Operating performance and free cash flow of asset buyers

Financial Management (Financial Management Association), Winter, 2003 by Steven Freund, Alexandros P. Prezas, Gopala K. Vasudevan

Following the purchase, asset buyers overall experienced a decline in operating performance relative to year -1. The declines are large and persistent on raw, industry-adjusted, and matched-firm-adjusted levels of performance.

Next, we regress the change in unadjusted operating performance against a dummy variable that equals 1 if the payment is cash only, a dummy variable that equals 1 if the asset purchased and the buyer firm are in the same industry, the free cash flow of the buyer, and the log of the buyer's book value of assets. We use the raw rather than adjusted performance because the independent variables are the firm variables. (7)

Table VII reports the results. The dependent variable in the first column of the table is the change in operating performance from year -1 to 1 for the overall sample. The only significant variable is free cash flow scaled by the book value of assets. The coefficient of the free cash flow variable is -0.212, significant at the 1% level. This suggests that, compared to the year prior to the purchase, buyers with large amounts of free cash flow experience a performance decline in the year following the transaction. The F-value is 4.94 (significant at the 1% level) and the adjusted R-squared is 4.8%.

The second column reports the results for the overall sample when the dependent variable is the change in operating performance from year -1 to 2. The only significant variable is the free cash flow variable. Its coefficient is -0.379, significant at the 1% level. The F-value is 8.00 (significant at the 1% level), and the adjusted R-squared is 8.4%.

The third column reports the results for the overall sample when the dependent variable is the change in operating performance from year -1 to 3. Again, the coefficient of free cash flow is negative, -0.349, and significant at the 1% level. The coefficient of free cash flow in the second and third column is much larger than that in the first column. This implies that free cash flow has a larger effect on long term performance. The coefficient of the book value of assets is positive, 0.005, significant at the 10% level. The F-value is 6.87 (significant at the 1% level), and the adjusted R-squared is 7.4%

The fourth, fifth, and sixth columns report the results for the high-growth buyers when the dependent variable is the change in operating performance from year -1 to 1, -1 to 2 and -1 to 3 respectively. The coefficient of free cash flow is negative and significant in all three regressions. The coefficient of firm size is positive and significant in all three regressions. This implies that the performance declines are smaller for larger firms.

The seventh column reports the results for the low-growth buyers when the dependent variable is the change from year -1 to 1. The coefficient of free cash flow is negative, -0.284, and significantly different from zero at the 1% level. The F-value is 2.61 (significant at the 5% level), and the adjusted R-squared is 4.2%. The eighth and ninth columns report the results with the change in operating performance from year -1 to 2 and from year -1 to 3 as the dependent variable, respectively. The only significant variable here is the free cash flow. Its coefficients are negative (-0.657 and, -0.483, respectively), significantly different from zero at the 1% level in both regressions. The corresponding F-values for these two regressions are 5.78 and 3.19, significant at the 1% and 5% levels, respectively. The corresponding adjusted R-squared are 11.7% and 5.9%.