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Fundamentals
of Corporate
Finance
Sixth Edition
Chapter 21
Mergers, Acquisitions and
Corporate Control
Richard A. Brealey
Stewart C. Myers
Alan J. Marcus
Slides by
Matthew Will
McGraw
McGraw Hill/Irwin
Hill/Irwin
Copyright ©Copyright
2009 by The
McGraw-Hill
Companies, Inc.
All rights
reserved
© 2009
by The McGraw-Hill
Companies,
Inc.
All rights reserved
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Topics Covered

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Sensible Motives for Mergers
Dubious Reasons for Mergers
The Mechanics of a Merger
Evaluating Mergers
The Market for Corporate Control
Proxy Contests
Takeovers
Leveraged Buyouts
Divestitures, Spin-Offs and Carve-Outs
The Benefits and Costs of Mergers
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Mergers (1962-2007)
Number of Deals
12,000
10,000
8,000
6,000
4,000
2,000
0
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Recent Mergers
Industry
Banking
Acquiring Company
Selling Company
Royal Bank of Scotland,
Fortis, Santander
ABN Amro
Payment ($ bil)
Telecoms
AT&T
Bellsouth
72.7
Electricity
Enel and Acconia
Endesa
58.7
Offshore drilling
Transocean
Global Santa fe
53.0
Banking
Banca Intesa
Sanpaolo IMI
37.7
Banking
Bank of America
35.8
Oil
Conoco Phillips
MBNA
Burlington
Resources
Steel
Mittal Steel
Arcelor
32.2
Telecoms
Telefonica
O2
31.7
Medical devices
Boston Scientific
27.9
Banking
Wachovia
Guidant
Golden West
Financial
Construction/Airports Ferrovial
BAA
21.8
Banking
Bank of America
LaSalle Bank
21.0
Pharmaceuticals
Bayer
Schering
20.6
101.0
35.4
25.5
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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.
Reduces costs
$
$
$
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Sensible Reasons for Mergers
Economies of Vertical Integration
 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
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Sensible Reasons for Mergers
Combining Complementary Resources
Merging may results in each firm filling in the
“missing pieces” of their firm with pieces from the
other firm.
Firm A
Firm B
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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.
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Dubious Reasons for Mergers
 Diversification

Investors should not pay a premium for
diversification since they can do it themselves.
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Dubious Reasons for Mergers
The Bootstrap Game
Acquiring Firm has high P/E ratio
Selling firm has low P/E ratio (due to low
number of shares)
After merger, acquiring firm has short term
EPS rise
Long term, acquirer will have slower than
normal EPS growth due to share dilution.
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Dubious Reasons for Mergers
The Bootstrap Game
World Enterprises
(before merger)
EPS
Price per share
P/E Ratio
Number of shares
Total earnings
Total market value
$2.00
$40.00
20
100,000
$200,000
$4,000,000
Current earnings
per dollar invested
in stock
$0.05
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
$0.10
$0.067
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The Mechanics of a Merger
 Forms of Acquisition
“Merge” – When the acquiring firm buys all the
assets and all the liabilities of the other firm and
combines them into one firm.
 “Tender Offer” - The acquiring firm buys all the
stock of the target firm.
 “Asset Purchase” – When the acquiring firm buys
only the assets of the target. The target continues
to exist as a firm with cash instead of assets.

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Evaluating Mergers
 Questions
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)
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Evaluating Mergers
 Economic Gain
Economic Gain = PV(increased earnings)
=
New cash flows from synergies
discount rate
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Evaluating Mergers
Example - Given a 20% cost of funds, what is the
economic gain, if any, of the merger listed below?
Cislunar Foods Targetco Combined Company
Revenues
150
20
172
(+2)
Operating Costs
118
16
132
(-2)
Earnings
32
4
40
(+4)
4
Economic Gain =
= $20
.20
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Evaluating Mergers
 Estimated net gain
Estimated net gain = DCF valuation of target including synergies
- cash required for acquisition
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The Merger Market
Methods to Change Management
Proxy battle for control of the board of directors
 Firm purchased by another firm
 Leveraged buyout by a group of investors
 Divestiture of all or part of the firm’s business
units

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The Merger Market
Tools Used To Acquire Companies
Proxy Contest
Tender Offer
Acquisition
Leveraged
Buy-Out
Merger
Management
Buy-Out
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Merger Tactics
White Knight - Friendly potential acquirer sought by
a target company threatened by an unwelcome
suitor.
Shark Repellent - Amendments to a company charter
made to forestall takeover attempts.
Poison Pill - Measure taken by a target firm to avoid
acquisition; for example, the right for existing
shareholders to buy additional shares at an attractive
price if a bidder acquires a large holding.
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Leveraged Buy-Outs
Unique Features of LBOs
Large portion of buy-out
financed by debt
Shares of the LBO no longer
trade on the open market
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Leveraged Buy-Outs
Potential Sources of Value in LBOs
Junk bond market
 Leverage and taxes
 Other stakeholders
 Leverage and incentives
 Free cash flow

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Divestitures, Spin-Offs, and Carve Outs
 Divestiture – When a firm sells some of the assets to
another entity as a going concern.
 Spin Off – The process of a business separating the
ongoing operations of a unit of that business and
giving the shareholders of the parent firm shares of
the unit. The unit and parent function as separate
entities.
 Carve Outs – Similar to a spin off, but the carve out
issues shares of the new firm to the public.
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Benefits and Cost of Mergers
 Who Usually Benefits from the merger?
Shareholders of the target
 Lawyers & Brokers
 The executives of the acquiring firm

 Who Usually Losses a merger?
Shareholders of the acquirer due to overpayment
 Executives on the target
 All employees due to restructuring

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Web Resources