Practical financial managment 7e LASHER chapter 17

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
– Proposal submitted
for stockholder vote

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

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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

tax.

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

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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
number shares

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PV ÷


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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