VideoIt has the ring of a merger-and-acquisition truism: the sale goes to the highest bidder. But as some recent deals suggest, in reality a lower bidder may well prevail.
In 2005's most-watched M&A contest, MCI Corp. repeatedly favored Verizon Communications Inc.'s offers — even though they were worth as much as $2 billion less than Qwest Communications International Inc.'s — and finally chose an $8.4 billion Verizon deal over Qwest's $9.7 billion bid. While leaving that much on the table is extreme, for a while Hollywood Entertainment Corp., too, favored a $700 million offer from Movie Gallery Inc. over a $1 billion bid from Blockbuster Corp.
Certainly, a simple price tag rarely captures the whole M&A story. But why would a public company settle for less than the top bid?
"There are lots of potential reasons," answers Robert Holthausen, Nomura Securities Co. professor of accounting and finance at the University of Pennsylvania's Wharton School. Number one on his list is "a low probability that the higher bidder can obtain financing." Next comes "the form of consideration" — usually the mix of cash and securities — followed by the potential for a government challenge of the high bid. (That was the case with Hollywood Entertainment, which believed the Federal Trade Commission might block a Blockbuster deal at any price. After talking with the FTC, Blockbuster eventually pulled out, and Hollywood valued the final Movie Gallery deal at $1.2 billion.) Other factors that may overshadow the stated price: doubts over the value of securities, questions about tax status, and the appeal of certain closing-related items, such as a suitor's offer of compensation for a decline in business before a deal is consummated (see "Why Go Low?" at the end of this article).
Rejecting a bidder because the target doubts it can actually pay "happens all the time," says Frederick S. Green, senior partner and head of M&A at law firm Weil, Gotshal & Manges LLP in New York. Take the case of a suitor "who comes in after a deal is announced and offers significantly more, then says, 'By the way, it's subject to financing.' The whole offer could be illusory."
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Such concerns may arise whether a bid is all-cash, all-stock, or a mix of both. But without question, the broadest range of seller concerns materialize when an offer is wholly or partly in stock — as is true of about three-quarters of all deals these days. When a cash-only auction for a target occurs, in fact, the so-called Revlon rules may apply, based on a court decision that aims to protect shareholders by requiring a board to accept the highest cash bid (see "The Makeup of Revlon," at the end of this article).
When equity is involved, though, the seller's board members must act, in effect, as security analysts, notes Mark Sirower, M&A strategy practice leader for PricewaterhouseCoopers LLP. The directors "really have to understand what the buyer's business plan is," he says. Sometimes, a superior plan may trump a higher offer.
"Not only does the target have to look at the long-term value of the stock being offered, but it also has to look at things from a combined basis," says attorney David Fine, of Ropes & Gray in Boston. That calls for analysis of how the two companies fit together operationally and culturally. A company might thus prefer a slightly lower bid, says Fine, if there are synergies that offset the price difference. While "far and away, the top bid usually prevails," he adds, "taking the lower bid may be legal and defensible in some cases."
Both defensible and desirable, according to CFO Robert Kelly of Wachovia Corp., the Charlotte, North Carolina-based bank formed in 2001 by a $14.1 billion merger after the target rejected a competing $15 billion bid from SunTrust Banks Inc. "Big premiums are flashing red lights to me," says Kelly, at the time the CFO of Wachovia's friendly suitor, First Union Corp. (After First Union's two-for-one exchange of shares, the combined company adopted the smaller Wachovia's name.) When there is too big a gap between the top two bidders, he explains, it tells the target that number one is "an undisciplined acquirer." But that may be only the start of problems after the acquisition is completed.
"If you pay too high a price, it's going to create two tiers of management," creating the sense among managers from the acquired firm that they are second-class citizens. That can lead to more managerial turnover at the combined company, says Kelly, and "when you lose managers, that's usually the kiss of death." In his view, in fact, "the only people benefiting are short-term shareholders who take the money and run. And what you want is long-term shareholders."
The Wachovia-First Union deal certainly rewarded its investors. The combined company produced an 84 percent return over three years, Kelly notes, and exceeded its expectations in cost reductions and branch eliminations. "We promised $890 million in expense synergies, and came up with more than $900 million," he says, in large part by cutting 7,000 jobs. Revenue synergies were significant, too, he adds, with First Union's more-advanced investment-banking services being introduced into the smaller Wachovia system, for example.
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