Dec. 1, 2004 COLUMBUS, Ohio – While stock prices of firms almost always go up immediately after an announcement of a takeover bid by another company, a new study shows that there's a lot of variation in just how far the stock prices may change.
In fact, the study showed that about one-quarter of stock prices actually go higher than the initial bid price announced by the acquiring firm.
Overall, investors seem to be savvy about pricing stocks of target firms, said Ralph Walkling, co-author of the study and professor of finance at Ohio State University's Fisher College of Business.
"We found that the market is very good at determining whether a proposed acquisition deal is going to go through, how long it is going to take, and the final price," he said.
Walkling conducted the study with Jan Jindra from Cornerstone Research in Menlo Park, Calif. Their study was published in a recent issue of the Journal of Corporate Finance.
The researchers studied 362 cash tender offers between 1981 and 1995 in the United States in which the bidding firm was attempting to own 100 percent of the target firm. These were all cases in which the target firm was listed on the NYSE, AMEX or NASDAQ exchanges, and the total value of the transaction exceeded $10 million.
Walkling said he and Jindra were interested in the "speculation spread" – the difference between how much the acquiring firm bid on the target firm's stock, and the price of that stock at the end of the first trading day after the announcement. For example, if the acquiring firm bid $40 a share for the target firm's stock, and that stock rose to $38 the day after the announcement, the speculation spread is $2.
The average speculation spread is just about 2 percent, the findings revealed.
"This shows the typical stock price of a target firm on the day after the acquisition announcement increases to an amount just below the initial bid price," Walkling said. "But there's really a big range."
In fact, the speculation spreads ranged from 42 percent below the initial bid price to 30 percent over that price. Results showed 23 percent of the speculation spreads were over the initial bid price.
"This means that in about a quarter of the cases, the market thinks the bid price was too low and will probably go up," Walkling said.
And the results showed that, on average, when the market priced the stock above the initial offer, the final offer did, in fact, increase.
While the speculation spread reflects whether the market believes the acquisition will go through at all, the study also showed the spread reflects how long the market thinks the acquisition will take, Walkling said.
The speculation spread is larger if the market thinks the deal will take a relatively long time to go through. That's because investors are often reluctant to see their money tied up for long periods of time while a deal is negotiated. And results showed the market is often right – larger speculation spreads did foreshadow longer times to finalize a deal.
"That was an interesting finding," Walkling said. "It isn't surprising that some of the fundamental aspects of the offer are built into the market price. But it is more surprising that the duration of the offer is built into the price – that is a more subtle characteristic."
Overall, of the 362 offers studied, 207 of them did not change when the deals were completed, 140 offers were revised upward, and 15 offers actually declined from the original proposal.
One other interesting finding was that $1 invested in 1981 grows to $7.06 in 1995 when invested into each cash tender offer one day after the announcement and holding these stocks until the deals were finalized – much better than the return from investing in broad stock market indices over the same period.
But Walkling cautioned against using this as an investment strategy.
"Based on these results, investing in acquisitions appears to be highly profitable, but there are large inherent risks in such a strategy," he said. "You certainly couldn't always expect to get that rate of return, and in some periods you could lose money."
Walkling said the findings show that the market does a very good job of evaluating acquisition attempts and determining whether they will be successful, how long the deals will take to complete, and the final price of the deal.
"There's quite a bit of information that's contained in market prices after an acquisition bid," he said. "The market is pretty efficient in factoring all the relevant information into the prices investors are willing to pay."
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