Mergers & Acquisitions
Topics Covered
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Sensible Motives for Mergers
Some Dubious Reasons for Mergers
Estimating Merger Gains and Costs
The Mechanics of a Merger
Proxy Fights, Takeovers, and the Market
for Corporate Control
Mergers and the Economy
Types of Mergers

Horizontal mergers
Combinations of two firms in the same industry (Bank
of New York and Mellon Financial Corporation, 2007)

Vertical mergers
Involves companies at different stages of production
Forward integration: Boise Cascade (paper manufacturer)
acquire Office Max (office products distributor), 2003
Backward integration: TomTom (maker of car navigation
devices) acquire Tele Atlas (digital map data), 2008
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Conglomerate mergers
Involves companies in unrelated line of businesses
MIG (financial services) acquire Olympic Airlines (Travel &
Leisure), 2009
M&A Around the World (1981-1998)
44.600 Deals
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Horizontal mergers
41.7%
Vertical mergers
4%
Conglomerate mergers
54.3%
 Cross border 21.7%
Please see, Gugler, Mueller, Yurtoglu and Zulehner (2003)
Sensible Reasons for Mergers
Economies of Scale
A larger firm may be able to reduce its per unit cost by
using excess capacity or spreading fixed costs across
more units.
Sensible Reasons for Mergers
Economies of Vertical Integration
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Control over suppliers “may” reduce costs.
Over integration can cause the opposite effect.
Pre-integration
(less efficient)
Post-integration
(more efficient)
Company
S
S
S S
S
Company
S
S
S
Sensible Reasons for Mergers
Combining Complementary Resources
The two firms have complementary resources - each has
what the other needs.
Merging may results in each firm filling in the “missing
pieces” of their firm with pieces from the other firm.
Firm A
Firm B
Sensible Reasons for Mergers
Mergers as a Use for Surplus Funds
If your firm is in a mature industry with few, if any,
positive NPV projects available, acquisition may be the
best use of your funds.
Firms with a surplus of cash and a shortage of good
investment opportunities often turn to mergers financed
by cash.
Such firms often find themselves targeted for takeover by
other firms that propose to redeploy the cash for them.
Example: the early 1980s many cash-rich oil companies
found themselves threatened by takeover.
Sensible Reasons for Mergers
Eliminating Inefficiencies
There are firms with unexploited opportunities to cut
costs and increase sales and earnings (poor
management). Such firms are natural candidates for
acquisition by other firms with better management.
A merger is not the only way to improve
management, but sometimes it is the only simple and
practical way.
Sensible Reasons for Mergers
Industry Consolidation
The biggest opportunities to improve efficiency seem
to come in industries with too many firms and too
much capacity.
The banking industry is an example. The US entered
the 1980s with far too many banks, largely as a result
of outdated restrictions on interstate banking. As
these restrictions eroded and communications and
technology improved, hundreds of small banks were
swept up into regional or super-regional banks.
Bank of America Family Tree
Dubious Reasons for Mergers
Diversification
Investors should not pay a premium for
diversification since they can do it themselves.
The trouble with this argument is that diversification
is easier and cheaper for the stockholders than for
the corporation.
Dubious Reasons for Mergers
Increasing EPS: The Bootstrap Game
Acquiring Firm has high P/E ratio
Selling firm has low P/E ratio
After merger, acquiring firm has
short term EPS rise
Long term, acquirer will have slower than
normal EPS growth due to share dilution
Dubious Reasons for Mergers
Increasing EPS: The Bootstrap Game
World Enterprises
(before merger)
EPS
Price per share
P/E Ratio
Number of shares
Total earnings
Total market value
Current earnings
per dollar invested
in stock
$
$
$
$
$
2.00
40.00
20
100,000
200,000
4,000,000
World Enterprises
(after buying Muck
and Slurry)
Muck and Slurry
$
2.00 $
2.67
$
20.00 $
40.00
10
15
100,000
150,000
$
200,000 $
400,000
$
2,000,000 $
6,000,000
0.05 $
0.10 $
0.067
Dubious Reasons for Mergers
Earnings
per dollar
invested
World Enterprises (after
merger)
World Enterprises (before
merger)
Muck & Slurry
.10
.067
.05
Now
Time
Lower Financing Costs
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When two firms merge, the combined company (AB) can
borrow at lower interest rates than either firm could
separately. In part this is true!
While the two firms are separate, they do not guarantee
each other’s debt. But after the merger each firm
effectively does guarantee the other’s debt. Because
these mutual guarantees make the debt less risky,
lenders demand a lower interest rate.
Does the lower interest rate mean a net gain to the
merger? Not necessarily!
Although AB’s shareholders do gain from the lower
interest rate, they lose by having to guarantee each
other’s debt.
Estimating Merger Gains
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Questions
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Is there an overall economic gain to the
merger?
Do the terms of the merger make the
company and its shareholders better off?
PV(AB) > PV(A) + PV(B)
There is an economic gain only if the two
firms are worth more together than apart
Estimating Merger Gains and Costs
Gain
PVAB (PVA
PVB )
Cost
Cash paid
NPV
gain cos t
PVAB (cash PVB )
PVB
PVAB
Example:
Firm A has a value of €200M, and B has a value of €50M.
Two firms merge creating €25M in synergies. Firm A
buys B with cash for €65M. What is the merger cost to
firm A’s stockholders?
PVA
200
PVB
50
Gain
PVAB
25
PVAB
PVA PVB Gain
Cost
Cash paid
PVB
65 50 15M
275M
Example (cont’d)
What is the merger gain to firm A’s stockholders?
The NPV to firm A’s stockholders will be the difference
between the gain and the cost.
NPVA
Gain
Cost
25 15 10 M
NPVA
wealth wit h merger - wealth without merger
(PVAB Cash ) PVA
(275 65) 200
10 M
Merger is Financed by Stock
Cost
NPAB
PVB
target firm shareholde rs receive N shares
of the combined firms
Cost
xPV AB
PVB
target firm shareholde rs receive
the fraction x of the combined firms
Accounting for a Merger
Accounting for the merger of A Corp and B Corp
assuming that A Corp pays $18 million for B Corp.
Initial Balance Sheets
A Corporation
NWC
20
30
FA
80
70
100
100
D
E
NWC
FA
B Corporation
1
0
9
10
10
10
Balance Sheet of AB corporation
NWC
21
30 D
FA
89
88 E
Goodwill
8
118
118
D
E
Takeover Methods
Tools Used To Acquire Companies
Proxy
Contest
Tender
Offer
Acquisition
Leveraged
Buy-Out
Merger
Manageme
nt Buy-Out
Takeover Defenses
Anti-takeover Devices
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Greenmail (Management offer to buy him out, at a
substantial bonus over the market price of the stock)
Example: Bass brothers acquired 9.9% of Texaco (1984). Texaco’s
management paid the Bass brothers $137 million premium over the
market price or $55 per share - $35 market price of the stock

poison pills or shareholder rights plans
(the
plans usually take the form of rights issued to shareholders.
Pills give shareholders the ability to purchase shares from, or
sell shares back to, the target company (the flip-in pill) and/or
the potential acquirer (the flip-over pill)
Other Anti-takeover Devices
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white knight
(third party who agrees to buy a
significant portion of stock to keep it out of the acquirer’s
hands)
New class of shareholder with unequal
voting rights
“Crown Jewel strategy” (the target company
would sell the most valuable assets)
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“I’ will eat you before you eat me”
pacman defence (example: Bendix - Martin Marietta
(1982))
Winners and Losers in the Merger
Game
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Stock Market Reaction to Merger Announcements
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The average 3-day CAR for acquirer and target firms
combined is 1.8% (AMS)
The average 3-day CAR for target firms is 16% (AMS)
The average 3-day CAR for acquirer firms is -0.7% (AMS)
Target firm shareholders also do better when there is no
equity financing (AMS)
The losers were mainly the largest acquirers; the
stockholders of the other acquirers appeared to gain (MSS)
Mergers seem to create value for shareholders overall, but
the target firm shareholders are clearly winners in merger
transactions
Please see, Andrade, Mitchell and Stafford (2001) JEP (AMS) and Moeller,
Schlingemann and Stulz (2004) JFE (MSS)
Winners and Losers in the Merger
Game (cont’d)
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Long-Term Abnormal Returns
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Long-term event studies measuring
negative abnormal returns over the three to
five years following merger completion
Serious methodological concerns with the
long-term event studies (for example, crosssectional correlation of ARs)
Winners and Losers in the Merger
Game (cont’d)
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Pre- and Post-Merger Profitability
 Healy, Palepu and Ruback (1992) find that merged
firms experience improvements in asset productivity,
leading to higher operating cash flows relative to
their industry median.
 Operating performance (cash flow to sales) is strong
relative to industry benchmarks prior to the merger,
and improves slightly subsequent to the merger
transaction (AMS).
 On average, there is an improvement in operating
performance following the merger (AMS).
Empirical Features of Merger
Activity
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Mergers occur in waves
Within a wave, mergers strongly cluster by
industry
Often prompted by deregulation and by
changes in technology (for example, deregulation
of telecoms and banking in the 1990s led to a spate
of mergers in both industries)
Recent Mergers
Payment
($
billions)
Industry
Pharmaceuticals
Acquiring Company
Pfizer
Selling Company
Wyeth
Electricity
Enel (Italy)
Endesa (Spain)
58.7
Brewing
InBev SA (Belgium)
Anheuser-Busch
50.6
Banking
Bank of America
Merrill Lynch
46.4
Pharmaceuticals
Roche (Switzerland)
Genentech
44.3
Pharmaceuticals
Merck
Schering-Plough
38.4
Mining
Rio Tinto (UK)
Alcan (Canada)
38.1
Telecoms
Verizon Wireless
Alltel
28.1
Food
Mars Inc
William Wrigley
27
Banking
Lloyds TSB (UK)
HBOS (UK)
18
Banking
Wells Fargo
Wachovia
64.5
12.7
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
Number of Deals
Mergers (1962-2009)
12,000
10,000
8,000
6,000
4,000
2,000
0
Web Resources
www.cfonews.com
www.mergernetwork.com
www.mergerstat.com
www.globalfindata.com