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

III. Results

We present our results as follows. First, we report the buyers' announcement period returns during the three-day period around the asset purchase. Then, we examine changes in the buyers' operating performance over the seven-year period around the purchase. Lastly, we report changes in other measures of buyers' efficiency over the same seven-year period.

A. Stock Price Reaction

Table III, Panel A, reports the three-day abnormal stock return to the buyer. The mean cumulative abnormal return for the buyer is 1.261%, significantly different from zero at the 1% level. Panel B reports the mean cumulative raw return is 1.555% during this period and significantly different from zero at the 1% level.

In Panel C, we first examine the stock price reaction for firms with more growth opportunities. For the high q/high FCF firms, the mean cumulative abnormal return is -0.404%, not significantly different from zero. For the high q/low FCF firms, the mean return is 2.691%, significantly different from zero at the 1% level. This implies that the market perceives asset purchases by firms with valuable growth opportunities and low free cash flow as value-enhancing.

We also examine the stock price reaction among firms with fewer growth opportunities. For low q/high FCF firms, the mean is positive, 0.707%, but not significantly different from zero. For low q/low FCF firms, the mean is positive, 2.183%, and significantly different from zero at the 1% level.

Panel D reports the cumulative raw returns for the four groups of firms. For the high q/high FCF firms, mean returns are not significantly different from zero. For the high q/low FCF firms, the mean return is 3.017%, significantly different from zero at the 1% level. For the low q/high FCF firms, the mean return is 0.952%, significantly different from zero at the 5% level. For the low q/low FCF firms, the mean return is positive, 2.282%, significantly different from zero at the 1% level. (5)

The univariate analysis in Table III does not control for other factors that might affect announcement period returns. Emery and Switzer (1999) and Sicherman and Pettway (1992) show that factors such as the method of payment, the relatedness between the asset purchased and the buyer's lines of business, and firm size are associated with announcement period returns. Hence, we estimate regression equations that control for these factors in our analysis of the relation between announcement period returns and growth opportunities and buyer free cash flow.

Specifically, we regress the announcement period returns 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 buyer's free cash flow scaled by the book value of its assets, and the natural log of the book value of the buyer's assets. Table IV reports the results. For the overall sample, the significant variables are the scaled free cash flow and the natural log of the buyer's book value of assets. The adjusted R-squared of the regression is 6.2%, and the F-value is 6.94 (significant at the 1% level). (6)