CHAPTER 30: MERGERS AND ACQUISITIONS
Topics:
• 30.1
• 30.4-30.5
• 30.6, 30.7, 30.9
• 30.10
• 30.11
Background
Synergy
NPV Analysis of Mergers
Defensive Tactics
Empirical Evidence
This set of slides is a brief introduction to Chapter 30.
1
Background
• Merger: Companies A and B become one company (A+B)
via an agreement which is
– Negotiated between the firms’ boards
– Subsequently voted on by shareholders
– Company B receives some number of company A shares, plus
also (perhaps) some cash.
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Background
• Acquisition: One company (or individual) A buys a controlling
stake of company T.
– Management/board approval not required
– No shareholder meeting/vote required
– Accomplished by tender offer: a public offer made to each
shareholder independently. May be cash, stock or some
combination thereof.
• Tender offers are typically conditional.
– E.g., if more than 50% of shareholders do not tender, then offer is
canceled.
• Usually the parties can be classified as: acquirer & target
• In most cases, a substantial premium is paid
• M&A activity has been quite extensive in the past two decades.
3
Types
• Friendly vs. hostile
– Mergers are almost always considered friendly
– Acquisitions may be hostile: resisted by the target’s
management and board.
• Cash vs. stock merger
4
Common defensive tactics in Hostile acquisition
• Supermajority agreements (approval of a specified majority
(usually 2/3 or ¾) of the acquired firm’s shareholders)
• Poison Pill Agreement (Shareholder rights plans)
– Existing shareholders are given the right to acquire shares at halfprice.
– Acquirer’s rights are cancelled.
• Greenmail: payoff to acquirer to drop the bid
• Golden parachutes
• White knight
• Proxy contest: One group of shareholders attempt to gain
controlling seats on the board by voting out the board of directors.
– A response to defensive tactics
5
The Inco M & A case: The players
• INCO
– Primary products: Nickle, 2005 sales: $4.5 billion US. Based in Toronto
• Falconbridge
– Primary products: Copper and nickle, 2005 sales: $8.1 billion US. Based in
Toronto
• Xstrata
– Copper, coking coal etc, 2005 Sales: $8 billion US. Based in Switzerland.
• Phelps Dodge Corp.
– Primary products: copper, 2005 sales: $8.3 billion US. Based in Arizona
•
Teck Cominco
– Primary products: zinc, metallurgical coal, coper, 2005 sales: $4.4 billion
Cdn. Based in Vancouver
• Companhia Vale do Rio Doce (CVRD)
– Largest global producer of iron ore and pellets. Based in Brazil.
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Case cont’d: From Hunter to Hunted
Xstrata submitted a
hostile takeover
bid for
Falconbridge
Oct. 2005: Inco
announced a
friendly
takeover to buy
Falconbridge
for $12 billion
The Xstrata bid was
successful, but not before
Falconbridge employed a
poison pill to delay the
acquisition, raising its
share price from $28 to
$62.50. (firm
value:$23.8bn)
May 2006: Teck
Cominco submitted a
hostile takeover bid to
purchase Inco for $16
billion if it agreed to
abandon its takeover of
Falconbridge.
August 2006:
Brazilian mining
company CVRD
extended an allcash offer to buy
June 2006: Phelps Dodge
Inco for $17
submitted a friendly takeover billion. Now Inco
to buy a combined Inco and becomes CVRD
Falconbridge for around $40 Inco.
billion; offer withdrawn due
to the failure of the IncoFalconbridge merger.
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Why merge?
• To justify a merger we need to show that
PV(A + B) > PV(A) + PV(B)
• If so, there are synergies:
Synergy = PV(A+B) – [PV(A) + PV(B)]
• NPV of merger to acquirer = Synergy – Premium
8
Sources of synergy (see section 30.5)
• increased revenues
• reduced costs
– Including replacing ineffective managers
• tax benefits
– Net operating losses
– Unused debt capacity
• reduced cost of capital
– Economies of scale
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Valuation of Synergy
• In principle, synergy can be determined using the standard
DCF approach:
T CF
t
synergy  
t
t 1 ( 1  r )
• In practice, it is difficult to determine synergy
– it is hard to estimate incremental cash flows precisely
– discount rate – should reflect risk associated with use of funds
– there are also costs to consider (e.g. transaction costs)
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How to pay for the target: Cash or stock?
• assuming that synergies have been calculated (i.e. the PV of
the benefits of a merger), the next step is to assess the costs
involved
• simple when cash is paid - the value of the merger to the
acquiring firm is simply the synergies minus the PV of the
costs
• with a stock offer, the costs depend on the gains because the
post-merger stock price depends on the gains
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Example
Before a merger announcement:
Market price per share
Number of shares
Market value of firm
Firm A
$75
1,000,000
$75,000,000
Firm B
$15
600,000
$9,000,000
Suppose that synergies have been determined to be $4,750,000 (due
to cost savings)
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Example cont’d: Cash offer
Cash offer: Assume that A will pay $12 million for B.
Then the premium paid is $3 million and
NPVA =
However, this assumes that B’s current market price
accurately reflects its value as a separate entity. What if
takeover rumours have already increased B’s share price
by $2?
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Example cont’d: Stock offer
• Suppose that A will offer 160,000 shares instead of $12
million cash. The apparent premium being paid is
• However, note that the total value after the merger is
• This means that the new share price will be:
so the real premium is
• How can the terms be set so that the premium is really $3
million?
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Cont’d: solution
Premium = 3m = Pnew x Nb – 9m
α = % of merged firm owned by B’s S/H
α = B’s value/total firm value post merge =
= B’s shares/total shares
=
NB =
Pnew =
Verify: Premium = 76.75 (156,352) – 9m = 3m
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Choice of cash or stock
• If A’s management believes its shares are undervalued by the
market, then it will tend to prefer a cash offer.
• Conversely, if A’s management believes its shares are
overvalued, it will tend to prefer a stock offer
– B’s S/H will likely figure this out if A makes a stock offer 
signal that A’s shares are overvalued B’s S/H will want
better terms
– With a stock offer, B’s shareholders will share in any
subsequent gains (if the merger ultimately proves to be very
successful) and any subsequent losses (if it doesn’t).
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Empirical evidence
• Do acquisitions help shareholders?
– most evidence suggests that shareholders of target firms gain
substantially, but shareholders in bidder firms do not
– bidder firm results are lower for stock offers than cash offers
– on average, the combined market values of bidders and targets
do increase around the time of merger announcements
– diversifying acquisitions had positive bidder returns in the
1960s, but negative returns since then
• Do defensive tactics help target shareholders?
– evidence is mixed – on average, target stocks decline in value
but there are many exceptions
• e.g. greenmail is most often viewed negatively, but if it is seen as
giving management more time to find a better offer, it can be
viewed positively by investors.
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Who captures the value of synergy?
---Table 30.9 Stock Price Changes in
Successful U.S. Corporate Takeovers
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Realities of M&A
• Warren Buffet:
“Many managements apparently were overexposed in
impressionable childhood years to the story in which the
imprisoned handsome prince is released from a toad's body
by a kiss from a beautiful princess. Consequently, they are
certain their managerial kiss will do wonders… We've
observed many kisses but very few miracles.”
• Buffet is right!
– In practice, targets almost always capture synergies
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• Assigned problems: # 30.1, 5-6
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