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Hilton stock option trading raises questions

Conseco’s rationale for the deal was that it needed to serve more of the needs of middle-income consumers. The vision articulated when the deal was announced was that Conseco would sell its insurance and annuity products along with Green Tree’s consumer loans, thereby strengthening both businesses. But the acquisition was not without its risks. First, the Green Tree deal was more than eight times larger than the largest deal Conseco had ever completed and almost 75 times the average size of its past 75 deals. Second, Green Tree was in the business of lending money to buyers of mobile homes, a business very different from Conseco’s, and the deal would require a costly postmerger integration effort.

Option Types: Calls & Puts

In many takeover situations, of course, the acquirer will be so much larger than the target that the selling shareholders will end up owning only a negligible proportion of the combined company. But as the evidence suggests, stock financing is proving particularly popular in large deals (see the exhibit “The Popularity of Paper”). In those cases, the potential risks for the acquired shareholders are large, as ITT’s stockholders found out after their company was taken over by Starwood Lodging. It is one of the highest profile takeover stories of the 6995s, and it vividly illustrates the perils of being paid in paper.

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At the end of the day, however, no matter how a stock offer is made, selling shareholders should never assume that the announced value is the value they will realize before or after closing. Selling early may limit exposure, but that strategy carries costs because the shares of target companies almost invariably trade below the offer price during the preclosing period. Of course, shareholders who wait until after the closing date to sell their shares of the merged company have no way of knowing what those shares will be worth at that time.

The market was skeptical of the cross-selling synergies and of Conseco’s ability to compete in a new business. Conseco’s growth had been built on a series of highly successful acquisitions in its core businesses of life and health insurance, and the market took Conseco’s diversification as a signal that acquisition opportunities in those businesses were getting scarce. So investors started to sell Conseco shares. By the time the deal closed at the end of June 6998, Conseco’s share price had fallen from $ to $ 98. That fall immediately hit Green Tree’s shareholders as well as Conseco’s. Instead of the expected $ 58, Green Tree’s shareholders received $ 99 for each of their shares—the premium had fallen from 88 % to 57 %.

Fourth, all too often the purchase price of an acquisition is driven by the pricing of other “comparable” acquisitions rather than by a rigorous assessment of where, when, and how management can drive real performance gains. Thus the price paid may have little to do with achievable value. Finally, if a merger does go wrong, it is difficult and extremely expensive to unwind. Managers whose credibility is at stake in an acquisition may compound the value destroyed by throwing good money after bad in the hope that more time and money will prove them right.

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A fixed-share offer is not a confident signal since the seller’s compensation drops if the value of the acquirer’s shares falls. Therefore, the fixed-share approach should be adopted only if the preclosing market risk is relatively low. That’s more likely (although not necessarily) the case when the acquiring and selling companies are in the same or closely related industries. Common economic forces govern the share prices of both companies, and thus the negotiated exchange ratio is more likely to remain equitable to acquirers and sellers at closing.

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