Mergers And Acquisitions Flashcards
Corporate finance materials
What is an Acquisition
Buying part of another company (a segment) or its assets
What are two key points of a Merger
The acquirer absorbs an entire company.
The merged company will cease to exist in a statutory merger
What are the 3 forms of integration
Statutory merger
Subsidiary merger
Consolidation
How does A acquire B in a statutory merger
A + B = A
A absorbs all assets and liabilities of B,
B ceases to exist
How does A acquire B in a subsidiary merger
A+B= A(B)
B is a subsidiary of A
How does A acquire B in a consolidation
A+B=C
C is an entirely new company incorporating all the assets of A and B
What type of M&A is common for two companies of similar size
Consolidation
When do subsidiary mergers commonly occur
When a company wants to acquire a brand
What is a horizontal merger
When two companies in the same business segment merge
What is a vertical merger
When thec acquiring company seeks an additional position in its supply chain
What is forward integration
Give one example
Acquisition to move up the supply chain
A manufacturer acquires retail stores to sell its products
What is backward integration
Give an example
Acquirer moves down the supply chain
A anufacturervpurchases the supplier of some of its raw materials
What is a conglomerate merger
An acquisition of a target in a completely different segment with few synergies for the acquirer.
Give two reasons for horizontal mergers
Economies of scales Market share (power)
Give two reasons for forward integration
1 Greater control of distribution
2. Cost savings
Give two reasons for backward integration
- Control of procurement of a key resource
2. Cost savings
What two things do synergies usually result from?
- Cost savings (horizontal) by rationalising duplicated costs
- Increased revenues
What four reasons to justify M&A through external growth
- In mature industries organic growth is limited
- Achieving growth through M&A can be less risky than internal projects.
- Growth can be faster than developing internal project
- Increased market power
Give 3 ways M&A can increase revenues
- Cross selling
- Increased market share / reduced competition
- Increasing prices (reduced competition)
Give two reasons horizontal merger increase market power
- Greater market share / reduced competition
2. Stronger pricing power
Gice four reasons vertical mergers increase market power
- Control inputs
- Lock out competition for inputs
- Influence prices of inputs
- Reduce dependence on suppliers
Give three types of Merger
Horizontal
Vertical
Conglomerate
List 10 common motivations for M&A
- Synergies
- Growth
- Market power
- Unique capabilities
- Diversification
- Bootstrapping EPS
- Manager Benefits
- Tax benefits
- Unlocking hidden value
- International business goals
Give 5 examples of international business goals of M&A
- Market inefficiencies - e.g. where real cost of labour is lower
- Exploit more favourable government policies
- Use new technology in new markets
- Product differentiation
- Following clients - Support existing international clients
Describe the pioneer / development phase in 3 points.
- Unsure of consumer acceptance of product or service
- Large Capex for product development and production capacity
- Low but increasing revenues and profits
Give two merger motivations for pioneer/development stage
- Sell to mature firms in declining sector.
- Access to capital
- Pool management and resources - share management
Which types of merger are common in pioneer/development stage
- Horizontal
2. Conglomerate
Describe the rapid growth phase in 3 points.
- High profit margins
- Accelerating sales and earnings
- Low competition
Describe two M&A motivations for rapid growth
- Access to growth capital
2. Expand capacity
What merger types are common for rapid growth phase
- Conglomerate
2. Horizontal
Give two characteristics of mature growth phase
- New competition reduces margins
2. Opportunity for above average growth
Give three M&A motivations for mature growth phase companies
- Operational efficiencies
2. Synergies / Economies of scale
What type of Mergers are common for mature growth companies
- Horizontal
2. Vertical
Give two characteristics of stabilisation (Market mature) phase
- Competition reduces growth potential
2. Capacity constraints
Give two motivations for M&A in stabilization phase
- Economies of scale to match competitors costs etc.
- Improve management
- Increase financial base (e. g. bootstrap EPS)
What type of mergers are common during stabilization phase
Horizontal
Give two characteristics during the decline phase
- Consumer preferences shift
2. Overcapacity - shrinking profit margins
Give 3 motivations for M&A during Decline phase
- Survival
- Operational efficiency
- Growth through acquisition
Give 3 common M&A types for companies in the decline phase
- Horizontal
- Vertical
- Conglomerate
What do vertical mergers commonly achieve
- Improve efficiency / management
2. Improve margins
What do horizontal mergers commonly achieve
- Survival
2. Economies of scale
What do Conglomerate mergers often achieve
- Access to capital
2. Growth through acquisition
Give two forms of acquisition
- Stock purchase
2. Asset purchase
In a stock purchase acquisition who gets paid?
How are they paid?
- Shareholders
2. Acquirers stock and/or cash
What type of approval is required in a stock purchase acquisition?
Majority shareholder approval
What corporate tax is payable in a stock purchase acquisition
Neither acquirer nor Target pay tax
What tax is paid in a stock purchase acquisition
Shareholders of the Target pay capital gains tax
Who assumes the liabilities of a target in a stock acquisition
The acquiring company
Who gets paid in an asset purchase
The target company that sells the asset
What approval is required by shareholders in an asset purchase
No shareholder approval except in the case it is a large asset sale or divestment
Who pays tax in an asset purchase
Target company that sells the asset
What taxes do shareholders pay in an asset sale
None
What liabilities does an acquirer assue in an asset purchase
None
Explain the potential tax benefit for stock purchases over asset purchases
- For stock purchase accumulated Tax losses in a target is allowable for reduction of the acquirers tax liability.
- This is not the case for an asset purchase
What is an exchange ratio in a stock purchase
The the number of shares in the acquiring company for 1 share in the target.
What is a mixed offering?
The acquirer offers cash and shares to shareholders of the target company
Which three factors make up the total compensation paid in a securities offer for a target
- Exchange ratio (agreed in advance)
- Number of shares in the target company
- Share price of acquiring conpany on completion date.
What does a cash offer by an acquirer indicate
Confidence in the merger
What does a stock offer to target shareholders say about risk
The acquirer wants to share the risk of success of the merger with the target company shareholders
What does a stock offer to target shareholders say about risk
The acquirer wants to share the risk of success of the merger with the target company shareholders
What is an acquirer likely to do if it believes its stock is relatively over valued relative to a target company stock price.
Seek acquisition of the target
What signal may an acquisition for shares give to the market?
The acquirer believes its stock price is over valued
What is the potential tax benefit for a company acquiring a target
The acquirer can offset the targets accumulated Tax losses against the acquirers tax liabilities
What is more common acquisitions or asset purchases?
What is easiest to effect?
- Acquisitions are more common
2. Asset purchases are easier to effect than acquisitions.
What is the key payment difference between stock purchase and asset purchase
- Stock is purchased from target shareholders
2. Assets are purchased from Target company
What is the difference in approval for a Stock purchase and an asset purchase
- Target Shareholder approval is required for stock purchase
- Target shareholder approval is not usually required.
What is the difference in corporate tax between Stock purchase and Asset purchase
- No corporate tax for stock purchaser
2. Usual corporate capital gains tax for target company on asset sale
What is the difference in shareholder tax for stock purchase and asset purchase
- Target company shareholders pay capital gain tax on sale of their shares
- In an asset sale there are no tax consequences for target shareholders
What is the different treatment of target liabilities in a Stock purchase or Asset purchase
- A stock purchase assumes the liabilities of the target company
- In asset purchase acquirer is not usually liable for target company debts.
What is the effecr on the acquirers capital structure if debt is uses to acquire target
- Debt goes up.
- Leverage ratio goes up
- Risk goes up
May affect share price of acquirer
What is the effect on the acquirer if it raises equity through issuance of new shares
Existing shareholders of acquirer will suffer dilution
Give 8 steps in a friendly merger
- Acquirer approaches Target Management
- Merger discussions
- Due diligence from both sides
- Definitive merger agreement is signed
- Transaction is made public
- Shareholder approval may be sought
- Transaction is filed with SEC
- Consideration is paid to target shareholders
What is a bear hug
Acquirer approaches targets board of Directors because the Targets management is not receptive.
What is a tender offer, when is it made, to who
- If both Target Management and Board do not support offer.
2. Acquirer invites target shareholders to sell directly
Why do lawyers encourage pre-offer defences to be in place?
- US legal system embraces pre-offer defences but scrutinizes post offer defenses
Describe a proxy fight
- Acquirer approaches (proxy solicitation) target shareholders to vote in acquirer nominated board members.
- Proxy solicitation must be approved by regulators
Name 8 pre-offer defense mechanisms
- Poison pill
- Poison put
- Restrictive takeover laws
- Staggered board
- Restricted voting rights
- Supermajority voting for mergers
- Fair price amendment
- Golden parachute
Which two pre-offer defences combined means an acquirer could lose voting rights while increasing shares but have to reach a high majority
- Restricted voting rights.
2. Supermajority for merger.
Names two types of poison pill
“Flip in pill”
“Flip over pill”
Give 3 points describing a flip in pill
Is it pre or post offer
- Management and target shareholders have the right to buy shares in the Target at a discount
- Triggered when a shareholder exceeds an ownership threshold level
- Acquirers not allowed to purchase shares at discount so get diluted down
Pre-offer
Describe two points of a flip-over pill.
Is it pre or post offer
- Management and target shareholders have the right to buy shares in the Acquirer at a discount
- Causes dilution for Acquirers shareholders
- Acquires not allowed to purchase shares at discount so get diluted down.
Pre-offer
What is a dead-hand provision
- Provision in a poison pill
- Only allows “continuing directors” of the Target to vote
- Continuing directors probably pre-date a hostile offer
Describe 2 features of a poison put
Is it pre or post offer
- Right for Targets Debt holders to redeem above par
- This means the Acquirer needs to raise additional debt capital
Pre offer
Describe how state laws can be used in a pre-offer take over defence. Which two states typically give the most target protection
- Incorporate or reincorporate in a state with restrictive takeover laws
- Ohio and Pennsylvania
Describe 3 points of a “staggered board” defence
Is it pre or post offer
- Roughly 1/3rd of targets board is elected each year (3 year terms)
- In any one year the acquirer can only win over a minority.
- Likely takes 2-3 years to get a majority.
This is pre-offer
2.
3.
Pre-offer
Describe 2 points of restricted voting rights
Is it pre or post offer
- Restricts voting rights for recent purchases of large blocks of 15-20%
- Once triggered these shareholders cannot vote until the board releases them from the provision
Its pre-offer
Give 2 points for a super-majority for takeovers
Is this pre or post offer
- Company byelaws can include a provision for majority in excess simple majority
- The provision is triggered under a hostile takever attempt.
Pre-offer
Give 3 points describing “fair price amendments”
Is it pre or post offer
- A charter / byelaw that sets a floor on target shareholder price.
- Protects from temporary declines in share price of target
- Protects for “two tier tender offers”
Pre offer
Describe Golden parachute in two points
Is it pre or post offer
- Not usually an effective defense.
- Eases the management to accept an offer due to lucrative compensation agreements
Pre offer
Give 9 post-offer defence mechanisms
- Just say no
- Litigate
- Greenmail
- Share repurchase
- Leveraged recapitalisation
- Crown jewels
- Pac Man
- White Knight
- White squire
Explain “just say no” defence in 3 points.
- Management say no to an offer
- If it gets hostile management lobbies board to build a case of why it is not in shareholders interests.
- Target makes a piblic case to its shareholders.
3.
Explain “litigation defence” in 2 points.
- Typically file a suit alleging securities or anti trust violations
- Cases rarely succeed but by time for other post offer defences, such as white knight/squire, management buyout, target share repurchase
Explain Greenmail defense in 3 points
- Payoff to acquirer to go away
- Target repurchases shares held by the Acquirer at a premium.
- Acquirer usually must sign agreement not to make another hostile bid for some period.
- Changes in the US tax code mean acquirers pay 50% tax on profit from a Greenmail.
Explain how share repurchase can be post offer defence
- Target buys irs own shares from its shareholders
- Increases leverage but also increases share price - making it a less attractive target.
- Target can also be taken private through a management leveraged buyout
How does a “leveraged recapitalisation” deter a hostile bid
- Uses debt to buy some but not all target shares. Leaving the target still public.
- The dramatic change in capital structure deters hostile bid while Target company is buying shares.
Explain the “crown jewel” defence in 4 points
- Where an asset or subsidiary is of particular value to potential Acquirers.
- The Target agrees and announced to sell the asset or subsidiary to a third party.
- If the sale is initiated post a hostiel bid being opened it could be declared illegal by the courts.
- However the complication may buy time or still deter.
3.
Explain “pac man” defence in 3 points
- Target makes a counter offer to buy acquirer
- Rarely uses because Target is usually smaller than Bidder
- The strategy precludes other defences like the litigation defence.
Explain white knight defense in 3 points
- Target seeks an alternative bidder with a better strategic fit and or prepared to pay more.
- May start a bidding competition.
- Winning bidders have axtendancy to overpay - winners curse
Give 3 reasons for winners curse
- Intrinsic value is overestimated
- Emotion from management overcomes rationality
- Information asymmetrys
Explain white squire defense in 5 points
- Target seeks a friendly third party to buy a minority stake large enough to block a takeover.
- The shares may be purchased directly from the Target not the shareholders. e.g. preference shares.
- Stock exchange or local regulators may require shareholder approval.
- Shareholders may not approve because they do not benefit by selling their shares at a premium
- If shareholders do not approve of White Squire there are significant litigation risks
Why was market share replaced as a measure of market power?
Too simplistic and rigid in practice
Explain HHI in 4 points. Describe when a challenge will be 5. Certain 6. Possible 7. Unlikely
- Herfindahl-Hirschman Index
- The sum of the square of the market share of each company in the sector.
- Market share = (sales firm x)/(total sales of sector)
- HHI calculate pre and post merger
- Challenge if HHI pre= > 1800 and HHI post is increase of 50
- Possible challenge if HHI pre 1000 - 1800 and change HHI post is 100
- No challenge where HHI pre < 1000
Give 4 considerations in addition to HHI that are used to evaluate mergers
- Responsiveness of consumers to price changes
- Efficiency of companies in their industry
- Financial viability of a merger
- Ability of US company to compete in foreign markets
What are the 5 key points of the Williams Act
- Section 13 - public disclosure of purchase of 5% or more
Section 14:
- Tender offer process
- Tender offer period minimum 20 days
- Acquirer must accept all shares tendered
- Target management must have adequate time to respond to hostile tender offer
Give the six main steps for evaluating the value of a target
- Creation of Pro forma financials that reflect synergies and cost reductions due to merger
- Convert Pro forma to FCF target
- Discount Pro forma to PV using dr=(1+WACC)
- Calculate Terminal value(TV) = FCF (1+g) / (WACC +g)
- Apply dr to TV to give PV TV
- Add PV TV to 3 (PV Pro forma)
What are the 3 adjustments to NOPLAT to give FCF for a target
FCF=
NOPLAT
+ Dep note: FCFF uses NCC=Dep + Def tax
- change Net WC (WCInv) note: same as FCFF
- Capex (FCInv) note: same as FCFF
What are the 2 adjustments to Net Income to obtain NOPLAT
NOPLAT=
NI
+ NET INTEREST AFTER TAX, Int ( 1-T). Note: as FCFF, interest exp
+ change in deferred tax
What are the 5 adjustments to Net Income to get FCF target
FCF =
NI
+ NET INTEREST AFTER TAX Note: as FCFF, interest exp
+def Tax
=NOPLAT
+ Dep note: FCFF uses NCC=Dep + Def tax
- change Net WC (WCInv) note: same as FCFF
- Capex (FCInv) note: same as FCFF
What is the relative value method for calculating terminal Vue of a target
- TV = multiple x FCF
2. PV TV = TV discounted by dr for the number of years of the Pro forma
Outline 4 issues with DCF valuation of a target
- Early Negative cash flow means the model relies on future cashflows
- Future cashflows are successively more difficult to predict
- The model is sensitive to changes in the discount rate caused by market or company changes
- Changes to the WACC or growth rate also have a large impact. e.g. change in D/E or growth
What are the 5 steps in using comparable company analysis for a takeover target.
- Make a sample set of comparable firms
- Make a set of relative value measures usually based on EV or share price, P
- Obtain the mean or media for the set of comparables and apply these multiples to values for the target
- Estimate a takeover premium. Usually obtained from similar recent transactions.
- Calculate estimated takeover price = 3 (estimated value) + 4 (takeover premium)
Eplain takeover premium in five points
- The price paid by the acquirer over the stock price
- TP is Expressed as a percentage of share price
- TP = (DP-SP)/SP
- DP = deal price
- SP = stock price
What is the main advantage of using comparable transaction analysis over comparable company analysis
- All recent transactions include the takeover premium
Give 3 advantages of DCF analysis of a target
- Changes due to synergies or cost advantages are easily modelled
- Model is easy to customize
- Uses forecasts based on the company data
Give 3 advantages of Comparable company analysis of a target
- Data for comparable companies is easily obtained
- Sound assumption that similar assets have similar value
- Estimates of value obtained from the market not forecasts
Give 4 disadvantages of Comparable company analysis of a target
- Assumes the market valuation is correct.
- Market valuation gives only fair stock price, not fair takeover price
- Takeover premium must be determined separately.
- Not easy to incorporate merger synergies or new capital structures
- Historical data may not be timely enough to be accurate
Give 3 advantages of comparable transaction analysis
- Includes estimate of takeover premium
- Estimates derived from actual recent deals
- Recent transaction data reduces litigation risk from shareholders
Give 3 disadvantages of Comparable transaction analysis
- Assumes past M&A transactions are accurate and they may be influenced by Market conditions.
- There may be insufficient number of comparable transactions to form a reliable set
- Difficult to incorporate merger synergies
List 6 elements for evaluating a takeover bid
- Post merger value of an acquirer
- Gains accrued to the target
- Gains accrued to the acquirer
- Cash payment vs stock payment
- Effect of price
- Effect of payment method
What is the formula for post merger value?
What are the 4 components?
V(a+t)=Va + Vt + S - C
Va= pre merger value of acquirer
Vt= pre merger value of target
S=synergies of merger
C=cash paid to target shareholders
What is the formula for gains to the target when evaluating a bid?
What are the 3 components
Gain_T=TP
TP= Ptpost - Vtpre
Gain_T=gains accrued to target shareholders
TP = takeover premium
Ptpost=price paid for target
Vtpre= value of target shares pre merger
What is the formula for gains accrued to the acquirer in a bid evaluation? What are the three components?
Gain_acq = S-TP
Gain_acq = S-(Pt-Vt)
In a cash deal Pt=C
What two components is the value of Synergies equal to
S= Gain Target + Gain Acquirer
- Gain Target = TP
- Gain Acquirer = S-TP
S= 1+2
Gain Target + Gain Acquirer
=TP + (S-TP)= S
Explain bootstrapping earning of a target
- A high P/E firm acquires a low P/E firm.
- Total earnings are the same
- Number of outstanding shares is less thsn for both companies previously.
- EPS increases.
Explain three factors that should be considered when negotiating type of payment with a target
- Distribution between acquirer and target of the risks and rewards
- Relative value of Acquirer and Target
- Changes in capital structure due to acquisition
Which merger valuation methods do not require a takeover premium estimate?
Why
- DCF - not part of the TV model
2. Comparable transaction analysis - built in to past transactions
Which types of target evaluation are difficult to incorporate synergies and capital structure
- Comparable companies
2. Comparable transactions
Who assumes risk of a merger in a cash offer
Acquirer
Who assumes risk of merger in a share offer
Risk is shared by both acquirer and shareholders of the target
Explain 2 features of a cash divestiture
- Sale to an outside party
2. For cash
Give two features of an equity carve out
- New corp subsidiary raises money from investors.
- Parent places an equity interest to new corp subsidiary company
- New corp subsidiary management is independent from parent
Explain 5 features of a Spin-off
- Create an independent corp
- Shares are distributed to existing parent shareholders
- Shareholder base is the same as the parent
- No cash consideration for shares to parent
- Management of spin out corp is separate from parent corp
What is the main difference between a spin off and equity carve out
- Shares in carve out are offered to public
2. Shares in spin off are held by existing shareholders of parent corp
Give 2 features of a split off
- A division corp of a parent offers shares to existing shareholders of the parent.
- The division shares are given in exchange for the investors shares in the parent corp.
Give two features of liquidation
- Break up the firm and sell irs assets piece by piece
2. Usually a function of insolvency / bankruptcy
What are the features of Weston & Weaver 2001
- Merger targets gain 30%
2. Acquirers lose 1-3%
What is the main driver of a cash offer
More certain synergies
What is the main driver of a stock offer
Uncertain synergies
What is the balance of risk reward in a cash offer
- Acquirer assumes all risk and reward
2. Target return is capped, there is no risk
What is the balance of risk reward in a stock offer
Acquirer shares risk and reward with target shareholders
What does managerial hubris in relation to M&A lead to
- Over estimate of synergies
2. Losses post merger
Describe the findings of Koller, Goedhart and Wessels for M&A returns.
What explains the results
- Post merger Acquirers underperform peers on average by 4%
- More than 60% lagging peer group
Believed to be a result of failing to capture synergies
What four factors increase likrlihood of acquirers making positive returns from M&A
- Buyer with strong stock performance before merger
- Low takeover premium
- Few bidders
- Facvourable market reaction to merger
Explain restructuring
- Smaller through voluntary divestiture
2. Direct sale of portion of firm
Give 4 reasons for divestiture
- Division no longer fits Parent strategy
- No or low profit division
- Receive a cash infusion for something else or to reduce debt
- Reverse synergy: individual parts worth more than the whole
What is the main feature of pooling of interests method?
What are the 3 main effects relative to acquisition method?
Joins two company books using Historical book values. Fair value not used: 1. Assets lower 2. Equity lower 3. Expenses lower 4. Profits higher
