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1 Do Rejected Takeover Offers Maximize Shareholder V alue? Jeff Masse Supervised by Dr. James Parrino Abstract In the context of increased shareholder activism, how do shareholders fare in situations where target companies reject takeover acquisition offers? This paper analyzes 32 rejected takeover offers from January 1 st 1998 to January 1 st 2003 analyzing investor returns using an Internal Rate of Return (IRR) approach as well cumulative excess returns relative to both market and sector benchmarks. The results suggest that relative to the returns that could have been realized with the acceptance of the initial takeover offer fi rms that reject acquisition and are not subsequently acquired in the five years following the initial offer experience long run returns that are inferior to those that would have been realized with the offer. In contrast, firms that are later acquired in the five year period following the initial offer do not experience significantly different investor returns. An analysis of cumulative excess returns suggests that target performance after a rejected acquisition offer does not significantly differ from th e market or a sector benchmark Targets that reject takeover offers appear to be neither superior nor inferior when creating shareholder value in the long term
2 Introduction On Wednesday, October 9 th use announced that its Board of Dire ctors had share in cash A New York Times Dealbook article later that week would to effectively limit a shareholder from obtaining an interest in the company larger than 10% (Davidoff, 2013) maximize shareholder value? This paper seeks to provide an answer to that question. By analyzing failed takeove r attempts between January 1 st 1998 and January 1 st 2003 target company performance will be analyzed relative to offer pr emium s as well as relative to market returns after the takeover offer This paper will expand upon previous research by focusing on the long term effects (greater than three years from the offer date) on target company returns. This paper also presents a methodology for evaluating investor returns had the target company ac cepted the takeover offer, which differs from the existing literature Literature Review In this study Dodd analyzed propos als to acquire NYSE listed firms during the seven year period ending December 31, 1977 in order to assess the impact of both accepted and rejected merger proposals on shareholder wealth. By analyzing abnormal returns Dodd found that targets exhibit signif icant positive abnormal returns during the offer window and that in situations where target management rejects the offer proposal, the target while experiencing negative abnormal returns during the termination window, still trades at a premium to the pre o ffer value. This suggests that takeover targets that reject a merger proposal, in the short run after termination of the offer see a permanent revaluation in their shares which increases shareholder value. In contrast to Dodd my r esearch will focus on the long
3 work extends only until 40 trading days after the announcement of the offer termination (Dodd, 1980) explanation for the permanent revaluation phenomena by examining the abnormal returns of firms that were targets of unsuccessful tender offers and firms that h ad made unsuccessful tender offers between 1963 and 1980. Again Bradley, Desai, and Kim were able to confirm the positive revaluation of target shares for targets that rejected tender offers; however abnormal returns differ ed for targets that were acquired in the five year period following the initial offer. For targets that were eventually acquired within five years permanent revaluation held (initial offer premium was not completely erased) for the one and two year periods following the termination of th e initial offer. However, for target s that were not subsequently acquired, permanent revaluation did not hold and the firms experienced significant negative abnormal returns in the one and two year period s following the termination of the initial offer. This led Bradley, Desai, and Kim to conclude that permanent revaluation is the result of anticipation of assumed synergies to be had in a subsequent takeover offer as opposed to superior information exposed through the offer process (information hypothesi s) (Bradley, Desai, Kim, 1983) Following Bradley, Desai, and Kim research was produced that conflicted with the permanent Ruback analyzed unsu ccessful tender offers between 1962 and 1980 of firms listed on the NYSE or American stock exch anges to further evaluate permanent revaluation and to extend research on abnormal returns following offer termination to the t hree year period following termin ation. Ruback finds that management resistance to takeover attempts decreases wealth of existing shareholders; however initially at offer termination merger announcement gains are not completely reversed supporting revaluation in the short term. In the lo ng term, while not statistically significant, firms who reject takeover offers experi ence negative abnormal returns. Again a disparity was noted between firms who were subsequently acquired, seeing more modest negative cumulative abnormal returns, and thos e that were not subsequently acquired (Ruback, 1988)
4 Price Performance of Target Firms in Unsuccessful Mergers and Acquisitions examined the retu rns on 459 targets in unsuccessful M&A deals initiated between January 1 st 1989 and December 31 st 2001 and terminated between January 1 st 1990 and December 31 st 2001. s work is broader, and not limited to failed deals where the target company rejected a takeover offer Croci finds that permanent revaluation does not occur when target management rejects an offer for both targets that are later acquired as well as for targets that are not later acquired In fact Croci finds that c umulative abnormal returns from offer proposal to the post termination window are negative, leading him to suggest the new information hypothesis in which what we learn about firms when they are under attention from an acquisition proposal explains their negative performance and revaluation. In the long term Croci found that cumulative abnormal returns were not statistically significant for targets that rejected a takeover offer (Croci, 2006) The existing body of research has focused on abnormal returns a nd the comparison of target company returns to those of the broader market. My research differs in that it compares investor returns after the offer to investor returns prior to the offer utilizing an Internal Rate of Return (IRR) approach and that it anal yzes cumulative excess returns in the traditional fashion, however attempting to control for sector bias by calculating excess return relative to a sector specific benchmark. The ultimate goal of my research is to provide a comparison of investor return re lative to the offer premium and to determine if relative to the market as a whole target companies who reject takeover offers differ significantly in their performance from the market after the takeover offer Data To identify unsuccessful takeover offe rs I used Thompson SDC to generate a list of rejected takeover attempts initiated between January 1 st 1998, and January 1 st 2003. The screen was limited to contain offers where ownership soug ht was greater than 80%, the proposed de al value was greater th an $50 million and the targets traded on either the NYSE or NASDAQ stock exchanges. With the initial screen I then refined the data set using CapIQ to remove any REITs, target offers where a takeover offer had already been made, and target companies who w ere subsequently acquired within one year from the failed offer. Corporate histories were confirmed
5 using CapIQ and news articles when necessary. The final data set used in my analysis includes 32 target companies. Of these 32 target companies nine targets still have a publicly available market value (though several now trade over the counter), three have filed for bankruptcy and cease to exist as operating companies, and 20 were later acquired. All 32 targets traded publicly for at least one year after the initial offer, 29 traded for at least two years, 22 traded for at least three years, 16 traded for at least five years, and eleven traded for at least ten years. Market data for share prices was found using Bloomberg. To isolate differences in shareholde r returns between firms who rejected an offer but were open to being acquired at a more favorable valuation, as opposed to firms who felt they could create superior value as an independent entity, firms who were subsequently acquired within five years were years Support for the five year acquisition period as a relevant time win dow can be seen in its application in Bradley, Desai and Kim, 1982. Methodology To measure whether shareholder value was maximized by rejecting a takeover offer two tests were employed. The first test was a comparison of investor internal rate of return (IRR) in the one year prior to the takeover offer (T 1 ), ending on the offer date (T), against investor IRR in the one (T+1 ) two (T+2 ) three (T+3 ) five (T+ 5 ) and ten year (T+1 0 ) period s after the offer date as well as in the time until the firms terminal event (defined as either bankruptcy or acquisition). Two of the firms lacked one year of trading history prior to their failed takeover offers, for these firms the first available close price was used in the IRR analysis For the T 1 period the IRR analysis used the share price one year prior to the offer date as the initial cash outflow and the offer value at the offer date as t he terminal cash inflow. The T 1 IRR becomes the point for comparison as it evaluates what investor returns would have been had the takeover offer been accepted at the offer date For the T+1, T+2, T+3, T+5, and T+10 periods the share price on the day of the offer was used as the initial cash inflow and the share price at the end of the time period was used as the terminal cash inflow. For the Offer Terminal event time period for targets that were eventually acquired the acquisition value per share was used as the terminal cash inflow. Fo r the three targets that eventually filed for bankruptcy two had terminal
6 cash inflows of zero as equity holders were wiped out in bankruptcy proceedings and the third utilizes the liquidation value per share as the terminal cash inflow. The T 1 IR R was th en compared to the T+1, T+2, T+3, T+5, T+1 0 and T Test s Data Analysis ToolPak to assess for statistically significant differences in investor IRR across time periods. The second test I used to determine if rejected takeover offers maximized shareholder value was an analysis of cumulative excess returns, relative to the Russell 3000 and the target company specific Russell 3000 sector index, from both the offer date and t he date the offer was withdrawn. Cumulative excess returns were analyzed for the one, two, three, five, and ten year periods after the offer date and withdrawal date as well as the periods from the offer date and ent. Each target company was assigned to a sector specific Russell 3000 sector index. Russell 3000 sector indices include Technology, Consumer Discretionary, Consumer Staples, Utilities, Health Care, Producer Durables, Energy, Financial S ervices, and Mate rials and P rocessing. Target companies were assigned to a sector index based on their SIC code as reported on Bloomberg. Target company SIC codes were compared to the Russell 3000 sector indices current SIC code based on current sector index constituents In areas where there was an overlap between sector indices business descriptions on CapIQ were used to properly assign target companies. Daily excess returns were calculated for target companies and geometrically linked from the offer date and the offer withdrawal date in order to calculate cumulative excess returns. A t test was then performed to assess for statistically significant deviation from an assumed mean of zero; a mean of zero would suggest that the targets on av erage experience market returns Results IRR Analysis The IRR analysis provided the most statistically significant results and also highlighted the distinction between firms that were acquired within five years from the initial offer and firms that were not acquired within five years. Re sults are displayed below.
7 Figure 1: IRR Analysis As illustrated in Figure 1 above, results for all data points were only statisti cally significant for the T+5 and T+1 0 time periods. In these cases investor IRRs in the period after the takeover offer we re inferior to the investor IRR s had an offer been accepted. This evidence suggests that in the long term investor returns are inferior when rejecting a takeover offer In ord er to improve the quality of the results as mentioned above the data set was di group experienced IRRs that were statistical ly significant relative to the pre offer IRR at all t ime periods except for the T+1 time period. Insignificant returns can be expected for the T+1 time period as target company returns typically see price appreciation in the one year period following a takeover offer. significant when compared to the pre offer IRR for any of the observed time periods This can
8 again be expected, as firms that are involved in later takeover offers should experience positive abnormal returns relative to the market. As seen in panel three of Figure 1, the T Of the six data points available three of the firms had negative T 1 IRRs. When negative T 1 olling for poor performers, the results still hold for all time periods (T+1, T+2, and T+3) with investor IRRs not differing significantly from the T 1 time period The IRR analysis allows us to conclude that firms who reject a takeover offer with the int ent of remaining an independent company experience returns that are inferior to returns that would have been realized had an offer been accepted in the long term (two, three, five and ten year periods) However, firms that re ject a takeover offer, but are willing to be acquired at a later time or more favorable valuation, experience returns that do not significantly differ from those that would have been realized with the original offer. The results of the IRR analysis lead us to conclude that the rational e for offer rejection is a key determinant of future investor returns. Investors should be wary of rationale that focuses on remaining an independent entity. These findings support the work of Bradley, Desai, and Kim who found that firms who are acquired i n the five years following an initial takeover experience positive revaluation after the initial offer that is sustained until the time of their acquisition. synergy hypothesis can be applied to the results of the IRR analysis. I nvestor returns fail to differ will still be realized, however at a later time. While varying in methodology (utilizing IRR as opposed to cumulative excess ret urns) and time period, my research supports permanent revaluation for targets that are subsequently acquired as well as illustrates that it does not hold for targets that are not subsequently acquired. Offer Date Cumulative Excess Returns Relative to the R ussell 3000 With an understanding of how investor returns compare to the returns that could have been realized had an offer been accepted, it is also important to understand target company returns relative to the market from the offer date. In existing res earch cumulative excess returns have been the preferred method for evaluating target company performance relative to the market.
9 As illustrated in Figure 2 below cumulative excess returns for all data point s were significant for the T+2, T+3 and Terminal were only significant for the T+3 significant only for the Terminal time period. The lack of broadly statistically significant results and the randomness of statistically significant time periods, suggest that relative to the market as a whole target company returns after an offer do not differ dramatically from the market in the long term It appears that managers who reject ta keover offers are neither superior nor inferior when creating value for shareholders. found that on average, while not statistically significant like my results, firms who reject takeover offers experience negative cumulative abnormal returns and that firms who were not later acquired experience relatively worse cumulative abnormal returns than their acquired peers. In contrast, relative to the market, both for firms that were and were not subsequently acquired targets that rejected takeover offers on average experienced positive abnormal returns. The directional difference of mean returns is likely attributable to time period length were my research extended to include a larger time period accounting for multiple business cycles (Ruback included 18 years of offers while my research included only five years of offers) the direction of mean returns may have been more consistent. In line with Ruback, later acquired firms experienced average cumulative abnormal returns that were in excess of their not acquired peers. Figure 2: Cumulative Excess Returns Relative to the Russell 3000 (Offer Date)
10 Offer Date Cumulative Excess Returns Relative to the Target Specific Russell 3000 Sector Index Previous research has not attempted to control for sector performance when analyzing cumulative excess returns. As detailed below in Figure 3, controlling for sector performance by results in no significant deviation from the sector benchmark. Cumulative excess returns were in significant for all data sets at all tim e periods. The findings here suggest that target managers who reject takeover offers are again neither superior nor inferior at creating shareholder value relative to their sector peers in the long term Because results were statistically insignificant for all time periods, in contrast to cumulative excess returns from the offer date relative to the Russell 3000, it suggests that isolating sector bias is valuable when analyzing cumulative excess returns.
11 Figure 3: Cumulative Excess Returns Relative to Rus sell 3000 Sector Indices (Offer Date) Offer Withdrawal Date Cumulative Excess Returns Relative to the Russell 3000 The offer withdrawal date, and returns thereafter, are also relevant for evaluation. Much of the existing research has focused on post with drawal date cumulative excess returns. This paper finds insignificant cumulative excess returns for all time periods and data sets with the exce ption time period (Figure 4) Generally insignificant cumulative excess returns after th e offer withdrawal date are in line with those experienced from the offer date allowing us
12 to make similar conclusions. Takeover targets that resist appear not to experience significantly different returns than the market following the withdrawal of a takeover offer in the long term Figure 4: Cumulative Excess Returns Relative to Russell 3000 (Withdrawal Date)
13 Offer Withdrawal Date Cumulative Excess Returns Relative to the Target Spe cific Russell 3000 Sector Index from the offer withdrawal date was also conducted. Cumulative excess returns relative to the sector index were insignificant for all data sets and for all time periods (Figure 5) From this we can conclude that takeover targets that resist acquisition do not differ significantly in their performance relative to their sector peers after the offer withdrawal date in the long term Figure 5 : Cumulative Excess Returns Relative to Russell 3000 Sector Indices (Withdrawal Date)
14 Conclusion The results of the IRR analysis allow us to conclude that target companies who intend to remain independent, and are not acquired within five years of the initial offer experience investor returns that are inferior to those that would have been realized had the takeover offer been accepted. In contrast, firms that are acquired within the five year period after the original offer do not experien ce returns that differ significantly than those that would have been realized with the original offer. These findings confirm previous research related to revaluation ( Bradley, Desai, and Kim and Dodd ) while differing methodology and time period. The IRR analysis proves an effective means for evaluating the synergy hypothesis and re sults of previous research hold particularly in relation to the difference between firms that are and are not later acquired (Bradley, Desai, and Kim and Ruback) The value of the IRR analysis, in contrast to the cumulative excess return analysis, is that it allows us to interpret results relative to the value that could have been realized as opposed to returns relative to the market. The IRR analysis provides a mea ns of assessing offer decision making from the perspective of the investor. The results of the IRR analysis suggest that investors should be wary of the rationale for rejecting a takeover offer. If the rationale is focused on improving acquisition price, then investors can generally expect little difference in realized returns. However if the rationale is focused on remaining an independent entity, investors should pressure the target company to accept the takeover offer. The cumulative excess return analy sis allows us to conclude that target companies do not experience returns that are abnormal relative to the market or a sector benchmark. These results hold when controlling for later acquisition. This suggests that target companies who reject takeover off ers are no better or worse at maximizing shareholder value relative to other firms in the market in the long term
15 These findings confirm previous research focused on cumulative abnormal returns for targets rejecting takeover offers that failed to find sta tistically significant differences in return While this paper found relative to the market there are directional differences in mean cumulative abnormal returns in contrast to prior research, cumulative abnormal returns remain statistically insignifican t suggesting that the directional differences in mean cumulative abnormal returns are attributable to differences in data set time period and size. Broadly speaking cumulative abnormal returns relative to sector benchmarks were less statistically significa nt than cumulative abnormal returns relative to the market. Controlling for differences in sector performance appears valuable and is perhaps a better benchmark for assess ing manager performance after the rejected takeover offer. While rejecting a takeover offer may not maximize investor returns by failing to take advantage of an offer premium, target management d oes not appear to be inadequate in the context of post offer performance.
16 Works Cited Bradley, M., Desai, A., & Kim, E. H. (1983). The rationale behind interfirm tender offers: information or synergy?. Journal of Financial Economics 11 (1), 183 206. Croci, E. (2006). Stock price performances of target firms in unsuccessful acquisitions. Available at SSRN 766304 Davidoff, S. (2013, October 11). DealBook. In a Bid for Men s Wearhouse a Merger Battle With Modern Strategies Retrieved November 21, 2013, from http://dealbook.nytimes.com/2013/10/11/in a bid for mens wearhouse a merger battle with modern strategies/ Dodd, P. (1980). Merger Proposals, M anagement Discretion and Stockholder Wealth. Journal of Financial Economics 8 (2), 105 137. Men's Wearhouse Board Of Directors Rejects Unsolicited, Non Binding Proposal From Jos. A. Bank. (2013, October 9). Men's Wearhouse Investor Relations: Press Release s Retrieved November 21, 2013, from http://ir.menswearhouse.com/press releases/detail/1125/mens wearhouse board of directors rejects unsolicited non binding proposal from jos a bank Ruback, R. S. (1988). Do target shareholders lose in unsuccessful control contests?. In Corporate takeovers: Causes and consequences (pp. 137 156). University of Chicago Press.