Takeovers, which used to be the exclusive fund territory of private equity funds, have been eyed by businesses. Ever since hedge funds began feeling pressure from competitors to generate high returns. Some examples include Edward Lampert’s takeover of Kmart in January 2000. Nelson Peltz’s acquisition of Wendy’s in 2008 and merged it with Arby. In 2011, they sold Arby’s to a private equity firm, the Roark Capital Group.
Dramatic Evolution
In 2014, the takeover business made a dramatic evolution. William Ackman’s Pershing Square Fund teamed up with Valeant Pharmaceuticals to bid for Allergan at $45.6 billion. Ackman wasn’t only good in financing but also in skills. From being a successful activist throughout the years, purchasing 9.7% as a toehold in Allergan. But this value could fall if the bid does not succeed, which is what happened to Ackman’s innovative bid. Actavis outbid the team with a $66 billion cash and stock offer. Although Ackman did not win the bidding contest, he did win financially. As Allergan’s largest shareholder since the bid was expensive and it made good returns on Ackman’s holding.
Hedge funds take an interest in investing in companies for great returns. One of their focuses is the debt of distressed companies. In fact, they have been engaging in debt financing of M&As. Commercial banks become sources of M&A debt financing. The syndicate to hedge funds that assume what usually is second lien debt. This new origin has changed the total capital available for M7&A financing.
M&A Volume
As for activist hedge funds and M&A, the former usually have short-term goals. As they seek to obtain short gains from their share positions in the investment. Usually, one or more hedge funds offer to acquire a position in an undervalued company to be restructured. As a result, it contributes to an increase in M&A volume. Acquirers’ transaction also helps increase overall M&A volume. When activists pressure a company to sell certain assets. But if the goal of the activist is to pursue a strategic merger that pays gains long term. The hedge fund opposes the deal and it leads to a lower overall level of M&A. Activists indeed have impacts on overall M&A volume.
When the M&A volume is low, activist funds have to use different strategies. That may even lead one to become a financial engineer or one who uses balance sheets to buy back shares. One can be an operational activist. By getting more involved in the company’s operational performance and may want to have the company run differently.
Based on a study by Boyson, et al., activist hedge fund interventions significantly increased. The likelihood of the target being taken over. When another party implements a takeover, the target receives higher bids and premiums. Even when the bid failed, the operating and equity market performance of the targets improved in the years that followed. However, these positive patterns were not present when the activist was the actual bidder as opposed to a third party.
Accumulation of n Equity
Moreover, the accumulation of an equity position by an activist hedge fund can have great effects on the stock price, and that is evident in the well-known Carl Icahn’s situation. There are also various studies that prove the announcement of hedge fund activism. That has a correlation with abnormal returns over a short window around that announcement date. It is also worth noting that a study by Clifford in 1998-2005 found that companies that were targeted by activists realized higher excess stock returns. Specifically a 3.39% cumulative excess return around the announcement date. They also showed great operations proven by the return on assets.
Klein and Zur confirmed these findings and added a comparison regarding the market effects of activist hedge funds. Sharing accumulations with those of what they called entrepreneurial activists. These consist of individuals or asset managers who act for private equity firms and venture capitalists. They are activists if they aim to bring about change in the company. That would raise the stock prices and provide them with a profit from their investment as a result of their activism.
Hedge Funds
The two types are associated with positive abnormal stock returns. But hedge funds showed 10.2% returns while the entrepreneurial group was associated with a 5.1% return. Hedge funds had a 60% success rate. While the entrepreneurial group was successful 65% of the time, meaning both were often successful in their bidding. Both seemed to target different companies too. Where hedge funds target those in better financial conditions, than did the entrepreneurial activists. Hedge funds seemed to seek out companies that had higher cash resources. Then they tried to pressure them into buying back shares and make other changes. Like lowering senior executive compensation and increasing dividends. The entrepreneurial activists tended to focus more on the company’s strategy. Both also achieved their goals through a proxy process.
Shareholder Wealth Effect
Meanwhile, Greenwood and Shor analyzed the source of positive shareholder wealth effects. Through huge samples of companies that filed Schedule 13Ds. They then cross-referenced this sample to the 13F filings, which are made by institutions. Leading to a bigger sample which included many passive investors that had to be deleted. The DFAN14A filings, which are filings made with the SEC by those non-management investors considering pursuing a proxy fight were examined. The must be filed with the SEC by any registrant when there is a shareholder vote. The researchers found that period returns of greater than 5% for those companies that were eventually acquired. This is almost double of other companies’ returns. Therefore, activists have the ability to generate above-average returns because of the target being sold to their own advantage.
© image credits to Steve Johnson