Mergers, Acquisitions, and
Corporate Control
VENTURE CAPITAL CONSULTANTS
Course VCC / MCCI060107
Corporate Control
Corporate control: monitoring, supervising and directing a
corporation or other business organization
Changes in corporate control occur through:
• Acquisitions (purchase of additional resources by
business enterprise):
• Purchase of new assets
• Purchase of assets from another company
• Purchase of other business entity (merger)
• Concentration of voting power (LBOs and MBOs)
• Divestiture: transferring ownership of a business unit
• Spin-off: creation of new corporation
2
Corporate Control Transactions
Statutory
mergers
Subsidiary
merger
Consolidation
“Going
private”
transactions
3
• Acquired firm is consolidated into acquiring
firm with no further separate identity.
• Acquired firm maintains its own former
identity.
• PepsiCo and Pizza Hut maintained their
identities after merger in 1977.
• Two or more firms combine into a new
corporate identity.
• Leverage buyout (LBO): public shares of a
firm are bought and taken private through
use of debt.
• Management buyout (MBO): an LBO initiated
by the firm’s management
Resource Disintegration
Divestiture: resources of a subsidiary or division are sold to
another organization.
Spin-off and split-off: a new company is created from a
division or subsidiary.
Equity carve-outs: sale of partial interest in a subsidiary
Split-up: sale of all subsidiaries. Company ceases to exist
Bust-up: takeover of a company that is subsequently split-up
4
Corporate Control Transactions
Open
market
purchases
Proxy fights
Tender offers
• Buy enough shares on the open market to
obtain controlling interest
• Regulation in most developed countries
prevents this form of acquisition.
• Gain corporate control through consignment
of other shareholders voting rights
• Open and public solicitation for shares
Open market purchases, tender offers and proxy
fights can be combined to launch a “surprise attack.”
5
Active Anti-takeover Measures
Measure
Anti-takeover Effect
Fair price amendments
• Preset metric, such as P/E ratio, used to determine
the “fair price” of the company in case of takeover
Golden parachutes
• Lucrative termination arrangements for executives
in event of takeover
• Supports managerial entrenchment hypothesis
Greenmail
• Repurchase at a premium of shares held by
potential hostile bidder
• Declined in popularity after TRA86 imposed a 25%
surtax on greenmail payments
“Just say no” defense
• No consideration offered is sufficient to give up
control
Pac-man defense
• Initiation of a takeover attempt for the hostile
acquirer itself
• Change in capital structure designed to make the
target less attractive
Recapitalization
6
Active Anti-takeover Measures, cont.
Measure
Anti-takeover Effect
Staggered term for the Corporate charter amendments that make replacement
board
of board of directors difficult
Standstill agreements
Substantial shareholders agree through negotiated
contracts not to participate in any takeover attempts.
Supermajority
approvals
Corporate amendments that require a large majority
(67% or 80%) of votes to approve a takeover
White knight defense
Friendly companies bid for a takeover against a hostile
acquirer.
Losses in shareholder wealth due to overbidding
Friendly companies acquire a substantial block of
shares, but not of controlling interest.
Can lead to white knight situation with leg-up options:
allow the white squire purchase of additional shares at
a favorable price
White squire defense
7
Pre-emptive Anti-Takeover Measures
Measure
Poison pills
Anti-takeover Effect:
Flip-overs: Firm issues call options that allow owners to buy the
stock at a low price upon a complete takeover of the target.
Flip-ins: rights can be exercised in case of partial acquisitions as
well.
Higher takeover premiums (69% higher) for successful takeovers
Unless a takeover attempt is successful, poison pills decrease
shareholders wealth.
Poison puts Bonds with put options that can be redeemed with a high
premium over face value in case of a takeover.
Such bonds can seriously decrease the cash position of the target
if a hostile transaction is initiated.
Shark
repellents
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Amendments to the corporate charter that make hostile
takeover more difficult to accomplish
Require shareholder approval, as opposed to poison pills/puts
May be restrained by state laws
Mergers by Business Concentration
Horizontal
mergers
• Between former intra-industry competitors
• Attempt to gain efficiencies of scale/scope
and benefit from increased market power
• Susceptible to antitrust scrutiny
Vertical
mergers
• Between former buyer and seller
• Forward (Disney merger with Capital
Cities/ABC) or backward (Texaco and Getty
Oil merger in 1984) integration
• Creates an integrated product chain
Conglomerate
mergers
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• Between unrelated firms
• Creates a “portfolio” of businesses
• Product extension mergers vs. pure
conglomerate mergers
• For example, merger between GM and EDS
Transaction Characteristics
Method of payment used to finance a transaction
• Pure stock exchange merger: issuance of new shares of common
stock in exchange for the target’s common stock
• Mixed offerings: a combination of cash and securities
Attitude of target management to a takeover
attempt
• Friendly deals vs. hostile transactions
Accounting treatment used for recording a merger
• Prior to June 30, 2001, two methods: pooling-of-interest and
purchase methods
• With the implementation of FASB Statements 141 and 142, one
standard method of accounting for mergers
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Merger and Intangible Assets Accounting
•
•
Target firm has 5 million shares at $10 per share.
Acquirer pays a 20% premium ($12 per share) to expand in the geographic
area where target firm operates.
• Transaction value 5 million shares x $12/share = $60 million.
• Net asset value of target company is $45,000,000.
Current assets
Restated fixed assets
Less liabilities
Net asset value
•
$10,000,000
$65,000,000
$30,000,000
$45,000,000
Acquirer pays $15 million for intangible assets ($60 million - $45 million).
Goodwill will remain on the balance sheet as long as
the firm can demonstrate that it is fairly valued.
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Returns to Target and Bidding Firm
Shareholders
Shareholders of target firm experience significant wealth
gains in case of merger.
Jensen and Ruback survey: average 29.1% premiums for
tender offers and 15.9% for mergers
On average, positive returns result for tender offers and zero
returns for successful mergers.
Negative trend in acquirer returns over time attributed to
adoption of Williams Act.
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Empirical Findings in Corporate
Control Events
Mode of
payment
Returns to
other
stakeholders
13
• Shareholders gain higher returns in cash
transactions than in stock transactions.
• Signaling model: Equity offers signal that
acquirer’s stock is overvalued.
• Tax hypothesis: Target shareholders require
capital gains tax premium for cash
transactions.
• Preemptive bidding hypothesis: premium for
cash offers required to deter other potential
bidders.
• Significant wealth gains result for holders of
convertible and nonconvertible bonds.
Value-Maximizing Motives for Mergers
and Acquisitions
Geographic (internal and international) expansion
• Greenfield (internal) entry vs. external expansion
• M & A is better alternative for time-critical expansion.
• External expansion provides an easier approach to
international expansion.
• Joint ventures and strategic alliances give alternative
access to foreign markets. Profits are shared.
Synergy, market power, and strategic mergers
14
• Operational, managerial and financial merger-related
synergies
• Eisner on Disney and Cap Cities/ABC merger:
“1+1=4”
Value-Maximizing Motives for Mergers and
Acquisitions
Operational synergies
• Economies of scale:
• Merger may reduce or eliminate overlapping resources.
• Economies of scope:
• Involve activities that are possible only for certain company size
• The launch of national advertising campaign
• Economies of scale/scope most likely to be realized in horizontal
mergers
• Resource complementarities:
• One company has expertise in R&D, the other in marketing.
• Successful in both horizontal and vertical mergers
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Value-Maximizing Motives for Mergers
and Acquisitions
Managerial synergies and market power
• Managerial synergies are effective when management teams with
different strengths combine.
• Market power is a benefit often pursued in horizontal mergers.
• Number of competitors in industry declines.
Other strategic reasons for mergers
• Product quality in vertical merger
• Defensive consolidation in a mature or declining industry
• Tax-considerations for the merger
16
Non-Value-Maximizing Motives
Agency problems: management’s (disguised) personal
interests are often drivers of mergers and acquisitions.
17
Managerialis
m theory
• Dennis Mueller (1969)
• Managerial compensation is often tied to
corporation size
Free cash
flow theory
• Michael Jensen (1986)
• Managers invest in projects with negative
NPV to build corporate empires
Hubris
hypothesis
• Richard Roll (1986)
• Acquirer’s management overestimate their
capabilities and overpay for target company
in belief they can run it more efficiently
History of Merger Waves
Five merger waves in the U.S. history
Merger waves positively related to high economic growth
Concentrated in industries undergoing changes
Regulatory regime determines types of mergers in each
wave.
Usually ends with large declines in stock market values
18
History of Merger Waves
19
First wave
(1897-1904)
• Period of “merging for monopoly”
• Horizontal mergers possible due to lax
regulatory environment
• Ended with the stock market crash of 1904
Second wave
(1916-1929)
• Period of “merging for oligopoly”
• Antitrust laws from early 1900 made
monopoly hard to achieve
• Just like first wave: intent to create national
brands
• Ended with the 1929 crash
Third wave
(1965-1969)
• Conglomerate merger wave
• Celler-Kefauver Act of 1950 could be used
against horizontal and vertical mergers.
• Stock market decline of 1969
History of Merger Waves,
Fourth wave
(1981-1989)
Fifth wave
(1993 –
2001)
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cont.
• Spurred by the lax regulatory environment of
the time
• Junk bond financing played a major role
during this wave: LBOs and MBOs
commonplace
• Hostile “bust-ups” of conglomerates from
previous wave
• Ended with the fall of Drexel, Burnham,
Lambert
• Friendly, stock-financed mergers
• Relatively lax regulatory environment
• Consolidation in non-manufacturing service
sector
• Explained by industry shock theory
Major U.S. Antitrust Legislation
Legislation (Year)
Sherman Antitrust Act
(1890)
Clayton Act
(1914)
Federal Trade Commission
Act
(1914)
Celler-Kefauver Act
(1950)
21
Hart-Scott-Rodino Act
(1976)
Purpose of Legislation
• Prohibited actions in restraint of trade, attempts
to monopolize an industry
• Violators subject to triple damage
•Vaguely worded and difficult to implement
• Prohibited price discriminations, tying
arrangements, concurrent service on competitor’s
board of directors
• Prohibited the acquisition of a competitor’s stock
in order to lessen competition
• Created FTC to enforce the Clayton Act
• Granted cease and desist powers to the FTC, but
not criminal prosecution powers
• Eliminated the “stock acquisition” loophole in the
Clayton Act
• Severely restricts approval for horizontal mergers
• FTC and DOJ can rule on the permissibility of a
merger prior to consummation
Determination of Anti-Competitiveness
• Since 1982, both DOJ and FTC have used HerfindahlHirschman Index (HHI) to determine market
concentration.
• HHI = sum of squared market shares of all
participants in a certain market (industry)
Not Concentrated
Moderately Concentrated
1000
Highly Concentrated
1800
HHI Level
• Elasticity tests (“5 percent rule”)is an alternative
measure used to determine if merged firm has the
power to control prices.
22
The Williams Act
Enacted in 1968 for fuller disclosure and tender offers
regulation
Section 13-d must be filed within 10 days of acquiring 5% of
shares of publicly traded companies.
Section 14 regulates tender offer process for both acquirer
and target.
Section 14 provides structural rules and restrictions on the
tender offer process in addition to disclosure requirements.
Section 14-d-1 for acquirer and section 14-d-9 by target
company
23
Insider Trading
SEC rule 10-b-5 outlaws material misrepresentation of
information for sale or purchase of securities.
Rule 14-e-3 addresses trading on inside information in
tender offers.
The Insider Trading Sanctions Act, 1984 awards triple
damages.
Section 16 of Securities and Exchange Act establishes a
monitoring facility for corporate insiders.
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Mergers, Acquisitions, and Corporate
Control
Merging firms may be integrated in a number of ways.
Target shareholders almost always win, but acquirers’ return
are mixed.
Managers have either value-maximizing or non-value
maximizing motives for pursuing mergers.
Merger activity occurs in waves.