Monday, October 8, 2012

The Best Takeover Defense - Don't Leave Money on the Table

Publicly traded firms can be targets for acquisition bids.  Sometimes the bids are welcome and target managements try to understand how to maximize the bid price.  Other times bids are unwelcome and target management seeks to avoid a hostile acquisition.  In both of these cases, target management has a better chance of achieving its objectives if it will follow a simple rule:  maximize value.  In particular, don't leave easy money on the table. Maximize firm value by every means possible.  If target management does seek to sell the firm, this strategy will raise the floor from which premia are added.  If the target firm is trying to avoid takeover, this takes the easy money off the table and makes the firm a less attractive target.

Acquiring firms launch takeover bids for numerous reasons, but most, if not all, reasons can be classified into two broad areas: shareholder welfare and managerial welfare.  The latter set of motives deal with empire building, with overbidding due to hubris and other problems often associated with corporate governance.  We'll have more to say about that in another blog.

In terms of shareholder welfare, one firm bids for another when they believe it is in the best interest of their own shareholders.  In short, the expected net present value from completing the deal is expected to be positive.  Just as there are numerous motives for mergers, there are numerous ways a deal can create value.  For example, gains could accrue because of greater market share and the power associated with that market share or because of synergies that exist between the combined firms.

When the potential acquirer thinks about a bid, they envision the value of the firm under their control.  They also imagine the least amount they could offer for the target to acquire control.  For publicly traded firms, this minimum amount is  the current stock price.  Absent extreme liquidity concerns, rational shareholders would not sell their shares for less than they could get on the open market.  Thus, that market price becomes the floor from which bidders begin their pricing.  If the anticipated gains are insufficient to warrant the risks of the deal, a bid will not materialize.

Maximizing value won't prevent an acquisition bid, but it will put management in the strongest possible position should a bid materialize and in terms of hostile bids, it will discourage bidders looking for easy money left on the table.  Bids that do materialize are more likely to occur because of the synergistic potential of the combination rather than a failure of target management to follow the best value maximizing strategies.  In this regard, one should not disregard the disciplinary force of the takeover market.  In numerous situations, target management faced with a bid decided to implement changes similar to those that would have followed a 'takeover'.  These changes include things like focusing the firm, eliminating redundant assets, spinning off a division that doesn't fit the strategic mission and finding ways to reduce overhead costs.  In other words, taking the easy money off the table.  But it is better to be proactive than reactive.   Don't wait for a hostile bid to force value increasing change.

Incidentally, managements often complain that they are forced to behave in myopic ways to meet quarterly earnings estimates.  But myopic behavior implies overemphasizing the short run and hence producing lower firm value.  Rather than discouraging acquisition, this type of behavior is likely to do the opposite.  Failing to run the firm optimally leaves easy money on the table, inviting acquisition by a management with the proper long term perspective.

No comments:

Post a Comment