By
MARK HULBERT
IF you own stock in a company
that is ripe for takeover, you should hope the company isn’t acquired by
a private equity firm.
That, at least, is the conclusion of a
new study, which found that public companies often pay a much higher
price than private equity firms when buying other companies.
The study, “Why Do Private
Acquirers Pay So Little Compared to Public Acquirers?,” began
circulating last month as a National Bureau of Economic Research working
paper. Its authors are four finance professors: René M. Stulz of the
Ohio State University, and
three from the
University of Pittsburgh:
Leonce L. Bargeron, Frederik Schlingemann, and Chad Zutter. A version of
their paper is available at
www.nber.org/papers/w13061.
Private equity firms are much in vogue
on Wall Street these days. They are investment firms that pool money
from wealthy individuals and institutions, and sometimes borrow money,
for the purpose of acquiring companies, in hopes of managing them better
for a couple of years and then selling for a profit.
Some of the largest private
equity firms produced returns last year in the high double digits. Such
performance has not surprisingly attracted huge sums of additional cash,
which the private equity firms have quickly put to work. This year
private equity firms have announced acquisitions whose total value
represents nearly a third of the $684 billion in domestic mergers and
acquisitions, according to
Thomson Financial.
The authors of this new study analyzed
cash-only acquisitions of publicly traded domestic companies completed
from 1990 through 2005. In total, they focused on 1,292 deals, 32
percent of which involved a private bidder and 68 percent involved a
public bidder. They found that “target shareholders receive 55 percent
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 private equity firms tended to purchase less profitable
companies than public bidders did. Nor did private equity firms tend to
acquire companies that were growing more slowly, or ones whose recent
stock performance was poorer.
The professors concluded that, if
differences among the target companies cannot explain the huge price
disparity, then differences among the acquiring firms must be the cause.
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 percent, the professors found no difference in
the average price paid by private and public acquirers.
This finding suggests that it is not
fair to say that private equity firms systematically pay too little to
acquire other companies. Instead, it would be more accurate to say 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, Professor Stulz said in an interview, their motivations may
simply be to satisfy their egos by building a corporate empire.
It might be tempting to view the
News Corporation’s recent bid
to acquire
Dow Jones & Company 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’s not a good illustration of the pattern
identified by the professors:
Rupert Murdoch, chairman of the
News Corporation, owns nearly 30 percent of the company through various
family trusts. In addition, Professor Stulz points out, “it is not clear
that Dow Jones’s current owners have maximized shareholder value.”
(Disclosure: MarketWatch, my employer, is a wholly owned subsidiary of
Dow Jones.)
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, Professor Stulz said,
since chances are high that the bid will 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’s falling through.
A more general investment implication,
according to Professor Stulz, is that investors should pay close
attention to the incentives under which corporate managers operate.
“You should favor companies whose
managers are working on behalf of long-term shareholder value and not
personal aggrandizement,” he said. 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, a service of MarketWatch. E-mail: strategy@nytimes.com.
