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Handle with care. As management buy-out fever sweeps the US, ever more executives are flirting with the idea of taking their company private.
Such deals are riddled with possible conflicts of interest. Most obviously, executives involved in a bid have an interest in minimising the price they pay rather than maximising the value ordinary shareholders receive. As managers, they have better information than the independent directors and external shareholders. Also, if management links up with financial sponsors, it is tough for rival bidders to compete. Instead of shouting about new profit opportunities – to drive bids higher – executives can keep ideas to themselves. To add insult to injury, management can collect change of control payouts, before loading up on incentives in the buy-out vehicle.
Boards should be on red alert. MBOs make it tough to create a real auction. In extreme cases, executives who are also dominant shareholders can even rule out competing offers. Some bids are opportunistic moves to capitalise on an oversold share price – private equity can take a longer view than public equity markets. Sometimes approaches should be rejected because it is simply the wrong time to sell. At the very least shareholders should think hard when well-informed buyers see extra value.
But MBOs should not be dismissed. At today’s levels, equities are not obviously undervalued. If private equity buyers add a decent premium, offers can be attractive. In some cases, over-exuberant debt markets – acting like default risk is a thing of the past – might be providing the fuel for prices equity investors might otherwise not see for a while. After all, rising leverage multiples and low interest rates are letting deal-hungry sponsors buy ever bigger companies with limited equity.
MBOs should be distrusted. Boards should turn deals down if the timing is wrong. If it is not, they should do everything possible to create an auction. But not all buy-outs will deliver huge returns. With debt markets funding increasingly aggressive deals, canny sellers could, in some cases, have the last laugh.
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