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The Wall Street Journal Interactive Edition -- March 6, 1997

When Mulling a Takeover, The Terms Make a Difference

By ROGER LOWENSTEIN

Investors are casual about whether an acquisition is made with stock or with cash, but the
dynamics of these deals differ far more than people realize. So do the results.

Acquirers who in the past used their stock fared worse --considerably worse -- than those
who used cash. Such a finding agrees with the suspicion, previously aired by a certain
financial columnist, that at least some share mergers are effected with financial funny
money. Until now, it was merely a suspicion.

But Tim Loughran and Anand M. Vijh, finance professors at the University of Iowa, have
contributed to the merger wave of the 1990s a breathtaking study on the mergers of the
1970s and 1980s. Their first finding is unsurprising: Over a five-year period, stocks of all
acquirers did slightly (but only slightly) worse than stocks of their peers. In other words,
acquisitions as a group are neither bad nor good, though on balance buyers slightly
overpaid.
But it turns out that acquisitions are not all created equally. The
just-finished study considered nearly 1,000 deals. Companies that
made cash acquisitions saw their stocks rise an exuberant 113% in
the five years following the merger. Those that used stock rose a
meager 61%.

Moreover, by comparing the acquirers with control groups


(stocks of similar size and similar stock price relative to
book value) the authors reached an even stronger conclusion.
Companies that made cash acquisitions did better than average -- not just better than other
acquirers. And acquirers that used stock did considerably (24%) worse than a neutral
benchmark. Such results are seemingly surprising -- but only seemingly.

As the authors note, it is useful to think of share-for-share mergers as a combination of two


events -- first, a sale of stock, and second, an acquisition. It is very different from an
outright purchase. By analogy, if your neighbor offers to buy your home, he is expressing
a
positive opinion about its value (or, possibly, a negative one about the desirability of
having you as a neighbor). If, on the other hand, he offers to join your two properties and
combine the deeds, he is hoping to acquire some of your property in exchange for giving
up some of his interest in his own.

That is what happens when an acquirer issues stock. When Chemical Bank "acquired"
Chase Manhattan, each Chemical shareholder gave up roughly half of his proportional
stake in Chemical -- that is, he sold it -- in exchange for an interest in Chase. Corporate
deal-makers, if they are doing their job, should be willing to part with a piece of their
company only when the price on it is high.

Previous studies (including one by Mr. Loughran and Jay Ritter of the University of
Florida) have shown that companies sell stock at opportune times -- meaning that people
who invest at such times do poorly. Though they would never say this, by their actions
stock-issuing executives are "signaling" that their stock is high. One inference from the
merger study is that share-using acquirers are signaling the same thing.
But more is going on here. The authors also divided the cash-payers into two groups:
friendly and hostile (via tender offers). By a huge margin (146% to 98%), shares of the
hostile acquirers outperformed. A tentative conclusion would be that it's easier to realize
gains by removing poor managers, as in hostile deals, than by pursuing the supposed
synergies envisioned by friendly combiners. It will be interesting to see if this holds for the
seemingly more cost-conscious mergers of the '90s. Taken as is, the study has ironic
implications for target shareholders. Takeover premiums were the same, regardless of
whether a merger was friendly or hostile or paid for with stock or cash. Target
shareholders made an average of 30% from just before the news until a merger closed,
during which time shares of similar companies gained 5%. But after the closing, the
returns of each merger type steadily diverged throughout the five years.

Shareholders who sold into a cash tender and used the money to invest in the acquirer
greatly magnified their gains. Thus, the takeover vaulted them 25% ahead of the norm, but
by the end of five years (assuming they were tax-exempt) their margin of over-performance
would have soared to 138%.

On the other hand, people who got a premium in the form of stock saw their gains steadily
dissipate. By the end of five years, they fared hardly any better than people who hadn't
been blessed with a takeover.

The implication: Shareholders who get paid in cash would do better with stock; those who
get stock should cash out. Of course, this isn't realistic for all ("everyone" cannot sell).

The bottom line is that acquirers who use stock tend to be those with overvalued shares --
thus, the premium they confer is illusory. Moreover, to hazard a guess, it is just a bit easier
to rationalize an overpriced deal when it is paid for in stock -- particularly when a friendly
partner is applauding your efforts. Just so, it takes more conviction to spend hard cash, as
it does to launch a hostile bid. That is why such deals work better.

Copyright ♦ 1997 Dow Jones & Company, Inc. All Rights Reserved.