Corporate Financial
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to edit Master title style II (#2, 3)
Mergers & Acquisitions
Chapter 21
Acquisition = (Big and Complex)
Capital Budgeting Project
Substantiation of Merger (Net
Advantage to Merging):
NAM = [VAB - (VA+VB)] - PB - Expenses
Valuation: DCF and Comparative
Analysis Methods; Break-up Valuation
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Valid Reasons for Mergers
Synergy: Value of the whole exceeds
sum of the parts. Could arise from:
Operating economies
Financial economies
Differential management efficiency
Taxes (use of accumulated losses)
Break-up value: Assets would be
more valuable if broken up and sold
to other companies.
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Questionable Reasons for Mergers
Diversification.
Purchase of assets at below
replacement cost (or “cheap”
refinancing).
Acquire other firms to increase size,
thus making it more difficult to be
acquired.
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Do Mergers Really Create Value?
According to empirical evidence,
acquisitions do create value as a result of
economies of scale, other synergies,
and/or better management.
Shareholders of target firms reap most of
the benefits, that is, the final price is close
to full value (i.e. PB > NAM).
 Target management can always say no.
 Competing bidders often push up prices.
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Hostile and Friendly Mergers
Friendly merger - Supported by
managements of both firms.
Hostile merger - Target firm’s
management resists the merger;
Acquirer must go directly to the
target firm’s stockholders, try to get
51% to tender their shares, or get
proxies.
Often, mergers that start out hostile end up as
friendly, when offer price is raised.
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Defensive Tactics
Changing by-laws (staggered election
of directors, supermajority voting)
Legal (filing on antitrust or other issues)
Unloading cash (acquisitions, stock
repurchase, investments, leveraging)
Capital-related (issue rights, special
classes of stock, friendly shareholder)
Tactical (counter tender, poison pills)
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Forms of Transaction
Merger or Consolidation
Combination of balance sheets
Has to be approved by both companies
Purchase of Stock
Open market or tender offer
Purchase of Assets
By-passes minority shareholders and
avoids hidden liabilities
Tends to be complicated and costly
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Accounting for Mergers
Pooling of interests:
Assumes a merger among equals.
New balance sheet is merely the sum of
the two existing balance sheets.
No income statement effects other than
summing the two income statements.
Purchase:
Assets of the acquired firm are “written up”
to reflect purchase price if it is greater than
the net asset value => Goodwill is created.
Goodwill amortized and expensed over
time, reducing future reported earnings.
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Merger Valuation
Comparative Methods
Merger Premium
Earnings (Cash Flow, EBIT) Multiples
Book Value Multiples
Price per Unit of Resource (natural
resources, customers...)
DCF Valuation
Prepare pro-forma statements forecasting
incremental cash flows expected to result
from merger.
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Financial Distress
Chapters 22
Firm cannot meet obligations (this
can mean repayment, covenant or
rating) =>
1) Try to renegotiate terms of loan
2) Find cash (refinance loan, sell assets)
3) File for bankrupcy
Reorganization,
Liquidation.
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Causes of Distress
Management
External Economic Factors
Structural Financial and Operating
Factors
Operational, Regulatory, Legal Risks
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Early Detection of Distress
Who cares to know?
Management, Shareholders
Lenders, Bondholders
Other Stakeholders (business
partners, sometimes regulators...)
Tools: Credit Analysis, Multiple Discriminant Analysis, Agency Ratings,
Market Developments, Business News
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Reorganization Outs. Bankrupcy
Usually cheaper than in bankrupcy:
Issue new securities for existing
securities, or
Modify the terms of outstanding
securities (maturity, covenants), or
Repurchase a specific issue.
Reporting, reputation, benefits.
Use incentives (eg. holdout problem).
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International Finance
Chapters 17
Earlier, most companies acted just in
their home markets.
Today, a number of companies are
multinational (i.e. operating in two or
more countries).
Others trade with foreign companies,
use foreign currencies etc.
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Why Firms Expand Internationally
To seek new markets.
To seek new supplies of raw
materials.
To gain new technologies.
To gain production efficiencies.
To avoid political and regulatory
obstacles.
To reduce risk by diversification.
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Main Distinctions
Currency differences
Economic and legal differences
Language differences
Cultural differences
Government roles
Political risk
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Asset Based Financing
Chapter 18
With traditional financing, investors
look to the entire cash flow of the
firm for a return on their investment.
Asset-based financing limits this to
cash flows from a specific pool of
assets (recourse or nonrecourse).
Lease Financing, Project Financing,
Limited Partnership Financing...
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Leasing
The lessee uses the asset and makes
the lease, or rental, payments.
The lessor owns the asset and
receives the rental payments.
The lease decision is a financing
decision for the lessee and an
investment decision for the lessor.
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Lease Types
Operating Lease
Normally short-term and cancelable;
maintenance included
Financial Lease
Normally long-term and
noncancelable; no maintenance
Sale and Leaseback
Combination, Leveraged, Synthetic...
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Economic Impact
Leasing is a substitute for debt. As
such, leasing uses up a firm’s debt
capacity.
Net Advantage to Leasing facilitates
comparasion with borrow and buy
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Leasing Highlights
In a perfect environment, leasing is zerosum. Why, then, is it so popular?
Provision of maintenance services.
Risk reduction for the lessee (project life,
resid. value, oper. risk, obsolence) Portfolio risk reduction enables lessor to
better bear these risks.
Cost of borrowing, altern. financing.
Bankrupcy considerations.
By-passing debt covenants, disclosure.
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Working Capital Management
Chapter 16
Net Working Capital = Current Assets Current Liabilities
Establishing Working Capital Policy:
Level of each current asset;
How current assets are financed.
Day-to-day control of:
Cash,
Inventory,
Receivables,
Short-term liabilities.
Cash Conversion Cycle
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Liquidity Management
Tradeoff between maintaining adequate
liquidity, and profitability.
 Cash earns no interest, so why hold it?
 Transactions: Must have some cash to pay
current bills.
 Precaution (“Safety stock”): Mitigated by credit
lines and marketable securities.
 Compensating balances: For loans and/or
services provided.
 Speculation: To take advantage of bargains, take
discounts, etc. (May be solved by credit line,
marketable securities).
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WC Management Toolbox
 Have sufficient cash on hand to meet the needs,
but not one dollar more.
 Increase forecast accuracy, centralize processing;
 Synchronize inflows and outflows;
 Hold securities, negotiate lines of credit instead of
holding cash;
 Wire transfers (minimize float), zero balance and
remote disbursement accounts, cash pooling.
 Optimize Cash Conversion Cycle (Inventory
management, Receivable management, Trade
Credit)
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