M&A Videos

Question 1

Remember…

Answer 1

In an all-cash deal, the buyer bears all the risk, as the buyer just walks away with a bag of cash! In a stock-for-stock deal, the risk is shared. In a cash-and-stock deal, the risk is also shared, but to a lesser extent compared to a full stock deal!
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This also means that, in an all-cash deal, the buyer has all the upside potential, but also has almost no downside protection. In a stock-for-stock deal, the risk is shared, which means that part of the upside is shared, but also part of the downside (which serves as protection)

Question 2

What does the term ‘wealth transfer’ try to capture?

Answer 2

The term ‘wealth transfer’ tries to capture what will happen if the deal is a zero-sum game. So it does not create value nor destroy value. This means that there are no synergies, and wealth will be transferred from the buyer shareholders to the target shareholders.

Question 3

Give the formula for the buyer’s expected gain in an all-cash deal

Answer 3

Buyer’s expected gain = E(synergies) –total value of premium
Total value of premium = # target S/O * (offer price –current share price)

Question 4

Give the formula for the premium paid in a stock-for-stock deal

Answer 4

1. Calculate stock price post deal of the combined entity = (Vb + Vt + S) / (Nbpost + Ntpost)
2. Calculate the MV of the target shareholders’ ownership post deal
3. Calculate increase in MV of the target shareholders’ ownership relative to standalone value
4. Calculate the target shareholder gain per share using Ntpre
5. Calculate the implied premium

Question 5

Give the formula for wealth transfer in a stock-for-stock deal

Answer 5

%T * (Vb + Vt) – Vt

Question 6

Give the formula for target downside protection and buyer break-even synergies in a stock-for-stock deal

Answer 6

Downside protection: %T * (Vb + Vt + S) = Vt, and solve for S
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Break-even synergies: %B * (Vb + Vt + S) = Vb, and solve for S

Question 7

Give the formula for the market consensus estimate of synergies in a stock-for-stock deal

Answer 7

∆Fundamental value buyer = –Wealth transfer + (a * S)
∆Fundamental value target = Wealth transfer + ((1-a) * S)
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S = ∆Fundamental value buyer + ∆Fundamental value target
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Here we can see that the change in fundamental value depends on 2 factors:
1. the wealth transfer
2. the expected benefit of synergies

Question 8

Are the wealth transfer and downside protection higher or lower in a cash-and-stock deal compared to an all-stock deal? Why is that?

Answer 8

In a cash-and-stock deal, the wealth transfer is higher and the downside protection is lower (i.e., more negative so higher protection) compared to a stock-for-stock deal. This is partly because part of the consideration is paid out in cash immediately and bears no risk. The level in uncertainty related to the payoff is lower.

Question 9

In a cash-and-stock deal, how do you calculate the premium?

Answer 9

1. Calculate stock price post deal of the combined entity = (Vb + Vt + S – Cash) / (Nbpost + Ntpost)
2. Calculate the MV of the target shareholders’ ownership post deal (includes cash)
3. Calculate increase in MV of the target shareholders’ ownership relative to standalone value
4. Calculate the target shareholder gain per share using Ntpre
5. Calculate the implied premium

Question 10

In a cash-and-stock deal, give the formula for wealth transfer

Answer 10

%T * (Vb + Vt – Cash) + Cash - Vt

Question 11

In a cash-and-stock deal, give the formula for downside protection and break-even synergies

Answer 11

Wealth transfer: %T * (Vb + Vt + S – Cash) + Cash = Vt and solve for S
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Break-even synergies: %B * (Vb + Vt + S – Cash) = Vb and solve for S

Question 12

What is the effect of a toehold in a transaction?

Answer 12

1. Toeholds reduce the cost of the acquisition for the buyer, as you don’t have to pay a premium for the shares you already own > this reduces the total premium you have to pay!!!!
2. They allow the bidder’s to make a profit in case of losing to a higher bidder.

Question 13

In a toehold transaction, how do you calculate the premium paid?

Answer 13

1. Total value received by target: %T * (Vb + Vt + S –Cash – toehold value) + Cash
   %T = adjusted of for the # shares that need to be issued
   Cash = adjusted for the # shares the buyer already
   toehold value = # shares the buyer owns * share price target
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2. Total premium paid: total value received by target - pre-acq. MV of target shares not owned by the buyer
   pre-acq. MV of target shares not owned by the buyer = share price target * (target S/O - shares owned by buyer)

Question 14

What is the arbitrage gap? And what does it signal?

Answer 14

Arbitrage gap: the difference between the post-announcement market price of the target and its theoretical value (based on deal terms). Usually, target’s post-announcement market price < Theoretical price. This reveals arbitrageurs assessment of deal completion probability. The higher the arbitrage gap, the higher the event risk – i.e., the risk that the deal may not go through. Event risk can be due to concerns regarding obtaining regulatory approval, challenges to the deal by dissident directors or dissident shareholders.

Question 15

How do you calculate the arbitrage gap?

Answer 15

1. Theoretical post-ann. share price target = (cash per share * (exchange ratio * share price buyer post ann.)
2. Arbitrage gap = actual price – theoretical price
   Or in %: arbitrage gap / theoretical price

Question 16

Explain what the arbitrage gap can imply about the implied synergies and deal success probability

Answer 16

1. Calculate the wealth transfer = %T * (Vb + Vt – Cash) + Cash - Vt
2. Use:
   ∆Fundamental value buyer = –Wealth transfer + (a * S);
   ∆Fundamental value target = Wealth transfer + ((1-a) * S)
   to back out implied S for the buyer and target
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   Large arbitrage gaps are reflective of significant disparities in the estimate of S from the buyer and the target shareholders’ perspective > greater event risk (i.e., the likelihood of deal not being completed).

Question 17

What does accretion/dilution analysis measure?

Answer 17

Accretion/dilution analysis measures the effects of a transaction on a potential acquirer’s earnings in the years immediately following the transaction (assuming a given financing structure) > compare the acquirer’s expected stand-alone EPS to the expected post-transaction EPS.

Question 18

Explain why EPS accretion/dilution is not a good measure of value creation

Answer 18

EPS accretion or dilution is not an indicator of the value creation from a deal (NPV) > the measure only captures the impact of deal on the bidder’s (immediate) EPS. Not all accretive deals are good; neither are all dilutive deals bad.
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- Accretive bad deals: acquisition of low P/E targets for a low premium. Assuming that the target was fairly valued (prior to the acquisition) such deals may destroy value in the long-run although the EPS may go up in the short-run.
- Dilutive good deals: acquisition of high P/E targets for a high premium. As long as the target was fairly valued (prior to the deal) and its P/E was high for a good reason; such deals pay off in the long-run although they reduce EPS in the short-run.

Question 19

Remember…

Answer 19

Sometimes, the EPS of the combined company can be higher than the standalone EPS of the buyer, the EPS will be growing at a lower rate (i.e., it will have a lower multiple in the combined entity). Focusing on EPS accretion or dilution can be misleading. So if you just look at EPS, you would be missing that the post-deal entity can have a different growth rate than the standalone firm.
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So the question is, should the buyer go for the deal which will lead to higher EPS but lower growth, or skip the deal which will lead to lower EPS but a higher growth rate.

Question 20

What are the key drivers of EPS accretion/dilution?

Answer 20

1. Purchase price
2. Acquirer and target projected earnings
3. Synergies (and how quickly they may be realised)
4. Form of financing: if you finance a deal with 100% cash / partly cash and partly equity / 100% equity, this will have an effect on whether the deal is accretive or dilutive. Therefore, a buyer’s management will structure the deal in such a way that it is accretive instead of dilutive. Cash can also be raised by the acquirer via a debt issue, which will then have implications for the financing costs.

Question 21

How do you calculate if the deal has a positive/negative NPV?

Answer 21

1. Calculate the P/E ratio = (Vb + Vt + S) / combined net income.
2. Calculate the EPS of the combined entity, using the combined net income and the # S/O in the deal
3. Calculate the implied share price by multiplying P/E ratio with the EPS.
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   If the implied price is lower than the pre-ann. share price, the deal has a negative NPV. Otherwise it has a positive NPV.

Question 22

Why are studies on stock deals on short-run performance of buyers problematic?

Answer 22

Inference based on short-run CARs is problematic, especially for deals financed with stock. This is due to merger-arbitrageurs, and a revaluation of the bidder’s stock due to the possibility of overvaluation. Therefore, it might be better to focus on long-run performance.
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Also, you assume that the market is (semi-strong) efficient in pricing in the deal terms in a short period of time. This might not always be the case.

Question 23

Name the methods for studying buyer’s outcome from M&A. What is the problem with the least popular ones?

Answer 23

1. Accounting-based measure (most popular)
2. Market-based measure
3. Surveys of managers
4. Case studies (least popular)
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   Although surveys and case studies are most likely to capture the managerial deal rationale, they’re not generalisable!

Question 24

What are the concerns with accounting based measures?

Answer 24

1. They only capture the immediate impact of the deal, it basically is a snapshot
2. There is no perfect benchmark
3. Changes in ROE/ROA may not always be appropriate
4. Synergies may not be realised immediately
5. Scope for earnings management
6. Lack of causality > there could be other factors affecting the business. Moreover, using industry non-acq. peers only goes to remove industry-specific confounding effects that may affect performance but not firm-specific ones.
7. Survivorship bias > bias the results upwards

Question 25

What is an advantage of using BHARs?

Answer 25

They allow for the fact that markets may not be able to price in all the implications of a deal into the stock price in a short time window.
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Note: by using BHARs, you are also assuming the market is right in assessing deals

Question 26

What are the concerns of using BHARs?

Answer 26

1. Causal attribution of performance to a specific deal is not possible > comparing BHARs of acquiring firms with those of non-acq. firms only goes to remove industry-specific shocks that may affect performance but not firm-specific ones.
2. Survivorship bias
3. Cannot be used for privately-held acquirers
4. BHAR often misspecified due to skewness > portfolios exhibit positive skewness, whereas single stocks exhibit normal distribution. This biases the BHAR downwards

Question 27

What is an advantage of CARs?

Answer 27

Possible to causally attribute CARs around deal announcements

Question 28

What are the concerns of using CARs?

Answer 28

1. Heavily relies on assumption that markets are (semi-strong) efficient
2. Only captures the unanticipated portion of the total economic effects when looking at [-5:+5] > it misses the little run-up before. So should you extend the time window?
   - YES: if the run-up is incorporating the premium that will be paid.
   - NO: if it reflects a revaluation of the bidder due to possible overvaluation of equity
3. Inferences regarding acquirer announcement returns could be problematic when deal payment is in the form of stock.
4. Cannot be used for privately held acquirers.

Question 29

What are 2 reasons that CARs are popular?

Answer 29

1. Greater scope for causal attribution of wealth effects to the deal.
2. Although noisy and imperfect, they are unbiased (do not systematically over/underestimate the value creation from the deal)

Question 30

Short-run event studies on acquirer announcement CAR incorporates:

Answer 30

1. Changes in standalone value due to possible overvaluation of equity
2. Potential gains/losses from the deal
3. Short-selling merger arbitrageurs

Question 31

Do smaller firms have higher CARs? Why? (short-run event studies)

Answer 31

Smaller acquirers have higher CARs, due to:
1. deals made by larger firms have smaller synergy gains
2. larger firms are more likely to overpay due to managerial hubris
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Larger bidders may even have negative CARs, which signals that they engage in value destroying deals

Question 32

Acquisition of public targets with stock tend to result in negative ARs for acquirers. But for private targets, the acquirer tends to gain, independent of financing structure. Why is that? (short-run event studies)

Answer 32

1. If paid with stock, the market updates the probability of overvaluation
2. Price pressure from arbitrageurs if paid with stock
3. Larger deals involving larger acquirers tend to be financed with stock

Question 33

For stock mergers, on announcement date, there’s a significant negative CAR for the acquirer. But we see a positive CAR on the closing date. Why is that? (short-run event studies)

Answer 33

This shows that part of the downward pressure is from short-sellers who sell short the stock on the announcement date and buy back the shares on the closing date. So the economic effect of the deal is distorted by these short sellers, and the wealth effects are biased downwards!

Question 34

The acquisition of privately held targets result in significant positive ARs for the bidder, due to? (short-run event studies)

Answer 34

1. Higher bargaining power of the acquirer due to the fact that private targets tend to be smaller and more capital constrained.
2. Private targets have an illiquidity discount
3. There’s less information available on these private firms

Question 35

Note on long-run event studies:

Answer 35

When looking at the performance of acquirers who make a deal, the average 3Y return is -13%. But if you compare this to a group of acquirers whose mergers ultimately failed, this is -44%. So it seems that mergers do create value!
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This is for stock deals, no effect was found for cash deals.

Question 36

How can you assess the overall deal gains from a merger?

Answer 36

It is the value weighted CAR, where the weights are the pre-ann. MV of equity, adjusted for toeholds. If this is positive, there is value creation beyond the reshuffling of wealth. But, any value created might be coming at the cost of other stakeholders!