What it means
The word is a blend of blackmail and greenback, and it describes a defensive move rather than an investment strategy. A corporate raider accumulates enough stock to look threatening, then lets the board know that a full bid may follow unless something is done.
What separates greenmail from an ordinary buyback is that only one holder is invited to sell. Everyone else keeps their shares and absorbs the cost, because the company has spent real cash to retire stock at a price no other investor was offered.
Boards defend the practice on the grounds that a hostile bid would consume management attention for a year and might break up a business worth more intact. Critics reply that the board is spending shareholder money to protect its own seats, which is why greenmail is usually described as entrenchment rather than defence.
Tax and regulation have made greenmail far rarer than it was in the 1980s. The United States applies a punitive excise charge to gains from certain greenmail payments, and many companies now carry charter provisions or shareholder rights plans that block selective repurchases outright.
The market normally reacts badly to the news. A share price that had climbed on takeover speculation tends to fall back once the bid threat is bought off, so the remaining shareholders lose twice: once through the cash paid out, and again through the premium that disappears from the quoted price.
In practice
Real-world examples.
Example
A family controlled hotel chain finds that an investment partnership has bought 8% of its shares and started writing letters demanding a sale of the property portfolio. The board negotiates a repurchase of the whole block at a 25% premium to the market price, coupled with an agreement not to buy shares again for five years.
Example
A specialty chemicals group is approached by an investor holding 12% who says he will launch a tender offer within a month. The finance director calculates that a defensive repurchase would use most of the cash earmarked for a new plant, and the board decides to fight the bid instead of paying the premium.
Example
A listed engineering firm adopts a charter amendment requiring supermajority approval before the company can repurchase more than 3% of its stock from any holder of over 5%. The clause is written specifically so that a future board cannot quietly settle a takeover threat with company cash.
Formula
Calculation
Greenmail premium = (repurchase price per share - market price per share) x shares repurchased
A quoted manufacturer's stock trades at $22.00. An activist fund has quietly bought 2,000,000 shares at an average cost of $18.00 and begins talking publicly about replacing the board. To end the campaign, the company agrees to buy the entire block back at $28.00 per share.
The premium above the market price is ($28.00 - $22.00) x 2,000,000 = $12,000,000. The raider's total profit is ($28.00 - $18.00) x 2,000,000 = $20,000,000, and the company parts with $28.00 x 2,000,000 = $56,000,000 of cash that could otherwise have gone into the business. No other shareholder receives anything at all from the transaction.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Harrowgate Foods, an invented regional bakery group with 25,000,000 shares in issue, saw its stock trading at $19.00 when an investor built a 2,500,000 share position, 10% of the company, at an average cost of $16.00. Within weeks the investor was briefing the trade press about closing two plants and selling the distribution arm.
The board, having sat through three years of turnaround work, agreed to repurchase the whole block at $24.50 a share, a total of $61,250,000. The premium above the market price was ($24.50 - $19.00) x 2,500,000 = $13,750,000, and the investor walked away with a profit of ($24.50 - $16.00) x 2,500,000 = $21,250,000 on an original outlay of $40,000,000.
In this fictional scenario the shares slid to $16.30 within a fortnight, once the takeover speculation faded and the cash had gone. For the 22,500,000 shares still in outside hands that was a fall of $2.70 each, about $60,750,000 of value, almost three times what the departing investor had made. Two large institutions voted against the entire board at the next annual meeting.
Watch out
Common mistakes.
- Treating greenmail as a normal share buyback, when a buyback is open to all holders on equal terms and greenmail is a private deal with one investor.
- Assuming the payment ends the problem, when a company seen as willing to pay once often attracts a second approach from a different investor.
- Judging the cost only by the premium, and ignoring the cash drained from the balance sheet and the fall in the share price once the bid speculation disappears.
Questions
People also ask.
Is greenmail illegal?
Not usually in itself, though tax charges, listing rules and company charters have made it expensive and difficult enough that it is now rare.
What is a standstill agreement and why does it accompany greenmail?
It is a contract in which the departing investor promises not to rebuild a stake or launch a bid for an agreed number of years, and it is what the company is really paying for.
Does the share price always fall afterwards?
Not always, but it commonly gives back the gains it made on takeover hopes, since the market prices in the fact that no bid is coming.
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