Question

UnderCo has 10M shares outstanding with shares trading at $8/share. One day UnderCo is targeted by a hostile tender offer for $9/share.

UnderCo’s management owns 40% of the firm, and will not sell its shares. In order to fend off the bid, management plans to make a competing tender offer to public investors. The company will borrow $30M and use the proceeds to finance the self-tender. UnderCo is initially 100% equity financed.

UnderCo faces a corporate tax rate of 50%. Assume UnderCo maintains the level of debt, and that interest tax shields are as risky as the debt.

a)Assume UnderCo announces an offer for $9.20/share. This would be a partial tender offer, the size of which is limited by the amount of debt proceeds. Will shareholders tender?

Answer 1

Shareholders will likely favor the management's self-tender offer over the hostile bid since it offers a higher price per share. However, with only $30M available for the self-tender, not all shareholders may be able to participate if demand exceeds supply.

Step-by-step explanation:

The student's question pertains to a scenario in which UnderCo is under a hostile tender offer at $9 per share, and the management, which owns 40% of the firm, wants to counter it with a self-tender offer financed by borrowing $30M. To address whether shareholders will tender their shares to the management's offer at $9.20/share, one needs to consider the incentives for shareholders to accept the tender offer over the hostile bid. Shareholders generally tend to favor offers that provide a higher per share price. Given that the management's offer is $0.20 higher per share than the hostile bid, shareholders may likely find the self-tender offer more attractive and choose to tender their shares provided they believe in the credibility and stability of the management's plan.

However, since the management only has $30M to finance the self-tender, and if all public shareholders (60% of shares) decide to tender their shares, the company would only be able to repurchase a limited number of shares ($30M / $9.20 per share). Therefore, not all shareholders may be able to participate in the tender offer if the demand to tender exceeds the financial capacity of UnderCo's self-tender offer. This potential limitation could affect some shareholders' decisions to participate in the tender offer.