If you own stock in a company that is ripe for takeover, you should hope the company is not acquired by a private equity (PE) firm.
That, at least, is the conclusion of a new study, which found that public companies often pay a much higher price than PE firms when buying other companies.
The study, ‘Why Do Private Acquirers Pay So Little Compared to Public Acquirers?’ began circulating last month as a US National Bureau of Economic Research working paper. Its authors are four finance professors, Rene Stulz of Ohio State University, and three from the University of Pittsburgh: Leonce Bargeron, Frederik Schlingemann, and Chad Zutter. A version of their paper is available at www.nber.org/papers/w13061, a pay-per-use site.
This year, PE firms have announced acquisitions whose total value represents nearly a third of the $684 billion (Rs28.04 lakh crore) in US mergers and acquisitions, according to Thomson Financial.
The authors of this new study analysed cash-only acquisitions of publicly traded US companies completed from 1990 through 2005. In total, they focused on 1,292 deals, 32% of which involved a private bidder and 68% with a public bidder.
They found that “target shareholders receive 55% more if a public firm, instead of a private equity fund, makes the acquisition.”
The professors were unable to account for this big price disparity in terms of any observable differences in the kind of companies that were acquired. It was not the case, for example, that PE firms tended to purchase less profitable companies, or those that were growing more slowly, than public bidders did.
The professors concluded that differences among the acquiring firms must be the cause of the disparity. Sure enough, the professors found that the highest prices tended to be paid by publicly traded acquirers whose managers owned the least amount of their companies’ stock.
Indeed, upon eliminating from their database those publicly traded acquirers whose managers had ownership stakes amounting to less than 20%, the professors found no difference in the average price paid by private and public acquirers.
This finding suggests that acquisition prices tend to be too high when the acquirer is publicly traded and its management has a low ownership stake.
Why would the percentage of shares owned by management have anything to do with the price paid to acquire another company?
The professors say that when corporate managers have only a small ownership stake, they are more likely to pursue acquisitions that do not enhance shareholders’ long-term value. In such cases, Stulz said, their motivations might simply be to satisfy their egos by building a corporate empire.
It might be tempting to view News Corp.’s recent bid to acquire Dow Jones & Co. as a good example of this empire-building, especially since the offer of $60 a share is so much higher than the price at which the stock had been trading. But in fact, it is not a good illustration of the pattern identified by the professors: Rupert Murdoch, chairman of News Corp., owns nearly 30% of the company through various family trusts.
How should you react if you own stock in a company that receives an acquisition bid from a publicly traded company whose management has a small ownership stake?
You may want to sell your stock immediately upon the announcement of that bid, Stulz said, since chances are high that the bid would have inflated the price of your stock to overvalued levels. By selling immediately, you lock in much of that higher price and protect yourself from the possibility of the deal falling through.
A more general investment implication, according to Stulz, is that investors should pay close attention to the incentives under which corporate managers operate. One clue that managers’ interests are aligned with shareholders’ is that they have a large ownership stake.
Mark Hulbert is editor of The Hulbert Financial Digest, which is owned by a unit of Dow Jones & Co. Comments welcome at firstname.lastname@example.org