Elon Musk is trending on Twitter about buying Twitter, and somewhere Bill Murray is reporting on Punxsutawney Phil.
However, this latest Elon Musk event allows us to dive further into Twitter's Board of Directors' latest defensive measure, the Poison Pill.
Aptly named, a poison pill is a defensive measure used by a company to fend off opportunistic, hostile, or abusive takeover transactions from an acquiring company or individual.
When the news states that a company is using a poison pill to defend against a takeover, they are typically referring to either a Flip-In or Flip-Out poison pill. While both types of poison pills are dilutive in nature, they achieve this dilutive outcome in slightly different manners.
Once activated, a flip-in poison pill strategy permits the holders of the flip-in rights, in this case the shareholders of Twitter stock, the right to purchase stock or debt of the target company (Twitter), at a discount to the current market price.
These flip-in rights activate after a particular threshold of ownership has been met by the acquirer. Here, Twitter's Rights Plan has set this threshold at 15% total ownership of Twitter's shares outstanding.
Therefore, if Elon were to acquire 15% or more of Twitter's outstanding shares, every shareholder – except the acquirer (Elon Musk) – would be able to buy newly issued shares in the company at a discount to its current market price.
For example, holding one share of Twitter stock would give you the right to buy another share of Twitter stock at a 50% discount to its current market price.
Issuing a significant number of shares at a discounted rate would wreak dilutional havoc on Elon by requiring him to purchase even more shares in the open market to regain control, greatly increasing transaction costs associated with the acquisition. At the same time, such an action would immediately benefit current Twitter shareholders as they would be able to sell these newly issued shares at a premium instantaneously.
A flip-over poison pill has similar dilutive effects as its flip-in relative. Yet, instead of issuing more shares of the target company, a flip-over poison pill allows shareholders to purchase shares in the acquiring company at a deep discount price if a change in control of the target company were to take effect.
For example, if Tesla, not Elon directly, were looking to acquire Twitter, then a flip-over poison pill would allow Twitter shareholders to purchase shares of Tesla at a 4 to 1 discount, which would severely dilute Tesla's market valuation post-acquisition and ultimately discourage an acquiring company from proceeding forward.
The board of directors of every company owes a duty of loyalty to their shareholders and must act in their best interest, especially when it comes to preventing takeovers of their company. To effectively perform this duty in the face of a takeover attempt, a company may use defensive measures such as a poison pill to buy time. Typically, the board uses this time to evaluate the market for any other interested bidders that may offer a higher acquisition price for the company and ultimately ensure that the company receives the best offer available.
Elon Musk's initial disclosure of his Twitter ownership sent the stock price rising over 30% in the following days. However, after Elon's acquisition announcement, the market did not show the same excitement; in fact, until the news of secured funding, the stock price traded flat at around $48.
Even now, after unanimous board approval of his acquisition, the market price of Twitter is sitting around $50. Compared to Elon's acquisition price of $54.20, the ironic $4.20 premium indicates that the market is still foreseeing some choppy waters before Elon can truly accomplish his acquisition of Twitter.
Elon Musk has already shown immunity to a poison pill and demonstrated that he knows how to navigate uncharted paths, so the richest man in the world might just set Twitter ablaze in more ways than one when this deal closes. Stay tuned.