Lecture 8b: Takeovers 2 Flashcards
1.) Economic Rationale for Takeovers 2.) Empirical Evidences of Takeovers
What are the 9 Economical Reasons for Takeovers (ACRONYM(
MU UCPD FT. EPS
TAKEOVER REASON 1: M
Management of Target Company is inefficient
What is the evidence to support the inefficient management of the target company? Breakdown the Trend
On average, target companies underperform months before the announcement (underperform with a negative cumulative abnormal return)
Few days before announcement, cumulative abnormal return goes up to 12%, because of disclosure and insider trading
On announcement date, share price goes up by about 10% to 24% and STAYS CONSTANT.
TAKEOVER REASON 2 : C
Complementary Assets
Elaborate on TAKEOVER REASON 1 (M)
MANAGEMENT
Takeover replaces managers who are inefficient and too self-interested
Having a more efficient management can increase the value of the firm
Elaborate on TAKEOVER REASON 2 (C)
COMPLEMENTARY ASSETS
Horizontal/Vertical - Takeovers attractive if companies can provide others with needed assets at relatively low costs (Economies of Scale)
Conglomerate - Taking over small companies who cannot realize their full potential because their managers do not have skills across all areas of management (asset + management)
Is the argument “complementary assets’ applicable to human resources
Yes. For examples, if T has engineers, B (bigger firm) might want to takeover to use them
TAKEOVER REASON 3: U
Target Company is Undervalued
Elaborate on TAKEOVER REASON 3 (U)
UNDERVALUATION
Not NECESSARILY in the sense that target company is undervalued in the stock market. Undervalued to the BIDDER.
Investors/Managers identify better value from using company’s assets ALTERNATIVELY (!)
TAKEOVER REASON 4: C
Cost Reductions
Elaborate on TAKEOVER REASON 4 (C)
COST REDUCTIONS
- Total operating cost of BT < Operating cost B + Operating Cost T
Horizontal: Economies of Scale
Vertical: Cost savings from coordinating activities, improved communications, reduced bargaining cost,
etc
TAKEOVER REASON 5: P
Increase market power
Elaborate on TAKEOVER REASON 5 (P) - Controversial
INCREASE MARKET POWER (i.e. monopolize)
- Potential for increase dependent on whether there are significant barriers to entry
E.g. ACCC/other jurisdictions prohibits mergers likely to have the effect of substantially lessening competition
TAKEOVER REASON 6: D
Diversification
Elaborate on TAKEOVER REASON 6 (D).
Perspective of SH, DH
DIVERSIFICATION
- SH: No difference. They can diversify themselves (with a. own risk preference, and b. control premium)
- DH: Co-insurance effect. 2 companies whose earning streams less than perfectly correlated reduces default risk. If no economic benefit DH + SH - .
Main point: Equity holders do not gain/worse off by diversification
TAKEOVER REASON 7: F
Excess Free Cash Flow
Elaborate on TAKEOVER REASON 7 (F)
EXCESS FREE CASH FLOW
- Managers might prioritize acquisition over returning excess cash to shareholders (buyback/dividend)
- Conflict of interest between shareholders and managers may lead to little value/negative NPV takeovers
TAKEOVER REASON 8: T
Tax Benefits
Elaborate on TAKEOVER REASON 8 (T).
Tests to satisfy
TAX BENEFITS
If target company has accumulated tax losses, reduces total tax payable by combined company
Continuity-of-Ownership-And-Control = Owners >50% of shares in target company when it incurred losses remains as owners (Hard to pass)
Same-Business Test = Same line of business
Takeover of foreign company can shift company from high to low tax environment
Which taxation systems does taxes favor in takeover reason 8 (T)
Classical: Tc + Tp. Lowering Tc is good
Imputation: Tp. No benefits (assuming fully franked)
TAKEOVER REASON 9: EPS (Controversial)
Increase EPS and P/E Ratio Effects
Elaborate on TAKEOVER REASON 9 (EPS).
IINCREASE EPS AND P/E EFFECT
-By itself, an invalid argument: Can increase EPS without creating value
Bootstrapping: Whenever P/E of Bidding is higher than P/E of Target, EPS Increases and P/E Decreases if value remains constant.
Empirical Evidence of Takeovers 1: Do takeover comes in waves
Yes. Takeovers are positively correlated with behavior of share prices.
Empirical Evidence of Takeovers Wave: Why are there waves
Increase real demand = Increase Equity Returns = Increase productive capacity
As business and consumer confidence increases, takeover increases