The good war

“War! Huh, yeah. What is it good for? Absolutely nothing!”

Well, now that I have you humming that popular 1960s Edwin Starr song that points out the horrible destruction of real wars, I would like to flip that notion on its head and discuss wars that create value. If Mr. Starr were writing about M&A, the lyrics might have been something like, “Bidding wars! What are they good for? Increasing value! Say it again.”

OK, that’s a little corny, but you’re still reading so maybe your interest is piqued. So, what is a bidding war when selling a company? True bidding wars occur regularly when the acquisition target is a publicly traded company. When the first buyer makes an offer to acquire the target company it is immediately disclosed to the public. The public disclosure signals other likely buyers to quickly evaluate the acquisition opportunity to determine if they are interested in acquiring the target. Knowing the target company is in play and could end up in the hands of their competitor will usually motivate the second buyer to make a better offer. Maybe a third and fourth potential buyer enter the fray and submit bids for the company. The first buyer has certainly left some room in their initial offer to negotiate, so they submit another offer that is higher. This process continues until one of the potential buyers submits an offer the others are unwilling to meet. The acquisition gets completed at the price offered by the victorious bidder. That is a bidding war, and it always benefits the selling shareholders.

A recent example of a bidding war occurred when Uphill Investment Co. announced an agreement to acquire publicly traded semiconductor company Integrated Silicon Solution Inc. for $19.25 per share. Cypress Semiconductor then made an unsolicited offer of $19.75 per share, starting the bidding war. After multiple rounds of competing offers by Uphill and Cypress, Uphill was victorious, agreeing to pay $23.00 per share. The bidding war increased the acquisition price by 19.5% and enriched the selling shareholders by an additional $119 million.

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For small- to middle-market private companies, the process doesn’t happen exactly the same way but is similar. Bidding wars for private companies are started and managed by an investment banker through an “auction” process. The auction starts when the investment banker contacts prospective buyers to get them interested in acquiring the company. They will confidentially share information about the company for sale, then set a deadline for offers, which usually results in multiple prospective buyers making offers. The investment banker will give the prospective buyers feedback after each round of bidding and encourage them to increase their offers and improve other terms contained in the offers. Through this multiple round bidding process, which is effectively a blinded bidding war, the maximum market value for the company is discovered. The seller invariably receives a higher price and better overall terms when selling their company in this manner rather than pursuing and negotiating a sale with a single buyer.

My partners and I regularly have conversations with business owners who have been approached by strategic or financial buyers interested in acquiring their companies. They often entertain those inquiries and enter into one-on-one negotiations with the buyers. As soon as they choose that approach they are giving up a significant amount of their negotiating power and are unlikely to maximize the selling price for their company. In a one-on-one negotiation, the seller has very few effective negotiating options. If they receive an offer from a buyer they generally need to respond with a counter-offer, which sets the maximum possible value they will receive for the company. If the buyer doesn’t accept the counter offer then the buyer can debate variables and assumptions used in determining the valuation, but unless new facts are introduced they aren’t likely to make much progress on the purchase price or other important terms. Their primary source of negotiating power is the ability to say “no” to the sale and walk away. Conversely, when negotiating with multiple potential buyers and coordinating the receipt of all offers at the same time, the seller can communicate to any of the buyers that their offer is not the best offer received and they need to sharpen their pencil and submit another offer. By using that method sellers are letting the buyers know that others in the market are offering a higher valuation for the company. If all else is equal, there isn’t a good counter argument to having others in the market offering a higher price. Further, no counter offer is communicated and thus no ceiling on valuation has been set, so there is still a possibility that one of the buyers will make an offer that exceeds the highest expectation of the seller.

Selling a company is a complicated endeavor, and is as much art as it is science. However, one thing that all experienced M&A practitioners will agree on is that creating an auction, or bidding war, is the best way to maximize the sale price and get the most favorable terms when selling a company. “War! What is it good for?”

Steven G. Sprindis, CFA, is managing director for Waypoint Private Capital Inc.

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