Private equity bidders listed targets selection

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Private equity bidders listed targets selection

A comparison between Europe and the United States before and during the financial crisis

Anton van der Laan

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Thesis MSC Finance

University of Groningen

Abstract:

Using a unique European and US dataset comprising 234 public to public transactions and 227 public to private (PTP) transactions during the period 1998 to 2013, this paper explores differences between listed targets acquired by private equity bidders and listed targets acquired by public bidders. We find support for the argument that listed targets acquired by private equity firms are larger, less profitable, have higher free cash flows, more financial slack and use their assets more efficient compared to listed targets acquired by public companies. With respect to geographical differences, European private equity targets are smaller compared US private equity targets. Alternatively, univariate results indicate that listed targets acquired by private equity bidders(public bidders) during the financial crisis have lower free cash flows and lower growth prospects compared to listed targets acquired by private equity bidders (public bidders) before the financial crisis.

Key words: Mergers & acquisitions, Private equity bidders, Public bidders, Public targets, Financial crisis.

JEL classification: G34

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1. Introduction

The term private equity is associated with different types of acquisitions, over the years the term is regularly related to buy outs and public to private transactions, with the objective to improve growth prospects and performance of the acquired firms. The private equity investments helped to develop an innovative business sector and experienced an unusual growth, with a peak in 2007. The unexpected growth of private equity investments in the beginning of the 21st century was recognized as the eclipse of the public corporations (Cheffins and Armour, 2007). This eclipse was forecasted by Jensen (1997), who argues that public corporations have outlived its usefulness and new organizations like private equity funds will emerge.

Private equity firms are organized through limited partnerships, managed by fund managers who receive a percentage fee of the fund. Acquisitions are the major investments of those funds. Fund managers of a private equity fund determine potential targets and decide in cooperation with the investors whether to invest or not. In this study, acquisitions of private equity firms refer to acquisitions of listed companies with the intention of taking it private through a delisting (public to private-PTP-transactions).

This study investigates financial characteristics of listed targets acquired by public and private equity bidders. Several studies find evidence, that private equity bidders acquire underperforming firms with agency problems and aim at restructuring companies (Weir and Wright, 2006, Osborne, Katsales and Chapple, 2012 and Bargeron, Schlingemann, Stulz and Zutter, 2007). Conversely, public bidders seek for operational synergy when acquiring firms, as suggested by Chapple, Clarkson and King (2010). In agreement with this argument Lehn and Poulsen (1989) show that US listed firms acquired by private equity funds are associated with high free cash flows. Powell (1997) suggests that high free cash flows indicate agency problems, because firms with high free cash flows are likely to waste money instead of paying shareholders, which creates conflicts of interests between managers and shareholders.

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3 less obligations regarding interest payments and financial slack increases. Following the arguments, it is expected that more debt (lower financial slack) reduce agency problems. Alternatively, Powell (1997) emphasize that firms with high free cash flows and low growth prospects are subject to agency problems of free cash flows. Thus, taken together, firms with high levels of financial slack, high free cash flows and low growth prospects are targets of private equity bidders.

With respect to geographical differences, Lee (2012) shows that listed targets acquired by European firms have more financial slack compared to listed targets acquired by US firms. Different creditor rights might explain these differences, stricter creditor rights in European countries incentivize equity holders and management not to take on too much debt, as suggested by Rajan and Zingalis (1995). Alternatively, Lee (2012) identifies US companies as large-scale companies with dispersed ownership and a short-term orientation, who have more agency problems compared to European companies. Consistent with this argument, Jensen (1997) shows that debt financing mitigate agency problems, which clarifies the lower levels of financial slack of US targets.

The main objective of this study is to investigate the differences between listed targets acquired by private equity bidders and listed targets acquired by public bidders. In addition, US and European targets are compared and bid preferences are analyzed before and during the financial crisis.

This study hypothesizes that listed targets acquired by private equity bidders have higher free cash flows, more financial slack and lower growth prospects compared to listed targets acquired by public bidders. With respect to geographical differences, this study hypothesized that European private equity targets have more financial slack than US private equity targets. In addition, it is expected that bid preferences of private equity bidders (public bidders) changed during the financial crisis.

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4 Consistent with prior literature, listed targets acquired by private equity firms are larger and less profitable, have higher free cash flows and use their assets more efficient compared to listed targets acquired by public targets (Weir and Wright, 2006, Osborne et al., 2012 and Bargeron et al., 2007). They are larger and less profitable, which reflects the different incentives of private equity bidders and public bidders. Public bidders acquire companies to increase their market share or with a monopolizing view. So, they acquire companies to generate a maximum profit after the combination whereas private equity bidders delists target companies and aim at restructuring companies and increasing value. With respect to the geographical differences, we find evidence that European private equity targets are smaller compared to US private equity targets. Alternatively, we find that bid preferences differ between the financial crisis and the pre financial crisis.

Moreover, univariate results indicate that listed targets acquired by private equity bidders(public bidders) during the financial crisis have lower free cash flows and lower growth prospects compared to listed targets acquired by private equity bidders (public bidders) before the financial crisis.

This study is contributing given the lack of prior research on public to private transactions in Europe and the US. Its contribution lies in the comparison of listed firms acquired by public bidders and those acquired by private equity firms. In this regard, European and US listed targets are compared, prior studies investigate target characteristics of private equity bidders in Europe and the US, but outcomes were not compared before. Also US and European listed targets acquired by private equity bidders (public bidders) before and during the financial crisis are compared.

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2. Literature review

2.1. Synergistic and disciplinary takeover motives

In public to private transactions, the private equity fund delists a target company and aims at increasing the value by restructuring companies. The restructure of acquired firms entangles stewardship and a financial injection, at the maturity of the investment horizon the targets will be divested at a higher value, which will generate wealth for the private equity fund. Osborne et al. (2012) state that this way of restructuring is beneficial for both parties since the private equity firm: (1) introduces skilled management, (2) enhances the profitability and efficiency, (3) recognizes potential risks and (4) the management of the target firm will not be ceased to public monitoring and associated monitoring and bonding costs.

Chapple et al. (2010), Powell (1997) and Weir and Wright (2006) identify underlying motivations of takeovers, making a distinction between synergistic and disciplinary motivations. The synergistic motives are considered to be friendly in the sense of both parties benefit such as improved marketing economies, more technical expertise and increased market power (Morck, Schleifer and Vishny, 1989). Public bidders are considered to be synergistic acquirers, since they seek for operational synergy when acquiring firms, as suggested by Weir and Wright (2006). Disciplinary motives are those takeovers that are hostile and can be viewed as a key mechanism to discipline underperforming managers. Managers underperform as a result of information asymmetry, which effects are reflected in the stock prices and the Tobin’s Q of companies. Consistent with this prediction, Morck et al. (1989) investigate a sample of 500 US takeovers during the period 1975 to 1987 and show that disciplinary takeover targets have lower stock prices and Tobin’s Q prior to the bid compared to synergistic takeover targets. A similar pattern has been reported for Australian firms (Brown and da Silva Rosa, 1998). So, disciplinary acquirers target underperforming firms whereas synergistic acquirers have more friendly motives.

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6 motives but can close a deal with disciplinary motives. Therefore, this study identifies private equity bidders as disciplinary friendly acquirers.

2.2. Public to private transactions versus public to public transactions

Modigliani and Miller (1958) find evidence that the value of the firm is independent of capital structure decisions when capital markets are perfect. However, in this study we assume that capital markets are not perfect, therefore public and private equity bidders have different capital structures, which can be attributed to leverage effects. Private equity bidders finance acquisitions with high proportions of debt because of favorable tax treatments whereas public bidders enhance lower proportions of debt because of the involved credit risk. Prior research of Kaplan and Stormberg (2009) find that high proportions of debt creates value for private equity investors, which clarifies private equity deals having debt ratios around 60% to 90%. However, the high proportions of debt financing imply more credit risk and therefore in some cases it is better to use lower proportions of debt. For example, the return on equity of private equity funds might decline because of the use of debt, if the targets return on assets is lower than the cost of the debt needed to buy it.

Private equity bidders finance acquisitions with high proportions of debt whereas public bidders are more cautious because of involved credit risk. Then, it is questioning why public firms take less risk compared to private equity firms. The theory of Axelson and Weisback (2009) gives some insight, comparing the capital structures of private equity firms and public firms. According to this theory, public firms have different reasons in making leverage choices compared to private equity firms. For example, the average Chief Financial Officer (CFO) of a public firm will be concerned about financial distress cost and financial flexibility whereas a private equity fund is willing to borrow as much as the banks lend. So, public firms are commonly using less debt compared to private equity funds.

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7 these high free cash flows to cover the acquisition debt. Consistent with this perspective, Myers and Maljuf (1984) find that value of such takeovers is created from additional positive net present value (NPV) investments, that low leveraged firms might pass up. Thus, taken together, firms acquired by private equity bidders have more financial slack compared to firms acquired by public bidders.

Weir and Wright (2006) find evidence for differences regarding regulations and disclosure of public and private equity targets. Companies involved in PTP transactions will be delisted and will not be ceased to public monitoring and associated costs. Contrary, the authors state that a listed firm acquired by another listed firm is still subject to the effects of public monitoring of analysts and the associated costs. Those associated costs reduce the attractiveness of being a public corporation, which is confirmed by private equity owners, who have criticized the public markets for being too much regulated. Blackstone co-founder Stephen Swarzman use the same argument arguing that regulations temper public companies, which lead to a "going-out-of- business sale’’ for public companies.

Bargeron et al. (2007) examine acquisitions of US public and private equity firms during 1980-2005 and show that shareholders of listed targets receive a 55% higher premium when the acquirer is a public firm compared to a private equity firm. These authors suggest that the difference in shareholder premiums reflects the different bid preferences. This is confirmed by Officer (2003), who shows that target shareholders gain less when their firms are larger. So differences in size of targets explain differences between shareholder gains. Chapple et al. (2010) state that listed firms acquired by private equity companies are larger compared to listed firms acquired by public companies. Given the difference, the authors state that public bidders are less concerned with the size of the target and acquire companies to increase their market share or with a monopolizing view. Private equity bidders acquire larger firms because the payoff of these deals is higher, as suggested by Chapple et al. (2010).

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8 consists of many investors, but interests are aligned by a managing partner making the decisions. In contrast, public companies are more diffusely owned. It can be stated that private equity managers have better incentives compared to public companies, which effects are reflected in the lower premiums.

2.3. Firm specific determinants of private equity targets 2.3.1 Free cash flow

Several studies document high free cash flows for listed targets acquired by private equity bidders. Powell (1997) studies a sample of 411 acquisitions in the UK over the period 1984-1991 defines free cash flows as “cash flows in excess of that required, to fund all projects that have a positive net present value when discounted at the relevant cost of capital”. The author states that firms with high free cash flows are likely to waste money instead of paying shareholders, which creates conflicts of interests between managers and shareholders. This is in agreement with Opler and Titman (1999), who state that the problem is how to convince managers to disgorge cash instead of wasting it on organizational inefficiencies. Following these arguments, Jensen (1986) emphasize that firms with high free cash flows and low growth prospects are subject to agency problems of free cash flows. Mitigation of these agency problems by a private equity acquirer creates value by changing the organizational form of the target. Consistent with this prediction, Weir and Wright (2006), Chapple et al. (2010), Morck et al. (1989) and Osborne et al. (2012) show that listed targets acquired by private equity firms have higher free cash flows compared to listed companies acquired by public firms. In agreement with these studies, no differences are observed for targets listed in Europe and the US (Achleitner, Betzer and Goergen, 2007, Bargeron et al., 2007 and Lehn and Poulsen, 1989). Thus, in short, listed targets acquired by private equity bidders have higher free cash flows compared to listed targets acquired by public bidders, which is similar for European and US targets.

2.3.2. Financial slack

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9 governance mechanisms reduce the likelihood of becoming a target, which is in agreement with Bargeron et al, (2007). It can be argued that more debt reduce free cash flow problems( as noted in section 1.3.1) and decrease the likelihood of becoming a target.

Powell (1997) shows that acquiring companies have opposite characteristics compared to the targeted company. Acquiring companies with low growth prospects, low leverage and high liquidity are likely to target companies with high growth prospects, high leverage and low liquidity. A similar pattern has been reported in previous studies (Myers and Majluf, 1984, Bruner, 1988 and Kim and Smith, 1994). Private equity firms have high debt to equity ratio’s, which implies that listed targets acquired by private equity bidders have lower debt to equity ratio’s.

Prior studies show that financial slack of listed targets acquired by private equity bidders differ between Europe and the US. Bargeron et al. (2007) find evidence that US listed firms acquired by private equity bidders have higher debt to equity ratios compared to US listed firms acquired by public bidders. The conclusion of these authors seems to reject the idea that private equity targets have low debt to equity ratio’s. The authors argue that levered companies have weaker bargaining positions and are unable to defend themselves against a takeover attempt. Achleitner et al. (2007) find that European listed firms acquired by private equity bidders have lower debt to equity ratios, their results differ from Bargeron et al. (2007). Achleitner et al. (2007) state that that more debt financing decreases the free cash flows, which prevent the management making harmful decisions.

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10 The author argues that large-scale companies with dispersed ownership and a short-term orientation have more agency problems. Consistent with this perspective, agency problems seem to be more common in the US compared to the UK, which clarify the differences in financial slack.

2.3.3 Growth

Companies involved in PTP transactions are expected to have low growth prospects. Lehn and Poulsen (1989) examine 263 going private transactions from 1980 through 1989 and show that listed firms acquired by private equity bidders have stable business histories and lower growth prospects compared to listed firms acquired by public bidders. These authors suggest that low growth prospects reflect agency problems, which implies conflicts of interest between shareholders and managers concerning investment and payout policies. A similar conclusion is provided by Jensen (1986). In addition Opler and Titman (1993) find that free cash flows, on its own, have no big impact in becoming a target but the combination of free cash flows and low growth prospects do. It can be suggested that a combination is attractive for private equity bidders because the combination indicate weak corporate governance systems. Boone and Mulherin (2009), Bageron et al. (2007) and Achleitner et al. (2010) show that listed companies acquired by private equity firms have lower growth prospects compared to listed companies acquired by public bidders, no differences are observed between the US and Europe.

2.3.4. Size

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11 et al., 2012,Chapple et al., 2010 and Dijk, Fidrmuc and Roosenboom, 2007). No differences are observed between Europe and the US.

2.4. Hypothesis

Previous researches argue that financial slack of targets differ between public to public and public to private transactions. Additional debt force managers not to waste money, since they have to make principal payments and pay interests. Consistent with this argument, Jensen (1997) argue that the use of debt function as a governance mechanism. Since, private equity bidders acquire mismanaged firms we expect that listed targets acquired by private equity bidders have more financial slack compared to listed targets acquired by public bidders.

Consistent with this prediction, previous researchers state that consensus exists that acquiring companies have opposite characteristics compared to the targeted companies (Powell, 1997, Myers and Majluf, 1984, Bruner, 1988 and Kim and Smith, 1994). Private equity bidders are highly levered companies compared to public bidders, as observed by Axelson and Weisback (2009). Following the arguments, listed targets acquired by private equity bidders have more financial slack compared to listed targets acquired by public bidders. Given the existing literature and the use of debt by private equity firms, we propose the following hypothesis:

Hypothesis 1: listed targets acquired by private equity bidders have more financial slack

compared to listed targets acquired by public bidders.

High free cash flows

are a signal of potential agency problems, as suggested by Jensen (1997). Given the agency problems, firms with high free cash flows are likely to waste money instead of paying shareholders. Since private equity bidders target poor managed firms and aim at restructuring companies, we expect that listed targets acquired by private equity bidders have higher free cash flows compared to listed targets acquired by public bidders. Following these arguments, we propose the following:

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12 Acquired companies in PTP transactions are expected to have low growth prospects. This, in turn, is confirmed by Boone and Mulherin (2009), Bageron et al. (2007), Achleitner et al. (2010) and Lehn and Poulsen (1989), who show that listed companies acquired by private equity bidders, have lower growth prospects compared to listed companies acquired by public bidders. The low growth prospects reflect agency problems, as suggested by Lehn and Poulsen (1989). We expect that public bidders acquire companies with higher growth prospects because they seek for operating synergies whereas private equity bidders aim at restructuring firms. Following these arguments, the following hypothesis is tested:

Hypothesis 3:

Listed targets acquired by private equity bidders have lower growth prospects compared to listed targets acquired by public bidders.

Prior studies document that financial slack of listed targets acquired by private equity bidders differ between Europe and the US. This argument is confirmed by Achleitner et al. (2010), Bargeron et al. (2007) and Lee (2012), who show that different creditor rights and governance mechanisms explain those differences. Rajan and Zingales (1995) state, stricter creditor rights in European countries incentivize equity holders and management not to take on too much debt. In addition Lee (2012) identifies US companies as large-scale companies with dispersed ownership and a short-term orientation, who have more agency problems. Thus, taken together, US listed firms are more levered compared to European listed firms, which implies that US private equity targets have more financial slack compared to European private equity targets. Consistent with these arguments, we propose the following:

Hypothesis 4

: European listed targets acquired by private equity bidders have more financial slack compared to US listed targets acquired by private equity bidders.

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13 In the 4thquartile of 2007, private equity firms headquartered in the US, acquired approximately 800 firms whereas in the 4thquartile of 2013 this number was only 400. Thus, the financial crisis flattened the growth of private equity funds but did it also influence the bid preferences of private equity funds?. Therefore, it is interesting to compare bid preferences before and after the financial crisis. Based on these arguments the following hypothesis is tested:

Hypothesis 5: Listed targets acquired by private equity bidders (public bidders) during the pre-financial crisis have different bid attributes compared to listed targets acquired by private equity bidders (public bidders) during the financial crisis

3. Data and methodology 3.1 data

This study is based on a pooled sample including public to private acquisitions and public to public acquisitions during the period 1997 to 2013. Financial firms, like insurance companies and banks, are eliminated from this sample because they have non-standard accounts and cannot be compared to firms in other sectors. Furthermore, we include only completed acquisitions of listed targets. In addition, eliminating all the firms with incorrect data and the removal of firms which are active in the financial services sector, has led to a sample 461 acquisitions. Of these, 123 were US public to private transactions and 104 were European public to private transactions. The comparison sample consists out of 87 US public to public transactions and 147 European public to public transactions.

We collect data on US and European acquisitions from two sources, Thomson Reuters database and the Zephyr Database. Zephyr is a database that includes data on initial public offerings (IPO), private equity and venture capital deals and mergers and acquisitions (M&A). Financial information used to test the hypotheses was taken from the Thomson Reuters database, which provides financial data on US and European listed companies. The obtained financial information were the last accounts published prior to the bid. Hence, if the observed acquisition occurred in 2009, the obtained financial data refers to 2008.

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14 Two sample t-tests determine significant differences between the mean values, where median values are compared using the non-parametric Man-Whitney test.

Given the binary dependent variable, multivariate regressions outcomes are generated using binary logistic regressions. The models are based on the following function, where PTPi is denoted as the explanatory variable if a takeover is a PTP.

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Where =1 is a listed target acquired by a private equity bidder, a listed target acquired by a public bidder, E is the expected value for private equity bids and ԑ is the exponential in the logistic approach. The initial estimated logistic model is:

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In formula 3, all the regressed variables are included, where is a dichotomous variable, which takes the value 1 if the takeover is a PTP and 0 for public to public offers. Followed by the independent variables, FSLACK is calculated by dividing long-term debt (total) by common/ordinary equity (total). Free cash flows (FCF) are calculated by dividing the operating cash flow by the total assets were MTB is defined as the market to book ratio.

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15 In formula 4, interaction dummy variables are created to examine changes in coefficients. The interaction dummy variable (CD) is created to test differences between US and European listed targets. The dummy equals 1 when the target is listed on the US stock exchange and 0 if the target is listed on a European index. In addition, year dummiesare included controlling for time differences.

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(4) All regressors are presented in table 1, based on the hypotheses; inferences can be made regarding the expected relationship with the dependent variable. Elaboration on the expected signs: free cash flows, financial slack and the market to book ratio are presented in section 1.4. Explanation of the expected signs of the control variables are presented below.

Table 1: Description of variables and expected signs

Explanation signs control variables

To start, we expect that listed targets acquired by private equity firms are less profitable compared to listed targets acquired by public bidders. This, in turn, is confirmed by Manne (1965) who shows that private equity targets have lower profits prior to a bid. Alternatively, public bidders have different incentives than private equity bidders, since the acquisition of larger firms imply more transaction costs, we expect that public bidders acquire smaller companies compared to private equity bidders (Chapple et al., 2010). With respect to efficiency, Jensen (1997) argued that debt reduces the agency costs by reducing the free cash flows, leading to more efficient organizations. Following these arguments, we expect that listed targets acquired by private equity bidders are less efficient compared to listed targets acquired by public bidders. In addition, we expect that listed targets acquired by private equity bidders have lower capital expenditures compared to listed targets acquired by public bidders.

Variables Name Expected sign

Free cash flows FCF +

Financial slack D/E +

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Table 2: Correlation matrix independent and control variables

This table reports the cross correlation coefficients of the independent and control variables. Outcomes are based on European PTP transactions (N=104) , European public to public acquisitions (N=147), US PTP transactions (N= 123) and 87 US public to public acquisitions.

Panel A: Europe & US

Free cash flow Financial slack Market to book Return on equity Size Asset turnover Capital expenditures

Free cash flow 1

Financial slack 0.047 1 Market to book -0.005 0.032 1 Return on equity 0.129 0.037 0.021 1 Size 0.338 0.159 0.002 0.223 1 Asset turnover 0.129 -0.041 -0.035 0.032 -0.015 1 Capital expenditures 0.034 -0.029 -0.068 -0.111 -0.002 0.034 1 Panel B: Europe

Free cash flow 1

Financial slack 0.038 1 Market to book 0.033 0.107 1 Return on equity 0.077 0.047 0.284 1 Size 0.282 0.154 0.002 0.227 1 Asset turnover 0.098 -0.098 0.107 -0.021 -0.104 1 Capital expenditures 0.039 -0.054 0.005 -0.137 0.02 0.079 1 Panel C: US

Free cash flow 1

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17 3.1.2 Correlations

Table 2 presents an overview of the cross correlation coefficients of the independent and the control variables. All the variables are divided in three sub samples:(1) Europe & US, (2) Europe and (3)the US. Regarding panel C, coefficients indicate that size and free cash flows are highly correlated (0.633), which might influence regression outcomes.

3.2. Univariate analysis

Table 3 presents the descriptive statistics for the financial characteristics of listed firms acquired by private equity bidders and listed firms acquired by public bidders. The figures presented are those for the pooled sample (Europe & US), those comprising only European acquisitions and those comprising only US acquisitions. Mean and median values of all variables and the p-values for tests of differences are reported in table 3.

The reported statistics in panel A, suggest that there is evidence that listed targets acquired by private equity bidders are larger, have more financial slack, have higher free cash flows and use their assets more efficient compared to listed targets acquired by public bidders. The median value for free cash flows of listed targets is 5.347 for all public to private acquisitions whereas targets in public to public acquisitions have a median value of 2.615. The P-value on the difference is 0.002, this strengthen the argument of private equity targets having higher free cash flows compared to public targets. A comparison of financial slack between PTP and public to public transactions find that, consistent with the literature, the median value of 0.275 in PTP transactions is significantly higher compared to firms acquired by public bidders. Alternatively, mean values of the coefficients free cash flow and financial slack provide no significant evidence. Overall, the univariate results provide mixed support for the hypotheses that listed firms acquired by private equity bidders have higher free cash flows and have more financial slack compared to listed firms acquired by public bidders. Conversely, results reject the hypothesis that private equity bidders target listed firms with low growth prospects.

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18 capital expenditures compared to public targets. The mean value of private equity bids is 5.527 whereas public targets have a mean of 3.879. The p-value on difference is 10%. The variables free cash flows and asset turnover indicates that listed targets acquired by private equity bidders have higher free cash flows and asset turnovers. Thus, the univariate results support the hypotheses that private equity bidders prefer firms with more financial slack. Alternatively, results provide mixed support that private equity bidders prefer firms with higher free cash flows compared to public bidders. Again, results reject the hypothesis concerning lower growth prospects.

Finally, panel C comprising all US acquisitions, support the hypothesis that listed firms acquired by public bidders have higher free cash flows compared to listed companies acquired by public bidders. In addition, results present evidence that private equity bidders seek more profitable and larger firms. The mean and median values for size indicates that private equity bidders seek larger targets relative to public bidders, a mean value of 5.759 for private equity targets whereas public targets have a mean value of 5.033. The p-value on difference is 1%.

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19 Table 3: Univariate results and descriptive statistics

This table reports the financial characteristics of listed targets acquired by public and private equity bidders (PTP) during 1997 to 2013. Two sample t-tests determine significant differences between the mean values, where median values are compared using the non-parametric Man-Whitney test. Outcomes are presented using p-values, here * is 1% significance,** 5% significance and *** 10% significance, respectively.

Pooled sample PTP Public Test-value (p-value)

Variables N Mean Median N Mean Median N Mean Median Mean Median

Free cash flow 461 -4.202 4.216 227 0.397 5.347 243 -8.664 2.615 0.107 0.002*

Financial slack (D/E) 461 0.858 0.381 227 0.640 0.275 243 1.069 0.489 0.030** 0.099***

Market to book ratio 461 2.275 1.630 227 2.198 2.070 234 2.351 1.300 0.900 < 0.001*

Profitability (in %) 461 -21.753 5.050 227 -30.394 5.220 243 -13.371 4.690 0.163 0.676 Size 461 5.496 5.474 227 5.341 5.569 243 5.366 5.354 0.012** 0.124 Asset turnover 461 0.699 0.530 227 0.756 0.610 243 0.643 0.480 0.051*** 0.085*** Capital expenditures 461 4.967 2.590 227 5.428 3.000 243 4.519 2.385 0.179 0.177 Panel B: Europe

Free cash flow 251 -2.491 4.492 104 3.997 6.068 147 -7.081 3.501 0.195 0.009*

Financial slack (D/E) 251 1.023 0.439 104 0.604 0.273 147 1.319 0.573 0.024** 0.033**

Market to book ratio 251 2.191 1.630 104 1.604 1.855 147 2.606 1.490 0.141 0.048**

Profitability (in %) 251 -24.110 6.220 104 -41.639 7.565 147 -11.708 6.060 0.227 0.662 Size 251 5.528 5.465 104 5.479 5.425 147 5.563 5.513 0.554 0.557 Asset turnover 251 0.774 0.640 104 0.876 0.870 147 0.701 0.530 0.032** 0.048** Capital expenditures 251 4.562 2.690 104 5.527 3.200 147 3.879 2.500 0.096*** 0.488 Panel C: US

Free cash flow 210 -6.248 2.989 123 -2.648 4.830 87 -11.338 1.226 0.036** 0.005*

Financial slack (D/E) 210 0.660 0.317 123 0.674 0.276 87 0.645 0.329 0.828 0.575

Market to book ratio 210 2.376 1.625 123 2.699 2.250 87 1.919 1.190 0.769 < 0.001*

Profitability (in %) 210 -18.936 2.410 123 -16.181 2.870 87 -20.885 0.000 0.581 0.401

Size 210 5.458 5.516 123 5.759 5.848 87 5.033 5.222 < 0.001* < 0.001*

Asset turnover 210 0.609 0.460 123 0.655 0.490 87 0.545 0.260 0.177 0.117

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20 3.2.1. Univariate results financial crisis

For the analyses reported above, we benchmarked listed targets acquired by private equity bidders against listed targets acquired by public bidders. This section compares listed targets acquired by private equity bidders (public bidders) before the financial crisis with listed targets acquired by private equity bidders (public bidders) during the financial crisis. The pre-financial crisis sample comprises all acquisitions during the period 1998 to 2007, were the financial crisis contains all acquisitions during the period 2007 to 2013. To consider differences in bid attributes of PTP and public to public transactions before the financial crisis and during the financial crisis, univariate regression outcomes are reported in table 4 and 5. Table 4 indicates whether bid attributes of public bidders changed during the financial crisis and table 5 presents differences for private equity bidders.

3.2.3. Univariate results financial crisis public bidders

Table 4, panel A reports the univariate analysis and the descriptive statistics for European an US listed targets. In terms of results, this table finds significant evidence, that listed companies acquired by public bidders are smaller and have lower free cash flows during the financial crisis compared to listed targets acquired by private equity bidders before the financial crisis. A comparison of free cash flows find that, the mean value of -0.05 during the pre-financial crisis is significantly higher compared to the financial crisis.

Table 4 panel B, comprising European public to public targets, presents evidence that the market to book ratio and the asset turnover are significantly lower during the financial crisis. The mean value of the market to book ratio before the crisis is 3.347 whereas during the financial crisis 1.458. This, in turn, is confirmed by Dimelis, Giotopoulos and Louri (2013), who state that growth prospects of companies declined during the financial crisis.

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21 Table 4: Univariate results and descriptive statistics: public to public acquisitions during and before the financial crisis

This table reports the financial characteristics of listed targets acquired by public bidders before the financial crisis (1997-2007) and during the financial crisis (2007-2013). Two sample t-tests determine significant differences between the mean values, where median values are compared using the non-parametric Man-Whitney test. Outcomes are presented using p-values, here * is 1% significance, ** 5% significance and *** 10% significance, respectively.

Pooled sample Pre-financial crisis Financial crisis Test-value (p-value)

Variables N Mean Median N Mean Median N Mean Median Mean median

Free cash flow 234 -8.664 2.615 110 -0.050 3.524 124 -16.306 1.215 0.094*** 0.238

Market to book ratio 234 2.351 1.300 110 3.307 1.510 124 1.502 1.140 0.420 <0.001*

Profitability (in %) 234 -13.371 4.690 110 -11.501 8.810 124 -15.029 0.000 0.683 0.005* Size 234 5.366 5.354 110 5.524 5.513 124 5.226 5.278 0.084*** 0.149 Asset turnover 234 0.643 0.480 110 0.600 0.415 124 0.681 0.565 0.332 0.188 Capital expenditures 234 4.519 2.385 110 4.317 2.160 124 4.698 2.710 0.674 0.238 Panel B: Europe

Free cash flow 186 -5.526 3.421 74 1.308 4.360 112 -10.042 2.833 0.311 0.178

Market to book ratio 186 2.210 1.480 74 3.347 1.765 112 1.458 1.230 0.023** 0.010*

Profitability (in %) 186 -16.777 5.770 74 -10.646 10.095 112 -20.828 33.05 0.443 0.099*** Size 186 5.532 5.469 74 5.575 5.535 112 5.503 5.336 0.682 0.294 Asset turnover 186 0.724 0.600 74 0.639 0.480 112 0.781 0.675 0.133 0.111 Capital expenditures 186 3.722 2.300 74 3.889 1.990 112 3.611 2.465 0.742 0.653 Panel C: US

Free cash flow 87 -11.338 1.226 36 -2.840 1.764 51 -17.337 0.420 0.036** 0.040**

Profitability (in %) 87 -16.181 0.000 36 -13.259 7.560 51 -18.243 0.000 0.679 0.072***

Size 87 5.033 5.222 36 5.418 5.347 51 4.761 5.138 0.028** 0.096***

Asset turnover 87 0.545 0.260 36 0.521 0.215 51 0.562 0.390 0.751 0.573

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22 3.2.4. Univariate results financial crisis private equity firms

According to table 5 panel A, for the pooled sample, listed firms acquired by private equity bidders are smaller, have lower capital expenditures and free cash flows during the financial crisis compared to listed firms acquired by private equity bidders before the financial crisis. Moreover, comparing size, presents a median value of 5.842 before the crisis which is significantly higher compared to 5.339 during the crisis. The p-value on the difference is 5%.

Table 5 panel B, for the European sample presents similar findings. Listed firms acquired by private equity bidders have lower growth prospects, lower free cash flows and lower capital expenditures during the financial crisis compared to listed companies acquired by private equity bidders before the financial crisis. However, there is no significant evidence to believe that financial slack, profit, size and asset turnover differ between those periods.

Panel C comprising all US private equity deals, presents statistical evidence that capital expenditures, size, free cash flows and financial slack differ between those periods. The mean and median values for size and capital expenditures indicate that private equity bidders seek smaller firms with lower capital expenditures during the financial crisis compared to the pre-financial crisis. For the free cash flows, we again find lower free cash flows during the financial crisis.

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23 Table 5: Univariate results and descriptive statistics: public to private acquisitions during and before the financial crisis

This table reports the financial characteristics of listed targets acquired by private equity bidders before the financial crisis (1997-2007) and during the financial crisis (2007-2013). Two sample t-tests determine significant differences between the mean values, where median values are compared using the non-parametric Man-Whitney test. Outcomes are presented using p-values, here * is 1% significance, ** 5% significance and *** 10% significance.

Variables N Mean Median N Mean Median N Mean Median mean median

Free cash flow 227 0.397 5.347 135 4.545 5.782 92 -5.691 3.258 <0.001* 0.245

Market to book ratio 227 2.198 2.070 135 2.439 2.210 92 1.844 1.905 0.444 0.501

Profitability (in %) 227 -30.394 5.220 135 -28.337 7.780 92 -33.411 2.720 0.811 0.089*** Size 227 5.631 5.569 135 5.757 5.842 92 -5.691 5.339 0.008* 0.025** Asset turnover 227 0.756 0.610 135 0.813 0.790 92 0.672 0.535 0.065*** 0.186 Capital expenditures 227 5.428 3.045 135 6.863 4.360 92 3.323 1.585 <0.001* <0.001* Panel B: Europe

Free cash flow 103 3.983 6.150 65 6.195 6.568 38 0.201 3.045 0.076*** 0.344

Profitability (in %) 103 -42.076 10.36 65 -45.092 10.36 38 -36.918 3.465 0.854 0.344 Size 103 5.486 5.448 65 5.519 5.448 38 5.428 5.271 0.662 0.897 Asset turnover 103 0.880 0.950 65 0.914 0.950 38 0.823 0.690 0.464 0.426 Capital expenditures 103 5.572 4.070 65 6.965 4.070 38 3.189 1.435 0.009** 0.176 Panel C: US

Free cash flow 123 -2.648 4.830 70 3.014 6.062 53 -10.125 3.319 0.009** 0.937

Financial slack (D/E) 123 0.674 0.276 70 0.819 0.466 53 0.483 0.058 0.025** 0.168

Market to book ratio 123 2.699 2.250 70 2.718 2.010 53 2.675 2.450 0.957 0.124

Profitability (in %) 123 -20.885 2.870 70 -12.78 6.380 53 -31.59 -3.800 0.110 0.168

Size 123 5.759 5.848 70 5.977 6.062 53 5.470 5.384 <0.001* <0.001*

Asset turnover 123 0.655 0.490 70 0.720 0.510 53 0.568 0.490 0.116 0.937

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24 4. Regression

4.1 Multivariate regression results comparing Europa and the US

The results of the logistic regressions are presented in table 6, were hypotheses are tested in a multivariate setting. Panel A includes European and US targets together, where panel B models the differences between US and European acquisitions using an interaction dummy, which equals 1 for US acquisitions and 0 for European acquisitions. Models (1)(2)(3) presents regressions of one independent variable with all control variables, the 4th model includes all the variables together and the 5thmodel controls for the year effects using an interaction dummy, which equals 0 for the period 1998 to 2007 and 1 during the period 2007 to 2013.

The reported outcomes in panel A, provide evidence that listed companies acquired by private equity bidders are larger, more profitable, have more financial slack and use their assets more efficient compared to listed companies acquired by public bidders. Thus, private equity bidders seek larger companies. This, in turn, is confirmed by Osborne et al. (2012), Chapple et al. (2010) and Dijk et al. (2007), who state that this difference is attributed to different incentives. These authors state that private equity bidders acquire larger listed companies they can take private because the payoff of these deals are higher whereas public bidders are less concerned with the size of the targeted company. Further and in contrast with the univariate results, free cash flows and market to book ratios present insignificant coefficients, which reject hypothesis 2 and 3. In addition, controlling for year effects, multivariate analyses present that bid preferences changed during the financial crisis. Capital expenditures and asset turnovers are significantly higher during the pre-financial crisis compared to the financial crisis.

Differences between the US and Europe are presented in panel B of table 6. The results present that listed targets acquired by US private equity bidders are larger compared to listed targets acquired by European private equity targets. In addition, hypothesis 4 (financial slack) is rejected, multivariate results presents no evidence to believe that listed targets acquired by US private equity bidders have more financial slack compared to listed targets acquired by European private equity bidders.

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25 Table 6: Multivariate results: financial characteristics of European and US listed targets and a comparison between European and US listed targets.

This table presents the results of the following binary logistic regression: =

Where is a dichotomous variable, which takes the value 1 if the takeover is a PTP and 0 for public to public offers. Followed by the independent variables, free cash flow (FCF) is calculated by dividing the operating cash flow by the total assets, Financial slack (D/E) is the long-term debt (total) divided by common equity (total). Market to book (MTB) is defined as the market to book ratio, Profitability (ROE) is measured using the return on equity ratio, Size (LNTA) is defined as the natural logarithm of sales, asset turnover (ATURN) is measured as the net sales or revenues divided by total assets and capital expenditures (CAPEX) are the capital expenditures divided by total assets. In panel A and B, the outcomes are calculated using a pooled sample including: 87 US public to public firms, 123 US private equity firms, 147 European public to public firms and 104 European private equity targets. *, **, *** indicate significance at 1%, 5% and 10% confidence levels. In model (1),(2) and (3), 1 variable is regressed with all control variables, in model (4) all variables are included and model (5) control for year effects. Panel B, includes an interaction dummy equals which equals 1 when the target was listed on the US stock exchanges and 0 if the target was listed on a European index.

Panel A: Europe & US

Variables 1 2 3 4 5 Constant -1.612 -2.161 -1.866 -1.867 0.168 <0.001* <0.001* <0.001* <0.001* 0.185

Free cash flow 0.004 0.005 0.010

0.399 0.308 0.113

Financial slack (D/E) -0.230 -0.237 -0.351

0.009* 0.008* 0.022** Market to book 0.003 0.000 -0.001 0.968 0.968 0.936 Profitability -0.003 -0.003 -0.003 -0.004 -0.005 0.070*** 0.047** 0.083*** 0.034** 0.080*** Size 0.229 0.358 0.270 0.311 0.025 0.022** <0.001* 0.002* 0.004* 0.637 Asset turnover 0.298 0.318 0.331 0.279 -0.198 0.061*** 0.043** 0.033** 0.083*** 0.404 Capital expenditures 0.014 0.013 0.014 0.279 -0.046 0.321 0.344 0.298 0.083*** 0.088*** R^2 0.029 0.042 0.027 0.045 0.033

Panel B: US interaction dummy

Constant -0.413 -0.430 -0.426 -0.417 -0.074

<0.001* <0.001* <0.001* <0.001* 0.483

Free cash flow 0.009 0.009 0.016

0.193 0.194 0.082***

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26 4.2. Multivariate regression Europe and the US

Table 7 provides estimates of the coefficients separated for the US and Europe. Models (1)(2)(3) presents regressions of one independent variable with all control variables, the 4th model includes all the variables and the 5thmodel controls for the year effects using an interaction dummy, which equals 0 for the period 1998 to 2007 and 1 during the period 2007 to 2012.

From table 7 panel A, and consistent with univariate outcomes, multivariate results indicate that European listed targets acquired by private equity bidders have more financial slack and higher free cash compared to listed targets acquired by public bidders. This, in turn, is confirmed by Myers and Maljuf (1984), Jensen (1997), Bruner (1988), who show that slack-poor firms acquire slack-rich firms. Free cash flows seems to be higher for private equity targets, which is almost significant at a 10% level. Higher free cash flows indicates agency problems, which is an attractive bid attribute for private equity bidder, as suggested by Powell (1997) and Weir and Wright (2006). These outcomes strengthen hypotheses 1 (financial slack) and 2 (free cash flow).

Alternatively, US takeover regression results presented in panel B show different outcomes. As can be seen, multivariate results show that listed targets acquired by private equity bidders have more financial slack compared to listed targets acquired by public bidders. For the control variables, multivariate results present significant and negative coefficients on capital expenditures and profitability while other control variables are insignificant. Thus, in short, the results provide direct support for hypothesis 1 (financial slack) and rejects hypotheses 2 (free cash flows) and 3 (growth prospects).

Worth mentioning is that during the pre-financial crisis, listed companies acquired by private equity bidders are smaller and have lower financial slack compared to listed companies acquired by public bidders.

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27

Table 7: Multivariate result: financial characteristics European and US listed targets

This table presents the results of the following binary logistic regression: =

Where is a dichotomous variable, which takes the value 1 if the takeover is a PTP and 0 for public to public offers. Followed by the independent variables, free cash flow (FCF) is calculated by dividing the operating cash flow by the total assets, Financial slack (D/E) is the long-term debt (total) divided by common equity (total). Market to book (MTB) is defined as the market to book ratio, Profitability (ROE) is measured using the return on equity ratio, Size (LNTA) is defined as the natural logarithm of sales, asset turnover (ATURN) is measured as the net sales or revenues divided by total assets and capital expenditures (CAPEX) are the capital expenditures divided by total assets. In panel A, outcomes are calculated using 147 European public to public firms and 104 European private equity targets. In panel B, outcomes are calculated using a pooled sample including: 87 US public to public firms, 123 US private equity firms. I. *, **, *** indicate significance at 1%, 5% and 10% confidence levels. In model (1),(2) and (3), 1 variable is regressed with all control variables, in model (4) all variables are included and model (5) control for year effects. Panel B, includes an interaction dummy equals which equals 1 when the target was listed on the US stock exchanges and 0 if the target was listed on a European index.

Panel A: Europe Variables 1 2 3 4 5 Constant -0.222 -0.852 -0.577 -0.163 -0.116 0.774 0.237 0.423 0.838 0.492

Free cash flow 0.014 0.016 0.003

0.147 0.111 0.511

0.095*** 0.097*** 0.269 Market to book -0.051 -0.050 -0.001 0.157 0.190 0.994 Profitability -0.002 -0.001 -0.001 -0.001 -0.003 0.267 0.396 0.544 0.471 0.347 Size -0.102 0.040 -0.026 -0.066 -0.041 0.433 0.748 0.831 0.628 0.894 Asset turnover 0.324 0.361 0.435 0.324 0.007 0.119 0.076*** 0.034** 0.127 0.137 Capital expenditure 0.027 0.026 0.029 0.026 -0.194 0.151 0.179 0.155 0.192 0.223 R^2 0.035 0.038 0.033 0.055 0.034 Panel B: US Constant -4.196 -4.917 -4.335 -4.855 0.566 <0.001* <0.001* <0.001* <0.001* <0.001*

Free cash flow 0.002 0.002 0.020

0.815 0.848 0.024**

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28

5. Conclusion

This research use a European and US dataset, to explore differences between listed targets acquired by private equity bidders and listed targets acquired by public bidders. Several studies presents theories explaining the likelihood of becoming a target, however most of these studies focus on listed or unlisted targets instead of private equity targets. Only a few studies, study listed targets acquired by private equity bidders. Alternatively, there is no extant literature comparing the bid preferences of US and European private equity bidders.

This study hypothesized that relative to public target firms, private equity targets have higher free cash flows, more financial slack and lower growth prospects. In addition we expect that US private equity targets have less financial slack compared to targets acquired by public bidders. Finally, we proposed that bid attributes of private equity bidders (public bidders) differ between the pre-financial period and the financial crisis.

In detail, consistent with prior studies, univariate results for European and US listed targets together, indicate that listed targets acquired by private equity bidders have more financial slack and use their assets more efficient compared to listed targets acquired by public bidders. This, in turn, is mainly confirmed for European listed targets. In addition, univariate results for US listed targets show that private equity targets are larger and have higher free cash flows compared to targets of public bidders.

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29 In addition, with respect to geographical differences, regressions indicate that listed targets acquired by US private equity bidders are larger compared to listed targets acquired by European private equity bidders. Alternatively, results indicate that bid preferences of public and private equity bidders changed during the financial crisis. Univariate results indicate that listed targets acquired by private equity bidders(public bidders) during the financial crisis have lower free cash flows and lower growth prospects compared to listed targets acquired by private equity bidders (public bidders) before the financial crisis

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30

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