LT (9) M&A's Flashcards
What is a merger?
Merger:
Two firms combine to form a single firm Implies a ‘marriage of equals’
What is a takeover?
Takeover:
One firm (‘Acquirer’) buys a sufficient number of shares or assets of another firm (‘Target’) to gain control.
Not a marriage of equals - the management of the Target is subordinate to that of the Acquirer
What is a buyout?
Buyout:
A (public) firm (or a division of a firm) is bought and then taken private
What are the three types of merger?
Horizontal Mergers:
Firms that are in the same industry, and the same stage of production process.
Vertical Mergers:
Firms that are in same industry but at different stages of the production process
Congolmerate mergers:
Firms that are in the different industries
What is the difference between a friendly and hostile takeover?
Friendly:
the board of directors of two firms agree to combine and seek shareholders approval for the combination (generally > 50%)
Hostile:
Raider can make offer to board of directors
Raider can make offer directly to shareholders (‘Tender Offer’)
Often a hostile takeover attempt will result in the firm being sold to a friendly third party, called a ‘white knight’
How does a target company pay acquirer shareholders?
Cash deals:
Target shareholders receive cash compensation. e.g. Every share of the target receives $10. Similar to selling the shares to the acquirer.
Stock deals (‘Stock swap’)
Target shareholders receive payment in the form of the acquirer’s stock.
e.g. Every share of the target receives 0.3 share of the acquirer’s (post-merger company).
Combination of cash and stock
Does payment method matter?
Not in M&M world (i.e. w/o frictions)
Yes, in reality.
What are some of the Motives behind a M&A
Valid Reasons for source of value:
1) Restructuring
If restructuring through mergers is cost effective, then it will add value.
e. g. Obsolete product, Increased foreign competition (e.g. textiles) Deregulation (e.g. banking, airlines)
2) Increased market power
If you cannot undercut competitors, buying them could be an alternative. Fewer participants allows monopoly pricing. Stock price increase incorporates higher profits
Good for the companies. Bad for society.
3) Synergies and strategic benefits / Economies of scale/ Economies of scope (Vertical/Horizontal Integration)
(higher cash flows, i.e. increase revenue, lower costs)
Transfer technology. Allows small firms to gain access to distribution and advertising. Easier to enter a new market.
4) Corporate tax economies
Interest tax shields (advantage of debt, not merger) Reorganise into a trust or partnership
Other tax tricks
5) Improved management (Realign managements’ incentives)
Replace bad managers
Alternatives: Proxy contests, . . .
Prevent empire building
Prevent entrenched management, captured board
Dubious Reasons for source of value:
Lowering financing costs
Increase financial slack (get cash):
Managers may reject profitable investment opportunities if they have to raise new capital to finance them (Pecking order theory)
Does this make any sense? It costs about a pound to buy a pound
Risk reduction through diversification
Combining several industries to lower total risk is diversification at the firm level.
Do investors need it? They can diversify by holding a portfolio. (more cheaply)
Increasing earnings-price (E/P) ratio
Buy a low price target to boost EPS?
Acquiring firm has low E/P ratio –>
Selling firm has high E/P ratio (perhaps due to low growth expectations) –> After merger, acquiring firm has short- term EPS rise –> Long term, acquirer will have slower than normal EPS growth due to share dilution
Empire building / CEO overconfidence
CEOs are often overconfident in their management abilities and might overestimate potential gains (Rolls Hubris hypothesis).
What are some ways in which takeover defenses occur?
Targeted repurchase: bribe the raider to go away (Greenmail) average premium = 16% to bidder
comes from existing shareholders’ wealth
File antitrust suit to block acquisition
Anti-takeovers amendments (‘Shark Repellents’)
Poison Pill (rights issue at a deeply discounted price)
Staggered terms for board of directors
Super majority provisions
ESOPs (employee stock ownership plan): put votes in the hand of employees
Look for friendly alternatives (‘White Knights’)
How would you estimate the gains from a merger?
Gain from merger:
Gain = PV(AB) − (PV(A) + PV(B)) = ∆PV(AB)
Cost of merger:
Cost = Cash paid − PV(B)
NPV of acquisition:
NPV = Gain − Cost
= ∆PV(AB) − (Cash paid − PVB)
You add value only if you can generate additional economic rents.
OR Valuation by multiples.
If the merger is financed by acquirer’s stock, and sellers receive N shares in merged company, then what is the cost of the merger?
If the merger is financed by acquirer’s stock, and sellers receive N shares in merged company, then cost depends on the value of the shares in the new company:
Cost = (N × P(AB)) − PV(B)
Due to asymmetric information, optimistic managers prefer to finance mergers with cash.
How would you use valuation by multiples?
Assess the firm’s value based on that of publicly traded comparables:
Cash-flow-based Value multiples:
MV of firm/Earnings, MV of firm/EBITDA, MV of firm/FCF
Cash-flow-based Price multiples:
Price/Earnings (P/E), Price/EBITDA, Price/FCF
Asset-based multiples:
MV of firm/BV of assets, MV of equity/BV of equity (BOOK value)
PROCEDURE
Hope: Firms in the same business should have similar multiples (e.g. P/E)
STEP 1: Identify firms in same business as the firm you want to value
STEP 2: Calculate P/E ratio for comparables and come up with an estimate of P/E for the firm you want to value (e.g. take the average of comps’ P/E)
STEP 3: Multiply the estimated P/E by the actual Net Income of the firm you want to value
Free rider problem.
The free-rider problem explains why target prices jump up on a takeover announcement and why most of the gains go to the initial shareholders and not the acquirer
