That’s Billion with a B
Harrah’s got a bid from a private-equity firm to purchase their company for $15 billion dollars.
These bids are always very interesting. As economists, we think the stock market does a very good job reflecting all available information about Harrah’s, its profitability, and its future prospects. In fact, this post is in the same spirit as Dr. Coats’ post on political/terrorism markets. Markets are very powerful agglomerators of information.
In this case, the stock market consensus (yesterday) suggested that the value of Harrah’s is $64 a share, or roughly $12 billion.
Why do economists think these markets are efficient?
If you think a company is worth more than the stock market’s price, you certainly can buy shares of the company and hope that the value increases. If you are right, you will be rewarded financially. Likewise, if you think a company is overvalued, you can sell (short) the stock, and again you will be wealthier if the value decreases.
Because there are monetary incentives to be right (just as there are in the Iowa election markets), there is a incentive to acquire information about the company’s prospects, and therefore much information and analyzing occurs. Stated a bit differently, if you have information about a stock price, you have a major incentive to act on it. In doing so, your information is reflected in the market price. As a result, most economists think that stock prices are very efficient – on average they are correct predictors about future profitability of companies.
What is interesting here is that this equity firm disagrees with the market consensus and is offering to buy the company for $81 a share, or $15 billion. This firms thinks Harrah’s is seriously undervalued, to the tune of about $3 billion.
Why? You’d have to ask the leaders of the buyout. An obvious candidate is management. If you think the managers are adversely affecting the stock price (company’s value), then one option is to buy the whole company yourself, stick in your own managers, and increase the value of the company by making better managerial decisions. If you own the whole company, you will receive all of the rewards of doing so. If they are wrong, well they just paid 20% to much for the company. Not to hard to figure out how that will go.
Because many buyout attempts are announced, but ultimately don’t go through, another interesting part of the story is the stock market’s reaction to the announcement.
If investors were certain this buyout would go through, and because the equity firm is offering to buy shares at $81, the share price would rise to (just less than) $81 per share.
If investors were certain the buyout would not go through, there would be little stock price reaction. Say I offered $20 billion for Harrah’s – investors will soon learn I can’t afford Harrah’s on my meager salary.
The fact that the stock market appreciated significantly, but not completely, suggests there is a significant probability of the buyout going through, but that it is not certain, as is often the case with these deals. Yet, the fact that someone is willing to pay $81 is new information for the stock market.
Stay tuned…these things take a long time to resolve, and every once in a while, new bidders will show up on the scene, making things even more interesting.
–CT