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.
Tender Offers
Are in general faster for public companies.
Is an offer made by the bidder directly to target SHs.
Specifies the price per share, method of payment, etc.
In US must be open for min 20 business days.
There are public info disclosure requirements to protect SHs.
But concerns exist that these increase expected competition among bidders and possibly raise offer premiums and deter some bids. Evidence backed by Jarrell & Bradley 1980.
Choice between tender offer & merger
For bidders there are 2 advantages of the tender process: Speed of execution & does not require prior approval by target mgmt, therefore is an option when they believe target will refuse to negotiate.
Disadvantages: Target takeover defences significantly increase the cost of the transaction to the bidder. And a friendly cooperative approach gives the bidder access to the target’s books, crucial to pricing correctly.
Factors that DO matter to the value created in a merger
Hazelkorn et al 2004:
- Financing structure (cash gives higher)
- Public v Private target (Private)
- Earnings growth (Low)
- Focused v diversifying (Focused (only in long run))
- Foreign vs domestic acquisition (Foreign)
Factors that DO NOT impact on abnormal return generation created in a merger
Hazelkorn et al 2004:
- EPS impact
- Transaction size
- Profitability
- Credit Rating
- Industry
Method of Payment impact on value creation
Significant factor for both target & bidder abnormal returns. In a perfect world financing structure shouldn’t matter, but we know it does.
- Tax - D/E affects tax ratios
- Asymmetric information = information revelation affects both division of synergy gains & probability of offer being successful.
- Corporate control within bidder firm = Agency costs of mgmt having power within the firm - if bidder pays with shares then they’d have to issue more, diluting those of the current owners.
- Behavioural arguments - May want to use shares if you believe yours are currently overvalued.
Tax explanation for value creation
Tax treatment of cash & stock deals is different.
In US the target SHs must pay capital gains taxes in an all cash purchase immediately, but in all stock they are deferred until shares are sold.
An often important issue is whether the bidder compensates the target SHs for the differential tax treatment in the premium.
This is consistent with empirical evidence.
Method of payment & control explanation
All cash offer preserves the bidder’s control position, while all stock may significantly dilute this, therefore may drive use of cash.
Faccio & Masulis 2005 find these control incentives are particularly strong in bidder firms with concentrated share ownership structures.
Behavioural Arguments
Bidders are able to sell overpriced stock to less overpriced targets.
Schleifer & Vishny 2003 - stock is good payment for overpriced bidders.
Fundamental assumption that financial markets are not efficient, allowing mis-valuations.
Mergers are therefore a form of arbitrage by rational managers operating in inefficient markets.
Empirical evidence applied by Savor & Lu 2009.
Common characteristics of merger waves
Occur in periods of economic recovery, rapid credit expansion, and stock market booms (due to cheap finance).
Expansion through takeovers - corporate growth strategy.
Can be fuelled by regulatory changes, tech/industry shocks, herding behaviour of managers.
End with a stock market crash.
1st Merger Wave
1895-1904
Motivated by changes in economic infrastructure & production technologies e.g. transcontinental railroads creating a national market & innovations like electricity changing many industries.
Also driven by economies of scale, & availability of financiers & underwriters.
Lots of ‘merging for monopoly’ - horizontal mergers to form giant companies & exploit economies of scale & reduce price competition.
More than 3000 firms disappeared in the process - very little regulation limiting this.
Began downturn in 1901 as some failed to realise gains, recession in 1903, 1904 established anti-trust laws by Supreme Court.
2nd Merger Wave
1922-1929
Critical innovations post war - transportation making buyers & sellers more mobile; communications of radio enabling national advertising; mass distribution with low profit margins.
Merging for Oligopoly - with major vertical mergers.
Around 1/8 total manufacturing assets acquired between 1921-23.
Motivated by product & market extension e.g. IBM, and consolidation of fragmented industries.
Significant use of debt, and rise of pyramid holding Co.s
Investment banking played key role.
Economic slowdown in 1929 ended wave.
3rd Wave
1960s - Conglomerate mergers.
Tightening antitrust regime in US in 1950s.
Decline in relative importance of horizontal & vertical mergers.
Defensive diversification to avoid sales instability, poor growth prospects, adverse competitive shifts, tech obsolescence.
Some also wanted to form conglomerates similar to those that seemed to achieve high growth.
Also prominent ‘risk of mgmt’ theory.
But little evidence to suggest these c mergers created value - buyers often overpaid, 60% of cross-industry ace.s were sold or divested by 1989.
Ended through antitrust laws against conglomerate firms in 1968. Also punitive tax laws introduced in 1969, and an oil crisis and economic downturn in 1973.
4th Wave
1981-1989
Driven by Surges in economy & market; International competition was impacting on mature industries e.g. steel; Unwinding of diversified firms; new industries resulting from tech innovations.
Became cheaper to borrow money so PE firms began leveraged buyouts.
Decade of big deals.
Financial innovation of Junk bonds provided financing for aggressive acquisitions - hostile tender takeovers became acceptable practice.
Financial buyers arranged to go private.
IBs provided innovative products both to prevent and facilitate takeovers.
Non-US firms began expanding into stable US market - International mega deals, also driven by devaluation of US dollar.
Ended in Govt actions reforming Financial institutions, development of powerful takeover defences, and economic recession associated with gulf war.
5th Wave
1992-2000 Strategic mergers
Driven by major changes in internet & tech creating new industries & firms, and major globalisation. Strong economic environment & deregulation of numerous industries.
Saw a wide use of stock for stock transactions, less leverage. Also prominent use of stock options. Top 10 deals totalled about 700b$.
Ended with huge losses to bidding firms in late 1990s, mostly due to tech crash. But this was mostly driven by a couple of firms with very high losses, with investors reconsidering the huge valuations of some acquisitions, especially when considering they seemed to fall into the vicious cycle of repeated bad deals.
6th Wave
2002-2007
Started in 2002, ended with FC
Ample liquidity meant more deals financed with cash.
Lower valuation differences between bidders & targets.
Less frequent acquisitions by frequent acquirers.
Premiums paid were significantly lower than previous wave.
Greater participation of PE
7th Wave
2015 - tech deals coming back & asian firms investing in US.
