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.

If UnderCo offers $10, will shareholders tender? Explain using numbers.

Answer 1

Shareholders of UnderCo may choose to tender their shares at the $10 offer price due to the higher offer compared to the hostile bid, the interest tax shields provided by the new debt, and the potential increase in value for the remaining shares.

Step-by-step explanation:

Given that UnderCo has 10 million shares outstanding and the management owns 40%, this leaves 60% or 6 million shares available to the public. UnderCo plans to borrow $30 million for a self-tender offer at $10/share, which means they could buy back 3 million shares. If the company follows through with this plan, shareholders might choose to tender their shares for several reasons:

• Higher offer price: UnderCo's offer of $10/share is higher than the hostile tender offer of $9/share.
• Tax benefits: Under a 50% corporate tax rate, the interest paid on the debt to finance the buyback is tax-deductible, providing interest tax shields that increase the value of the firm.
• Reduced supply of shares: After the buyback, the total number of shares outstanding will decrease, potentially increasing the value of the remaining shares.

Therefore, shareholders might find the $10 self-tender offer more attractive than the hostile bid of $9/share and may choose to tender their shares to UnderCo.