4.1 Sample selection
Our initial sample of 4463 leveraged buyouts was taken from the Securities Data Company (SDC) Mergers and Acquisitions database for the period of 1991-2006. We deleted 6 hostile deals, 30 deals that were pure stock swaps, and other non-pure cash acquisitions. To be included in our sample, the deals had to meet four criteria. (1) Deals had to have an offer price, announcement dates, completion or withdrawal dates, and deal size information. (2) Transaction values had to be more than 10 million dollars. (3) We took out a few observations which were rumored deals and secondary LBOs. (4) Acquirers had to be a private investment group. They held listed targets during the period, and then made targets go private on the completing date. The remaining 1816 samples were pure cash offers, which included 1667
13
successful deals and 149 failed deals. Some information on announcement dates, competing dates, cash offers, deal values and offer prices were also obtained from the SDC database.
Stock prices and dividends were drawn from the Center for Research on Security Prices (CRSP). We were limited by the fact that many LBO target firms in the U.S. were mainly privately held and rather small, and we therefore excluded 1484 firms that were private companies not listed in the CRSP. We then determined whether the acquisition and price information was consistent with information obtained from Lexis-Nexis. If the information was inconsistent, the data was deleted. This left us with 332 examples. The results are shown in the Table 1. Finally, we delete 33 whose stock tickers did not match each other in the SDC and the CRSP. Our final sample consisted of 299 cash offers during the 1991-2006 periods.
Of these, 234 deals were successful and 65 deals were failed.
4.2 Distribution of spread returns, risk arbitrage returns and durations
Table 3 shows the statistical distribution of spread returns, revision returns and total arbitrage returns for the whole sample, both successful and failed deals. The mean and median spread returns were 11.46% and 6.03% respectively. Fortunately, only 20 observations, which consisted of 14 successful and 6 failed deals, had negative spread returns. By comparing the two kinds of deals, failed deals obviously had larger mean and median spread returns than successful deals, and they were highly dispersed. The average total returns, the sum of spread returns and revision returns, were positive, with mean and median returns of 7.12% and 4.24% respectively.
Since offers were outstanding for different periods, it was important to calculate annual post-announcement returns. We also annualized returns by multiplying the period return by the quotient of x/365 of the duration. The annual mean and median of spread returns were 41.71% and 17.4%, and the annual mean and median of risk arbitrage returns were 19.84%
and 13.51% respectively.
Table 4 shows the frequency distribution of offer durations. The majority (62%) of
14
offers had durations of 2-5 months, to more than 7 months. The mean and median duration of deals in our sample were 141 and 127 days. The duration range was large, from a minimum of 14 days to a maximum of more than 425 days.
4.3 Descriptive statistics of variables and characteristics of target firms
Table 5 shows several attributes of target firms and deals. (1) Most target firms were small cap firms whose market equity value was less than $10 billion, and only two firms were large cap firms. (2) The industries mostly belonged to the manufacturing, service and trade sectors (see Table 6). (3) Acquirers have completed ownership after acquiring targets firms. (4) The average transaction values during the period of 1999~2006 are about 742 millions. (5) 70% of the firms yielded less than 20% sales growth and 15% ROE. We are surprised that targets firms seem to have had acceptable profitability. (6) Private equity funds preferred target firms with stable cash flows and lower debts. (7) Target firms had 1.6 times average P/B, which indicated they were valuable firms or firms with potential. (8) Most target firms (about 75%) largely enjoyed high liquidity. This finding provided direct evidence that private equity funds liked highly liquid firms. (9) Bid premiums in our final observation were 29% on average. Apparently, private equity funds were willing to offer higher prices in order to acquire target firms.
4.4 Realized arbitrage returns in the portfolios
First, to understand the economic and statistical significance of realized risk arbitrage returns of LBOs to arbitrageurs, we calculated the returns on a simple trading strategy: buying a target firms’ stock 1 day after announcement day and holding it until completion or withdrawal of the deals. Realized arbitrage returns are spread returns (SR) for successful deals and total returns (R) for failed deals. We computed annual returns based on the different weight of transaction value to calculated annualized value-weighted returns of LBO portfolios during the period of 1990-2006. Second, to compare LBO portfolio returns to market
15
portfolio returns, we calculated annualized value-weighted returns of market portfolios during the period of 1990-2006. We assumed we had same capital to invest in the market index (S&P 500 NYSE/AMEX/NASDAQ value-weighted market index) during the period of every compared acquisition. We adjusted equivalent period of every compared deal for the market index to obtain market returns.
Average value-weighted returns were 11.75% for LBOs and 5.61% for the market index at the end of the period. We found that LBO portfolios did not necessary overwhelm market returns before the bursting of Dot.com Bubble in 2000. However, LBO portfolios returns have risen since 2001, and beat the market portfolio performance by some degree (see Figure2). Table 7 also shows that total risk (volatility) were 18.53% and 6.48% for LBOs and the market index.