Biotech Values

[DewDiligence]

Why the Kneejerk Response to Buyout Offers is No

http://blogs.wsj.com/deals/2010/10/14/in-ma-shareholders-win-may-be-ceos-loss

›In M&A, Shareholders’ Win May Be CEO’s Loss

October 14, 2010, 5:49 PM ET
By Gregory J. Millman

Many CEOs stand to come out losers if they sell their companies, even when shareholders would reap a substantial premium.

Only 14.5% of chief executives would do better selling their companies at a 25% premium than they would under their current pay packages, according to an analysis of compensation packages for CEOs of companies in the Standard & Poor’s 1500 index by compensation consulting firm Shareholder Value Advisors.

In many cases, the loss of expected future pay and the option time value would more than wipe out gains on equity and on the spread between the option exercise price and the take-out price.

Consider Genzyme CEO Henri Termeer. The board has twice rejected Sanofi-Aventis’s recent hostile $69-a-share offer as inadequate. The price is a 27% premium to Genzyme’s $54 closing price on July 22, the day before reports of Sanofi’s interest.

Though shareholders could pocket the premium, he would be a net loser, as the gain on his stock would be more than offset by the loss of future pay and the loss on time value of his options. Genzyme declined to comment.

Sanofi would have to offer $71 a share for Termeer to break even. To improve on his July 22 position by 25% Sanofi-Aventis would have to offer around $90–well above Genzyme’s roughly $80 historic high in January 2008.

Dow Jones Investment Banker asked Stephen O’Byrne of Shareholder Value Advisors to rank the CEOs of S&P 1500 companies by the answer to the question, “Would a target company CEO win or lose in an acquisition that brought target shareholders a 25% premium?” The analysis showed that only 14.5% of CEOs would be richer if they backed such an offer and departed the company.

The analysis covers 924 firms from the S&P 1500, based on the data from ExecuComp current as of December 2009. Excluded are companies that changed CEOs since then. Also excluded are CEOs whose tenures are too short to estimate future pay, and firms no longer in the S&P 1500. The 25% threshold is a rounding: The average premium over a preannouncement stock price for acquisitions of S&P 1500 targets in the last three years has been 27%. [The average for biotech buyouts during the past few years is higher than that—see #msg-55426176.] This Excel spreadsheet shows how far these CEOs’ interests may diverge from shareholders’ interests.

The CEO perhaps best positioned in a sale situation is Paul D. Finkelstein of Regis Corp., a hair salon franchiser with a roughly $1 billion market cap. The analysis indicates that Finkelstein’s wealth totals $27 million but would jump to $66 million if the company sold at a 25% premium. He is one of six CEOs who would at least double their wealth in such a sale. Regis didn’t return phone calls seeking comment.

The analysis also showed that most CEOs–729, or 78.9%–would be significantly worse off (more than a 5% loss) if their companies were acquired at a 25% premium, though shareholders likely would be better off. Of those CEOs, 428, or 46% of the full sample, would see their wealth fall by 50% or more in a sale that brought shareholders a 25% premium.

Another 61 (6.6%) CEOs would come out roughly even (within +/- 5%) with a sale at a 25% premium.

The analysis factors in three basic elements of compensation: equity (stock and options); the present value of expected future pay; and pension. The analysis is based on pretax numbers and assumes a retirement at 65. The analysis doesn’t factor in the possibility that the CEO of a target company might be retained by the new owners or find another job, mitigating any losses.

Termeer’s case shows how a CEO can come out a loser. Under Sanofi’s $69-a-share offer, the Genzyme CEO would show a profit of $8.5 million on his Genzyme options (which increase in value from $62.4 million to $70.9 million) and $9.6 million on his Genzyme stock. The 13.6% gain on the options—roughly half of the premium shareholders would pocket in the sale–comes because the higher stock price is offset by his loss of the time value of the options.

Termeer also would get a cash change-in-control payment of $11 million. So he would pocket $29 million if Genzyme accepts the $69-a-share offer. However, he would lose $38 million in the present value of three year’s future pay and so would end up $9 million in the hole.‹