What is a Tender Offer?
In order to explain how tender offers work we shall begin with a brief description. A tender offer is a type of conditional public takeover bid by a prospective acquirer constituting an offer to purchase some or all of the shares in a target firm. The term relates to the existing stockholders being invited to “tender“, or sell their shares to the acquirer.
Tender offers are typically made publicly. The bidder contacts shareholders directly and invites them to sell their shares for a specified price during a specified time. This is often subject to the tendering of a minimum and maximum number of shares. In an exchange offer, a specialized type of tender offer, securities or other non-cash alternatives are offered in exchange for the target stock.
To convince the target shareholders to sell, the price offered is usually at a premium to the current market price and is often contingent upon a minimum or a maximum number of shares sold. The directors of the company may or may not have endorsed the tender offer proposal which in turn may affect the level of control premium offered. It is the preferred method by which a hostile takeover can be accomplished by the acquirer firm who seek control despite the objection of the board of directors. The tender offer may be made by one, or a group of persons or other business entities.
Once the offer is completed, the stock becomes the property of the purchaser. This affords the acquirer the same rights to trade the stock at their discretion.
How Tender Offers Work?
The acquirer normally offers a significant premium over the company’s stock price, providing shareholders a greater incentive to sell their shares. A tender offer might, for instance, be made to purchase outstanding stock shares for $24 a share when the current market price is only $20 a share. In this case a 20% premium. Premiums as high as 50% are not unheard of and may act to discourage rival bidders. In the case of a takeover attempt, the tender may be conditional on the prospective buyer being able to obtain a certain amount of shares, generally 50% + 1 share of the outstanding shares.
The upcoming offer may be well known in advance, especially if the deal is friendly. A hostile offer on the other hand may not necessarily be expected, but could be assumed to take place following the failure of any negotiations. Hostile or friendly, once the tender offer officially commences, it remains open for 20 days. For more information on how hostile takeovers work in terms of merger arbitrage, see our article Hostile Takeovers and Merger Arbitrage – What All Traders Should Know. After the announcement, a target company’s shares generally trade at a discount to the offer price. This is because of the uncertainty of deal closure and the time needed to complete the offer. As the closing date nears and outstanding issues are resolved, the spread typically narrows.
An Example of How Tender Offers Work
An example of a tender offer is the Wright Medical (WMGI) deal. Stryker have proposed a tender offer to acquire the outstanding stock of Wright Medical for $30.75 per share. The stock is currently trading at $30.23. Immediately prior to the deal the stock was trading below $21. This is a significant bid premium and should help guarantee a successful offer. The tender is scheduled to close on February 27, 2020. The full offer document can be viewed on the SEC website. Of EXTREMELY important note is the minimum condition on page vii,
What is the Minimum Condition?
The “Minimum Condition” requires that there have been validly tendered pursuant to the Offer, and not properly withdrawn, a number of Shares (excluding Shares tendered pursuant to guaranteed delivery procedures that have not yet been delivered in settlement or satisfaction of such guarantee prior to the Expiration Time) that, together with the Shares then owned by Stryker or its wholly owned subsidiaries, represents at least ninety-five percent (95%) of Wright’s issued and outstanding share capital (geplaatst en uitstaand kapitaal) immediately prior to the Expiration Time, provided that, Purchaser may, in its sole discretion, reduce the required threshold to a percentage not less than eighty percent (80%), provided, further, that if, prior to the Expiration Time, the Asset Sale Resolutions, the Merger Resolutions and the Demerger Resolutions are adopted at the EGM or any subsequent EGM, the required threshold will be reduced to eighty percent (80%).
If traders decide to accept the offer, they must submit instructions prior to the deadline or else they will not be eligible to participate. This is a simple case of instructing your broker, generally through a website. If the tender offer is successful and the required number of shares are tendered (in this case 95%), the transaction is completed. The stock position will disappear from the account and be replaced by cash. If on the other hand the tender offer fails, as not enough stock is successfully tendered, the trader will see no change to his/her account and the stock position will remain the same. Although a most likely drop in the stock price may cause the trader to see a decline in the balance of the account.
If the trader does not tender but enough people do for the offer to succeed, the acquirer will eventually force the sale of minority holdings. However, the acquirer does go on to warn that this action may be delayed for various reasons. Thus causing a delay in payment to the stockholder. A gentle nudge you might think in order to encourage traders to tender their stock.
How Tender Offers Work - Requirements and Regulations
In the United States, tender offers are controlled by strict regulation. Not only do the regulations provide protection for investors, but also set down the procedure for the process of making a tender offer thus increasing fairness to capital market participants. Target firms are given a fixed window of time in which they are better able to respond to any potential takeover by determining whether it is beneficial or harmful for the company and its shareholders,
The most important piece of legislation regarding the operation of tender offers is the Williams Act, codified in Section 13(d) and Section 14(d)(1) of the Securities Exchange Act of 1934 which was added to the Act in 1968, when New Jersey Senator Harrison A. Williams proposed the amendment. This states, “a bidder must file schedule TO with the SEC upon commencement of the tender offer“. Information that is required to be disclosed in schedule TO is
… required to include, among other things, the target’s name; the number of shares sought and the price offered; any conditions attached to the offer; the background of any discussions or other contacts between the buyer and the target; the source and amount of funds the buyer has available for the purpose; the reasons the buyer is making the offer and what it proposes to do if it succeeds; and who is soliciting shares for the buyer.
If the potential acquirer is acquiring more than 5% of the shares of another company it must also file a Schedule 13D within 10 days of the offer. For more information on important SEC forms, see our article SEC Filings – Mergers & Acquisitions.
A second important regulation is Regulation 14E which was established by the U.S. Securities and Exchange Commission (SEC). This regulation set up rules that must be followed by the individual(s) looking to acquire the bulk of a company’s stock through a tender offer. One such rule makes it illegal for anyone to submit an offer if they aren’t entirely sure that they will have the financial means to seal the deal. This is because doing so would make the price of the stock fluctuate significantly and make it easier for the price to be manipulated in the market.
Illegal Practices
Securities transactions based on material, non-public information when tender offers are in action are considered illegal. Transactions are also prohibited when partial tender offers have been made. However, the extent of these rules, being different to those associated with a merger or acquisition for example are beyond the scope of this article. For traders and investors wishing to familiarize themselves with the finer pints of corporate law we always recommend seeking out specific legal advice tailored to each individuals unique situation. To begin with, the SEC website is a great source of information.
Advantages of a Tender Offer
- One of the biggest advantages of a tender offer is that the acquirer is not obligated to buy shares until a set number are tendered. This has a number of benefits
- It eliminates a large upfront cash outlay
- Prevents investors from liquidating stock positions if offers fail
- Guarantee of a result for the acquirer before action is taken. For example, insufficient shares are tendered results in no payment and the acquirer walks away. Or vice versa, the acquires buys the stock and takes control of the company.
- Acquirers can also benefit by including escape clauses, which release any liability for purchasing target stock. A popular release cause is the failure to achieve regulatory approval and allows the acquirer to exit the deal without penalty.
- The speed at which a tender offer can be completed is also an advantage. Acquirers can gain control of a target in less than a month. The speed in which target shareholders can be paid for their stock also delivers a huge return (depending on the premium paid) in a short space of time.
- Once an acquirer owns a sufficient quantity of the outstanding target shares, they are able to force the remaining stockholders to sell out and take the company private. This is known as a squeeze out. Alternatively, they can merge the target into an existing business. All of this can eventually be done even if the remaining shareholders did not accept the original tender offer.
- One of the biggest advantages of a tender offer is that the acquirer is not obligated to buy shares until a set number are tendered. This has a number of benefits
Disadvantages of a Tender Offer
If a tender offer is not completed on time as expected at the initial announcement of the deal, it can result in an expensive way to complete a hostile takeover. Ongoing fees for services such as those listed below could indirectly push the price of the target much higher than originally anticipated
- SEC filing fees,
- Legal / attorney costs
- Investment bank advisory fee
- Other fees for specialized services
Should other potential suitors become involved in a hostile takeover, the offer price will increases. Should the original acquirer lose this battle, the ongoing fees listed above may prove to be significant. Should the original acquirer win control, it is likely they would have paid much more for the target.
Shareholders may be undecided whether to tender their shares. If the tender is not certain to succeed, investors may hold off tendering in hope of a higher offer. This may cause the deal to be abandoned or delayed.
How Tender Offers Work - Key Points
- Tender offers can be an effective and powerful tool for the investor, group, or business seeking to acquire the major portion of a target company
- Tender offers can be effective when done without the target board of director is against deal ie a hostile takeover.
- Strict rules and guidelines govern the manner in which tender offers must be conducted. It is vitally important companies (both acquirer and target) pay attention to these rules and understand how tender offers work
- These rules and regulations help both the target and target stockholders in deciding how to respond to the tender offer
Further Reading
- Hostile Takeovers – The use of Attack and Defence Strategies by Panagiotis Papadopoulos gives an academic and theoretical analysis of hostile takeovers and defenses paying close attention to how tender offers work
- Predicting Successful Takeovers and Risk Arbitrage, Branch and Yang (2003)
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