Mergers & Acqusitions

Question 1

What are some of the Reasons to Merge?

Answer 1

Managers should focus on synergies (increases in value and/or economic efficiency that result when firms merge together)

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

• PV (AB) is value of the combined firm
• PV (A) is the value of Firm A
• PV (B) is the value of Firm B
• If economic gain from merger is negative, no value added; only way investors benefit is if you acquire the other firm by paying less than other company’s stand alone value.

Question 2

What are the possible sources of Synergies?

Answer 2

1. ) Economies of Scale- large company can operate more efficiently than 2 smaller ones
2. ) Vertical Integration - merge with supplier or customer; facilitates coordination and administration
3. ) Eliminating Inefficient Management
4. ) Industry Consolidation- overcrowded industries can shrink; remaining firms can return to profitability; allows firms to increase market power and profitability

Question 3

Firm A acquires B for standalone value; how much does A investors gain?

Answer 3

Investors from Firm A pocket all the gain = PV(AB) - [PV (A) + PV (B)]

Question 4

What is the acquirer’s gain from cash acquisition? (equation)

Answer 4

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 5

How much should you be willing to pay for Firm B?

Answer 5

Any amount that makes your gain greater than 0.

= Total Gain - [Cash - PV(B)]
Gain is positive if Cash < Total Gain + PV(B); hence should be willing to pay up to Total Gain + PV (B)

Question 6

How do you estimate PV (B) ?

Answer 6

Can look at its market price to estimate PV (B); but if market is aware of possibility of merger, market cap will be greater than PV (B)

Question 7

How do you estimate Total Gain?

Answer 7

Zero in on synergy; if combining firms could cut costs by $25M (in PV) and if revenues are unaffected, total gain is 25M

Question 8

What do we mean by PV (B) ?

Answer 8

Intrinsic Value of the firm as a stand-alone entity

Question 9

What is the difference between Stock and Cash Purchases?

Answer 9

Cash purchases, target’s gains are unaffected by value of synergy; with stock purchases gains from synergy are shared by both firms

Question 10

Are Acquirer’s stock returns higher when they announce a cash or stock-based acqusition?

Answer 10

Cash… 1.5% versus 0.4% for stock .

Question 11

What are some bad reasons for merging?

Answer 11

1. ) Empire Building
2. ) Diversification-
3. ) Increasing Firm’s EPS - firm has high P/E, it can raise its EPS by acquiring firms with lower P/E’s even if there are no synergies; however investors are not necessarily better off just because EPS increases.

Question 12

What are some common takeover defeneses?

Answer 12

1. ) Poison Pill - one S/H obtains a certain percentage of company’s stock, all the other shareholders can buy shares at a discount
2. ) Golden Parachute- management gets large payoff if firm is acquired.