 Madness of Hostile Bids
Adam Hamilton
Archives
December 27, 2004
For gold-stock investors and
speculators, 2004 proved fascinating on multiple fronts. While
gold stocks didn't perform as well as they did in 2003 in general,
they still offered returns far in excess of the mainstream stock
markets for contrarians willing to buy during the wicked spring correction.
And with the underlying gold bull still in Stage
One, the best is almost certainly yet to come.
As I reflect on this past year,
one thing that really sticks out in my mind is the frenzy of
gold-stock mergers and acquisitions. Of the 15 companies that
make up the flagship HUI gold-stock index, an amazing 7 tried
to acquire other gold or silver miners during the course of 2004!
The fabled gold-stock bull is finally stirring up some excitement
four years after it stealthily
launched in November 2000.
For gold miners, the urge to
merge is totally understandable. Unlike your average information
company that can spin up to full operations from nothing in under
a year, it usually takes 3 to 5 years to develop a gold mine,
sometimes much longer if all the fruitless exploration before
the big mineralization discovery is considered. As such, it is
very difficult for gold miners to grow organically at any reasonably
rapid pace.
And investors and speculators,
as you and I well know, demand rapid growth. We are monumentally
fickle with our capital and will chase the best growth stories
in our sectors of choice, gold and silver stocks at the moment.
Thus, in order to attract our capital and praise managements
at the gold companies are under immense pressure to add to their
reserves and mine production through acquisitions.
From an investor's perspective
though, there is an expensive dark side to all of this frenzied
acquisition activity. Depending on how potential deals are executed,
acquisitions can cost the shareholders of the acquiring
company dearly. And since the numero uno mission of management
is to enhance value for existing shareholders, they have to be
ever cognizant of the great damage they can wreak on shareholders
from ill-structured deals.
The worst type of acquisition
possible for the acquiring shareholders is the hostile bid. In
general a hostile bid occurs when the acquiring company launches
a takeover campaign without the consent of the target company.
In order to finance these hostile bids, the acquirer usually
dilutes its existing shareholder base, reducing their ownership,
by issuing new shares to finance the potential deal. Fears of
excessive dilution virtually always spawn sharp selloffs when
hostile bids are announced.
With at least 4 of the 7 major
HUI component acquisition attempts in 2004 outright hostile,
without the consent of the target, I would like to discuss their
ugly impact on investors this year. This is not purely academic
for me either, as I, my partners, and our clients were blasted
out of positions in acquirers when our stops were nearly immediately
hit in 3 of these 4 hostile HUI deals.
For the purposes of this essay,
I am not interested in whether a deal actually went through or
was voted down. Instead I am focusing solely on the brutal immediate
impact on the shareholders of the acquiring company when a hostile
bid is announced. Free markets exact swift and merciless judgment
on hostile bidders.
There is no quicker way for
managements to kick their existing shareholders in the teeth
than to announce a hostile bid. Actually, I am surprised bloodthirsty
lawyers aren't all over this as strong cases can be made that
managements brazenly violate their fiduciary duties to shareholders
by going hostile. The ugly results are so predictable that no
manager on earth could convince a judge that he had no idea that
his hostile bid would crush his shareholders.
Our lone graphic this week
is kind of a flowchart that shows who was bidding for whom in
the HUI in 2004, and whether their bid was hostile or a more
amiable mutually consented merger. In order to determine if a
particular bid was hostile, we went back to the original press
releases and accompanying financial news stories released the
day the announcements were originally made. If you disagree
with the classification of any of these deals, your argument
is with the press releases and day-zero news stories released,
not me.
Each HUI acquirer is colored
in red or blue, for hostile or amiable buyout attempts respectively.
The only stock on this chart that is not a member of the HUI
is WHT, but WHT was just the most sought-after merger target
in 2004, it didn't do any major HUI acquisition attempts itself.
As you look at the arrows, marvel at our incestuous little gold-stock
world!
Under each acquisition attempt,
hostile or amiable, a small chart is rendered. These charts show
the acquiring company's stock performance 10 days before through
60 days after bid announcements. In addition, under the hostile
bid attempts there is a number that shows the potential acquirer's
stock performance in the single trading day of the announcement
(if announced during market hours) or after the announcement
(if announced after market close).
The inescapable conclusion,
which managers at acquiring gold companies should consider very
carefully, is that hostile bids have very high costs for existing
shareholders in terms of the tremendous loss of market capitalization
suffered when dilution is feared from an expensive potential
deal. As far as I can tell there is generally no other way for
a gold company to hurt its shareholders faster than by going
hostile.
These tiny
charts really drive home why shareholders get so irate with their
managers when they go hostile. It is no wonder that investors
often feel their managers are telling them to "go to hell"
when they embark on such a reckless course with a nearly guaranteed
unpleasant outcome. The table in the lower right of this graphic
shows the average losses by acquiring HUI shareholders in the
trading days after a hostile bid is announced.
Within only
one trading day after the acquiring company announces it is trying to buy the target
without the target's consent, the acquiring shareholders take
a vicious 7.4% hit on average. 7.4% in a single trading day is
staggering, it annualizes out to something like an 1850% loss!
I believe this brutal first day hit is due to the fact that managers
often choose to dilute existing shareholders with new stock,
the corporate equivalent of governments printing fiat currency
for nothing, rather than prudently saving up and paying 100%
cash for their acquisitions.
Now managers could argue with
us investors that a one-day 7.4% hit is manageable. But the losses
just get worse on average. By trading day 5, the average HUI
hostile acquirer was down 10.4%. They kept falling to 12.3% by
day 10. Six weeks after the announcement, 30 trading days later,
the average loss grinded lower to 13.6%. By twelve weeks after
their hostile bids, trading day 60, the HUI hostile acquirers
were down 21.9% on average. Ouch!
In 2004, on average, the shareholders
of HUI companies that went hostile lost a horrific one-fifth
of their entire capital in the twelve weeks following the announcements.
Arguments about potential long-term value of acquisitions aside,
this is a big problem for any investors that actively manage
their risk as all prudent investors should. If investors run
20% trailing stops on positions to protect themselves from the
inevitable periodic HUI
corrections, then they can easily be stopped out by hostile
bids alone.
If selling to avoid excessive
future dilution is so intense during an average hostile bid that
it drives the acquiring company low enough to run stops, the
damage done can intensify significantly. The mechanical sell
orders after a certain percentage retreat add more cascading
downside pressure to the already wounded acquirer and magnify
its losses. Even more investors are induced to sell as its price
is driven lower and lower in a vicious circle. And the hostile
bid is the catalyst that ignites it.
This ugly phenomenon is certainly
not a hostile-only thing. When IAG attempted to merge amiably
with WHT, it plummeted 9.4% on day 1, 19.6% by day 10, and a
staggering 32.6% by trading day 30 only six weeks later! Provocatively,
the only time a HUI stock actually rose after a merger announcement
was when IAG solicited GFI to do a reverse merger to fend off
GSS's hostile bid. It was only in this white-knight scenario
in 2004 when the acquirer didn't initiate that its stock price
didn't take a serious hit.
In every other case though,
usually moreso on hostile bids, the acquiring shareholders were
kicked in the teeth. It is interesting to note that these 7 HUI
acquiring companies in 2004, collectively, command 44.8% of the
total market capitalization of the entire HUI index! Thus, odds
are high that the steep acquirer selloffs are a material factor
in the surreal decline of the HUI
leverage to gold that we are now witnessing. The hostile
bids may be not only hurting their shareholders, but the progress
of the HUI bull in general.
And sometimes the fallout from
these hostile bids goes far beyond the steep initial losses.
A key case in point is GSS, the single biggest gold-stock disappointment
in 2004 in my opinion.
Just over a year ago, in the
December 2003 issue of our Zeal Intelligence newsletter still
available on our website for our subscribers, we did a comprehensive
technical screen of all the blue-chip gold and silver stocks
of the HUI and XAU. The goal of the screen was to find the best
potential performers for the next upleg due to start in 2004
after the anticipated
correction. Out of every company in the HUI and XAU, GSS
emerged the shiny winner at the very top of the heap.
As of December 2003, GSS had
dwarfed the gains of the HUI on average in each of its four preceding
major uplegs. Its bull-to-date leverage to the HUI itself at
the time was a magnificent 2.5x, meaning that it tended to go
up on average two-and-half times whatever gain the HUI managed
to achieve in a particular upleg. GSS's leverage to gold was
even more mind-boggling, 15.7x bull to date at the time. The
company was a gold superstar.
Like virtually all other major
gold stocks, GSS corrected in early 2004 in line with the HUI
as it should have. It even started rallying sharply with the
HUI at its bottom in early May, again right as expected. But
on May 27th when GSS management suddenly went hostile at IAG,
the whole winning aura of GSS fell apart. Since that fateful
day of infamy, GSS has struggled and generally grinded lower
while most other HUI stocks went on to decent 2004 rallies.
GSS not only fell 6.4% the
day its hostile takeover attempt was announced, it plummeted
again when the financial carnage of this ill-fated gambit became
public in its SEC-filed financials. On August 16th IAG announced
it was refusing GSS's hostile offer and instead had created an
agreement with GFI, calling in GFI as a white knight to save
it from a predatory GSS. Then on November 3rd after market close
GSS released its Q3 financial results, including the IAG hostile
bid expenses it was forced to write off.
The next day alone, over five
months after GSS's hostile bid, its stock plummeted by another
12.1% on the Q3 losses. This stopped us out too, no big surprise,
for a modest realized profit. Incredibly 91% of the $4.3m loss
was a direct writeoff of costs incurred by GSS in going hostile
on IAG! Thus, negative fallout from hostile bids can hammer shareholders
hard many months after the bids and even after they fall through.
Hostile bids are the curse that keeps on cursing!
I have talked with several
consulting clients of mine, savvy gold-stock players with 7-figure
gold-stock portfolios, who have just flat out lost confidence
in GSS's management due to this hostile bid nonsense. They were
as excited as I was last year about GSS, but after seeing its
management squander most of its reputation with investors by
going hostile, it is going to be hard for GSS to earn back their
trust.
Not only did GSS lose market
capitalization and profits, but it forfeited the far more valuable
and harder-to-win-back trust and respect of many investors. It
has also modestly dragged down the HUI with its poor 2004 performance,
but thankfully it makes up less than 5% of the flagship gold-stock
index.
As a speculation masochist,
I still like GSS and may buy and recommend it again in
the next upleg so I am not trying to unduly single it out in
this essay, but for me personally it is the shining 2004 example
of why hostile bids can be so catastrophic for shareholders in
acquiring companies. Believe me, similar dark tales of woe can
be weaved for CDE and HMY too, and maybe GLG a few months from
now.
Since these initial hostile
bid announcements are totally beyond the control of us shareholders,
the onus of finding a better way to do things really falls on
our managers. Gold-company managements must balance their need
to grow with ensuring that existing shareholders are not brutally
beaten to a bloody pulp when managements decide to launch acquisition
campaigns. I have a few ideas for managers to consider.
First and foremost, resist
the big temptation to go hostile. Yes it is an adrenaline rush
to be a wheeler and dealer and yes it is the simplest way to
undertake a business combination since no real groundwork needs
to be laid with the target. But, even if the bid is successful
odds are the staggering costs to your existing shareholders,
not to mention your reputation, may ultimately prove to be too
high to justify the acquisition.
If you truly feel that your
company and another company may be far more valuable to both
sets of shareholders as a combination, then try to pull off
an amiable merger. Your managers can talk with the other company's
managers quietly, behind the scenes, with absolutely nothing
going public. If both Boards of Directors then agree that the
combination would be favorable and mutually beneficial, then
you can jointly announce the amiable merger via a press conference.
If one company is perceived as the de facto acquirer it may still
take a stock hit, but probably not as much as it would via a
hostile bid.
If the other company doesn't
want to merge amiably, then so be it. No sense in going hostile.
Managers change and perhaps the potential target will change
its mind down the road a little ways. Remember that hostile bids
have a way of escalating out of control as egos get involved,
and it is not prudent nor sound from a fiduciary perspective
to pay too high of price for another company's mines and assets.
An excessively high purchasing price can destroy return on investment
for years to come.
There are also some structural
strategies that you can follow to ease the impact of a merger
on your shareholders. If you want to buy another company, don't
start merger talks until you can offer an all-cash deal.
Gold-stock investors in general hate fiat currencies and the
practice of companies issuing stock out of nowhere to dilute
them is painfully like governments printing fiat. Dilution is
like inflation, in a sense unfairly taxing existing shareholders.
If you can pull off a deal without dilution, paying 100% cash,
the markets will smile on it much more favorably.
Another key thing to consider
is to not to bite off more than you can chew. Some of the acquisition
proposals in 2004 were asinine, smaller companies trying to eat
far bigger companies which necessarily means massive dilution
and probably big debt. Just as most fish in nature generally
feed on fish smaller than themselves, it is much easier to do
all-cash deals if you only look at targets significantly smaller
than your company. Rather than stalking majors or intermediates
that you have to dilute to buy, buy up small juniors for cash
instead. Many juniors have great promise and they are very cheaply
valued compared to expensive HUI gold stocks.
Finally, don't forgo or give
up on truly organic internal mine growth. Exploring and growing
your own properties is usually far more cost effective over the
long run then paying someone else a huge premium for their exploration
and development work. Internal organic growth is far slower than
acquisitions most of the time, but it ends up building stronger
and more financially sound companies. A tightly run carefully
grown company is far more valuable to investors than a loosely
stitched together Frankenstein's Monster of expensive acquisitions.
Hostile bids may seem attractive
up front, but there is an indisputable madness about them when
the typical fallout on acquiring shareholders is systematically
studied. Hostile bids should almost never be used, as the costs
are so high in market-cap, profits, reputation, and trust terms
that the benefits of a business combination may not be able to
overcome the negative stigma for years. Hostile bids are usually
bad all the way around.
The frenzied HUI merger mania
of 2004 really shuffled the elite gold stocks around in terms
of their relative attractiveness for investing in the next major
HUI upleg. At Zeal right now we are hard at work researching
some big internal gold-stock studies to try and find the best
candidates for investment and speculation going forward in this
gold bull.
We hope to publish this exclusive
gold-stock research for our monthly Zeal
Intelligence newsletter subscribers
sometime in the coming months as we finish various stages of
it. Don't miss it if you are getting ready to reinvest in the
next major gold and silver uplegs!
The bottom line is the madness
of hostile bids is difficult to argue against. Hostile bids in
general do more serious damage to stock prices and acquiring
company shareholders than almost any other events, including
bad negative earnings surprises. Mergers are fine if executed
properly via mutually amiable acceptance and little or no dilution,
but hostile bids tend to muck up an acquirer for a long time
to come.
Managers need to refrain from
going hostile and shareholders have to strive to hold managers
accountable if they destroy shareholder wealth by going hostile.
Shareholders should vote no on any hostile deal, period,
that has hurt their wealth by seriously eroding the market capitalization
of a company they own. They should also fire managers who brazenly
violate their fiduciary duty to shareholders by going hostile.
There are certainly better
ways to grow gold-stock companies than unleashing the madness
of hostile bids!
December 24, 2004
Adam Hamilton, CPA
email:
zelotes@zealllc.com
Archives
 So how can you profit from this information? We publish an acclaimed
monthly newsletter, Zeal Intelligence, that details exactly
what we are doing in terms of actual stock and options trading
based on all the lessons we have learned in our market research.
Please consider joining us each month for tactical trading details
and more in our premium Zeal Intelligence
service.
Questions for Adam? I would be more than happy to address them
through my private consulting business. Please visit www.zealllc.com/financial.htm for more information.
Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering
and perpetually increasing e-mail load, I regret that I am not
able to respond to comments personally. I will read all messages
though and really appreciate your feedback!
 Copyright ©2000-2004
Zeal Research All Rights Reserved (www.ZealLLC.com)
321gold Inc
|
