Lecture 8 :
Mergers & Acquisition
Learning Outcomes
• LO 1) Mergers & Acquisitions
• LO 2) Motives of Mergers & Acquisitions
• LO 3) Financing Mergers & Acquisition
• LO 4) Empirical Researches
LO 1)
Mergers & Acquisition
Mergers & Acquisition
• Forms of strategic alliance
• Alternative to organic growth
• Involves rapid and dramatic change
Mergers – Key Features
Merger
• A friendly re-organisation of assets into a new firm
• Mutual agreement of both sets of managers
• Merge shares into new company e.g. Lloyds TSB
• Usually firms of similar size and industry
Mergers – Key Features
M&A = “Mergers and Acquisitions”
Company A
+
Company B
“joint agreement”
=
Company
AB
MERGED
COMPANY
Takeovers – Key Features
Takeover/Acquisition
• Acquisition of one company’s share capital by another. E.g. A
makes a direct offer to shareholders of B to gain control.
Price usually above market value e.g.
• HSBC took over Midland – latter name disappeared
• Can be hostile or friendly
Takeovers – Key Features
M&A = “Mergers and Acquisitions”
“takeover”
Parent A
buys
Company A
ACQUIROR
Company B
TARGET
=
Subsidiary B
GROUP
Implications of Mergers & Acquisition
Implications of Mergers & Acquisition
• Highlights long term strategic aspirations of the firm
• May represent a new direction
• Major investment
• Shift in ownership
• Replacement of ‘old’ management
• Consequences - vast e.g.. Operations, legal, financial dividend policy, gearing, risk, cost of capital...
Types of Mergers & Acquisition
Types of Mergers & Acquisitions
Horizontal
Same industry
e.g. Morrisons & Safeway
Vertical
Expand backward/forward to
different stage of supply chain:
Forward: Brewers and pubs, oil
companies and filling stations
Backward: retailer buying a supplier
Conglomerate
Unrelated diversification
e.g. Unilever, Hanson
LO 2)
Motives of Mergers & Acquisition
Motives of Mergers 7 Acquisitions
MOTIVES
ECONOMIC
FINANCIAL
MANAGERIAL
a) Economic Motives
Synergy : 2 + 2 = 5 ?
• Operating synergies
• Economies of scale
• Managerial synergies
• Entry to new markets
• Growth
• Market power/market share
b) Financial Motives
Financial synergies
Tax effects
Target
undervalued
Bootstrapping…
Bootstrapping Example

Acquiror
Firm A
Target
Firm B
Earnings
£1m
£1m
No of shares
10m
10m
Share price
£2
£1
Earnings per share
= £1m / 10m
= £0.10
= £1m / 10m
= £0.10
P/E ratio
= £2.00 / £0.10
= 20.0 x
= £1.00 / £0.10
= 10.0 x
Firm A makes an all equity offer for Firm B
1 share in A for every 2 shares in B
A must therefore issue 5m new shares
Bootstrapping Example
Acquiror
Firm A
Target
Firm B
Earnings
£1m
£1m
£2m
No of shares
10m
10m
15m
Share price
£2
£1
?
Earnings per share
= £1m / 10m
= £0.10
= £1m / 10m
= £0.10
= £2m / 15m
= £0.133
P/E ratio
= £2.00 / £0.10
= 20.0 x
= £1.00 / £0.10
= 10.0 x
= 20.0X
Assume that A post-deal is valued on
the same multiple of 20.0x, therefore :
 Share price of A
= P/E ratio * EPS
= 20.0x * £0.133
= £2.66

Post deal Firm
A
BUYER P/E > TARGET P/E
A’s share price
and market
cap increase
c) Managerial Motives
Managerial Motives
• Raising issues of the agency relationship
• Managerial pay and power
• Power Needs & Empire Building
• Executive Compensation
• Human Capital Risk Diversifications
Stages of Acquisition
Stages of Acquisition
• Firm appoints advisers
• Identify suitable target companies
• Obtain information on these targets
• Value each target company and decide on the maximum
purchase price
• Choose the best potential target
• Identify the best way to finance the acquisition
• Select tactics likely to make the bid successful
• Approach the target
• Notify shareholders
• Negotiation
• Recommendation to shareholders
LO 3)
Financing a Merger or Acquisition
• Method must be both attractive to target shareholders and
acceptable to acquirer
• Choose from:
CASH
AND/
OR
SHARES IN
ACQUIRER
• Cash will often need to be raised externally through borrowings
• The acquirer will have to take into account the effect on capital
structure
Defenses – to Fend Off Bidders
Defences – to Fend Off Bidders
• Promise dividend increase (but casts doubt on current policy &
bidders usually offer better dividends)
• Publish improved forecasts – realistic?
• Seek a white knight – a friendly/acceptable bidder
• Lobby competition authorities for referral
LO4)
Empirical Research – The Economy
The economy:
• Research shows acquisitions have, at best, a neutral effect on
the economy
• Although overall economic wealth may not increase, wealth
redistribution can occur
• Cowling et al (1980) found efficiency gains neutralised by
greater monopoly power, although some benefits were noted
Empirical Research – The Acquirer
The acquirer shareholders:
• Accounting studies indicate that acquisitions are
unprofitable to the acquirer
• Acquiring company shareholders get no gains or
make a loss
• The acquirer managers:
• Benefit from
• increased power and status
• increased financial rewards
• increased job security
Empirical Research – The Target
The target shareholders:
• Studies show that target company
shareholders get significant gains.
• Gain is likely to be a result of bid premium
• Perhaps share ownership in new company in
the long run
The target managers/staff:
• Managers of target companies tend to lose
their jobs
• Employees also face an uncertain future
Winners & Losers
Winners
• Target shareholders
• Bidding managers
• Financial services
industry
• Society?
Losers
• Bidding shareholders
• loss in value
• lack of management
attention to core activity
• Target managers & staff
• Society?
…… and Finally
• If an acquisition is to benefit the shareholders of the bidding
company rather than the egos of its managers there is a need
for :
• A clear strategic fit
• Demonstrable synergies
• Confidence in bidder’s ability to manage the target better
• A long term view
• Being prepared to pay a realistic price or to walk away