PERSPECTIVE ON THE DRUG FIRM MERGER : Stock Swaps Are Coming Back Into Style, Analysts Say
Bristol-Myers’ agreement this week to merge with Squibb through a stock swap signals a growing popularity of that takeover method, triggered in part by a recent Delaware court decision, merger specialists said Friday.
However, such stock-for-stock exchanges could be a mixed bag for shareholders. They won’t reap the huge windfalls they earn when one company pays a premium for another firm’s stock. But they also won’t incur an immediate capital gains tax liability either, and can vote on the swap deals.
Stock swaps are a device in which merging firms exchange stock, giving shareholders of each company stock in the combined company at a set ratio. If one company is seen as more valuable than another, shareholders of the higher-valued firm are likely to get a higher percentage of stock in the combined company.
Swaps Much Cheaper for Firms
By not involving any actual purchase of stock, swaps are far cheaper for companies. But they had fallen out of favor in recent years because companies feared that offering to exchange their stock meant they were in effect putting themselves “in play”--that is, up for sale. That meant that other companies, possibly including hostile ones, might be enticed to bid. And the company in play would be obligated to accept the highest offer.
But a Delaware court’s decision earlier this month in the Paramount Communications-Time Inc. takeover skirmish has heightened interest in the technique. The court ruled that a swap proposed by Time to merge with Warner Communications didn’t necessarily mean that Time put itself into play, and thus Time’s management had no obligation to accept Paramount’s hostile stock-purchase offer.
Reviewing Decision
Merger specialists say the decision, while not triggering a swap boom, could influence some firms that might not otherwise have gotten to the altar to tie merger knots. Others may consider swaps as a way to avoid the high cost of stock-purchase mergers. Or they may see swaps as a way to combine with competitors of relatively equal size, to make both companies more competitive against foreign rivals.
“Many companies are reviewing it right now, where the Delaware decision has broadly influenced their thinking,” said J. Tomilson Hill, head of mergers and acquisitions at the Wall Street firm of Shearson Lehman Hutton, which advised Time. “But whether or not they decide to go forward and implement their deals is a function of different factors. Each will evaluate it on a case-by-case basis.”
“I think you will see more of them, if only because it’s an attractive way to join two companies during a period when high premiums are being paid,” said Jon B. Kutler, a vice president and chief of the Los Angeles office of Wasserstein, Perella & Co., a major investment banking firm.
Already, at least two recent merger deals are said to have been influenced by the Delaware decision. Dow Chemical’s $5-billion-plus bid for 67% of Marion Laboratories, announced July 17, utilizes a partial stock swap. Bristol-Myers’ $11.5-billion bid for Squibb engages an all-swap strategy.
Swaps offer several advantages over stock-purchase deals. For one, firms generally don’t incur more debt. Second, acquiring firms avoid having to add to their books “goodwill,” an accounting technicality that represents the premium paid over the target firm’s net worth. Goodwill must be written off over time, reducing the acquiring firm’s earnings. Because foreign firms don’t face such rules, they have an advantage over U.S. firms in acquiring domestic companies through stock purchases, Shearson’s Hill said.
Some Disadvantages
Companies in entertainment, consumer products and pharmaceuticals, where stocks have high prices relative to earnings per share (price-earnings ratios), are prime candidates for swaps, Hill said. Companies already laden with high debt also will be more amenable to swaps, he added.
But swaps have disadvantages to companies as well. For one, the process is slow, requiring months to file registration statements and seek regulatory and shareholder approvals. In the meantime, the relative prices of each firm’s stock could change, thus altering the ratio at which shareholders of both firms get stock in the combined company.
Also, negotiations relating to who will run the merged companies and serve on the combined board of directors can be complicated. Such talks are said to have consumed Time and Warner managements for months.
In addition, swaps don’t guarantee that no hostile suitors will come forth. An unwanted suitor offering a high enough premium could still prevail in buying one or both companies engaged in a swap. And if it appears that one company’s management will dominate over another’s in a swap, the merger may be interpreted as a purchase rather than a merger of equals. Thus, the target company may still be seen as putting itself into play--and vulnerable to hostile bids.
Also, to avoid hostile bids, mergers using swaps still have to make strategic business sense and can’t be done solely to avoiding unwanted takeovers, Wasserstein Perella’s Kutler said.
As for shareholders, whether swaps are good or bad depends largely on whether the exchange ratio is fair, said Ralph Whitworth, director of the United Shareholders Assn., a Washington-based shareholder rights group.
“If the exchange price makes sense, there’s no reason for a shareholder not to like a stock swap deal,” Whitworth said. Shareholders also like the ability to vote on such deals, he added.
