CFA, Finance

Poison Put with Example

What is Poison Put?

  • Poison Put is a strategy that is employed in order to prevent the hostile takeover by Acquirer Company.
  • In the world of Mergers & Acquisitions, there are times when such a scenario plays out when the competitor of the company tries to take over its target company in a friendly manner & when competitor gets refused to entertain such offer, they attempt to take over the company in a hostile fashion.
  • The target company issues such bonds which can be redeemed at premium to its par value before the occurrence of maturity date should the bondholders experience any scenario of change in management control or restructuring events.

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Poison Puts Explained:

  • In case of a potential hostile takeover, Target Company has the rights to issue bonds that can be bought back at premium prices before maturity date.
  • Target Company can have clauses like early repayments to bondholders before maturity periods in their bond covenants and keep the trigger of poison put strategy as potential threat of restructuring scenarios or acquisition of controlling interest in unfavorable manner.
  • By triggering such provisions, it becomes expensive for the acquirer company to finance the acquisition because of requirement to replenish additional debt capital requirement.
  • Additionally, the acquirer company has to incur debt refinancing costs which pose uncertainty because refinancing costs are dependent on credit quality of the company- the poorer the quality, the higher are the credit spreads & higher refinancing costs. Interest rate environment also comes in picture for refinancing debt.
  • Target Company can face teething problems in the adoption of poison puts strategy when its credit quality is sub-optimal or fixed income markets are relatively illiquid resulting in higher credit spreads.
  • Poison Puts have been designed as a way to protect bond investors from potential degradation of bond ratings in case of changes in structural control or perceptible threat perception in business valuation because of the precarious nature of takeover strategies.
  • Poison Puts compel the acquirer company to carefully evaluate and take cognizance of altered valuation scenarios, the attractiveness of the target company post additional debt capital fulfillment requirements & carefully weigh the additional cost burden to fund the acquisition by way of raising more capital or sell off its assets.
  • Poison Puts gained prominence when there was huge buoyancy of leveraged buyouts on Wall Street.

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Practical Example of Poison Puts:

  • Company TLR operates in the food & beverage industry with domestic presence, reasonable profit margins & supply chains. Company ABC is a competitor company having a foreign origin, equipped with significant cash flows & follows the growth-by-acquisition strategy by exploiting economies of scale & adds extraordinarily valuable economic benefits with proven records.
  • Company ABC attempts a hostile takeover of company TLR after friendly takeover proposals are declined by shareholders & board of directors of company TLR.
  • After a lot of board deliberations, Company TLR decides for fresh issuance of debt capital worth 100 million USD with early prepayment provisions & buying bonds at 5% premiums. This proposal shall mean an additional 105% replenishment of debt capital in addition to the acquisition price of 1 billion USD.
  • The sudden trigger of contractual bond covenants like poison puts shall deliver a blow to Acquirer Company because of the huge debt burden being due immediately & potential unattractive valuations of business because of the acquisition price.
  • Company ABC might have to refinance Target Company’s debt in the existing interest rate scenarios which can further add to its woes if the interest rates are high.
  • Such situations shall likely discourage Company ABC to pursue a takeover in view of potential threat perceptions of earnings downgrade because of rationales shared above. 

About the Author:

Ashutosh Buch is CFP (FPSB India) & has passed Level-I of CFA Program. His primary interest lies in analyzing investments in primary & secondary markets. At present, he focuses on learning the nuances of financial markets & management consulting. He remains committed to his goal of helping businesses scale up & making them ESG-friendly.

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