Question about Buyouts

Brainwalter · #1 03-01-2007, 08:35 AM

This has been bothering me some recently.

I have heard "ABC company is buying XYZ company, the XYZ shareholders will recieve $100 a share (or 1.5 shares of ABD or whatever)", these deals appear to be approved by the board/management?

My question is, if I am a XYZ shareholder, and I supposedly own a share of the company, how can anyone buy my share without my explicit consent and sale? Do they only need a majority of shares to vote for the sale, and then they can buy the remaining shares at market price? This would appear to be deomcracy in the market, when in my opinion markets should be capitalistic.

I suppose this is a condition of the stock ownership in this country but I still don't really get it. It does seem like this makes mergers/acquisition easier.

Any thoughts?
How does this work, and why is it good?

Edit: I would also be interested to know, is this an SEC/Federal regulation, or just a market convention?

DesertCat · #2 03-01-2007, 12:00 PM

The deals are approved by the board, then submitted for shareholder vote. Typically, it only requires over 50% to be approved. Theoretically in some states dissenting shareholders have "appraisal rights" meaning they can go to court with hired experts to try to establish a higher value. I've never actually seen this done.

I believe this is written into each companies articles of incorporation. And it's incredibly valuable and important to the individual shareholder. Imagine you own shares in XYZ corp, and ABC offers $100 per share when it was trading at only $50. But the deal requires 100% consent. That will never happen, and you will never get paid. There would never even be an offer (who would spend all those legal fees on something doomed to fail). Without the possibility of a future buyout, stocks will trade at lower prices, so you'll lose when you sell them (though you'll save money when you buy them).

Brainwalter · #3 03-01-2007, 02:37 PM

[ QUOTE ]
I believe this is written into each companies articles of incorporation. And it's incredibly valuable and important to the individual shareholder. Imagine you own shares in XYZ corp, and ABC offers $100 per share when it was trading at only $50. But the deal requires 100% consent. That will never happen, and you will never get paid...

[/ QUOTE ]

I'm not so sure about this. The alternative I had imagined is that the purchasing company would have to buy all the shares on the open market. So they might not be able to buy 100% of the company if some stubborn shareholders just refuse to sell, but they could buy enough. In this example that might drive the market price higher than $100, and I suspect that in fact the purchasiing companies are getting a discount when they make buyouts, compared to buying on the open market.

DesertCat · #4 03-01-2007, 03:47 PM

[ QUOTE ]

I'm not so sure about this. The alternative I had imagined is that the purchasing company would have to buy all the shares on the open market. So they might not be able to buy 100% of the company if some stubborn shareholders just refuse to sell, but they could buy enough. In this example that might drive the market price higher than $100, and I suspect that in fact the purchasiing companies are getting a discount when they make buyouts, compared to buying on the open market.

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There are so many difficulties with buying on the open market that it doesn't happen in practice. Among the issues are

1) Take over restrictions. Many companies have "poison pill" agreements that kick in when someone buys more than a certain percentage of the company, say 10% or 20%. At that point the company will basically dilute the buyer by giving shares to all other shareholders, making it economically unreasonable to continue.

2) Public reporting requirements that start to kick in once you are over 5% and allow everyone to track every buy.

3) And once an open market acquirer gets lots of the shares, the public float diminishes (the number of shares available to trade). This would typically have the effect of driving the price up to ridiculous levels, like thousands of dollars per share for the last shares. That may sound great for the few holdout shareholders, but no acquirer wants to get into an open ended arrangement where the price continually rises.

3) They could just stop at 51% or so, but most acquirers don't want to keep the company public and deal with minority shareholders. It exposes them to expensive legal requirements and potential liabilities, and an unpleasant minority shareholder could make it more difficult to run the business. An acquirer will typically pay more per share for 100% of the company than 51% of it because of the benefits of total control.

So the default process is that the acquirer meets with the board and the board is required to negotiate on your behalf to get the best possible price. Sometimes how well they negotiate is questionable, but that's the process. It works fairly well.

Believe it or not, the acquirers usually have a strong idea of the value of the company they are buying and will walk away if they can't get it for a reasonable price. So if open market purchases were the only way to buy a company, fewer sales would happen, and your shares would trade lower because of that.

yellowbastard · #5 03-01-2007, 09:52 PM

How hard is it to make money doing merger arbitrage in these situations? One morning not too long ago, Merrill Lynch announced that it was buying out a small publically owned bank for $10 above the current stock price. By the time I looked it up the price was already bid up $10 and the bid and ask both said "n/a."

DesertCat · #6 03-02-2007, 02:00 AM

[ QUOTE ]
How hard is it to make money doing merger arbitrage in these situations? One morning not too long ago, Merrill Lynch announced that it was buying out a small publically owned bank for $10 above the current stock price. By the time I looked it up the price was already bid up $10 and the bid and ask both said "n/a."

[/ QUOTE ]

Every deal is different. Merger arbitrage isn't a way to get rich quick. You try to make 2%, 3% or 4% over a few months, but if the deal collapses you lose 20% or 30%. Sometimes you see a deal with a wider spread, but that usually means bigger risks (financing issues, etc). The funds that do merger arbitrage typically do a bunch of deals a year to spread the risk. And usually there is a bad year every once in while where some big deals blow up and the funds lose money.