The Wall Street Journal Interactive Edition -- March 6, 1997
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
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
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
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.
Copyright © 1997 Dow Jones & Company, Inc. All Rights