At the Apr. 6 press conference announcing the Citicorp-Travelers Group
merger, attendees were worked into such a frenzy that it felt more like
a rock concert than a Wall Street announcement.
But investors would be wise to cast a skeptical eye on such highly
touted deals. According to a Journal of Financial Economics study to be
published in August, stocks of companies that were involved in mergers
and acquisitions trail their peers by an average of 4 percent three
years after the deal is completed. That underperformance is even worse
if you look specifically at companies that the study defines as
overvalued and that execute their deals by a merger (in which bidders
tend to pay for another company with stock), say the authors,
Raghavendra Rau of Purdue University and Theo Vermaelen of Insead, a
business school in France.
The professors examined more than 3,000 mergers and nearly 350 tender
offers (in which companies usually pay with cash) that took place from
1980 to 1991. The stock of overvalued firms that used mergers to come
together underperformed the stock of similar firms that did not
participate in a merger by a whopping 17 percent. (The professors used
book-value/market-capitalization multiples or net assets divided by
market cap to find overvalued companies. The lower the multiple, the
pricier a stock.) Interestingly, overvalued firms that use tender offers
to make an acquisition do not underperform -- but neither do they
outperform.
On the other hand, the authors found that out-of-favor companies that
bought competitors via a tender offer did 15.5 percent better than the
average company of a similar size and book/market-cap ratio three years
later. Even value companies that merged outperformed their peers by 7.6
percent.
Why do value firms outperform more fast-growing companies? "Hubris,"
says Rau. "With growth companies, managers are more likely to
overestimate their own abilities to manage an acquisition."
Value managers, he maintains, are more prudent.
What's an investor to do? Instead of chasing the latest deal, you may
want to consider putting money into an industry that is consolidating in
general, such as banking, telecommunications or media. M&A fever can
rally an entire sector, whether or not your company gets bought or
sold.
Street Smart
Research alert
Research alert
By David Geracioti
06/01/1998
SmartMoney
Page 40
(c) 1998 SmartMoney. All rights reserved.