1
11/9/2001
Lecture
Mergers and Acquisitions, M&A
© K.Cuthbertson, D. Nitzsche
2
Topics
Types of Merger/ M&A Activity
Good/Bad Economic Motives
Economic Gains and Distribution of Gains
~ Cash Offer/ Share Offer
Financing of Mergers and Defence Tactics
Who Benefits/Loses: Empirics
Self Study: Regulation of Mergers: UK
© K.Cuthbertson, D. Nitzsche
3
Types of Merger/ M&A Activity
© K.Cuthbertson, D. Nitzsche
Types of Merger
Merger
Combining of two business under common ownership
(over 95% are friendly, 5% hostile takeovers)
Horizontal
Banks and Building Societies
Glaxo-Welcome, Nestle-Rowntree, GranadaForte(1996)
Vertical
Oil drilling, refinery and petrol stations
Car manufacturer and retail
AOL (America Online) and Time Warner (2000), Yahoo
and others(1996-)
Conglomerate: Hanson Trust
© K.Cuthbertson, D. Nitzsche
4
Types of Merger
Disbursement/Disinvestment/Downsizing
- we will not discuss this
Strategic Alliances
- BA, Quantas, Air Liberte etc
© K.Cuthbertson, D. Nitzsche
5
6
M&A Activity
end 1960’s -conglomerate mergers
(then broken up in 1980’s and 1990’s)
1970’s- vertical integration
(now ‘outsourcing’ !)
1980s - leveraged buyouts (USA)
- RJR Nabisco
1990’s- horizontal mergers
(eg. banks)/cross-border (eg. in Europe)
UK ‘waves’ 71-72, 87-89, 97-2000
© K.Cuthbertson, D. Nitzsche
7
M&A Activity
1997-2000
British Petroleum acquires Amoco ($48bn)
Exxon acquires Mobil ($80bn)
Daimler-Benz acquires Chrysler ($38bn)
Travellers Group acquires Citicorp ($83bn)
Deutsche Bank acquires Bankers Trust ($10bn)
AOL-Time Warner ($190bn)
Lloyds - Abbey National ?
© K.Cuthbertson, D. Nitzsche
8
Good/Bad Economic Motives
© K.Cuthbertson, D. Nitzsche
Good Economic Motives
More Efficient Use of Resources
Better management in merged firm
(e.g. Marriott takeover of Renaissance hotel grp, Dec
1996)
Cost savings (e.g. close bank branches)
Additional revenue generation (e.g. AOL-Time Warner)
Technology transfer/know-how (e.g. Glaxo-Welcome)
Strategic objectives
(‘option’ to do something in the future e.g. AOL-Time Warner)
© K.Cuthbertson, D. Nitzsche
9
Bad Economic Motives
Tax Advantages - loss ‘carry forwards’ used by ‘profitable’
bidder (merely a redistribution of income from tax payers
to shareholders)
Increase Market Power / Reduce Competition-Regulation
‘Using up’ Free Cash Flow after undertaking all NPV>0
projects - Empire Building
~ funds should be paid out to shareholders who then
decide the best use for the cash (eg. to invest in other
firms).
Hubris (=Overconfidence) - Guinness-Distillers
Generate fees for Corporate Bankers/Lawyers !
© K.Cuthbertson, D. Nitzsche
10
11
Economic Gains
and
Distribution of Gains
© K.Cuthbertson, D. Nitzsche
Economic Gains and Distribution of Gains
1) Economic Gains
2) Distribution of Gains
- cash offer
- cash offer and underpriced
3) Distribution of Gains
- share offer
© K.Cuthbertson, D. Nitzsche
12
13
Economic Gains
Gains from a merger
Are the 2 firms worth more together than apart?
Assume current share prices correctly reflect each firm’s
‘stand alone’ value
Let
PVA = PA x NA = $200 x 1m = $200m (reflects PV of FCF)
PVB = $50m
and assume
© K.Cuthbertson, D. Nitzsche
PVAB = $275
Economic Gains
GainAB = PVAB - (PVA + PVB) - transactions costs
$25 = 275 - (200 + 50) - 0
The difficulty is in assessing PVAB
Major difficulties in using NPV to assess the gains
(‘synergies’)
is because of lack of data on FUTURE performance
of A+B, at the time of the takeover
Friendly takeover - more data may be available on value of
A+B
Hostile takeover - much less data available on possible
synergies
Scenario/sensitivity analysis will be used to estimate PVAB
© K.Cuthbertson, D. Nitzsche
14
Economic Gains
‘REAL OPTIONS THEORY’
~ is now being used to value the merged company
(when involving ‘young’ dot.coms)
Value of merged company
= ‘conventional’ estimate of PVAB + value of ‘new’ options
e.g.
‘New options’ = option to expand into new markets
~ -if these ‘take-off’, then large profits (e.g. AOL-Time
Warner with Disney films down the internet ?)
© K.Cuthbertson, D. Nitzsche
15
Distribution of Gains: Cash Offer
Target ‘Correctly’ Priced in the market
‘A’ takeover of ‘B’:
Gain for B= Cost for A
CostA = (cash paid - PVB ) = 65 - 50 = $15m
This is the ‘bid premium’
This is a gain to B’s shareholders
Gain for A’s shareholders
GainA = GainAB - CostA = 25 - 15 = $10m
Return to B’s shareholders = 15/50 = 30%
Return to A’s shareholders = 10/200 = 5%
© K.Cuthbertson, D. Nitzsche
16
Distribution of Gains: Cash Offer
17
Note:
If GainAB had been 10 (rather than 25) then A’s
shareholders would loose from the merger:
GainA = GainAB - CostA = 10 - 15 = -$5m
and PA would fall on announcement of merger terms
© K.Cuthbertson, D. Nitzsche
Cash Offer: Target Underpriced
If PB << PVB : ie. B is underpriced
Then (for a given bid premium) more of the gains
go to A. ‘A’ can gain, even if there are
no synergies
(In this case there is not a gain for ‘society’, but a
redistribution from B’s shareholders to A’s )
~ but note that A could ‘realise’ this gain by
simply buying B’s shares (and not merging) and
merely waiting for the ‘market correction’ that
increases B’s price.
© K.Cuthbertson, D. Nitzsche
18
19
Share Offer
Assume A pays $65m for B (as with the cash offer)
We also have
PVAB = $275m, PVA = $200m, NA =1m and PA= $200
If B’s shareholders are to receive the equivalent of $65m
then
Number of (A’s) shares to be issued to B-shareholders
NB = PVB / PA (before merger) = $65m /$200 = 0.325m
This is announced BEFORE the actual merger takes place
© K.Cuthbertson, D. Nitzsche
20
Share Offer
Apparent(but incorrect cost to A)
= 0.325 (200)-50 = $15m (as in ‘cash offer)
= NB PA - PVB
BUT correct’ cost of bid to A depends on the share price
of the merged company AFTER the merger
AFTER MERGER
NAB = 1.325m hence
PAB = PVAB/ NAB = $275/1.325 = $207.55
‘True’ Cost to A of shares given to B’s shareholders:
CostA = 0.325 x 207.55 - $50m = 17.45m
© K.Cuthbertson, D. Nitzsche
21
Cash versus Share Offer
CASH:
cost to A of the merger is unaffected
by the post-merger gains.
SHARES
Cost to A depends on the merger gains
PVAB , which show up in the post merger price, PAB
© K.Cuthbertson, D. Nitzsche
22
Financing of Mergers
and
Defence Tactics
© K.Cuthbertson, D. Nitzsche
23
Financing of Mergers
CASH (TENDER) OFFER
Source of cash can be provided by the acquirer undertaking
a ‘rights issue’ or, by bank borrowing or, issuing debt
(e.g. LBO) or by using retained profits (‘free cash flows’)
- advantage to target shareholders is ‘precision’,
and free to re-invest the cash in any other company
- disadvantage is cash paid out may be treated as
realised capital gain and taxed.
- advantage for acquirer is that it retains total control of
the new merged firm (ie no ‘dilution’ for its shareholders
© K.Cuthbertson, D. Nitzsche
24
Financing of Mergers
SHARE OFFER
- advantage to target shareholders is that any capital gain
on ‘new’ shares are not realised and hence not subject
to immediate capital gains tax
- advantage is target shareholder have (voting) shares
in the new company
-disadvantage to acquirer, if target (B) is overvalued by
stock market or bid premium is ‘too high’
MIXED OFFERs ARE ALSO USED:
Cash, shares, preference shares, share options
© K.Cuthbertson, D. Nitzsche
25
Defence Tactics
PAC MAN
- mount a counter bid against the predator
WHITE KNIGHT
- arrange another bid from a friendly company
POISON PILL
- make bid costly (e.g. your shareholders can buy shares
of new company at v. large discount.
Rights issue to dilute predators holdings )
POISON PUT (in bond covenants)
- bondholders of target can demand immediate repayment
in full, if there is a change in ownership
CROWN JEWELS
- sell off bits the acquirer is most interested in
© K.Cuthbertson, D. Nitzsche
26
Defence Tactics
GOLDEN PARACHUTES
- managers get massive payoff if they are taken over
GREENMAIL
- bribe your shareholders with promise of large future
dividend payouts if they don’t sell their shares.
- buy-up shares promised to the predator, at a premium.
SHARK REPELLANTS
- supermajority (80%) to approve merger
- restricted voting rights (for shareholders who own
more than x% of stock)
© K.Cuthbertson, D. Nitzsche
27
Who Benefits/Loses:
Empirics
© K.Cuthbertson, D. Nitzsche
28
Who Benefits/Loses: Empirics
MANAGEMENT
- acquiring management gain control and $’s
- 4 directors of RBS shared £2.5 for successful
takeover of Nat West
- Vodaphone CE Chris Gent £10m for takeover
of Mannesmann
- acquired managers(‘golden parachutes’ or redundancy)
EMPLOYEES
- usually redundancies for some employees of target
© K.Cuthbertson, D. Nitzsche
29
Who Benefits/Loses: Empirics
SHAREHOLDERS
- TARGET SHAREHOLDERS gain
- ACQUIRING SHAREHOLDERS - lose or break even,
THE ECONOMY
- v. mixed (see CAR and Post merger performance - below)
© K.Cuthbertson, D. Nitzsche
30
Who Benefits/Loses: Empirics
The markets reaction/interpretation
- Abnormal Return and Cumulative Abnormal Return
1) Use data from -70days to -10 days before announcement
Normal Return = a + (beta) Rm
2) Data -10 days to +10 days after announcement
AR = Actual R - Normal Return
CAR = sum of AR (from -10 to +10 or longer)
Markets are forward looking so change in price reflects the
PV of all future prospects/profits
© K.Cuthbertson, D. Nitzsche
AR and CAR: Target = Renaissance Hotel Grp
80
60%
31
AR
(Daily)
and CAR
40%
AR
CAR
20%
Doubletree
drops out as
Marriott
announces
agreement to
acquire 18/2/97
0%
-20%
13/12/96
Bid announced by
Doubletree
31/12/96
© K.Cuthbertson, D. Nitzsche
12/3/97
32
Who Benefits/Loses: Empirics
The markets reaction/interpretation
RESULT (Average of US mergers)
Acquired/Target firm’s shares have CAR of around +30%
Acquirer, CAR of -3.2% (stock offer)and -0.8% (cash offer)
For acquirer, over 2-years after merger, CAR is -17% (US)
SIZE MATTERS
PVB=$10m and CAR = +100%, $-gain = $20m
PVA =$1000m and CAR is -2% $-loss = $20m
© K.Cuthbertson, D. Nitzsche
33
Who Benefits/Loses: Empirics
Long term Post-Merger Performance
Uses accounting measures of return (eg. ROC ) in the
merged firm relative to those in the ‘control group’
(eg. non-merged firms in the same industry= ‘matched
sample’).
- Result mergers (on average) are ‘neutral’ or ‘negative’
(UK and US)
© K.Cuthbertson, D. Nitzsche
34
End of Lecture
© K.Cuthbertson, D. Nitzsche
35
Self Study
Regulation of Mergers
© K.Cuthbertson, D. Nitzsche
Regulation of Mergers: UK
36
Takeover Panel
- to ensure fairness for all shareholders
- In UK when ‘one firm’ holds 3% of the total shares
outstanding of B, then you must make this public.
- Purchase of more than 10% of shares in B within 7 days
is not allowed if this takes total shareholding to over 15%
- to prevent purchases from ‘professionals’ rather than
general shareholders
© K.Cuthbertson, D. Nitzsche
Regulation of Mergers: UK
- over 30% holding then T.P usually insists on a bid for all
of B’s remaining shares. B comes ‘into play’ as a
takeover target (observable by all).
Office of Fair Trading (OFT)
- ensures competition
Monopolies and Mergers Commission
- investigates M&A referred to it by OFT.
© K.Cuthbertson, D. Nitzsche
37
38
End of Slides
© K.Cuthbertson, D. Nitzsche