MERGERS AND ACQUISITIONS

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MERGERS AND ACQUISITIONS

• The Market for Corporate Control

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MA Activities

• Mergers
• Takeovers
• LBOs
• Compensation
• Spin-offs, etc.

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Definitions

• Corporate control -- the power to make investment
  and financing decisions.
• Corporate governance -- the role of the Board of
  Directors, shareholder voting, proxy fights, etc.
  and the actions taken by shareholders to
  influence corporate decisions.
• Corporate structure -- the financial organization
  of the business.

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Recent Mergers
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Sensible Reasons for Mergers

• Economies of Scale
• A larger firm may be able to reduce its per unit
  cost by using excess capacity or spreading fixed
  costs across more units.

Reduces costs


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Sensible Reasons for Mergers

• Economies of Scope or Vertical Integration
• Control over suppliers may reduce costs.
• Over integration can cause the opposite effect.

Pre-integration (less efficient)
Post-integration (more efficient)
Company
Company
S
S
S
S
S
S
S
S
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Sensible Reasons for Mergers

• Combining Complementary Resources
• Merging may result in each firm filling in the
  missing pieces of their firm with pieces from
  the other firm.

Firm A
Firm B
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Sensible Reasons for Mergers

• Combining Complementary Resources
• Merging may result in each firm filling in the
  missing pieces of their firm with pieces from
  the other firm.

Firm A
Firm B
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Sensible Reasons for Mergers

• Mergers as a Use for Surplus Funds
• If your firm is in a mature industry with few,
  if any, positive NPV projects available,
  acquisition may be the best use of your funds.

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Dubious Reasons for Mergers

• Diversification
• Investors should not pay a premium for
  diversification since they can do it themselves
• Empire Building
• EPS Game
• EX High PE firm buys Low PE firm -- resulting
  in higher EPS for merged firm (the bootstrap game)

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Dubious Reasons for Mergers

• The Bootstrap Game

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Dubious Reasons for Mergers

• The Bootstrap Game

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Dubious Reasons for Mergers
EP Ratio (log scale)
World Enterprises (after merger)
World Enterprises (before merger)
Muck Slurry
.10 .067 .05
Time
Now
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Sensible Reasons for Mergers

• Unused Tax Shields
• More Debt Capacity
• More Tax Shield
• Lower BK Costs

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Sensible Reasons for Mergers

• Inefficient Management (Agency Problems)
• Management Controls
• Capital Markets (mergers, takeovers, LBOs)
• Other Managerial Controls
• Board of Directors
• Labor Markets (External Internal)
• Compensation Incentives (options)

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Board of Directors

• Independent?
• Monitoring
• Hire/Fire
• Compensation
• Strategic Planning

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Estimating Merger Gains

• Questions
• Is there an overall economic gain to the merger?
• Do the terms of the merger make the company and
  its shareholders better off?

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Estimating Merger Gains

• Economic Gain

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Example Snowbird Alta
Snowbird is examining the purchase of Alta, which
would become a subsidiary of Snowbird if the
merger goes through. The projected cash flow
statement for Alta (if merged) is shown on the
next slide. These cash flows include all
synergistic effects. Altas market-determined
beta is 1.63. The risk-free rate is 10 percent
and the market risk premium is 5 percent. Alta
has 10 million shares of stock priced at 6.25.
What is the possible economic gain to this
merger, if any?
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Snowbird Alta
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Snowbird Alta
Discount Rate
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Snowbird Alta
Terminal Value Assume terminal growth rate of
10
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Snowbird Alta
Total Firm Value
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Snowbird Alta
Possible Economic Gain Merger Value -
Pre-merger Value 92.8 - 6.25 x
10,000,000 92.8 - 62.5 30.3
million
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Snowbird Alta
Change in Stockholders Wealth
Snowbird (Acquirer)
Alta (Target)
Bargaining Range Synergy
Price Paid for Target
62.5
92.8
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Takeover Methods

• Tools Used To Acquire Companies

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Takeover Defenses

• White Knight - Friendly potential acquirer sought
  by a target company threatened by an unwelcome
  suitor.
• Shark Repellent - Amendments to a company charter
  made to forestall takeover attempts.
• Poison Pill - Measure taken by a target firm to
  avoid acquisition for example, the right for
  existing shareholders to buy additional shares at
  an attractive price if a bidder acquires a large
  holding.

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Leveraged Buyouts

• The difference between leveraged buyouts and
  ordinary acquisitions
• 1. A large fraction of the purchase price is debt
  financed.
• 2. The LBO goes private, and its share is no
  longer trade on the open market.

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Leveraged Buyouts

• The three main characteristics of LBOs
• 1. High debt
• 2. Incentives
• 3. Private ownership

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Leveraged Buyouts
10 Largest LBOs in 1980s and 1997/98 examples
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Phillips Petroleum Case
Philips balance sheet was dramatically changed by
its leveraged restructuring (figures in
billions).
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Spin-offs, etc.

• Spin off -- debut independent company created by
  detaching part of a parent company's assets and
  operations.
• Carve-outs-- similar to spin offs, except that
  shares in the new company are not given to
  existing shareholders but sold in a public
  offering.
• Asset Sales-- the sale of the assets of a
  division to other firms .

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EXIT (Overcapacity)

• Capital Markets
• Internal Control Mechanisms
• Regulation and Legal System
• Product and Factor Markets
• (Michael Jensens arguments)
• Is MA good or bad for economic efficiency?

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Summary

• MA is Corporate Control Activity
• Many Sensible Reasons for Mergers
• Measure the Gains to Merger
• New cash flows from synergies
• Discount rate
• DCF Analysis
• Other MA Activities
• The Role of MA Activity for the Economy