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

Table V summarizes the mean and median operating performance for the sample. Since the medians show a similar trend as the means in all panels, we only discuss means. The sample size differs from year to year because data for all sample firms are not available for every year. Panel A summarizes the cash flow-to-book value of assets ratios for the sample of industrial firms for the seven years centered on the year of the asset purchase. Mean values of this ratio are 0.144 in year -3 and 0.149 in the year before the acquisition. This ratio declines to 0.136, 0.132, and 0.133 in year's 1, 2, and 3 respectively. Mean operating performance is significantly different from zero at the 1% level in all years.

Panel B reports results for the industry-adjusted measure of operating performance. Mean industry-adjusted cash flow is 0.033 in year -3 and 0.040 in year -1. It declines to 0.026, 0.023, and 0.025 in years 1, 2, and 3. Again, mean industry-adjusted performance is significant at the 1% level in all seven years. The results suggest that the average firm in our sample performs better than the industry median during the seven-year period of our analysis.

Panel C reports the matched-firm-adjusted levels of operating performance. The mean matched-firm-adjusted level of operating performance is -0.004 in year -3, and 0.000 in year -1. Following the asset purchase, the matched-firm-adjusted cash flows are an identical -0.009 in years 1, 2, and 3. Cash flows are negative and significantly different from zero in all three years after the acquisition, implying that the sample firms are not performing as well as firms that did not make asset purchases.

Table VI reports both the mean and median changes in cash flow-to-book value ratio in the same order as Table V. Again, we only discuss means. Panel A provides the results for the changes in raw operating performance. The mean change in performance from year -2 to -1 is positive 0.005, and significantly different from zero at the 10% level. Relative to year -1, operating performance worsens in years 1, 2, and 3. The mean changes for these three periods are -0.013, -0.019, and -0.017, all significant at the 1% level. These changes are economically quite large. For example, in year -1 the mean level of cash flow-to-book value ratio is 0.149, and the -0.017 relative decline in year 3 represents a change of -11.40%.

Panel B reports the changes in the industry-adjusted cash flow-to-book value ratio. Again, the mean change in performance from year -2 to -1 is positive (0.005) and significant at the 10% level. Relative to year -1, mean values of this ratio show declines in years 1, 2, and 3: -0.014, -0.018, and -0.016, all significantly different from zero at the 1% level. The mean industry-adjusted level of cash flows in year -1 is 0.040, so the mean decline from year -1 to year 3 as a percentage relative to year -1 is 40%.

Panel C reports the change in the matched-firm-adjusted cash flow-to-book value ratio. Mean changes from year -2 to -1 are not significant at customary levels. The mean change from year -1 to 1 is -0.010, significant at the 1% level. The mean change from year -1 to 2 is -0.013, significant at the 1% level; the mean change from year -1 to 3 is -0.009, significant at the 1% level.