Undervaluation and private equity takeovers

Abstract

Undervaluation is often offered as an important consideration in private equity transactions. This study analyzes the importance of undervaluation, vis-à-vis information asymmetry, as a determining factor in 'going-private' transactions in Australia. Using a matched sample of firms from 1990 to 2012, we test a predictive choice model. The empirical results show that market undervaluation is a dominant factor in private equity takeovers. These results are robust to alternative measures of valuation, prevailing market conditions, money flows and subperiods.JEL Classification: G11, G15

Systematic Literature Review of Private Equity Determinants: Status, Evidence and Open Issues

“…Future studies can thus explore whether firm-level determinants affect the propensity of private equity firms to invest. The authors observe that majority of research on private equity investments is based in developed countries (Chapple et al, 2010;Moller & Yngvesson, 2020;Rath & Rashid, 2016) as these countries attracted private equity early on and gained researchers' attention on growth, performance and successful exits of private equity; while in emerging countries the investment in private equity has recently gained momentum and there is only modest research yet (Table 3). The limited view on private equity can also be attributed to the lack of comprehensively recorded data on private equity transactions in emerging countries (De Lima Ribeiro & Gledson de Carvalho, 2008;Neerza & Tripathi, 2019).…”

“…Acharya et al (2009) identify the selection pattern for PE targets, documenting stable operating performance and nonlinear profitability (EBITDA margin) in companies acquired by PE firms. Several studies conduct relative studies for determining firm-specific factors in selecting PE targets and corporate targets (Chapple et al, 2010; Osborne et al, 2012; Rath & Rashid, 2016). Chapple et al (2010) emphasize that private equity targets possess greater financial slack and financial stability along with higher free cash flow, and a lower growth potential relative to corporate targets; Osborne et al (2012) examine higher market-to-book ratio, greater abnormal operating income, firm size and lower stock volatility as significant internal drivers for attracting PE investment relative to tender/merger targets.…”

“…Moreover, they iterate the importance of firm-specific factors in selecting targets over country-specific factors. While Rath and Rashid (2016) analyse PE targets against public mergers and find market undervaluation as a dominant factor in private equity takeovers.…”

Evidence of governance arbitrage by private equity sponsors

“…For firms with high information asymmetries, intense monitoring by the board may not be worth the costs, and instead, their governance may place greater reliance on external controls and incentive compensation. Rath and Rashid () analysed the importance of undervaluation, vis‐à‐vis information asymmetry, as a determining factor in ‘going‐private’ transactions in Australia. Hartnett and Shamsuddin () found a relationship between initial public offer (IPO) returns and corporate governance.…”

Small-scale private equity: demand versus supply

“…Much of the investment supply-side literature concerns large PE firms seeking to take over listed companies or debates on active versus passive management of large, indexed equity portfolios (Chen et al 2010). The literature tends to focus on PE firms targeting larger, undervalued, poorly governed, or underperforming listed companies (Lonergan 2007;Clarkson et al 2016), for which there is substantial available audited data (Osborne et al 2012;Rath and Rashid 2016). To the best of our knowledge, our Australian study is ground-breaking in that it gathers substantial private industry data to determine the financial equilibrium, if any, between small incorporated PE providers and SMEs, including HGFs.…”