Mergers and Acquisitions
Arzac, Chapter 9
Mergers
•
many people including Warren Buffett have expressed skepticism of the
power of mergers:
• 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 for the profitability of Company
T(arget) … Investors can always buy toads at the going price for
toads. If investors instead bankroll princesses who wish to pay
double for the right to kiss the toad, those kisses had better pack
some real dynamite. We’ve observed many kisses but very few
miracles. Nevertheless, many managerial princesses remain
serenely confident about the future potency of their kisses – even
after their corporate backyards are knee-deep in unresponsive
toads… We have tried occasionally to buy toads at bargain prices
with results that have been chronicled in past reports. Clearly our
kisses fell flat. We have done well with a couple of princes – but
they were princes when purchased. At least our kisses didn’t turn
them into toads. And, finally, we have occasionally been quite
successful in purchasing fractional interests in easily identifiable
princes at toadlike prices.
M&As
• changing forces driving mergers:
• technological change
• globalization and freer trade
• deregulation
• economies of scale, scope, and technological catch-up
• change in industry organization
• individual entrepreneurship
• macroeconomic factors
** Weston, Siu, and Johnson (2001)
• mergers vs. tender offers
• types
Changes in Ownership Structure
•
•
•
•
•
•
exchange offers
leverage recapitalizations
dual-class recapitalizations
share repurchases
LBOs, MBOs
ESOPS
Control of Decision Powers
•
•
•
•
•
•
compensation arrangements
proxy contest
premium buy-backs (greenmail)
takeover defenses
stakeholder relationships
ethics and reputation
Theories of Mergers
•
•
•
•
•
•
efficiency increases (restructuring)
operating synergies
financial synergy
information
hubris
agency problems
Pattern of Gains Related to Takeover Theories
(with value changes referring to movements in prices of securities of firms)
Motive
Efficiency and/or synergy
Hubris
Agency problems
Total Gains
+
0
-
Gains to Target
+
+
+
Gains to Acquirer
+
-
Forms of Transaction
• merger
• acquisition
• of assets
• of stock
• tax implications
• legal implications
Form of Transaction
• stock purchase
•
•
•
•
avoids tax at corporate level
acquirer can use NOL of target
sh of target taxed on capital gain
acquirer can not step-up basis of target’s assets for tax purposes
•
•
•
seller is subject to corporate taxes
buyer can step-up basis and amortize goodwill over 15 years
buyer can not use NOLs of target
•
•
forward merger
reverse subsidiary merger
• asset purchase
• merger
Example 1
• Assume the buyer acquires a debt-free target for
$100 cash, the target’s tax basis in the assets is $40,
the target shareholders’ basis in the stock is $15, and
the fair MV of the stock was $70 prior to the
acquisition. Let the corporate tax rate be 40%, the
personal tax rate on capital gains be 20%, and
assume that all the gain to the seller is classified as
capital gain and the buyer’s price in excess of the
target’s basis is allocated to goodwill. Look at the
proceeds to the target using both a stock purchase
and an asset purchase.
• Review Example 2 and 3 in the text.
Returns in M&As
• Kaplan and Weisbach (1992), Servaes (1991),
and Mulherin and Boone (2000)
• mergers in banking industry
• Becher (2000) – looked at because of increased
number of bank mergers that occurred around
industry deregulation
• evidence that bank mergers created wealth
• target returns
• bidder returns
Value of Mergers
•
•
•
•
VC = VA + VT + Synergies – Cash
Premium = PT – VT
Premium = pc*m + cash
Acquirer’s Gain = Synergies – Premium
• Acquirer’s Gain + Seller’s Gain = Synergies
• pC = VC / (n + m)
or pC = (VA + VT + Synergies – Cash)/(n + m)
where n = # of old shares of acquirer
and m = # of shares issued to target shareholders
• Break-Even Synergies = Premium = mpA + Cash – VT
• GainA = Synergy - Premium
Accretion/Dilution Analysis
• alternate way to look at the impact of the
merger to the shareholders of the acquirer
• find pro-forma EPS for merged firm for year
prior to merger and then years after also
• for share exchange, combine NI and divide by
new number of shares outstanding
• if new EPS is > EPS of acquirer, then there is
accretion if new EPS < EPS of acquirer, then there
is dilution
Merger Analyses
•
•
•
•
•
•
•
terms of the merger
financing the merger
break-even synergies
financial model of the merger
accretion-dilution analysis
free cash-flow valuation
stress-testing and scenario analysis
Balance Sheet XYZ Inc. as of 12/31/2004
Cost
Current Assets
Cash and marketable securities
Accounts Receivable
Inventories
Raw Materials
Works in Progress
Finished Goods
Other Current Assets
Total Current Assets
Investments
Net PP&E
Intangible Assets
Total Assets
Current Liabilities
ST Debt and Current LTD
Accounts Payable
Accrued Expenses
Taxes Payable
LT Debt
Deferred Income Taxes
Total Liabilities
Preferred Stock
Common Stock and Retained Earnings
Total Net Worth
Total Liabilities and Equity
Fair Value
14,000
86,702
14,000
81,523
34,671
18,790
70,415
123,876
11,500
236,078
45,123
19,342
85,457
149,922
11,500
256,945
25,460
38,634
987,234 1,470,381
265,211
143,782
1,513,983 1,909,742
43,784
56,234
2,840
8,128
335,578
8,561
455,125
42,512
54,318
2,840
8,128
310,456
8,561
426,815
249,870
229,455
808,988 1,253,472
1,058,858 1,482,927
1,513,983 1,909,742
Balance Sheet XYZ Inc. as of 12/31/2004
ABC
Current Assets
Cash and marketable securities
Accounts Receivable
Inventories
Other Current Assets
Total Current Assets
Investments
Net PP&E
Intangible Assets
Goodwill
Other
Total Assets
34,021
196,032
298,723
30,044
558,820
XYZ
14,000
81,523
149,922
11,500
256,945
Eliminations and Adjustments
Debit
Credit
Consolidated
48,021
277,555
448,645
41,544
815,765
1,554,230
38,634
3,568,229 1,470,381
1,500,000
246,528
92,864
5,038,610
789,541
143,782
6,470,820 1,909,742
246,528
933,323
7,127,090
Current Liabilities
ST Debt and Current LTD
Accounts Payable
Accrued Expenses
Taxes Payable
LT Debt
Deferred Income Taxes
Total Liabilities
67,834
108,340
4,567
12,690
1,890,450
32,189
2,116,070
110,346
162,658
7,407
20,818
2,200,906
40,750
2,542,885
Preferred Stock
Common Stock and Retained Earnings
Total Net Worth
Total Liabilities and Equity
229,455
4,354,750 1,253,472 1,500,000
4,354,750 1,482,927
6,470,820 1,909,742
42,512
54,318
2,840
8,128
310,456
8,561
426,815
229,455
246,528 4,354,750
4,584,205
7,127,090
B’s acquisition of T
B
T
Pre-announcement stock price
$ 30
$ 22
Net income (million)
$ 80
$ 37.50
Shares outstanding (million)
40
15
EPS
$ 2.00
$ 2.50
P/E
15
Market value (million)
$1200
8.8
$330