The Intangibles Song in Takeover Announcements: Good Tempo, Hollow Tune
Takeovers are major corporate actions; they significantly impact the future of the acquiring company. A successful acquisition requires a plausible valuation of the deal -- but such valuations are arguably particularly challenging in the presence of intangible assets, an increasingly important component of firm value in many industries. Casual observation indeed suggests that acquirers often refer to intangible assets in takeover announcements. What can market participants infer from this intangibles talk? Are frequent references to intangibles just inconsequential managerial guff? Or do such references indeed reveal something about the deal over and above other observables?
Consider an example. On July 20, 2011, Minnesota-based Ecolab Inc., a cleaning and sanitizing products producer, announced an $8.1 billion acquisition of Nalco Holding Co., which makes chemicals used in industrial water treatment, energy and air applications. As the key assets relevant for the deal, Ecolab's management listed, in the acquisition announcement, concepts such as “innovation, processes, customers, markets, technology know-how, team, and corporate culture”. Ecolab's CEO was cited as stressing the importance of Nalco's “expertise, services, efficiency, and market”. In short, Ecolab tried hard to convince investors that Nalco is rich in intangible assets. However, investors were not convinced. The Ecolab stock price sharply fell and closed at $51.31 on the announcement day, a drop of 7.4% from the previous day's closing price. This is substantially larger than the median bidder price reaction to acquisitions of public chemicals companies over the 2002 to 2016 period, which was -1.3%. Ecolab's share price recovered mildly the following day, but then drifted down further to end the 10-day period after the announcement at 49.53, a fall of 10.6%. Despite the negative market reaction, the deal was completed and Ecolab acquired Nalco.
This paper studies whether this pattern -- even if an extreme case -- is typical, that is, whether a seemingly strong use of “intangibles talk” in a takeover announcement indeed usually goes hand-in-hand with a negative (abnormal) investor reaction to the announcement.
We employ textual analysis to parse the announcements of corporate takeover deals between 2002 and 2016. We first develop a novel word list of intangibles – such as innovation, processes, customers, expertise, or services. We find that, after controlling for industry effects, the amount managers talk about intangible aspects shows little correlation with the actual intangibles of a given target or acquirer. Strikingly, intangibles talk is positively related to the deal completion speed and probability, but negatively related to announcement returns (as in the motivating example) and the performance of the deal. Further tests reveal that this relation is likely due to managerial overconfidence about deal quality.
Overall, our paper provides new evidence of the role of corporate communication and managerial motivations in corporate transactions – and it shows that for investors it can pay off to pay attention to the phraseology of takeover announcements.