Stalking Horse

A Stalking Horse is the first potential buyer to make a bid for the assets of a company that has filed for bankruptcy. Think of them as the brave soul who steps forward to make the first offer at an auction, setting the stage for everyone else. This initial offer, known as a “stalking horse bid,” is negotiated with the bankrupt company and is subject to court approval. Its primary purpose is to establish a minimum price—a floor—for the assets being sold. By doing so, it prevents other potential bidders from swooping in with ridiculously low offers. This process is common in Chapter 11 bankruptcies in the United States, where the goal is to maximize the sale price of the assets to best repay the company's creditors. The stalking horse essentially “stalks” the asset on behalf of the debtor, but in return for taking on the risk and expense of being the first bidder, they receive special protections and advantages.

Imagine a company in financial distress needs to sell its most valuable division to survive. Without a clear starting point, the bidding process could be chaotic and might not yield the best price. This is where the stalking horse gallops in. The process typically unfolds as follows:

• The Initial Bid: A potential buyer (the stalking horse) conducts extensive due diligence on the bankrupt company's assets and negotiates a purchase agreement.
• Court Approval: This agreement, the stalking horse bid, is then presented to the bankruptcy court. If the court finds the bid reasonable, it approves the bidder as the “stalking horse.”
• The Auction: The court then sets up a formal auction process. The stalking horse's bid becomes the baseline offer that other interested parties must beat. The court will also approve bidding procedures, which define what constitutes a higher or better offer (a “qualifying overbid”).
• The Outcome: If other bidders emerge and drive the price up, the creditors benefit from a higher recovery. If no one else bids, the stalking horse wins the assets at the agreed-upon price.

This structure is designed to create a competitive bidding environment. It gives other potential buyers a concrete bid to evaluate and beat, ultimately leading to a more transparent and hopefully more lucrative sale for the bankrupt estate.

Why would anyone want to be the stalking horse? It involves a lot of work, time, and legal fees, with no guarantee of winning the assets. To make it worthwhile, the stalking horse negotiates for several key protections before they agree to make their bid. These incentives are their reward for setting the floor price.

This is the most common and important protection. A Break-Up Fee (or termination fee) is a sum of money paid to the stalking horse if they are ultimately outbid at the auction. This fee is meant to compensate them for the significant resources they invested in due diligence and for the risk they took. It typically ranges from 1% to 3% of the deal's value. This fee also acts as a slight deterrent to other bidders, as they must factor the cost of the break-up fee into their own calculations.

In addition to the break-up fee, the stalking horse often negotiates to have their out-of-pocket expenses reimbursed if they lose the auction. This can include legal fees, advisory fees, and other costs directly related to preparing the bid.

The stalking horse can also negotiate for favorable bidding procedures. For example, they might set a high “minimum overbid,” which is the minimum amount by which a competing bid must exceed the stalking horse's offer. This prevents rival bidders from winning with a trivially small price increase.

For the savvy value investor, the stalking horse mechanism is more than just legal jargon—it's a field of opportunity. Distressed situations often allow for the purchase of good assets at bargain prices, and the stalking horse process is a structured way to do just that. While becoming a stalking horse is typically the domain of private equity firms or strategic corporate buyers, understanding the process offers valuable insights:

• Uncovering Value: The stalking horse bid provides a real-world, heavily-researched valuation floor for a company's assets. For an investor analyzing a struggling company, this can be a powerful piece of data, signaling what a sophisticated buyer believes the assets are worth.
• Asymmetric Risk-Reward: The position of a stalking horse offers an interesting risk profile.
  1. Best Case: No other bidders emerge, and you acquire valuable assets at a price you have already determined is attractive.
  2. Worst Case: You get outbid, but the break-up fee and expense reimbursement compensate you for your time and effort, effectively paying you to do research.
• Signaling: When a highly respected firm becomes a stalking horse for a bankrupt company, it signals confidence in the underlying value of the assets, which can be a bullish sign for investors monitoring the situation.

In essence, the stalking horse process is a fascinating intersection of law, finance, and strategy. For a value investor, it's a reminder that some of the best opportunities are found not in soaring markets, but in the carefully structured fire sales of distressed companies.