Merger Posturing and Agency Dilemmas
As I watch takeover announcements, something called the principal-agent problem crosses my mind. Also called “the agency dilemma”, it can be described as follows (paraphrasing from wikipedia):
More specifically, the owners of a company hire managers to run the company on their behalf. Those managers, often called “officers” are better known as the CEO, President and other corner office, executive suite titles. The owners or shareholders elect a board of directors who are supposed to find, hire and compensate managers so that owners’ interests are aligned with management’s interests. Put more simply, if management makes the company more money, the managers earn more money too- at least that is usually the intent.
We have discussed compensation a number of times here at TLRB, but here is yet another way this issue crops up: when one company bids to take over another company. The case in point that brought this to mind is Kraft’s bid for Cadbury. Kraft is seeking to acquire Cadbury on the basis that each has different strengths in different markets: Cadbury is strong in developing markets and could help accelerate the distribution of Kraft products there, while Kraft has increased buying power and distribution might in other markets. The combination makes a certain amount of sound strategic sense, depending on the price Kraft is willing to pay for Cadbury.
When the offer was made in early September, Kraft offered a 31% premium to Cadbury’s stock price at the time. Cadbury’s management immediately rejected Kraft’s offer. Here is where it gets interesting: in a statement, Cadbury said the proposal “fundamentally undervalues the group and its prospects,” adding that the board is confident in the company’s stand-alone strategy. The first take on this statement seems to mean that management and the board believe the company is worth more and are going to reject the first offer in hopes of a higher offer. That is exactly what they should do.
But, we could also read that management wants to protect its interests, namely jobs, compensation and future stock appreciation. The board, which we all know is handpicked by management, is generally on the side of management. After all, they have cushy director jobs to protect too. The idea that a 31% premium to the market price is fundamentally undervaluing the company is a pretty weak claim. If the company was really that attractive on its own, don’t you think the market and the shareholders would have valued more? We aren’t talking about tech or biotech companies with unknown growth potential. Instead we’re talking about well established businesses that are easy to understand, easy to handicap and easy to value. So the “fundamentally undervalued” argument is disingenuous at best.
How can we tell if this is the agency dilemma at work or simply the merger dance in action? I’m not so sure you can tell. Management should be doing what it can to maximize the sale price, including rejecting the offer and talking tough. On the other hand, Cadbury’s CEO, is acting a bit dodgy. Quoting from the WSJ:
The company claimed in a brief statement that Chief Executive Todd Stitzer’s comments at an investor conference this week had been “misconstrued.”
“For the avoidance of doubt, Mr. Stitzer does not believe that Kraft’s proposal makes strategic or financial sense for Cadbury and his comments should not be interpreted in any other way,” the company said.
Those are some harsh words. It is tough to deny the merger makes strategic sense, which he does anyway. Furthermore, no competing offers have arisen yet- so other companies don’t see value in paying more for Cadbury either. Can the CEO really think the company is better off worth 30% less? Will the shareholders be pleased? How will the CEO reverse his sentiment if Kraft decides to offer a little more?
As it stands now, it looks as though this may end up as a tender offer where shareholders will either approve or disapprove. Management will get to make its case and try to convince them that going it alone and foregoing the payday and expanded global reach is a good idea. As an investor who has met with both sides of similar deals many times, I can tell you that I’ve never been confident whose side management is really on.
I hope watching this merger mambo is as fun for you as it is for me.
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