Except it does not appear that way. The Athletic Director seems intent on following through on the threat.

  • G. J.

    You wrote:

    One can devise a Poison Pill in such a way that it reduces the effectiveness of a hostile takeover by allowing existing shareholders (But not the acquirer) to purchase shares at a discount. This means that having bought a certain percentage of Yahoo! (in this case, 15%), Yahoo! shareholders can then get more shares at a huge discount. This means that the percentage of shares owned by Microsoft will come be less than 15% and may not be enough for a takeover. This is called a Dilution Poison Pill.
    ——–
    You missed a couple key features of this type of poison pill, sometimes called a “flip-in” shareholder rights plan. It is a very common (in not the most common) type of takeover prevention mechanism. I don’t know the particular details of Yahoo!’s rights plan, but here is an illustration of how such a plan is indeed effective because it poses a credible threat.

    In short, a “dilution poison pill” as you called it, doesn’t really harm anybody except the entity attempting to acquire the company:

    The “pill” become triggered when a single entity (Acquiring Person) comes into possession of more than a certain percentage of stock (we’ll assume 10% here) without the Target Company’s approval. When this occurs, each share of stock, except for those belonging to the Acquiring Person, is entitled to buy another share of stock at a substantially discounted price (say 50% of the current market price). A share of the stock should reflect its proportionate share of the value of the company. Assume that Company Y is worth $100 and has 10 outstanding shares (each worth $10). and that Company Z has acquired 10% of the stock (1 share):

    Y chooses to oppose the takeover by allowing the public shareholders to exercise their right to buy the discounted shares from the company treasury:

    Y sells 9 new shares at $5 each, netting $45 for the company. The company is now worth $145 ($100 initial value + cash proceeds from stock sale) and has 19 outstanding shares (18 at-large, 1 owned by Z).

    Each share is now worth $145/19=$7.63. What was the net result of “swallowing the pill” to the shareholders at-large (those other than Z)?: Each now has two shares of Y’s stock, and thus has an investment valued at $15.26. This represents a net gain of $0.26 for each shareholder ($10 initial value of share plus $5 cost of discounted share).

    Z still owns only 1 share of Y stock, and thus suffered a loss of $2.37 (a 23.7% drop!).

    And there we are–the threat is credible. This takeover defense essentially just redistributes value from the Acquiring Person to the other shareholders of the company.

    You wrote:

    Will this be effective? Let’s say that microsoft has bought 15% of Yahoo! stock for tens of billions of dollars. That money is a sunk cost. Once they’re bought, they’re bought. Microsoft must treat this as a sunk cost, and continue to buy up more Yahoo! shares to gain a controlling interest since the additional cost of buying the shares is much less than the amount already sunk in. So this Poison Pill holds no threat either.
    —-
    The shares aren’t a sunk cost for Microsoft–they have an intrinsic value and can be sold on the market.

Leave a Reply

 

 

 

You can use these HTML tags

<a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>