A Highly Confident Letter is a document given in place of a definitive financing commitment popularized by Drexel Burnham Lambert (DBL) in the 1980’s. It was generally accepted during this time that the raising of financing was not an issue for DBL and their word was sufficient to convince a target firm that financing was available for the purchase of their company. Through Michael Milken’s network of lenders, he was able to arrange vast amounts of credit almost in an instant thus giving rise to the famed corporate raiders. If on the other hand financing was not forthcoming, DBL would not stand to lose anything.
The highly confident letter was first used in conjunction with Carl Icahn during his attempted takeover of Phillips 66 in 1983. Leon Black, Drexel’s lead investment banker on the deal, originally suggested that Drexel should write a letter advising that it was “highly confident” that it would be able to raise the required financing for Icahn. This approach unlike the actual takeover attempt itself was considered a huge success by DBL and used repeatedly during its heyday in the 1980’s. For more background on this episode in financial history see “The Predators Ball“ by Connie Bruck, or “Den of Thieves” by James B. Stewart.
Highly Confident Letter - Legal Status
Generally speaking, there are three common forms of the letter
- highly confident
- commit to provide
- willing to arrange and underwrite
Although they have no legal status, highly confident letters can both reassure and frighten nervous investors by persuading them that a deal can be completed. Thus making them extremely effective in a hostile takeover situation. This is in spite of not all financing mechanisms having yet been fully arranged. Armed with this letter, an acquirer might just have the edge to prove it has the superior offer should a bidding war materialize.
However, in recent times, financing is one of the key points analyzed by merger arbitrageurs and traders when trying to identify the deal closing probability (DCP) of a takeover. If financing is yet to be arranged, this often signals a red flag to the markets and requires further investigation. Through a combination of shark repellents and other anti takeover defenses, many firms simple refuse to engage with hostile bidders if financing is or sources of finance can not be accurately and specifically demonstrated. In turn, the trader expects a larger merger arbitrage spread before initiating a what may be termed as a speculative position. The lack of arranged financing may also delay the deal closing and thus widen the spread further.
