Please explain: How do corporate takeovers work?

Macquarie University/The Lighthouse
US investment giant Ares Management in February withdrew its conditional $6.4 billion offer to take over Australian wealth manager AMP. Macquarie Business School researcher Dr Farida Akhtar explains the mechanics of takeovers and why they sometimes fail.

Takeovers are motivated by a bigger company wanting to control a smaller company to create synergy for the entire business. Bidder companies are aiming to generate wealth for their shareholders.

Shake on it: A friendly takeover occurs when both parties are amenable to the merger.

Sometimes the result may be the opposite but to understand the true value of a bidder around a bid announcement, we must first understand the motive of a takeover bid. (I have conducted research into evaluating returns to bidder firms around announcement events and the determinants of cumulative abnormal returns (CAR) for bidder firm shareholders.)

A friendly takeover occurs when both parties are amenable to the merger. A hostile takeover occurs when the targeted company resists the overtures of the bidder company.

Hostile takeovers tend to create tensions and can result in a less positive outcome.

Market reaction

Stock markets react to available information. A takeover bid can engender a positive or a negative reaction. The market will judge both the bidder company and the target company with a view to their potential future values in the light of the takeover bid.

The market will analyse the offer price (called a premium) based on available information from the past performances of the companies with a view to determining whether the takeover will be value enhancing.

Markets may not be privy to some internal information that has not been made public. This information may be surprising and could have positive or negative consequences on returns when it does eventually emerge.

Why do some takeovers fail?

There are many reasons why a takeover may not proceed. The most common would be issues with a company’s fundamentals. While a company’s financial position is important, so is its culture, values and the credibility of the board. Corporate governance and systems can say a lot about a company.

Following an initial offer, bidder firms typically undertake more in-depth investigations of the target company, known as conducting due diligence. As investigations by the bidder firm continue, issues may come to light that weren’t previously known to them.

Very larger takeovers are extremely complex and a great deal of analysis is required to discern whether synergies will flow.

While a company’s financial position is important, so is its culture, values and the credibility of the board.

Bidder firm’s directors, who often have multiple board positions, care about their reputations and want to ensure they are making the right decision. They will therefore be meticulous in assessing the synergies the target company may bring to the bidder company.

Other non-financial factors are being increasingly considered. Investors – and especially large institutional investors – are placing more and more weight on a company’s ESG (Environmental, Social and Governance) criteria. This has been coming out in research more and more strongly over the past five years or so.

A poor ESG score reflects badly on a company. It raises concerns about whether it is a responsible corporate citizen.

Unethical behaviour by a company can be far-reaching. Investors will ultimately focus on whether a takeover will be value enhancing and, as part of this assessment, will consider whether these non-financial factors will have consequences further down the road.

Farida Akhtar

Dr Farida Akhtar (pictured) is a Senior Lecturer in the Department of Actuarial Studies and Business Analytics at Macquarie Business School.

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