What is Greenmail?

The target firm is forced to buy its stock at an increased price to ward off a corporate raider. It is 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 acquisitionsMergers And AcquisitionsMergers and acquisitions (M&A) are collaborations between two or more firms. In a merger, two or more companies functioning at the same level combine to create a new business entity. In an acquisition, a larger organization buys a smaller business entity for expansion.read more, this payment is made to stop 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 pays the premium price and buys back its shares over a hostile takeoverHostile TakeoverA hostile takeover is a process where a company acquires another company against the will of its management.read more. It is like blackmail, where the raider asks for a ransom to release the control of shares over the target company. One should remember that the raider has no intention of buying the target company, but it just wants to 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 it has taken to finance the greenmail. The term derives from the combination of blackmail and greenbacksGreenbacksGreenback refers to the first paper money issued by the United States government in the 19th century to finance the expenses of the American Civil War.read more (dollars).

How does Greenmail work?

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Let us 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 not to harass the target company by 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. As a result, the target company leaves with considerable debt and reduced value. In comparison, 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 feared he might go for a hostile takeover and further increase his stake.Saxon Industries offered to buy back Carl Icahn’s stake at an average price of $10.50 per share.It represented a premium of 45% of his purchase price, 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.Secondly, the target company can pay a premium price above the market value to avoid hostile takeovers and buy back its shares.

Suppose X Co. buys 30% shares of Y Co. and then threatens X Co. with a takeover. The management of company Y Co. decides to buy back the shares at a premium price to avoid the takeover bid. After this greenmail, X Co. makes a considerable profit from the resale of shares at the premiumShares At The PremiumShare premium is the difference between the issue price and the par value of the stock and is also known as securities premium. The shares are said to be issued at a premium when the issue price of the share is greater than its face value or par value. This premium is then credited to the share premium account of the company.read more price. Still, Y Co. makes a significant loss and leaves with additional debt.

Although greenmail exists 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 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 from greenmail. 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 it may often lead to proxy contests, which eventually can affect the management and operations of the company.

Conclusion

Greenmail is a profit-making strategy wherein the investor buys large stakes in the target company and then threatens the company with a hostile takeover. It creates a situation where the target company forces them 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 is a guide to Greenmail. Here, we discuss how greenmail works, 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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