Takeover Activity and the Long-Run Performance of Reverse Leveraged Buyouts
Mian, Shehzad, Rosenfeld, James, Financial Management
A reverse leveraged buyout occurs when either a publicly traded firm or a division within one converts to private ownership via a leveraged buyout (LBO) and subsequently goes public. This paper examines the three-year investment performance of these firms after going public,(1) and further explores the high incidence of takeover activity that occurs within this group of firms.
Our study also provides an interesting comparison with the performance of initial public offerings (IPOs). Ritter |12~ reports that over a three-year period an investment in a typical IPO underperforms an investment in the seasoned stock of a firm of similar size and industry. He also finds variation in underperformance across both years and industries, and that those companies that went public in high-volume years fared the worst. He concludes that the evidence is consistent with the hypothesis that firms exploit "windows of opportunity" by going public when investors are generally overoptimistic about the prospects of their industries. According to the "investor-uncertainty hypothesis," this underperformance is due to subsequent price revisions as uncertainty surrounding firm prospects is resolved. This explanation implicitly assumes that, at the time of issuance, insufficient information to determine accurately the intrinsic value of IPOs results in systematic pricing errors. Given that there are important differences between first and second IPOs (SIPOs) in terms of investor access to information, our empirical results have implications for the investor-uncertainty hypothesis. For a first public offering, the primary source of firm-specific information is the prospectus prepared by the corporation. At the time of a second public offering, in addition to the prospectus, investors have access to other information sources about the firm from when it either was publicly traded before the LBO or was a division within a publicly traded company. This additional information includes stock-price history, SEC disclosures, annual reports, analysis of manager quality from news and magazine reports, and analysts' research reports. Since second public offerings are more likely to take place in an environment of greater investor familiarity, the investor-uncertainty hypothesis predicts that the pricing of reverse LBOs should be more accurate relative to IPOs. We additionally investigate the implications of our empirical evidence for Muscarella and Vetsuypens' |9~ findings. These authors examine the financial performance of reverse LBOs over the time when the firm was privately held. They report that such firms go public at a price significantly higher than their going-private price. Muscarella and Vetsuypens attribute this performance to the organizational efficiency of the private firm. However, if the investment behavior of reverse LBOs was similar to that of a typical IPO, as reported by Ritter, then part of the premium paid by investors at the time of the reverse leveraged buyout could be due to overpricing. That is, investors systematically pay too high a price at the time of the offering and subsequently revise the price downward. This explanation, if valid, would yield results that are contrary to Muscarella and Vetsuypens' interpretation of the increase in share prices as evidence of the firms' organizational efficiencies while they were private. Our investigation of the performance of reverse LBOs should shed light on this issue. A finding that reverse LBOs are fairly priced by the market, as evidenced by "average" long-run performance, would support Muscarella and Vetsuypens' interpretation. On the other hand, evidence of underperformance following reverse LBOs would suggest that overpricing also contributes to the premium paid at the time of the reverse LBO. Over the three-year period beginning one day after the firm goes public, an initial sample of 85 reverse LBOs outperforms a portfolio of comparable firms matched by industry and firm size. The direction of this performance is in sharp contrast to that of IPOs, as reported by Ritter. …