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 overperformance 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.

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Reserved.