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Market for Corporate ControlFinance 7311
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Terminology

• Target
• Potential takeover candidate
• Acquirer (Bidder)
• Firm doing the taking over
• Merger
• Friendly combination of two firms
• Tender Offer (Hostile Takeover)
• Opposed by target management

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Terminology, cont.

• Leverage Buyout
• Takeover in a highly leveraged transaction
• Advantages
• Concentrates ownership in fewer hands
• Takes cash out of management hands
• Tax advantage of debt
• Disadvantages
• Effect of economic downturn

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Terminology, cont.

• Management Buyout
• Same as LBO, except existing management is major
  shareholder
• Proxy Contest
• Voting by S/H on major corporate transactions
• Restructuring
• Significant change in allocation of corporate
  resources
• Current management stays on

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Defensive Tactics

• Methods used by management to avoid being taken
  over
• Poison Pill
• White Knight
• Greenmail
• Just Say No
• Supermajority Voting
• Courts OK if only one bidder

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Selecting and Valuing a Target

• Business Plan or Objective
• Vertical Integration
• Excess Capacity
• Product Distribution
• Distribution Product
• (Time Warner Paramount)
• Strategic Enter a new market for example
• Diversification (Later)

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Valuation

• PVt PV of target (stand alone)
• PVa PV of acquiring firm (stand alone)
• PVc PV of combined firm
• TP tender price

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Synergy Value Created

• PVc - (PVa - PVt) Total Synergy
• NPV of acquisition to acquiring firm
• PVc - (Pva PVt) - (TP - PVt)
• total synergy - synergy to target

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Synergy

• Sources of Synergy?
• Economies of Scale in
• Production
• Distribution
• Management/Administration
• Strategic
• Management better allocation of resources

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Calculation of Synergy

• Estimate combined cash flows and subtract sum
  of the parts
• Estimate the change in cash flows
• Must identify the source of value

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Acquisition

• What is reflected in Targets current price?
• Value as is
• Value with expected changes (current mgmt)
• Value in play
• How much of a change in control premium is
  already reflected in price?

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Acquisition

• Acquirer must offer a Premium to induce S/H to
  tender
• Must bid less than total value (Neg NPV)
• Do other Bidders exist? Is source of value
  generic or specific?
• Provision of information to market
• If value highest to you, you can win

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Acquisition, cont.

• Strategy Bid high enough to deter potential
  bidders, but low enough to retain value
• Avoid Winners Curse
• Target
• Defensive Tactics

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Motives or Reasons

• Corporate Raiding
• Raider buying company for less than value
• Premiums average 30
• Creation of Monopoly Power
• Hard to test others should benefit
• Wealth Transfer from other parties
• Not much evidence
• Taxes May support economics

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Motives, cont.

• Market Inefficiency
• Firm is Undervalued by Market
• Information to market
• Unsuccessful takeovers
• Target value goes back to preoffer price
• No perm. Reevaluation of firm
• Value created in combination

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Diversification

• Reduce Risk - may obtain better terms and/or
  better relationships from
• Employees
• Suppliers
• Customers
• Analagous to too much debt before
• Management - much human risk and human capital
  tied up in firm S/H?

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Diversification Evidence

• Comment Jarrell (95 JFE)
• Firm performance is increasing in firm focus
• Lang Stulz (94 JPE)
• Firms diversify when growth opportunities within
  industry exhausted
• Such diversification does not benefit S/H

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Diversification Evidence

• Berger Ofek (95 JFE)
• Compare stand-alone value of diversified firm
  segments to specialized firms
• Diversified firm worth 13 - 15 less than sum of
  stand alone components
• Day (95 JFE)
• Examines motives for risk reduction

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Day, cont.

• Firms pursue equity variance reducing activities
• Higher levels of personal wealth in firm
• More years invested w/ firm
• The poorer previous performance
• CEO specialists invest in similar specialties

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Performance Changes

• Dennis Denis (95 JFE)
• Turnover
• Forced
• Normal
• Forced Operating Income/Assets decreases in 3
  years prior increases following
• Normal Little difference prior small
  improvement afterward

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Dennis Dennis, cont.

• Forced resignations are rare
• 68 preceded by active monitoring by large s/h,
  b/h or potential acquirers
• 56 are the target of some form of control
  activity
• Boards not so effective in isolation
• Modern Trend Outside Directors