Takeover dilemma is to go or stay

By Bina Brown
For CNN

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(CNN) -- With global private equity firms awash with cash, it seems no listed company is immune from a takeover bid.

American private equity giant the Blackstone Group recently lifted the bar on what was affordable when it raised a staggering $15.6 billion for investment.

Blackstone is yet to find a home for the money but in the meantime takeovers -- by both private equity investors and companies wanting to expand -- continue to dominate global market news.

For many shareholders, this raises the question of whether to take any cash being offered by a bidding company or hold on to see what the new ownership may bring.

According to the analysts at independent stock newsletter The Intelligent Investor, private equity investors aim to improve the performance of their investments by setting a sensible management compensation system, re-evaluating strategy and, typically, adding a large slab of debt.

As well as the increased profits that flow from making the business operations more efficient, private equity investors usually benefit from the discrepancy between what businesses sell for in the private, unlisted market and what they sell for once they become a listed commodity.

Like most things to do with investing, there is no guarantee of success and a private equity investor may struggle to add any further value to a merged or listed entity.

Natural fit

David Jones, an executive director at independent buyout funds manager Castle Harlan Australian Mezzanine Partners, estimates that around 20 percent of mergers and acquisitions are natural fits for private equity investors.

"We have a very legitimate role to play, but only in certain circumstances --when companies have lost their way and need a re-positioning. It can be difficult for a management team to refocus and restructure in a publicly traded environment, even if they know what's needed," he says.

Benefits expected from any takeover include reduced costs, better exploitation of assets, realising the value of under performing assets, benefits of changed market perception from an expanded group, expansion without duplication or start up costs and diversification of operations.

But there is also plenty of evidence that acquisitions rarely deliver the benefits promised.

Reports show that cash bids are better for investors in the target company and what happens after the merger can be a disaster for the acquirer's shareholders.

A summary of several academic studies outlined by consultants McKinsey and Co show that shareholders of acquired companies are the big winners, receiving an average premium of 20 percent for friendly mergers and 35 percent for a hostile takeover.

Shareholders of acquiring companies (those parting with the cash) earn very small returns by comparison.

A report released last year by JP Morgan into takeovers, mergers and spin-offs among top ranking listed companies in the ten years to 2005 found that about 80 percent of takeovers reduce the value of the acquiring company.

Further research conducted by fund manager Clime Capital found that almost every acquisition in Australia where the offer price was greater than the equity of the acquirer resulted in a drop in the share price over the subsequent two years of up to 80 percent.

Expansion in mind

Roger Montgomery, chairman of Clime, says that while acquisitions should be motivated by a desire to maximise real economic benefits, often they are aimed at "expanding the dominion over which management presides".

Running a bigger company, with greater potential to grow shareholder wealth often means more money -- even if they fail to deliver.

He believes too many "corporate chieftens" overrate their ability to identify and then turn under performing companies into gold.

"It was U.S. investment guru Warren Buffett who first said 'they think their kisses pack such a punch that it can turn any toad into a princess'," says Montgomery.

"But they end up with a backyard full of toads that have to be written off. What has happened is they have bought something for reasons other than the good of the company and have paid too much for it," he says.

Montgomery's advice to shareholders of companies being acquired is: "If the price being offered seems absurd then take the money and run."

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