All Flashcards
Horizontal Merger
Buying the competition Acquisition of firm in same industry Possible synergies: - Reduce competition - Reduce overhead expenses - Complementary resources (Markets)
Vertical Merger
Buying a firm up or down the supply chain
Was a wave of this in 1960s
But current trend is of outsourcing instead.
Conglomerate Merger
Business Diversification Merger of firms in different industries Less popular now as evidence shows they destroy SH value. Possible diversification synergies. Current trend is specialisation.
Sources of synergies
Economies of scale
Complementary resources e.g. increase sales through overlapping business in R&D
Economies of integration - supply chain optimisation
Surplus funds - More efficient use than returning to SH
Management inefficiency - Bad firms become takeover targets, typically hostile
Industry consolidation if highly fragmented.
Dubious reasons for mergers
Diversification - it is cheaper to achieve by investors doing this themselves.
Boost EPS - bad accretive deals
Accretive v Dilutive Deals
Accretive if Buyer’s EPS goes up after sale, dilutive if goes down.
EPS is almost universally used as key measure of mgmt performance, therefore they are naturally interested in how a deal impacts their EPS.
If deal has positive NPV but is dilutive, managers use a lot of effort to explain why it’s good.
So dilutive deals are risky to managers.
Also Manager remuneration may be linked to EPS.
But dilutive deals can have a +ve NPV - many companies are highly priced because SH know their Co. is good, so if a firm buys them at a high price (even though their earnings may initially be low) the PE ratio will be diluted but can turn good in long term.
Accretive Bad Deals
Those where the PEt is low for a good reason.
e.g. if target is risky or in a market with no growth.
If this target is fairly valued and buyer with high PE pays a premium to buy it, Buyer’s EPS will go up, but growth is illusory. Deal will actually destroy value because Co. was fairly valued in first place.
EPS Trap
Accretive bad deals.
The more often a firm buys firms for the wrong reasons, the more likely they can become trapped trying to satisfy the EPS growth expectations of the market by purchasing even more mediocre firms.
Dilutive Good Deals
Those in which the targets EPS is high for a good reason, e.g. because it is experiencing temporary crisis or because its in a market with very high growth.
These will dilute buyer’s EPS in short run, but enhance it in long run.
Value Increasing theories for M&As
- They reduce transaction costs. Organisation of firms is reaction to balancing operations & markets (Coase 1937)
- Create synergies (Bradley et al. 1983)
- Takeovers are disciplinary (Manne 1965) - can be used to remove poor managers & facilitate competition btwn different mgmt teams.
Value Decreasing Theories for M&As
Agency Costs of free cash flow (Jensen 1986) - Co.s waste money on these projects because internal funds exceed investment required for +ve NPV projects.
Managerial Entrenchment (Schleifer & Vishny 1989) - Managers hesitant to distribute cash to SH, may instead choose investments that look better for them, where they overpay but decrease likelihood of their own replacement.
Value Neutral Theories for M&As
Merger bids result from managerial hubris (Roll 1986) - can explain why bids are made even when a valuation represents a positive valuation error when overpaying above current market price.
So if we assume zero synergy, then bidders should not pay a premium for the target firm. This hubris explains why some managers pay a premium even when synergy is zero ( and therefore destroy value for SH).
Event Study Methodology
Introduced by Ball & Brown 1968.
Evaluate the impact of a specific event on the value of a firm.
Relies on semi-strong market efficiency (Fama 1970).
New public info should be reflected in stock prices.
1. Define event of interest
2. Define the event window
3. Determine selection criteria
4. Choose a benchmark & define estimation window.
Cumulative Abnormal Returns
Aggregate abnormal return for firm over the window period - sum of individual returns. Therefore ignores any compounding effect.
On average, Short term ARs are very small but significant, but the dispersion of AR gives us a better picture owing to the fact that ARs are highly polarised so the average may be misleading.
Buy & Hold abnormal returns
Measure the long-term effects due to the compounding changes.
Equals the compound return on a sample minus compound return on a reference portfolio.
= How much we would earn if we invest in the firm and kept our money in for whole year.
Therefore are better when analysing long-run performance.
Abnormal Return Evidence
Betton et al 2008:
Hugely significant jump in share price for target that occurs very quickly, regardless of public/private, leaving a permanent new level. There is information leakage prior to the announcement - roughly 1/3 returns are realised before. If bidder is private then jump is not quite as big as if plc.
Returns for bidders are much less - perhaps because they are paying a premium. If target is public, then general expectation is of a larger premium, so leads to a negative impact on bidder’s stock price. If target is private then does suggest a positive return, but very significant.
