Mergers, LBOs, Divestitures, and Holding Companies

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Mergers, LBOs, Divestitures, and Holding Companies

• (Chapter 25)

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Outline

• Types of merger
• Motivation for mergers
• MA process
• Hostile Takeovers
• Related Topics
• Empirical Evidence
• Merger Analysis

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Types of Merger

• Horizontal
• Same line of business
• Vertical
• Different stages of product cycle
• Supplier, producer, distributor, etc..
• Congeneric
• Same industry, but no supplier/customer links
• Conglomerate
• Different industries

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Motivation for Mergers

• Synergy
• Bargains
• Diversification
• Managerial Self-Interest
• Empire Building
• Maintain Control

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Motivation for Mergers

• Synergy
• VAB VA VB
• Might arise from
• Economies of Scale
• In operations
• In financing
• Eliminate inefficient target firm management
• Increase market power by reducing competition
• Taxes
• Target has negative EBT and unusable tax credits
• Acquirer has large positive EBT and would benefit
  from targets tax credits

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Motivation for Mergers

• Bargains
• Purchase price (market value)
• In efficient markets, market value reflects true
  value of target
• Target isnt actually a bargain after all
• Diversification
• Reduce volatility of cash flows
• Diversification can be achieved by shareholders
  instead
• Managerial Self-Interest
• Empire Building
• Maintain Control
• Defensive Mergers

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MA Process

• Identify Target
• Determine Offer Price
• Choose Method of Payment
• Cash
• Stock
• Bonds
• Accounting for Acquisition
• Goodwill Purchase Price Net Asset Value
• Reduces taxes for acquiring firm
• Hostile v. Friendly Mergers
• Tender Offers and Proxy Fights

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Hostile Takeovers

• Target Defense
• White Knight
• Poison Pill
• Golden Parachute
• Acquirer Actions
• Tender Offer to Target Shareholders
• Proxy Fight

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Related Topics

• Corporate Alliance
• Divestitures
• Leveraged Buyouts

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Corporate Alliance

• Cooperative arrangement between firms
• No actual merger
• Joint Venture
• Alliance for specific project with a limited
  duration
• Often found in foreign investment as a means to
• Support projects otherwise too large for a single
  firm to undertake
• Gain expertise in several areas needed for a
  project
• Minimize country risk

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Divestitures

• Sell off entire division to another firm
• Spin-off
• Make separate corporation out of division
• Issue new firms stock to existing shareholders
• Equity Carve-out
• Sell minority interest of divested unit to new
  investors or to current shareholders (pro-rata)
• Liquidation
• Sell division in pieces (individual assets)
  rather than as an operating business
• Liquidation value Market Value

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Divestitures

• Reasons
• Market value doesnt reflect true value of firm
• Firm needs cash infusion to continue operations
• Divest assets that are no longer profitable
• Required by government
• ATT

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Leveraged Buyouts

• LBO
• Investors buy stock to take firm private
• Investors typically current management and/or
  shareholders
• Use debt to finance acquisition of stock
• Heavy debt burden reduces agency costs
• Forces management to operate efficiently
• More efficient firm eventually goes public

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Empirical Evidence on MA Activity

• Questions
• Do Acquisitions Create Value?
• Who benefits from Acquisitions?
• Answers
• Target stock prices increase at announcement of
  intended acquisition (20-30)
• Target shareholders gain wealth
• Acquirer stock prices tend to remain flat
• No change in wealth for acquiring shareholders
• No value creation

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Empirical Evidence on MA Activity

• Foreign Acquisition of U.S. Firms
• Bidder (A) shareholder wealth gain/loss mixed
• Target (B) shareholder wealth gain
• VAB VA VB
• Bidder or Target usually has some intangible
  asset that is difficult to license out
• Merger allows use of that intangible asset in
  other markets
• Example
• Coke acquires Indian firm to produce and bottle
  Coca-Cola in the Indian market.
• Licensing out the formula for Coca-Cola to a
  separate firm exposes Coke to loss of a trade
  secret (secret formula for coca-cola)

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Empirical Evidence on MA Activity

• Bondholder Impact
• Evidence that shareholder wealth gains in some
  MA activity comes at the expense of bondholders
• Example LBOs
• Existing debt may not have seniority provision in
  debt covenant
• New debt issued to finance the LBO has equal
  status as the old/existing debt
• With increase in debt ratio, old debt becomes
  riskier (higher default risk)
• Bond Price falls as Yields increase
• VEquity VFirm VDebt
• As VDebt falls, VEquity rises
• Wealth transfer from bondholders to shareholders