McGraw-Hill/Irwin
Chapter 31
Mergers
Principles of
Corporate Finance
Tenth Edition
Slides by
Matthew Will
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

Topics Covered

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
31-2

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
$
$
$
31-3

Sensible Reasons for Mergers
S
Economies of Vertical Integration
– Control over suppliers “may” reduce costs.
– Over integration can cause the opposite effect.
Pre-integration
(less efficient)
Company
Post-integration
(more efficient)
Company
S
S
S
S
S
S
S
31-4

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.
31-5
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.
31-6

Dubious Reasons for Mergers

Diversification
– Investors should not pay a premium for diversification since they can do it themselves.
31-7

Dubious Reasons for Mergers
The Bootstrap Game
Acquiring Firm has high P/E ratio
Selling firm has low P/E ratio (due to low earnings growth)
After merger, acquiring firm has short-term
EPS rise
Long term, acquirer will have slower than normal EPS growth due to share dilution.
31-8

Dubious Reasons for Mergers
The Bootstrap Game
EPS
Price per share
P/E Ratio
Number of shares
Total earnings
Total market value
Current earnings per dollar invested in stock
World Enterprises
(before merger) Muck and Slurry
$ 2.00
$ 40.00
20
100,000
$ 200,000
$ 4,000,000
$
$
$
$
2.00
20.00
10
100,000
200,000
2,000,000
World Enterprises
(after buying Muck and Slurry)
$
$
$
$
2.67
40.00
15
150,000
400,000
6,000,000
$ 0.05
$ 0.10
$ 0.067
31-9

Dubious Reasons for Mergers
31-10
Earnings per dollar invested
(log scale)
World Enterprises (after merger)
World Enterprises (before merger)
Muck & Slurry
.10
.067
.05
Now
Time

Estimating Merger Gains

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)
31-11

Estimating Merger Gains
Gain

PV
AB

( PV
A

PV
B
)
 
PV
AB
Cost

Cash paid

PV
B
NPV
 gain
 cost
 
PV
AB

( cash

PV
B
)
31-12

Estimating Merger Gains
Example – Two firms merge creating $25 million in synergies. If A buys B for $65 million, the cost is
$15 million.
PV
A

$ 200
PV
B

$ 50
Gain
PV
AB
 
PV
AB
 
$

$ 275 million
25
Cost


Cash
65
 paid
50

PV
B

$ 15 million
31-13

Estimating Merger Gains
Example – The NPV to A will be the difference between the gain and the cost.
NPV
A

25

15

$ 10 million
NPV
A
 wealth wit h merger


( PV
AB
( 275

Cash

65 )

)

200
PV
A

$ 10 million
wealth wi thout merger
31-14

Estimating Merger Gains

Economic Gain
Economic Gain = PV(increased earnings)
=
New cash flows from synergies discount rate
31-15

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
FA 80
100
30
70
100
D
E
B Corporation
NWC 1
FA 9
10
0
10
10
D
E
Balance Sheet of AB corporation
NWC 21 30 D
FA
Goodwill
89
8
118
88 E
118
31-16

Takeover Methods
Tools Used To Acquire Companies
Proxy Contest Tender Offer
31-17
Acquisition Merger
Leveraged
Buy-Out
Management
Buy-Out

12 000
10 000
8 000
6 000
4 000
2 000
0
Mergers (1962-2009)
31-18

Web Resources
Click to access web sites
Internet connection required www.cfonews.com
www.mergernetwork.com
www.mergerstat.com
www.globalfindata.com
31-19