Mergers and Aquisitions

Question 1

Introductory perspectives?

Answer 1

• Historical patterns
• Waves tend to follow periods of econ growth/booms in financial markets
• Waves differ from one another
• Waves influenced by new types of finance sources
• Waves can be allied to financial booms

Question 2

Merger waves - Douma and Schreuder - different motivations?

Answer 2

• First merger waves – 1897 to 1907 – followed depression of 1883, concentrated in petroleum products, mining, metals, and transportation – horizontal mergers, so affected industries became highly concentrated, led to anti-trust legislation in US
• 2nd merger wave 1916 to 1929 – increased scrutiny bc of gov concerns, more vertical mergers than horizontal
• 3rd merger wave 1965 to 1969 – coincided w period of econ prosperity in US and firms having resources necessary to acquire other companies – conglomerate mergers, strict anti-trust

Question 3

4th merger wave?

Answer 3

1981 - 1989
* More hostile takeovers
* Emergence of corporate raider
* Use of debt more common to finance activity
* Mergers larger – in billion dollar range became common
* Growth of more complex takeover defences

Question 4

5th merger wave?

Answer 4

1993-2000
* Larger mergers at same level as during fourth wave by hostile activity diminished
* Fourth mergers were ST gain, here emphasised more LT strategy
* Debt finance mergers less common

Question 5

21st C.?

Answer 5

nternational wave – why large cross border M&A
* Globalisation – lower trade barriers, industry restructuring and renationalisation at national and international
* Strong econ growth after 2003, emergence of India and China, boosted industrial consumption
* Private equity share increased, more deals by private equity firms, favourable debt markets allowed to finance deals w high leverage
* Activity falls after 2007/08
* But stronger growth in 2018

Question 6

Largest M&A deals 2017?

Answer 6

Broadcom targeting Qualcomm - $130.3Bn

Walt Disney acquiring 21st Century Fox - $69Bn

Question 7

Why M&As occur?

Answer 7

• Ambitions – trans cost min, market power, risk reduction, simple speculation, synergies, hubris
• Results – replacing markets w hierarchies? Profits? Reducing profit flux? Reducing WACC/tax shields?
• Theory – Williamson, agency theory, monopoly growth
• But exp problems in process – info assym, AS etc.

Question 8

Profit maximisation hypothesis?

Answer 8

• Mergers to achieve shareholder welfare max
• Condition Vm > Va + Vb
• Firm value -> discount earning stream
• Earnings impacts – mergers mean comp reduced thus market power – vertical mergers and foreclosing on others markets – conglomerate mergers may lead to cross subsidisation of products/predatory pricing

Question 9

Efficiency and Economies of Scale?

Answer 9

• Efficient resource use
• Economies of vertical integration – better coordination, reducing transaction costs esp search costs
• Reducing over capacity – steel industry

Question 10

Tax effects?

Answer 10

Global M&A i.e. purchasing firms in country w lower marginal tax rate
* Carrying tax losses forward
* Merged entities in same country may be in lower tax bracket

Question 11

Debt capacity, finance costs?

Answer 11

• Effects on risk and investors discount rate –
• Reduction of risk dep on – correlation between profits of merging firms – relative size of SD of profits
• Mergers to diversify v popular in 60s and 70s
• Even if risk reduced – very expensive method – investors can diversify risk themselves

Question 12

Financial synergies?

Answer 12

• M&A impacts WACC in newly formed unit
• Financial synergy from lower costs of internal financing v ext financing – a mix of firms w diff CF positions and investment opp may achieve lower WAAC
• Plus post merger combined debt capacity may be greater than in the two component parts
• If CF rate of acquiring firm > target, then capital relocates to acquirer and invest opp are bettered

Question 13

Profit max?

Answer 13

• If its ab profit max should be able to see results
• Problem w looking solely from investors POV – other stakeholders
• Directors in target and acquirer, employees, consumers, econ as a whole

Question 14

Areas of study?

Answer 14

• Corporate finance studies based on val of abnormal returns of share price i.e. event horizon studies
• Industrial organisation studies – multi variable research, but also comprising consideration of counterfactual

Question 15

Event study structures and data - estimation window?

Answer 15

Provides info needed to specify the normal return

e.g., in case of the market model, the stock returns are regressed on the market returns in order to specify the typical relationship between the stock of the focal firm and its reference index, Notably an intercept, a slope and an error term are retrieved and then used to predict the normal returns for the event window

Question 16

Event study structures and data - event window?

Answer 16

Based on the actual returns during the event window and the normal returns predicted, abnormal returns are calculated for all days within the event window

These abnormal returns provide insights on whether the event was of material relevance for the focal firm - and whether info about the event had leaked to the stock market and whether the market needed additional time to absorb the informational content of the event

share price abnormal move up/down - good/bad news for shareholders

Question 17

Event study structures and data - post event window?

Answer 17

Typically not considered

However, may be used to investigate longer term stock/company performance following the event

Question 18

General corporate finance studies findings?

Answer 18

• Jensen and Ruback – 1983 – gains created by corporate takeovers don’t appear to come from acquisition of market power – little evidence that shareholders damaged in process
• If Jensen and Ruback were right, acquisition creates value as assets allocated to better management team – effective market for corp control?
• Conclusions vary from time period of study

Question 19

Problems with event studies?

Answer 19

ocus on share price movements around announcement date – maybe should be looking longer term on the firm
* Market can get v upbeat around time of announcement and then settle when reality sinks in – ex post recognition of problems
* Markets may not be efficient
* Event study findings may not tally w mergers that fail

Question 20

Outcome studies?

Answer 20

• Industrial organisation research – i.e. pre/post performance against a peer group
• Multiple variables – ROI, CF, sales, labour use, consumer prices
• Tichy 2002 found profits come out weaker in non merging control group in 58% of studies
• Studies suggest overall they are successful
• Inevitably dep on merger – how well planned and executed

Question 21

Review?

Answer 21

• Horizontal takeovers may do better than unrelated takeovers
• But even here – synergy is not automatic – managers must take adv of the opportunities
• Issues – existence of management who can effect changes – post merger organisation, analysis of target company needs – development of synergy dep on extent of skills carryover

Question 22

Summary?

Answer 22

Enough evidence to suggest performance of M&A very variable
* Likely then there are other motives
* Likely then that there also may be problems in the M&A process such that buyers do not have adequate information on targets
* Poor quality decisions may be made!

Question 23

Incorrect valuations link to agency problems in the process?

Answer 23

• Info problems
• Buyers – have private info relating to p willing to offer
• Sellers – private regarding how much the assets are worth
• Acquirer needs to work out val, always at disadv here as seller knows better
• M&A targets have attributes only understood ex post and sellers may have role in misrepresenting p of the asset
• Claims of the seller will be discounted heavily by the buyer
• Sellers of good companies risk of not receiving good val of their assets
• Market fails, lemon problem following Akerlof

Question 24

Problems compounded by valuation discrepancy?

Answer 24

• Priv info problems – hazardous transactions
• Manipulation – stock watering – misleading rumours
• Exp earning from merger poorly est
• Info problem – i.e. merger might occur where –
• Both discount rates the same but earnings of B est as higher by A
• Or earnings the same but A uses a lower discount rate

Question 25

Gort 1969 - problems to accurate valuation of target firms caused by…?

Answer 25

Tech change and rapid changes in price cause confusion
Growth of the stock market and speculation
Application of incorrect discount rates

Question 26

Problems in M&A process causing problems?

Answer 26

• Adverse selection – hidden info – market for lemons
• Due diligence procedures – Escrow accounts – auction design

Question 27

Other motives for M&A may be linked to process problems?

Answer 27

• Growth maximisation and managerial utility
• Hubris – excessive pride or self confidence
• Managerial tactics

Question 28

Hubris?

Answer 28

CEO current performance
CEO media praise
CEO inexperience
CEO self importance

can all lead to hubris and an acquisition premium

Question 29

Roll 1986 - the mechanisms?

Answer 29

• Do managers seek to acquire firms for personal motives
• Pure econ gains to acquiring firm may not be sole motivation or primary in acquisition
• If hubris hypothesis explains takeovers, following may occur –
• Acquirer stock p should fall after makes aware of takeover
• Stock p of target should increase w bid for control – occur bc acquiring firm not only pays premium but may pay premium for excess of the val of the target
• Combined effect of the rising val of the target and the falling val of the acquiring firm should be negative – accounts for costs of completing takeover process
• Investment banks/lawyers/accountants – always win the M&A process

Question 30

Perhaps link to winners curse problem?

Answer 30

idders who overestimate val of target likely to win contested process – more inclined to overpay rivals who more accurately val target
* Links to growth max hypothesis of Mueller 1976
* Empirical research for CEO overconfidence significant in explaining winners curve and val destruction in M&A
* Research reveal cases that avg winning bid in takeover contests can overstate capital markets est of any takeover gains

Question 31

Do defence mechanisms work to stop acquisitions or to raise shareholder returns?

Answer 31

• Legality of defence mechanisms can vary by country
• Shareholders rights plans can water down others shares
• Staggered boards – board keeps changing means you have to deal w diff people all the time
• Golden parachutes – acquirer may have to bear cost of golden parachutes, disincentive to takeover
• Greenmail – someone buys some of your stock – tell them to go away and purchase what they bought – they will receive premium on top – can be deemed pos or neg – can be putting off potential beneficial bids
• Poison pills – something triggered when someone makes a bid
  Supermajority voting
  Underfunded pension schemes

Question 32

Poor defence in economic terms?

Answer 32

• Defences can make it expensive to launch a bid, or giving acquirer a decent return if they drop an offer
• Former implies the poison pill – shareholder rights plans, taking on lots of debt, pension schemes underfunded
• Latter implies the greenmail

Question 33

Confusing devices - other defence mechanisms?

Answer 33

• Golden parachutes - incentive to act in shareholders interests or a poison pill?
• ESOPS – development of – might also be seen as anti takeover device – employee share ownership schemes
• ESOPS found to be strong deterrents to takeovers

Question 34

Conclusions?

Answer 34

Given problems cited, some concerns that market for corporate control may not work too well
Note links to growth of leveraged buy-outs and private equity developments
Agency theory and Information problems provide themes for study of M&A

• If have exam Q – join the dots - auctions, agency , transaction cost econ