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Merger Revival Also Boosts 'Premiums' for Shareholders

Takeovers: Lower share prices attract bidders willing to pay higher percentage over market value to seal a deal.


As this week's bevy of big deals shows, mergers are making a comeback. More important for investors, takeover "premiums" are staging an equally significant rebound.

The takeover premium is the percentage over the current stock price that a bidder pays for its target company. For example, if a company's stock trades at $10 and it receives a buyout offer worth $13, the premium is 30%.

The average takeover premium last year was 28%, according to Mergerstat, a division of Los Angeles-based investment bank Houlihan Lokey Howard & Zukin.

But since the stock market began to pull back in mid-July, average premiums have shot up, according to CommScan, a New York-based investment banking research firm.

After falling as low as 18% in June, the average takeover premium this month is a whopping 49%.

"Spreads have increased rather dramatically over the past two months," said Wolfgang Armbruster, managing director at Wyser-Pratte & Co., a New York risk-arbitrage firm.

Of course, premiums have soared in large part because of the summer plunge in stock prices. Even though their shares have sunk, many companies believe their prospects remain strong. So they're unwilling to drop their asking prices to potential acquirers by the degree that their stocks have fallen, experts say.

"The external market has an impact on these [deals], but not percent by percent," said Jim Zukin, managing director at Houlihan Lokey. "When a stock price drops 20%, its [takeover] value will typically drop less, maybe 5% to 10%."

The revival of deals, after a sharp slowdown in August and September, has been fueled by returning confidence in financial markets worldwide--in part thanks to the Federal Reserve Board's two interest rate cuts since Sept. 29.

On Monday, six deals were announced totaling more than $24 billion. That included McKesson's $14-billion offer for HBO & Co., Kroger's $7.5-billion bid for Fred Meyer and Clorox's $1.5-billion deal for First Brands. On Wednesday, Newell agreed to buy Rubbermaid for $5.8 billion.

"The last couple of weeks we've seen a number of big deals," noted Ian Pereira, head of merger and acquisition activity for the western U.S. at Morgan Stanley Dean Witter. "That's a pretty good indication that companies are still looking out to the longer-term and there are still deals worth doing."

But the premiums offered vary widely from one deal to another.

Based on the stock prices the day before the deals were announced, HBO shareholders got a measly 11% premium, while Fred Meyer's was a negative 1%--meaning the proposed buyout value was less than the market price.

In those two deals, there are specific reasons for the low premiums. McKesson and HBO had scuttled a controversial earlier deal, and takeover rumors had driven up Fred Meyer stock in the days leading up to the announcement.

Many experts say a more accurate measure of a premium is the five-day premium, which is the offering price relative to the target's stock price a week before the deal is divulged. For HBO and Fred Meyer, the five-day premiums were each 22%.

By contrast, First Brands shareholders got a whopping 93% premium in Clorox's bid. The premium offered by Newell for Rubbermaid was 65% over the market price.

For investors who want to bet on takeovers--and potentially reap rich premiums--Charles LaLoggia, editor of the Rochester, N.Y.-based Special Situation Investor newsletter, which identifies potential takeover targets, advises looking among small- and mid-sized companies whose stock prices have been decimated.

To identify possible targets, look for smaller companies in which larger corporations already own stakes and may purchase the remainder, LaLoggia said. Look also for companies where corporate insiders are heavy buyers, he said.

LaLoggia suggests Brylane (ticker symbol: BYL), AMC Entertainment (AEN), Smart & Final (SMF) and National Presto Industries (NPK). Other potential targets include Alarmguard Holdings (AGD), Drug Emporium (DEMP), Frontier (FRO), City National (CYN), Genovese Drug Stores (GDXA) and Longs Drug Stores (LDG), he said.

For investors owning a stock that gets a takeover offer, the best advice is to sell, many experts say. Though the immediate gain in the stock price is often slightly less than the buyout offer, it's better to take the money right away.

"If you get a takeover bid, you sell it," LaLoggia said. "If you hold on for that last 5%, you run the risk that the deal will fall apart. A lot of deals [recently] have fallen apart."

Another risk: The acquirer's stock often declines after a deal is announced. If the offer is a stock-for-stock swap, that can reduce the ultimate buyout value to the target's shareholders.

McKesson's shares, for example, have slid 7.3% since Monday, pulling HBO's shares down 5%.


What Takeovers Are Fetching

After a two-month lull, mergers are back on track and more are expected. But the "premium" that target stocks receive from suitors--the percentage of the bid price over the stock's market pricecan vary widely. Here are recent big deals and the premiums versus the target's price five days before the offer was made.


Deal size, Takeover Announced Buyer Seller in millions premium Oct. 19 McKesson HBO & Co. $14,142.77 22% Oct. 19 Kroger Fred Meyer 7,531.58 22 Oct. 21 Newell Rubbermaid 5,799.15 65 Oct. 9 Cardinal Health Allegiance 4,348.39 32 Oct. 8 Clear Channel Jacor Comm. 2,639.67 10 Oct. 15 Kerr-McGee Oryx Energy 1,840.08 55 Oct. 19 Clorox First Brands 1,522.76 93 Oct. 5 AT&T Vanguard Cellular 969.34 23 Sept. 28 HBO & Co. Access Health 963.64 36 Oct. 13 Safeway Dominick's 914.79 21


Source: Mergerstat

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