In M&A, Cash Isn’t Always King


In stark contrast with its near-death experience over the summer, Knight Capital Group (NYSE:KCG) now finds itself in the enviable position of evaluating not just one but two takeover bids.

But like some companies at the center of a bidding war, Knight’s board and management must weigh the pros and cons between deals with vastly different compositions: an all-cash offer and a more lucrative bid that contains a mixture of both cash and stock.

The preference among most boards tends to skew towards all-cash bids due to the freedom they offer, but target companies must consider a litany of factors, including tax implications, the future prospects of the acquirer’s share price and legal ramifications.

“One size does not fit all. You can’t say that one method of payment is best. It really does depend,” said David Becher, a finance professor at Drexel University.

It’s clear, though, that companies are increasingly reaching all-cash deals in favor of share swaps.

Cash Deals Offer Speed, Certainty

According to Dealogic, 65% of the $662.49 billion worth of U.S. deals announced this year have been all-cash, compared with 15% in shares only and 20% that were a mixture of the two.

By comparison, Dealogic said 59% of 2011’s $770.52 billion of deals and just 37% of the $679.25 billion of transactions in 2009 were all cash. The numbers were even more skewed back in the heady days of the dotcom era, when just a quarter of deals had no stock component.

If given a choice, many companies would choose to ink a deal that is comprised entirely of cash, like the $1.6 billion buyout (NASDAQ:ACOM) landed in October from a group of investors.

“Cash is cash. It’s a highly liquid way for a company to get an exit,” said Peter Fitzpatrick, a partner at K&L Gates. “All things being equal, as long as the valuation is correct, I think boards place greater value on an all-cash offer.”

Cash transactions also tend to be faster to execute from a regulatory standpoint than all-stock or mixed transactions.

That may help explain why Knight Capital’s board and management are strongly considering an all-cash takeover bid from high-speed trading firm Virtu believed to be valued at $3.00 to $3.20 a share -- as much as 14% less than a cash-and-stock bid from Getco worth $3.50 a share.

“In these uncertain times, cash is a good thing,” said Fitzpatrick.

Tax Hits Weighed

Of course, a great deal of today’s uncertain environment surrounds the murky tax outlook caused by the fiscal cliff.

One major drawback of an all-cash deal is that shareholders will be on the hook to pay potential capital gains taxes -- which are likely to climb from their current levels. On the other hand, an all-stock transaction would likely defer tax hits for shareholders.

“There is a question about whether a taxable transaction will be good for your shareholders,” said Larry Laubach, chair of the corporate law practice group at Cozen O’Connor.

Some cash deals also carry the added risk that the acquirers won’t be able to finance the transaction or that the financing itself could collapse, scuttling the deal.

Execution Risk Looms

While buyouts that contain at least some component of stock may have favorable tax implications, they do carry potential risks.

One major concern for a target company is that the acquiring company’s stock could lose value due to macroeconomic troubles or execution errors, thereby hurting shareholders.

“The selling shareholders always continue to bear the risk of whether the combination will be successful,” said Fitzpatrick.

Although it didn’t involve two public companies, one example of a stock deal backfiring is the $1 billion cash-and-stock buyout of Instagram by Facebook (NASDAQ:FB) earlier this year.

In retrospect, Instagram’s owners would have probably preferred to accept all cash rather than Facebook shares, which plummeted more than 50% from their initial public offering value.

Stock Deals Dominated in Dotcom Bubble

The M&A market exploded during the dotcom boom, topping out at $1.45 trillion of announced deals back in 1999 just before the bubble burst.

According to Dealogic, a whopping 74% of transactions that year were paid for with some form of stock and all-stock deals peaked at 76% in 1998.

“It was all funny money. People were paying inflated prices but with inflated stock,” said Scott Eisenberg, a managing partner at boutique investment bank Amherst Partners.

That means many shareholders whose companies were lucky enough to be acquired before the bust were left holding equity that eventually evaporated anyway.

Legal Ramifications Weighed

No matter the composition of the deal eventually sealed, companies must always be mindful of the threat of shareholder lawsuits, especially if a more lucrative offer is left on the table.

Shareholders “could craft an argument it’s been sold for less than it’s worth and there’s been a breach of fiduciary duty. There’s always that risk if you’re accepting a lesser price,” said Fitzpatrick.

However, courts typically give boards “a lot of latitude in negotiations -- as long as they are acting in good faith,” said Becher.

If push comes to shove, legal experts believe it’s far easier for a board to defend taking an all-cash deal than one that includes stock.

“A board member can always pose the argument that cash is the strongest currency you can get,” said Fitzpatrick.