Unique Synergies and the Tyson Foods/Hillshire Merger

The Tyson Foods/Hillshire merger provides an excellent illustration of Joe's Blog regarding the gains to merger (see Chance Favors the Prepared Mind).  Joe wrote that:

 Net Value Added to Acquiring Firm = (Unique Synergies + Common Synergies) -  (Market Cycle Premium/Discount + Common Synergies)  = Unique Synergies - Market   Cycle Premium/Discount

The basic idea behind this equation is simple.  Value added is the difference between what you get and what you pay.  The amount you pay is the premium over the pre-market value of the target.  This premium is driven by the competitive position of the bidder/target and also the competitive pressure of other bidders.  Hence the winning bidder will pay at least the common synergies.  

Now normally, we don't know what the unique synergies are in a merger.  But in this case there were multiple bidders for Hillshire and we know that the second highest bidder ( Pilgrim's Pride) offered $55./share.  Tyson "won" the contest by offering $63. per share.  

In this case, we can estimate the common synergies as the difference between the final bid price of the losing bidder (i.e., the $55 offered by Pilgrim) and Hillshire's $37.  stock price on May 9, the day before the merger activity began.  Thus, the common synergies of $18. (= 55 - 37) are included in the price paid by the "winning" bidder (Tyson).  Tyson paid $8. per share more than the common synergies to acquire Hillshire offering a final bid price of $63. 

 So how much must Tyson earn in unique synergies for the contest to be worthwhile?  Enough so the net value added exceed zero. 

Thus, for Tyson to succeed the deal must ultimately be worth over $8. per share in unique synergies.

Net Value Added to Acquiring Firm 

= (Unique Synergies + Common Synergies) -  (Market Cycle Premium/Discount + Common Synergies)  

= (      ?                      +       18          ) -  (                  8                           +          18          )

Which implies Unique Synergies must be at least $8.  to succeed.

But that's not all.  To succeed, Tyson must earn greater than the $8. premium and  successfully earn the common synergies of $18.  

Also note, we estimate the market cycle premium or discount as the difference between the highest and second highest bids.  The actual value is more complex than this and depends in part on whether the target's pre-market value was already over or under inflated.  That is, we are assuming here that Hillshire's pre-merger value of $37. per share was a fair value of the company as a stand alone.

The bids for Hillshire illustrate many important points about mergers and acquisitions:

• When multiple bidders compete, target shareholders win.
• Multiple bidders will emerge when there are common synergies, available to multiple parties.
• Bidders are likely to earn higher returns in cases without common synergies and in cases where the combination of this bidder/target produces unique gains unattainable by other bidders.
• Bidders face a tension between paying too little and losing the deal, and overpaying and reducing their rate of return.
• Unique synergies can also include precluding a rival (like Pilgrim) from establishing a competitive position.  That is, one motivation for Tyson's purchase is likely to be preventing Pilgrim from occupying the same space.
• Synergies that look good on paper may fail to materialize because of misestimation or problems of integration.  
• The Winner's Curse is a distinct possibility.

All the best,

Ralph

Do Bad Bidders Become Good Targets?

We all have our favorites, from food to songs and so it is with titles to academic articles.  Today’s post features one of my favorites, “Do Bad Bidders Become Good Targets?”  The answer, in a very interesting article by Mark Mitchell and Ken Lehn, is yes. 

We’ve argued before that the best takeover defense is to not leave money on the table.  The analysis of this article follows this logic.  Companies that lose money through bad acquisitions are wasting shareholder value and are likely to be targets themselves.  The complete article can be downloaded here.  The abstract is shown below.

“Do Bad Bidders Become Good Targets?”

by Mark Mitchell and Ken Lehn

This paper empirically examines one motive for takeovers: to change control of firms that make acquisitions that diminish the value of their equity. Firms that subsequently become takeover targets make acquisitions that significantly reduce their equity value, and firms that do not become takeover targets make acquisitions that raise their equity value. Within the sample of acquisitions by targets, the acquisitions that reduce equity value the most are those that are later divested either in bust-up takeovers or restructuring programs to thwart the takeover. This evidence is consistent with theories advanced by Robin Marris (1963), Henry G. Manne (1965), and Michael C. Jensen (1986) concerning the disciplinary role played by takeovers. 

All the best,

Ralph

Rolls Hubris Hypothesis and Acquiring Firm Returns

I've heard management professors and some consultants throw around comments like "Seventy percent of all acquisitions fail."  I don't believe it and the statistical evidence doesn't support that claim.  True, there is a lot of evidence that suggests bidders break even or lose a few percent at the announcement of a bid.   The combined returns to bidders and targets, appropriately weighted for size, are positive.  The typical deal creates value.   What I might believe is that 70 percent (or more) of mergers fail to realize their potential.  But that is typically a problem of integration and the subject of other posts. 

So what do we make of the continuing story that bidders tend to lose or break even?  After all, bidding activity continues to be quite popular (even if currently dampened).   There are many explanations in the literature to explain bidder returns.  Today, I will mention two.

The first is the possibility that we, as researchers, are not measuring returns correctly.  In a recent paper published in the Review of Financial Studies we present evidence that the typically measured bidder return doesn't adjust for anticipation.   When returns are measured correctly bidder returns are positive.  See (Anticipation, Acquisitions and Bidder Returns.)  

But let's return to the fact that some deals, however measured, do result in the loss of value to the acquiring firm.  Even in our sample this occurs as much as 40% of the time.  Why? A good place to start looking for the answer is in the price paid for the target.  As we have noted, Every deal is a bad deal at some price.  Not every deal is a good deal at some price.

In an efficient market, the value of a firm's shares are priced correctly.  Why would bidders typically add 20-40% to the market price in their bids?  Why would bidders pay more than this? The obvious, and always cited reason is synergies.  Synergies, of course, can be easily overestimated and in other posts we note that you should always challenge the assumption of synergies.  Why are they available to your firm and to no one else?  

Another reason to explain high bid prices is behavioral - the hubris factor. Roll (1986) was the first to point this out in the finance literature.  

Anyone who has bid for an object on Ebay understands that it is easy to overpay, to go beyond the rational limits we might set in advance on our bids.  We get caught up in deal fever or a desire to 'win' regardless of price.  The same behavior must certainly be true of at least some acquiring managments.  One can imagine the psychological pressures on management in certain bidding wars.  Multiple sides express multiple views with many unkind words and suggestions.  If psychological factors lead bidders to go beyond pre-determined boundaries (or equivalently if management directly or indirectly causes their own analysts to overestimate the gains to mergers in setting those boundaries) shareholders lose.  As we have noted, some of the best deals are those not attempted or in this case, not completed.  

One of the best illustrations of the hubris phenomena are found in the words of Warren Buffett, quoted in a previous post,

"Many managers were apparently over-exposed in impressionable childhood years to the
story in which the imprisoned, handsome prince is released from the toad's body by a kiss
from the beautiful princess.  Consequently, they are certain that the managerial kiss will
do wonders for the profitability of the target company.  Such optimism is essential.
Absent that rosy view, why else should the shareholders of company A want to own an
interest in B at a takeover cost that is two times the market price they'd pay if they made
direct purchases on their own?  In other words investors can always buy toads at the
going price for toads.  If investors instead bankroll princesses who wish to pay double
for the right to kiss the toad, those kisses better pack some real dynamite. We've observed
many kisses, but very few miracles.  Nevertheless, many managerial princesses remain
serenely confident about the future potency of their kisses, even after their corporate
backyards are knee-deep in unresponsive toads." 

(Warren Buffett in the 1981  Berkshire Hathaway Annual Report)

We'll continue this discussion in two ways in the future.  One will be through an analysis of other factors related to bid premia and to bidding and acquiring returns.  A second avenue of analysis will continue to explore the role of behavioral factors in mergers and acquisitions.

All the best,

Ralph 

May the Odds Be With You

This blog has highlighted the difficulty for acquirers to create value for their shareholders. This is due to a variety of factors ranging from behavioral biases to governance breakdowns. This does not mean that all M&A is bad as some do succeed. Those success stories share some common characteristics. A key is the establishment of an appropriate process with effective procedural safeguards.

This process incorporates many of the following steps (my Ten Commandments) :

1)     Avoidance of large transformational transactions-especially when proposed by a new CEO seeking to make a reputation for himself. He usually succeeds in making the reputation-unfortunately, not the one he intended. HP’s Leo Apotheker stands out as the poster boy example with the disastrous Autonomy acquisition.

2)     Actively engage the board in the process from the beginning rather than just asking them to approve a fully cooked deal under a tight deadline.

3)     The board should establish a subcommittee chaired by a knowledgeable outside director to challenge management concerning, inter alia, pricing, valuation, synergies, and alternatives.

4)     Establish a firm up front walk away price before the negotiations begin. Beware having to adjust your price to “win”-AKA the winners curse. This reservation price should reflect your best alternative to a negotiated agreement (BANTA). This protects against accepting an unfavorable agreement compared to a better alternative outside of the negotiations. To paraphrase Warren Buffett-there are no called third strikes in M&A. There is always another opportunity.

5)     Carefully consider the “whole deal” and not just price. Remember, you can name the price if I can name the terms, and I will win every time.

6)     Ask yourself if you are honestly the best owner of the target. This means you can extract the highest value through an optimal mix of strategy and execution. If not, then you are unlikely to extract the premium paid in a competitive bidding situation. As my favorite Chicago mayor Richard Daley Sr. eloquently stated-“don’t play no games you can’t win”.

7)     Make sure you get what you thought you were buying through extensive hands on due diligence(DD). DD is not glamourous and is frequently out sourced to consultants by executives who do not want to get their hands dirty. This leads to failure like those at HP in their failed acquisitions program. The seller enjoys an informational advantage over the buyer. Since they are unlikely to tell, it is up to the buyer to find out. A useful supplement to DD is using the reps and warranties in the sales and purchase (merger agreement) to flesh out matters you should explore more deeply.

8)     Develop a detailed integration plan updated by DD results covering the first 100 days after the closing. You need quick victories and must consider the complex social issues.

9)     Tie management’s incentive compensation to the target’s post close performance.

10)  Conduct a post mortem a year after closing to uncover lessons to be learned.

Of course, there are no guarantees, but the odds for success can be increased through an appropriate process.

Good luck

j