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H1: INTRODUCTION TO M&A’S:
1.Background and historical trends:
M&A are part of the market for corporate control
acquirer/bidder + target/seller
acquisition or merger => both are takeovers (economically the same but not legally)
global takeover market highly active: averaging more than 1 million dollar per year in transaction
value.
Merger waves = peaks of heavy activity folowed by quiet throughs of few transactions
merger activity is greater during economic expansions than during contractions and correlates with
bull markets
the same ecnomic activities that drive expansions most likely also drive peaks in merger activity
1960s: conglomerate wave = acquiring in unrelated businesses
1980s: hostile takeovers
1990s: strategic/global deals create strong firms that would allow them to compete
globally
2000s: consolidation in many industries + private equity
2015 (after dip bause of economic crisis in 2008)
Types of mergers:
Horizontal merger = target and acquirer are in de same industry
Vertical merger = target’s industry buys from or sells to acquirer’s indsutry
Conglomerate merger = unrelated businesses
Methods of payment:
Cash
most common and simplest form
cash arranged by through internal sources (SEOs) or through additional debts (leveraged
buy outs)
ADVANTAGE: corporate identity and ownership structure of acquirer remains unchanged
DISADVANTAGE: must compensate for taxes that target shareholders have to pay on their
capital gains
Stock (= stock swap = acquiring companies issue its own equity shares to target company)
both acquirer and target share post M&A deal outcome
determine right exchange ratio !!
ADVANTAGE: when price-earnings ratio of acquirer is much higher and no taxable gains
DISADVANTAGE: takes more time to complete the deal, higher transaction costs and
potential misvaluation and much legal procedures
Debt (= target shareholders exchange old stock for debt instruments issued by the acquirer or
a newly created firm)
no income taxes to pay until they receive the debt payments
paid out with other creditors when seller goes bankrupt
acquirer could sell off assets or simply let the equipment run down => seller can recover
little
,2. Market reaction to a takeover:
Most U.S. states: fair value is obligated
bidder is unlikely to acquire a target company for less than its current market value (premium +
current market value)
Acquisition premium = the percentage difference between the acquisition price annd the pre-merger
price of a target firm
average = 43% over the pre-merger price
Stock price reactions:
Target: gain of 15%
Acquirer: gain of 1% (BUT half receive a price decrease)
3. Reasons to acquire:
Large synergies:
cost-reduction (easier to achieve) and revenue enhancements (harder to achieve and predict)
Economies of scale and scope:
Of scale = the savings a lare company can enjoy from producing goods in high volume that are not
available to a small company
of scope = due to combining the marketing and distribution of different types of related products
BUT larger firms are more difficult to manage
Vertical integration:
better coordination BUT not all suvccessful corporations are vertically integrated (see Microsoft)
Expertise:
may be more efficient to purchase the talent as an already functioning unit by acquiring an existing
firm (harder to hire experienced workers)
Monopoly gains:
limited since most companies have antitrustlaws
HOWEVER lack of convincing evidence that monopoly gains result from reduction of competition due
to takeovers: alle companies in an industry benefit but only merging company pays tha associated
costs
Efficiency gains:
elimination of duplication: acquirers think they can run the target organization more efficiently
than existing management could (hower identification is easier than replacement!!)
Tax savings from operating losses:
losses in one devision can offset profits in another devision
requires argument that tax savings are larger than savings using carry back and carry forward
provisions
,example:
Both firms either make 50 million or lose 20 million every year with equal probability
Firms’ profits are perfectly negatively correlated
Corporate taks rate is 34%
firm 1: after-taks profits: 50*(1-0,34) = 33 million
expected: 33(0,5) – 20(0,5) = 6,5 million
identical for firm 2
mergerd: 50-20 = 30 => 30*(1-0,34) = 19,8 million > 2*6,5 million
Diversification:
risk reduction: less unsystematic risk (however it ignores the fact that investors can achieve
themselves by purchasing shares in two different firms)
debt capacity and borrowing costs: lower probability of bankruptcy due to increaseable leverage
and thus lowering capital costs + increasing debt and enjoy greater taks savings without costs of
financial distress
asset allocation (ex. Redeploy managerial talent where it is most needed) (however agency costs by
helping bad devisions longer than optimal)
liquidity provided by bidders to woners of a private firm
Earnings growth:
earnings/share can increase even when the merger itself does not create economic value
example: two firms with $5 per share, firm1 has 1 million shares priced for 60 each and firm 2 has
1 million shares priced for 100 each). Firm2 acquires firm1 using its own stock and the takeover adds
no value
Since takeover adds no value: new value firm2 = 100*1 million + 160 million
To acquire firm1 60 million must be paid = using 600 000 of its shares => firm1 wil get
0,6 new shares for their old shares (price per share from firm2 remains the same) =>
firm2 has a value of 160 million ith 1,6 million shares outstanding
Prior both companies: 5/share * 1 million shares = 5 million => combined earnings of
10 million
After merger: 1,6 million shares outstanding : 10 million / 1,6 million shares =
6,25/share firms2 has raised its earnings per share
price-earnings ratio before merger: = 20
price-earnings ratio after merger: 100/6,25 = 16
has dropped to reflect the fact that taking over , more of the value comes from
earnings from current projects than from its future growth potential
Managerial motives:
conflicts of interest = may prefer to run a larger company due to additional pay and prestige
empire building
maybe do bad merger that increases their personal benefit instead of firm value
overconfidenc = hubris hypothesis = overconfident CEOs pursue mergers that have low
chance of creating value because they believe that their ability to manage is great enough to
succeed
, 4. Valuation and the takeover process:
Takeover synergies = any additional value created
Price paid = target’s pre bid market capitalization + premium
only positive NPS project for bidder if the premium paid does not exceed the synergies created due
to this takeover
1.THE OFFER:
!not all tender offers are succesful: often acquirers have to raise the price to consummate the deal!
stock-swap: positive NPV investment for acquirer if the share price of the merged firm ecxceeds
the premerger price of the acquiring firm:
A +T + S A A+T + S Na+ x T +S x x∗A
> =Pa → > →1+ > +1 →T + S> =x∗Pa
Na+ x Na A Na A Na Na
exchange ratio =
( Pa )
1
∗T + S
T + S x∗Pa
Nt
> →
Nt
x
> →
Nt Nt ( Pa1 )( T +S ) ( PtT )> NtX → Ntx < PaPt (1+ TS )
Na = number of shares outstanding before the merger
x = max amount of new shares issued to pay for the target to achieve positive NPV
A= pre-merger value acquirer
T= pre-merger value target
S= value synergies created by the merger
Example: A announced to acquire B while stocka was trading for 25 per share and stockb for 30 per
share. If the synergies were 12 billion and B had 1,033 billion shares outstanding what is the max
exchange ratio A could offer in a stock swap ? What is the max cash offer A could make?
T = 1,033 * 30 = 31 billion
Exchange ratio <
30
5 (1+
12
31 )
=1,665
1.665 shares of A for each share of B
Offer cash: 12 billion/1,033 billion shares = 11,62 per share => 30 + 11,62 = 41,62 (= cash
value exchange offer : 25 * 1,665)
2.MERGER ARBITRAGE:
once a tender offer is announced the uncertainty about whether the takeover will succeed adds
volatility to the stock price
opportunity to speculate on the outcome of the deal
risk-arbitrageurs = traders who , once a takeover is announced, speculate on the outcome of the
deal
merger-arbitrage spread = the difference between a target stock’s price and the implied offer price
(!not a true arbitrage opportunity, because of the risk that the deal will not happen)
3.TAX AND ACCOUNTING ISSUES:
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