A bear hug is a business term used by investors to describe the process of paying more than market value for another company’s share price. Although it sounds positive, a bear hug is often seen as a hostile takeover strategy with several negative implications.
Though a bear hug between friends may be a warm embrace, the business version is not as kind. When a business employs a bear hug, they are attempting to entice another business to sell by offering a higher stock price than what the target company’s shares are currently worth. Even though a bear hug sounds like something that all businesses would want, this usually isn’t the case.
Although a bear hug is occasionally positive, it’s also used in hostile takeovers. This method may even allow the buyer to change a company’s structure when the company or the company’s shareholders don’t necessarily want this to happen. Therefore, it’s fundamental to understand why a bear hug occurs.
What is a bear hug?
A bear hug is when an entity or individual wants to buy a company and offer more than the current market price of the company’s stock.
Say a company is trading on the stock market for $10 a share. A private equity fund feels that the company is managed incorrectly and wishes to buy it, take the company private, and then list it again with changes made. They might send a bear hug offer letter of $14 a share, which is a 40% premium over the current price. This is to incentivize the shareholders to sell the company.
What is a bear hug letter?
A bear hug letter is a letter sent by the acquiring company to the target company. Its purpose is to let the target company know that they are willing to give a bear hug. It can also affect the market price if made public, as now everyone knows this company may be taken over.
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How a bear hug is utilized in takeovers
When a financial institution, company, or individual is interested in acquiring another company, there are effectively three options:
- They could pay the market price for the company;
- Pay a discounted price for the company; or
- Pay a price above and beyond the market price by using the bear hug takeover method.
1. Market value acquisition
This type of acquisition strategy is the simplest of the three as the buyer offers to purchase the company based on the target company’s current value on the open market. If it’s a public company, then paying the market price is equal to paying the stock price on the open market.
2. Discounted value acquisition
Sometimes, a target company can be acquired for a discounted price instead of what it is currently traded at. This is typical because the company has financial problems or there are expected problems that will have an adverse effect on the stock price.
In this scenario, the company’s board of directors would like to sell at all costs. This means they will probably let the company go for below the current market value to sell it as quickly as possible.
3. Bear hug acquisition
When a company offers a bear hug, it’s usually because the target company is currently doing well and is sought after by multiple parties. Unfortunately, the board members of the targeted business may not want to sell at all but could nonetheless get cornered into accepting a deal.
The acquiring company will utilize bear hug offers in order to try and acquire the target company with an overly generous offer to incentivize the shareholders to sell. However, it must be decided by the board what is in the best interest of the shareholders. This is especially true if the company’s growth trajectory in the future will result in an even higher stock price than what the bear hug offer brings to the table. On behalf of the shareholders, they must consider such a generous offer.
Examples of bear hugs
The first financial bear hug took place in 1982, when T. Boon Pickens sent a letter about a bear hug offer to Cities Service, a smaller oil company. Some of the most famous companies in the world either utilized bear hugs themselves to acquire target companies or received bear hugs themselves.
IBM’s purchase of Lotus
In 1995, IBM was interested in acquiring Lotus Notes. At the time, IBM was not doing well in terms of growth trajectory and thought that acquiring Lotus Notes would be crucial to turning the business around.
They ended up paying $3.5 billion for Lotus Notes, acquiring and integrating them seamlessly. IBM was able to acquire the target company for $64 a share, which was $4 higher than the market value of Lotus ($60 a share at the time).
Which companies have sent a bear hug letter to shareholders in the past five years?
Based on the above example, you may think that bear hugs are a strategy of the past. However, companies continue to use this method today.
Although not covered in this article, Xerox sent HP a bear hug letter at the end of 2019. Though the deal never actually went through, some even classify the offer as a “grizzly bear hug” because of the force Xerox attempted to put behind its offer.
In 2017, Broadcom made an unsolicited $103 billion bid, or $70 per share, to acquire Qualcomm. More recently (2022) Elon Musk initiated a bear hug offer to buy Twitter at $54.2 per share (total of $43 billion) which was a 38% premium over the price of Twitter shares on the day of the offer.
Financial advantages and disadvantages of a bear hug strategy
As with most business strategies, a bear hug presents both advantages and disadvantages to the acquiring and target company. Since bear hug letters can become public, companies must consider all the risks and benefits of a bear hug before making such an offer.
Here is a list of the benefits and drawbacks to consider.
- Limited competition. If a company is doing well and has a great growth trajectory, it’s going to be desired by multiple different suitor companies. A bear hug strategy allows the acquiring to flex their financial might that competitors may not have by paying over and above the asking price.
- Maximizes shareholder value. Obviously, if you are a current shareholder in the company, you are an investor as well. The fundamental goal of investing is to make as much money as possible while hedging risk. A bear hug allows all of the shareholders to receive a premium on their current shares, thus substantially increasing their ROI.
- Avoids drama with the target company. If one company buys another, the current management and staff will most likely be acquired as well. Paying over and above the market value for a target company lets the acquired business’s shareholders and employees feel valued.
- Hostile takeover strategy. Hostile takeovers are when an acquiring company tries to acquire a target company when the target company’s shareholders do not want to sell. Bear hugs are commonly associated with hostile takeovers because sometimes the target company doesn’t want to sell.
- May entirely change a business’s practices. Bear hugs are common with “activist investors.” These are investors trying to take over a business to change the target company’s management practices and fundamental structure. Activist investors feel that the company does not have the best interest of the shareholders at stake and thus try to take it over and increase its value.
- A bear hug in business is the act of paying above market value for the stock price in order to take the company over. It’s derived mostly from the idea of humans giving love, above and beyond what is usually standard, by hugging the person more closely and strongly.
- A bear hug is one of a number of acquisition strategies used by companies and financial institutions.
- Bear hugs have been utilized in several famous acquisitions, such as the takeover of Lotus Notes by IBM in 1995.
- Bear hugs don’t always work out for the acquiring company in the long term, so it’s important to look at the feasibility of increasing value in the targeted company.
- A bear hug has several advantages, such as limited competition, maximum shareholder value, and no drama.
- Bear hugs are often synonymous with hostile takeovers and can thus be viewed in a negative light.
View Article Sources
- Merge and acquire businesses — U.S. Small Business Administration
- SEC: Takeover Bid of Fortune 500 Company was a Sham — U.S. Securities and Exchange Commission
- How To Invest In The Stock Market: 8 Basic Concepts — SuperMoney
- Bear Trap: Stock Market Investing for Beginners — SuperMoney
- What is a Bull Trap in Stock Market Investing? — SuperMoney
- What is a Stock Float? Examples of High Vs. Low — SuperMoney