Custom Search

WHO GETS THE GAINS?

Is it better to own shares in the acquiring firm or the target? In general, shareholders of the target firm do best. Franks, Harris, and Titman studied 399 acquisitions by large U.S. firms between 1975 and 1984. They found that shareholders who sold following the announcement of the bid received a healthy gain averaging 28 percent.8 On the other hand, it appears that investors expected acquiring companies to just about break even.

The prices of their shares fell by 1 percent.9 The value of the total package ¤buyer plus seller ¤increased by 4 percent. Of course, these are averages; selling shareholders sometimes obtain much higher returns. When IBM took over Lotus, it paid a premium of 100 percent, or about $1.7 billion, for Lotus stock.

Why do sellers earn higher returns? The most important reason is the competition among potential bidders. Once the first bidder puts the target company ¬in play, ­ one or more additional suitors often jump in, sometimes as white knights at the invitation of the target firm`s management. Every time one suitor tops another`s bid, more of the merger gain slides toward the target. At the same time the target firm`s management may mount various legal and financial counterattacks, ensuring that capitulation, if and when it comes, is at the highest attainable price.

Of course, bidders and targets are not the only possible winners. Unsuccessful bidders often win, too, by selling off their holdings in target companies at substantial profits. Such shares may be sold on the open market or sold back to the target company.10 Sometimes they are sold to the successful suitor.

Other winners include investment bankers, lawyers, accountants, and in some cases arbitrageurs, or ¬arbs, ­ who speculate on the likely success of takeover bids.

¬Speculate ­ has a negative ring, but it can be a useful social service. A tender offer may present shareholders with a difficult decision. Should they accept, should they wait to see if someone else produces a better offer, or should they sell their stock in the market? This quandary presents an opportunity for the arbitrageurs. In other words, they buy from the target`s shareholders and take on the risk that the deal will not go through.11

Leveraged Buyouts

Leveraged buyouts, or LBOs, differ from ordinary acquisitions in two ways. First, a large fraction of the purchase price is debt-financed. Some, perhaps all, of this debt is junk, that is, below investment grade. Second, the shares of the BO no longer trade on the open market. The remaining equity in the LBO is privately held by a small group of (usually institutional) investors. When this group is led by the company`s management, the acquisition is called a management buyout (MBO). Many LBOs are in fact MBOs. In the 1970s and 1980s many management buyouts were arranged for unwanted divisions of large, diversified companies. Smaller divisions outside the companies` main lines of business often lacked top management`s interest and commitment, and divisional management chafed under corporate bureaucracy. Many such divisions flowered when spun off as MBOs. Their managers, pushed by the need to generate cash for debt service and encouraged by a substantial personal stake in the business, found ways to cut costs and compete more effectively.

During the 1980s MBO/LBO activity shifted to buyouts of entire businesses, including large, mature public corporations. The largest, most dramatic, and best- documented LBO of them all was the $25 billion takeover of RJR Nabisco in 1988 by Kohlberg Kravis Roberts (KKR). The players, tactics, and controversies of LBOs are writ large in this case.

9 The small loss to the shareholders of acquiring firms is not statistically significant. Other studies using different samples have observed a small positive return.

10 When a potential acquirer sells the shares back to the target, the transaction is known as greenmail.

11 Strictly speaking, an arbitrageur is an investor who makes a riskless profit. Arbitrageurs in merger battles often take very large risks indeed. Their activities are sometimes known as ¬risk arbitrage. ­