Greenmail

What is Greenmail?

Greenmail is an intentional purchase of a substantial number of shares in an entity with an ultimate objective to threaten it with a hostile takeover, which usually results in forcing the owners to repurchase the shares at a premium.

The target firm is actually forced to buy its stock at an increased price to ward off a corporate raider. It is a blackmail that gives the corporate raiderCorporate RaiderA corporate raider is an investor who benefits by buying a significant stake in an undervalued company either to influence the decision-making process or to sell it for a profit. The most common example is a change of the board of directors, helping them influence the vital decisions.read more a good profit by just creating a takeover threat. In the case of mergers and acquisitions, this payment is made to put a stop on the takeover bid.

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Greenmail – “BLACKMAIL of a DIFFERENT COLOR”

It is a very challenging situation for the target company. They are forced to decide between being taken over and paying a high premium to buy back their shares from the corporate raider. In most circumstances, the target firm chooses to pay the premium price and buy back their shares over a hostile takeoverHostile TakeoverA hostile takeover is a type of acquisition of a target company by an acquiring company in which the target company's management is not in favour of the acquisition but the bidder still uses other channels to acquire the company, such as acquiring the company through tender offer by directly making an offer to the public to buy the shares of the target company at a pre-specified price that is higher than the prevailing market prices.read more. It is like blackmail, where the raider asks for a ransom amount to release the control of shares over the target company. It should be kept in mind that the raider has no intention of buying the target company, but it just wants to make the profit from the costly premium it demands from the target company.

On accepting this payment, the raider will stop harassing the target company for takeover and cannot buy any shares of the target company for a specified period. Though the target company gets back its control over its shares, it may have an additional debt of a considerable amount that the target company has taken to finance the greenmail. The term is derived from the combination of blackmail and greenbacks (dollars).

How does Greenmail work?

How does Greenmail work

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Let us have a look at the process, followed with the help of a diagram.

  • Purchase – A corporate raider or an investor gets hold of a large stake in the target company by purchasing its shares from the open market.
  • Struggle – Threaten the target company over a hostile takeover. Still, they offer to sell the acquired shares to the target company at a premium price, much above the market value. The raider also makes a promise of not harassing the target company on repurchasing the shares by the target company.
  • Sale – The corporate raider sells its share at a higher price. The target company utilizes the shareholder money to pay the premium price for buyback. The target company is left with a considerable amount of debt, and its value is reduced, whereas the raider makes a handsome profit.

Examples of Greenmail

  • American Investor Carl Icahn bought an approximately 9.9% stake in Saxon Industry at an average price of $7.21 per share
  • Saxon Industries were afraid that he might go for a hostile takeover and increase his stake further.
  • Saxon Industries offered to buyback Carl Icahn’s stake at an average price of $10.50 per share.
  • It represented a premium of 45% of his purchase price, thereby making Icahn a handsome profit.

Effective Measures by the Target Company

During these situations, the target companies have two options.

  • The first option is that the target company can take no action and allow the hostile takeover to happen.
  • Secondly, the target company can pay a premium price above the market value to avoid hostile takeovers and buy back its shares.

Suppose a company X buys 30% shares of company Y and then threatens X for a takeover. The management of company Y decides to buy back the shares at a premium price to avoid the takeover bid. After this greenmail, company X makes a considerable amount of profit from the resale of shares at the premium price. Still, company Y makes a significant loss and is left with additional debt.

Although there is still the existence of greenmail in various forms, the state has implemented regulations that make it quite difficult for companies who plan to repurchase shares from short-term investors above the market price. In the year 1987, the Internal Revenue Service (IRS) introduced an excise taxExcise TaxExcise tax is the tax applied to the sale of particular goods and services like tobacco, fuel, and alcohol. It is not directly paid by an individual consumer, instead, the tax department levies the tax on producer or merchant of products.read more of 505 on the profits made from greenmail. Additionally, the companies also have incorporated different defense mechanisms known as poison pills to keep such investors at bay from threatening hostile takeovers. It does not always mean hostile takeover bidsTakeover BidsThe price offered by the acquiring company to the target company to purchase the company is known as a takeover bid. Such bids are typically placed by larger companies to buy smaller companies in the market and the bids can be in the form of cash, equity, or a combination of both.read more, but many times it may lead to the proxy contest, which eventually can affect the management and operations of the company.

Conclusion

Greenmail is a profit-making strategy wherein the investor buys large stakes of the target company and then threatens the target company of hostile takeover and creates a situation in such a way that the target company is forced to buy back their shares at a significant premium.

It is similar to blackmail, where threats are made to establish a benefit and gain profit. This money is paid to another company to stop the aggressive behavior.

Greenmail Video

 

This article has been a guide to what is Greenmail. Here we discuss how greenmail works along with practical examples and effective measures the target company can take in such a situation. You may learn more about M&A from the following articles –

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