M&A Flashcards
When would a M&A make sense?
When synergies can be recognized
Given two firms, A and B, the economic gain from a merger is given by what equation?
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
If economic gain from a merger is negative, is there value added by merging?
No (only way investors could benefit from merger is if you acquire other firm by paying less than the other co. stand alone value)
If economic gain from a merger is positive, is there value added by merging?
Yes
What are four possible sources of synergies in M&As?
1) Economies of scale
2) Economies of vertical integration
3) Eliminating inefficient management
4) Industry consolidation
Expand on the following possible synergy in an M&A:
Economies of scale
- 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
Expand on the following possible synergy in an M&A:
Economies of vertical integration
- Merge with a supplier or a customer
- Facilitates coordination and administration
Expand on the following possible synergy in an M&A:
Eliminating inefficient management
- If a co. is poorly managed, a co. with better management can acquire it and run it more efficiently
Expand on the following possible synergy in an M&A:
Industry consolidation
- 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
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?
- 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)]
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?
- If you pay more than firm B’s standalone value (say $2 million more), then firm B’s investors gain $2 million from merger
In general, the acquirer’s (Firm A’s) gain from a cash acquisition of Firm B is given by what equation?
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)
How much should you be willing to pay to acquire firm B?
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)]
Is your gain positive or negative if Cash < (Total Gain + PV(B))
Positive
- hence you should be willing to pay up to
total gain + PV(B)
How do we estimate the “PV(B)” portion in Total Gain + PV(B) if Firm B is a publicly traded firm?
- 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)
How do we estimate the “Total Gain” portion in Total Gain + PV(B) if Firm B is a publicly traded firm?
- 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
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.
$25M
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
$75M
= $50M stock value + $25M synergy value
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?
$10M gain
=$25M synergy value - $15M B’s gains
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?
$15M gain
= $65 cash - $50M value of B
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?
- Willing to pay more than standalone value if info leaked
What is the key difference b/w stock and cash purchases?
- 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)
What are three bad reasons for merging?
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)
What are two common takeover defenses target firms use?
1) Poison pill
2) Golden parachute
Expand on the following takeover defense:
Poison pill
- If one S/H obtains a certain % of co. stock (e.g. 25%), all the other S/Hs can buy shares at a discount
Expand on the following takeover defense:
Golden parachute
- Management gets large payoff if firm is acquired
