It is a common occurrence that when a publicly traded company announces plans to acquire another publicly traded company the “value” of the acquiring company decreases, while the value of the company to be acquired increases. For example, when Oracle Corporation announced its proposed acquisition/hostile takeover of PeopleSoft, the value of Oracle’s stock steadily declined for the nearly 18 month battle while PeopleSoft stock rose $5.1 billion! This seems to occur in spite of whether investors and analysts believe the acquisition will be profitable to the expanded company or not. It is understandable why the public would invest in the company to be acquired- they will usually be paid a premium for their shares. What I question is why the public would believe the acquiring company is so much more worthless because it is venturing to expand. It seems that Wall Street must believe that the economies of scale have reached a saturation point. Of course, there are inherent risks when a large purchase is made. The integration may not be smooth, but in the long run why would the public believe that expansion is devaluing?
3 comments:
This seems more like finance than ManEc, but that's OK (fortunately for me, I teach a little finance too). In the end, it comes back to something we've already discussed.
My answer is going to turn the title of the post around - Wall Street cares about economics but sometimes managers don't care enough.
The drop in the price of a potential acquirer is a reflection of the fact that most firms doing the buying do not do well after the acquisition. The lower prices follow from investors understanding of this. So, buying is a bad sign. Of what you might ask? The answer is that the acquirer has too much cash (which doesn't produce much income) and too few ideas (on where to invest that money to make more money). Generally, both of those are signs that management is too risk-averse. And it turns out that risk-aversion by managers is one facet of the principal-agent problem (owners committed to buying risky equity, if they had wanted less risk they could have bought debt ... but they didn't).
This is related to a disturbing outcome of some research in the finance literature - there is a consensus that a lot of management can be shown to be a net liability to the firm.
What happens typically is that the acquirer's stock price drops (suggesting this is a move that isn't appreciated by investors), and the acquiree's stock price rises (suggesting that investors recognize that the company is badly run, and have been waiting for someone to help improve it).
-1 on Homer's comment for a spelling mistake (waived).
I just thought I'd let you know that Karsten is a financial professional in Germany who reads this blog, and authors CurryBlog (in the list to the left).
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