The Wall Street Journal Interactive Edition -- March 6, 1997

               When Mulling a Takeover,

               The Terms Make a Difference

 

               By ROGER LOWENSTEIN

 

               Investors are casual about whether an acquisition is made

               with stock or with cash, but the dynamics of these deals

               differ far more than people realize. So do the results.

 

               Acquirers who in the past used their stock fared worse --

               considerably worse -- than those who used cash. Such a

               finding agrees with the suspicion, previously aired by a

               certain financial columnist, that at least some share

               mergers are effected with financial funny money. Until now,

               it was merely a suspicion.

 

               But Tim Loughran and Anand M. Vijh, finance professors at

               the University of Iowa, have contributed to the merger wave

               of the 1990s a breathtaking study on the mergers of the

               1970s and 1980s. Their first finding is unsurprising: Over a

               five-year period, stocks of all acquirers did slightly (but

               only slightly) worse than stocks of their peers. In other

               words, acquisitions as a group are neither bad nor good,

               though on balance buyers slightly overpaid.

 

                But it turns out that acquisitions are not all

               created equally. The just-finished study considered nearly

               1,000 deals. Companies that made cash acquisitions saw their

               stocks rise an exuberant 113% in the five years following

               the merger. Those that used stock rose a meager 61%.

 

               Moreover, by comparing the acquirers with control groups

               (stocks of similar size and similar stock price relative to

               book value) the authors reached an even stronger conclusion.

               Companies that made cash acquisitions did better than

               average -- not just better than other acquirers. And

               acquirers that used stock did considerably (24%) worse than

               a neutral benchmark. Such results are seemingly surprising

               -- but only seemingly.

 

               As the authors note, it is useful to think of

               share-for-share mergers as a combination of two events --

               first, a sale of stock, and second, an acquisition. It is

               very different from an outright purchase. By analogy, if

               your neighbor offers to buy your home, he is expressing a

               positive opinion about its value (or, possibly, a negative

               one about the desirability of having you as a neighbor). If,

               on the other hand, he offers to join your two properties and

               combine the deeds, he is hoping to acquire some of your

               property in exchange for giving up some of his interest in

               his own.

 

               That is what happens when an acquirer issues stock. When

               Chemical Bank "acquired" Chase Manhattan, each Chemical

               shareholder gave up roughly half of his proportional stake

               in Chemical -- that is, he sold it -- in exchange for an

               interest in Chase. Corporate deal-makers, if they are doing

               their job, should be willing to part with a piece of their

               company only when the price on it is high.

 

               Previous studies (including one by Mr. Loughran and Jay

               Ritter of the University of Florida) have shown that

               companies sell stock at opportune times -- meaning that

               people who invest at such times do poorly. Though they would

               never say this, by their actions stock-issuing executives

               are "signaling" that their stock is high. One inference from

               the merger study is that share-using acquirers are signaling

               the same thing.

 

               But more is going on here. The authors also divided the

               cash-payers into two groups: friendly and hostile (via

               tender offers). By a huge margin (146% to 98%), shares of

               the hostile acquirers outperformed. A tentative conclusion

               would be that it's easier to realize gains by removing poor

               managers, as in hostile deals, than by pursuing the supposed

               synergies envisioned by friendly combiners. It will be

               interesting to see if this holds for the seemingly more

               cost-conscious mergers of the '90s. Taken as is, the study

               has ironic implications for target shareholders. Takeover

               premiums were the same, regardless of whether a merger was

               friendly or hostile or paid for with stock or cash. Target

               shareholders made an average of 30% from just before the

               news until a merger closed, during which time shares of

               similar companies gained 5%. But after the closing, the

               returns of each merger type steadily diverged throughout the

               five years.

 

               Shareholders who sold into a cash tender and used the money

               to invest in the acquirer greatly magnified their gains.

               Thus, the takeover vaulted them 25% ahead of the norm, but

               by the end of five years (assuming they were tax-exempt)

               their margin of overperformance would have soared to 138%.

 

               On the other hand, people who got a premium in the form of

               stock saw their gains steadily dissipate. By the end of five

               years, they fared hardly any better than people who hadn't

               been blessed with a takeover.

 

               The implication: Shareholders who get paid in cash would do

               better with stock; those who get stock should cash out. Of

               course, this isn't realistic for all ("everyone" cannot

               sell).

 

               The bottom line is that acquirers who use stock tend to be

               those with overvalued shares -- thus, the premium they

               confer is illusory. Moreover, to hazard a guess, it is just

               a bit easier to rationalize an overpriced deal when it is

               paid for in stock -- particularly when a friendly partner is

               applauding your efforts. Just so, it takes more conviction

               to spend hard cash, as it does to launch a hostile bid. That

               is why such deals work better.

 

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