Investment Banking: How to Identify if a Merger is Friendly or Hostile

By Matt Krantz, Robert R. Johnson

In the investment banking world, business combinations can be characterized as either friendly or hostile. Although the end result is the same — the combination of two previously separate firms into one entity — the investment banking process differs substantially depending upon the nature of the transaction.

In a friendly merger, the two firms work together on the transaction, and the combination is approved by both the target firm’s board of directors and the acquiring firm’s board of directors. Essentially, there is a meeting of the minds, and both parties agree that the acquisition is beneficial to their respective shareholders.

Not surprisingly, academic research has provided evidence that friendly mergers are more likely to be synergistic than hostile takeovers are. It makes sense that integrating the operations of two companies is easier if both of them favor the combination — people who want to work together are more successful than people who have to work together.

In a hostile takeover, the transaction is opposed by the target company’s board of directors and management. Not surprisingly, many acquisitions are opposed by the management of the target firm — after all, they may find themselves unemployed if the transaction takes place.

Because the deal is opposed, the acquiring company must gain control of the acquired firm to get it to agree to the transaction. Because the board of directors isn’t amenable to the business combination, in a hostile takeover the acquiring company will do one of the following to acquire the target company:

  • Make a tender offer. A tender offer is simply a public offer to buy the shares of the target firm at a fixed price that represents a substantial premium to the current market price. The tender generally has stipulations that the offer is good only if 51 percent of the shareholders agree to sell at that price.

    If enough shareholders agree to sell — or tender — their shares, the acquiring firm can take control of the company, change the composition of the board of directors, and ultimately acquire control of the company.

    Tender offers are good news for the shareholders of the target company, because the typical market reaction to a tender offer is a dramatic increase in the stock price — reflecting the premium that the tender is to the current market price. Even if the tender offer doesn’t succeed, it signals that the target firm is “in play,” and you may see other firms get into a bidding war.

    A recent example was when Knight Capital Group — the stock-trading firm whose technology breakdown contributed to a major disruption of the U.S. stock markets in 2012 — was acquired by Getco after a bidding war with Virtu Financial. Knight shareholders ended up receiving a premium that was about 20 percent over market price for the troubled firm.

  • Engage in a proxy fight. A proxy fight is a little different from a tender offer, but the goal is identical — to gain control of the target firm so that the acquisition is ultimately approved. A proxy vote is a situation in which a shareholder gives her vote (or proxy) to someone authorized to vote for her on a particular matter.

    In this case, it’s to seek a change in control of the organization and establish a board and management team that is favorable to being acquired. With proxy authority, the acquiring corporation is able to take control of the target company, replace the directors with its own appointees, and approve the merger resolution.

    An example of a successful proxy fight was Weyerhaeuser’s 2002 acquisition of Willamette Industries. Upon rejection of two previous offers to buy Willamette, Weyerhaeuser secured control of the Willamette board via a proxy fight. This ended a protracted four-year process that began with a friendly merger offer and included two tender offers. Who said high finance was easy?