QUESTION: What do Trans World Airlines Inc., Beatrice Cos. Inc., MGM/UA Entertainment Co., R. H. Macy & Co. and Baltimore's Easco Corp. have in common?
ANSWER: They all recently signed agreements to sell out to another company, only to have their buyer later lower the offer.
Some investment bankers said that special circumstances in each of these deals -- such as larger-than-expected losses by TWA -- led to lower takeover bids.
But others believe the revised deals reflect problems on Wall Street. Shareholders of TWA, Beatrice and MGM/UA have been hurt as stock prices plunged following revised bids.
One of the problems investment bankers cited is the growing difficulty in financing takeovers with high-yield securities known as "junk bonds." Another problem in several recent deals was that bidders agreed to pay unrealistically high prices, without have financing lined up, investment bankers said. A third, more serious, problem is an abusive takeover strategy in which a suitor eager to win a bidding war agrees in writing to pay a high price for a company, figuring the bid can be lowered later.
"In each of these situations, there is some unusual wrinkle to the deal," said Martin Sikora, editor of Mergers & Acquisitions magazine. "But usually it is the unique ones that are on the leading edge if there is going to be a problem. This is sort of an alert sign."
After seeming for months as though it could arrange financing for almost any takeover through the sale of junk bonds, Drexel Burnham Lambert Inc. has encountered serious problems raising funds for Ted Turner's bid for MGM/UA Entertainment Co. That deal is in danger of falling through following Turner's unsuccessful attempt to raise cash by selling some MGM assets or a minority stake in his Cable News Network.
The deal has hurt Drexel's credibility, because the firm issued a letter saying it was "highly confident" of its ability to arrange Turner's financing. Turner initially agreed to pay $29 a share in cash for MGM but then lowered his offer to $25 a share in cash and $4 a share in stock. This week, Turner said the deal would have to be renegotiated again because of difficulty in arranging financing.
Drexel, the leading Wall Street purveyor of junk bonds, also helped arrange financing for Carl Icahn's lowered bid for TWA and Kohlberg Kravis Roberts & Co.'s lowered bid for Beatrice. Drexel frequently sells these high-yield securities, which are rated "below investment grade," to finance takeover bids that rely heavily on borrowing.
Investment bankers, including E. F. Hutton merger chief Dan Good, said yesterday that buyers of junk bonds are growing more conservative and are requiring bidders to put more of their own money into deals. Drexel's Leon Black disagreed. Black said unique factors contributed to problems with each of the deals, adding that Drexel is confident the market for junk bonds is as strong and viable as ever.
Last week, the Federal Reserve Board adopted a new rule restricting the use of junk bonds in certain hostile takeovers. However, none of the investment bankers interviewed suggested any connection between the Fed's move and the difficulty Drexel is having in arranging junk-bond financing for some deals.
"I don't think there is necessarily anything sinister going on," said Stephen Waters, head of the merger department at Shearson Lehman Brothers. "For most of these takeover targets , the winning bidder has come up with a top-dollar offer. He then gets to go and study the target company's confidential books and frequently finds things are not quite as good as he hoped.
"He uses that to renegotiate. At that point, the interest of other bidders may have waned or the company being sought may have fewer choices, so you may not be in that bad a bargaining position if you want to try to re-cut the deal . I don't think it is a function of banks and other lenders getting tighter on lending."
Beatrice is the biggest takeover target involved in a deal in which the offer was lowered after a merger agreement was signed. The Beatrice board of directors met yesterday to consider a revised $6 billion offer from the New York buyout firm of Kohlberg Kravis Roberts & Co.
Initially, KKR agreed to pay $43 in cash and $7 in stock for each share of Beatrice stock, but retained the right to lower its offer after studying Beatrice's private financial information. After looking at the company's books, KKR lowered its per-share offer to $40 in cash and $10 in stock. KKR's new offer, which relies heavily on borrowing, also gives it the right for several years to issue additional stock to pay dividends, rather than paying dividends in cash.
Sources said KKR was not forced to lower the cash share of its bid because of difficulty in arranging financing, but chose to reduce the bid after becoming aware of some potentially negative tax matters at Beatrice.
In a similar situation, the Rales brothers agreed to acquire Easco Corp. for $20.50 a share in cash, and then signed a revised agreement this week at $17.50 a share. Sources said the bidders lowered their offer after discovering potentially costly environmental problems in Easco's New Jersey operations.
Several investment bankers and buyout specialists said privately they do not believe all of these bids are being lowered for the reasons stated. They said there are significant financial gains for the savvy bidder who lowers his offer, although the damage to a bidder's reputation could hurt credibility in future deals.
Hutton's Good said that, if this trend continues, companies may consider making bidders pay penalties if they lower the price from their original merger agreement.