Mergers and Acquisition Flashcards
First merger movement 1895-1904 characteristics:
Surge in economy and stock market
Changes in infrastructure
Merged for economies of scale and monopolies
Second merger movement 1922-1929 characteristics:
Surge in economy
Heightened regulation against horizontal mergers
Product-extension, market-extension and vertical-mergers
Conglomerate mergers of the 1960s characteristics:
Surge in economy
Decline in Importance of vertical and horizontal mergers
Defensive diversification to avoid profit instability
E.g. Aerospace industry and its changing market demand
The deal decade (1981-89)’s characteristics:
Surge in economy
Impact of international competition + new industries due to technology
Mostly hostile, paid in cash and financed with debt
Strategic mergers (1992-2000) characteristics:
Surge in economy + globalisation and deregulation of industries
Mosty friendly takeovers, paid with stock
The permacrisis (20th century) characteristics:
Mergers have taken place a lot during this period, apart from dips during financial crisis and covid
What are the common key drivers of merger movements?
- Government (De)regulations
- Technical/financial innovations
- Rising stock prices
- Favourable economic setting - low interest rates, favourable term structures etc
Why do mergers occur?
- Size and returns to scale (economies of scale)
- Transaction costs
Turning points of the first merger movement?
1901 - downturn because some combinations failed to make money
1903 - economy went into recession
1904 - supreme court ruled that mergers can be attacked by Sherman Act
What was a turning point of the 1920 merger movement?
1929 - stock market crash
What was a turning point of the 1960s merger movement?
1968 - Antitrust laws - congress began to move against conglomerate firms
- Declining stock prices
What were the turning points of the 1981-89 merger movement?
- Government actions - passing FIRREA in 89
- Implementation of takeover defences
- Economic recession associated with Gulf War
What was a turning point of the 1992-2000 mergers movement?
Dot.com bubble
What are some of value reducing theories? (3 things)
FCF - firms with FCF are those where internal funds exceed investment required for positive NPV projects
Managerial entrenchment - managers hesistant to distribute cash to shareholders
Value neutral theory - bids result from managerial overconfidence: winner’s curse
What are some valuation increasing effects? (3 things)
Synergy and scale
Transaction costs optimisation
Disciplinary (replacing poor management)
What is the value neutral principle? (valuation effect)
Over-confident
Winner of takeover is the firm that most overvalues
What are the different ways of measuring whether an M&A has been successful?
Weak form: if the stock price after M&A announcement is larger than stock price before
Semi-strong form: if the announcement-period stock return for acquiring firm is higher than the announcement-period stock return on a benchmark
Strong form: if announcement-period for the acquiring firm is higher than the return of the same firm would have been without M&A announcement
What are the 4 methodologies to test M&A performance?
Survey analysis - asking managers directly (good because insights, bad because different focuses)
Clinical study - analyse a transaction in great depth (good because in-depth analysis, bad because results not generalisable)
Accounting study - examine financial results before and after M&A (good because credibile, bad because backward-looking and data may not be comparable)
Event study - examine stock price responses to financial decisions = from similar firms and their similar announcements (good because direct measure of shareholder wealth impact, bad because relies on strong assumptions about the stock market **semi-strong form efficient)
How to carry out an event study:
- Identify event (stock split, dividend initations, stock repurchases)
- Calculate normal stocks returns using a benchmark model
- Calculate and analyse the abnormal returns around the event date
What is the target’s stock price reactions?
- Almost always experiences gain in wealth (from merger effects not from revaluation)
- Cash deals bring about more wealth
- Target share prices have a positive run-up in period prior to takeover announcement
What is the bidder’s stock price reactions?
- Neutral to negative (more negative in cash than stock)
- Lower in deals with multiple bidders
What is the asset sales method of restructuring?
Sale of division or other assets to another firm, usually for cash
- Quaker sold Snapple in 1997
What is an equity carve-out as a method of restructuring?
Public offering of full or partial interest in subsidiary creating a new firm with atl least some autonomy
What is a spin-off as a form of corporate restructuring?
Proportionate distribution of subsidiary shares to the existing shareholders of the parent firm, creating an independent firm
What is “splitting-up” as a method of corporate restructuring?
Separating of two firms, often via spin-off
What is tracking stock as a method of corporate restructuring?
Creation of new class of stock with value based on cash flows of a division
(used in high growth divisions during dotcom era)
What is an exchange offer as a method of corporate restructuring?
Distribution giving shareholders choice between the parent and subsidiary stock - creating a separate firms
What is are some examples of a restructuring method being used in tandem?
Equity carve-out before sale of remaining interest to another firm
Split-ups employ a variety of methods, usually spinoffs
Tracking stock may be the first step of a spinoff or exchange offer
What are some possible motives for restructuring?
Increase transparency and monitoring
To remain competitive and correct mistakes
Corporate focus
What does the Modigliani-Miller theorem of irrelevance state?
If there are no transaction or information costs, corporate organisation is irrelevant - value is determined by assets rather than finanical doctoring
Managers cannot improve value by chopping the firm into pieces - market cannot be fooled
Theory guides that information and transaction costs are possible sources of shareholder value creation
How does the incentive of the strucutre of the firm and monitoring of teams create shareholder value?
(Monitoring of inputs by shareholders)
Divestiture may improve managerial incentives and improve monitoring by the market
How does informational asymmetrics create value? (equity carveout example)
(Managers know more than shareholders)
Equity carve out indicates that company has chosen to raise cash by not issuing its own shares - signal of undervaluation
How do transaction costs create value?
Divestiture is a response of internal organisation being higher than contracting through the market (making rather than buying things)
What is divestiture?
Action of selling off subsidiary investments or interests
What are some of the empirical findings on corporate restructuring?
Larger the divestiture, larger the announcement return
Positive returns to both buyer and seller indiciate that assets are being deployed efficiently
What is a Joint Venture?
A combination of assets from two or more parent firms placed into a separate business entity
E.g. R&D or joint production of one product (Toyota - Mazda 2018)
What are some motives of joint ventures?
Risk reduction
Expansion of activities with smaller required investment
International aspects
What are some reasons that Joint Ventures fail?
Technology never developed
Inadequate pre-planning
Disagreement over basic objectives
Managers refuse to share their expertise with their counterparts of the firm
What are some requirements for success for joitn ventures?
Preplanning
Agreement should be flexible
Participants both need to add value
Key executives should be involved in the implementation
What is a strategic alliance?
A formal or informal agreement between two or more firms to cooperate in some way
E.g. Uber and Spotify (you can play Spotify as you get driven around)
What are some reasons that strategic alliances succeed?
Defined strategic objectives
Good communication
Positive incentives to overcome tension
Involvement from high-level management
What are the characteristics of acquisitions:
Rapid augmentation of firm capabilities
Consequences are long lasting
Often costly due to takeover premium
Challenges of combining organisations
Summarise joint ventures:
Reduce relative size of investment and risks
Creates new entities and relationships
Develop learning and new opportunities
Summarise why strategic alliances happen:
Broaden range of potential opportunities
Relationships are more ambiguous
Greater need for communication
What is Minority Equity Investment?
Type of equity funding where the investor takes a non-controlling position in the company (between 1 and 49%)
E.g. Microsoft investing in Dell (2013)
What is the rationale for an investor during a minority equity investment?
Can yield high returns and substantial long term benefits
Information source about growth opportunities
Identification of new managerial talent
Expand markets for investor’s products
What is the rationale for a recipient during a minority equity investment?
Gain knowledge from investing firm
Increases financing resources
Brings visibility
What is a licensing agreement?
Where a licensee reaches an agreement to use the knowledge or process of a licensor for a fee
E.g. Disney
Method of expanding market for a firm’s product
High immediate returns for licensor, but could create a future competitor
What is co-branding? What is its purpose?
Using 2 names on the same product
Combines market strength, brand awareness, positive associations, and cachet of two or more brands to get consumers to pay more for them
E.g. Apple and Nike making Nike+
What is franchising?
A contract between a franchisor and franchisee that allows the franchisee to use name, brand etc within a specific area
Reduces monitoring costs - because franchisee returns are tied to performance
What are some of the risks of franchising?
Franchisee may not conform to standards
Franchisee may prefer to use different vendors
Disagreements with respect to size of franchisee’s exclusive area
What is the valuation rule 1?
Think like an investor
- Time = money
- Opportunity cost (what are the alternatives?)
- Private information main source of advantage
- Focus on cash flow, not earnings
What is the valuation rule 2?
Intrinsic value is unobservable
- Results of valuations are estimates and measured with error
What is valuation rule 3? (Rule for creating value)
If Price < Intrinsic Value, there is opportunity
Buyers view: Intrinsic value of target to buyer > price
Sellers view: Intrinsic value of target to seller < price
What is the accounting book value?
Book value of company stated on the balance sheet
(good because based on reliable information, bad because ignores intangibles and is backward looking)
What is the liquidation value?
Sum of values that might be realised if the firm is liquidated today (good because conservative, bad because ignores “going concern” and is hard to determine)
What is the “replacement value”?
Cost to replace the assets of the firm today (good because gives valuable insights in high-inflation setting, bad because it is often unclear what needs to be replaced and is highly subjective)
What is the “market value”?
Sum of market values of equity and debt (good because it reflects what is public known about a firm, bad because markets are efficient and securities are actively traded)
What is the “trading multiples of peer firms” method?
Estimating value of a firm by using multiple ratios of peer firms to the target (P/E, EV/EBIDTA) (good because widely used, bad because not always comparable depending on accounting standards)
What is the DCF method?
DCF = Present value of future cash flows, using an estimated cost of capital (If NPV > 0 = if DCF value - price > 0) (good because captures important notions, bad because there is a risk of “analysis paralysis”
What is valuation rule number 5, exercise estimators?
Analysts should ‘exercise’ the estimators to define
- Reasonable range of value
- Identify key value drivers or assumptions
What is valuation rule 6? Think critically, triangulate carefully
If done right, valuation yields large number of value estimates
Different steps in valuation:
- Scrutinise data and estimators
- Scrutinise spreadsheet model
- Eliminate estimates in which you have little confidence
What is synergy?
When the whole is larger than the sum (2+2=5)
There are many synergy opportunities but they are often poorly defined and remain unrealised
Why is synergy assessment important? (4 reasons)
Crucial for value creation
Helps predict investor reaction to deal announcements (If Price < Vtarget,stand alone + Vsynergies: ARbuyer > 0
If Price = Vtarget,stand alone + Vsynergies: ARbuyer = 0
If Price > Vtarget,stand alone + Vsynergies: ARbuyer <0)
Helps analysts to disclose synergies to investor community
Foundation of post-merger information
Why is it so difficult to create synergies?
- Stock prices of buyer and target already reflect anticipation of improvement in stand-alone value
- They are not free
- Competitors might easily replicate the benefits from the deal
- Demands of integration can divert attention away from competitors company more likely to be under attack
What 2 components do synergies consist of?
Vsynergies = Vsynergies in place + Vreal option synergies
What is the synergies in place formula?
Same as DCF
What are some types of synergies in place?
Revenue enhancement (cross-selling, critical mass, bundling)
Cost reduction synergies (arise from economies of scale)
Asset reduction (disposal of idle assets)
Tax reduction
Financial synergies
What are some real option synergies?
Dependent on a real event to produce a payoff
E.g. Growth option synergies (R&D), Exit option synergies (arises from increased flexibility in altering investment strategies)
What are some rules of thumb for investing in synergy valuation?
- Establish credibility of synergy source
- Everything used is after tax
- Use a terminal value to reflect extended synergy life (terminal value formula attached)
What is short selling?
Selling of a security that the seller doesn’t own or is borrowed by the seller
Short sellers assume they are going to be able to buy the stock at a lower price than the price at which they sold the short
Advanced trading strategy, with many unique risks
What are the 2 reasons that short selling is carried out?
Hedging - adopting a short position to offset the long position
Speculation
What does short interest mean?
Total number of shares of a security that have been sold short
What does short covering mean?
Purchasing securities in order to close an open short position -> done by buying the same type and number of securities that were sold short
What is a short squeeze?
Lack of supply/Excess demand for a traded stock forces price upward
What are some cons of short selling?
Not popular on Wall St
Considered to be unethical (“UnAmerican”)
European countries banned short selling
“Short and distort” - short a stock then spread rumours about it so the price falls (illegal)
What are some pros of short selling?
Provides liquidity
Identifies overvalued stocks
Makes markets more efficient
“Blaming short sellers for a drop in the price is like blaming a thermometer for a drop in the temperature”
What are the characteristics of merger arbitrage?
Involves the purchase of stock right after the merger announcement
Allows for merger arbitrageurs to:
- Evaluate deal spread
- Estimate probability of deal failure
- If the spread is big enough (purchase shares in target firm, short acquiring stock)
What is the formula for market expectation of deal failure?
What determines an arbitrageur’s interest in a deal?
Time estimated to complete the deal (longer it is, the less likely it is to be completed)
Hostility of the deal (more hostile, less likely to complete)
Any factor that affects the ease of short selling the acquirer’s shares in an equity swap:
- Percentage of institutional ownership (+)
- Liquidity (+)
- Whether the acquirer pays dividends (-)
Why are payments including securities more complex?
Security may not be publicly traded
Considerable market risk, it is difficult to hedge
Why are transactions where investors have a choice of payment difficult?
The arbitrageur must accurately forecast other investors’ election decision (difficult to do)
High market risk - if the arbitrageur miscalculates investors’ decisions, they may be unhedged
What is a floating exchange ratio?
Determined by stock prices during specified period before merger close
Hedge - buy target stock at announcement and short buyer during pricing period (“late hedge”)
Why does merger arbitraguer = selling insurance?
Target shareholders can hold on to shares until the deal is completed, but may lose if the deal fails
Merger arbitrageurs provide liquidity that target shareholders demand to avoid blow-up risk
Why do merger arbitrageurs diversify their portfolios?
Because a failure in one M&A deal is usually idiosyncratic and uncorrelated with the general market
Risk/return in context of CAPM: assuming efficient markets, return to portfolio should be equivalent to the risk free rate
What causes Merger Arbitrage excess returns?
Large abnormal returns to merger arbitrage may suggest stock market is not very efficient at pricing mergers
Arbitrageurs are risk averse: must be compensated for bearing idiosyncratic risk - excess returns represents the risk premium
What are the explanations for acquirer’s negative stock price reaction on announcement of a merger?
Negative NPV merger
Signal of diminishing stand-alone growth opportunities for the acquirer
Signal that the stock was previously overvalued
Selling pressure on the acquirer stocks due to hedging the deal spread by merger arbitrageurs
What do arbitrageurs do during the takeover process?
Are active
- Act quickly at announcement
- Build positions over time
- Constantly monitor the deal
What do arbitrageurs do regarding the overall portfolio?
- Don’t invest all funds in one deal
- Diversify failure risk by investing in many deals - may limit the amount invested in single deal or type of deal
What is a horizontal merger?
Between firms in the same industry
What’s the rational of horizontal mergers?
Economies of scale and scope
Create Synergies
Whats a vertical merger?
Combinations of firms at different stages like along the supply chain
What is the rationale behind vertical mergers?
Improve info
Lower transaction costs
Reduce the lock-up problem
What is a conglomerate merger?
Firms in unrelated business activities
What is the rationale for conglomerate mergers?
Diversification
“Good managers can manage anything”
What is a mission or vision?
Strategy with a definition
What is the objective of strategic planning?
Fulfilling the mission
What are some tactics of strategic planning?
Cooperate with other firms
Expand firm through organic/inorganic growth
Divest segments of the firm
What are the analytical tools for planning?
SWOT - strength weakness opportunities threats
BCG experience curve - cost per unit declines as production increases
BCG product life cycle concept - development, growth, maturity, decline
What were the innovations of 92-2000 period?
Venture capitalists
Stock options
Share repurchases - sign of future growth
Roll-up mergers - buying everything in industry
What were the innovations of the 81-89 period/
High yield bonds (no junk bonds)
Leveraged buyouts
Bust up acquistiions - divesting parts of the bought firm
What was the innovation of the 20’s period?
Vertical mergers
What was the innovation of the 60’s?
Conglomerate mergers
What is management theory?
A good manager can manage anything - risen in 60s
What is the impact of CEO narcicissm?
Stock prices negatively affected by degree of narcicism
What is a rundown of merger target run-ups?
Drastically decreased - could be due to insider trading regulation
What is the impact of CSR?
Bidders with best CSR have best stock price reaction
