What it means
Most acquisitions begin with friendly talks between the two boards. An unsolicited bid skips that stage, so the target's directors first learn of the interest when the offer arrives.
The bidder usually believes the company is undervalued or badly managed and is willing to pay a premium (an amount above the current share price) to win control. The board's first duty is to consider the offer carefully and advise shareholders, who own the company and decide whether to sell.
Directors often hire investment bankers and lawyers to judge whether the price is fair and whether a better offer might appear. They may reject the bid, negotiate a higher price, or look for a rival buyer, who is sometimes called a white knight.
If the board refuses to engage, the bidder can go directly to shareholders through a tender offer (a public offer to buy shares at a stated price for a limited time). The bidder may also try to replace directors at a shareholder meeting.
When the pursuit continues against the board's wishes, it is commonly called a hostile takeover. Targets have several defences.
A shareholder rights plan, often called a poison pill, makes a takeover more expensive by letting other shareholders buy shares at a discount if a bidder crosses a stake threshold; other defences include staggered boards, seeking a rival offer or selling a key business. Whether these are allowed, and how directors must behave, depends on the law of the country and state where the company is based.
For finance teams, the main tasks are valuing the company honestly, modelling the bid against its standalone plan, and managing information carefully. Share prices usually jump when a bid becomes public, and the market's reaction tells directors how likely investors think a deal is.
An unsolicited bid is not always unwelcome, because it can force a board to face its own underperformance.
In practice
Real-world examples.
Example
A large brewer writes to the board of a smaller craft-beer company offering $18 a share, a 35% premium. The board says the offer undervalues its growth and refuses to meet. The brewer announces a tender offer directly to shareholders to put pressure on the directors.
Example
A private equity fund approaches a listed software company and proposes to take it private. The directors form a committee of independent members to review the proposal, because executives who might stay on under the new owner have a conflict of interest. The committee hires an adviser to test the price.
Example
A regional bank receives an unsolicited offer from a larger rival. The board declines it but invites other banks to bid. A second bidder emerges, and the final price is 10% higher than the first offer.
Formula
Calculation
Bid premium % = (offer price - undisturbed share price) / undisturbed share price x 100
Total offer value = offer price per share x shares outstanding
Suppose a company's shares trade at $40 before the bid is public, which is the undisturbed price. A bidder offers $52 a share in cash. Bid premium = (52 - 40) / 40 = 12 / 40 = 0.30, or 30%. With 10,000,000 shares outstanding, total offer value = 52 x 10,000,000 = $520,000,000, compared with an undisturbed market value of 40 x 10,000,000 = $400,000,000, so the bidder is offering $120,000,000 more.Case study
Seen in the real world.
Alder Controls is an illustrative, fictional manufacturer of industrial sensors with 20,000,000 shares trading at $25. One Monday morning its board received a letter from a larger competitor offering $32 a share in cash, with a request for an answer within ten days.
The finance director calculated that $32 was a 28% premium, worth 32 x 20,000,000 = $640,000,000 in total. Her own discounted cash flow valuation suggested a standalone value of around $35 a share if the company hit its new product targets.
The board rejected the offer as too low and explained its plan to shareholders. The competitor raised its bid to $36, and the board accepted. The illustrative lesson is that an unsolicited bid, even when refused, makes a company prove what it is worth.
Watch out
Common mistakes.
- Assuming that an unsolicited bid must be accepted or rejected within days, when boards can take time to review and negotiate.
- Judging an offer only by the premium over the current share price, when the price may have been depressed for reasons that the board believes are temporary.
- Treating every unsolicited bid as hostile, when many are later turned into agreed deals once the price improves.
Questions
People also ask.
Does the board have to accept a bid at a premium?
No, directors must act in the interests of the company and its shareholders, and they can refuse an offer they believe is too low, although they must consider it properly.
What is a white knight?
It is a friendly rival buyer that the target's board invites to make a better offer than the unwelcome bidder.
Why do share prices rise when a bid is announced?
Investors expect either that the bid will succeed at a premium, or that a higher one may follow.
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