Higher abnormal returns in the case of a minority acquisition by a private equity firm compared to a minority acquisition by a public firm

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Higher abnormal returns in the case of a

minority acquisition by a private equity

firm compared to a minority acquisition by

a public firm

17 December 2013

Name: Bas Baas

Student number: 10002406

Specialization: Financiering & Organisatie Thesis supervisor: M.A. Dijkstra

Date & Place: 17 December 2013, Amsterdam Thesis: Bachelor thesis

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Abstract

This paper investigates the abnormal returns (on stock prices) of investing in a company where a private equity firm buys a minority stake. Abnormal returns are the difference between the actual returns of the company compared with the expected returns. Between January 1996 till December 2012 the abnormal returns are compared with the abnormal returns of comparable public firms during an event window of 2 months. The data set consists of 53 private equity firms and 53 comparable public firms in the regions European Union and North America.

Companies where a private equity firm takes a minority stake have .206%

significantly higher abnormal returns (during the event window) than companies where a public firm takes a minority stake. Abnormal returns are significantly different from zero and have a value of .22% per day during the event window.

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For investors it is important to understand why stock prices fluctuate. Many aspects can influence the fluctuations of stock prices, some of these aspects can’t be explained and some can. One of the aspects which cause stock prices to change is the situation when a company acquirers another company. After an acquisition it is common that the acquirer will change different aspects of the acquired company. Throughout these changes there will be a positive or negative effect on the value of the company which (if markets are efficient) will result in a positive or negative effect in the stock price. The knowledge of understanding and predicting the fluctuations of stock prices is of high value for any type of investor. With gathered data about the fluctuations of stock prices, the risk free rate and by using the CAPM model it is possible to calculate the expected returns, the actual returns and eventually the abnormal returns.

The abnormal returns is the difference between the expected returns and the actual returns achieved by a certain company. These abnormal returns are the returns investors are interested in, this is the percentage of return with which they are able to perform better than their calculated expected returns.

A type of firm that is known for their acquisitions are private equity firms. Private equity firms have different strategies than public firms in order to achieve an increase in firm value after their acquisition. These strategies consist of a financial aspect, an operational aspect and a governance aspect (Jensen, 1989). Some examples of these strategies are the implementation of a different type of board structure (Cornelli, 2008), a higher involvement of the management in the equity upside and downside (Kaplan, 1989) and a higher percentage of leverage within the investment (Kaplan, 2009). These strategies will be explained further on its ability to increase value in section 1 of the literature review.

Previous investigations show a higher abnormal return in the case of a leveraged buyout done by a private equity firm. But in the case of a minority stake bought by a private equity firm these different aspects could have a lower or even non effect on the stock prices. the effect of a minority stake bought by a private equity firm will be investigated in this paper. It is examined what different types of factors affect the abnormal returns in the case of a minority acquisition by a private equity firm. This is compared to the abnormal returns of minority acquisitions by a public firm. Section 2 of the literature review is dedicated to explain minority acquisitions regarding this investigation.

Section 3 of the literature review will explain the effect of insider trading and what causes insider trading. Insider trading occurs when investors are in the advantage of having

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more information than their competitors (other investors) (Acharya, 2010). Because of this information they can make better decisions in order to make a higher profit. This type of investing (possessing more information than others and use this information to make an abnormal profit) is illegal. In this investigation it will be taken into account by examining stock prices one month before the announcement date which will record some of these effects of insider trading.

Results show higher abnormal returns when a private equity firm takes a minority stake compared with the case when a public firm takes a minority stake. This higher abnormal return is significantly different from zero and has a value of .22% per day during the event window. The percentage stake taken by the private equity or public firm does have an effect on the abnormal returns. The higher the percentage stake taken by the private equity firm the higher the abnormal returns. With a positive effect of .009% on abnormal returns for every extra percentage stake taken by the private equity firm.

Literature review

1.) The private equity firm

In the case of a leveraged buyout, an investment firm buys a majority stake of an existing company. According to Zephyr (online database containing financial data regarding mergers and acquisitions), 84% of these leveraged buyouts are financed by private equity firms (PE firms). The PE firm uses a small portion of equity and a large portion of debt financing. Kaplan (2009) describes two private equity waves. The first wave occurred between 1982 and 1989, the second wave between 2003 and 2007. In the first wave acquisitions are financed with 10-15% equity and in the second wave with 30% equity (Kaplan, 2009). The PE firm is organized as a partnership with limited liability. Through a private equity fund the PE firm raises capital. Most of the time these funds are closed-end. A closed-end fund gives the buyer the opportunity to buy and sell his or her shares on the market, unlike open-end funds where the buyer can sell his or her shares back to the fund (Deli, 2002). The PE firm does not have to cope with buying stock back, which gives the PE firm a predetermined time (usually 10 years) to invest. This predetermined time normally consists of five years to invest and five years to pay the investment back to its investors (Kaplan, 2009). The investor commits to pay for investments in companies and for management fees to the PE firm. A private equity fund typically consists of general partners (PE firm) who manage the fund and limited partners (pension funds, insurance companies, high net-worth individuals, foundations, etc.) who provide most of the equity capital (Kaplan, 2009). A private equity fund is raised and

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managed by a PE firm. A single PE firm will typically manage several private equity funds (Cumming, 2010). The data set Cumming (2010) used consisted of 221 PE funds managed by 72 PE firms. These 221 PE funds include 5038 firms. So based on this data a PE firm

manages on average 3 PE funds and an average PE fund consist of 23 firms.

Jensen (1989) argues that PE firms use strategies which consist of a financial aspect, an operational aspect and a governance aspect to increase firm value. The financial aspect exists of the incentives provided by the PE firm to the management. The PE firm requires from the management to buy a percentage stock of the company. This differs from public companies in such a way because there is a higher upper bound or no upper bound at all (i.e. there is no maximum bonus the management can receive) (Jensen, 1989). The effect of the difference in maximum bonus between PE firms and public firms is investigated by Baker and Wruck (1990). They found an average bonus before the buyout of 10.3% in 1985 and 17.3% in 1986, and after the buyout an average bonus of 65.8% in 1987 and 38.8% in 1988

(percentage of year end salary). According to Holthausen et al. (1995) it is standard for listed firms to have a maximum bonus, approximately 80% of the base salary. The operational aspect that the PE firms apply consists of the needed industrial expertise. When PE firms are organized around industries (i.e. a large focus on a specific industry), they hire professionals with operating background and industry focus. For example, the former CEO of IBM Lou Gerstner is affiliated with Carlyle (PE firm, #2 of the Private Equity International’s exclusive annual ranking). Jack Welch the former CEO of GE is applying his industry knowledge with Clayton Dubilier (one of the oldest PE firms, founded in 1978 and managed investments of approximately $17 billion; #33 of the Private Equity International’s exclusive annual ranking) (Kaplan, 2009). Finally, the governance part consists of the composition of the board, the interaction with the board and/or board restructuring. PE firm boards are on average 15-30% smaller than boards of public companies (Cornelli, 2008). One of the differences between PE firms and public firms are the restructuring plans. Deng (2010) describes that the abnormal return of a PE firm is the largest (after 43 days: 46%) of the four investment groups

(individual, corporate, state-owned and private equity) when the PE firm announces strategy changes. But when it doesn’t announce strategy changes the PE firms end with the lowest returns (after 43 days: -16%). Deng (2010) describes these restructuring plans as CEO turnover, board restructuring and corporate strategy changes. The PE firm has the highest CEO turnover percentage (15 out of 21 observations).

The percentage of the management ownership increases by a factor four after private equity takeover (Kaplan 1989). That is, after the buyout the management owns four times the

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shares of outstanding stock than before the buyout. Kaplan (1989) found that the median pre-buyout management owns 5.88% whereas the median post-pre-buyout management owns

22.63%. The PE firm requires from the management to make an investment in the company. Throughout these investments the management can experience higher payoff when stock price goes up or lower payoff when stock price goes down. With regards to the higher payoff, Kaplan (2009) investigated the returns to management in the United States in the case of a leveraged buyout from public to private. He stated that the median chief executive officer received 5.4% of the equity upside while the management team as a whole received 16%. In other words the chief executive officer received a bonus of 5.4% (above his salary) of the increase in firm value and the management team as a whole 16%. With regards to the lower payoff this might be due to poor performances of the management (and in result the company) which might cause the market to sell their stock due to losing faith. As an effect, the stock price decreases and the management lose a certain amount of money they invested in their own company. The PE firm could also decide to fire the management. After a takeover by a PE firm, one third of the chief executive officers are replaced in the first 100 days and two thirds over a four year period (Acharya et al., 2009).

The investment by the PE Firm is highly leveraged. Leverage puts pressure on managers in a way that they don’t waste money. This pressure reduces the free cash flow problems (Jensen, 1986) and potentially increases firm value because the company benefits from the tax deductibility of interest. Leverage can also cause problems such as debt overhang. The debt overhang theory of Myers (1977) states that a firm which is highly leveraged has an increased probability of not accepting positive NPV projects because this project has a lower payoff to shareholders, because the benefits mostly flow to debt holders. Not accepting positive NPV projects reduces the growth of the company which can result in a lower stock price (Cai, 2011). Another problem that arises when the company is highly leveraged is that it needs to make monthly interest payments to its debt holders. These

required payments increase the chance of costly financial distress (Kaplan, 2009). The third of the three aspects is the governance aspect which refers to the control the PE Firm has on the board of their acquired company. The boards are typically smaller and the PE firm is more actively involved. Boards monitor and provide advice to management. When ownership is dispersed, which is the case of most public companies, boards monitor management on behalf of the owners. When a PE Firm acquires a public firm the board size reduces. On average PE firm boards are 15-30% smaller than boards of a public company (Cornelli, 2008). When a PE

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firm invests in a public company they request board seats. With these board seats they are actively involved and can directly monitor managerial activity (Dai, 2007).

Guo et al. (2011) show that, on average (in their sample 120 PE firms and 74 public firms), firms experience increases in total value from the time of the buyout until the acquirer sells the company. These increases are: the mean nominal return 68.9%, the mean market- and risk-adjusted return 48.1%, both significantly different from zero. The authors give three possible explanations. First of all, firm value will increase if there are operational

improvements, improved profitability, sale of unproductive assets (assuming the market has not adjusted for these unproductive assets, PE firm can discover these unproductive assets) or use their assets more efficiently. Deng (2010) shows in his results that the company

profitability of these strategy changes are the highest when they are implemented by a PE firm. Secondly, because of the tax shield the firm may boost returns by increasing the cash flows available to the investors by using additional leverage. A tax shield is the reduction in the corporate obligation to pay income taxes. Because interest on debt is deductible, taking on debt creates a tax shield (Kemsley, 2002). The PE firms have high leverage which ensures a high tax shield.

Firm value and long-term performance can be influenced by new controlling

shareholders who buy a stake above 50%. The new controlling shareholders are focused on creating long-term value, whereas old shareholders could be more short-term focused (Deng, 2010). This shift from short term focus to long term focus arises because the PE firm gives the management long term incentives. Rimmer (2012) describes the incentives the PE firm gives the management as the distinguishing factor. The PE firm demands management to buy in to long term compensation arrangements, to ensure that the management is retained and

incentivized to achieve the value creation the PE firm desires. This long term incentive gives the management under control by a PE firm a strong incentive to create value. The interest of the PE firm is (with these long term incentives) aligned with the interest of the management. In the investigation Deng (2010) did with 21 PE Firms observations the mean block size (percentage of voting rights purchased by the acquirer (as Franks (2001) describes 25% of the shares) with which the investor has privileges, prevent new shares being issued or the

dismissal of members of the supervisory board) was 39.79% and the mean time the PE firm was in control was 29 months. Deng (2010) found that if a PE Firm is the new controlling shareholder, the cumulative average abnormal return on the event day is 27 percent. Of all four groups which are individual investor, corporate investor, state-owned company, and private equity firm this is the highest cumulative average abnormal returns.

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The findings of Jensen (1989), Kaplan (2009) and Guo (2011) are based on the case that the PE Firm acquired the company. This thesis will not cover acquisitions, but only the events when a minority stake of a listed company is bought by an unlisted firm. The creation of economic value which Jensen (1989) and Guo (2011) describe (financial, operational and governance aspects) should not affect the stock price when only a minority stake is bought. When a PE firm buys a minority stake they don’t have the power to make radical adjustments within the company.

Franks (2001) describes the effect of a minority stake greater than 25% in Germany, based on 75 firms in the period 1989-1994. This stake of 25% or more provides a blocking minority. This blocking minority can be used to prevent new shares being issued or the dismissal of members of the supervisory board. Shleifer and Vishny (1997) described the blocking minority as large investors representing their own interest, which doesn’t necessarily conflict with the interest of other investors. The control rights this large investor has can maximize firm value which is positive for both the large investor and the small investors. But if he is selfish he can redistribute this wealth from others and thereby harm the small investors (Shleifer and Vishny, 1997). As a good example the Parmalat case from Italy can be used. The company was controlled by a strong block holder, the Tanzi family, this controlling shareholder distributed money from the public company to other companies under control of the Tanzi family. With this strategy making other stockholders worse off and the Tanzi family better off (Melis, 2005).

The PE firm has the interest to buy the company and sell it with a profit. With a minority stake the PE Firm can influence the management to create value. So this is different from the Parmalat case. Because the PE firm puts effort to create value this is not only profitable for the PE firm but also for other investors who have a share in this company. Shleifer and Vishny (1986) show that the presence of large shareholders can benefit minority shareholders. Because the large shareholder can monitor and exert pressure on the actions of the manager, this can result in a company that will perform better.

As Deng (2010) describes PE firms have the highest returns when they announce strategy changes. The operational improvements and sale of unproductive assets as Guo et al. (2011) shows will be similar between a public or private minority buy. But the extent to which these changes occur makes the minority stake bought by a PE firm different than the minority stake bought by a public firm.

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3.) Insider trading

Insider trading arises when managers use their exclusive information from inside the company to make an abnormal profit, i.e. a higher profit than the expected profit in this market or sector (Boujelbene, 2012).

In the case of absent regulation and all insiders would have the same information this would drive prices immediately to their full information level. Because, when precise

information is available for every investor the stock price is a reflection of the true value of the company. When all investors have the same information the price of the stock would be a perfect indication of the value of the company and therefore would drive prices to their full information level (Acharya, 2010). Insider trading is regulated so this cannot be applied to most markets. So whether or not the number of people with inside information will lead to more insider trading will depend on the enforcement regime and the penalties given (Acharya, 2010). Trading based on exclusive access to information can harm other investors and

destabilize investment. This is because the inside trader has better information and can maximize his own welfare but will decrease the welfare of other investors.

As an example: a pharmaceutical company (Company A) is active on the stock market. After years of research and high investments they discover a new cure for diabetes (Drug A). At their first attempt to receive a pharmaceutical patent for Drug A they get

rejected. After adjusting some active ingredients in Drug A, Company A tries a second time to receive patent on Drug A. During the process of evaluating Drug A, the board director of the patent company has exclusive information that Company A will receive patent on Drug A. This patent will ensure that Company A will receive net profits 5 times the value compared to this moment, for the next 10 years. The board director of the patent company is the one with the final decision and the only one who has the exclusive information that Company A will receive their requested patent on Drug A. If the board director buys share of outstanding stock of Company A before the news is available to other investors he is able to buy this stock for a price which is lower than the stock price after the news is available. After the news is

available for all investors the stock price will rise and the board director will benefit the most from this increase. This type of information and using this information to make an abnormal profit is called insider trading.

Insider trading is legally forbidden in almost every country. All 22 developed

countries Beny (2002) describes have insider trading regulation. And Beny (2002) states that within 82 developing countries 16 do not have an insider trading regulation. The U.S. rule

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10b5-1 of the Securities and Exchange Act of 1934, which is the foundation of the current regulation, prohibits that an investor trades on the basis of information which is not available to the public (Bozanic, 2012).

Data

The data on the stock returns of the companies where a PE Firm and a public firm has taken a minority stake are collected using Zephyr (online database containing financial data regarding mergers and acquisitions). The restrictions of Zephyr to get to these results in case of the PE firm were: the PE firm acquired minority stake (5-50%), the PE Firm was unlisted and the target company listed, only deals which are financed by a PE Firm and only completed transactions will be taken into account using data for United States and Europe between 1996 and 2012. The restrictions of Zephyr to get the results in case of the public firm were: the firm acquired minority stake (5-50%), the acquired company was listed and the target company listed and only completed transactions will be taken into account using data for United States and Europe between 1996 and 2012.

With these restrictions Zephyr showed 92 deals. Some companies did not exist as long as the predetermined estimation period, so there was not an estimation window available, these companies are deleted from the data. After selecting useable data the dataset was decreased to 53 deals. Throughout the dataset of the public firms 53 comparable companies were selected (based on deal value, percentage stake, date and region).

DataStream was used to get the daily stock return belonging to these companies, 45 months before the announcement and 1 month after the announcement. These 46 months consist of the estimation window which has a period of 35 months (45 months before the announcement till 10 months before the announcement) and the event window which has a period of 2 months (1 month before the announcement and 1 month after the announcement).

In DataStream the Total Return Index of the different companies were requested. These returns needed to be transformed into daily returns, using Formula 1.

Formula 1:

=

-

/

Where are the daily returns on stock prices, the stock price on day t+1 and the stock price on day t.

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Thereafter the market returns were required. Which are used to find the expected returns with the CAPM-model:

Formula 2:

(E (

)) -

= α + β * (

-

)

Where

(E (

))

is the expected return, is the risk free rate and are the market returns. With this CAPM-formula the Alfa and Beta were calculated, then these are filled in the same CAPM-model but in a different form. In Formula 3 the market returns and risk free rate are calculated in the event window, with use of the Alfa and Beta calculated with Formula 2, the expected returns are calculated.

Formula 3:

(E (

)) = α + β * (

-

) +

From this formula the expected return

(E (

))

is computed. Then the actual return is compared with the expected return which results in the abnormal return.

Formula 4:

– (E (

)) =

being the actual return and

the abnormal return.

Lastly the cumulative abnormal returns are calculated by Formula 5.

Formula 5:

=

Where

is the cumulative abnormal returns, is the summation of the abnormal returns during the event window and

the abnormal returns.

The market returns have been collected with DataStream. For every country where a PE Firm or public firm acquired a minority stake the market return was computed by the national leading stock list (so for Netherlands: AEX; for US: S&P 500; for Spain: IBEX 35; for Germany: DAX; for Denmark: OMX Copenhagen; for France: CAC 40; for Greece: FTSE/ATHEX Capped 20; for Italy: FTSE MIB; for the United Kingdom: FTSE 100, for Ireland: ISE, for Portugal: Euronext Lisbon, for Finland: Helsinki Stock Exchange, for

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Belgium: Euronext Brussels, for Canada: CNSX, and for Sweden: OMX S30). The risk free rates (for the European Union and the United States) are found using DataStream. For the European Union the risk free rates of the European Central Bank are used. For the United States the Fama French risk free rates are used.

The different returns [expected (PE firm), actual (PE firm), actual (comparable firm) and abnormal (PE firm)] are tested if their mean differs from zero (Table 1). The actual return of the PE firm has a mean of .24% per day during the event window and the abnormal return of the PE firm a mean of .22% per day during the event window. The actual return of the public firm has a mean of .15% per day during the event window and the abnormal return of the PE firm a mean of .085% per day during the event window. There is enough evidence to conclude that the actual and abnormal returns of the PE firm differ from zero with a

significance of 99%. There is not enough evidence to conclude if the abnormal returns of the comparable firms differ from zero with a significance of 90%.

Results show that the abnormal returns of a company bought by a PE firm are .127% above the abnormal returns of the company where a public firm bought a minority stake. The lowest cumulative abnormal return of the PE firm is -.59% and the highest cumulative abnormal return is 1.328% (with a mean of .22%) (Table 1 and Figure 3).

18 of the 53 minority stakes bought by a PE firm have a negative cumulative abnormal return (35 positive returns), this is 33.9%%. 22 of the 53 minority stakes bought by a public firm have a negative cumulative abnormal return (31 positive returns), this is 41.5%. But as can be concluded from Figure 3 and Table 1 the lowest negative return is -.92% and the highest positive return is 3.943% with an average of .085% (Table 1 and Figure 3).

Table 1:

The average returns of the companies from day 1 to day 45 will give an estimation of the average cumulative return after 2 months (Figure 1). This means when there would be an investment (one month prior to the announcement day) in the 53 companies where a PE firm buys a minority stake and when there would be invested (one month prior to the

Minimum Maximum Mean Standard

deviation

Median

Actual (PE firm) -1.076 1.279 .236 .479 .234

CAR (PE firm) -.592 1.328 .222 .421 .177

Actual (public firm) -1.037 3.764 .148 .606 .103

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announcement day) in the 53 companies where a public firm buys a minority stake and this investment will hold for 2 months. The result (after these 2 months, the event window) is the average cumulative return.

The investment in the 53 companies where a public firm bought a minority stake will result in an average cumulative return of 1.071, or 7.1%. The investment in the 53 companies where a PE firm bought a minority stake will result in an average cumulative return of 1.121, or 12.1% (Figure 1). The largest average return of the public companies is the day prior to the announcement day: 1.95%, so this is 1.95% within one day. The largest average return of the PE companies is the announcement day: 1.797%.

This result shows that it is on average profitable to invest in a company where a PE firm will buy a minority stake, the problem is that the investor does not know when and if the PE firm will buy a minority stake. If the investor would know this, this knowledge would be insider trading.

Figure 1:

The days are on the horizontal axe, starting with -22 (22 days before the

announcement day), and ending with 22 (22 days after the announcement day), with 0 being the announcement day. The investment starts at 100 (on the vertical axe) and ends at 107.1 for the public company and at 112.1 for the PE company.

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The announcement of a PE firm taking a minority stake has (in our sample) on average a positive effect on stock prices within the event window (2 months).

Results show that the lowest abnormal returns of the PE firm are –.592% per day and the highest abnormal returns of the PE firm are 1.328% per day. The mean abnormal return of the PE firm is .22% with a standard deviation of .42. The lowest abnormal returns of the public firm are –.92% per day and the highest abnormal returns of the public firm are 3.94%. The mean abnormal returns of the public firm are .085% per day with a standard deviation of .62 (Table 1). Results show a difference in variance per day. As Figure 2 shows that investing in a company which will be partly acquired by a PE firm or public firm comes with some risk. On the announcement day of the PE firm the lower 95% confidence bound is .42% and the upper 95% confidence bound is 3.18%. The day after the announcement day of the PE firm the lower 95% confidence bound is –.6% and the upper 95% confidence bound is 3.88%. Results show different values in the case of the public firm. Where the largest variance is the day before the announcement day, with a lower 95% confidence bound of –.38% and an upper 95% confidence bound of 4.29%. On the announcement day of the public firm the lower 95% confidence bound is –1.88% and the upper 95% confidence bound is .28%.

These results show that the average daily returns are not significantly different from zero. It is on average profitable to invest in a PE firm, results show that the abnormal returns are significantly different from zero. But the investor must know when to buy and when to sell. Figure 2 shows that de daily returns (of the PE firm and the public firm) have large variances.

The lowest value of the lower 95% confidence bound of the public firm (per day) is –2.9%, the highest is .19%, with a median of –.51%. The lowest value of the upper 95% confidence bound of the public firm (per day) is –.18%, the highest is 4.29%, with a median of .8%.

The lowest value of the lower 95% confidence bound of the PE firm (per day) is –1.53%, the highest is .47%, with a median of –.57%. The lowest value of the upper 95% confidence bound of the PE firm (per day) is –.03%, the highest is 3.88%, with a median of .94%.

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Figure 2:

Research Methodology

1.) Regressions

It will be investigated if the market responds to the minority stake taken by the PE Firm, and if this response is reflected in the stock price of the target company. It will be tested if it is different from the expected returns, using the CAPM model, and if it differs from comparable (public) companies. By using Regression 1 and Regression 2. (The reason for not regressing all variables in one regression is because the missing data on the variables Pre-deal total

assets and Deal value compared with assets are perfect multicollinear with the dummy

variable EU.)

Regression 3 will investigate the different abnormal returns per country, every country

has a dummy variable which equals 1 if the minority is acquired in that country and 0 otherwise. The Netherlands is omitted from this sample to avoid the dummy variable trap (perfect multicollinearity). Every country coefficient in Regression 3 can be interpreted as the difference in abnormal returns between that country and The Netherlands.

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Regression 1:

CAR = α + PEfirm + PercentageStake + AcquiredOwnCountry + Date + DifferenceBetweenAnnouncementDateAndRumorDate + PreDealTotalAssets +

DealValueComparedWithAssets + DealValue + EconomicCrisis + ɛ

Regression 2:

CAR = α + PEfirm + PercentageStake + EU + Date + AcquiredOwnCountry + ɛ

Regression 3:

CAR = α + PEfirm + PercentageStake + Spain + Belgium + Canada + Germany + Denmark + Finland + France + GreatBrittain + Greece +

Ireland + Portugal + Sweden + United States + ɛ

2.) Explanations and the expectations of the different variables

PE firm:

A dummy variable which separates the comparable (public) firms with the PE firms. The dummy variable equals 1 when the company is acquired by the PE firm and 0 when acquired by the public firm. This variable will show the difference between the cumulative abnormal returns of the PE firm and the public firm.

Expectation of the variable PE firm:

Jensen (1989) and Guo et al. (2011) states that PE firms use strategies which consist of a financial aspect, an operational aspect and a governance aspect to increase value. They show that on average, firms experience increases in total value from the time of the buyout until the acquirer sells the company. These strategies are different from the strategy implemented by a public firm. Therefore the expectation is that the PE firm will (because of these strategies which separates them from public firms) have higher abnormal returns comparing to public companies.

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Percentage stake:

The variable percentage stake will show the effect of the amount of stake bought by the PE firm or public firm on the cumulative abnormal returns. This thesis covers the case when a firm buys a minority stake, so all observations will be below 50%.

Expectation of the variable Percentage stake:

This event study will cover the first phase of a potential acquisition, some PE Firms will decide to buy more shares and eventually acquire the whole firm, and other PE Firms won’t (Slovin, 1993). It is examined if the difference in the stake acquired by PE firm has an

influence on the stock price effect. So it is examined if the stake rises this will have a positive effect on the stock prices and therefore will also rise. Franks (2001) describes the effect of a minority stake greater than 25%. This stake provides a blocking minority which can be used to exert pressure on the management to make certain decisions. The creation of economic value which Jensen (1989) and Guo (2011) describe could have less effect on the stock price when a minority stake is taken in the company. The expectation is that percentage stake bought will have a positive effect on abnormal returns, because of the pressure the PE firm can exert and the creation of economic value Jensen and Guo describe.

Acquisition in own country:

A dummy variable which separates international acquisitions and domestic acquisitions. The dummy variable equals 1 if the acquisition is domestic and equals 0 if the acquisition is international.

Expectation of the variable Acquisition in own country:

As Kaplan (2009) describes that when PE firms are organized around industries (i.e. a large focus on a specific industry), they hire professionals with operating background and industry focus. This should also be the case when the PE firm buys a company in another country. They will hire professionals with knowledge about this industry. The expectation is that this variable will have a very small positive effect.

Announcement date:

Controls for the effect on the difference between minority acquisitions at the beginning of the data (1996) and at the end of the data (2012). The time period of the coëfficient effect is 1,000 days.

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Abnormal returns arise when the market is not fully adapted to certain events. As Ball and Brown (1968) state that capital markets are efficient in a way that the market will adjust prices quickly so there is not any opportunity for abnormal gain in the future. The reputation of PE firms are getting more widely known amongst the investors. If it would be given that there is abnormal return present, this abnormal return should be diminished over time. So the expectation is that the abnormal returns decrease.

Difference between rumor and announcement date:

This variable shows if there is a difference in abnormal returns when the rumor date is before the announcement date and when there is no rumor date. When the rumor date is before the announcement date it is possible that the market can adapt. The time period of the effect is 1,000 days.

Expectation of the variable Difference between rumor and announcement date: When a PE Firm makes an acquisition the stock price will rise in the stage prior to the announcement if it is a result from insiders trading (Wansley, 1983). As Acharya (2010) describes that in the case of absent regulation and all insiders would have the same information this would drive prices immediately to their full information level. When the expectation is that the market responds positively on an acquisition by a PE firm, if the market would have the information on the acquisition before the announcement date this would drive prices to their full information level. Therefore it will lower the abnormal returns, because this stock price change will partly be adapted before the event window.

.

Pre-deal total assets:

This variable shows the effect on abnormal returns regarding the total assets before the deal. The coefficient results being the effect of 1,000,000 euro higher pre-deal assets.

Expectation of the variable Pre-deal total assets:

Guo et al. (2011) give three possible explanations why firms experience increases in total value from the time of the buyout until they sell the company. One of these explanations is operational improvements. If the PE firm can use their assets more efficiently and sell

unproductive assets they could make more profit if the pre-deal total assets are higher. So the expectation is that pre-deal total assets will have a positive effect on abnormal returns, the higher pre-deal value the higher the abnormal returns.

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Deal value compared with assets:

This variable consists of: the assets * percentage stake bought, compared with the deal value. This will examine the effect on the price paid for the percentage stake taken (times total pre-deal assets) and the value of the pre-deal.

\ Expectation of the variable Deal value compared with assets:

Kaplan (2009) describes different causes of the rise in the stock price: the paid premium, negotiation skills and firm specific information. There will be examined if these negotiation skills will have an effect. By taking into account the firms pre-deal total assets, and the

percentage stake bought by the firm compared with the price they paid. If the firm would have good negotiation skills this would be reflected in the price they paid compared to the value of the company. The lower value the PE firm paid in comparison with the percentage stake taken times the assets the higher the negotiation skills and therefore a positive effect on the

abnormal returns.

Value of the deal:

This variable will examine the effect on the abnormal returns if the deal value increases. The result of this variable will represent the effect of a higher deal value. The deal value is in one million euro’s.

Economic crisis:

The effect of the economic crisis on the abnormal returns is examined with the variable Economic crisis. With a dummy variable which amounts 1 if the date is after the economic crisis and which amounts 0 otherwise.

Expectation of the variable Economic crisis:

The investment by a PE firm is highly leveraged (Jensen, 1986). During and after the economic crisis it was harder to get a loan. Ivashina and Scharfstein (2010) show in their paper that new loans fell by 47% during the financial crisis. If it is harder to get a loan, this could affect the PE firms in the amount of available debt, which results in a lower percentage of leverage. High amount of leverage implemented by the PE firm is a large factor which affects the abnormal returns. Therefore the expectation is that the abnormal returns will decrease after the economic crisis.

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EU:

This dummy variable separates the minority acquisitions within the US and the minority acquisitions within the EU. The dummy variable equals 1 when the company is acquired in the EU and 0 when acquired in the US. This variable will show the difference between the cumulative abnormal returns of the minority acquisitions in the US and the EU.

Expectation of the variable EU:

Conyon et al. (2013) examined the difference in CEO payments between the US and the UK. They found that the US CEOs pay was 1.4 times the pay of the CEOs in the UK. Also the equity incentives of the US CEO is 5.5 times greater than the equity incentives of the UK CEO. When the PE firm acquirers a company one of its strategies is the implementation of an incentive plan. Rimmer (2012) describes the incentives the PE firm gives the management as the distinguishing factor. The PE firm demands management to buy in to long term

compensation arrangements. When there is a difference as Conyon et al. (2013) stated the expectation of a higher equity compensation (CEO and management benefit from stock price increase) will result in higher incentives to exert more effort. Therefore the expectation will be that the incentives given by the PE firm will have a higher effect in the EU than in the US. Because the US is already used to the equity incentives, 5.5 times greater equity incentives than in the UK.

3.) Hypothesis

The CAR will be calculated with the use of Formula 3, 4 and 5. The results will be tested on their significance using the one sample t-test. The actual and abnormal returns (from both the PE firm and comparable (public) firm) will be tested if the mean is different from zero. The test will cover the significance of the abnormal returns over the 2 month period (t – 30, t + 30). If there are no abnormal returns, the expected cumulative price change over this period will be zero.

The first hypothesis will be:

H0: E = 0 vs H1: E ≠ 0

Secondly there will be investigated if the abnormal returns of companies where a PE firm bought a minority stake differ from the abnormal returns where a public firm bought a minority stake. Second hypothesis will be:

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Results

Regression 1:

CAR CAR CAR CAR CAR CAR CAR CAR CAR PE-firm .206** .143 .122 .096 .099 .180** .198** .206*** .208*** (.104) (.102) (.105) (.106) (.106) (.074) (.078) (.077) (.078) Stake .009** .009** .009** .008** .000 .001 –.001 .000 (.004) (.004) (.004) (.004) (.003) (.003) (.003) (.003) Own country .102 .101 .104 –.017 –.025 –.044 –.045 (.107) (.108) (.110) (.076) (.077) (.078) (.078) Date –.019 –.018 –.074**–.075** –.074** –.052 (.046) (.047) (.035) (.035) (.035) (.069) Difference between .092 –.015 –.032 –.208 –.158 ann. and rum. Date (.633) (.406) (.408) (.427) (.450) Pre-deal total assets .001 .003 –.007 –.007 (.001) (.004) (.008) (.008) Deal value compared –.055 .141 .141 with assets (.075) (.164) (.164) Deal value .158 .155 (.117) (.118) Economic crisis –.052 (.141) Constant .085 –.061 –.085 .685 .641 2.957** 2.971** 2.912** 2.076 (.073) (.094) (.098) (1.832) (1.867) (1.396) (1.401) (1.394) (2.652) N 106 106 106 106 106 86 86 86 86 .016 .068 .076 .078 .078 .109 .115 .135 .137 Adjusted .007 .050 .049 .041 .032 .041 .036 .045 .035 Note: *, **, and *** indicate statistical signiﬁcance at the 10, 5, and 1 percent levels, respectively.

The results from Regression 1 between CAR and PE firm (dummy variable) are a constant of .085 and a coefficient of .206. When the PE firm buys a minority stake the abnormal returns of the company are .206% higher than the abnormal returns of the public firm. In both cases the abnormal return is positive. These abnormal returns are predicted

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within the two months of the event window, one month prior to the announcement till one month after the announcement. So in order to make this abnormal profit by investing in a public or PE firm, the investor needs to invest one month before the announcement date and hold his investment for two months.

Regression results also show a positive coefficient at the stake variable of .009 significantly different from zero. When the PE firm buys 5% stake this model predicts an abnormal return (within two months, one prior and one after the announcement) of –.061 (constant) + .143 (PE firm) + .009 * 5 (percentage stake) = .127% per day. But when the PE firm buys 50% stake (4 of 53 acquisitions were above 45%) the model predicts an abnormal return of –.061 + .143 + .009 * 50 = .532% per day (within the event window, 2 months). This is a difference of .405% per day.

When a firm buys a minority stake in his own country, so the acquirer and the target are from the same country, then the abnormal return is .102% higher. This is the case when there are three control variables: PE firm, percentage stake and own country. When there are more control variables this effect becomes negative. This effect is not significantly different from zero.

To examine if there is a difference between the abnormal returns at firms in an early stage of this investigation (which is from 1996-2013) and firms at a later stage. The variable date is added, this coefficient is not significantly different from zero and very small. To give an indication, the coefficient is –.019 this is a decrease in abnormal returns of –.019% in 1,000 days. So the regression predicts a decrease in abnormal returns of –.069% in a period of ten years.

The effect of a rumor date before the announcement date is indicated by the coefficient of ‘difference between announcement date and rumor date’. When the rumor date is before the announcement date, the market could adjust to new information. This effect on the abnormal returns is tested. Results show that if the rumor date is 1,000 days before the announcement date the abnormal returns increase with .092%. So when the rumor date is three months before the announcement date the prediction is that the abnormal return should increase with .008%.

The variable pre-deal total assets control for the effect the assets of the target firm have on the abnormal returns. The coefficient of the control variable differs from positive to negative. These results are not significantly different from zero.

The effect of the ability of the PE firm to negotiate a better price is examined by the control variable: ‘deal value compared with assets’. So when the PE firm buys the minority

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stake for more than the percentage stake * the total value of the assets, it will have a negative effect on the abnormal returns of –.084%.

The effect of the economic crisis is not significantly different from zero. It’s coefficient is –.052, this means that the abnormal returns are decreased after the economic crisis with –.052% per day.

The highest is when all the variables are added, this is because when we add a variable which is different from zero this will cause a rise in the . If the adjusted is used as an indication on what regression explains the most of the variation in the abnormal returns. The adjusted is the highest (adjusted = .05) after the two control variables: PE firm and percentage stake, these variables are the only control variables which are significantly

different from zero.

In Regression 2 the variable EU is added. This results in a higher adjusted (.112), when compared with Regression 1 this adjusted of .112 is the highest of all measured values of adjusted .

Regression 2:

CAR CAR CAR CAR CAR CAR

PE-firm .206** .143 .084 .087 .082 .080 (.104) (.102) (.099) (.099) (.103) (.104) Stake .009** .008** .007* .007 .007 (.004) (.004) (.004) (.004) (.004) EU –.543*** –.559*** –.547*** –.547*** (.190) (.191) (.199) (.200) Date –.034 –.034 –.042 (.045) (.045) (.082) Own country .024 .026 (.108) (.109) Na crisis .023 (.184) Constant .085 -.061 .489** 1.868 1.831 2.158 (.073) (.094) (.213) (1.808) (1.824) (3.188) N 106 106 106 106 106 106 .016 .068 .137 .142 .142 .142 Adjusted .007 .050 .112 .108 .099 .091

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Note: *, **, and *** indicate statistical signiﬁcance at the 10, 5, and 1 percent levels, respectively.

The first two variables are of the same value as in Regression 1, PE firm .206 and percentage stake .009. Both significantly different from zero.

The variable added in Regression 2, EU has a coëfficient of –.543, significantly different from zero. This means that a company acquired by a PE or public firm in the EU has on average a lower CAR of –.543% per day. This can partly be explained by the largest abnormal return within the comparable firms of 3.94% which belongs to the US. And the second largest abnormal return within the PE firms of 1.27% also belonging to the US. These high abnormal returns increases the prediction of the abnormal return within the US and therefore it shows a large negative coëfficient on the variable EU. The adjusted is the highest when the variables: PE firm, percentage stake and EU are added. This results in a adjusted of .112.

The variables date, with a coëfficient of –.034 and own country, with a coëfficient of .024 are both not sicnificantly different from zero. The variable own country increases in

Regression 1 the adjusted but in Regression 2 it has a negative effect on the adjusted .

Regression 3 will examine the different abnormal returns within the 14 countries from

the sample. The Netherlands is omitted from the regression, the abnormal returns showed in

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- 25 - Regression 3: CAR PE firm .025 (.108) Stake .010** (.004) Spain .132 (.223) Belgium .086 (.291) Canada .875 (.548) Germany .018 (.192) Denmark .021 (.268) Finland –.101 (.382) France –.058 (.176) Great Brittain .029 (.233) Greece –.747** (.334) Ireland –.305 (.529) Portugal –.601 (.349) Sweden .189 (.523) United States .461** (.231) Constant –.042 (.157) N 106 .254 Adjusted .129

Note: *, **, and *** indicate statistical signiﬁcance at the 10, 5, and 1 percent levels, respectively.

Regression 3 has the highest adjusted of Regression 1, Regression 2 and Regression 3. Canada has the highest abnormal return. Compared with the Netherlands it has an abnormal return of .875%, folowed by the United States with an abnormal return of .461%. The

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abnormal return of the United States and Greece are significantly different from zero. The dummy variable PE firm is in Regression 3 not significantly different from zero, but percentage stake is significantly different from zero. Regression 2 showed that the US has higher abnormal returns than the EU as a whole, Regression 3 shows that the US has higher abnormal returns than every European country individualy.

The Netherlands has higher abnormal returns than 5 countries from the European Union and lower abnormal returns than 6 countries from the European Union. Germany, Denmark and Great Brittain show almost the same abnormal returns as The Netherlands with a difference of .18 (Germany) .21(Denmark) and .29 (Great Brittain). The countries which have the lowest abnormal returns are Greece (–.747) and Portugal (–.601), the coefficient of Greece is significantly different from zero.

Conclusion

The abnormal returns of PE firms are significantly different from zero, these returns are during the event window higher than the expected market returns and higher than the abnormal returns of the comparable firms where a public company takes a minority stake. This means that it is on average profitable to invest in a company where a PE firm will buy a minority stake in one month time, and to hold this investment for the period of two months. The percentage stake bought by the PE firm has an influence on the percentage of the abnormal returns, the higher the percentage stake bought by the PE firm the higher the abnormal returns.

It is on average profitable to invest in a company where a PE firm will buy a minority stake in one month time, but not always, 33.9% have negative abnormal returns. If the investor would invest (during the event window) in all the 53 companies where the PE firm bought a minority stake it would make an abnormal profit of 12.1%.

This investigation shows the effect of a minority stake taken by PE and public firms. Results show that there is a significant effect. There is enough evidence to conclude that PE firms outperform public firms when they take a minority stake. The strategies that the PE firm implements at an acquisition has not only effect on a majority acquisition but also on minority acquisition. This effect on abnormal returns is dependent on the percentage stake taken by the PE firm, the higher the percentage stake bought by the PE firm the higher the predicted abnormal returns. Whether the PE firm acquirers a company within its own country or within a foreign country has no significant effect on the abnormal returns. What does have a

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significant effect on abnormal returns is the location of the target company difference in the US or in the EU. A company acquired in the EU has on average a lower abnormal return of – .543, which is significantly different from zero. Between the different countries from the sample there are high differences in abnormal returns, it varies between –.747 (Greece) and .875 (Canada). These abnormal returns are the difference between the abnormal returns measured in that country compared with the abnormal returns measured in The Netherlands.

This investigation has proven that there is an effect on abnormal returns when a PE firm has taken a minority stake within a company. This abnormal return is significantly different from zero and can be on average cumulate till 12.7% abnormal returns within two months. It is also proven that PE firms do differ in their ability to increase firm value compared to public firms. they outperform public firms who acquired a minority interest by .206% per day. The fact that the strategies performed by the PE firms have an influence on firm value when they acquire a minority stake was already recognized. Now there is also proof that there is enough evidence these strategies also work in case of a minority acquisition.

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Appendix

Higher abnormal returns in the case of a minority acquisition by a private equity firm compared to a minority acquisition by a public firm