C14 M&A - Bidding strategies

Question 1

Decide on payment mechanism: cash and stock

Answer 1

Cash: bidder simply pays for the target, including any premium, in cash
Stock: in a stock-swap transaction, bidder pays for the target by issuing new stock and giving it to the target shareholders
Exchange ratio: number of bidder shares received in exchange for each target share

Question 2

Acquirer’s share price pre- and post-merger

Answer 2

Share price of acquirer should increase if:
A: pre-merger value of acquirer; T: pre-merger value of target; S: value of synergies; NA: acquirer’s outstanding shares pre-merger; x: number of new shares issued to pay for the target

Question 3

formula Exchange ratio

Answer 3

Question 4

formula Exchange ratio in terms of pre-merger share prices

Answer 4

Question 5

Accretion / Dilution Analysis

Answer 5

(1) Does proposed deal increase or decrease post-transaction EPS of acquirer?
If EPSpost < EPSpre: dilution
If EPSpost > EPSpre: accretion
(2) What is the expected share price of A after the announcement of the deal?
PA,post — PA = accretion(dilution) per share

Question 6

Definition Exchange ratio

Answer 6

Exchange ratio: relative number of new shares given to existing shareholders

Question 7

Calculate EPSpre

Answer 7

EPSpre = EarningsA / NA
NA: #shares outstanding of Acquirer A

Question 8

Calculate EPSpost

Answer 8

EPSpost = Earningspost / (NA + x)
with x = exchange ratio x NT , exchange ratio = A’s offer per share / PA

Question 9

Calculate post-merger A’s share price PA,post

Answer 9

PA,post = P/E post x EPSpost
P/E post = PA,post / EPSpost
EPSpost = PA,post / P/E post

Question 10

Summary Accretion/Dilution Analysis

Answer 10

(1) Calculate EPSpre of A
(2) Calculate EPSpost of A
(3) Calculate PA,post
(4) Calculate per share dilution/accretion

Question 11

Decide on payment mechanism: cash vs stock

Answer 11

• *A’s believing their stock is undervalued** will use cash to do acquisitions
• *A’s believing their stock is over- or correctly valued** will use stock to do acquisitions
• *premium paid is larger** when acquisitions is financed with stock
• *accounting rationale** for using stock rather than cash as you are allowed to use pooling instead of purchase
• *tax rationale** for using stock as cash acquisitions create tax liabilities to the target firm’s shareholders

Question 12

Distribution of takeover gains

Answer 12

Evidence: payed premium by A = added value: Ultimately, T’s shareholders get the value added by A
Why?
Explanation 1: The Winner’s curse
Explanation 2: The Free Rider Problem

Question 13

Winner’s curse

Answer 13

Information asymmetry about the true value of T:
Winner of the auction is the most optimistic bidder regarding T’s true value
Solution: bid adjustment
Winner’s curse is worse when uncertainty is high and number of bidders is large

Question 14

Free Rider Problem

Answer 14

A makes a tender offer for T’s shareholders: b
If b ≤ E(PA,post): shareholders can gain more if they do not tender -> incentive to free-ride. If all shareholders free-ride, takeover is called off -> A has to make a bid:
b > E(PA,post): T’s shareholders tender their shares, but this removes any profit opportunity for A

Question 15

Solution for Free Rider Problem

Answer 15

(1) Toehold bidding:
A has initial ownership of T’s stock (fraction