Mergers and Acquisitions (M&A) Flashcards
What is a merger?
Transaction combining two firms into one firm.
What is an acquisition?
Purchase of one firm by another –> acquiring firm (bidder) initiates offer; target firm/acquired firm receives offer.
What is the takeover premium?
Diff. between prior share price & amount offered –> typically acquiring firm offers to buy target’s shares at substantial premium over target’s prevailing share price.
What are the 5 different types of acquisitions/takeovers?
1) Strategic acquisitions –> aims to enhance acquirer’s competitive position or achieve specific strategic objectives e.g. target company may possess valuable assets, tech, or market presence to strengthen acquirer’s own business –> often result in synergies e.g. cost savings, increased market share, or access to new mkts.
2) Financial acquisitions –> aims to enhance acquirer’s financial returns on investments e.g. through cost reduction, operational efficiency improvements or financial restructuring –> may involve private equity firms, hedge funds, or other investors –> e.g. disciplinary acquisition may involve investor influencing management & strategic direction of target to improve performance & increase shareholder value e.g. through changes in corporate governance, operational practices, or capital allocation.
3) Conglomerate acquisitions –> aims to diversify investment portfolio of target company by acquiring target operating in diff industry –> acquirer gains from diversification e.g. spreading risk across diff. markets or industries –> may offer opportunities for synergies through shared resources across diff. industries.
4) Hostile takeover –> occurs when individual or entity acquires target company against wishes of its management by purchasing a large fraction of target corporation’s stock to get enough votes to replace target’s board of directors & CEO –> usually via tender offer where acquirer purchases specified no. of shares of target company directly from its shareholders at predetermined price.
5) Friendly Takeover –> acquiring company & target company negotiate terms and conditions mutually agreeable to both parties.
What are the 4 advantages of M&A activity?
KEY AIM = SYNERGY –> where combined firm’s value > sum of values of separate firms.
1) Risk reduction & diversification –> diversification when investments spread across diff assets or industries to reduce impact of any single asset’s performance on overall portfolio –> combined firm less susceptible to fluctuations in any one sector (less unsystematic risk) compared to individual firms pre-merger –> lower probability of bankruptcy –> however investors can diversify their own personal portfolios by holding shares in multiple separate firms.
2) Debt capacity & borrowing costs –> merged firms often have greater debt capacity due to their increased size, diversification & perceived stability –> seen as lower-risk borrowers by creditors because they have multiple revenue streams & assets to support debt obligations –> lower borrowing costs for merged entity compared to individual firms –> larger firms may benefit from econs of scale in borrowing to negotiate more favorable terms w lenders, e.g. lower interest rates or longer repayment periods –> greater ability for merged firm to invest & expand in new projects as well as survive econ downturns.
3) Economies of scale gains –> larger combined firm can spread fixed costs over a larger output volume, reducing average costs per unit produced compared to individual firms –> increased profitability.
4) Econs of vertical integration –> merger of two companies in same industry making products required at diff. stages of production cycle –> better synchronisation of activities across supply chain, leading to reduced inefficiencies, improved product quality/customer satisfaction, reduced risk of supply chain disruption & increased profitability –> also creates barriers to entry for competitors by controlling critical inputs or distribution channels, increasing acquirer’s mkt power.
Why is there an increase in the number of poorer quality mergers during merger waves?
1) SHAREHOLDER-MANAGER AGENCY PROBLEMS –> during merger waves, managers may be incentivised to pursue acquisitions benefiting their own interests over max. long-term shareholder wealth. e.g. by increasing their power, prestige, career prospects or compensation which can lead to empire-building, value-destructive acquisitions which increase size & not value of company & may dilute value per share –> merger waves characterised by high uncertainty & poor quality of analysts’ forecasts due to volatile mkt–> asymmetric info where investors cannot assess true value & potential risks associated w M&A transaction –> reduced external monitoring/higher costs of external monitoring —> hence managers may exploit situation to pursue acquisitions which do not max. shareholder returns –> managers likely concerned about
long-term impact of unsuccessful acquisitions on their
reputations & careers however could be mitigated by reduced penalties for making value-destroying
acquisitions as acquirers share blame of unsuccessful mergers w other managers i.e. weaker CEO turnover-performance sensitivity –> may increase volume of poorer quality agency-driven acquisitions.
2) Managerial herding –> managers pressured to follow predecessors’ actions due to career concerns & industry trends –> initiate mergers of deteriorating quality during merger wave –> these late-mover managers who follow the herd after trend has been established, are more likely to pursue value-destroying mergers due to not having same level of info of early movers –> distinct from agency problems arising from separation of ownership & control in firms.
3) Managers may be evaluated more favourably after merger if their actions during merger waves align w those of other managers –> may exacerbate agency problem as managers may face less scrutiny & accountability.
–> hence in-wave acquirers exhibit weaker governance characteristics compared to out-wave acquirers e.g. board independence, CEO/chairman duality etc.
What are merger waves & what drives them?
Merger waves are periods of M&A activity within specific industries or across entire mkt –> tend to cluster by time & industry –> typically driven by:
1) Industry shocks –> leads to restructuring & consolidation of industries e.g. via tech advancements, regulatory changes, or econ. shifts that create opportunities for companies to merge in order to adapt to new mkt conditions –> increasing no. of M&A deals.
2) Stock mkt overvaluation –> when stock prices exceed firm’s fundamental value, companies may perceive M&As as highly profitable –> increasing no. of M&A deals.
What are the 2 managerial motives to merge?
1) Conflicts of interest/shareholder-manager agency problems –> manager only be interested in M&As for personal gain & career advancement over shareholder value max.
2) Overconfidence i.e. ‘hubris hypothesis’ –> overconfident CEOs may pursue mergers w low chance of creating value due to exhibiting excessive optimism about potential benefits of mergers –> underestimate risks & overestimate their ability to manage post-merger integration effectively –> e.g. failure of RBS bid for ABN Amro after successful National Westminster Bank takeover.
–> under conflict of interest explanation, managers know they are destroying shareholder value but personally gain from doing so –> under hubris hypothesis, managers believe they are acting in best interest of shareholders.
What are the 2 potential disadvantages of M&A activity?
1) SHAREHOLDER-MANAGER AGENCY PROBLEMS
2) TARGET FIRM SHAREHOLDERS’ DISPROPORTIONATELY GAIN –> target firm shareholders often experience significant gains w average returns of 20% or more following acquisition whereas unclear effect on bidders –> bidding firms often larger than target firms, leading to lower % gains for bidder shareholders –> more difficult for large firms to achieve significant growth through acquisitions due to their already substantial mkt presence –> bidding firms may overestimate anticipated gains from acquisition resulting in muted or -ve stock price reactions for bidder firms –> announcement of takeover may not convey significant new info to mkt about bidding firm, particularly if transaction anticipated so mkt response to M&A announcements may be muted or ambiguous.
