Club Deals in the European Buyout Market
A multiple analysis on the consequences of the
formation of consortiums on buyout prices
Club Deals in the European Buyout Market
A multiple analysis on the consequences of the
formation of consortiums on buyout prices
Abstract
We investigate whether clubs pay different prices than sole sponsor deals in the European buyout market. So far, the existing empirical research is inconclusive and predominantly focuses on the US. We analyze two samples, one with 346 EBITDA- and one with 559 sales multiples, that consists of European buyouts that were announced between 1998 and 2008. The results from our EBITDA sample are insignificant and inconclusive. More importantly, from the larger sales multiple we learn that clubs, although they may look questionable on the surface, pay significantly higher prices than sole sponsor deals. In addition, we find that renowned private equity firms pay higher prices, also in clubs. Finally, we observe that prices in the buyout market increased from 2006 onward, the year private equity came under media-and government scrutiny. Our findings do not justify the resistance documented in financial media and academic literature (Officer, 2008) against club deals.
Pieter Everard
pietereverard@gmail.com
Student number: 1322338
JEL codes: G14, G24, G34
Preface
First and foremost, this paper is an academic study which aims to fill an existing gap in the literature on European buyouts. Besides that, it will be beneficial to managers and shareholders of European companies that are contemplating a buyout by a club of private equity firms.
There are a number of people that are specifically worth mentioning for their help in the realization of this thesis. First of all, I would like to thank mr. H. Gonenc for his patient supervision and advice. He helped me to maintain an academic perspective and provided me with very helpful comments. In addition, I extent profound gratitude to the M&A group of Credit Suisse in London. They helped me gain a practical perspective, which was especially helpful for my multiple analyses. Aside from that, they provided me access to databases I could otherwise have never used. Without these professional databases I would have not been able to conduct an investigation into a field as private and concealed as private equity. Last but not least I would like to thank my family, friends and girlfriend for their continued support.
List of Tables and Figures
Tables
Table 1. Relevant research on buyouts and private equity……….18
Table 2. Previous literature on club deals ... 27
Table 3. Previous literature on syndication in the venture capital (VC) industry ... 28
Table 4. Time-series distribution of our sample of buyouts ... 36
Table 5. Distribution according to country, industry and buyout fund ... 37
Table 6. Descriptive statistics of transactions ... 38
Table 7. Descriptive statistics of premiums ... 39
Table 8. Median comparison for club- and sole sponsor multiples ... 45
Table 9. Median comparison for club- and sole sponsor premiums ... 46
Table 10.OLS regression results – EBITDA (M&A Monitor) ... 50
Table 11. OLS regression results – EBITDA (LCD Comps) ... 51
Table 12. OLS regression results – Sales (M&A Monitor) ... 52
Table 13. Overview of hypothesis, expected signs and results ... 53
Figures
Figure 1. Number and total transaction value of non-US leveraged buyouts ... 11Figure 2. Number of completed P2P transactions of European and US targets ... 12
Table of Content
List of Tables and Figures ... 3
Tables ... 4
Figures ... 4
Table of Content ... 5
1. Introduction ... 7
2. Literature review ... 10
2.1 The buyout market... 10
2.1.1. Historical developments ... 10
2.1.2. Different forms of buyouts ... 13
2.1.3. Reason d’être ... 14
2.1.4. Buyout Pricing ... 15
2.1.5. Empirical evidence on buyouts ... 18
2.2. Club deals ... 19
2.2.1. Historical developments ... 19
2.2.2. Club deal characteristics ... 19
2.2.3 Reason d’être ... 21
2.2.4. Competitive pressure ... 24
2.2.5. Joint bidding ... 26
2.2.6. Empirical evidence on effects of club deals ... 27
2.3. Hypotheses ... 29
2.3.1. Pricing in club deals ... 29
2.3.2. Deal flow ... 30 2.3.3. Media spotlight ... 30 2.3.4. Top 10 PE firms ... 31 3. Data ... 33 3.1. The sample ... 33 3.2. Descriptive statistics ... 35 4. Methodology ... 39
4.1. Comparable industry transaction method ... 39
4.2. Industry adjustments... 41
4.3. Mean and Median comparison ... 43
5. Results ... 44
5.1. Deal Size ... 44
5.2. Mean and Median Comparison ... 45
5.2.1 Industry Adjustments ... 45
5.3. Regression analysis ... 46
5.4. Discussion of results ... 53
6. Conclusion ... 56
6.1 Conclusion and reflection ... 56
6.2 Limitations and recommendations ... 57
1. Introduction
“As long as two girls show up to the dance, there's enough competition.”1
This is a quote of a banker who gave his sophisticated view on whether the formation of clubs was a threat for the competition in the buyout market. The goal of this paper is twofold. First, we investigate the effect of “clubbing” on buyout prices, measured in two metrics: EBITDA2 and sales multiples. Second, we attempt to discover how reputation and deal flow influence the premium paid in club deals and whether the premiums changed from 2006 onward, when private equity and club deals in particular, received substantial media attention. When multiple private equity firms make a bid for a company as a consortium, we define this as a club deal. Club deals are a relative new, but already extraordinarily popular, phenomenon in the buyout market. So far the empirical research is not conclusive on its consequences and predominantly focuses on the US. Aside from filling the research gap on club deals, our findings have practical implications for European shareholders and managers that are contemplating a buyout.
The quoted text below comes from a New York Times article that was published after the Department of Justice sent letters to the biggest private equity firms seeking information on their, potentially anti competitive, bidding practices in club deals. It illustrates some of the resistance there is against club deals.
Two rival leveraged buyout firms make bids for the same company. At the 11th hour, one firm drops out of the auction, unwilling to pay more. The remaining buyout firm is declared the winner. A month later, another company is put up for sale — only this time the two firms that had just been fierce competitors have teamed up to bid together for it. Friendly competition? Or collusion?3
There are several reasons why firms “join a club”. First of all, it allows private equity firms to diversify their risk and spread their capital across a greater number of investments. Secondly, the combination of additional analytical skills and specific knowledge in particular industries are resources from which the consortium may benefit in the form of superior selection and management of investments. Thirdly, by combining their financial resources buyout firms can target bigger companies and nowadays names as British Telecom and Vodafone are no longer seen as “untouchables” for buyout firms. Fourthly, there is the “deal flow” argument. Investors, and also buyout funds always like to be in a position where they can choose from as many deals as possible. If they involve another
1
Sorking, A.R.: “One Word Nobody Dares to Speak”, NY Times, 16 October, 2005
2 EBITDA is the abbreviation of Earnings Before Interest, Taxes, Depreciation and Amortization 3
buyout firm in one of their deals, they expect to be reciprocated down the line, i.e. joining a club will increase the number of deals in the future. The final argument is one which buyout firm managers will deny, namely that club deals prevent costly bidding wars and thus restrict competition in the buyout market. The first four arguments tend to push transaction prices upward, the latter artificially depresses it.
As we said, club deals have become increasingly popular during the last decade. The topicality is supported by the publication dates of the papers on club deals, which are all exceptionally recent. The existing empirical literature is inconclusive on the consequences of clubbing on buyout prices. Officer, Ozbas and Sensoy (2008) find that target shareholders receive roughly 10% less in club deals. Boone and Mulherin (2008) on the other hand, find no evidence that the formation of consortiums by private equity bidders facilitates collusion in the corporate buyout market. Axelson, Jenkinson, Stromberg and Weisbach (2007) and Cao (2008) find the formation of a club can facilitate even higher bids. All in all, the evidence is inconclusive and the research designs and data sets differ substantially. In addition, these studies all have a different geographical context, since they focus on the US. This study distinguishes itself from previous research in three ways: its focus on Europe, the fact that we use interaction variables to examine the influence of reputation, deal flow and media attention on prices and finally the two exclusive proxies for matching industry portfolio’s, which make our findings more robust.
This research will be conducted in three main steps. At first, we establish portfolios with comparable transactions, matched per industry and year. This method, which is called the “industry comparable transaction method” (Kaplan and Ruback, 1995), allows us to calculate a premium4 for every transaction. Secondly, we test whether clubs and sole sponsor deals pay different premiums by means of a Mann-Whitney U tests and an OLS regression analyses, since the latter allows us to control size and industry effects. Thirdly, we propose factors, such as reputation, degree of acquisitiveness, and media attention and test if they explain the prices paid in club deals and the buyout market in general. The transactions in our sample are identified by Dealogic and Mergermarket. We analyze the EBITDA and sales multiples of respectively 346 and 559 deals, of which the target are located in Europe and the deal is announced between January 1998 and June 2008.
First of all, we find highly significant support for the argument that buyout firms team up in order to pool their financial resources and acquire larger targets. Second, and more importantly, we find that clubs pay higher prices than sole sponsor deals. The results from our EBITDA multiple sample are inconclusive and therefore our focus shifts to the larger sales multiple sample. The evidence we find is positive and highly significant. In addition we find strong evidence that prominent private equity firms
4 In this paper we interpreted premium as the percentage difference of the transaction multiple relative to the
pay higher prices than ‘normal’ firms. Taking this effect into account by means of interaction variables, we also find marginal statistical evidence that renowned buyout firms pay more in club deals. Thirdly, we find that prices in the buyout market increased from 2006 onward, the year private equity came under media/government scrutiny. Finally, we find no empirical evidence that highly acquisitive firms pay more in club deals.
2. Literature review
This chapter is divided into two sections. To fully understand the rationale behind a club deal we think it is vital to understand the buyout market in general. The first section sheds light on the historical developments and various characteristics of the buyout market and ends with an overview of empirical research conducted on this matter. This should provide a solid foundation to further explore the characteristics and theory behind club deals, which is done in section 2.
2.1 The buyout market
2.1.1. Historical developments
To better understand today’s buyout market it is essential to know how this market evolved over the last decades. Over the last two decades the buyout market has grown at an unprecedented rate and private equity received substantial media attention. In 1990 Barbarians at the Gate was published, which told the story about the iconic $31 billion leveraged buyout of RJR Nabisco orchestrated by Kohlberg Kravis and Roberts (KKR) in 1989. The last couple of years the press coverage has been predominantly skeptical, especially in continental Europe where financial sponsors were labeled “locusts” trying to take advantage of public investors. In 2004 The economist proclaimed the leaders of the private equity industry as “the new kings of capitalism” and compared their rapid growth in size, power and reputation with that of the kingdom of Louis XIV. Stromberg (2007) estimates that the value of firms acquired in leveraged buyouts between 1970 and 2007 to a total of $3.6 trillion, of which three-quarters is undertaken after 2000. Kaplan and Stromberg (2008), using CapitalIQ as their source, find 17,171 private equity sponsored buyouts between 1970 and 2007. From January 2005 through June 2007, CapitalIQ recorded a total of 5,188 buyouts with a combined enterprise value of $1.6 trillion5 Those 2.5 years account for 30% of the transaction between 1984 and 2007 and 43% of the total real value of these transactions. The negative skew of the distribution of buyouts, i.e. the fact that the mass of the distribution is concentrated in the past few years, illustrates its current popularity. The rise of buyout transaction was neither a linear nor an exponential function, but occurred in waves. These recurring boom and bust cycles are related to past returns and the level of interest rates relative to earnings. (Kaplan et al., 2008) The first buyout wave emerged as an important phenomenon in the 80s, largely driven by innovative use of debt which enhanced the buying power of buyout firms. Cheffins and Armour (2007) explain how high-yield, low grade paper christened “junk bonds” were rarely used to finance buyouts during the first half of the 1980s, but were used in a majority of such deals in the remainder to the decade. Increased regulation and the crash in the bond market, following
5
the demise of the investment bank Drexel Burnham Lambert, let to a large number of high profile LBOs that resulted in default and bankruptcy. Leveraged buyouts activity was lower in the early 1990’s, but picked up in the late 90s and after a short dip in transaction volume in 2002 after the internet bubble, continued to grow.
Axelson et al. (2008) show that deal volume has grown significantly in the last decade. In 2006 buyout transactions totaled around $233 billion in the US and $151 billion in Europe. Eckbo and Thornburn (2008) postulate that LBO volume outside the United States reached a record high in 2007 with a total deal value of $289 billion across 1,200 transactions, which is depicted in Figure 1.
Figure 1: Number (line) and total transaction value (bars) of non-US leveraged buyouts
Source: SDC
The current credit crisis has put a stop to the third buyout wave. The credit crunch increased the cost of borrowing and tightened the covenants for new loans. Private equity firms are unable to secure the financing for their transactions and even previously announced buyouts had to be cancelled. Private equity will focus on smaller targets, since these are financed more easily. This might put the surge in club deals on hold, since smaller targets can be financed individually more easily, assuming the size argument is a validone. The future will learn us whether or not this is the case.
there are fewer opportunities for restructuring”6. Differences like this might have implications on the pricing of deals in Europe. Barachdi (2008) focuses on competition policy in the European buyout market and also draws upon the importance of future research in the field of price fixing and collusion in this market. Axelson et al. (2007) find that US deals are on average priced higher than European. The method they employ to investigate pricing is similar to the one we use in our empirical research. Finally, a very notable difference between the US and the European buyout market is the size of the deals. Although Europe is catching up, acquisitions like the Equity Offices Properties Trust by Blackstone ($39 billion) and TXU Corp ($45 billion) only appear to happen on the other side of the ocean. Hypothetically, the need for pooling financial resources could be less profound in Europe, thereby weakening the ‘size argument’7 to form a club in Europe. The graph depicted below shows how public-to-private transactions evolved in the US and Europe and supports the view of dissimilarities between the two continents. In summary, it is shortsighted to conclude that European and US buyout markets are the same and that US academic literature is wholly applicable to the European buyout market. To our knowledge, this study is the first to empirically examine club deals in the European buyout market and thereby fills the research gap.
Figure 2: Number of completed public to private transactions of European and US targets
Source: Thomson Banker One
The differences within Europe fall within the scope of this research since they may affect the pricing of (club) deals. Therefore some attention is given to this topic in the section below. Wright, Renneboog, Simons and Scholes (2006) have compared the different buyout markets within Europe. The key differences stem from disparities in the maturity of the market, something that varies
6
International Herald Tribune, September 29, 2005
7 The ‘size argument’ is further explained in Section 2.2.3. Basically it implies that by combining financial
markedly. One widespread indicator used to indicate the maturity of the market is the ratio of the value of buyout transactions to the country’s GDP. In 2004 the U.K. and the Netherlands have the largest buyout markets, representing about 1.5% of their GDP. The France and the German markets appear to be about half their size. Spain and Italy have relatively under developed buyout markets. The authors explain the varying maturities by differences in terms of supply of buyout opportunities, in attitude toward entrepreneurial risk, willingness of managers to do a buyout, the infrastructure for doing deals and cross-country differences in (deal) exit routes. It is clear that the amount of LBO activity varies between countries in Europe, but as far as we know no research has been conducted on the relation between maturity and pricing.
2.1.2. Different forms of buyouts
Before we shed light on buyouts, we feel the need to further define private equity in general. Private equity comprises both buyouts and venture capital. The leveraged buyout investment firm today refer to themselves (and are generally referred to) as private equity firms. In a typical leveraged buyout, the private equity firm buys a majority of an existing and mature firm. (Kaplan et al., 2008). This is where buyouts differ from venture capital, which typically invests in young or emerging companies, and not always obtains majority control. In this dissertation we focus on private equity firms, the consortia they form and the leveraged buyouts in which they invest.
We distinguish two different forms of buyouts, namely management buyouts (MBOs) and leveraged buyouts (LBO’S). Eckbo et al. (2008) give a clear description of a leveraged buyout, namely the acquisition of an entire company or division, financed primarily with debt. The financial sponsor relies on the company’s cash flow, often supplemented by asset sales, to service the debt. The objective is to improve operating efficiency and grow revenues on average during a 3 to 5 year time span, before divesting the firm. Debt is paid down over time and all excess returns accrue to the equity holders. The exit may be in the form of an IPO, a sale to a strategic buyer, or a sale to another LBO fund. Due to its heavy debt load, the target firm is traditionally characterized by a strong predictable cash flow, supported by a history of profitability, operates in a mature industry with low growth and has limited need for additional capital expenditures. However, the recent popularity of buyouts and the fact that too much money is chasing too few deals may result in firms that lack the characteristics mentioned above to become a buyout target. Kaplan et al. (2008) define a leveraged buyout as followed: “A company is acquired by a specialized investment firm using a small portion of equity and a relatively large portion of outside debt financing”. Palepu (1990) states what the fundamental differences are with a typical public corporation, namely high leverage, large management ownership, active corporate governance, and loss of investors’ access to liquid public equity markets.
generally smaller than traditional LBOs and, depending on the size of the transaction, a sponsor need to be involved.
Since club deals seem to occur in both leveraged and management buyouts, we include both in our research.
2.1.3. Reason d’être
According to Stehpen Schwarzman, co-founder of Blackstone8, “public markets are overrated” and regulation is “the brake on American public companies” that is leading to a “going out of business sale” for public corporations.9 It is not surprising that the founder of one of the biggest private equity funds proclaims the success of buyouts of public companies, but two decades ago there was already academic research forecasting this trend. Jensen (1989) predicted, in an article called “The Eclipse of the Public Corporation” that the leveraged buyout organizations would eventually become the dominant corporate organizational form. His pronouncement proved to be premature, but the current wave of buyout activity has revived speculation that the publicly quoted company could be largely marginalized in the not too-distant future.
His argument is that the public firm is subject to agency cost because the interests of management and shareholders are not perfectly aligned. Public companies tend to be owned by a large number of dispersed shareholders and managed and controlled by executive teams who often have little ownership. As a result, an inherent conflict arises between shareholders whose interests lie in maximizing the company’s value and managers who may seek other benefits, such as long-term control, country club memberships, private jets and a bigger (but perhaps less profitable) business empire. (Haardmeyer, 2008). Linking ownership with control and having a large, active, and highly interested investor in the boardroom are defining characteristics of private-equity firms and important ingredients to solving the governance problem.
In 1986 Michael Jensen draws upon the fact that LBOs are especially well suited to suppress the temptation that free cash flow creates, something he calls “agency cost of free cash flow”. The large amount of debt on a company’s balance sheet, usually after a buyout, entails a legal contractual obligation for the firm to pay it down. Forced to make debt repayments, management must quickly gain strategic clarity, focus on its core business, increase revenues and improve operating margins. In other words, less surplus cash available means fewer resources to waste and to divert management’s attention from its main goal, value creation.
8 According to PEI 50 2008 Blackstone is the 10th biggest PE fund, measured by capital raised over the last 5
years
9 Guerrera, F. and Politi, J.:(2007): “Reason to Believe? What may Underlie Blackstone’s New-Found Faith in
Besides aligning incentives, attracting the right managerial talent, making operational changes and optimizing the capital structure, is having a “value maximizing board” (Gertner and Kaplan, 1996). Significant ownership interests, industry expertise, and intimate involvement are critical in driving the governance transformation that public companies undergo when they are taken private.
Klein and Zur (2006) and Kahan and Rock (2007) examine the restrictions and regulations of the public markets. They identify various restrictions on mutual funds limiting their ability and incentives to scrutinize portfolio companies closely and explaining why they do not play a more active role in monitoring the managers of public companies. The argument above explains the phenomenon from an investor’s objective, but increased regulations have impact on performance from a managerial perspective too. Managers are increasingly concerned with obeying to rules and regulations, looking at compliance issues and informing their shareholders, business analysts and financial media, which can draw their attention away from focusing solely on value creation.10 This situation in the public market is ironic, given that most rules and regulations are meant to diminish corporate governance abuse and protect shareholders, but at the same time make the public markets less attractive in the eyes of many investors.
Colvin and Charam’s (2006) view on private equity captures most of the arguments we presented above. “Here's what private equity firms have figured out how to do: Attract and keep the world’s best managers, focus them extraordinarily well, provide strong incentives, free them from distractions, give them all the help they can use and let them do what they can do. No wonder these companies tend to be outstanding performers.”
Above we tried to give a concise explanation on why buyouts occur, which should provide a foundation for helping understand club deals and their impact on transaction prices. In the next section we look a LBO transaction prices in general.
2.1.4. Buyout Pricing
As the purpose of this empirical investigation is to find out whether acquisition multiples differ for individual buyouts and club deals, it is imperative to understand how buyouts are priced in general.
Multiples
The methodology we use in this paper is the “comparable industry transaction method”, described in Kaplan et al. (1995) and further explained in section 3. In short, in this method a ratio or a multiple of
10 According to management gurus Colvin and Charan (2006) a public-company CEO is lucky if he spends 60%
value (EV) relative to a performance (EBITDA/Revenues) is calculated for a set of comparable firms. We will shed some light on the various company and industry specific factors influencing this multiple in section 3.
Eckbo et al. (2008) show a chart with average price multiples in LBOs, defined as a ratio of the purchase price to the adjusted EBITDA11, for the period 1997 – 2007. This bar chart is depicted in Figure 3. They show that average prices have risen from a relatively low average multiple of 6.4 in 2001 to a high of 9.8 in 2007. Besides the various company and industry specific characteristics that influence the “multiples” paid in these transactions, there are macro economic factors, such as interest and inflation that affect them. Kaplan and Stein (1993) provide evidence that the booming junk bond market of the late 1980s contributed to higher transaction prices in the buyout market. The credit crunch of 2008 has cogently tampered down private equity activity and it will surely have a downward pressure on transactions multiples. Axelson et al. (2007) document the financial structure of 153 large U.S. and European buyouts between 1985 and 2006. They find that the leverage of LBO firms is unrelated to debt levels of size- and industry-matched public firms. Besides that they find that the economy-wide cost of borrowing seems to drive both leverage and pricing in buyouts. These results are consistent with the view that the availability of financing impacts booms and busts in the private equity market
Figure 3: EV/EBITDA multiples paid by buyout firms, 1997 – 2007
Source: Eckbo et al. (2008)
11 When adjustments for non operating income and expenses are made the EBITDA of the operating company
Therefore, LBO capital structures are largely driven by the economy-wide cost of borrowing rather than firm specific factors. After controlling for other factors that potentially affect the pricing of a deal, they find a strong relation between leverage and the acquisition price. Besides leverages they dedicate part of their research to the pricing of LBOs, which is of interest for our research. They find that public-to-private and independent private deals have the highest valuation, relative to EBITDA and that US deals are on average higher than European transactions. They also find a strong positive relation between pricing in buyouts and in public firms within the same industry, time-period and geographical area.
A different methodology used to compare acquisition prices of LBOs and strategic buyers is based on CARs and buyout premiums.
Takeover Premiums and Cumulative (Average) Abnormal Returns
The value created in a buyout can be split into two parts: the takeover premium, which accrues to the target’s shareholders and the return for the LBO investor. The premium is defined as the final offer price in excess of the target stock price and can be measured in a different time spans prior to, or after, the announcement of the bid. The shareholder wealth effect can be measured by calculating the abnormal returns of a company’s stock during the days surrounding the announcement of the buyout. These risk-adjusted share price movements provide a determination of the wealth gains to the pre-transaction shareholders. These returns are referred to as cumulative abnormal returns (CAR), or cumulative abnormal returns (CAAR). The returns captured by the LBO investor, something we do not touch upon in this research, are usually expressed as the internal rate of return (IRR). Examining whether this buyout performance metric differs between club and sole sponsor acquisition is something interesting for future research.
buyouts. Our research focuses on both public and private targets and due to a lack of market data we do not investigate differences in CARs for club deals and sole sponsor acquisitions. However, we do think this could provide interesting insight in the pricing of club deals and therefore future research should prove if this method confirms our findings.
2.1.5. Empirical evidence on buyouts
It is beyond the scope of this research to state all results of studies conducted on the buyout matter. However, to provide the best possible foundation for the second part of our literature review, that about club deals, we show a table with most relevant research in the field of buyouts.
Table 1. Relevant research on buyouts and Private Equity
Authors Results
Jensen (1986) Interests and incentives of managers and shareholders conflict over issues like the optimal size of the firm and payment of cash to shareholders. These conflicts are most severe firms with large free cash flows – more cash than profitable investment opportunities. He constructs the famous “Free Cash Flow (FCF) Hypothesis”
Jensen (1989) LBO would become most dominant corporate organizational form. He argues that PE combines concentrated ownership stakes in its portfolio companies, high-powered incentives for the private equity firm professionals, and a lean, efficient organization with minimal overhead costs. These structures are superior to those of the typical public corporation with dispersed shareholders, low leverage, and weak corporate governance
Authors Data Method Results
DeAngelo, DeAngelo 81 going private Single factor market Going private transactions do not and Rice (1984) transaction between model, market factor - result in expropriation of wealth
1973-1980 and comparison from target shareholders period approach
Kaplan and 124 MBOs between EBITDA/EV Price to CF ratio rose, principal Stein (1989) 1980-1989 and NCF/EV repayments accelerated, subordi-
Source: SDC multiples nated debt replaced by junk debt.
The LBO market is overheating. Bargeron, Stulz, Acquisition between Cumulative Shareholders receive (55%) more Schlingemann 1995-2005 in the US. abnormal returns when public vs. private firms and Zutter (2007 Source: SDC (CAR) make a bid. Influenced by
managerial ownership of bidder Kaplan and Fund performance IRR calculation Avrg. fund returns (net of fees) Schoar (2005) between 1980-2001 and comparison are equal to S&P500 returns.
Source: Venture Better performing funds raise
Economics (VE) more follow on funds.
Kaplan and Empirical Review of Since PE creates value, PE has Stromberg (2008) evidence available permanent component. Will keep
In Table 1 we separated Jensen’s research from the rest, since we consider Jensen’s research to be the underlying rationale for buyouts in general and therefore key to devote some additional attention to.
2.2. Club deals
Now that we discussed private equity in general; we will shed more light on the main topic of our dissertation, club deals. We define club deal as follows; Two or more private equity firms that jointly conduct a buyout. In this section we look at various characteristics of club deals and summarize the academic literature conducted on this topic.
2.2.1. Historical developments
The last decade we not only experienced a significant increase in buyout activity, but aside from this we saw the club deal become an increasingly popular way to conduct a buyout. Boone et al. (2008) investigated the effect of private equity consortiums on takeover competition in the UK. They found that the fraction of winning bids by private equity firms has risen five-fold, from 6 percent to 30 percent of corporate takeovers. Much of this increase has been driven by the growing incidence of takeovers in which the winning bidder is two or more private equity firms, bidding jointly as a consortium. A statistic that illustrates the surge in club deals comes from Officer et al. (2008). They gathered their US transaction dataset from SDC from 1984 until 2007. In their sample 37 out of 59 club deals occur between 2004 and 2007, which equals 62.7%. Axelson et al. (2008) use a dataset where 31% of the buyouts between 1985 and 2006 can be classified as a club deal. Of these club deals 50% occurred between 2002 and 2006, showing their topicality.
Despite its popularity club deals are currently under scrutiny. In 2006, the Department of Justice wrote to five major private equity firms asking them for information as part of an investigation into whether such alliances constitute unlawful collusion to hold down acquisition prices.
2.2.2. Club deal characteristics
Differences in acquisition multiples in club deals and sole sponsor buyouts might stem from the fact that they seek to acquire different types of firms. Ideally we control for as many target characteristics as possible, but due to the private nature of private equity we were unable to obtain most of this information. Below, we discuss various characteristics of club deal targets and what is documented on them in academic literature.
Size
members in the four year window centered on the club deal announcement date. Moreover, club deals do not appear systematically riskier than targets of individual deals. Boone et al. (2008) also find that the target values for private equity consortiums are above average. If a target is too big to acquire on a standalone basis, either because of capital constraints or the private equity firms portfolio would become underdiversified, this induces buyout firms to team up with each other in order to close the acquisition. We test whether clubs acquire larger than average targets in section 5.1.
Debt characteristics
Axelson et al. (2007) find no noticeable difference in leverage of club deals and single-fund deals. It is not unthinkable that club deals, since multiple well known acquirers can attach their name to a deal, can apply higher leverage and thereby pay more in acquisitions. Officer et al. (2008) results are also inconsistent with the hypothesis that clubs are able to benefit from higher leverage ratios as a result of attaching multiple private equity sponsors to a deal.
Tobin’s Q
Lang, Stulz and Walking (1989) argue that acquirers have greater scope to create value if a low target’s Tobin’s Q is caused by rectifiable agency problems at the target firm. Officer et al. (2008) also find evidence for this well-known finding that private equity firms in general acquire significantly “cheaper” targets, i.e. targets with a lower industry adjusted Tobin’s Q, than public acquirers. However, they find no differences in target industry adjusted Tobin’s Q’s for club deals and individual deals. These latter results put forward that a lack of scope to create value is unlikely to explain why they find lower premiums associated with club deals.
Profitability
Officer et al. (2008) find no differences in pre-deal operating performance for targets of club deals and targets of sole private equity deals. Target’s operating performance is measured as a ratio of EBITDA tot total assets for the fiscal year prior to the announcement of the deal.
Institutional ownership
paid that are excessively low when left unchecked, but that institutional investors are sophisticated enough to counter the potentially anticompetitive effects of clubs at the bargaining table.
Except for the size of the deal, we are not able to obtain information on the characteristics mentioned above, mainly due to secretive nature of the buyout market. None of the characteristics is mentioned in the databases we have at our disposal. From the literature we learn that this will not radically bias our finding. However, ideally we would have controlled for them. In line with Cao (2008) we control size and industry effects in the regression we propose in section 4.4.
2.2.3 Reason d’être
According to Meuleman and Wright (2006) there are several reasons why firms syndicate, namely portfolio diversification, improved screening, selection and value adding, deal flow generation and reducing the agency conflicts. Forming a consortium allows financial sponsors to combine, enhance and supplement expertise, bringing the best resources to bear for the benefit of the investment, portfolio company and the ultimate return. It allows buyout firms to share the work and costs associated with due diligence, and the documentation involved in submitting a bid. Brander et al (2002) suggest that the inter- firm networks arising from club deals might decrease the competition in the PE market. While on the other hand, PE funds that would have otherwise been too small to compete can team up and join the auction process. This makes the auction only livelier. In any case, we see the arguments above as different forces affecting the acquisition price, some pushing the price up and some depressing it. We will discuss the arguments for club deals in more detail below.
Diversification
One of the reasons for the fact that private equity firms are clubbing is that it allows them to diversify their risk, said Mark Gallogly, the co-founder of private equity firm Centerbridge Partners, speaking at a Columbia Business School event in New York.12 Although several buyout funds approach and exceed $10 billion, not many are willing to fund the entire equity portion of the purchase price in a transaction and many are even being restricted from investing a too large percentage – most of the time 10 % - in any given transaction.13 Lockett and Wright (2001) investigate competing finance- and resource based arguments and deal flow explanations for the syndications14 of venture capital investments, the non buyout part of private equity. However, they also include management buyouts, which make it relevant for our research. They see syndication not only as a mean of risk sharing via
12 Flaherty, M. (2007): “Buyout firms find ways around club deals”, Reuters website, 20 February 2007 13 Article form International Financial Law Review: “What it takes to make a consortium work”, 2006
14 Lockett and Wright define syndication in the venture capital market as follows: “Two or more venture capital
portfolio diversification, which it is according to traditional finance theory, but also as a method of accessing specific resources from other firms in order to reduce the risk of investment. We devote attention to the latter in the section resources.
Risk can be subdivided into two groups: unique (non-systematic or company risk) and market (systematic) risk. Unique risk is associated with a particular investment, whereas market risk is associated with market wide variations. By diversifying their risk, financial sponsors can eliminate (part of the) unique risk by holding a well-balanced portfolio whose returns do not covary. According to Wilson (1968) through syndication, or club deals, firms can share the risk associated with a particular investment and spread their capital across a greater number of investments and hence reduce their portfolio risk.
Resources
We show that firms can share the risk through teaming up, but besides that the can lower their risks as well. Lockett et al. (2001). A buyout fund can be seen as a financial intermediary that buys and sells assets. However, it can also be viewed as a “collection of productive resources”. Penrose (1995) A resource can be seen as a strength or weakness of a firm, with syndication being a method of accessing specific resources from other firms in order to reduce the overall risk. For example, funds with specific knowledge in particular industries may lower the risk by sharing information within the consortium and thereby they benefit from superior selection and management of investments. In doing so, they raise the mean expected return on their investment, but not the variance of the underlying distribution of returns.
Secondly, we have to note that a distinction can be made on the stage in the decision making process where the risk is reduced through forming a consortium, namely ex-ante and ex-post decision making. Ex-ante relates to the selection of investments, whereas ex-post decision making relates to the subsequent management of the investments. Forming a consortium reduces the potential for adverse selection in the selection stage of the deal, since more people analyze the investment. According to Sah and Stiglitz (1986) on average this results in a superior outcome for the investment as a whole. According to Lerner’s selection hypothesis (1994) it is advantageous when more investors evaluate the project before it is selected. Besides the selection stage, resources are needed in the management stage of the investment. Some buyout firms have extensive networks with industry experts that prove to be valuable resources when managing portfolio companies. If these resources can be combined in order to reduce the overall risk, forming a club will be beneficial.
expertise and Vornado’s real estate know-how into its bid. Next to that, Silver Lake, a technology specialist, usually serves as the resident tech expert when it is part of a consortium, and Providence Equity Partners plays a similar role in many entertainment and media deals. 15
Size
This argument is straightforward. By combining their financial resources buyout firms can target bigger companies, without violating certain thresholds from a portfolio risk management point of view. Blackstone16 president Hamilton James told magazine The Deal: "While fund sizes have escalated, deal sizes have escalated even faster. Not only are funds not catching up to the market, they are falling further behind. So I think clubs are here to stay."17
Deal flow
Deal flow generation is another argument to form a club. A managing partner at a large market firm said18: “If we bring someone into a deal, and it is successful, we would absolutely expect them to reciprocate down the line”. Lockett et al. (2001) and Sorenson and Stuart (2002), although they focus solely on venture capital, confirm that access to future deal flow may be a motivation to syndicate a deal. By allowing other funds to “join the club”, firms are intending to create an expectation to reciprocate the gesture in the future. Besides that, it is important for buyout funds to be in a position to compete for as many deals as possible, so that they can make their investment selections from a wide supply of deals, which will have implications on the quality of the deals. Deal flow becomes even more essential in times when the competition for deals is great and when large sums of money are available. The amount of club deals a buyout firm participates in might be a proxy for the network of a firm. By frequently syndicating investments, a dense inter firm network is created, that disseminates information across geographic and industry boundaries (Sorenson et al., 2002). This network might supply you with a vast and steady amount of profit opportunities. Whether this advantage results into higher prices paid in a buyout is something we examine in section 5.1.
The arguments we showed above can be interpreted as reasons why club deals would pay more, i.e. pay higher multiples, than sole sponsor deals. If buyout firms can diversify their risk, they can pay more. If firms have more analytical skills and superior industry knowledge, the resource based argument; they can easier spot value creation opportunities and therefore offer a more attractive price.
15 Article from Investment Dealers Digest: “Assembling the consortium puzzle”, 18 September 2006
16 According to PEI 50 2008 Blackstone ranks number 10 in the top 50, measured on capital raised over the last
five years
17
Article from thedeal.com: “Dealwatch: PE Clubs”, March 2007
18
If firms expect to benefit from future profits that arise because of a higher deal flow, they can pay a higher price. Finally, clubs can “bag bigger game” than it could “hunt down” individually. Few buyout funds explored value creation opportunities of the bigger targets since they were considered “untouchable”. That value is now in reach and can be capitalized by teaming up.19 In the section below we will discuss the competitive forces that may depress the multiples paid in buyouts.
2.2.4. Competitive pressure
“While no buyout executives will say on the record that the purpose of forming a team is to keep the asking price from going too high, privately, most will concede that reducing the final takeover price is sometimes the result. ‘You’re not going to get me to say that aloud, but let's just say that you’re not wrong,’ said one legendary private equity investor who then immediately added, ‘Please don't quote me by name.”20
The quoted text above illustrates that club deals are not only perceived to drive up the price in transactions. The fundamental concern is that buyout funds may be colluding to depress prices by limiting the number of competing bidders in an auction for a takeover target. The last couple of years questions started to arise challenging the validity of their bidding techniques during a club deal auction process. In 2006 the US Department of Justice deviated from their traditional hands off approach to the buyout business and begun to look more critically as to whether any potential antitrust issues are raised by club deals.21 Officer et al. (2008). Letters were sent, to six of the largest private equity firms, requesting information on recent deals, in an effort to determine whether any of the record-breaking deals in 2006 involved collusion among competing bidders or were otherwise anti-competitive. Resistance against “clubbing” comes from the corporate sector as well. In January 2007 General Electric informed potential private equity bidders for its plastic unit that they face restrictions on their ability to team up with other private-equity bidders 22 Sell-side bankers, a group also benefiting from high transaction prices, have implemented confidentiality agreements to counter the anti-competitive effect of clubbing. These agreements restrict bidders from talking to each other, and, in some cases, from forming their own bidding consortia without prior consent. Another concern of sellers is the so called “bid jumping”, which occurs when a losing bidder joins the winning club after the deal is
19 Think of the following buyouts: TXU Corp by KKR and TPG for $32 billion and Bell Canada Ontario
Teachers Plan, Providence Equity Partners and Madison Dearborn Partners LLC
20
Sorkin, A.(2005) in the New York times, 16 October, 2005, pp. 3
21
Until this date no “smoking gun”has been identified and two years after DOJ’s request for information, it had neither taken any action, nor offered explanation of its findings. Haardmeyer (2008)
22 Smith, R. and Kranhold, K.(2007): “GE Sets Private-Equity Limits”, The Wall Street Journal, 9 January,
closed. This could indicate a deal was struck by the bid jumpers to underbid and subsequently lose the auction in exchange for being allowed to take part after the winning club determined the price. In addition, the formation of powerful clubs, with members whose clout and influence allows them to lock-up advisers and debt providers, limits the capability of other bidders to finance an offer. According to Franchini (2007) this has occurred in past auctions, where the seller and its advisors have had to request that banks make themselves available to other bidders.
Whether the anti-competitive behavior can be proven and to what extent it occurs remains debatable. There are rumors that the UK’s Financial Service Authority (FSA) viewpoint is at odds with DOJ’s vision.23 According to these rumors the FSA postulates that target’s company stockholders are not obligated to accept bids submitted by would-be acquirers and emphasizes the pro-competitive justifications for club deals, such as facilitating larger transactions and diversifying individual firm risk.24
In this paragraph we document academic literature that focused on the (anti) competitive effects of club deals and joint bidding in general. Boone et al. (2008) find that the formation of private equity consortiums is related to above average levels of takeover competition. Indeed they postulate that the level of competition is greater or as great in deals in which private equity consortiums are the winning bidders, than that for single private equity deals. While the formation of a consortium appears to arithmetically reduce the level of competition, their formation is actually associated with more bidding than an average deal. Hence, their results indicate that consortiums are a competitive response by private equity firms when bidding for larger targets. In contrast to Boone et al. (2008) Officer et al. (2008) do find evidence for collusion in club deals. They find that target shareholders receive roughly 10% less in club deals than in sole-sponsor LBOs. The results are the most pronounced before 2006, when club deals began to receive heightened media and government scrutiny. Barachdi (2008) show the relevance of research on European buyouts by concluding that, on the contrary to the US, there is thus no empirical evidence in Europe that private equity players are colluding in the bidding processes on public companies
We feel the need to note that, although this might not always have been the case, we think the buyout business is highly competitive at the moment. There are several examples of consortia outbidding other consortia25. Besides that, hedge fund activists are increasingly locking horns with buyout firms,
23 In November 2006 the FSA published a discussion paper on the regulatory challenges posed by the rapidly
growing private equity market, but did not mention anything negative on club deals
24 Vaiana, B.C. and Nurnberg, P.(2007): “Club Deals and DOJ investigation considerations for private equity
investors”, Nixon Peady Private Equity Newsletter, Winter 2007 Issue
25
making sure the buyout process is as competitive as possible.26 In the end, it is the ultimate goal for these stakeholders to obtain the highest possible price for their stake. The wide range of increasingly active and sophisticated investors can serve as a powerful safeguard against collusion within club deals. It would be interesting to investigate whether the presence of a (renowned) hedge fund influences the takeover prices in club deals. Unfortunately we lack the target specific shareholder data to test such a hypothesize.
2.2.5. Joint bidding
It is vital to understand how the formation of clubs influences the bidding process and therefore we devote some attention to the academic literature on joint bidding. Hendricks and Porter (1992) investigated the joint bidding of major oil companies for offshore oil leases. They found no conclusive evidence that joint bidding leads to collusion in auctions and they claim that the presence and the characteristics of collusive mechanisms depend critically on the nature of the object being auctioned. The auction theory (Graham and Marshall (2005)) on collusive strategy among bidders typically finds that colluding members bid a lower price in English auctions. However, in our opinion this theory is not completely applicable to club deals because private equity firms are repeated players in the market and they have reputation considerations. Besides that, arguments that start from the foundation that a bidding consortium reduces the number of bidders available to bid is predicated on an assumption that the consortium members would bid individually absent the consortium. We believe that in a world were multibillion dollar buyouts bids are becoming increasingly common, this is not a realistic assumption.
Although joint bidding looks questionable at first, it is too shortsighted to simply postulate that forming clubs reduces competitiveness in an industry. It might even increase the number of bidders when funds can afford to bid for a target collectively. Hendricks et al. (1992) show that if returns to firms participating in joint bidding increase, entry rates are likely to respond accordingly and therefore have no effect on ex ante returns, which means that target’s shareholders are not harmed in the long run. Our empirical test should give conclusive evidence on whether or not shareholders are harmed when a club of private equity firms bids for their firm.
26 Haardemeyer (2008) gives a couple of examples: Knight Vinke Asset Management demanded better financial
2.2.6. Empirical evidence on effects of club deals
Since club deals are occurring more frequently and become a topic of public debate27 it is not surprising that nowadays they are mentioned in academic literature more often. Some research had a sole focus on club deals (Officer et al., 2008) and its effect on competition (Boone et al., 2008). Other empirical research shortly discussed club deals, but primarily focused on buyouts in general. To get a clear picture of the academic background of club deals we created a table summarizing the literature.
Table 2. Previous literature on club deals
Authors Data Method Results
Club deals main topic of research
Officer, Ozbas Completed trans- CAR3 Target shareholders receive 10% and Sensoy (2008) actions between “Comparable industry less in club deals. Results most
1984-2007 in US transaction method” pronounced before 2006. High
Source: SDC (Kaplan & Ruback 1995) institutional ownership mitigates
this effect
Boone and Completed take- Analysis of SEC No evidence that formation of Mulherin (2008) overs between 2003- document in order to private equity consortiums
2007 of publicly estimate amount of facilitates collusion in the take- traded targets in US. takeover competition over market
Source: SDC
Club deals part of research
Axelson, Jenkinson, Largest buyouts in Transaction multiple Club deals are priced higher than Stromberg and Europe and US. analysis. individual deals.
Weisbach (2007) Source: CapitalIQ, Deal value/EBITDA
Dealscan, Amadeus multiple
Meuleman and UK buyouts between Hedonic regression No evidence for a negative effect Wright (2007) 1993 – 2002 approach (Gompers from syndication on the extent of
Source: CMBOR, EVCA and Lerner, 2000) competitive rivalry.
Guo, Hitchkiss 192 public US buyouts OLS regression Cash flow performance is not and Song (2008) between 1990 – 2006. significantly different for club
Source: SDC, Dealogic deals. Club deals have higher
returns.
Cao (2008) 5305 worldwide M&A Two-stage Heckman Controlling for the selection bias, deals between 1995 – regression and a probit club deals have significant higher 2007. and OLS regression premium. No support for
Source: Dealogic collusion among club deals
The table above illustrates that the evidence on club deals is inconclusive and points in different directions. Officer et al (2008) shows that target shareholders receive less when sponsors team up,
27 Referring to section 2.2.4., where we mention club deals to be the subject of an investigation by the
suggesting collusion to occur. Boone et al. (2008) and Meuleman et al. (2007) see no evidence of collusion in the takeover market and Axelson et al. (2007) even find evidence that club deals are priced higher than sole sponsor deals. We think it is worthwhile to shed some light on the literature on syndication in the venture capital industry, to see if more conclusive results are available.
The venture capital industry is characterized by firms that have high growth potential, entrepreneurial talent and are in need of finance and business skills to exploit market opportunities. (Lockett et al., 2001) According to Wright and Robbie (1998) this industry is characterized by relative high risks and therefore it is not surprising that they have developed various strategies throughout the years for dealing with it, one of which is syndication. The literature on club deals in the venture capital industry looks to be a bit older than that of the buyout industry. We see no reason to assume that there are different motives for clubbing in the VC industry and in the buyout industry, only the risk diversification argument might be more pronounce in the former. We depicted the articles that cover syndication in venture capital that could be relevant for our research below.
Table 3. Previous literature on Syndication in the Venture Capital Industry
Authors Data Method Results
Wright and 58 UK Mann-Whitney Lead investors have higher equity stakes. Locket (2003) questionnaires U-tests Relationships are more important than
contracts, decisions follow discussions
Brander, Amit 584 surveys T-test to evaluate mean Syndication leads to higher returns, due to and Antweiler conducted in returns and a regression complementary management skills; (2002) Canada analysis empowering the value-added hypothesis
Locket and 60 UK Mann-Whitney- Finance argument strong motive for syn- Wright (2001) questionnaires U tests dication, but resource argument found to
be more important firms involved in early stage transactions
Lerner Financing rounds of Regression and various Syndication allows established VC firms (1994) 651 biotech firms test for significance to obtain information to decide whether to
between 1978 – 1989 invest in risky firms. When skilled VC
Source: VED invests in later rounds, target does well.
Bygrave USA deals between Resource exchange Primary reason for co-investing is sharing (1987) 1966 – 1982. Source: - model (Pfeffer and knowledge, rather than spreading risk.
Table 3 predominantly shows us that the literature on syndication in the VC industry mainly points at the resource based arguments, i.e. a greater supply of analytical and management skills resulting from different funds’ teaming up is the main reason for syndication. Whether this argument is equally applicable to the buyout industry is debatable. Earlier stage investments might be in bigger need of analytical and managerial resources than “buyout stage” investments. Established companies already have management structures in place, are an established market presence and have existing suppliers and customers. (Barry, 1994). It is not our goal to determine to what degree the above arguments are applicable to the buyout theory, but it is our ambition to provide a sound foundation to investigate our hypotheses about the pricing of club deals.
2.3. Hypotheses
2.3.1. Pricing in club deals
We presented several motives for buyout firms to pay more in club deals, such as need for diversification, more analytical and financial resources and a higher future deal flow. On the other hand, currently buyout firms are accused of collusion in club deals in order to unnaturally depress the transaction price. General Electric refused to sell its plastic division to groups of buyout funds joining forces in the bidding process and the US Department of Justice (DOJ) is investigating the practice since they expect anticompetitive behavior. In addition to the Department of Justice inquiry, a class action complaint was filed in the Southern District of New York against several well-known private equity firms alleging that they formed clubs that artificially deflated a target’s price by exchanging information about bid prices and agreeing upon which party would win the auction.28 Whether the combination of these forces has an upward or downward effect on acquisition prices should stem from our empirical tests. Therefore we hypothesize the following:
Hypothesis 1: “Buyout firms pay different industry adjusted multiples in club deals than in sole sponsor deals”
We are not only interested if syndication influences prices, but also in which direction and whether we can propose factors that cause this variation in price. Unfortunately, we lack the target- and buyout firm specific information to investigate all the arguments we put forward above. Nevertheless, we do test the influence of a high deal flow, the media spotlight that was ‘turned on’ in 2006 and ranking on takeover premiums.
2.3.2. Deal flow
We devoted attention to the deal flow arguments in section 2.2.3. Although the literature we quoted focused on venture capital, we believe these arguments (Lockett et al., 2001 and Sorenson et al., 2002) are applicable to the buyout literature as well. This impression is supported by quotes of private equity fund managers in financial media, which draw on the advantages of high deal flow29. The expectation to reciprocate the gesture in the future when a fund gets involved in a club deal and the importance of being in the position to compete for as many deals as possible, sound as valid arguments to join a club. Besides a higher supply of deals, it allows them to benefit from more specific industry expertise and additional analytical resources from other private equity firms.
As far as we know, the relation between “(club) deal flow” and pricing has not been empirically investigated yet. To summarize, firstly we test whether highly acquisitive firms pay higher acquisition premiums in general. Subsequently, we test whether this effect differs for club- as opposed to sole sponsor deals.
Hypothesis 2.a:“Buyout firms with relatively high deal flow pay different acquisition premiums” Hypothesis 2.b:“Buyout firms with a relatively high deal flow pay different acquisition premiums in
club deals”
2.3.3. Media spotlight
Changing behavior as a result of an occurrence might be evidence of collusion. In 2006 the financial media turned a spotlight onto the practice of club deals and the Department of Justice started its informal inquiry into the practice. Dyck, Volchkavo and Zingales’(2007) show that media shaming might be effective in reducing corporate governance violation only if most people believe it is socially valuable to protect minority shareholders. This is more applicable to developed countries, i.e. European countries, than for developing countries. It is therefore not unthinkable that private equity changed its, potentially anti competitive, behavior after the spotlight “was turned on”. Officer et al. (2008) find that discounts for club deals were larger for pre-2006 deals than for post-2006 deals. The evidence is statistically significant. Besides the media, it might be increased competition that has reversed collusion in the buyout market. Nowadays, hedge funds and institutional investors have become increasingly involved in buyout transactions. As shareholders with substantial stakes these active investors have strong incentives to make sure that the buyout process is open and competitive and eventually a fair price is paid. We showed several examples of hedge fund rejecting a bid, because
they thought the premium was too low. Besides that, with more than 2000 LBO groups the current buyout industry is highly competitive. Rosenbush (2007) shows that in the beginning of 2007 70% of the announced buyouts had multiple bids, compared to 4% in 2005. If two buyout firms would collude in order to keep transaction prices low, they would be outbid by other strategic of financial sponsors. If we see a significant change in the club deal acquisition multiples before and after 2006, we interpret this as evidence that could indicate prior anti-competitive behavior. Future research should point out to which extent this can be attributed to the media spotlight, or that other forces, such as increased competition have amplified this. Firstly, we test to what extent premiums changed in 2006, both for club and sole sponsor deals. Subsequently, we expect this effect to be more pronounced for club deals, since they received the lion share of negative attention.
Hypothesis 3.a: “Acquisition premiums30 significantly changed from 2006 onward in European buyout transactions”
Hypothesis 3.b: “Club deal acquisition premiums significantly changed from 2006 onward in European buyout transactions”
2.3.4. Top 10 PE firms
Fenn et al. (2001) emphasize the importance of reputation in the private equity market. Firms with a strong reputation and a favorable track record have better possibilities of raising money from their limited31 partners. The raising of limited partnerships is very time consuming and costly, involving presentations to institutional investors and their advisors that can take from two months to well over a year, depending on the general partners’ reputation and experience. Therefore we assume that the firms that are able to raise the most funds have a strong and renowned reputation. Besides that, it might be fair to say that the firms with huge amounts of capital are in less need of forming clubs, since the need for diversification is smaller, off course depending on the size of the transaction. Smaller firms cannot put 20 percent of their capital at work in one acquisition and therefore need to diversify more. Therefore, bigger private equity firms might have different motives to form a club, motives that might have to do with collusion. A club made up of two firms from the top 10 is even more evidence of collusion, since it is more likely these firms would have bid against each other in an auction. Officer et al. (2008) also link anticompetitive effects with the strength and reputation of the PE firms. Another reason that more reputable firms participate more often in club deals might have to do with the fact
30
In section 3.2 we explain how we calculate premiums
31 Partners in a private equity firm are usually referred to as general partners. The investors who provide cash,
