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.
Private takeover Process
The period from the private initiation of the takeover to the first public announcement of it.
Usually starts either by a prospective buyer approaching a target, or a management decision to offer their company for sale. This is ‘Deal initiation’.
The selling company mgmt and its financial advisor arrange an auction or negotiate the deal privately with an exclusive buyer.
After the public announcement there is then the public takeover process until a resolution.
Formal Auctions
Structured - sale process is predetermined by the target and follows multiple planned rounds.
Financial advisor serves as the auctioneer, draws up preliminary list of potential bidders & obtains idea of their interest in making a potential bid.
The interested, contacted parties receive a very cursory description of the selling Co. and can sign NDA to get more in-depth.
Bidders then submit preliminary, non-binding offers of intent, giving indicative range of target valuations.
Remaining bidders then allowed access to in-depth & senior management.
This restriction of info is in contradiction to standard auction theory, but is required owing to the high value to customers, suppliers & competitors.
Finally, bidders submit sealed, binding bids.
Usually a single bidder is then granted exclusivity period to resolve remaining issues & complete due diligence.
Controlled sale
Selling firm negotiates with a limited number of bidders.
Private Sale
All happens hidden from the public eye, in private, prior to public announcement.
Shows a robust competitive environment & can actually lead to a good premium - bidders have incentive to make a good offer as otherwise they will simply be dropped.
Sale type Stats
Boone & Mulherin 2007 studied large US targets over 1989-1999.
Out of 400 firms, 202 were sold in auction.
In average auction 21 bidders contacted, 7 then signed confidentiality agreements, 1.7 submitted written bid.
Targets sold in auctions are smaller, bidders are relatively smaller, relative size is not different.
Large companies tend to be sold in private negotiations due to the amount of info they hold that could trigger price changes.
Premiums paid in auctions vs private are not different.
Fidmuc 2013 studied 1078 US public targets:
33% auction, 37% controlled sale, 30% private negotiation.
44% deals initiated by target, 38% of the bidder-initiated deals end up with a different bidder.
Private process takes 248 days on average, Public takes 40.
Premium is lowest for auction(36%), and highest for controlled sale (38%).
Regression evidence shows that competition leads to lower premiums.
Costs & Benefits of Auctions
Benefits - Increased competition leads to higher premium & efficient allocation of control over the target.
Costs - Bidders incur costs searching for potential targets, to learn their valuation or to revise their bid. These costs may imply lower premium for the target.
Trade off for the bidder: Higher competition means lower probability of success for a bidder. If they incur high evaluation costs and there is tough competition, they might offer a lower premium or not even bid at all. Winner’s curse is also stronger with more bidders, as higher chances of informational asymmetry leading to other bidders better knowing the actual valuation of the target.
Trade off for the target: Evaluation and search costs might imply that limiting No. bidders can induce more aggressive bidding by participants, because they have a greater chance of winning, so expected value from bidding is higher. Sellers might also prefer to limit competition to avoid info leakage. Costs arising from auctions can seriously limit their apparent benefits.
Pre-emptive bidding
Explains why private negotiations may result in higher premiums.
Fishman 1988:
Assumes that bidders must pay an evaluation cost to identify their respective private valuations of the target. If both bidders enter at the same time, both investigation costs will be sunk, and an open English auction with costless bidding ensues and produces the efficient outcome.
However if one bidder offers first, there then exists an initial bid that deters the 2nd bidder from paying the investigation cost & entering the auction. The high initial bid signals that the initial bidder has a high valuation, reducing the rival bidder’s expected value of winning. For a sufficiently large investigation cost, the expected value will be negative and the rival does not enter.
Evidence on pre-emptive bidding
Betton et al. 2008
Examined US initial control bids 1980-2005.
95% were single bids, with 73% of these successful.
On average it takes 64.6 days from first public announcement, relative to 80 days for tender offers.
