A casual pass is a preliminary takeover step used in mergers and acquisitions intended as an informal approach made to the target management. This is often made by an investment banker on behalf of the would-be acquirer although is occasionally made by the acquirer itself and maybe the result of a “chance” encounter. The discussion is viewed as a friendly takeover action. The result of this action could lead to either a friendly deal, a hostile bid or the acquirer walking away without any loss of face to either side.
It is unlikely traders and investors will learn of this tactic until much later in the takeover process. If knowledge of such an action is acquired any investment made using that information may pay attention to applicable insider trading rules. It is from this point onwards that rumors may begin to circulate, such as the observation of key personnel in the same locale. However, the possibility of a successful takeover or merger at this point is still a remote possibility and investors are cautioned against the risks of trading in such a situation. Speculation on a deal at this point would be considered pre-arbing. Despite the increased rewards of such an investment strategy due to the wider spread, the risks naturally will of course be much higher.
Reasons for a Casual Pass
If the expected response from target management to a casual pass is negative, the acquirer would not want to risk forewarning the target as to its intentions and refrain from using the tactic. A potential negative response could be indicated by the target management previously spurning alternative advances from rival suitors. The firm may also have initiated corporate actions such as the adoption of a poison pill or an alternative shark repellent anti-takeover tactic. In addition, as part of a previous corporate strategy presentation, the target may have subsequently stressed its desire to remain independent. In these instances, a casual pass may serve to “sound out” the target response. However, as pointed out, this action may forewarn the target as to the acquirer’s intended strategy and allow the target time to prepare its defenses. Thus, the approach ultimately backfires. Management are often advised NOT to engage in casual discussions to avoid accusations of impropriety.
On the other hand, if the expected response is positive, the acquirer management will most likely first notify the board of directors about the approach. Then the companies will move in with a plan of action in an official capacity. Therefore, a casual pass is frequently used if the acquirer team are unsure of the target response or they believe a welcoming response is possible and wish to more accurately assess the situation before moving forward.
See our article Hostile Takeovers and Merger Arbitrage – What All Traders Should Know for a discussion on hostile takeover tactics.
