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Chapter 17
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International Takeovers and Restructuring
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Background
• Significant proportion of total takeover
activity has an international dimension
Worldwide M&A Activity ($ Trillion)
1998
1999
% Increase
World
2.70
3.40
25.9%
U.S.
1.32
1.42
7.6%
Rest of World
1.38
1.98
43.5%
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• Main reasons for large increase in
foreign M&A activity
– Europe is moving toward a common market
– Globalization and increased intensity of
international competition
– Rapid technological change
– Consolidation of major industries
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Historical and Empirical Data
• U.S. acquisitions of foreign businesses
Average of U.S. Acquisitions of Foreign Companies
Number of
% Total
Dollar Value
% Total
Transactions
M&As
($ Billion)
M&As
1980-86
139
5.4%
2.5
2.4%
1987-91
205
9.6%
14.3
8.8%
1992-98
689
14.5%
45.6
10.0%
• Foreign acquisitions of U.S. companies
Average of Foreign Acquisitions of U.S. Companies
Number of
% Total
Dollar Value
% Total
Transactions
M&As
($ Billion)
M&As
1980-86
187
7.3%
12.5
12.0%
1987-91
253
11.9%
36.3
22.4%
1992-98
318
6.7%
59.6
13.0%
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• Dollar values of foreign acquisitions of
U.S. targets have exceeded U.S.
acquisitions of foreign targets
• For 25 largest cross border transactions
in history completed as of 12/31/99
– Transactions involving U.S. targets
amounted to $305.1 billion
– Transactions involving U.S. acquirers
amounted to $105.4 billion
– Transactions involving only foreign
companies amounted to $229.6 billion
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• Major reasons for cross border
transactions
– Combine complementary capabilities
– Strengthen distribution networks
– Achieve critical mass required for new
approaches to R&D, production, etc.
• Industry characteristics related to M&A
pressures
– Telecommunications
• Technological change
• Deregulation
• Efforts to develop a global presence
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– Media
• Technological change in content and delivery
• Overlap in content of different media outlets
• Attractive and glamorous industry
– Financial
• Globalization
• Serve clients globally
– Chemicals, pharmaceuticals
•
•
•
•
High amount of R&D
Rapid imitation
Rapid changes in technology
High risks due to competitive pressures
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– Autos, oil & gas, industrial machinery
• Advantage of size — critical mass
• Global excess capacity
• Oil price and supply instability
– Utilities
• Deregulation
• Geographic expansion
• Broadening of managerial capabilities
– Food, retailing
• Slower growth
• Seek growth in new international markets
– Natural resources, timber
• Exhausting sources of supply
• Match raw material supplies with manufacturing capacity
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Forces Driving Cross Border
Mergers
• Growth
– Most important motive
– U.S. highly regarded by foreign markets
– U.S. firms have looked abroad to countries in
relatively earlier faster-growing stages of life
cycle — especially U.S. food companies
– Enable medium-sized firms to attain size
necessary to improve their competitiveness
– Achieve size necessary for economies of scale;
for effective global competition
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• Technology
– Impact on international mergers
• Technologically superior firm may exploit its
technological advantage worldwide
• Technologically inferior firm may acquire
technologically superior target to enhance competitive
position
– Technological superiority tends to be more
portable
• No cultural baggage
• Acquirer may select technologically inferior target —
improve target competitive position and profitability
• Buy into foreign markets to exploit their technological
knowledge advantage
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• Value increasing acquisitions
– Acquiring firm may have an advantage in
general management functions such as
planning and control or research and
development
– Specific management functions such as
marketing or labor relations tend to be
environment specific
• Not readily transferable
• May explain predominance of U.K. and Canada
as international merger partners of U.S.
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• Extend advantages in differentiated
products
– Strong correlation between
multinationalization and product
differentiation
– Firms that have developed a reputation for
superior products in domestic market may
also find acceptance for their products in
foreign markets
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• Roll-ups — combine firms in fragmented
industries
• Consolidation — adjust to worldwide
excess capacity
• Government policy
– Circumvent tariffs and quotas on imports or exports
– Avoid restrictions that may protect a large lucrative
market
– Environmental and other regulations can increase
cost of building de novo facilities
– Response to changes in government policy and
regulations
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• Exchange rates
– Affect prices of foreign acquisitions, cost of
doing business abroad
– Affect value of repatriated profits to the
parent
– Exchange rate risk management becomes
important
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• Political/Economic stability
– Can alleviate or exacerbate higher risks
inherent in operating abroad
– Political factors
•
•
•
•
Changes in administrations in power
Likelihood of government intervention
Risk of expropriation
War vs. peace
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– Economic factors
•
•
•
•
•
Low or at least predictable inflation
Labor relations climate
Stability of exchange rates
Depth and breadth of financial markets
Transportation and communications networks
– U.S. market attractive to foreign investors
in terms of political/economic factors
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• To follow clients
– Importance of long-term client relationships
– Example: Financial firms expand abroad to
retain clients who have expanded abroad
• Diversification
– Provide diversification
• Product line
• Geographically
– Systematic risk reduction possible if world
economies are not perfectly correlated
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Premiums Paid
• Foreign bidders pay higher premiums to
acquire U.S. companies than premiums
paid in all acquisitions
• Harris and Ravenscraft (1991)
– Sample of companies between 1970-1987
– Foreign bidder pays higher premia by 10
percentage points
– High foreign currency values led to
increased premia
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– Foreign buyers concentrate on R&D
intensive industries when they buy U.S.
firms — intensity is 50% higher than in
purely domestic transactions
– U.S. bidders earn only normal returns in
both domestic and cross-border acquisitions
• For period 1987-1998, premiums in
foreign acquisitions exceeded all
acquisitions by about 5 percentage
points
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• Possible reasons
– Foreign buyers may offer higher premium to
preempt potential domestic bidders
– U.S. targets have less knowledge of foreign
buyers and need higher premiums to
resolve uncertainty
– If foreign currencies are strong, can afford
to pay more in dollars
– If prospective future exchange rate
movements favor the U.S. dollar, foreign
firms must pay more in dollars
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Event Returns
• General results
– Similar results as domestic transactions
– Targets receive large abnormal returns
– Buyers earn nonsignificant returns
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• Doukas and Travlos (1988)
– Positive abnormal returns for U.S.
multinational enterprises with no previous
operation in target firm's country
– Positive but not significant when U.S. firms
expand internationally for first time
– Negative but not significant for U.S. firms
that have already been operating in target's
home country
– Greatest benefits from foreign acquisitions
when there is simultaneous diversification
across industry and geography
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• Harris and Ravenscraft (1991)
– Sample of 1,273 U.S. firms acquired in
1970-1987
– 75% of cross-border transactions, buyer
and seller not in related industries
– Takeovers more frequent in R&D intensive
industries than are domestic transactions
– Percentage gain to U.S. targets of foreign
buyers significantly higher than targets of
U.S. buyers
– Cross-border effects positively related to
weakness of U.S. dollar
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• Kang (1993)
– Japanese takeovers of U.S. firms
– Significant wealth gains for both Japanese
bidders and U.S. targets
– Returns increase with
• Leverage of bidder
• Bidder's ties to financial institutions
• Depreciation of dollar in relation to Japanese
yen
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• Dewenter (1995)
– Controls for relative corporate wealth and
levels of investments in different countries
– Finds no significant relationship between
exchange rate levels and foreign
investment relative to domestic investments
in U.S. chemical and retail industries
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• Eun, Kolodny, and Scheraga (1996)
– 225 foreign acquisitions of U.S. firms
during 1979-1990
– For eleven-day window, [-5,+5], CAR was
a positive 37.02% and significant for whole
sample of U.S. targets
– Firms acquired by firms from other
countries than Japan had CARs between
35% and 37%
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• Cakici, Hessel, and Tandon (1996)
– 195 foreign acquisitions of U.S. firms during
1983-1992
– Sample compared to 112 U.S. acquisitions
of foreign firms
– Foreign acquiring firms experienced positive
and significant CARs of 0.63% for event
period [0,+1] and 1.96% for period [-10,+10]
– U.S. acquirers had negative but not
significant CARs of -0.36% for event period
[0,+1] and -0.25% for period [-10,+10]
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• Doukas (1995)
– 234 U.S. bidding firms involved in 463
international acquisitions during 1975-1989
– Study relationship between bidders' gains and
its q ratios
– Value maximizing firms (q ratios > 1), CAR was
positive and significant 0.41% for window [-1,0]
– Overinvested firms (q ratio < 1), CAR was
negative and insignificant -0.18%
– Negative relationship between dollar exchange
rate and level of foreign direct investment
– Method of payment and industry relatedness not
significant
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• Seth, Song, and Pettit (1999)
– 100 cross-border acquisitions of U.S.
targets during 1981-1990
– For event window [-10,+10], CAR for
acquirers was an insignificant 0.11%, CAR
for targets was significant 38.3%
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International Joint Ventures
• Advantages
– May be only feasible method of obtaining
raw materials
– May involve different capabilities and link
together complementary skills
– Local partners may reduce risks involved in
operating in foreign country
– May be necessary to overcome foreign
government restrictions
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– May enhance advantages found in
domestic joint ventures such as economies
of scale and may provide basis for faster
growth rate
– Knowledge acquisition potentials can be
substantial
• Disadvantages
– Provide information which makes partner a
future competitor
– Different cultures may increase tensions
normally found in joint ventures
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• Principles for management of successful
collaborations
– Should involve complementary capabilities
– Contracts should make it easy to terminate
relationship
– Control and ultimate decision makers should
be specified
– Formulate terms under which one company
can buy out other
– Activities and information flows should be tied
into normal communications structures
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– Criteria for evaluation of performance
should be defined
– Allocation of rewards and responsibilities
under different types of outcomes should
be considered
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• Chen, Hu, and Shieh (1991)
– Sample of 88 international joint ventures
– Significant positive portfolio excess returns
when U.S. firms invest relatively small
amounts in joint venture
– Excess returns no longer significant when
firms make relatively large investments
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• Mangum, Kim, and Tallman (1996)
– Summary data on investments by 7 foreign
steel makers in U.S. joint ventures
– In-depth case studies of 7 joint ventures
• Foreign partners mainly form Japan
• Initial motive was availability of foreign capital for
modernizing U.S. steel industry
• Another main objective was transfer superior process
technologies of Asian partners to American plants
• Tension from cross-cultural differences
• Joint ventures generally successful
• Only joint venture that experienced great difficulties —
NKK of Japan and National Steel Corporation of the U.S.
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Cost of Capital in Foreign
Acquisitions and Investments
• Main concepts
– Fundamental international parity or
equilibrium relationships — related to cost
of debt of domestic and foreign firm
– Issues of whether global capital markets
are integrated or segmented — related to
cost of equity capital in different countries
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• Cost of Debt Relationships
– International parity relationships assume
perfect and efficient markets
•
•
•
•
Financial markets are perfect
Goods market are perfect
Future is known with certainty
Markets are in equilibrium
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– Interest rate parity theorem (IRPT)
• Ratio of forward and spot exchange rates equal
current ratio of foreign and domestic nominal
interest rates
Xf
X0
where
Xf
X0
Rf0
Rd0
Ef
E0
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
1 R f 0
1  Rd 0
E0

Ef
= current forward exchange rate expressed as number
of foreign currency units (FC) per dollar
= current spot exchange rate expressed as FC per dollar
= current foreign nominal interest rate
= current domestic nominal interest rate
= current forward exchange rate expressed as dollars
per FC
= current spot exchange rate expressed as dollars
per FC
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– Forward parity theorem (FPT)
• Current forward foreign exchange rates should
be unbiased predictors of future spot rates
X f  X1
• Current forward rate, Xf , should equal future
spot rate, X1
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– Purchasing power parity theorem (PPPT)
• Expression of the law of one price
• In competitive markets, exchange-adjusted
prices of identical tradable goods and financial
assets must be equal worldwide (taking account
of information and transaction costs)
X1 Tf

X 0 Td
where Tf = 1 + foreign country inflation rate
Td = 1 + domestic inflation rate
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– International Fisher relation (IFR)
• Nominal interest rates reflect anticipated rate of
inflation
1  Rn  (1  r )  T
where
T = 1 + rate of inflation
r = real rate of interest
Rn = nominal rate of interest
• If other parity relations hold, real rates will be the
same across countries, but nominal rates will
differ by the countries' inflation factors
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• Notes on parity relationships
– In the shortrun, many real world frictions
cause departures from parity conditions
– In the longrun, international financial
markets move toward parity relationships
– Hedging foreign exchange risk
• Futures markets
• Borrowing in foreign markets for foreign projects
• Conducting manufacturing operations in
multiple countries
• Making sales in multiple countries
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Cost of equity and cost of
capital
• Capital asset pricing model (CAPM)
ks  R f  ( RM  R f )  j
where
k s = cost of equity capital
R f = risk-free rate
( R M  R f ) = market price of risk
 j = systematic risk of individual asset or firm
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• Market definition
– Integrated global markets — investments are
made globally and systematic risk is
measured relative to world market index
– Segmented capital markets — investments
are predominantly made in particular
segment or country and systematic risk is
measured relative to domestic index
• World is moving toward a globally
integrated capital market
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• There is still a home bias phenomenon —
investors place only a relatively small part
of their funds abroad
– Extra costs of obtaining and digesting
information
– Greater uncertainty associated with foreign
investments
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• If capital markets are not fully integrated
– Gains from international diversification
– Multinational corporation (MNC) would
apply to foreign investment a lower cost of
capital than would a local (foreign)
company
– MNC will have a cost of equity capital
related to beta measured with respect to
markets in which it operates
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• Procedure
– Cost of equity for a foreign investment in nominal
foreign currency terms should reflect risk
differential above cost of debt borrowing in that
foreign country
– Cost of capital calculated based on an estimated
leverage ratio and tax rate
– Cash flows expressed in foreign currency units
(FC) discounted by the FC cost of capital gives
present value expressed in FC
– Present value in FC can be converted to dollars
at the spot exchange rate to give net present
value of investment in dollars
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• Similar alternate procedure
– Begin with expected cash flows in FC
– Adjust expected cash flows by risk factors that
reflect foreign country's risk
– Convert risk-adjusted expected FC cash flows to
dollars over time by using expected foreign
exchange rates at time t based on interest rate
parity and relative inflation rates
 Tf
X t  X 0 
 Td



t
– Discount dollar cash flows by WACC of U.S. firm
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