When the Buyer's Stock Crashes
Lindorff, Dave, Global Finance
Like many an executive invested in his company, Douglas Coltharp, CFO of Proffitt's, has a personal stake in seeing that the Birmingham, Alabama retailer's stock performs well. So he was particularly chagrined when, after announcing plans to acquire prestigious department store Saks for $3.4 billion in a stock-forstock pooling of interest deal, Proffitt's stock crashed, losing 26.1% over the next five days.
A few years ago investors hailed merger announcements with an enthusiasm born of a rampaging bull market. But by 1998-even before the US stock market's summer volatility-shareholders more often than not greeted acquisition announcements by abandoning the buyer. (The impact on the target's stock is usually more positive.) In some cases, the stock decline is a deal slayer. While Proffitt's determined to go ahead with its acquisition, health care company Humana, based in Louisville, Kentucky, called off its purchase by United HealthCare following a drop in United's share price from $62.50 at the time of the announcement in May to $33.375 by early August. Had the two-for-one stock swap proceeded, Humana shareholders would have received just over half the $5.5 billion they'd anticipated.
A J.P Morgan study examining 1,800 mergers and acquisitions over the past 10 years found that the market's response to acquirers has grown increasingly less positive since 1994, when a merger announcement brought an average appreciation in the buyer's shares of 1.5%; during the first half of 1998 that average appreciation had fallen to 0.7%, and many acquiring companies, like WorldCom, AT&T, and Office Depot, suffered double-digit drops in their share prices.
The reasons for shareholder disillusion are many.To some extent, the drubbing of an acquirer's stock is the result of action by arbitrageurs. On widely anticipated pairings, investors who have built appreciation into the share price may jump ship if the terms are not up to expectation. Complex transactions, or deals whose synergies aren't clear, such as SBC's acquisition of Ameritech, can sour investors on a buyer's stock.
A drop in share value is especially likely for the second merger in an in dustry, if investors view it as an illconceived "copy cat" transaction. For example, whereas Staples shares rose 4.6% during the 10 days surrounding the April 7 announcement of its acquisition of Quill, Office Depot's shares fell 11.9% when it said it would buy Viking Office Products in May. Similarly, the May announcement of the $2.9 billion purchase of Dillard's department store chain sent Mercantile Store's stock up 8.3%. Two months later Proffitt's announcement led to a falloff in its stock price from which it still has not recovered. "There may have been some investor skepticism about our deal," concedes Coltharp. Although Proffitt's was "pretty far along" in negotiations with Saks by the time of the Mercantile transaction, a press leak led investors to think Proffitt's was following a "me-too" game plan. "We built this company with six acquisitions since 1994, so this shouldn't have been a surprise to investors," says Coltharp. Although short-sellers pushed the company's stock down briefly after three of those deals, it rebounded quickly each time to set new highs.
Timing is certainly a major factor, since the state of the overall market or an industry sector can steer a company's share price movement. Broad market falls affecting, respectively, the oil services and health care sectors, amplified investor concerns about acquisitions by Baker Hughes and United HealthCare. "We hadn't had a good quarter," says Bernie McDonagh, investor relations director of Minneapolis-based United HealthCare, "and the whole industry was having problems. We expected the stock to fall to the low 40s. But we thought we'd packed a reasonable message, so we were shocked when it crossed into the 30s!"
Whatever the reasons for investor skittishness, what can an acquiring company do to reduce the likelihood of a negative shareholder response? …