Acquisitions and restructuring
Target
How should
the
evaluation
be done?
diversification?
uncertainties?
Differences:
1. No access to intelligence about the target beyond published financial
and market data
2. Takeovers are undertaken for longer-term strategic motives, and the
benefits are hard to quantify. ‘The Strategic Window Problem’
Learning objectives
• Why firms select acquisitions rather than other strategic options
• How acquisitions can be financed?
• How acquisitions should be integrated?
• How the degree of success of a takeover can be evaluated
• How corporate restructuring can enhance shareholder value
Structure
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Definitions.
Motives for take-over.
Take-over evaluation.
Why do take-overs fail?
Why do take-overs succeed?
The impact of take-overs.
Types of acquisition
• A take-over is:
– absorption of a target firm into a new parent – acquirer
offers capital (cash, shares, or stock) in exchange for
equity of acquiree.
• A merger is:
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– a ‘pooling of interests’ into a new enterprise, involving a
‘friendly’ re-structuring of the assets and capital of the two
parties into a new organisation.
Most amalgamations are take-overs – true mergers are very
rare, but the word ‘merger’ is frequently used to apply to both
forms.
Motives for merger and takeovers
• Managers acting in best interests of
shareholders seek out valuable opportunities
to exploit.
• Two sources of enhanced value:
– value release – acquisition of target for less
than it true value e.g. asset stripping – EMH.
– value creation – expanded firm worth more
than the two separate entities, due to
exploitation of ‘synergies’. VA+B>VA+VB
How different types of acquisition
creates value
Conglomerate
or unrelated
integration
Horizontal
integration
Vertical
integration
Sources of value creation
• Scale economies – a function of size
• Cost savings – elimination of duplication
• Synergies – matching of corporate
resources and capabilities, unrelated to size
• Exploitation of new markets
• Restoration of growth impetus
• Accretion of market power
• Diversification to lower risk.
• To provide ‘critical mass’
The market for managerial control
• Take-overs usually result in ousting of old set of
managers, hence a way of securing changes in
management control.
• More effective than two other main mechanisms
i.e. corporate failure, voting.
• So, a ‘market for corporate control’ (Jensen) is
the favoured mechanism for replacing inefficient
managers with an alternative group more
committed to working in shareholder interests.
The ‘Managerial’ explanation
1. Managers seeking own personal objectives
The 3 Ps – pay, power and prestige are all
enhanced by size
A reflection of the agency problem.
2. Managerial ‘hubris’ – despite failure record of
take-overs, managers still believe they can
succeed.
Financing a take-over
• Cash-for-shares:
– easy to understand; cannot fall in value
– may trigger tax liability for selling shareholders
– may lead to excessive leverage if bidder borrows
• Shares-for-shares exchanges:
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easier on cash flow
but value fluctuates with bidder’s share price
may dilute EPS of bidder
may alter balance of voting power –‘reverse take-over’
• Mixed offers:
– cash or shares; or cash or shares plus cash.
Evaluating an acquisition using cash
(Company A taking over company B)
• The gain = PVA + B – (PVA + PVB)
• The net cost = The outlay less the value obtained e.g.
cash spend – PVB
• The NPV = The gain - the cost
= PVA + B - (PVA + PVB) - (cash spend - PVB)
= PVA + B - PVA - cash spend
Example of cash bid
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Bidder: Fewston, value = £200M, 100M shares
Target: Dacre, value = £40M, 10M shares
Predicted merger savings = PV of £20M
Fewston buys Dacre for £50M cash
NPV = PVF + D - PVF - Cash Spend
= (£200M + £40M + £20M) - £200M - £50M
= £10M
• Hence, merger benefits split 50/50 between both
firm’s shareholders i.e. £10M to each group.
Financing via shares
• Again, the gain = PVA + B - (PVA + PVB)
• The cost = What you give up less what you
receive = [target’s owners share of merged firm
(S%) less value of target]
i.e.
S(PVA + B) - PVB
• NPV = gain - cost
i.e. PVA + B - (PVA + PVB) - [S(PVA + B) - PVB]
= PVA + B - PVA - S(PVA + B)
= (1 - S) PVA + B - PVA
Fewston/Dacre example
• Share prices: Fewston: (£200M/100M) = £2; Dacre:
(£40M/10M) = £4. If Fewston bids £50M, must offer
(£50M/£2) = 25M shares
• Number of shares = (100M + 25M) = 125M
• Hence, Fewston gives up (25M/125M) = 20% of firm
• NPV of merger = (1 - S) PVF + D - PVF
= (1 - 0.2)(£260M) - £200M = £8M
• Balance of gains (£12M i.e. 60%) tilted towards
Dacre – share exchange passes over some of the
benefits to target’s shareholders.
Why do take-overs fail or succeed?
It’s hard to assess what would happened had a takeover trail not been embarked…
FAIL = does not enhance shareholders value
• Acquirers pay too much, often in debt form
– Poor evaluation, ‘machismo’ in a bidding war
• Acquirers fail to plan integration
• Acquirers fail to judge cultural differences
SUCCEED
• Generally, due to careful planning, evaluation of
strategic contribution of the target and conservative
valuation – ‘the strategic approach’.
Payne’s strategic framework
Figure 1: A strategic framework (based on Payne, 1985)
Take-over defences
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Rush out an enhanced profits forecast
Denigrate the profit and share price record of the bidder
Revalue assets
Promise a higher dividend
Stress bidder’s unsuitability – ‘lack of industrial logic’,
‘opportunism’
Lobby the competition authorities
Seek a ‘White Knight’
Sell the ‘Crown Jewels’
‘Pacman’ defence – launch a counter-bid for the raider
Golden parachutes for senior staff
Enhance firm size
Share re-purchase (buybacks)
Place shares in friendly hands.
Drucker’s 5 Golden Rules
Chances of successful merger enhanced if
acquirer:
1. Ensures a ‘common core of unity’.
2. Contributes skills and resources to
acquired firm.
3. Respects the products and markets of the
acquired firm.
4. Provides top management for acquired firm.
5. Makes cross-company promotions.
Jones’s integration sequence
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Reporting relationships
Rapid control of key factors
Resource audit
Harmonise corporate objectives
Revise corporate structure
Assessing the impact of mergers
Two approaches:
1. Examine the financial ratios of the expanded
firms relative to those of the separate firms premerger – ‘financial characteristics approach’.
2. Use the CAPM to examine the returns on shares
of bidder and acquired firms before and after the
take-over event – ‘capital market approach’
Problems with the financial
characteristics approach
• Different accounting policies between firms
• Application of acquisition accounting – writeoff of goodwill to reserves?
• Key ratios worsen post-merger when firms
acquire an inefficient firm
• What would have happened without the
merger?
• Ignores risk – merger may alter risk profile of
firm.
Capital markets approach
• Method – examine share prices pre- and post-bid
announcement; any abnormal returns attributed to bid
event
e.g. Beta = 1.2, return on market = 5%.
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Return on take-over target = 30% on event day.
Expected return = (1.2 × 5%) = 6%.
Hence, abnormal return = (30% - 5%) = 25%.
Suffers from usual problems with CAPM.
Also, impact of bid spread out over time
– e.g. pre-bid ‘creep’ in share price of target.
Assessment
• Most studies show the bulk of merger gains
accrue to target’s shareholders
• Little evidence that firms perform better postmerger
• Easy to get caught up in a bidding war and to
over-pay
• Best strategy is to go for friendly acquisitions in
related activities
• A major key to success is carefully planned
integration, and attention to cultural issues.
“Value gaps”
The near certainty that shareholders of targets will benefit suggests that market
values typically fall short of the value that potential or actual bidders would place on
them. These disparities are called value gaps.
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Poor corporate parenting
Poor financial management
Over-enthusiastic bidding
Stock market inefficiency
Corporate restructuring to create value
• Concentration of equity ownership in the hands of the
managers or ‘inside investors well-placed to monitor
managers’ efforts.
• Substitution of debt for equity
• Redefinition of organizational boundaries through
mergers, divestment, management buy-outs etc.
Financial managers should be ever-alert to:
Review the corporate financial structure from the shareholder’s
viewpoint
Increase efficiency and reduce the after-tax cost of capital
through the judicious use of borrowing
Improve operating cash flows through focusing on wealth-creating
investment opportunities, profit improvement and overhead
reduction programs
Pursue financially-driven value creation using various new
financing instruments and arrangements (i.e. financial
engineering).
Types of restructuring
Corporate
Business unit
Asset
Diversification/demerger
Share issues
Share repurchase
Strategic alliances
Leveraged buy-outs
Liquidation
Acquisitions
Joint ventures
Management buy-outs
Sell-offs*
Franchising
Spin-offs*
Pledging assets as security
Factoring debts
Leasing
Sale and leaseback
Divestment
The structure of
the parent company
The structure of
the strategic business
unit
Changing the
ownership of
assets
Good restructuring should result in:
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Better business fit and focus
Elimination of sub-standard investment
Judicious use of debt
Incentives for good performance