There has been a resurgence of hostile takeovers in the aftermath of the financial crisis, such as the deal between Kraft and Cadbury. From the acquirer’s perspective, the current environment provides a good time to acquire weaker rivals, and mergers are seen as reward for maintaining liquidity and exercising capital prudence, says David Becher, Ph.D., associate professor of finance at Drexel University’s LeBow College of Business. From the target’s point of view, many of these hostile deals undervalue the target and are representative of opportunistic bidders trying to transfer wealth from target to bidders shareholders.
Recent research by Becher provides significant evidence for a price improvement motive for contested mergers, and little if any evidence that contested auctions are a byproduct of the entrenchment motives of incumbent managers.
“In spurning these deals, many target managers are claiming that acquirers are merely trying to take advantage of the target’s current low stock price and profit from the crisis without caring about long-term gains to target shareholders,” Becher says. “In the Kraft-Cadbury deal, Cadbury consistently argued that the offer undervalued the firm, was not a strategic fit, and would relegate Cadbury to slow growth. Kraft countered that the combination of Kraft’s strength with Cadbury’s product could create a powerhouse in the field and create positive synergies.”
“This constant battle between the two sides leads to key questions in merger negotiations: When should firms accept a bid? How much of a premium is enough? How does the market know if the target management is entrenched or bargaining in good faith? My research (conducted with Thomas A. Bates, Ph.D. of Arizona State University) attempts to document the expected value of a contested takeover for target shareholders and address these issues,” Becher explains.
In general, Becher’s research shows that in mergers where the target contests a deal and does not accept the first premium offered, over half of the targets receive at least one additional bid and the raw premiums are 22 percentage points higher. Further, bids that receive an increase in premium are significantly more likely to be completed. Conversely, examining long-run performance for deals that are not completed, Becher’s research shows that shareholder returns after the merger is rejected do not exceed the final premium offered in the merger. In addition, his research shows a significant increase in forced managerial turnover and a greater likelihood of firm delisting for target firms after a withdrawn deal. These findings suggest that managers are indeed bargaining in good faith, but risk overplaying their hand.
The current Kraft-Cadbury deal specifically highlights the results from Becher’s findings. Kraft initially offered a 31 percent premium for Cadbury, which Crandbury deemed as grossly undervaluing. During the past few months, the two sides have been publicly feuding over the bid as Cadbury sought a considerable increase in merger premium, while Kraft seemed determined to keep the price tag from skyrocketing.
Becher points out that only days before the deal was agreed upon, Cadbury’s management deemed the deal as having “no strategic, operational, managerial or financial reason” to be completed. By offering a 50 percent premium over the initial stock price prior to the merger and shifting a majority (60 percent) of the offer to be paid in cash, Becher says Kraft substantially increased the value of the deal to Cadbury shareholders. “This result is consistent with our findings that managers that initially resist a contested offer are likely to receive at least one follow-on bid, this bid (or bids) are likely to represent a significant increase in premium offered, and the deal is much more likely to be completed.”
On the alternative side, Becher says, given that just a few days ago Cadbury’s management was publicly dismissing the deal as unworthy of investor support, it is clear that target management viewed the sizable ownership (30 percent) of their stock by short-term investors as a threat to their viability.
To speak to Dr. Becher about the Kraft-Cadbury merger, contact Lisa Litzinger, assistant director of communications, LeBow College of Business, at 215.895.2897 or firstname.lastname@example.org