Mergers & Acquisitions
Prof. Ian Giddy
New York University

Mergers and Acquisitions



Copyright ©1999 Ian H. Giddy
M&A 3

Corporate Finance
CORPORATE FINANCE
DECISONS
INVESTMENT
PORTFOLIO
CAPITAL
M&A
FINANCING
DEBT EQUITY
RISK
MANAGEMENT
MEASUREMENT
TOOLS
Copyright ©1999 Ian H. Giddy
M&A 4

Principles of Financial Management




Invest in projects that yield a return greater than the minimum acceptable hurdle rate.
 The hurdle rate should be higher for riskier projects and reflect the financing mix used owners’ funds (equity) or borrowed money
(debt)
 Returns on projects should be measured based on cash flows generated and the timing of these cash flows; they should also consider both positive and negative side effects of these projects.
Choose a financing mix that minimizes the hurdle rate and matches the assets being financed.
If there are not enough investments that earn the hurdle rate, return the cash to stockholders.
 The form of returns - dividends and stock buybacks - will depend upon the stockholders’ characteristics
Minimize unnecessary financial risks.
Objective: Maximize the Value of the Firm
Copyright ©1999 Ian H. Giddy
M&A 5

The Market for Corporate Control
When you buy shares, you get dividends; and potential control rights
There is a market for corporate control — that is, control over the extent to which a business is run in the right way by the right people.
This market is constrained by
 Government
 Management
 Some shareholders
Copyright ©1999 Ian H. Giddy
Example:
Allied Signal’s attempts to acquire AMP, which is located in Pennsylvania
M&A 6

The Market for Corporate Control






M&A&D situations often arise from conflicts:
Owner vs manager ("agency problems"
Build vs buy ("internalization")
Agency problems arise when owners' interests and managers' interests diverge. Resolving agency problems requires
 Monitoring & intervention, or
 Setting incentives, or
 Constraining, as in bond covenants
Resolving principal-agent conflicts is costly
Hence market price may differ from potential value of a corporation
Copyright ©1999 Ian H. Giddy
M&A 7

“Internalization”: Is an activity best done within the company, or outside it?
Issue: why are certain economic activities conducted within firms rather than between firms?
 As a rule, it is more costly to build than to buy —markets make better decisions than bureaucrats
 Hence there must be some good reason, some synergy, that makes an activity better if done within a firm
 Eg: the production of proprietary information
 Often, these synergies are illusory
Copyright ©1999 Ian H. Giddy
M&A 8

Takeovers as a Solution to “Agency
Problems”
 There is a conflict of interest between shareholders and managers of a target company —Eg poison pill defenses
 Individual owners do not have suffcient incentive to monitor managers
 Corporate takeover specialists, Eg KKR, monitor the firm's environment and keep themselves aware of the potential value of the firm under efficient management
 The threat of a takeover helps to keep managers on their toes —often precipitates restructuring.
Copyright ©1999 Ian H. Giddy
M&A 9

Goal of Acquisitions and Mergers


Copyright ©1999 Ian H. Giddy
M&A 10

Value Changes In An Acquisition
Profit on sale of assets
Synergies and/ or operating improvements
Value of acquired company as a separate entity
Value of acquiring company without acquisition
40
50
75
175
10
30
Taxes on sale of assets
Takeover premium
50
Gain in shareholder value
250
Copyright ©1999 Ian H. Giddy
Initial value plus gains
Final value of combined company
M&A 12

Goals of Acquisitions
Rationale: Firm A should merge with Firm B if
[Value of AB > Value of A + Value of B + Cost of transaction]
 Synergy
 Gain market power
 Discipline
 Taxes
 Financing
Copyright ©1999 Ian H. Giddy
M&A 13

Goals of Acquisitions
Rationale: Firm A should merge with Firm B if
[Value of AB > Value of A + Value of B + Cost of transaction]


Synergy
 Eg Martell takeover by Seagrams to match name and inventory with marketing capabilities
Gain market power
 Eg Atlas merger with Varity. (Less important with open borders)
 Discipline
 Eg Telmex takeover by France Telecom & Southwestern Bell
(Privatization)
 Eg RJR/Nabisco takeover by KKR (Hostile LBO)
 Taxes
 Eg income smoothing, use accumulated tax losses, amortize goodwill
 Financing
 Eg Korean groups acquire firms to give them better access to within-group financing than they might get in Korea's undeveloped capital market
Copyright ©1999 Ian H. Giddy
M&A 14

M&A Program Must be Part of Long-
Range Strategic Planning:



What’s our business? Company’s capabilities and limitations? Our mission?
Key trends in the business environment?
Corporate flexibility to meet critical changes and challenges?




Competitive analysis?
Relationships with suppliers, customers, complementary firms?
Internal performance measurement system? Reward system?
Organization and funding for implementation?
 Where do we want to go, and how are we going to get the resources to get there?
Copyright ©1999 Ian H. Giddy
M&A 15

Developing an Acquisition Strategy









Define your acquisition objectives
Establish specific acquisition critieria
Select a good team of advisors
Focus on the company’s “wish list”
Is it the right target?
Is the market going to like the deal? Why?
What is the business vision that justifies it?
How much dilution is the buyer’s stock price will there be?
What will it take after the deal to make it work?
Copyright ©1999 Ian H. Giddy
M&A 16

Rigorous Search Procedures
 What are our weaknesses and how do we have to improve?
 What companies can help us or how can we help them?
 How can we build a group of complementary business groups that will give strength to one another?
Copyright ©1999 Ian H. Giddy
M&A 17

Steps in a Successful Merger and
Acquisition Program - Step 1 and 2
1. Manage preacquisition phase



Instruct staff on secrecy requirements
Evaluate your own company
Identify value-adding approach
Understand industry structure, and strengthen core business
Capitalize on economics of scale
Exploit technology or skills transfer




2. Screen Candidates
Identify knockout criteria
Decide how to use investment banks
Prioritize opportunities
Look at public companies, divisions of companies, and privately held companies
Copyright ©1999 Ian H. Giddy
M&A 18

Steps in a Successful Merger and
Acquisition Program - Step 3 to 5
3. Value remaining candidates
 Know exactly how you will recoup the takeover premium



Identify real synergies
Decide on restructuring lan
Decide on financial engineering opportunities
4. Negotiate
 Decide on maximum reseervation price and stick to it
 Understand background and incentives of the other side



Understand vlue that might be paid by a third party
Establish negotiation strategy
Conduct due diligence
5. Manage postmerger integration


Move as quickly as possible
Carefully manage the process
Copyright ©1999 Ian H. Giddy
M&A 19

Case Study: Sterling Drug
Questions:

What was Kodak’s acquisition strategy?
 What was the motivation for the bid for
Sterling Drug?
 What were the potential sources of synergy?
 What would you expect to happen to the value of Kodak’s shares? Of its debt?
Copyright ©1999 Ian H. Giddy
M&A 20