March 13, 2019

To Shop or Not to Shop: Lower Valuations for Target Initiated Deals?

Here’s an interesting new study that compares the valuations of deals initiated by sellers to those initiated by buyers.  It turns out that who makes the approach matters a lot when it comes to the value that the target’s shareholders receive.  Here’s the abstract:

We investigate the effects of target initiation in mergers and acquisitions. We find target-initiated deals are common and that important motives for these deals are target economic weakness, financial constraints, and negative economy-wide shocks. We determine that average takeover premia, target abnormal returns around merger announcements, and deal value to EBITDA multiples are significantly lower in target-initiated deals.

This gap is not explained by weak target financial conditions. Adjusting for self-selection, we conclude that target managers’ private information is a major driver of lower premia in target-initiated deals. This gap widens as information asymmetry between merger partners rises.

The authors contend that when a target initiates a deal, potential buyers become more skeptical about valuation, because companies with stocks that are undervalued prefer to remain independent – while overvalued targets are happy to pursue a sale before the roof caves in.

John Jenkins