Corporate Valuation, Restructuring and M&A’s
Contents
1. Introduction to Mergers 2
2. Motives for Mergers 5
3. Returns to Mergers 10
4. Returns to Mergers – Empirical Evidence 15
5. Valuation of an Acquisition 25
6. Going Private and Leveraged Buyouts 29
7. Takeover Defenses 35
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,Introduction to Mergers
What is an M&A? Why Should We Care?
• Merger: Two (or more) companies come together to combine their resources and achieve a
common goal. In practice, one company is often dominant. Mergers are often friendly
(supported by incumbent management).
• Acquisition: One company acquires shares and control of another company.
• M&A is important because
o An important event in firms’ life cycles
o Acts as a corporate governance tool
o May generate value
o Also, it is a big business
See slide 2,3,4 for examples
The Drivers of the Merger Business
1. Technological change
• Computers, internet and information systems
2. Economies of scale, economies of scope, and the need to catch up technologically
• AT&T acquired companies in the 1990s to catch up
• Complementarities between internet, TV and other services
3. Globalization and freer trade
• GATT, introduction of the EURO
4. Changes in industrial organization
• Increased competition in airlines, financial services etc.
5. Deregulation and regulation
6. Economic conditions, trends
Do Mergers and Acquisitions create value?
• Yes: M&A creates value by facilitating efficiency and moving resources to their optimal use
• No: Firms are already operating at their optimal capacity. M&A is just a way to redistribute the
existing wealth across stakeholders
Merger Terminology
• Tender offer: A firm makes an offer directly to the shareholders to sell (tender) their shares at
specified prices. Some tender offers may be hostile.
• Conditional tender offer: The tender offer is conditional on the bidder receiving a certain
percentage of shares (normally 50%).
• Unconditional tender offer: The bidder accepts all shares that are tendered after the condition is
met.
• Restricted tender offer: The bidder only accepts a certain percentage of outstanding shares, i.e.,
50%. Often there is prorating all tendering shareholders sell a percentage of the tendered shares.
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,• Two tiered tender offer: A first tier is employed to get 50% of the shares – this offer is normally
in cash. In the second tier a lower value can be offered since control has already been achieved.
The second tier is often paid in securities such as debt rather than cash or equity of the bidder.
• ”Three-piece suitor” three steps:
1. An initial ”toehold” is acquired by the bidder
o A toehold is an initial stake in the target firm (normally 5%)
o At 5% regulation 13(d) requires that the ownership is disclosed to the Securities and
Exchange Commission (SEC).
2. A tender offer is made to get control
3. Minority shareholders are bought out in a squeeze-out
• Minority squeeze out: Majority of shareholders forces the sale of shares from the minority to the
majority.
• Equity carve out: An offering of a full or partial interest of a subsidiary to the investment public.
• Divestiture: A sale of a particular set of assets of the firm to another firm.
Types of Mergers from an Economic Standpoint
Three types of mergers, vertical, horizontal and conglomerate
1. Horizontal: The two merging firms are competitors in the same industry
2. Vertical: One of the merging firms uses the other firms output as input
3. Conglomerate: Merging firms are in unrelated businesses
Horizontal mergers
→ E.g. Exxon acquisition of Mobil in 1999
• One possible explanation is ”economies of scale”
→ Cannot explain why mergers bunch in time
→ Not all small firms merge horizontally
• Another potential explanation ”monopoly power”
• Industry roll up – particular form of horizontal merger
o One firm acquires a number of small firms in an industry - often motivated by the pursuit of
”economies of scale”
o Often the consolidator undertakes an IPO to get financing to purchase the small firms
o Many consolidators that have taken the IPO route have filed for bankruptcy
Vertical mergers
• Oil industry (Exploration, production, refining, marketing)
Pharmaceutical industry (R&D, drug production, marketing)
• Why vertical integration?
o Improvement in production and inventory planning
o Reduction of search, negotiation, payment collection and advertising costs if producer is
located within the firm
o Hold up problem may be avoided
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, The Hold-up Problem
Hold-up problem, Klein, Crawford and Alchian (1978)
• One firm must make an investment to transact with another. This investment is relation-specific;
that is, its value is appreciably lower (perhaps zero) in any use other than supporting the
transaction between the two parties.
• Impossible to draw up a complete contract that covers all the possible issues that might arise in
carrying out the transaction and could affect the sharing of the returns from the investment.
• Example: Dies used to shape steel into the specific forms needed for sections of the body of a
particular car model. These dies are expensive—they can cost tens of millions of dollars. Further,
they are next-to-worthless if not used to make the part in question. Suppose the dies are paid for
and owned by an outside part supplier. Then the supplier will be vulnerable to hold-up. Because
any original contract is incomplete, situations are very likely to arise after the investment has
been made that require the two parties to negotiate over the nature and terms of their future
interactions. Such ex post bargaining may allow the automobile manufacturer to take advantage
of the fact that the dies cannot be used elsewhere to force a price reduction that grabs some of
the returns to the investment that the supplier had hoped to enjoy.
• Outcome: The supplier may then be unwilling to invest in the specific assets, or it may expend
resources to protect itself against the threat of holdup. In either case, inefficiency results: either
the market does not bring about optimal investment, or resources are expended on socially
wasteful defensive measures. Having the auto company own the dies solves the problem.
Vertical integration solves the hold-up problem.
Conglomerate Mergers (Firms involved in unrelated business)
→ E.g. merger of Mobil Oil and Montgomery Ward
• Reduce risk through diversification
o Combination of businesses whose returns are not highly correlated would reduce the overall
variance of the returns
• Better financial planning and control
o In practice, conglomerates have "more professional" financial planning
o Improves resource allocation
• Can be easier to change the management
o Less dependent on business-specific knowledge
Legal Aspects of Mergers
• Statuary Provisions of mergers (depends on the country(ies) that firms are chartered)
o Percentage of vote required to approve M&A
o Who is entitled to vote
o How the votes are counted
o The rights of the voters that object to the transaction
• Ex: Statutes in Delaware (typical)
o Board of directors have to approve the transaction first
o Then submitted for ratification to the shareholders of respective corporation
→ Prior to the 1960s most states required 2/3 majority
→ 1967 Delaware required majority vote, other states include California, Michigan and New Jersey
→ New York still requires 2/3 majority
→ Most mergers are approved …
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