IFM7 Chapter 17

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Mergers and
Acquisitions
M&A Market

Market for Corporate Control


Competition for control of firm assets
Associated with Downsizing

“It’s amazing that the basic cause of downsizing is so rarely
acknowledged: these companies have more workers than
they need or can afford to pay… If we must blame
somebody for the layoffs, it ought to be you and me…. I
haven’t met one person who would agree to pay AT&T twice
the going rate if AT&T would promise to stop laying people
off. These companies are responding to the constant pressure
from consumers and shareholders.”
- Peter Lynch, formerly of Fidelity’s Magellan fund
M&A Introduction


Purchase & Sale of Firms or Divisions
Bidder




Target
Consideration


Company
Raiders
Cash or securities offered
Advisors

I-Banks, Consultants, Attorneys, Accountants
M&A Types

Friendly - Mgmt support

Hostile - Without mgmt support


Horizontal


2 Competitors
Vertical


Williams Act ’68 made more difficult
Target in same industry, but different production stage
Conglomerate

2 Unrelated Firms
Taxes

Tax-free acquisition


Business purpose; not solely to avoid taxes
Continuity of equity interest


Target stockholders have an equity interest in the combined firm
Taxable acquisition


Firm purchased with cash
Capital gains

Target stockholders require a higher price to cover the taxes
Merger versus Consolidation

Merger
One firm is acquired by another
 Acquired firm ceases to exist
 Advantage: legally simple
 Disadvantage: approval of both stockholders


Consolidation

New firm is created by combining existing firms
Takeovers


Control transfers from one group to another
Possible forms

Acquisition
Merger or consolidation
 Acquisition of stock
 Acquisition of assets

Proxy contest
 Going private

M&A Motivation

‘Synergy’

Whole is worth more than the sum of the parts

Break-up Value
Market Power

Agency Issues, Hubris

Diversification

Avoid takeover attempts

Synergy

ΔV = VAB – (VA + VB)


Synergy: ΔV > 0
Possible sources
Δ CF = Δ Rev. - Δ Costs - Δ Taxes - Δ Cap Req.
 Increase revenue
 Reduce costs
 Lower taxes or capital requirements

Revenue Enhancement

Marketing gains
Advertising
 Distribution network
 Product mix



Strategic benefits
Market power
Cost Reductions

Economies of scale


Lower average cost by spreading overhead
Economies of scope (vertical integration)
Coordinate operations more effectively
 Reduced search cost for suppliers or customers
 Reduce contracting problems

Lower Taxes or Capital Needs

Taxes:

Take advantages of net operating losses
Carry-backs and carry-forwards
 IRS can prevent merger if sole purpose is to avoid taxes



Unused debt capacity
Capital Requirements:

Reduce relative to the two firms operating separately
Acquisitions

Cash Acquisition



NPV = VB* – cash cost
Value of the combined firm
Stock Acquisition


Value of combined firm
Cost of acquisition



VAB = VA + (VB* - cash cost)
VAB = VA + VB + V
Depends on # shares given to target stockholders
Depends on post-merger stock price
Example
Cash vs. Stock

Sharing gains


Taxes


Cash acquisitions are generally taxable
Control


Target stockholders don’t participate in stock price
appreciation with a cash acquisition
Cash acquisitions do not dilute control
Signal

Stock acquisitions indicate your stock is overvalued
M&A Valuation




Market values
Only incremental cash flows
Appropriate discount rate
Consider transaction costs
After Valuation

Friendly


Work with management
Hostile

Toe-hold or Bear-hug





Open market purchase
Threaten target BOD with tender offer
Proxy Fight
Tender Offer
Defenses

Poison pills/put, greenmail, golden parachute, etc.
Defensive Tactics

Corporate charter




Establishes conditions that allow for a takeover
Standstill agreements / Targeted repurchase
Poison pills (share rights plans)
Leveraged buyouts
Free-Rider Problem

Purchase toe-hold

Buy from large shareholders

Two-tiered offer
Value to Acquirer

Target - 10 million shares, $9/share
~ Target’s value to bidder
Target’s current market value
Merger premium
= $163.9 million
= $ 90.0 million
= $ 73.9 million
Change in Shareholders’
Wealth
Acquirer
Target
$9.00
0
5
$16.39
10
15
Bargaining Range =
Synergy
20
Price Paid
for Target
Market Reaction

Target shares increase +20%

Bidder shares are stagnant or decrease



Stock offers: -1.5%
Cash offers: unclear
Effect on competitors varies
M&A Risk

Overpayment


Operating Risk




Winner’s Curse
Integration issues, culture
Mgmt resources
Continued subsidization of sub-par groups
Financial Risk

Leverage
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