Mergers & Acquisitions
(and Divestitures)
Prof. Ian GIDDY
Stern School of Business
New York University
www.stern.nyu.edu/~igiddy/dakar
Mergers and Acquisitions
 Mergers
& Acquisitions
 Divestitures
 Valuation
Concept: Is a division or firm worth more
within the company, or outside it?
Copyright ©2003 Ian H. Giddy
M&A 3
The Gains From an Acquisition
Gains from merger
Synergies
Top line
Copyright ©2003 Ian H. Giddy
Control
Bottom line
Financial
restructuring
Business
Restructuring
(M&A)
M&A 4
Goal of Acquisitions and Mergers
 Increase
size - easy!
 Increase market value - much
harder!
Copyright ©2003 Ian H. Giddy
M&A 5
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 ©2003 Ian H. Giddy
M&A 6
Fallacies of Acquisitions
Size (shareholders would rather have
their money back, eg Vivendi Universal)
 Downstream/upstream integration
(internal transfer at nonmarket prices,
eg DuPont/Conoco, AOL/Time Warner)
 Diversification into unrelated industries
(Kodak/Sterling Drug)

Copyright ©2003 Ian H. Giddy
M&A 8
Who Gains What?
Target firm shareholders?
 Bidding firm shareholders?
 Lawyers and bankers?
 Are there overall gains?

Changes in corporate control increase the
combined market value of assets of the
bidding and target firms. The average is
a 10.5% increase in total value.
Copyright ©2003 Ian H. Giddy
M&A 9
The Price: Who Gets What?
Market value before deal
leaked
Value added by merger
Daimler
Chrysler
Combined
$52.8
$29.4
$82.2
$18.0
Merged Value
$100.2
Shareholders get
57.2%
42.8%
100%
Which is now worth
$57.3
$42.9
$100.2
Shareholders' shares of
the gain
Premium, as %
$4.5
$13.5
$18
9%
46%
Copyright ©2003 Ian H. Giddy
M&A 10
Equity Valuation:
Application to M&A
Prof. Ian Giddy
New York University
How Much Should We Pay?
Applying the discounted cash flow
approach, we need to know:
1.The incremental cash flows to be
generated from the acquisition, adjusted
for debt servicing and taxes
2.The rate at which to discount the cash
flows (required rate of return)
3.The deadweight costs of making the
acquisition (investment banks' fees, etc)
Copyright ©2003 Ian H. Giddy
M&A 12
The Gains From an Acquisition
Gains from merger
Synergies
Top line
Copyright ©2003 Ian H. Giddy
Bottom line
Control
Financial
restructuring
Business
Restructuring
(M&A)
M&A 13
Equity Valuation in Practice
Estimating discount rate
 Estimating cash flows
 Application to Optika
 Application in M&A: Schirnding-Optika

Copyright ©2003 Ian H. Giddy
M&A 15
Optika
Optika
Growth
Tax rate
Initial Revenues
COGS
WC
WACC:
Equity Market Value
Debt Market Value
ReE/(D+E)+RdD/(D+E)
Beta
Treasury bond rate
Debt spread
Market risk premium
Value:
FCFF/(WACC-growth rate)
Revenues
-COGS
-Depreciation
=EBIT
Equity Value:
EBIT(1-Tax)
Firm Value - Debt Value
-Change in WC
= 2278-250 = 2028 =Free Cash Flow to Firm
Cost of Equity (from CAPM)
Cost of Debt (after tax)
WACC
Firm Value
Copyright ©2003 Ian H. Giddy
5%
35%
3125
89%
10%
1300
250
1
7%
1.5%
5.50%
T+1
3281
2920
74
287
187
16
171
12.50%
5.53%
11.38%
CAPM:
7%+1(5.50%)
Debt cost
(7%+1.5%)(1-.35)
2278
M&A 16
Optika & Schirnding
Schirnding-Optika
Optika
Growth
Tax rate
Initial Revenues
COGS
WC
Equity Market Value
Debt Market Value
Beta
Treasury bond rate
Debt spread
Market risk premium
Revenues
-COGS
-Depreciation
=EBIT
EBIT(1-Tax)
-Change in WC
=Free Cash Flow to Firm
Cost of Equity (from CAPM)
Cost of Debt (after tax)
WACC
Firm Value
Copyright ©2003 Ian H. Giddy
5%
35%
3125
89%
10%
1300
250
1
7%
1.5%
5.50%
Schirnding
5%
35%
4400
87.50%
10%
2000
160
1
7%
1.5%
5.50%
Combined
5%
35%
7525
T+1
3281
2920
74
287
187
16
171
12.50%
5.53%
11.38%
T+1
4620
4043
200
378
245
22
223
12.50%
5.53%
11.98%
7901
6963
274
664
432
38
394
12.50%
5.53%
11.73%
2278
3199
5859
10%
3300
410
1
7%
1.5%
5.50%
M&A 17
Optika-Schirnding with Synergy
Schirnding-Optika
Optika
Growth
Tax rate
Initial Revenues
COGS
WC
Equity Market Value
Debt Market Value
Beta
Treasury bond rate
Debt spread
Market risk premium
Revenues
-COGS
-Depreciation
=EBIT
EBIT(1-Tax)
-Change in WC
=Free Cash Flow to Firm
Cost of Equity (from CAPM)
Cost of Debt (after tax)
WACC
Firm Value
Increase
Copyright ©2003 Ian H. Giddy
5%
35%
3125
89%
10%
1300
250
1
7%
1.5%
5.50%
Schirnding
5%
35%
4400
87.50%
10%
2000
160
1
7%
1.5%
5.50%
T+1
3281
2920
74
287
187
16
171
12.50%
5.53%
11.38%
2278
Combined
5%
35%
7525
10%
3300
410
1
7%
1.5%
5.50%
Synergy
5%
35%
7525
86.00%
10%
3300
410
1
7%
1.5%
5.50%
T+1
4620
4043
200
378
245
22
223
12.50%
5.53%
11.98%
7901
6963
274
664
432
38
394
12.50%
5.53%
11.73%
T+1
7901
6795
274
832
541
38
503
12.50%
5.53%
11.73%
3199
5859
7479
1620
M&A 18
Optika-Schirnding with Synergy
Schirnding-Optika
Optika
Growth
Tax rate
Initial Revenues
COGS
WC
Equity Market Value
Debt Market Value
Beta
Treasury bond rate
Debt spread
Market risk premium
5%
35%
3125
89%
10%
1300
250
1
7%
1.5%
5.50%
Schirnding
5%
35%
4400
87.50%
10%
2000
160
1
7%
1.5%
5.50%
T+1
3281
2920
74
287
187
16
171
12.50%
5.53%
11.38%
2278
Combined
5%
35%
7525
10%
3300
410
1
7%
1.5%
5.50%
Synergy
5%
35%
7525
86.00%
10%
3300
410
1
7%
1.5%
5.50%
T+1
4620
4043
200
378
245
22
223
12.50%
5.53%
11.98%
7901
6963
274
664
432
38
394
12.50%
5.53%
11.73%
T+1
7901
6795
274
832
541
38
503
12.50%
5.53%
11.73%
3199
5859
Case Study: Ashanti-Bogoso
Revenues
-COGS
-Depreciation
=EBIT
EBIT(1-Tax)
-Change in WC
=Free Cash Flow to Firm
Cost of Equity (from CAPM)
Cost of Debt (after tax)
WACC
Firm Value
Increase
Copyright ©2003 Ian H. Giddy
7479
1620
M&A 19
Ipoh-Kelantan
Ipoh-Ke lantan Bank
As part of the consolidation of banks in Malaysia, Bank of Ipoh and
Kelantan Bank Holdings Bhd are planning a merger. The proposed
merger will occur through an exchange of shares, with Kelantan
paying 1.5 shares for each share of Ipoh. Ipoh shares are cur
The following are the details of the two potential merger candidates
(RM figures in millions):
Revenues
Cost of Goods Sold
(w/o Depreciation)
as % of Revenue
Depreciation
Tax Rate
W orking Capital
Market Value of
Equity
Outstanding debt
Ipoh
Ke la nta n
RM4,400.00 RM3,125.00
87.50%
89.00%
RM200.00
RM74.00
35.00%
35.00%
10% of
10% of
Revenue
Revenue
RM2,000.00 RM1,300.00
RM160.00
RM250.00
Both firms are in steady state and are expected to grow by 5% a year
in the long term. Capital spending is expected to be 90% of
depreciation. The beta for Ipoh is 1.7, and for Kelantan 1.5, and both
firms are rated BBB, with an interest rate on their deb
As a result of the merger, the combined firm is expected to have a
cost of goods sold of only 86% of total revenues. earnings will grow
faster, at 6%. The combined firm does not plan to borrow additional
debt.
Estimate the value of Ipoh and of Kelantan, operating independently.
Then estimate their combined value, assuming no synergies. If it does
not increase debt, the combined firm's rating will be A+ (with an
interest rate of 7.75%)
Now estimate the value of the merged bank, assuming synergies.
Finally, assume that, as a result of the merger, the Ipoh-Kelantan
Bank's optimal debt ratio increases to 20% of total capital from
current levels. (At that level of debt, the combined firm will have an A
rating, with an interest rate on its debt of 8%.)
W hat is the value of the combined bank? Is Kelantan overpaying?
Copyright ©2003 Ian H. Giddy
M&A 20
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 ©2003 Ian H. Giddy
M&A 22
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 reservation price and stick to it
Understand background and incentives of the other side
Understand value 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 ©2003 Ian H. Giddy
M&A 23
Conclusion
Copyright ©2003 Ian H. Giddy
M&A 25
Contact Info
Ian H. Giddy
NYU Stern School of Business
Tel 212-998-0426; Fax 212-995-4233
Ian.giddy@nyu.edu
http://giddy.org
Copyright ©2003 Ian H. Giddy
M&A 26