Mergers And Acquisitions Flashcards
What is a merger
It’s a combination of two business entities to form an enlarged group.
Merger and acquisitions are interchangeable.
Friendly takeover vs hostile takeover
Both companies are happy to be taking over. Company that is potentially be acquired, doesn’t want to be acquired.
Predator/bidder
Dominant party in a merger transactions
Target
Company being acquired.
Horizontal
Two companies in the same industry.
Very popular because they represent globalization of the merger and the business in general. Also popular in industry with over-capacity.
Example would be two supermarkets joining together.
Main reason = stronger market position as the combined company would be significantly larger. Also, economies of scale where costs savings of expanding. E.g bulk buying
Vertical
Two companies at different stages of production.
Upstream vertical integration = manufacturer buys the raw materials downstream integration = manufacturer acquires the sales outlet
E.g a cake shop, bakers and flour.
Baker needs flour to bake and would acquire from the maker - upstream integration
Oil industry is very highly vertically integrated.
e.g BP which has oil exploratory subsidiaries and they have drilling companies to extract the oil, then they have refineries which has make the oil kettles, then the distribution companies.
Main reason = secure sales or secure supplies. BP petrol stations would need petrol if vertically integrated. Same with distribution companies and have a secure place to sell the oil to. Also, increased market power and a better position. Thirdly, an advantage would be streamlined operations and reduced costs. Gol is for a smooth transaction between buyer and seller.
Conglomerate mergers
Where two or unrelated companies combine.
Best example is virgin company group which has various arms holidays, trains, media and internet which are totally unrelated.
Main reason = risk reduction which is caused by diversifying risk.
Recent example is the Walt Disney Company
Merger waves
Boom periods and there are not so many waves.
Causes:
1970s and 80s loads of merger activities.
Difficult to underpin reasons. But some patterns were identified:
High share price = economic stability = more mergers
Capital expenditure = general expansion = artificial growth is more efficient than organic growth. Artificially = merge with other companies
Surplus cash = managers may use it to purchase other companies.
Empire building = managers acquire other companies because they want to be in control of a bigger company.
Industry de-regulation and consolidation = 2004-6 which allowed more mergers, e.g telephone banking sector.
Effect of the current credit crunch = 2008 and brexit as it impacts mergers due to low confidence as share prices plummeted which made them more attractive. UK companies acquiring foreign companies as mergers.
Cross border mergers
Significant increases in UK companies acquiring foreign companies and vice versa
Uk companies are attractive to foreign bidders
This is because:
UK culture is less supportive of national sovereignty and we don’t care what company owns a company
there is limited red tape and regulation due to brexit.
Uk trade unions are pragmatic which work on employee rights and employees are not disadvantaged by takeovers.
But uk nationals are less motivated = foreign companies feel they can make uk companies more profitable.
Problems = language barriers, cultural differences, time differences and from a company perspective is that R&D suffers as they lose their comparative advantage. Also potential of job losses in usually the home company. Example is factory in Livingstone and hall’s sausages was acquired by a German company and they closed the livingstone firm and 50,000 people lost their jobs.
Both social and economic problems.
Synergy- Reasons for mergers
Primarily advanced by horizontal mergers and the idea is that two companies after the merger the merged company is now present value worth more than the separate companies alone.
The synergistic benefits come from economies of scale and cost of savings.
Post merger they now have increased market power.
You can get it for vertical and c.
Increased market power or share - reasons for mergers
Proposed for horizontal mergers but it does hold for vertical and conglomerate mergers.
Bigger = market share or position meaning a greater market power. Then there is less people selling the service meaning the company can now push prices up due to a lack of competition.
New market entry - reasons for mergers
Entrance to new market, location or industry.
Example is Tesco which acquired and American supermarket to enter the US market. But it was a disaster as Walmart acquired Asda which was a success.
Complementary resources - reasons for mergers
Both companies would benefit equally.
Large companies would enjoy research and development aspects as they seem to have more unique ideas.
The smaller company benefits from access lore funds for R&D and provide expertise and experience. Part of a larger and mote established company
Valuable assets - reasons for mergers
Desire to get a hold of both tangible and intangible assets.
Tangible = locations of property which is a fixed asset. E.g M&S takeover by Phillip green due to the locations of property.
Intangible assets = brand names, patents and licenses.
Secure supplies and certainty of sales - reasons for mergers
Vertical integration both upstream and downstream integration.
But the company may end up making a lot in house.
Risk reduction - Reasons for mergers
Diversification of risk.
Most common with conglomerate mergers.
Eliminating inefficient management - reasons for mergers
Idea is that a company wants to be taken over and shareholders want to get rid of the management team. But the board of directors can just be voted off
Using surplus cash - reasons
Buy other companies
Empire State Building on behalf of shareholders
Boost growth rates - reasons for mergers
Established company acquires a new company in the growth stage.
Earnings per share will increase by taking over more gross prospects.
However managers like to be able to advertise
Managerial motives - reasons for mergers
Higher remuneration- pensions and bonuses
Empire building
Status - controlling bigger empires
The hubris hypothesis
Richard roll (1986)
Hypothesis: decision makers in acquiring firms pay too much for their targets
Roll argues that if there are no synergistic benefits to a merger, hubris on the part of manages results in a positive valuation error
Roll assumes market efficiency
- but takeovers are initiated by individuals
Hubris does not imply managers deliberately act against shareholders interests
Mechanics of a merger
Step 1
Identify target
Understanding the mechanisms of the acquisition
Step 2
Mechanics of a merger
Appraise target via
Due diligence - employee contracts, termination clauses where staff are made redundant
Limited information - market information, competitors, customer base and what type of service or product
Commercial, employee and legal
Mechanics of a merger
Step 3
Negotiation between target company and bidding company
More due diligence - types?
How much to offer? Premium?
How to pay?
Is it a hostile or friendly takeover?
Mechanics of a merger
Step 4
The offer
Friendly merger
Target board advises shareholders to accept
Hostile bids
- dawn raids - bidding company buy all available shares on the open market
-3% rule = amassed shares they must tell target company = disclosure rule
- 30% rule =
Rules mean they are hostile or friendly
Unconditional offer when usually 50% has been acquired
90% rule = agreement and force rest to sell their shares
Financing the merger - how to pay
Cash
Bidding shareholders control is not diluted
Price being offered is clear to see
Target shareholders have more options and can spend on what they want
But targets shareholders are subject to capital gain tax which is on profit amassed
Financing the merger - how to pay
Equity
Share for share exchange
Become shareholders in a new combined group
Target shareholders = benefit is capital gains taxes is postponed and they benefit from merger gains and will enjoy higher share price.
Target shareholders = disadvantages = no immediate cash flow.
Bidder company = no immediate cash outflow = benefit
Disadvantage = arguably it is the most expensive form of capital and they shall suffer a dilution of control
Financing the merger - how to pay
Earns-out
Are reactively new.
Becoming more popular where part of payment of merger is paid on completion and part is paid at the end of the earn-out period.
Amount paid at the end is based on profits earned since acquisition which is variable.
An issue is earn out agreement has to be very clear, and the speed of the integration, and when the integration happens in the first two years - performance will be alright but after five years profit will go really high or really low.
Financing the merger - how to pay
Debt
E.g bank loans, convertible bonds and its usually combination of sources of finance are used e.g cash and equity.
Very common for company to do a rights issue when trying to finance a merger.
Regulation of mergers in the UK
UK listing Authority (UKLA)
Authority rules exist when bidding company is part of the London stock exchange.
City code/ Blue Book
Code of best practice, companies are treated fairly by their directors and its informal and has no legal backing. Companies will genuinely adhere to the guidelines because they don’t want to be shunned in the market and in practice. Other companies do not look favourably on them.
The office of fair trading OFT = review all potential mergers to make sure there is not a lessening of competition. Sainsbury’s merger could only continue if they agreed to sell off so many stores cause they would control too much of the market.
European Commission = overall say on all merger transactions, go against the European common market they can block it.
Estimating merger gains and costs
What to take from calculations
If cash is offered, the cost of the merger is unaffected by the merger gains.
If shares are offered, then cost depends on the gains being made.= share for share issue.
Defence strategy
Action that a target company can take if they don’t want to be taken over.
Board has to feel that takeover is in the company best interests.
Press coverage - defence strategy
Directors will try to build up shareholder loyalty.
By highlighting the strengths of the company in the media.
E.g a debt issue in order to increase share price which may put bidding company off
Revise profit forecasts - defence strategy
Announce to market that they expect future profit to be higher. Which increases share price and makes it more expensive to acquire.
Forecast has to be credible though and there needs to be some substance
Find a white knight = defence strategy
Find a defensive merger
Where they choose a more appropriate company but directors may be acting in their own best interests e.g losing their jobs. Shareholders need to be aware of the reasons behind.
Poison pills = defensive strategy
Target company may do a rights issue meaning there are more shares in the market and more shares to be acquired. This may increase the value of the company = expensive for bidding company. Also they can issue a convertible bond = instrument that starts off as debt but can be transferred to equity. Meaning there are more shares for the bidding company to acquire and may find it too expensive.
Sell off the Crown Jewels = defence strategy
Might sell of parts or asset that the bidding company wants which decreases the attractiveness of the merger for the buffing company.
But future becomes uncertain, selling off the Crown Jewels is prohibited in the blue book.
Pacman = defence strategy
In a very rare instance
Target company is subject to a takeover = target company then does a reverse bids on the bidding company.
But the target company is usually poor performing
Golden parachutes - defence strategy
Large termination payments or packages
Receiving directors will receive a higher package.
Employee stock action plans
Proposed by the French government
Companies give employees shares
Do what they’re told
Greenemail
Key shareholders are bribed in the USA by shareholders to sell back - repurchasing shares at a massive premium
Share buy back
Institutional shareholders
Repurchase shares from shareholders and target company therefore own the shares
Case of marks and spencer
Defence strategy
Pensions fund deficit = far too expensive for Phillip green to acquire
Consumers - winners and losers in a merger deal
May benefit from cost savings
May lose out from abuse of monopoly power
Predator company shareholders - winners and losers in a merger deal
At best, the effect is neutral
Evidence is mixed
Benefit from cost savings
Or lose out from overpaying
Target company shareholders - winners and losers in a merger deal
Seem to gain due to high premium paid by predator
Other stakeholders winners and losers in a merger deal
Employees
Directors
Financial institutions
Becoming stronger might actually create job positions
Two angles lose out if they lose jobs but receive substantial termination package
Biding company director tends to benefit cause they are in control of bigger empire and ego boost
Reasons for merger failure
Acquired for the wrong reason - primarily a conglomerate merge - is the merger compatible with overall business strategy
Overestimating gains/ underestimating costs
- forecasts are sometimes too optimistic
- underestimating management time
Merge fever
Badly planned integration
In practice it didn’t work.
Because of poor integration plan.