CFA CFA Level 2 Greenmail – how does it make sense?

Greenmail – how does it make sense?

  • This topic has 7 replies, 3 voices, and was last updated Mar-17 by fabian.
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  • fabian
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    Hi all – good to be back! 😀

    I was reading up on takeover defenses, and greenmail is just something I don’t really get.

    Definition: Greenmail is a post-offer defence whereby the target company buys back the shares from the acquirer with company cash, usually at a premium. It then goes on to say that in essence the target pays the acquirer to go away.

    Er, what the frak? How does that kind of defence even work? Paying someone to go away sounds fundamentally flawed. Can anyone add to this?

    Sarah
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    Welcome back @fabian

    Why do you say paying someone to leave you alone is fundamentally flawed? They made a nice profit out of it and didn’t have to go through the headache of having to deal with all the management headaches that come with a merger.

    Actually if I recall properly to discourage this practice the US slapped on extra taxes on this very kind of profit.

    Zee Tan
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    Greenmail came to prominence in the 80s where there were many corporate raiding activities (i.e. acquiring a company, and either aggressively steering to short term profitability, or breaking it up for sale).

    The best known case for this is Walt Disney Corporation and the corporate raider Saul Steinberg. In 1984, Steinberg acquired 6.3% of the stock before Walt Disney Corporation’s management recognized a risk of hostile takeover. The first defensive tactic chosen by the Walt Disney management to prevent the takeover was to make a $190M acquisition for Arvida Corporation in order to increase Disney Corporation debt and dilute Steinberg’s holdings. As a consequence, the management increased the debt to equity ratio from 25% to 60% and overall made the company less attractive.

    However, after Steinberg increased significantly his offer, Walt Disney’s management finally made an offer to Steinbeck who approximately generated $60M profit. Steinberg bought his shares at $63.25 in March 1984 and Walt Disney bought them back at $77.50 in June 1984.

    Why does greenmail happen?
    Using Walt Disney as an example: in the simplest sense, Steinberg (the acquirer) believes that Walt Disney is undervalued, and he can make a profit by acquiring Walt Disney and flipping the company for an increased price (either as a whole or a sum of parts) later. How Walt Disney could have (and did) prevent this is to offer to Steinberg to buy his shares at a price that Steinberg believes is fair (i.e. if he rejected their $77.50 offer and moved to acquire anyway, Steinberg probably didn’t believe he could have make a better profit). Hence to Steinberg, at $77.50 Walt Disney isn’t undervalued anymore.

    Why doesn’t another corporate raider come and do exactly the same thing again then?
    Two reasons:
    1. Walt Disney would have more stake in itself, and stealthily building a significant share holding is not an easy thing to do.
    2. By basically paying cash for one corporate raider to go away, Walt Disney has taken a financial blow in the short term, and depending on the current share price, corporate raiders may not view this as a profitable venture anymore.

    Going beyond CFA syllabus, it’s true that the general public also raises eyebrows at the practice of greenmail. There are two big reasons:
    1. By paying greenmail, the current management is essentially saying “I’m the right man for the job, even at this corporate raider’s price”. Investors may not necessarily agree with this, since management is incentivized to defend the company at all costs (they’re protecting their jobs, after all).
    2. The premium for the shares is only offered to the corporate raider, and quite often after greenmail the share price of the target plummets. Essentially the corporate raider has cashed out the entire undervaluation of the target company (under the threat of a hostile takeover) at the expense of all the other shareholders.

    fabian
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    Wow – a free masterclass in greenmail. Thanks!

    @Diya the part I didn’t understand was from the target’s perspective, and sort of what @Zee touched on, if they paid acquirers off, what’s to stop everyone from doing the same? And surely if you’re paying someone off to not do something in a free market, something is off somewhere…

    Sarah
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    @fabian like I mentioned I believe the profits earned from such a strategy is taxed at a much higher rate.

    From my M&A class in university the proffesor always told us that M&A is about more ego/image then economics and earning a profit. Most high profile mergers did not end well – think HP and PALM. From and outside perspective it was really hard to argue that the premium HP paid for PALM made any business sense or economical sense or even common sense. But the deal went through and look what happened…

    And the image of being a corporate raider is generally a negative one.

    Also from the acquirer’s point of view they can lose a pretty penny if they aren’t paid a premium from the target and the target rather just dilutes the shares or they have another hidden card that can drive down stock prices.

    fabian
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    It kind of makes more sense now that it’s put in real-life examples….

    Sarah
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    @fabian I think when it comes to M&A you have to realize that the management’s first and foremost priority is to save their job and that can result in weird decisions.

    fabian
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    @diya Yep that makes sense alright!

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