Do private equity investors take firms private for different reasons?

Transcription

1 Do private equity investors take firms private for different reasons? Jana P. Fidrmuc Peter Roosenboom Dick van Dijk Warwick Business School RSM, Erasmus University Rotterdam Econometric Institute, Erasmus University Rotterdam 1

2 Motivation in recent years, the number of firms deciding to go private has increased dramatically around the world Less than 1 billion in 1996 to more than 7 billion in 2005 in UK the involvement of private equity investors also increased substantially Blackstone, KKR, CVC s recently proposed record 9 billion offer to take Sainsbury private (Times, February ) moreover, private equity investors perform a different role than in the past in the 1980s hostile leveraged transactions 2 2

3 Motivation nowadays private equity investors partner with management their typical target is a long-term player, has leading market share within their defined niche, and has a strong customer base, good growth potential and good margins (financial press) Private equity investors are almost invariably attracted to firms that find traditional financing difficult and have the potential to evolve in ways that create value (Gompers and Lerner, 2001) 3 3

4 Our contribution we suggest that the new involvement of private equity investors may have led to changed reasons for going private we conjecture that the private equity backed going private deals have different characteristics and go private for different reasons than the management sponsored buy-outs that do not have the backing of a private equity house the population of going private firms is heterogeneous these two groups have their own unique characteristics and their own reasons for pursuing the going private deal 4 4

5 The heterogeneity of PTP firms our main motivation: Halpern, Kieschnick & Rotenberg (RFS 99); they suggest that The population of LBOs is heterogeneous and understanding the differences among LBOs is important in understanding both why each type of firm engaged in this transaction and what they did after the transaction. they consider two types of poorly performing firms based on the level of managerial ownership before the deal 5 5

6 What is different in our paper? we extend the heterogeneity idea of Halpern et al. highlight the involvement of the private equity funds as another key distinction among the going private deals two separate types of going private transactions: private equity backed going private transactions management buyouts where management initiates the deal without any direct involvement of private equity funds (we refer to this group as management-sponsored deals ) 6 6

7 What is different in our paper? for completeness of our model, our analysis also includes a third type of other going private transactions initiated by different parties such as non-executive directors, wealthy private individual investors, industrial firms or financial investors that are not private equity investors the three types of going private deals are compared against a random sample of firms that remained listed 7 7

8 The hypotheses our main hypothesis is that the population of going private firms is heterogeneous the two groups have different reasons for going private it is hard to come up with exact hypotheses concerning the private equity backed firms as there is almost no evidence on these deals yet we propose four possible ways in which the two types of going private firms can differ but these hypotheses are rather lose 8 8

9 The hypotheses what are the possible reasons for going private? undervaluation low visibility (illiquidity of stock and low analyst coverage) free cash flows and taxes high managerial ownership these reasons have been mentioned in the literature for management buy-outs but we expect that these reasons would not fit the PE backed deals private equity investors are after a relatively fast profit buy firms short of cash, turn them around and sell again 9 9

10 Undervaluation undervaluation of firms may limit their benefits from public listing (e.g. raising equity) Allen and Gale (JFI 99), Pagano et al. (JF 98) undervalued firms are more likely to attract hostile takeover interest (Lehn and Poulson JF 89) Maupin et al. (JBFA 84) show that managers perceive undervaluation is as important reason to go private private equity investors follow buy-and-build strategy and care about unexploited growth opportunities 10 10

11 Visibility liquidity, low cost of capital and public scrutiny are important benefits of public listing Bolton and von Thadden (JF 98), Boot et al. (WP 06) so illiquid stocks with low analyst following have to bear cost of listing while not profiting enough from being public they should have higher probability to go private (Mehran and Peristiani WP 06) higher visibility reduces monitoring and selection costs for private equity investors (Brennan and Hughes JF 91) 11 11

12 Free cash flows Jensen s free cash flow hypothesis cash-rich, slow growing firms should issue debt to pledge to pay out the free cash flow and not to overinvest equity is a pillow and debt is a sword tested in the literature, mixed results we propose that the private equity backed deals may actually be short of cash to exploit growth opportunities (Gompers & Lerner, 2001) alternative explanation cash-rich firms may find it easier to finance the deal 12 12

13 High managerial ownership managers with high stakes may be motivated to engage in a leverage transaction to increase control and free some wealth invested in the firm Halpern et al. (RFS 99), Elitzur et al. (JEBO 98) private equity investors look for support of a number of incumbent blockholders (irrevocable undertakings), Weir et al. (EFMJ 06) high institutional ownership increases the chances of the deal being successful but private equity investors also want to partner with management 13 13

14 Data 221 firms that went private over Bureau van Dijk ZEPHYR data base/cmbor we do not have ownership data on 9 firms PE backed deals, 69 MS deals, 53 other deals control firms 200 randomly selected firms in each year ownership data PWC Corporate Register financial statement data Worldscope market prices Datastream analyst coverage IBES takeover rumours Lexis-Nexis and SDC M&A data 14 14

15 Coding of the three types we downloaded offer documents from Thomson Research we used them to check for private equity participation this is the primary criterion then we examine involvement of executive directors in all other cases the transaction is coded as other deals backed by non-executive directors, wealthy families or institutional investors other than private equity houses 15 15

16 Methodology we use a random sample of control firms we have the population of PtP firms with three types we want to see what are the characteristics of these firms versus the control sample multinomial logistic regression the likelihood function is adjusted for the fact that we have almost the whole population of the PTP firms whereas only a random sample of control firms we employ weighted log-likelihood estimation 200 versus 1200 listed firms, correction of 1/6 all variables adjusted for industry median 16 16

17 Results model selection our regressions/tests confirm that the two types of PtP firms are different (1% level) we test the choice of model the independence of irrelevant alternatives is never rejected thus, a multinomial logistic model fits the data better than a nested logistic model this confirms the PTP decision process we propose the decision about the transaction and the type of the transaction is done at the same time 17 17

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19 Results heterogeneity in undervaluation variable market to book PE backed M sponsored coeff. s.e. coeff. s.e. p-value for LR test * *** rumours 0.414*** ***

20 Results heterogeneity in visibility variable PE backed M sponsored coeff. s.e. coeff. s.e. p-value for LR test illiquidity *** analyst cov *

21 Results heterogeneity in free cash flow variable PE backed M sponsored coeff. s.e. coeff. s.e. p-value for LR test cash ** * sales growth payout ratio 0.565* tax **

22 Results heterogeneity in ownership variable PE backed M sponsored coeff. s.e. coeff. s.e. p-value for LR test executive ow 2.044** *** fin.ints.ow 3.247***

23 Results control variables variable PE backed M sponsored coeff. s.e. coeff. s.e. p-value for LR test size ** total debt roa s.d.of returns 0.079**

24 Summary of the results PE backed M sponsored undervaluation + ++ visibility 0 -- cash -- + ownership fin / man man 24 24

25 Conclusions our analysis suggests that the population of the going private firms is heterogeneous we have two (three) types of PTP firms that have different reasons for going private, reflected in their characteristics private equity backed deals sound business short of cash and financing, slightly undervalued high ownership by financial institutions and management management sponsored deals might go private because of free cash flow high managerial ownership low benefits from listing illiquidity, low visibility, miss-valuation 25 25