ASK THE FOOL

In Buyouts

Q: When one company buys out another and spends, say, a billion dollars to do so, who actually gets that money? Where does it go? – Beverly Wolf, Richmond, Calif.

A: If the acquiring company pays cash, it goes to the shareholders of the acquired firm. There are also payments to other classes of equity, the preferred classes (think preferred stock). On some occasions, some of the cash tendered may go to debt holders, if part of the purchase price is allocated to buying back debt.

If the acquirer buys with its own stock, then shareholders of the acquired firm will get shares of the acquiring company in exchange for their acquired-firm stock. These shares can be sold for cash, or the shareholders can simply hold on. Companies typically buy other companies for more than their pre-purchase market price – they pay a “premium.”

Some purchases involve combinations of cash and stock. In all-stock transactions, no cash trades hands.

Q: Who exactly sets the price for stocks? – Larry W., Union, Ky.

A: A company’s stock price is not set by any person or even by the company itself. Rather, once shares have been sold by the company to the public (either via an initial public offering or a secondary offering), they trade fairly freely in the stock market.

Think of the market for collectible comic books. A comic book is valued at what people will pay for it. If demand falls, the price will, too, and vice versa. That’s why, if there’s very bad news about a company, its stock will quickly be worth less, and when there’s good news, the stock is often seen as more valuable. Learn more at www.fool.com/school.htm.

FOOL’S SCHOOL

Analyzing Industries

Before considering any company as a possible investment, it’s smart to study its industry. In his book “Competitive Strategy” (Free Press, $37.50), Harvard Business School professor Michael Porter laid out five competitive forces that affect an industry.

â Threat of entry. Evaluate how much capital it takes to enter the industry, the economies of scale, switching costs and brand value. It’s easier to enter the lawn service industry than the semiconductor equipment industry — one requires some relatively inexpensive equipment, while the other requires factories and much specialized knowledge. Switching costs protect companies, too. People will think twice about switching e-mail providers because they’ll have to alert too many people of their new address.

â Bargaining power of suppliers. There are only a few airplane suppliers (such as Boeing and Airbus), so if you’re running an airline it’s difficult to play one against the other, trying to strike a bargain. If there were many suppliers, they’d likely be competing more for your business, which might result in lower costs for you.

â Bargaining power of buyers. This is affected by brand power, switching costs, the relative volume of purchases, standardization of the product and elasticity of demand (where demand increases as prices fall, and vice versa). When buying electronics, for example, consumers have many choices and can compare many prices online. This gives them bargaining power.

â Availability of substitutes. If you’re in the restaurant industry, your business will be affected by how easily people can buy takeout meals at supermarkets, how many people prepare meals at home, and the availability of other alternatives.

â Competitive rivalry. The more competitive an industry is, the more likely you are to have price wars and reduced profitability. The airline industry is a good example here. Over the years, it has not offered the best returns to investors.

Consider factors such as these, and you might learn that an industry just isn’t as attractive as you thought. Get more investing insights in “The Future for Investors” by Jeremy J. Siegel (Crown Business, $27.50).

MY DUMBEST INVESTMENT

All in One Basket

Of all the stocks I had, only one was doing well. I sold everything and put it all on that one. Maybe that was dumb, but I managed to make back all my losses by doing it. What was really dumb was calling my broker and telling him to put everything on this one stock. I didn’t realize he would include my margin account, investing as much as I could borrow from the brokerage! I received a margin call the very next day when the stock went down just enough to require it. Luckily, I sold enough to cover that screw-up, and the stock still made up my original investment. But I definitely learned to be more careful about what I say to people. Here’s another scary thing: The day after I finally took all my money out, the stock dropped like a rock. Had I waited one more day, I wouldn’t have had even half of my original investment! — Brian Daniels, Garden Grove, Calif.

The Fool responds: You were lucky to get out alive from this. It’s extremely risky to put all your eggs in one basket.

FOOLISH TRIVIA

I first took flight in 1971, flying to Houston, San Antonio and Dallas. Today I’m the nation’s largest carrier in terms of domestic passengers, delivering more than 70 million passengers annually to some 61 cities in 31 states on nearly 3,000 daily flights. I’m wrapping up my 33rd consecutive year of profitability, an amazing thing for an American airline. I rake in more than $6 billion per year, and my average passenger airfare is $91. My ticker symbol makes many hearts beat fast, and employees own more than 10 percent of me. Who am I?

Last Week’s Trivia Answer: Founded in 1886 as the “Workshop for Precision Mechanics and Electrical Engineering,” today I’m a leading global supplier of consumer, automotive, building and industrial technology, raking in 40 billion euros per year. I’m based in Germany, but 72 percent of my sales are generated outside it. I employ some 240,000 people worldwide and sport about 270 subsidiary companies. With some 2,800 inventions, I’m the second-largest patent applicant in Germany. Since 1964, my majority shareholder has been a charitable nonprofit foundation named for my founder. I make gas water heaters, dishwashers, washing machines, Blaupunkt car stereos and much more. Who am I? (Answer: Bosch)

THE MOTLEY FOOL TAKE

China Bums a Smoke

Altria’s (NYSE: MO) Philip Morris cigarette business has struck an intriguing deal with China National Tobacco, licensing it to produce Marlboros in China for 10 years and forming a 50/50 joint venture to export tobacco products from China and market Chinese brands around the world.

In a country where brand counterfeiting is rife, Marlboros have apparently been one of the most popular targets. With this deal, though, real Marlboros will finally be legally available. What’s more, because China National Tobacco is a state-owned company, there may well be a clamp-down on Marlboro counterfeiting.

China National Tobacco is no fly-by-night operation, either. It sold about 1.9 trillion cigarettes last year — far surpassing Altria’s 761 billion — and holds something like 90 percent of the Chinese market.

It’s tough to say what this agreement will mean to Altria. The licensing fee should represent pure profit. As for the joint venture, we’ll see. Altria may also benefit from having access to more tobacco-leaf sources.

In any case, this represents at least a toehold in the Chinese market, and if Chinese smokers acquire a taste for genuine Marlboros, that could be worthwhile to Altria down the road. In the meantime, while Altria’s cash flow is appealing, its current stock price isn’t a screaming bargain. Investors might want to wait for a price drop.