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What is Greenmail?
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.
The target firm is actually forced to buy its own stock at an increased price to ward off a corporate raider. This is a kind of blackmail that gives the corporate raider 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.
Greenmail – “BLACKMAIL of a DIFFERENT COLOR”
This 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 own 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 takeover. Basically, 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 time period. Though the target company gets back its control over its shares it may have additional debt of considerable amount which the target company has taken to finance the greenmail. The term greenmail is derived from the combination of blackmail and greenbacks (dollars).
How does Greenmail work?
Let us have a look at the process followed in Greenmail 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 but they offer to sell the acquired shares to the target company at a premium price which is much above the market value. The raider also makes a promise of not harassing the target company on repurchasing of the shares by the target company.
- Sale – The corporate raider sells their 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 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 stake at an average price of $10.50 per share.
- This represented a premium of 45% of his purchase price thereby making Icahn a handsome profit
Effective Measures by the Target Company
During this situations, the target companies have two options with them.
- 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 the hostile takeover and buy back its own 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, the company X makes a considerable amount of profit from the resale of shares at the premium price but 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 which make it quite difficult for such 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 tax 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 bids but many times it may lead to the proxy contest which eventually can affect the management and operations of the company.
It involves buying a significant amount of shares in a target company forcing a hostile takeover. Then using this threat they make the target company buy back its own shares at a higher price than the market value. This 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.
This 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 –