Lecture 1

Question 1

What is a merger?

Answer 1

Combination of two companies to form a new company

Question 2

What is an acquisition?

Answer 2

Purchase of one company by another company, and no new company will be formed

Question 3

What are the three types of M&A?

Answer 3

Horizontal: Some line of business
Vertical: in the same line of productions
Conglomerate: Firms with completely un-related business

Question 4

What is a greenfield analysis?

Answer 4

Companies typically compare the costs, risks and benefits of an acquisition or merge with their organic opportunity (standard-alone versus Merger) analysis

Question 5

What is an inverse decision?

Answer 5

Whether to sell- a analysis that asks whether the benefits of continuing to operate an asset is a better risk-adjusted option that monetising the asset (for cash or stock of the acquirer)

Question 6

What is the Herfindalhl Hirschman Index (HHI)?

Answer 6

Measure of concentration in the industry and used to evaluate the effects of a merger?

Question 7

What is the HHI Formula and how to interpret it?

Answer 7

HHI? Sum of (Output of firm/ Total output of market x 100)^2
- If post merger HHI is <2000 or
Post merger HHI >2000, but change in HHI is <100

Question 8

What is the control premium and purchase price premium?

Answer 8

Control premium = the % difference between the price an acquirer will pay to purchase control of a target company compared to the price for owning a minority (non control position)
Purchase price premium (to the targets current share price) - in an acquisition is determined based on synergies and control premium
Purchase price premium = control premium + % synergies

Question 9

What is a breakup fee?

Answer 9

Paid because a target company walks away from transaction after merger agreement or stock purchase agreement signed

Question 10

What is a breakup fee designed to do?

Answer 10

Discourage other companies from making bids for the target company since they would, in effect, end up paying the breakup fee if successful in their bid

Question 11

What is a reverse breakup fee?

Answer 11

Fee that is paid if the acquiring company walks away from the transaction after signing the agreement

Question 12

How much are break up fees?

Answer 12

2-4% of the target company’s equity value (subject to negotiation)

Question 13

What are the three acquisition currencies?

Answer 13

1) Cash (forfeits interest earned on cash and tax on cash)
2) Debt (raising debt, however may lead to excessive leveraging - which may impact credit rating)
3) Equity - can be common/ preferred stocks

Question 14

How will equity be calculated as an acquisition currency?

Answer 14

Exchange ratio = offer price of target/ acquirers closing share price before deal is announced

Question 15

What are the benefits and drawbacks of equity?

Answer 15

Benefits: Target shareholders - capital gains are deferred until the acquiring shares received are sold & earn dividends,
Drawbacks: EPS dilution

Question 16

What is an accretion and dilution in relation to M&A?

Answer 16

Accreative: results in an increase in EPS
Decreative: Decrease in EPS - negative impact on share price

Question 17

What is a fairness opinion?

Answer 17

Publicly available document that states the transaction is “fair from a financial point of view”

• NOT an evaluation of business rationale, legal opinion or recommendation for board to approval
• Has a valuation analysis conducted by the investment bank to show the basis on which the opinion is offered

Question 18

What is the potential conflict of interest that arises from a fairness opinion?

Answer 18

Companies must decide if the same investment bank should perform the fairness onion and be the M&A advisory (since advisory fees are only paid if the transaction is deemed to be fair)

Question 19

What are the two types of mergers?

Answer 19

Friendly and hostile

Question 20

What can the acquiring company/ buyer do in the event of a hostile takeover?

Answer 20

1) Make a tender offer (substantial premium to the current market price - only works when can obtain over 51% of the shareholders (target))
2) Proxy fight: Take control of the company’s board and establish a FAVOURABLE board of directors via proxy vote (shareholder gives her vote to someone authorised to vote for her

Question 21

What are the five hostile defences?

Answer 21

1) Poison pills: allow shareholders to buy shares of the company at a substantial discount - leads to a dilute of ownership
2) Poison puts: Grant target firms bondholders the right to sell their bonds to the target company> increase debt of firm
3) Golden parachutes: Offer substancial compensation packaged to senior management of the target company to compensate them for loosing their jobs > increase cost of acquiring firm
4) Staggered board of directors: Long term board of director appointments, and only allow portion of directors sitting in electing
5) White knight: Seek friendly investor to takeover or purchase substantial stake in firm
6) greenmail: Pay acquirer to go away and take no further attempts to acquire the target company

Question 22

What is the difference between a financial and strategic buyer?

Answer 22

Financial buyer> interest on ROE, investment, capital structure and cash flows > they do not bring synergies
Strategic buyers > generally competitors of the target company> and will benefit from synergies when they acquire or merge with the target > usually able to pay a higher price than financial buyers

Question 23

Why is there more weight given to cost compared to revenue synergies?

Answer 23

• Revenue synergies are harder to predict and require more assumptions than cost synergies
• One of the primary motives behind an M*A is to achieve cost economics

Question 24

Why might an acquire chose equity over cash/debt

Answer 24

1) Acquirer has a high amount of leverage
2) Enticement for target firm given capital gains deferment
3) Not using debt - improves credit profit
4) Synergies realised in future can be shared between both sets of shareholders in the future

Question 25

Why might an acquirer chose cash over equity or debt

Answer 25

1) Less diltive of current ownership (less EPS dilutive)
2) No debt will not affect credit rating
3) Maintain control with current shareholders
4) More likely to be accepted by target shareholders
5) Take advantage of lazy balance sheet (ungeared)

Question 26

What risks will a fixed of floating equity stock currency create?

Answer 26

Fixed equity currency: for a fixed amount of shares - high volatations in the final economic amount of the deal
Floating: Significant fluctations in price can lead to significant variance in units - may lead to more shares being issued, which may dilute control