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Optical/IP

Stock Swap M&A: Is the Price Right?

As the public markets hit new lows, many so-called hot properties bought in high-flying stock transactions are deflating like leaky balloons.

Consider the following examples:

  • On May 31, 2000, Lucent Technologies Inc. (NYSE: LU) offers 78 million shares of its stock, valued at $58 per share, to buy privately held Chromatis Networks, a maker of optical metro access gear, in a deal valued at $4.5 billion. Today, thanks to a number of factors, Lucent's stock is trading at about $21.44, a drop of over 60 percent. The original Chromatis deal is now worth about $1.6 billion on paper -- a third of its original value.

  • Sycamore Networks Inc. (Nasdaq: SCMR) agrees in January to trade 28 million of its shares, valued at nearly $100 each, to buy privately held Sirocco Systems Inc. in a deal valued at about $2.9 billion. In September, the deal is closed, with Sycamore issuing 28.4 million of its shares, worth $116.25 -- a total value of about $3.2 billion. Now, Sycamore stock is trading at $77.75, and the deal's paper value is about $2.2 billion -- down $1 billion from its original value.

When a stock-swap acquisition loses its value, there's disappointment all round -- and analysts don't have any easy answers for preventing it.

"It all adds up to due diligence," says Alexandre Peterc, analyst at CDC Bourse, a European investment bank. "My view is that when acquisitions and mergers occur, investors need to restart the whole process of evaluating what they're buying into," he says.

If the investor is a stakeholder in a privately held company that's being acquired, the options are limited. "It's a difficult situation. In Chromatis's case, there's nothing that the shareholders could do," says Tim Savageaux, senior analyst with W.R. Hambrecht & Co.. In some cases, though, he points out that so-called collars exist that ensure that the acquirees can get more shares or even walk away from a deal if the acquirer's share price falls below an agreed-upon level. Such terms are included in the recent agreement by Metromedia Fiber Network Inc. (Nasdaq: MFNX) to acquire SiteSmith. In that case, SiteSmith stockholders are guaranteed to get shares equal to about $1.5 billion, even if more shares must be issued if the stock price falls.

If an investor is a shareholder in a public company being acquired, more options obtain, but analysts counsel prudence.

"My feeling is that you're best off cashing out and finding another company to invest in," says Peterc. "It's just too risky to hold the stock. In a lot of cases, mergers have resulted in value destruction." You can always reinvest in the same company after it's clear what's going to happen, he says.

Investors inside and outside of deals need to look closely behind the scenes in any merger, analysts say. Product overlap and staff turnover are key indicators of problems ahead. When Lucent bought Chromatis, for instance, it already had started its own development in the same space. Further mismanagement of the deal resulted in a mass exodus of Chromatis personnel. "Lucent bought an empty shell in the end," Peterc says.

In general, inflated valuations are a tipoff of things to come. "Companies shouldn't pay more for an acquisition than they're valued themselves," says Tim Savageaux. For example, if a company trading at ten times revenues buys a company trading at 50 times its revenues, the transaction's going to be dilutive to the acquirer's stock.

Some stock transactions are clearly gambles, and shareholders must be ready to roll with the punches. In the cases of Lucent buying Chromatis and Cisco buying Cerent, both big companies were buying organizations with big losses. Clearly, the deals were a gamble on the future.

In some instances, buying or holding a stock beyond a merger can pay off, as happened when Alcatel SA (NYSE: ALA) bought DSC Communications in 1998 in an exchange of stock worth about $4.4 billion. Shares of Alcatel stock subsequently dropped, then took two years to rise to all-time highs. Those who'd chosen to stick it out made a handsome profit.

Bottom line? Assess your tolerance to risk.

-- Mary Jander, senior editor, Light Reading http://www.lightreading.com

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