Practical financial management lasher 7th ed chapter 017

Chapter 17 Mergers and Acquisitions


Mergers and Acquisitions

Merger – a combination of two or more businesses under one
ownership
Acquisition or Takeover - one firm acquires the stock of another

– Acquired firm is the target
Consolidation - combining firms dissolve forming a new legal
entity

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Figure 17-1 Basic Business Combinations

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Mergers and Acquisitions
Relationships

– Consolidation implies the firms combined willingly
– Acquisition can be a friendly or hostile takeover

Stockholders

– Must be willing to give up their shares for the offered price
– Approval from majority necessary for acquisition to be successful

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Mergers and Acquisitions
Friendly Procedure

–
–
–

Target firm's management
approves and cooperates with
acquiring company
Negotiation occurs until
agreement is reached

Unfriendly Procedure

–
–

Target firm's management resists,
takes defensive measures to stop
takeover
Acquiring firm makes a tender offer
to the target's shareholders

Proposal submitted for
stockholder vote

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Why Unfriendly Mergers
are Unfriendly
A target's management may resist a takeover because:

– Acquiring firm offered too low a price for the stock
– Target’s management often loses jobs, power, and influence

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Economic Classification of
Business Combinations
Vertical Merger

–

Acquiring suppliers of customers

Horizontal Merger

–

Merging firms are competitors

Congeneric Merger

–

Firms are in related but not competing businesses

Conglomerate Merger

–

Firms are in entirely different fields

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A Further Classification

Strategic Merger

– Merger is undertaken to enhance the acquirer’s business
position

Financial Merger

– Merger is undertaken to make money from the merger process


Role of Investment Banks

Help companies issue securities
Instrumental in acting as advisors to acquiring companies
Assist in establishing a value for target

Help acquiring firm raise money for acquisition
Advise reluctant targets on defensive measures

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The Antitrust Laws

U.S. is committed to a competitive economy
Antitrust laws (enacted 1890 - 1930s) prohibit certain activities
that can reduce competitive nature of the economy
Mergers have potential to reduce competition

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The Reasons Behind Mergers
Synergies

– Combined performance is expected to be better than the sum of the
separate performances

– Usually cost saving or marketing opportunities
Growth

– External growth through acquisition is faster than internal growth

Diversification to Reduce Risk

– Collection of diverse businesses less risky than a single line

– Variations in different business lines offset each other

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The Reasons Behind Mergers

Economies of Scale
Guaranteed Sources and Markets
Acquiring Assets Cheaply
Tax Losses
Ego and Empire

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Tax Losses

Rich Inc.
EBT
Tax (35%)
Net Income

Poor Inc.

Merged

$2,000

($1,000)

$1,000

700

-0-

350

$1,400

($1,000)

$650

Combined Businesses pay less total tax.
But IRS will not recognize if sole purpose is to reduce tax.

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Holding Companies
Corporation that owns other corporations

–
–

Companies owned are subsidiaries
Holding company is the parent of the subsidiary

Advantages

–
–
–

Keeps business operations separate and distinct
Can keep liabilities of subsidiaries separate
It’s possible to control a subsidiary without owning all of its stock

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The History of Merger
Activity in the U.S.
Wave 1: The Turn of the Century, 1897-1904

–

Horizontal mergers transformed the U.S. into a nation of industrial giants,
with some monopolies

Wave 2: The Roaring Twenties, 1916-1929

–
–

Began with World War I and ended with the stock market crash of 1929
Horizontal mergers led to oligopolies

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The History of Merger
Activity in the U.S.
Wave 3: The Swinging Sixties, 1965-1969

–
–

Conglomerate mergers - unrelated fields
Stock market driven

An Important Development During the 1970s

–
–
–

Hostile takeovers uncommon prior to 1970s
1974 INCO acquires ESB assisted by respected investment bank Morgan Stanley
After that hostile takeovers became acceptable

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The History of Merger
Activity in the U.S.
Wave 4: Megamergers, 1981 – 1990

– Very large firms, often industry leaders, merge

Wave 5: Globalization, 1992 – 2000

– Began after 1991 – 1992 recession
– Large number of international mergers
– Ended with September 11, 2001

Wave 6: Private Equity, 2003 – 2008

– Private equity groups bought companies for financial reasons
– Ended with the financial crisis of 2008

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Mergers since the 1980s
Mergers since the 1980s are characterized by:
Large Size
Global
Horizontal mergers and antitrust
Easy financing
Hostility
Raiders
Defenses
Advisors


Megamergers since the 1980s

Companies

Year

Industry

$ Size

Citicorp and Travelers

1988

Financial Services

$140 billion

MCI and WorldCom

1998

Telecom

$ 37 billion

Daimler-Benz and Chrysler

1998

Automotive

$ 75 billion

AOL and Time Warner

2000

Media and Entertainment

$ 350 billion

Hewlett-Packard and Compaq

2001

Computer hardware

$ 25 billion


Social, Economic, and
Political Effects
Large mergers have implications regarding the concentration of
power and influence

– Anti-competitiveness of merging large companies
– Concentrates economic power in the hands of a few

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Merger Analysis and the
Price Premium

What is the most an acquiring company should pay for a target in
total and per share?

– Merger analysis attempts to answer this question
– Acquiring firm forecasts the target's cash flows and chooses
appropriate discount rate

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Merger Analysis and the
Price Premium
Estimating Merger Cash Flows

– Should be a straightforward cash flow estimation with two exceptions
Adjustments for expected synergies
Adjustments for reinvestment necessary to support growth

– Pitfalls of estimating cash flows

May not have access to the target's detailed information about future
prospects or the past
Uncertainty of future
Biases of people making estimates

– Acquirer tends to overestimate target’s value

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Merger Analysis
Appropriate Discount Rate

–
–

An acquisition is an equity transaction
Use target’s estimated equity rate (CAPM)

Value to the Acquirer is the PV of estimated cash flows from target

–

Maximum value makes NPV=0 if viewed in capital budgeting terms
Payment for target’s stock is C0 – the initial outlay

Maximum Per-share Price is Maximum

PV ÷ number shares

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Merger Analysis and the
Price Premium
Price Premium

– The price offered to target shareholders must be higher than the
stock's market price
High enough to induce stockholders to sell now
Offering price exceeds the current market price by the price premium

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The Price Premium
Effect on market price

– Certainty of a premium creates a speculative opportunity
– Investor strategy - buy stock in potential takeover targets to get
premium

– Size of Premium is the Point of negotiations
Remember: Insider trading illegal

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