Stock buying companies
Companies are increasingly paying for acquisitions with stock rather than cash. But both they and the companies they acquire need to understand just how big a difference that decision can make to the value shareholders will get from a deal. In alone, 12, deals involving U. But the numbers should be no surprise.
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Companies are increasingly paying for acquisitions with stock rather than cash. But both they and the companies they acquire need to understand just how big a difference that decision can make to the value shareholders will get from a deal. In alone, 12, deals involving U. But the numbers should be no surprise. After all, acquisitions remain the quickest route companies have to new markets and to new capabilities.
As markets globalize, and the pace at which technologies change continues to accelerate, more and more companies are finding mergers and acquisitions to be a compelling strategy for growth. This shift has profound ramifications for the shareholders of both acquiring and acquired companies.
In a cash deal, the roles of the two parties are clear-cut, and the exchange of money for shares completes a simple transfer of ownership.
But in an exchange of shares, it becomes far less clear who is the buyer and who is the seller. In some cases, the shareholders of the acquired company can end up owning most of the company that bought their shares.
Companies that pay for their acquisitions with stock share both the value and the risks of the transaction with the shareholders of the company they acquire.
The decision to use stock instead of cash can also affect shareholder returns. In studies covering more than 1, major deals, researchers have consistently found that, at the time of announcement, shareholders of acquiring companies fare worse in stock transactions than they do in cash transactions.
Despite their obvious importance, these issues are often given short shrift in corporate board-rooms and the pages of the financial press.
Both managers and journalists tend to focus mostly on the prices paid for acquisitions. Price is certainly an important issue confronting both sets of shareholders. But when companies are considering making—or accepting—an offer for an exchange of shares, the valuation of the company in play becomes just one of several factors that managers and investors need to consider.
In this article, we provide a framework to guide the boards of both the acquiring and the selling companies through their decision-making process, and we offer two simple tools to help managers quantify the risks involved to their shareholders in offering or accepting stock. The main distinction between cash and stock transactions is this: In cash transactions, acquiring shareholders take on the entire risk that the expected synergy value embedded in the acquisition premium will not materialize.
In stock transactions, that risk is shared with selling shareholders. More precisely, in stock transactions, the synergy risk is shared in proportion to the percentage of the combined company the acquiring and selling shareholders each will own. Suppose that Buyer Inc. The market capitalization of Buyer Inc.
Seller Inc. The managers of Buyer Inc. They announce an offer to buy all the shares of Seller Inc. The value placed on Seller Inc. The expected net gain to the acquirer from an acquisition—we call it the shareholder value added SVA —is the difference between the estimated value of the synergies obtained through the acquisition and the acquisition premium.
So if Buyer Inc. But if Buyer Inc. The new offer places the same value on Seller Inc. They will own only The rest goes to Seller Inc. The only way that Buyer Inc. In other words, the new shares would reflect the value that Buyer Inc. But while that kind of deal sounds fair in principle, in practice Seller Inc. In light of the disappointing track record of acquirers, this is a difficult sell at best. One thing about mergers and acquisitions has not changed since the s.
In most cases, that drop is just a precursor of worse to come. And the larger the premium, the worse the share-price performance. But why is the market so skeptical? Why do acquiring companies have such a difficult time creating value for their shareholders? First of all, many acquisitions fail simply because they set too high a performance bar. Even without the acquisition premium, performance improvements have already been built into the prices of both the acquirer and the seller.
The rest is based entirely on expected improvements to current performance. In other cases, acquisitions turn sour because the benefits they bring are easily replicated by competitors. Competitors will not stand idly by while an acquirer attempts to generate synergies at their expense. Arguably, acquisitions that do not confer a sustainable competitive advantage should not command any premium at all. Acquisitions also create an opportunity for competitors to poach talent while organizational uncertainty is high.
Take Deutsche Bank, for example. After it acquired Bankers Trust, Deutsche Bank had to pay huge sums to retain top-performing people in both organizations. A third cause of problems is the fact that acquisitions—although a quick route to growth—require full payment up front. By contrast, investments in research and development, capacity expansion, or marketing campaigns can be made in stages over time.
Thus in acquisitions, the financial clock starts ticking on the entire investment right from the beginning. Not unreasonably, investors want to see compelling evidence that timely performance gains will materialize. Thus the price paid may have little to do with achievable value. Finally, if a merger does go wrong, it is difficult and extremely expensive to unwind. Managers whose credibility is at stake in an acquisition may compound the value destroyed by throwing good money after bad in the hope that more time and money will prove them right.
The problem, of course, is that the stockholders of the acquired company also have to share the risks. In an all-cash deal, Buyer Inc. But in a share deal, their loss is only The remaining In many takeover situations, of course, the acquirer will be so much larger than the target that the selling shareholders will end up owning only a negligible proportion of the combined company. It is one of the highest profile takeover stories of the s, and it vividly illustrates the perils of being paid in paper.
Boards and shareholders must do more than simply choose between cash and stock when making—or accepting—an offer. There are two ways to structure an offer for an exchange of shares, and the choice of one approach or the other has a significant impact on the allocation of risk between the two sets of shareholders.
Companies can either issue a fixed number of shares or they can issue a fixed value of shares. But the acquisition was not without its risks. First, the Green Tree deal was more than eight times larger than the largest deal Conseco had ever completed and almost 20 times the average size of its past 20 deals.
So investors started to sell Conseco shares. The other way to structure a stock deal is for the acquirer to issue a fixed value of shares. In these deals, the number of shares issued is not fixed until the closing date and depends on the prevailing price. As a result, the proportional ownership of the ongoing company is left in doubt until closing.
At that share price, in a fixed-value deal, Buyer Inc. But that leaves Buyer Inc. As the illustration suggests, in a fixed-value deal, the acquiring company bears all the price risk on its shares between announcement and closing. If the stock price falls, the acquirer must issue additional shares to pay sellers their contracted fixed-dollar value.
The way an acquisition is paid for determines how the risk is distributed between the buyer and the seller. An acquirer that pays entirely in cash, for example, assumes all the risk that the price of its shares will drop between the announcement of the deal and its closing.
The acquirer also assumes all the operating risk after the deal closes. By contrast, an acquirer that pays the seller a fixed number of its own shares limits its risk from a drop in share price to the percentage it will own of the new, merged company. The acquirer that pays a fixed value of shares assumes the entire preclosing market risk but limits its operating risk to the percentage of its postclosing ownership in the new company.
By the same token, the owners of the acquired company are better protected in a fixed-value deal. They are not exposed to any loss in value until after the deal has closed. In our example, Seller Inc. The loss in the share price is made up by granting the selling shareholders extra shares.
And if, after closing, the market reassesses the acquisition and Buyer Inc. However, if Buyer Inc. Given the dramatic effects on value that the method of payment can have, boards of both acquiring and selling companies have a fiduciary responsibility to incorporate those effects into their decision-making processes.
Acquiring companies must be able to explain to their stockholders why they have to share the synergy gains of the transaction with the stockholders of the acquired company. All this makes the job of the board members more complex. The management and the board of an acquiring company should address three economic questions before deciding on a method of payment.
Second, what is the risk that the expected synergies needed to pay for the acquisition premium will not materialize? The answers to these questions will help guide companies in making the decision between a cash and a stock offer. The answer to that question should guide the decision between a fixed-value and a fixed-share offer. If the acquirer believes that the market is undervaluing its shares, then it should not issue new shares to finance a transaction because to do so would penalize current shareholders.
If the acquirer believes the market is undervaluing its shares, it should not issue new shares to finance an acquisition. That can cause a company to pay more than it intends and in some cases to pay more than the acquisition is worth.
Suppose that our hypothetical acquirer, Buyer Inc.
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People in the know are corporate insiders like directors and top managers who get daily reports on sales trends and projections, and who can read the body language and other signals inside companies. Importantly, insiders are going straight to all the sectors that will supposedly get hit hardest by the virus: air travel, amusement parks, restaurants and economically sensitive areas like basic materials, energy and industrials. They are doing so with repeated, large purchases. People who actually know about viruses, like virologist Michael Mina at Harvard University , believe the actual infection rate might be 10 times the commonly cited number, because of widespread under-reporting of mild cases. That suggests the real mortality rate is 10 times less than what Carlson repeated, drawing from media reports that also constantly repeat the false mortality rate.
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Stock or Cash?: The Trade-Offs for Buyers and Sellers in Mergers and Acquisitions
Stock also capital stock of a corporation , is all of the shares into which ownership of the corporation is divided. This typically entitles the stockholder to that fraction of the company's earnings, proceeds from liquidation of assets after discharge of all senior claims such as secured and unsecured debt , [2] or voting power, often dividing these up in proportion to the amount of money each stockholder has invested. Not all stock is necessarily equal, as certain classes of stock may be issued for example without voting rights, with enhanced voting rights, or with a certain priority to receive profits or liquidation proceeds before or after other classes of shareholders. Stock can be bought and sold privately or on stock exchanges , and such transactions are typically heavily regulated by governments to prevent fraud, protect investors, and benefit the larger economy. The stocks are deposited with the depositories in the electronic format also known as Demat account. As new shares are issued by a company, the ownership and rights of existing shareholders are diluted in return for cash to sustain or grow the business. Companies can also buy back stock , which often lets investors recoup the initial investment plus capital gains from subsequent rises in stock price. Stock options , issued by many companies as part of employee compensation, do not represent ownership, but represent the right to buy ownership at a future time at a specified price. This would represent a windfall to the employees if the option is exercised when the market price is higher than the promised price, since if they immediately sold the stock they would keep the difference minus taxes. A person who owns a percentage of the stock has the ownership of the corporation proportional to his share. The shares form stock. The stock of a corporation is partitioned into shares , the total of which are stated at the time of business formation. Additional shares may subsequently be authorized by the existing shareholders and issued by the company.
How to Buy Stocks Online Without a Broker – Direct Stock Purchase Plans
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