M&A

Question 1

When would a M&A make sense?

Answer 1

When synergies can be recognized

Question 2

Given two firms, A and B, the economic gain from a merger is given by what equation?

Answer 2

Economic gain = PV(AB) - [PV(A) + PV(B)], where

PV(AB) is value of combined firm
PV(A) is value of firm A
PV(B) is value of firm B

Question 3

If economic gain from a merger is negative, is there value added by merging?

Answer 3

No (only way investors could benefit from merger is if you acquire other firm by paying less than the other co. stand alone value)

Question 4

If economic gain from a merger is positive, is there value added by merging?

Answer 4

Yes

Question 5

What are four possible sources of synergies in M&As?

Answer 5

1) Economies of scale
2) Economies of vertical integration
3) Eliminating inefficient management
4) Industry consolidation

Question 6

Expand on the following possible synergy in an M&A:

Economies of scale

Answer 6

• Sometimes, marginal production costs (costs of producing one extra unit of the good) fall as production increases
• Hence, one large co. can operate more efficiently than two smaller ones
• In these cases, mergers increase economic efficiency

Question 7

Expand on the following possible synergy in an M&A:

Economies of vertical integration

Answer 7

• Merge with a supplier or a customer

- Facilitates coordination and administration

Question 8

Expand on the following possible synergy in an M&A:

Eliminating inefficient management

Answer 8

• If a co. is poorly managed, a co. with better management can acquire it and run it more efficiently

Question 9

Expand on the following possible synergy in an M&A:

Industry consolidation

Answer 9

• Mergers allow overcrowded industries to shrink
• Remaining firms might return to profitability
• Industry consolidation often allows the remaining firms to increase their market power/profitability

Question 10

Your firm (firm A) has identified a synergy with firm B. If you acquire B with cash (for its standalone value), how do we determine how much your investors gain, and how much B’s investors gain?

Answer 10

• If you’re firm A, and you acquire firm B by paying its standalone value [PV(B)], then you get to pocket all the gains from the merger
• Your gain [if you pay PV(B)] = PV(AB) - [PV(A) + PV(B)]

Question 11

Your firm (firm A) has identified a synergy with firm B. If you acquire B with cash (for more than its standalone value), how do we determine how much your investors gain, and how much B’s investors gain?

Answer 11

• If you pay more than firm B’s standalone value (say $2 million more), then firm B’s investors gain $2 million from merger

Question 12

In general, the acquirer’s (Firm A’s) gain from a cash acquisition of Firm B is given by what equation?

Answer 12

A’s gain = Total Gain - Firm B’s gain, where

Total gain = PV(AB) - [PV(A) + PV(B)]
Firm B’s gain = Cash - PV(B)

Question 13

How much should you be willing to pay to acquire firm B?

Answer 13

You should be willing to pay any amount that makes your gain be greater than 0

Your gain = Total gain - Firm B’s gain
Your gain = Total gain - [Cash - PV(B)]

Question 14

Is your gain positive or negative if Cash < (Total Gain + PV(B))

Answer 14

Positive
- hence you should be willing to pay up to
total gain + PV(B)

Question 15

How do we estimate the “PV(B)” portion in Total Gain + PV(B) if Firm B is a publicly traded firm?

Answer 15

• Look at its market price to estimate PV(B)

- Careful: if market is aware of possibility of merger, then B’s market cap will be greater than PV(B)

Question 16

How do we estimate the “Total Gain” portion in Total Gain + PV(B) if Firm B is a publicly traded firm?

Answer 16

• To estimate Total Gain, you want to zero in on the source of the synergy
• E.g. if combining the firms could cut costs by $25 million (in PV) and if revenues were unaffected, then the Total Gain would be $25 million

Question 17

Suppose firm A has value $200M. Firm B has value $50 M. Merging them creates $25M in value (from cost savings):

Compute Total Gains from merger.

Answer 17

$25M

Question 18

Suppose firm A has value $200M. Firm B has value $50 M. Merging them creates $25M in value (from cost savings):

Compute max amount A should be willing to pay to acquire B

Answer 18

$75M

= $50M stock value + $25M synergy value

Question 19

Suppose firm A has value $200M. Firm B has value $50 M. Merging them creates $25M in value (from cost savings). If A pays $65M to acquire B,

what are A’s gains?

Answer 19

$10M gain

=$25M synergy value - $15M B’s gains

Question 20

Suppose firm A has value $200M. Firm B has value $50 M. Merging them creates $25M in value (from cost savings). If A pays $65M to acquire B,

what are B’s gains?

Answer 20

$15M gain

= $65 cash - $50M value of B

Question 21

If the market already anticipated the possibility of a merger with B, is PV(B) still equal to B’s share price times shares outstanding?

Answer 21

• Willing to pay more than standalone value if info leaked

Question 22

What is the key difference b/w stock and cash purchases?

Answer 22

• Cash purchases: target’s gains are unaffected by the value of the synergy (value of the synergy only affects the acquirer’s gains)
• Stock purchases: gains from synergy are shared by both firms’ investors (mitigates danger of the acquirer overestimating the value of the synergy)

Question 23

What are three bad reasons for merging?

Answer 23

1) Empire building (management can manage larger co. which means more $$$)
2) Diversification (if S/Hs wanted a diversified portfolio, they can do it themselves for cheaper)
3) Increasing firm’s EPS (if firm has high P/E, it can raise its EPS by acquiring firms with lower P/E, even if there are no synergies)

Question 24

What are two common takeover defenses target firms use?

Answer 24

1) Poison pill

2) Golden parachute

Question 25

Expand on the following takeover defense:

Poison pill

Answer 25

• If one S/H obtains a certain % of co. stock (e.g. 25%), all the other S/Hs can buy shares at a discount

Question 26

Expand on the following takeover defense:

Golden parachute

Answer 26

• Management gets large payoff if firm is acquired