What is Sandbagging?
Sandbagging is a strategy to lower down expectations of the company or strength of an individual to relatively produce greater results than actually projected like when the top management of the corporation astutely tempers shareholder’s expectations by giving guidance which is well below from what they know is realistically possible.
It is a tool used by companies to set the expectations of their financial performance to stay low. When the company performs well or outperforms beyond expectations, it is seen as though the company has overperformed, thereby making investors happy.
- The company does this by controlling the investor’s expectations through analyst reports, media reports, independent analysis, press releases, etc.
- By lowering the shareholder’s expectation, the company creates a safe range for itself. It has lowered expectations and can overperform and gain added confidence in its business from all shareholders. It results in an increased stock price of the company, which in itself is very beneficial for the company’s financial health.
- Hence, sandbagging is a very important tool used for preventing a sudden change in investor expectation, which might disrupt the company’s financial health and cause significant fluctuations in its stock price.
How Sandbagging Works for a Stock Price?
Let us say there is a certain company, ABC Ltd, which has its analyst report scheduled to be released in a few weeks. The company decides to use this as a tool to control its shareholders’ expectations.
They employ this method by asking its in-house analysts to make a forecast stating a stable growth of the company in their reports. In contrast, the reality is that the company has been earning profits in double digits over the past year.
The shareholders’ expectations are contained and in line with what the company wanted. Once the company’s actual performance, as stated in the annual reports, is shown to be that of above-average growth, shareholders are happy as the results exceeded their expectations. It leads to an increase in the share price.
Applications of Sandbagging
#1 – Sandbagging by Start-ups
A start-up business is launched with the aim of being successful and producing better than expected results for the investors who have shown faith in the business.
- Given that initial investors in start-ups have invested a considerable amount of funds in the business, they would be expecting a good performance. It is important because the start-up’s performance in its initial years will allow the investors to make a decision about whether to continue holding the company’s stock or not. It motivates start-ups to deploy the sandbagging strategy to gain the trust of the shareholders and keep them happy.
- Start-ups use this tool by giving the earnings updates and estimates below what they hope to achieve in the future. Hence, when the actual results regarding the earnings of the company come out, it makes the managers and the company look as if they overperformed and went beyond shareholder expectations.
- Start-ups use sandbagging not just to gain the trust of existing shareholders but also use it to attract potential investors. Once potential investors observe the consistent over-performance in the start-up, they too would be interested in investing their funds in a promising business opportunity.
#2 – Sandbagging in M&A deals
In a merger and acquisition deal between the acquired company and the acquiring company, the purchase agreement contains a pro-sandbagging clause.
- This pro-sandbagging clause basically protects the interest of the purchaser or the acquiring company. In such a merger and acquisition deal, ideally, the seller or the acquired company is expected to disclose all accurate information related to the merger or acquisition of the company.
- However, there is a possibility that the seller ends up excluding the important information that should have been disclosed to the buyer or the acquiring company. In some cases, this information could be concealed deliberately by the seller.
- Under the pro-sandbagging clauses, the purchaser or the acquiring company has the right to recover the potential losses incurred due to the information that was concealed by the seller at the time of the deal.
- For instance, during due diligence, it is possible that the purchaser comes across a certain piece of information that goes against what has been disclosed by the seller. In such a situation, the purchaser has the option of recovering any potential losses from the seller after closing the transaction.
Sandbagging may seem like an effective tool in various scenarios, as mentioned above, but very few companies are able to continue using this strategy for an extended period of time. In the case of companies giving lower than expected forecasts about their earnings or revenue will end up consistently overperforming. It will result in shareholders and potential investors adjusting their expectations in line with the company’s actual performance and will start ignoring the public announcements about the expected or sandbagged earnings and revenue results.
This article has been a guide to What is Sandbagging? Here we discuss how sandbagging works along with practical applications for startups and in M&A Deals. You may learn more about investment banking from the following articles –