Restructuring Ownership: Mergers & Acquisitions Prof. Ian Giddy New York University
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Restructuring Ownership: Mergers & Acquisitions Prof. Ian Giddy New York University Mergers and Acquisitions z Mergers & Acquisitions z Divestitures z Valuation Concept: Is a division or firm worth more within the company, or outside it? Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 2 GULF Mardi-Gras Negotiation MARDI Before-and-after Valuation Copyright ©2004 Ian H. Giddy GRAS Signed Merger Agreement Corporate Financial Restructuring 5 The Basics IBM is considering the acquisition of Basix, Inc. The shares are trading at a P/E of 11, far below IBM’s P/E of 18. Based on past performance the company is expected to earn $2 per share next year, an increase from the current EPS of $1.93. If IBM acquires Basix, the long-run EPS growth rate could be raised to 5.5%. The Treasury bond yield is 4.5%, the company’s beta is 1.3 and the long run market return is 11.5%. Is the company worth buying at a P/E of 12? At how much of a premium should we say fugedaboudit? Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 6 Basix Use constant growth model Before Earnings $ 1.93 Next year $ 2.00 Growth rate 3.6% Risk free rate 4.50% Beta 1.3 Market return 11.50% Req ret on equity 13.60% Value $ 20.05 P/E 10.4 Price $ 21.23 After $ 1.93 $ 2.00 5.5% 4.50% 1.30 11.50% 13.60% $ 24.69 12.8 16% Source: basix.xls Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 7 Telia/Sonera March, 2002, FT. Sweden’s Telia is merging with Finland’s Sonera. Under the deal, Telia will offer 1.51 of its shares for each Sonera share, a premium of 15.8 per cent to Sonera's closing price. This gives Telia shareholders 64 per cent of the new company, and Sonera's 36 per cent. Adding the present value of E300m synergies promised annually from 2005 to the companies' combined market capitalization, and dividing by the increased number of shares, suggests a value of roughly SKr41 per Telia share, against yesterday's close of SKr35.4. But execution risks are high. The expected growth of this sector is 6-7% pa. Those risks mean Sonera ends up with a miserly premium. But although it is back from the brink of disaster, it has nowhere else to go. Governance arrangements look promising. Yet while bringing in an outside chief executive ensures neutrality, it leaves strategic questions unanswered. What happens to Telia's loss-making international carrier business, Sonera's 3G ventures and its interests in Turkey and central Asia? The strategic fit is not bad. Telia would acquire Sonera's market leadership in Finland, plus Sonera's interests in their joint ventures in the Baltic states and Russia. The biggest problem may be price. There are synergies on offer - Telia could shut down its loss-making Finnish mobile venture, and crunch head office costs. But they appear rather limited. The merged entity would not gain economies of scale in mobile to compare with a Vodafone or an Orange. Telia may find it hard to make an offer that does not destroy value for its shareholders, but is still worth Sonera bothering to accept. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 8 The Gains From an Acquisition Gains from merger Synergies Top line Copyright ©2004 Ian H. Giddy Control Bottom line Financial restructuring Business Restructuring (M&A) Corporate Financial Restructuring 9 The Market for Corporate Control When you buy shares, you get dividends; and potential control rights There is a market for corporate control— that is, control over the extent to which a business is run in the right way by the right people. This market is constrained by Government Management Some Copyright ©2004 Ian H. Giddy shareholders Example: Allied Signal’s attempts to acquire AMP, which is located in Pennsylvania Corporate Financial Restructuring 10 Goal of Acquisitions and Mergers z Increase size - easy! z Increase market value - much harder! Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 11 Goals of Acquisitions Rationale: Firm A should merge with Firm B if [Value of AB > Value of A + Value of B + Cost of transaction] z Synergy z Gain market power z Discipline z Taxes z Financing Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 12 AOL-Time Warner Now..when did the merger take place? Motivations? z Lessons? z Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 14 AOL-Time Warner Possible motivations z Economies of scale and scope z Diversification z Access to new technology z Regulatory arbitrage z Hubris Copyright ©2004 Ian H. Giddy Possible problems z Overestimating synergy z Slow pace of integration z Poor strategy z Payment in stock z Overpaying z Poor postmerger communication z Conflicting corporate cultures z Weak core business z Large size of target company z Inadequate due diligence z Poor assessment of technology Corporate Financial Restructuring 15 Who Gains What? Target firm shareholders? z Bidding firm shareholders? z Lawyers and bankers? z Are there overall gains? z Changes in corporate control increase the combined market value of assets of the bidding and target firms. The average is a 10.5% increase in total value. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 16 Gains to Bidding Firm Shareholders There are positive returns to successful bidders in tender offers z For successful bidders in mergers, evidence is mixed. It seems that returns are around zero. z For unsuccessful bidders in both tender offers and mergers, returns are negative. z Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 17 Do Acquisitions Benefit Shareholders? Successful Bids Technique Target Bidders Tender offer Merger Proxy contest 30% 20% 8% 4% 0 na Note: Abnormal price changes are price changes adjusted to eliminate the effects of marketwide price changes Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 18 Do Acquisitions Benefit Shareholders? Unsuccessful Bids Technique Target Bidders Tender offer Merger Proxy contest -3% -3% 8% -1% -5% na Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 19 The Price: Who Gets What? Market value before deal leaked Value added by merger Daimler Chrysler Combined $52.8 $29.4 $82.2 $18.0 Merged Value $100.2 Shareholders get 57.2% 42.8% 100% Which is now worth $57.3 $42.9 $100.2 Shareholders' shares of the gain Premium, as % $4.5 $13.5 $18 9% 46% Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 20 AMP/AlliedSignal/Tyco What defenses did AMP employ? z Who won? Who lost? z Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 21 Equity Valuation: Application to M&A Prof. Ian Giddy New York University What's It Worth? Valuation Methods z Book value approach z Market value approach z Ratios (like P/E ratio) z Break-up value z Cash flow value -- present value of future cash flows Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 23 How Much Should We Pay? Applying the discounted cash flow approach, we need to know: 1.The incremental cash flows to be generated from the acquisition, adjusted for debt servicing and taxes 2.The rate at which to discount the cash flows (required rate of return) 3.The deadweight costs of making the acquisition (investment banks' fees, etc) Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 24 Valuing a Firm with DCF: An Illustration Historical financial results Adjust for nonrecurring aspects Gauge future growth Projected sales and operating profits Adjust for noncash items Projected free cash flows to the firm (FCFF) Year 1 FCFF Year 2 FCFF Year 3 FCFF Year 4 FCFF Discount to present using weighted average cost of capital (WACC) Present value of free cash flows Copyright ©2004 Ian H. Giddy + cash, securities & excess assets - Market value of debt Terminal year FCFF … Stable growth model or P/E comparable Value of shareholders equity Corporate Financial Restructuring 25 Equity Valuation in Practice Estimating discount rate z Estimating growth rate and cash flows z Application to Optika z Estimating synergies z Application in M&A: Schirnding-Optika z Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 26 Estimating Future Cash Flows Copyright ©2004 Ian H. Giddy Dividends? Free cash flows to equity? Free cash flows to firm? Corporate Financial Restructuring 27 The Gains From an Acquisition Gains from merger Synergies Top line Copyright ©2004 Ian H. Giddy Bottom line Control Financial restructuring Business Restructuring (M&A) Corporate Financial Restructuring 28 Optika Optika WACC: ReE/(D+E)+RdD/(D+E) Growth Tax rate Initial Revenues COGS WC Equity Market Value Debt Market Value Beta Riskfree rate Debt spread Market risk spread Value: FCFF/(WACC-growth rate) Revenues -COGS -Depreciation =EBIT EBIT(1-Tax) -Change in WC -Free Cash Flow to Firm Cost of Equity (from CAPM) Cost of Debt WACC Equity Value: Firm Value - Debt Value = 2681-250 = 2431 Firm Value Copyright ©2004 Ian H. Giddy 5% 35% 3125 89% 10% 1300 250 1.0 7% 1.5% 5.5% T+1 3281 2920 74 287 187 16 171 12.50% 5.53% 11.38% CAPM: 7%+1(5.50%) Debt cost (7%+1.5%)(1-.35) 2681 Corporate Financial Restructuring 29 Optika & Schirnding Optika Growth Tax rate Initial Revenues COGS WC Equity Market Value Debt Market Value Beta Riskfree rate Debt spread Market risk spread Revenues -COGS -Depreciation =EBIT EBIT(1-Tax) -Change in WC -Free Cash Flow to Firm Cost of Equity (from CAPM) Cost of Debt WACC Firm Value Copyright ©2004 Ian H. Giddy 5% 35% 3125 89% 10% 1300 250 1.0 7% 1.5% 5.5% Schirnding 5% 35% 4400 87.50% 10% 2000 160 1.0 7% 1.5% 5.5% Combined 5% 35% 7525 T+1 3281 2920 74 287 187 16 171 12.50% 5.53% 11.38% T+1 4620 4043 200 378 245 22 223 12.50% 5.53% 11.98% 7901 6963 274 664 432 38 394 12.50% 5.53% 11.73% 2681 3199 5859 10% 3300 410 1.0 7% 1.5% 5.5% Corporate Financial Restructuring 30 Optika-Schirnding with Synergy Optika Growth Tax rate Initial Revenues COGS WC Equity Market Value Debt Market Value Beta Riskfree rate Debt spread Market risk spread Revenues -COGS -Depreciation =EBIT EBIT(1-Tax) -Change in WC -Free Cash Flow to Firm Cost of Equity (from CAPM) Cost of Debt WACC Firm Value Copyright ©2004 Ian H. Giddy 5% 35% 3125 89% 10% 1300 250 1.0 7% 1.5% 5.5% Schirnding 5% 35% 4400 87.50% 10% 2000 160 1.0 7% 1.5% 5.5% T+1 3281 2920 74 287 187 16 171 12.50% 5.53% 11.38% 2681 Combined 5% 35% 7525 10% 3300 410 1.0 7% 1.5% 5.5% Synergy 5.5% 35% 7525 86.00% 10% 3300 410 1.0 7% 1.5% 5.5% T+1 4620 4043 200 378 245 22 223 12.50% 5.53% 11.98% 7901 6963 274 664 432 38 394 12.50% 5.53% 11.73% T+1 7939 6827 274 837 544 41 503 12.50% 5.53% 11.73% 3199 5859 8074 Corporate Financial Restructuring 31 Valuation in a Bidding-War Context Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 32 Case Study: The Acquisition of Conrail Why merge Conrail and CSX? z How was the CSX offer structured? z How was Conrail’s resistance to an unfriendly bid structured? z How would you, as a Conrail shareholder, react to the offer? z What’s Conrail worth? z Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 33 The Network Conra il R a ilroa d Ope ra tions Operating Revenues $3,686 Operating Expenses 3,230 Operating Cost Ratio (%) 87.60% Railroad Employees 23,510 Total Carloads Originated (thousan 2,531 Revenue per Employee $156,784 Fina ncia l R a tios (% ) Return on Sales Return on Average Equity Copyright ©2004 Ian H. Giddy 11.4% 9% CSX N orfolk S outhe rn $4,819 3,951 82.00% 29,537 4,402 $163,151 $4,012 2,950 73.50% 24,488 3,435 $193,690 6.9% 15.5% 15.3% 15% Corporate Financial Restructuring 34 Conrail: Obstacles to an Unfriendly Takeover z Pennsylvania “Fair Value” statute: bids >20% all get same price Bidder’s voting rights maxed at 20% unless management approves “Constituency” statute: protect unions z Conrail Break-up fee to CSX CSX has “lock up” option to buy 16m new shares Poison pill (suspended for CSX): shareholders get new shares at half price if outsider buys 10% 6-month “no talk” clause Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 35 Takeover Defenses z Poison Pills Preferred flip-over stock Flip-over rights Flip-in rights Poison put bonds z Shark Repellants z Limitations on board changes Limitations on shareholder actions Supermajority rules Anti-greenmail limits on share repurchases Fair-price provisions Supervoting stock exchange offers Reincorporation Golden parachutes Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 36 Post-Takeover Bid Responses z z z z z z z “Just Say No” Litigation White Knight Greenmail ESOP Pac-Man Restructuring, including Copyright ©2004 Ian H. Giddy Leveraged Recapitalization Share Buybacks Using cash for acquisitions Divestitures Going private Liquidation Corporate Financial Restructuring 37 What is Conrail Worth? z Stand-alone value Market value: $71.00 Comparables P/E ratio) Conrail: $89/4.91=18x Discounted present value Value to acquirer z Value in bidding-war context z Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 38 Comparables Value ValueIndicator Indicator Earnings Earnings Cash Flow Cash Flow Revenues Revenues Book Book Copyright ©2004 Ian H. Giddy Average Average Comparable Comparable Industry Industry Firms Firms Deals Deals Target Target Company Company Numbers Numbersor or Projections Projections Estimated Estimated Value Valueof of Target Target Corporate Financial Restructuring 39 What is Conrail Worth? Conrail Valuation Multiples Average multiple Number Firm value Debt value Equity valuEquity Value per share Price/Earnings 17.19 $ 5.69 Price/EBITDA 10.57 1017 10749.69 2094 8655.69 93.58 2094 6876.02 74.34 Price/Sales 2.41 3722 Price/Book 3.63 32.46 Copyright ©2004 Ian H. Giddy 97.81 8970.02 117.83 Corporate Financial Restructuring 40 How Much Premium Can a Buyer Pay? Applying the discounted cash flow approach, we need to know: z The incremental cash flows to be generated from the acquisition, adjusted for debt servicing and taxes z The rate at which to discount the cash flows (required rate of return on equity) z The deadweight costs of making the acquisition (investment banks' fees, etc) z Cost of losing out! Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 41 Gains From an Acquisition of Conrail? Gains from merger Synergies Top line Copyright ©2004 Ian H. Giddy Bottom line Control Financial restructuring Business Restructuring (M&A) Corporate Financial Restructuring 42 What is Conrail Worth? Conrail Valuation CSX Valuation 1 Gain in Operating Income 3% TV w. const growth m After tax 35% PV NPV 1990.995 Shares 90.5 NPV per share $ 22.00 Pre-merger $71.00 Total $ 93.00 Copyright ©2004 Ian H. Giddy Re 16.15% Required return = = Rf 6.83% 1997 0 1998 188 1999 396 2000 550 0 0 122 91 257 164 358 196 + + Beta 1.3 Mkt Risk Prem 7.17% 2001 567 4441 3255 1540 Corporate Financial Restructuring 43 What is Conrail Worth? z Stand-alone value Market value: $71.00 Comparables Discounted present value Value to acquirer z Value in bidding-war context z Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 44 A Higher Price for Conrail Could Norfolk Southern make a bid? z How? How much? z Does this change what CSX has to pay? z Answer: Yes! z Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 45 What is Conrail Worth? Conrail Valuation CSX Valuation 2 Re 16.15% Required return = = Rf 6.83% Gain Gain in Operating Income TV w. const growth m 3% After tax 35% PV NPV 2634.565 Shares 90.5 NPV per share $ 29.11 1997 0 1998 240 1999 521 2000 730 0 0 156 116 339 216 475 261 Opportunity Cost Loss if rival gets target TV w. const growth m 3% After tax 35% PV NPV -682.571 Shares 90.5 NPV per share $ (7.54) 1997 0 1998 -66 1999 -123 2000 -189 0 0 -43 -32 -80 -51 -123 -67 Pre-merger Gain Opp cost Total Copyright ©2004 Ian H. Giddy + + Beta 1.3 Mkt Risk P 7.17% 2001 752 5890 4317 2042 2001 -196 -1535 -1125 -532 $71.00 $ 29.11 $ 7.54 $107.65 Corporate Financial Restructuring 46 But Where Are the Profits? January 2001 http://www.railwayage.com/jun01/conrail_split.html Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 47 But Where Are the Profits? NSC S&P500 CSX Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 48 Summary: What’s It Worth? Valuation Liquidation Dissolve Break-up Going concern Comparables Acquisition PV Cash Flows Synergies Top line Copyright ©2004 Ian H. Giddy Bottom line Control Business mix Rival Advantage Financial Corporate Financial Restructuring 49 Contact Info Ian H. Giddy NYU Stern School of Business Tel 212-998-0426; Fax 212-995-4233 Ian.giddy@nyu.edu http://giddy.org Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 53
