Dual Track vs. IPO

Table of Contents

Index of Figures

Index of Tables

Abbreviation Index

1 Introduction
1.1 Problem Definition and Objectives
1.2 Course of Analysis
1.3 Literature Review

2 Different exit strategies
2.1 Concept of Initial Public Offering
2.1.1 Definition and Process of Initial Public Offerings
2.1.2 Equity Market Development
2.2 Concept of Mergers & Acquisitions
2.2.1 Definition and Process of Mergers & Acquisitions
2.2.2 Mergers & Acquisitions Market Development
2.2.3 Reactions of Acquirers’ Returns to the Acquisition Announcement
2.3 Critical Comparison of Mergers & Acquisitions and Initial Public Offerings

3 The Concept of Dual tracking
3.1 Definition of and Rationale for Dual Tracking
3.2 Process and Procedures of Dual Tracking
3.3 The Chances of Dual Tracking
3.3.1 The Chances from the Target’s Perspective
3.3.2 The Chances from the Acquirer’s Perspective
3.4 The Risks of Dual Tracking
3.4.1 The Risks from the Target’s Perspective
3.4.2 The Risks from the Acquirer’s Perspective
3.5 Recent Dual Tracks
3.5.1 Saga Group plc
3.5.2 Praktiker Bau- und Heimwerkermärkte Holding AG

4 An Empirical Analysis of Acquirer Returns
4.1 Theoretical Implications
4.2 Sample Description
4.2.1 Selection of the Data
4.2.2 Characteristics of the Sample
4.2.3 Methodology of the Event Study
4.3 Results of the Event Study
4.3.1 Analysis of Acquirers’ Returns
4.3.2 Comparison of Different Acquirers’ Returns
4.3.3 Multivariate Regression of Acquirers’ Abnormal Returns
4.4 Critical Evaluation of the Event Study
4.4.1 Limits of the Sample
4.4.2 Limits of Methodology

5 Conclusion

Appendices

List of References

Index of Figures

Figure 1: Numbers of Dual Tracks (per year)

Figure 2: Frequency Distribution of CARs

Index of Tables

Table 1: Characteristics of CARs with in Different Event Period

Table 2: Wilcoxon Signed Rank Test (one day event period, t=0)

Table 3: Cumulative Abnormal Return (2 variables)

Table 4: Cumulative Abnormal Return (3 variables)

Abbreviation Index

AG Aktiengesellschaft (public company)

Abbildung in dieser Leseprobe nicht enthalten

1 Introduction

1.1 Problem Definition and Objectives

“Companies putting the final touches on initial public offerings of stock in the U.S. are increasingly calling a sudden halt in order to entertain acquisition offers from potential suitors. So far in 2005, 33% of the 18 withdrawn stock offerings [...] were put on ice because the issuers began discussions to be acquired instead.”¹

This phenomenon is known as dual tracking. It first emerged in the 1980s and became more attractive in the 1990s. After the economic depression in 2001, this strategy gained slowly in relevance and is now booming.² Today, it is understood as a useful marketing tool to increase the value for the seller. Broadly speaking, dual tracking in­cludes all exit strategies with two potential outcomes. In a narrower sense, dual tracking only refers to IPO vs. M&A. Presuming this, “Dual Track vs. IPO” is not the appropri­ate problem definition. The underlying problem is better formulated as “Dual Track – IPO vs. M&A”.

Despite recent public dual tracks – as e.g. those of Saga Group, Praktiker, Grohe as well as Tank & Rast - the idea of dual tracking is still widely unknown. Although its nature should lead to an increasing relevance in the future, it is a research field not yet thor­oughly examined. This lack of academic research motivates to explore the area of dual tracking in greater detail. Therefore, the main purpose of the paper is to present the con­cept of dual tracking. The focus lies on the choice between IPO and M&A and on the opportunities and risks which arise through the interaction between both tracks. Thereby, the key question of the paper is how the M&A market reacts to an IPO with­drawal.

1.2 Course of Analysis

This paper starts with a comprehensive summary of the two exit strategies IPO and M&A in Section two. This characterization also includes the development of the equity and the M&A market as prospering markets are prerequisites for a successful dual track. Despite the postponement of the decision which strategy to pursue, dual tracking in­cludes elements which are purely related to M&A and IPO respectively. Therefore, a critical comparison between M&A and IPO is conducted to create a framework for fur­ther elaboration. A general overview about capital market reactions to acquisitions serves as foundation for the evaluation of the reactions to dual tracking targets. Based on those fundamentals, section three gives a detailed description of dual tracking, in­cluding two recent dual tracks to illustrate the application. A key aspect in the analysis of the chances and risks of a dual track is the interaction of M&A and IPO. Going from theory to practice, an event study is conducted in section four. To answer the key ques­tion of this paper, the event study analyzes how the capital market reacts to acquisitions of firms which withdrew their IPO shortly before. On the basis of collected data cover­ing the time period from 01/01/1995 until 28/04/2006, the cumulative abnormal returns (CARs) of listed acquirers at the acquisition announcement will be tested for signifi­cance. Afterwards, a critical evaluation of the results follows and a conclusion is given.

1.3 Literature Review

A substantial amount of literature discusses the topic of IPO and M&A as potential exit strategies. Brau/Francis/Kohers (2003) give a critical comparison of both routes. How­ever, all these studies assume that the decision for an exit path is made at the beginning of the process. The possibility of postponing this decision to later stages of exit process is rarely mentioned. Thus, the interactions between the IPO registration and the prepara­tion of an M&A deal are still unexplored. Only Lian/Wang (2006) focus on explaining the dual tracking phenomenon. Going into greater detail, they analyze how the M&A market reacts to IPO withdrawals. According to them, nine percent of IPO withdrawals in the U.S. are acquired by public corporations shortly after the withdrawal.³ In their study, they analyze the valuation of dual tracking firms compared to other kinds of tar­gets. Despite the higher valuation ranges of dual tracking firms, Lian/Wang also find that the acquirer returns react positively to the acquisition announcement of dual track­ing firms. These results are comparable to the findings of Fuller/Netter/Stegemoller (2002), Chang (1998) and Faccio/McConnell/Stolin (2006) who showed that the acqui­sition of private targets results in a significantly positive return for the listed acquirer. In contrast, various evidence support the proposition that bidder returns are on average negative or zero when acquiring public targets. Why these returns differ depending on the status of the target will be explained in section 2.2.3.

2 Different exit strategies

2.1 Concept of Initial Public Offering

2.1.1 Definition and Process of Initial Public Offerings

An initial public offering (IPO) describes the first sale of stocks issued by a privately owned company.⁴ The main purpose for floating the public market is the company’s high demand for capital. Often companies intend to raise large amounts of capital for particular purposes as for example the expansion of the business.⁵ In the context of this paper, company owners can exit their current investments and cash out through an IPO.⁶ Particularly, private equity and venture capitalists often use an IPO as a reasonable strat­egy to exist their investment.⁷ In addition, a public floating does not require the seller to exit the investment entirely. The current business owner has the opportunity to sell the company only partially and, as a result, gain access to capital markets while maintaining a (controlling) stake in the company.⁸

When a company plans to go public, it first has to choose one or more investment banks as underwrites for the IPO. Typically, the underwriter monitors and assesses the con­temporary market conditions for an IPO. Moreover, the underwriter manages the whole IPO execution and marketing process. In addition to financial advisors, the company needs legal advice because the listing requirements impose strict legal compliance and reporting requirements of the respective stock exchange. The next step in the process is the due diligence. At this stage, the company will be scrutinized by the underwriter in order to achieve an accurate understanding of the business. After compiling the IPO prospectus, which contains extensive financial information, the papers are filed with and audited by the respective stock exchange.⁹ Next, so-called road shows are conducted to present the issuing company in front of potential major investors. Key goal is to create interest in the stock and to push the valuation expectations up. As the final step in the procedure, the pricing and the allocation of the stock is determined by the target with the help of the underwriter.¹⁰ After floating the market, high listing standards demand periodic disclosure of company information.¹¹

However, a company which has registered an IPO can withdraw the decision at any time before the listing. Obviously, all resources spent beforehand are sunk costs. It al­lows a company to walk away if investors do not put a reasonable price upon the firm.¹² Hence, the higher the ex-ante probability of a withdrawal, the less investors will gain from pushing the price under the fair value.¹³ Consequently, this option improves the selling company’s bargaining position.

2.1.2 Equity Market Development

From 1995 until 2000, the equity market in the U.S. showed a very positive develop-ment.¹⁴ The strong expansion period was not only limited to the U.S. Similar develop­ments could be observed in all major equity markets significantly driving up the number of IPOs. With the internet and technology boom, the number of IPOs as well as the amount of capital raised peaked in 2000. Due to the burst of the bubble, the market dropped severely. For instance, the number of IPOs dropped from 1,883 in 2000 to 832 in 2001. During the following two years, the equity market only slowly recovered. The number of IPOs only grew insignificantly. With respect to the amount of capital raised, the impact was even more severe. Beginning in 2000 with US$ 210 billion capital raised, the market decreased continuously until 2003 where only US$ 50 billion were raised. Since 2003, the equity market is growing again. After a very positive year 2005 with 1,537 IPOs and US$ 167 billion capital raised, an enlargement of the market is expected for the next years.¹⁵

2.2 Concept of Mergers & Acquisitions

2.2.1 Definition and Process of Mergers & Acquisitions

The term M&A refers to the consolidation of companies. Basically, the main reason for an M&A deal is to exploit synergy effects from combining businesses. Typical syner­gies are enhanced revenues, reduced costs, lower taxes, higher customer base and lower costs of capital.¹⁶ In a merger, at least two existing companies form a new one whereas in an acquisition at least one company is bought by another.¹⁷

Usually, mergers are of a friendly nature; both companies decide to cooperate. Accord­ingly, both companies take part in the due diligence process. This step helps to ensure a successful combination. In contrast to mergers, acquisitions can be friendly as well as hostile. In a friendly acquisition, both parties work together to ensure a positive out­come. In hostile takeovers the acquirer normally buys the majority of the outstanding shares of the target without any support of the targets’ management. Hence, a conflict of interest between acquirer and target exists.

For the purposes of this paper, the focus will be on the process and procedures for ac­quisitions. Friendly acquisitions can be performed through buying the stock or the assets of the target. When purchasing the stock, the acquiring company often makes a private offer to the target’s management before addressing the topic to the shareholders. Typi­cally, this is done by a (friendly) tender offer – “a public offer to buy the shares of the target”.¹⁸ The process of buying assets is similar: the acquirer makes an offer to buy all assets from the target. Such a transaction requires a vote from the stockholders.¹⁹ Before the acquisition is announced, a due diligence is conducted, allowing all involved parties to obtain essential information to evaluate the attractiveness of the deal. Also based on the due diligence, a “Business Integration Plan” is established.²⁰ Afterwards, the con­tract and required government filings need to be prepared.

The process of a hostile acquisition differs from the description above since the man­agement of both firms has diverging goals. Consequently, the incumbent management of the acquired firm has a lower or no incentive to work with the management of the acquiring firm and may thwart the process with poison pills. The acquirer usually makes a tender offer to the target shareholders without addressing the management.²¹ The process of valuing the company has to be done without the support of the target which complicates the process. Hence, the transaction costs to the acquiring firm are higher. Typically, such a transaction is done by a stock acquisition.²²

2.2.2 Mergers & Acquisitions Market Development

Beginning in 1995 and peaking in 2000, the market developed positively with a yearly increase in transaction volume. In 2000, the worldwide market volume (US$ 3,442 bil­lion) was nearly four times as large as in 1995. In 2001, the market dropped tremen­dously to an overall transaction volume of US$ 1,800 billion. This constituted the end of the fifth merger wave. The main reason for the collapse was the burst of the equity market bubble. 2002 was even worse since the market shrank again, before starting to grow until 2006. From 2002 to 2005, the market grew by 230 percent, peaking at US$ 3,150 billion. Reasons for the upswing are an overall economic pick-up, discovery of M&A market by small and medium sized companies and a rebound on the capital mar­kets. The positive trend is confirmed by 2006’s development. The first six month draw a positive image for this year’s development and indicate that the market volume is likely to grow again.²³ Market participants as well as stakeholders believe that the positive development will be sustained.²⁴

2.2.3 Reactions of Acquirers’ Returns to the Acquisition Announcement

This section considers the impact of acquisition announcements on the acquirer’s stock.

Thereby, the focus of attention will be on the different legal status of targets.

Private Targets

Recent evidence shows that the acquisitions of a private target results in significantly positive CARs to the bidder. An important explanation is given by the liquidity effect. Since non-public companies cannot be sold and bought as easily as public companies, these investments are less attractive. That’s why buyers usually claim a discount to the valuation as they cannot exit the investment as easily as a stock investment.²⁵ The em­pirical study conducted by Fuller/Netter/Stegemoller (2002) confirms this argumenta­tion and concludes that bidders acquiring private targets achieve a significant positive cumulative abnormal return of 2.08 percent.²⁶ These findings are supported by the most recent analysis, done by Faccio/McConnell/Stolin (2006), which finds that listed ac­quirers of private companies earn a significant average CAR of 1.48 percent when pur-

chasing a private target.²⁷ Regarding public targets, the next section will give a general idea of how acquirer returns perform.

Public Targets

In contrast to the acquisition of private targets, the market reacts negatively to the ac-

quisition announcement of public targets. Fuller/Netter/Stegemoller (2002) conclude that average CARs of firms buying public targets are significant at -1.0 percent.²⁸ Simi­lar, Faccio/McConnell/Stolin (2006) showed that listed acquirers of public companies earn an insignificant average CAR of -0.38 percent.²⁹ This can be explained mainly by the information and the liquidity effect. The listing requirements demand from the com­panies to publish all relevant and important corporate information. This allows inter­ested parties to inform themselves in more detail. In addition, public companies do not suffer from the liquidity effect. Since they are already listed, their shares can be sold and bought easily on the market. A buyer cannot claim a discount as for private compa­nies, arguing that a later disposal of shares could be difficult. Assuming all other factors to be equal, this leads to higher acquisition prices for public targets compared to private ones. The higher prices support the lower CAR to the acquirer discussed above.³⁰

To sum up, it can be said that if private targets are acquired, the stock return of the ac­quirer reacts significantly positive whereas acquisitions of public targets result in nega­tive or zero CARs on average.

2.3 Critical Comparison of Mergers & Acquisitions and Initial Public Offerings

This section points out a critical comparison of the exit strategies discussed above. Note that not only financial motivation influences the choice between M&A and IPO. Hence, different criteria are chosen to draw sound conclusions about what influences the deci­sion to go public or to be acquired. This elaboration is fundamental to dual tracking as it is ultimately a choice between both routes.

Liquidity and Ownership Structure

If the business owner intends to exit his investment completely, M&A is more suitable than an IPO. Stock investors would develop skepticism about the owner’s decision to dispose of the entire company. Therefore, the equity market would most likely interpret this as a negative sign and the stock price would be depressed. In contrast, the informa­tion asymmetries concerning the target’s valuation are typically smaller in the M&A context. This implies that sellers have the possibility to divest the whole firm by selling it to another business without causing major skepticism. Therefore, a more efficient cash-out is possible in the M&A context. If corporate insiders intend to retain the con­trolling stake in the company, an IPO is the better choice. Notwithstanding this fact, most of the shareholders of public corporations usually obtain the right to vote on par­ticular corporate decisions. As a result, the corporate insiders would have to give up some power in favor of the new shareholders.³¹

Management

The lacking predictability of the M&A outcome regarding the target’s management, results in insecurity and instability among the management. Usually, the chances of similar positions for them after the transaction are small. Thus, managers tend to avoid takeovers. In contrast, an IPO is perceived as “a public blessing by the investing mar-kets”.³² However, by exposing managerial decisions to the public market, an IPO in­duces also discipline upon managers. This includes the threat of a hostile takeover which is easier for public than for private companies.³³

Market-related Factors

When planning an IPO or M&A, it is crucial to also take external factors into account. The timing is the key determinant of the success of an IPO because the equity market is highly dependent on investor sentiment. The decision of going public depends heavily on the equity market performance. Since the burst of the internet bubble in 2000, inves­tors became highly precautious to stocks. To avoid enormous volatility, stocks need to have a very persuasive business plan in order to attract investors. In periods where in­vestors are overwhelmingly optimistic, more IPOs are registered and performed.³⁴ Con­trary, in pessimistic periods the likelihood of success is comparably low. Consequently, looking at the M&A market, volatilities are smaller as compared to the IPO market be­cause the success of an M&A transaction generally depends on the strategic fit of the

participating companies than on the whole market. Besides timing, industry characteris­tics are decisive. In industries with high concentration, strategic acquisitions are less likely because the consolidation potential is low. Moreover, acquisition may turn out to be difficult due to competition regulations. Contrary, an IPO does not at all bear any antitrust concerns.³⁵

M&A-related Factors

In the context of M&A, the major advantages of consolidating businesses are various opportunities of cost synergies. If the businesses fit strategically, this cost potential can be enormous on the level of procurement, production, administration or distribution. Moreover, the acquirer’s market share and competitive advantage can be strengthened. Basically, M&A facilitates overcoming entry barriers and access new markets and in­dustries more easily by using already existing resources with established brands. None­theless, these positive impacts are not realized automatically. The key aspect is the proper post merger integration of the businesses. Despite these integration efforts, the core business should not be neglected. However, looking at practice, many M&A deals fail to successfully integrate the business. A study by Ernst & Young supports that in­sufficient post-merger integration, lack of cultural integration and the loss of key per­sonnel destroy value. The capitalized value of roughly half of all companies which pur­sue M&A activities declines.³⁶

IPO-related Factors

A listed company enjoys several benefits in comparison to private ones. For instance, stock options can be used as part of the employee compensation.

From a value-maximizing point of view, it is rational to go public as long as potential investors value the company higher than the current owner does.³⁷ When stocks of listed companies from the same industry are overpriced an IPO can be attractive as it allows raising more money than in times of correct or under-pricing. It is likely that the new shares from the IPO will also be overvalued and, as a result, the company can sell them at a premium. This premium is an easily obtained benefit for the issuing company. ³⁸

Additionally, there are certain downsides. A larger group of investors must be per­suaded that the investment into the company is worthwhile.³⁹ Moreover, a public com­pany faces obligations towards their shareholders. In the U.S., they are mainly based on fiduciary duties, most important the duty of care and the duty of loyalty. Compliance with all these legal rules, in addition to the reporting standards, is costly and time con­suming. In addition, the periodical disclosure of company information allows third par­ties, including competitors, to inform themselves.

3 The Concept of Dual tracking

3.1 Definition of and Rationale for Dual Tracking

With dual tracking, the seller of a company pursues IPO and M&A plans simultane­ously. First, this allows the seller to assess the interest in the company. Second, a com­petition between the public market und potential buyers is created which establishes a high price tension until later steps of the process.⁴⁰ It is crucial to recognize that the ten­sion is only created when “the prices offered by the public markets and trade buyers are going to be pretty similar”.⁴¹ This implies that both markets must be prospering. The listing decision is used as a minimum price guarantee for a potential M&A deal. This gives the target the possibility to compare the offered prices of the potential acquirers with the price expectations on the equity market. Acquirers have to offer fair prices in order to win the bid.⁴² Ultimately, this mechanism will lead to higher valuations. Third, it provides flexibility as to the exit path. "Historically, the two [IPO and M&A] have been contracyclical," says Edward Annunziato of Merrill Lynch International. "When public equity market valuations are high, you get less M&A activity. When equity mar­ket values are low, trade buyers come in and companies sell to strategic buyers."⁴³ From this point of view, dual tracking also mitigates the risks of an IPO to be dependent on capital market conditions.⁴⁴ In short, dual tracking allows the seller to keep literally speaking all doors open until the late stages of the process. In spite of the benefits of dual tracking, the process is costly and, therefore, not in every case a dominant strategy.

[...]

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¹ Cowan (2005), p. C.6.

² Cf. Lian (2005), pp. 3, 32.

³ Cf. Lian/Wang (2006), p. 8.

⁴ Cf. Bodie/Kane/Marcus (2005), p. 66.

⁵ Cf. Pagano/Panetta/Zingales (1998), p. 38; Brau/Fawcett (2006) found that the effect of cost of capital reduction is relatively low valued by CFOs; cf. Welch/Ritter (2002), p. 5.

⁶ Cf. Brau/Fawcett (2006), p. 406.

⁷ Cf. Lerner (1994), p. 294; cf. Zingales (1995), p. 426.

⁸ Cf. Brau/Francis/Kohlers (2003), p. 585.

⁹ Cf. Ross/Westerfield/Jaffe (2005), p. 540.

¹⁰ Cf. Bodie/Kane/Marcus (2005), p. 11.

¹¹ Cf. Zingales (1995), p. 425.

¹² Cf. Busaba (2006), p. 170.

¹³ Cf. Busaba/Benveniste/Guo (2001), p. 78.

¹⁴ Cf. Welch/Ritter (2002), p. 4.

¹⁵ Cf. Ernst & Young (2006a), pp. 2-4.

¹⁶ Cf. Ross/Westerfield/Jaffe (2005), p. 796.

¹⁷ Cf. Weston/Mitchell/Mulherin (2003), pp. 5-8.

¹⁸ Cf. Ross/Westerfield/Jaffe (2005), p. 797.

¹⁹ Cf. Ross/Westerfield/Jaffe (2005), p. 798.

²⁰ Cf. Mallette/Fowler/Hayes (2003), p. 10.

²¹ Cf. Schnitzer (1996), p. 37.

²² Cf. Ross/Westerfield/Jaffe (2005), p. 798.

²³ Cf. Brühl/Oei (2006), pp. 334-337; for more detailed data cf. http://www.thomson.com/cms/assets/ pdfs/financial/league_table/mergers_and_acquisitions/4Q2005/4Q05_MA_Legal_Advisory.pdf date retrieved: 09/20/05.

²⁴ Cf. Ernst & Young (2006b), p. 9.

²⁵ Cf. Fuller/Netter/Stegemoller (2002), p. 1765.

²⁶ Cf. Fuller/Netter/Stegemoller (2002), p. 1775.

²⁷ Cf. Faccio/McConnell/Stolin (2006), p. 198.

²⁸ Cf. Fuller/Netter/Stegemoller (2002), p. 1775.

²⁹ Cf. Faccio/McConnell/Stolin (2006), p. 198.

³⁰ Cf. Fuller/Netter/Stegemoller (2002), p. 1784; cf. Lian/Wang (2006), p. 5.

³¹ Cf. Brau/Francis/Kohlers (2003), p. 585; cf. Brau/Fawcett (2006), p. 422; in their empirical study they find that maintaining decision control is the most important reason for CFOs for staying private. For an analysis of the influence of current investor’s willingness to invest into his own projects; cf. Leland/Pyle (1977).

³² Cf. Rautalahti (2004).

³³ Cf. Pagano/Panetta/Zingales (1998), p. 40.

³⁴ Cf. Brau/Francis/Kohlers (2003), pp. 591-592.

³⁵ Cf. Lee (1996), p .11; cf. Brau/Francis/Kohlers (2003), pp. 586-587.

³⁶ Cf. Ernst & Young (2006b), pp. 19-20; this study considers the stock price movement to judge whether a transaction had a positive influence on the business.

³⁷ Cf. Zingales (1995), p. 426; cf. Welch/Ritter (2002), p. 9.

³⁸ Cf. Pagano/Panetta/Zingales (1998), p. 41.

³⁹ Cf. Chemmanur/Fughier (1999), p. 251.

⁴⁰ Cf. Lian (2005), p. 9.

⁴¹ Bushrod (2005), p. 14.

⁴² Cf. Bushrod (2005), p. 14.

⁴³ Lee (1996), p. 10.

⁴⁴ Cf. Ritter (1984), pp. 238-239 finds that the IPO market acts cyclical.