Greenmail is a financial strategy involving the purchase of a significant block of a company’s stock to threaten a hostile takeover. The target company then buys back the stock at a premium price from the would-be acquirer to prevent the takeover, effectively paying the acquirer to go away. This practice became notably common during the 1980s.
What is Greenmail?
Greenmail is a portmanteau of “greenback” (a slang term for money) and “blackmail.” In the context of corporate finance, greenmail occurs when an investor purchases a large number of shares in a company and threatens a takeover. To avoid this hostile takeover, the company repurchases the shares at a higher price than the market value, providing the investor with a significant profit.
How Greenmail Works
- Initial Purchase: An investor or group of investors buys a substantial amount of a company’s stock.
- Threat of Takeover: The investor then threatens to take over the company, which usually involves significant changes that current management and other stakeholders may not favor.
- Company’s Response: To avoid the takeover and maintain control, the company offers to buy back the shares at a price higher than what the investor paid.
- Profit for Investor: The investor sells the shares back to the company at this premium price, making a considerable profit. The company uses its funds to buy back the shares, often at the expense of its cash reserves or through additional debt.
Example of Greenmail
One of the most famous examples of greenmail involved the Walt Disney Company and financier Saul Steinberg in 1984. Steinberg’s Reliance Group Holdings acquired a significant stake in Disney and threatened a hostile takeover. To avoid this, Disney bought back the shares from Steinberg at a premium price, which resulted in a substantial profit for Steinberg. This transaction is often cited in discussions of greenmail practices.
Advantages and Disadvantages of Greenmail
Advantages:
- Prevents Hostile Takeovers: Greenmail can be an effective way for companies to prevent unwanted takeovers, allowing current management to retain control.
- Quick Resolution: It provides a quick resolution to the threat of a hostile takeover, avoiding long and potentially disruptive battles for control.
- Temporary Stock Price Increase: The initial purchase of a large number of shares can temporarily increase the company’s stock price, benefiting shareholders in the short term.
Disadvantages:
- Costly for the Company: Buying back shares at a premium can be very costly for the company, depleting cash reserves or increasing debt.
- Unfair to Long-term Shareholders: Long-term shareholders may view greenmail negatively as it benefits a single investor at the expense of the company’s resources.
- Encourages Speculative Behavior: Knowing that companies may pay greenmail, some investors might be encouraged to engage in speculative and opportunistic behavior.
- Potential for Management Misconduct: There is a risk that company management might use greenmail to protect their own positions rather than act in the best interests of all shareholders.
Legal and Ethical Considerations
The practice of greenmail has been controversial and has led to changes in corporate governance and regulations. In some jurisdictions, laws have been enacted to discourage or restrict greenmail. For example, some companies adopt “anti-greenmail” provisions in their charters, which require shareholder approval for large share repurchases at a premium price.
Greenmail vs. Other Corporate Strategies
Greenmail is distinct from other corporate strategies like a poison pill or white knight:
- Poison Pill: A strategy used by companies to make themselves less attractive to potential acquirers by diluting the value of the shares.
- White Knight: A more favorable company that acquires a target company that is facing a hostile takeover, effectively saving it from the unwanted bidder.
Conclusion
Greenmail is a unique strategy in the world of corporate finance and mergers and acquisitions. While it can serve as a tool for companies to fend off hostile takeovers and maintain control, it also carries significant financial and ethical implications. Understanding greenmail helps investors, managers, and students of finance appreciate the complexities of corporate governance and the various tactics used to influence corporate control.
References:
- Jensen, Michael C. “The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems.” The Journal of Finance, 1993.
- Weston, J. Fred, Mark L. Mitchell, and J. Harold Mulherin. “Takeovers, Restructuring, and Corporate Governance.” Pearson, 2003.
- Disney Annual Report, 1984.