Showing posts with label Shareholder Wealth Maximization. Show all posts
Showing posts with label Shareholder Wealth Maximization. Show all posts

Monday, July 15, 2013

Robbing Peter to Pay Paul

They are at it again. There is another muddled attack on shareholder value Shareholder Primacy. Ordinarily, I ignore these, but this one sounded so smug that I could not let it pass. The separation of ownership from management in large public firms makes having a clear measurable managerial objective critical to govern a firm. That objective should be to maximize shareholder value, which is the value of the firm less debt claims. A firm’s value is the present value of its long-term cash flows discounted for their risk. Capital goes where it is welcome and stays where it is treated well. The shareholder value objective satisfies both requirements.

Shareholder value is especially important in M&A. For example, target management frequently alleges in a hostile takeover that the offer price does not reflect the target’s long term value (e.g. Jerry Yang resisting Microsoft’s offer for Yahoo). Another example is an acquirer’s management trying to justify an over-priced empire building acquisition as not being fully appreciated by the market (e.g. First Niagara’s HSBC branch purchase).

Shareholder value is usually attacked by management and their lawyers (e.g. M. Lipton) on the following grounds:

1)     Shareholder value is short term orientated. They mistakenly characterize shareholder value as myopically focusing on increasing current earnings - in particular earnings per share(EPS). It is true that some managers have twisted shareholder value towards such short term measures to maximize their bonuses ( e.g. Robert Nardelli at Home Depot). This more a governance - incentive compensation lapse by an ill informed board than a problem with shareholder value. Evidence clearly shows that capital markets reward firms that invest for the long term (e.g. Amazon), and penalize short term accounting-EPS orientated firms like the old Home Depot. Managers may be myopic, but markets are not.

2)     Capital markets cannot properly value strategies and managerial vision. Strategies and visions have financial implications and results, which sometimes differ from what was anticipated or promised. Ignoring stock market responses is like flying blind - it leads to crashes. Clearly share price does not always equal value. Rather, it represents investor consensus of value, not value itself. When the consensus differs from management’s value belief it reflects either an investor relations communication problem or that investors do not share management’s beliefs. Either way, management should react rather than ignore financial market responses just as they would react to product market customer input. This is required to protect against managerial visions becoming delusional.

3)     Shareholder value does not properly reflect the interests of other stakeholders. While shareholder value can be measured, I know of no way to meaningful measure stakeholder value. Furthermore, it is difficult to increase shareholder value if you are exploiting other stakeholders. Usually, when stakeholders are mentioned, management is trying to justify robbing Peter(shareholders) to pay Paul (themselves). In such circumstances you can always count on the support of the Paul’s and their lawyers. Allowing stakeholders coequal control over capital supplied by other is equivalent to letting one group risk another’s capital. This will impair future capital formation and depress share prices and shareholder wealth.

Bottom line, shareholder value attacks are really efforts to weaken governance by deflecting criticism of underperformance. Understandably, managers do not like having their actions questioned, but that is precisely the meaning of governance. In M&A, governance is critical to offset the impact of the winner’s curse, unless, of course, you are Paul.


J

Thursday, June 27, 2013

The Google Waze Acquisition

The proposed Google, Waze acquisition illustrates many of the themes we've developed in previous posts.  First would be motives for acquisition.  In this case, we have acquiring technology, increasing market share and staying relevant - all consistent with increasing shareholder value (see Catalysts for Merger and  Motives for Merger).  But then we also have Merging defensively - (to prevent a competitor from doing the deal and getting an advantage) and the motive of 'eliminating the competition - by acquiring them'.   Now this may also increase shareholder value, but is, of course, frowned upon by the FTC, which is precisely why the FTC is now investigating the issue.  What criteria will the FTC use in deciding whether the deal is in restraint of trade?  See our post concerning the Herfindahl index.  

As the Wall Street Journal reports, 


"The FTC is expected to focus on whether Waze would have become a head-to-head competitor with Google, whose Google Maps software is the dominant digital mapping and navigation service around the world, or whether there is any evidence, such as emails, that show that Google wanted to acquire the company only to keep it out of the hands of rivals."


The complete WSJ article can be downloaded here.  


All the best,

Ralph

Thursday, February 28, 2013

Merger Motives


It has been said that there are as many motives for mergers as there are mergers.  While each merger is certainly unique, there are certainly common themes.  That said, a very partial (top of the head) list of (non-mutually exclusive) motives would include:

  • Synergies
  • Tax strategies
  • Market share
  • Eliminating a competitor
  • Expanding geographically
  • Expanding the product line
  • Acquiring Technology (ex. patents)
  • Utilizing management skills
  • Acquiring management skills
  • Merging defensively - (to prevent a competitor from doing the deal and getting an advantage)
  • Regulatory reasons
  • Strategic plans
  • Acquiring an undervalued firm
  • Acquiring a supplier or customer to improve quality/costs
  • Eliminate redundancy (two CFOs, etc.)
  • Take advantage of economies of scale 
  • Improve product distribution
  • Corporate diversification
  • Increasing debt capacity

Etc.

There are several things to note about this list.  First, it can go on and on.  Indeed, in working with teams of executives I've frequently challenged each individual to come up with a motive for merger than hasn't been mentioned by one of their colleagues.  We can generally go to 20-30 motives before we start repeating and even then someone will mention a new idea. But as we go forward most ideas start to be nuances (subtle or blunt) of previous ideas.  

That is certainly the case with the brief list above.  So Second, the motives are overlapping.  For example, 'eliminating redundancies' and 'taking advantage of economies of scale' are both related and both can be considered as subcategories of 'synergies'. 

Third, there are two broad types of motives.  The first would be those motives related to shareholder wealth maximization.  Arguably, each of the motives listed above are rational attempts by management to improve shareholder value.  In practice, however, even well intentioned motives can lead to shareholder losses.  The distribution and reasons for those losses will be explored in future posts.  

But there is a second broad category of merger motives, not explicitly shown above: managerial motives.  These include:

  • Empire building
  • Acquiring to avoid being acquired
  • Paying too much to get the deal done
  • Hubris
  • Overconfidence
  • Merging to trigger golden parachutes
Empire building means expanding the size regardless of wealth effects and often falls under the guises of the earlier mentioned list of motives. Acquiring to avoid being acquired can be good or bad for shareholders.  If good (perhaps due to market misvaluation due to information asymmetry about the firm’s growth prospects between management and investors), shareholder wealth improves.  If bad (such as to preserve executive jobs) shareholder wealth declines.  Naturally, whether it is good or bad is arbitrated by management. Paying too much to get the deal done happens when executives get caught up in deal fever and overpay to win the deal.  (See our related posts on the Winner's Curse and AnyDeal is a Bad Deal at some price.)

Be careful with mergers – challenge all assumptions.  Ask why the same result cannot be achieved with internal growth.  Ask why any projected synergies are available.  Worry about the winner’s cures.  The moral of the story is that successful executives should think like the shareholders.  After all, they are the owners - it is their money being invested - or wasted.  

We'll follow up down the road with two related posts: catalysts for merger and merger waves.  In those posts we'll talk about the various factors that cause a firm - or an industry - to be in play.  We'll also look at the governance measures that can lead to better merger outcomes.  

All the best,

Ralph

PS Thanks to Joe and also Adam Yore and Jan Jindra for helpful comments on an earlier draft of this post.