Darryl Laws

 Winner’s curse. Originally this euphemism was coined by oil companies bidding for offshore oil rights in the Gulf of Mexico,  the winner’s curses is a tendency for the winning bid in an acquisition to exceed the intrinsic value of the target company purchased is quite prevalent. Because of incomplete information, emotions or any other number of factors regarding the target company being acquired, bidders can have a difficult time determining the target’s intrinsic value. As a result, the largest overestimation of a firm’s value ends up winning the auction. When several bidders compete for the acquisition of the same target company, they may not know the target’s exact value. Where good  information in regard to the target company’s value is difficult to come by, or just uncertain, bidders are obliged to fall back on trying to estimate its value independently. When the company is worth the same to all bidders, the only thing that  distinguishes them will be their respective valuation estimates (high bid) and the amount of equity cash deployed and the leverage debt taken on to facilitate the acquisition cost. The winner will thus be the one that makes the highest estimate (bid) coupled with the best capital stack. If, in fact, the average bid is accurate, then the highest bidder will have overestimated the target’s value, so, by definition, the winner is likely to have overpaid, the winner’s curse. In the M&A investment world, the term winner’s curse often applies to initial public offerings. The winner’s curse is a phenomenon akin to a ‘Pyrrhic victory’ that occurs in common value auctions with incomplete information. In short, the winner’s curse says that in such a bidding process, the winner will tend to overpay. The winner may overpay or be cursed in one or two ways: (1) the winning bid exceeds the value of the acquired firm such that the winner is worse off in absolute terms and the acquiring company struggles with the heavy debt load; or (2) the value of the asset is less than the bidder anticipated, so the bidder may still have a net gain but will be worse off than anticipated. [e.g. In 1985 the Belzberg brothers acquired Scovill Corporation. During the process of selling off the “pieces” they (I was charged with this responsibility) discovered that the sum of the parts of the subsidiary companies, H.H. Robertson Construction Materials, Hamilton Beach, NuTone, Schlage Locks and Rubber Maid, was not greater than the whole company and that the 14% junk bond laden financing provided by Michael Milliken at Drexel Burnham Lambert lead the company to file a Chapter 11 Bankruptcy reorganization in 1985. 

Darryl Laws