Corporate Finance #28 - Mergers and Acquisitioins Flashcards
Forms of integration (how firms physically come together from M&A)
LOS 28.a
- statutory merger - acquiring company acquires all of target’s assets and liabilities; target (usually the smaller firm) ceases to exist
- subsidiary merger - target becomes a subsidiary of the purchaser; typical form when target has well-known brand (e.g. P&G buying Gillette)
- consolidation - both companies cease to exist in prior form; common form for same-sized firms
Types of mergers (how firms’ business activities relate to one another)
LOS 28.a
- horizontal merger - two firms operate in same/similar industries, often competitors
-
vertical merger - acquiring company seeks to move up or down the value chain:
- forward integration - buy a customer
- backward integration - buy a supplier
- conglomerate merger - two companies operate in completely different industries; few synergies
Explain M&A motivations: Creating value
LOS 28.b
synergies - “sum is greater than the parts”
- common motivation for merger
- reducing costs or increasing revenues:
- cost synergies - motiviation of a horizintal merger; reduce fixed costs
- revenue synergies - cross-selling products, increasing market share, or raising prices (reducing competition)
achieving more rapid growth - “make vs buy”
- common motivation in mature industries where organic growth is limited
- faster and less risky to buy resources than to develop them internally
increased market power - “get bigger”; common in mature industries with few competitors or few suppliers
- horizontal merger - “buy a competitor”; greater pricing power
- vertical merger - “buy a supplier”; eliminate supplier power; gain industry output power and market pricing power; ensures supply and locks out competitors
gain access to unique capabilities - “make vs buy”
- If company needs a critical unique resources or capabililty (e.g. patents, R&D resources) only way to get it–or cheaper/faster/less risky to buy it.
unlock hidden value - “I can do it better”
- acquirer believes it can improve management, add resources, improve org structure, etc.
- acquirer belives it is purchasing assets below their replacement cost i.e. “buying key assets at a discount”
M&A motivation: Dubious motives
LOS 28.b
diversification - “sum is less than the parts”
- managers win; shareholders don’t
- evidence of conglomerate effect
bootstrapping EPS - “bootstrap effect”
- high P/E firm (growing) acquires low P/E firm (not growing) in stock transaction
- acquirer is exchanging high-priced shares for low-priced shares to reduce combined share count
- result is higher EPS, but no synergies
- post-merger P/E should adjust to weighted average of earnings contribution
personal benefits for managers - “empire building”
- higher pay (i.e. bigger company, bigger pay)
- greater power, prestige; ego trip
- no benefit to shareholders
tax benefits - “buying tax carryforwards”
- regulators unlikely to approve merger solely for tax benefits, which can be difficult to prove
Explain M&A motivations: Cross-border mergers
LOS 28.b
achieve international business goals - many factors to this motivation:
- capture market inefficiencies - e.g. cheap labor
- overcome government barriers - e.g. tariffs
- leverage technology in new markets
- product differentiation
- expand multinational client relations
Key differences between forms of acquisition
LOS 28.e
Stock Purchase
- Payment - made directly to target shareholders in exchange for their shares
- Approval - majority shareholder approval required
- Corp taxes - none
- Shareholder taxes - pay capital gains
- Liabilities - acquirer assumes target’s liabilities
Stock Purchase
- Payment - made directly to target company
- Approval - no shareholder approval needed unless asset sale is substantial
- Corp taxes - none
- Shareholder taxes - pay capital gains
- Liabilities - acquirer avoids assumption target’s liabilities
Methods of payment for merger or acquisition
LOS 28.e
Securities offering - quantity of acquirer’s shares received by target shareholders based on the exchange ratio, which is negotiated in advance (e.g. 1.3 shares for each target share)
Total compensation paid by acquirer based on: exchange ratio; number of outstanding shares of target; value of acquirer’s stock on the day the deal is completed
Cash offering - acquirer simply pays an agreed amount of cash for the target’s shares
Factors to consider during M&A negotiations
LOS 28.e
Distribution of risk/reward for acquirer & target shareholders
- stock offer - target shareholders share risk of post-merger value with acquirer
- cash offer - acquirer bears all risk of post-merger value; if acquirer is confident of merger synergies it will push for a cash offering
Relative valuations of companies involved
- if acquirer’s stock overvalued, it will push for a stock offer
- investors may interpret a stock offer as acquirer’s shares are overvalued
Changes in capital structure
- acquirer raises cash - will increase acquirer’s financial leverage (D/E ratio) and risk
- acquirer issues new stock - can dilute ownership interest for acquirer’s existing shareholders
Describe process of a friendly merger offer
LOS 28.e
Friendly merger offer
- acquirier secretly approaches target management. If parties like the idea of the merger, then they negotiate terms; not public yet
-
due diligence process. Each party protects their shareholders by confirming accuracy of merger assertions
- acquirer: make sure target’s assets exist
- target: ensure acquirer’s capacity to pay
- definitive merger agreement. attorneys draft it; outlines transaction terms and rights of each party
- announce to public once merger agreement is signed; accompanied by endorsement from target to encourage shareholders to vote for the deal.
- proxy statement given to target shareholders; outlines facts of the deal
- approval. once approved by target shareholders and relgulators, payment is made and the deal is done
Describe process of a hostile merger offer
LOS 28.e
Hostile merger offer
- acquirier secretly approaches target management. If target management does not like the idea of the merger, then they negotiate terms; not public yet
- acquirer delivers merger proposal to target BoD. Process is called a bear hug. If unsuccessful, then
-
acquirer appeals to target shareholders. Two methods:
- tender offer - acquirer offers to buy shares directly from target shareholders; each shareholder either accepts or rejects the offer
- proxy battle - acquirer seeks to control target with new BoD using a proxy solicitation; if approved by regulators and target shareholders, new board is elected, management is fired so merger can become friendly
Describe Pre-Offer Defense Mechanisms against a hostile takeover
LOS 28.f
Note: these are commonly used in combination
Poison pill - very effective; gives shareholders the right to buy additional shares at a deep discount, causing dilution and increases cost to acquirer; pill triggered at a certain equity stake (e.g. 10%); BoD usually allowed to redeem pill before friendly merger offer
- flip-in pill - buy more shares at a discount
- flip-over pill - buy acquirer’s shares at a discount
Poison put - gives bondholders the option to demand immediate bond repayment; adds cash burden for acquirer
Restrictive takeover laws - some states are more target friendly; target may seek to reincorporate in state with strict anti-takeoffer laws (e.g. Ohio or Pennsylvania)
Staggered board - example: BoD terms staggered into 3 groups of 3-year terms; takes at least 2 years for acquirier to gain BoD control
Restricted voting rights - equity ownership above a certain threshold (e.g. 15%) triggers loss of voting rights; effective against a tender offer
Supermajority voting provision for mergers
Fair price amendment - restrict a merger unless a fair price is offered to current shareholders; determined by formula or independent appraisal
Golden parachutes - gives target managers a big payout if fired after a merger; less effective against takeover but eases management concerns of losing their jobs
Describe Post-Offer Defense Mechanisms against a hostile takeover
LOS 28.f
Note: these are commonly used in combination
“Just say no” defense - target can publicly appeal to shareholders to decline the offer
Litigation - file lawsuit againt acquirer; long and expensive
Greenmail - payout to acquirer to terminate takeover actions
Share repurchase - target offers to buy its own shares; raises bid price and increases D/E to unattractive levels
Leveraged recapitalization - target assumes debt to finance a share repurchase; increases D/E to unattractive levels
Crown jewel defense - sells an essential asset to a neutral third party; courts could rule the strategy illegal
Pac-Man defense - target make counteroffer to acquire the acquirer; rarely used
White knight defense - friendly third party that offers higher price to create bidding war; Overpaying called “winner’s curse”
White squire defense - friendly third party buys a minority stake in target to prevent acquirer from gaining enough shares; high chance of litigation, especially if target shareholders uncompensated from a dilutive event
Calculate and interpret the Herfindahl-Hirschman Index (HHI)
LOS 28.g
As of 1982, the key measure of market power for determining potential antitrust violations
HHI = sum(MSi * 100)2 for (i=1 to n), where
MSi = market share of firm i
n = number of firms in the industry
Concentration level and likelihood of antitrust challenge:
post-merger Industry d(HHI) Antitrust
HHI Concentration pre/post Action
< 1,000 none any amt none
1,000 < 1,800 moderate 100+ possible
> 1,800 high 50+ highly certain
