Do Financial Buyers Pay Fair Value?

Part 2: A look at the Data

Posted by George Hickey on September 26, 2017

It is generally accepted that, on average, a strategic buyer will pay a higher price than a financial buyer for a company in a competitive sale process. This finding has been confirmed by multiple academic studies. For example, Gorbenko & Malenko (2014) analyze a sample of corporate takeovers announced and completed in the period from January 1, 2000 to September 6, 2008, where 100 percent of a non-financial US target is acquired through an auction process, and find that the winning bid paid when a strategic bidder wins the auction is, on average, 9.9 percentage points higher than the winning bid paid when a financial bidder wins the auction: 46.4% versus 36.5%. [1]

An analysis of 1-week premiums paid in the 10-year period from 2007 to 2017 tells a similar story. The visualization below compares 1-week premiums paid by financial and strategic buyers when acquiring US targets in closed transactions valued at $100 million or greater announced between September 18, 2007 and September 18, 2017.

Interestingly, the spread between 1 week premiums paid by financial and strategic buyers is the least pronounced just prior to (2007) and following (2010) the Great Recession, periods also marked by heightened activity from financial buyers (as measured by both transaction volume and value).

Since 2010, the spread between 1-week premiums paid by financial and strategic buyers (US Targets greater than $100 million) has averaged around 10%, very similar to the finding of Gorbenko & Malenko. However, this spread is hardly consistent, bouncing around in a range between 5% and 17% over the 6 year period from 2011 to 2016. And while the availability and size of synergies from year to year could certainly explain part of this variation, academic studies point to additional contributing factors.

Willingness to Pay

The conventional wisdom regarding strategic and financial bidders is that strategics traditionally pay more because of the synergies generated from the acquisition that are not available to the financial bidder.[2] While this has some intuitive appeal, it fails to acknowledge some other forces at work. Gorbenko & Malenko (2014) find that strategic bidders value a target on average 16.7% above its current value compared with 11.7% for financial buyers. So why are winning strategic bidders premiums on average 10 percentage points above financial buyers if their valuation is only 5 percentage points higher?

There are a variety of studies regarding the motivations of strategic and financial bidders that suggest reasons beyond the synergistic benefit. Simply put, different targets appeal to different bidders at different times for different reasons. So while synergies may tip the scale in favor of the strategic buyer, financial buyers can benefit from things like restructuring expertise or access to lower cost financing. Demiroglu and James (2010) find that reputable private equity buyers pay narrower bank and institutional loan spreads, have longer loan maturities, and rely more on institutional loans.[3] Similarly, Ivashina and Kovner (2011) find that bank relationships formed through repeated interactions allow leveraged buyouts sponsored by private equity firms to occur on more favorable loan terms.[4]

Additionally, Gorbenko & Malenko (2014) find that a significant subset of targets is systematically valued more by financial bidders. Specifically, poorly performing targets with fewer investment opportunities are found to be valued higher by financial bidders. They also find that valuations of different financial bidders are less dispersed than valuations of different strategic bidders and more correlated with aggregate economic conditions.[5]

In summary, the data and academic research regarding bid premiums and the motivations of financial and strategic buyers indicate that:

(1) Strategic buyers, on average, pay more;
(2) Strategic buyers pay more for reasons beyond the benefit of synergies;
(3) Financial buyers will pay more for underperforming companies with fewer investment opportunities;
(4) Financial buyer’s bids are less dispersed than strategic buyers;
(5) Financial buyer’s bids are more correlated with economic conditions; and
(6) More reputable financial buyers command more favorable loan terms.

Returning to the question of fair value from part 1 of this post, involving Petco in the process likely would have increased the clearing price. On the other hand, it was generally believed at the time that PetSmart was underperforming and the financial bidders competing with BC Partners could have been reputable firms with access to more favorable loan terms (they are only identified as bidder A, B, C, etc). That being said, BC Partners was only going to pay what it had to pay to secure the asset. Its max bid or willingness to pay is a ceiling imposed by internal economics (whatever they might be) and even if competitive forces like the underperformance of the target or more reputable financial bidders with lower borrowing costs pushed them up to that ceiling, that price still isn’t necessarily indicative of "fair value" (as defined by the Delaware Court).

Given the financial buyer’s focus on investment returns and their willingness to pay more for underperforming assets, one would expect to financial buyers to purchase on the cheap. However the data tells a less conclusive story. The visualization below compares the target’s stock price (one day prior to acquisition) as a percentage of its 52-week high for financial and strategic buyers. While financial buyers very clearly purchased companies at lower valuations (by this metric) than strategic buyers during the Great Recession, that pattern has been less consistent and less pronounced since.

In years where there is a discernible difference, the difference is concentrated in certain sectors. If you click a year in the visualization above, the lower panel will provide sector comparisons between financial and strategic buyers for that year. For example, in 2014 and 2015, the opportunistic purchasing by financial buyers is heavily concentrated in the Industrials sector. Similarly, opportunistic buying from strategic buyers in 2016 was heavily focused on the Healthcare Sector. This would seem to support the theory that different investments appeal to different investors at different times for different reasons.

The data and research support the theory that a financial buyer’s bid falls somewhere on the fair value spectrum and that it is informed by factors beyond solely the buyer’s cost of capital.

[1].     Gorbenko, Alexander and Andrey Malenko. 2014. “Strategic and Financial Bidders in Takeover Auctions.” Journal of Finance 69 (6):2513–2555.
[2].     Rhodes-Kropf, Matthew, David T. Robinson, and S. Viswanathan. 2005. “Valuation Waves and Merger Activity: The Empirical Evidence.” Journal of Financial Economics 77 (3):561–603.
[3].     Demiroglu, Cem and James, Christopher M. 2010. “The role of private equity group reputation in LBO financing.” Journal of Financial Economics., 96, (2): 306-330.
[4].     Ivashina, Victoria, and Anna Kovner. “The Private Equity Advantage: Leveraged Buyout Firms and Relationship Banking.” Review of Financial Studies 24, no. 7 (July 2011): 2462–2498.
[5].     Gorbenko, Alexander and Andrey Malenko. 2014. “Strategic and Financial Bidders in Takeover Auctions.” Journal of Finance 69 (6):2513–2555.