Corporate Finance - R23 - M&A Flashcards
a. classify merger and acquisition (M&A) activities based on forms of integration and relatedness of business activities;
Mergers can be classified according to the form of acquisition.
In a statutory merger, the target ceases to exist and all assets and liabilities become part of the acquirer.
In a subsidiary merger, the target company becomes a subsidiary of the acquirer.
With consolidations, both companies cease to exist in their prior form and come together to form a new company.
Mergers can also be classified by type:
Horizontal mergers, where firms in similar lines of business combine.
Vertical mergers, which combine firms either further up or down the supply chain.
Conglomerate mergers, which combine firms in unrelated businesses.
b. explain common motivations behind M&A activity;
Common motivations behind M&A activity include achieving synergies, more rapid growth, increasing market power, gaining access to unique capabilities, diversification, personal benefits for managers, tax benefits, unlocking hidden value for a struggling company, achieving international business goals, and bootstrapping earnings.
c. explain bootstrapping of earnings per share (EPS) and calculate a company’s post-merger EPS;
Bootstrapping is a technique whereby a high P/E firm acquires a low P/E firm in an exchange of stock. The total earnings of the combined firm are unchanged, but the total shares outstanding are less than the two separate entities. The result is higher reported earnings per share, even though there may be no economic gains.
d. explain, based on industry life cycles, the relation between merger motivations and types of mergers;
Companies tend to focus on different motivations for mergers depending on what stage of the industry life cycle they are in.
In the pioneer and rapid growth phases, companies look to mergers to provide additional capital or capacity for growth; conglomerate and horizontal mergers are common.
In the mature growth and stabilization phases, firms are looking for synergies to reduce costs; horizontal and vertical mergers are common.
In the decline phase companies are typically looking for new growth opportunities to survive; all three merger types are common.
e. contrast merger transaction characteristics by form of acquisition, method of payment, and attitude of target management;
A merger transaction may take the form of a stock purchase or an asset purchase.
In a stock purchase, the target’s shareholders receive cash or shares of the acquiring company’s stock in exchange for their shares of the target.
In an asset purchase, payment is made directly to the target company in return for specific assets.
The method of payment in a merger transaction may be cash, stock, or a combination of the two. Cash offerings are straight forward, but in a stock offering, the exchange ratio determines the number of the acquirer’s shares that each target company shareholder will receive.
The target company’s management will either view a merger as being friendly or hostile.
In a friendly merger, the acquirer and target work together to perform due diligence and sign a definitive merger agreement before submitting the merger proposal to the target’s shareholders.
In a hostile merger, the acquirer seeks to avoid the target’s management through a tender offer or proxy battle.
f. distinguish among pre-offer and post-offer takeover defense mechanisms;
Pre offer defense mechanisms to avoid a hostile takeover include poison pills, poison puts, reincorporating in a state with restrictive takeover laws, staggered board elections, restricted voting rights, supermajority voting, fair price amendments, and golden parachutes.
Post-offer defense mechanisms to avoid a hostile takeover include the “just say no” defense, litigation, greenmail, share repurchases, leveraged recapitalizations, the crown jewel defense, the Pac man defense, and finding a white knight or white squire.
g. calculate and interpret the Herfindahl–Hirschman Index and evaluate the likelihood of an antitrust challenge for a given business combination;
The Herfindahl-Hirschman Index (HHI) measures market power based on the sum of the squared market shares for all firms within an industry. High or increasing HHI values means that regulators are more likely to challenge a merger based on anti-trust grounds.
h. compare the discounted cash flow, comparable company, and comparable transaction analyses for valuing a target company, including the advantages and disadvantages of each;
The three basic methods for determining the value of a target in an M&A transaction are:
Discounted cash flow method.
Comparable company analysis.
Comparable transaction analysis.
Discounted cash flow analysis
Advantages:
Easy to model changes in cash flow from synergies or changes in cost structure.
Based on forecasts of fundamental conditions.
Easy to customize.
Disadvantages:
Difficult with negative FCF.
Estimates highly subject to error, especially for the distant future.
Discount rate changes over time can have a large impact on the estimate.
Heavily dependent on terminal value, growth rate, and discount rate.
Comparable company analysis
Advantages:
Data for comparable companies is easy to access.
Fundamental valuation assumptions are sound.
Current market-based estimates of value, not guesses about the future.
Disadvantages:
Assumes the market’s valuation of the comparable companies is accurate.
Estimate is a fair stock price, not a fair takeover price. An appropriate takeover premium must be determined separately.
Difficult to include synergies or changing capital structures into the analysis.
Historical data may not reflect current conditions in the M&A market.
Comparable transaction analysis
Advantages:
Based on actual transactions: no need to estimate a takeover premium.
Uses recent market prices from actual deals rather than assumptions and estimates about the future.
Easily justified to target’s shareholders, managers, and board.
Disadvantages:
Assumes that the M&A market valued past transactions accurately; mispricings will be carried over to the estimated value for the target.
Truly comparable transactions are rare. The analyst may be forced to use dissimilar M&A deals from other industries.
Difficult to incorporate synergies or changing capital structures into the analysis.
i. calculate free cash flows for a target company and estimate the company’s intrinsic value based on discounted cash flow analysis;
The process for valuing a target company with discounted cash flow analysis requires the following steps:
Determine which free cash flow model to use for the analysis.
Develop pro forma financial estimates.
Calculate free cash flows using the pro forma data.
Discount free cash flows back to the present.
Determine the terminal value and discount it back to the present.
Add the discounted FCF values to the discounted terminal value.
j. estimate the value of a target company using comparable company and comparable transaction analyses;
The process for valuing a target company with comparable company analysis requires the following steps:
Identify the set of comparable firms.
Calculate various relative value measures based on the current market prices of companies in the sample.
Calculate descriptive statistics for the relative value metrics and apply those measures to the target firm.
Estimate a takeover premium.
Calculate the estimated takeover price for the target as the sum of estimated stock value based on comparables and the takeover premium.
The process for valuing a target company with comparable transaction analysis requires the following steps:
Identify a set of recent takeover transactions.
Calculate various relative value measures based on completed deal prices for the companies in the sample.
Calculate descriptive statistics for the relative value metrics and apply those measures to the target firm
k. evaluate a takeover bid and calculate the estimated post-acquisition value of an acquirer and the gains accrued to the target shareholders versus the acquirer shareholders;
The value of the combined firm after a merger deal is a function of synergies created by the merger and any cash paid to shareholders as part of the transaction, or
VAT = VA + VT + S − C.
In a merger transaction, target shareholders capture the takeover premium, which is the amount that the price paid exceeds the target’s value:
GainT = TP = PT − VT.
The acquirer in a merger transaction captures the value of any synergies created in the merger less the premium paid to the target, or GainA = S − TP = S − (PT − VT).
l. explain how price and payment method affect the distribution of risks and benefits in M&A transactions
In a cash offer, the acquirer assumes the risk and receives the potential reward from the merger synergies, but in a stock offer, some of the risks and potential rewards from the merger shift to the target firm
m. describe characteristics of M&A transactions that create value;
Empirical evidence shows that targets receive the majority of benefits in a merger deal. In the years following a deal, acquirers tend to underperform their peers, which suggests that estimated synergies are not realized.
Acquirers are likely to earn positive returns on a deal characterized by:
Strong buyer: Acquirers that have exhibited strong performance in the prior three years.
Low premium: The acquirer pays a low takeover premium.
Few bidders: The lower the number of bidders, the greater the acquirer’s future returns.
Favorable market reaction: Positive market price reaction is a favorable indicator for the acquirer
n. distinguish among equity carve-outs, spin-offs, split-offs, and liquidation;
When a firm separates a portion of its operations from a parent company it is called a divestiture. Four common forms of divestitures include equity carve-outs, spin-offs, split-offs, and liquidations.
Equity carve-out: Creates a new, independent company by giving an equity interest in a subsidiary to outside shareholders. The subsidiary becomes a new legal entity whose management team and operations are separate from the parent company.
Spin-off: Creates a new, independent company that is distinct from the parent company, but unlike in carve-outs, shares are not issued to the public but are instead distributed proportionately to the parent company’s shareholders.
Split-off: Allows shareholders to receive new shares of a division of the parent company in exchange for a portion of their shares in the parent company.
Liquidation: Breaks up a firm and sells its assets piece by piece. Most liquidations are associated with bankruptcy.
o. explain common reasons for restructuring.
Reasons why a company may divest assets include:
A division no longer fitting into management’s strategy.
Poor profitability for a division.
Reverse synergy.
To receive an infusion of cash.
