How Netflix took the poison pill to save itself from getting acquired?

Synopsis: In 2012, Netflix faced a potential hostile takeover when Carl Icahn acquired a 9.98 percent stake. To defend itself, Netflix used a dual poison pill strategy, triggering if any investor crossed 10 percent. The plan diluted the acquirer’s shares, protected control, and lasted nearly two years, highlighting high-stakes corporate defense strategies. This article also covers risks, the Twitter takeover failure, and other defense strategies like Crown Jewel, Pac-Man, and White Knight.

In the world of big business takeovers, even billion-dollar companies can face sudden and unexpected threats. When aggressive investors try to take control, the company being targeted is forced to make a critical choice: fight to stay independent or give in to the takeover.

Netflix, the global streaming giant, found itself in exactly this situation, facing a powerful investor who could have changed the company’s future. To protect itself, Netflix used a clever and surprising strategy that not only defended its control but also grabbed the attention of investors and the market, showing how far a company can go to safeguard its independence.

Hostile Takeovers 

A hostile takeover occurs when an entity gains control of a company without the approval of its management. This acquisition strategy requires the acquiring party to obtain and control more than 50 percent of the company’s voting shares.

By doing so, the new majority shareholder(s) can exert control over the operations and decisions of the acquired business. In this context, the company being acquired is referred to as the target company, while the entity initiating the takeover is called the acquirer. 

The motivations behind hostile takeovers typically align with those of standard acquisitions or mergers. These include the belief that the target company is significantly undervalued, the desire to gain access to its brand, operations, technology, or industry presence, or a strategic effort by activist investors aiming to implement changes in the company’s management or operations.

What Is A Poison Pill? 

The “Poison Pill,” formally known as the Shareholder Rights Plan is a widely used strategy to prevent hostile takeovers. Under this strategy, the target company makes its shares less attractive to potential acquirers by giving existing shareholders, excluding the acquiring entity, the right to buy additional shares at a substantial discount. This results in the dilution of the acquirer’s ownership and makes a takeover more difficult and expensive.

In corporate practice, poison pills generally take two forms: flip-in and flip-over. Both are often used as a deterrent, signaling to the acquirer that pursuing the takeover could lead to significant post-acquisition stake dilution.

The flip-in strategy allows existing shareholders, except the acquirer, to purchase additional shares at a discounted price, effectively increasing their ownership and reducing the acquirer’s stake. The flip-over also called the flip-out strategy enables shareholders to buy shares at a discounted rate after the company has been acquired, discouraging the acquirer from proceeding because it would risk substantial dilution of their post-acquisition holdings.

Common Strategies for Hostile Takeovers

Hostile takeovers are typically carried out through one of two primary methods. The first is a tender offer, in which the acquiring entity offers to buy the target company’s voting shares at a price above their current market value. The second method is a proxy fight, where the acquirer seeks to convince shareholders to replace the existing management with a new team that would approve the takeover. 

In general, hostile takeovers can be executed through a tender offer, a proxy fight, or by purchasing shares on the open market. A tender offer requires approval from a majority of shareholders, while a proxy fight focuses on replacing a significant portion of the target company’s uncooperative board members. Alternatively, an acquirer may opt to gradually acquire enough shares in the open market to gain control of the company.

When Netflix Took The Poison Pill

A notable example of the successful use of a poison pill strategy is the 2012 confrontation between Netflix and investor Carl Icahn. In that year, Icahn, a well-known billionaire investor, acquired a 9.98 percent stake in Netflix, raising concerns of a potential hostile takeover.

To prevent this, Netflix implemented a poison pill plan. Under the policy, if any individual investor attempted to acquire more than 10 percent of Netflix shares, or 20 percent for institutional investors, without board approval, the poison pill would be triggered. This would allow all other shareholders to purchase additional shares at a discounted price, thereby diluting Icahn’s ownership in the company.

Netflix further strengthened its defence by issuing rights shares to common shareholders at half the market price, excluding those holding more than a 10 percent stake, effectively flooding the market with shares through the flip-in version of the poison pill.

Additionally, the company employed a flip-over strategy, enabling shareholders to buy the common shares of any individual who acquired shares at market prices, thereby further protecting against takeover attempts. This dual poison pill strategy successfully safeguarded Netflix from a hostile takeover, though it also led to increased scepticism in the market, with a surge in demand for short-selling Netflix shares.

What Were The Risks Involved? 

Although Netflix successfully defended itself, the use of a shareholder rights plan without obtaining a formal vote from shareholders can be seen as undermining principles of corporate governance.

The 10 percent threshold set for triggering the poison pill was unusually arbitrary and did not necessarily reflect the interests or intentions of the shareholders. Given Netflix’s global expansion and the success of its streaming services, the company was able to recover its share prices; otherwise, the strategy could have been highly risky.

At the same time, the combined use of both flip-in and flip-over mechanisms deserves recognition, as it effectively blocked hostile takeover attempts from multiple angles. The strategy of flooding the market with shares, causing dilution of the acquirer’s stake, proved to be a decisive factor in thwarting takeover efforts.

Netflix eventually terminated the poison pill plan nearly two years later, demonstrating that such measures are not required to be permanent and can be adjusted or removed according to the company’s evolving needs.

When The Poison Pill Failed: The Twitter Takeover by Elon Musk

A notable example of a poison pill strategy failing can be seen in Elon Musk’s acquisition of Twitter. Musk initially owned a 9.2 percent stake in the company and expressed his intention to acquire Twitter by sending a letter to the chairman, proposing to purchase 100 percent of the company for USD 43 billion. Twitter had implemented a poison pill policy similar to Netflix’s, under which rights shares would be issued if any individual crossed a 15 percent ownership threshold. 

These rights could be exercised at 50 percent of the market price but were only available to shareholders holding less than 15 percent, representing a standard flip-in poison pill. This mechanism was designed to drastically dilute Musk’s stake if he exceeded the 15 percent limit, giving Twitter time to negotiate.

However, the strategy proved ineffective. After securing a USD 46.5 billion cash commitment to support his bid, Musk disclosed his plan and indicated his intention to submit the offer to the US Securities and Exchange Commission while awaiting formal board approval.

The poison pill failed primarily because the board lacked shareholder support. Twitter’s stock had remained largely flat since its public listing, reflecting shareholders’ dissatisfaction with the board’s performance.

Musk’s determination to acquire the company allowed him to bypass the board by directly approaching shareholders through a tender offer, offering to buy their shares at a premium. 

His threats to sell his holdings further pressured the board, forcing them to choose between protecting their own interests or fulfilling their fiduciary duty to shareholders. This case highlights that, even when the poison pill provisions are structurally sound, external circumstances, particularly shareholder trust in the board, play a crucial role in determining the strategy’s effectiveness.

When executed properly and with adequate planning, a poison pill can provide the target company with leverage to negotiate and potentially secure a deal that significantly benefits its shareholders.

Other Post-Offer Defense Strategies

The crown jewel defense strategy involves the target company either selling its most valuable assets to a third party or spinning them off into a separate entity. The main objective is to make the company less appealing to a hostile acquirer by removing its key assets.

In a Pac-Man defense, the target company counters a takeover bid by attempting to acquire the shares of the potential acquirer. As the acquirer seeks to gain a controlling interest in the target, the target simultaneously buys shares of the acquirer to obtain a controlling stake.

This strategy is feasible only if the target company has sufficient financial resources to purchase the necessary shares. Faced with the threat to its own control, the acquirer often abandons the takeover attempt.

The white knight defense occurs when a target company is acquired by a friendly third party, known as the white knight. This strategic partner is favorable to the target company and typically acts as a last-resort measure. While the target company accepts that a takeover is inevitable, it can at least ensure the acquisition or merger happens with a cooperative company rather than falling victim to a hostile takeover.

-Manan Gangwar

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