Mergers and Acquisitions

M&A Market Market for Corporate Control

Competition for control of firm assets

Associated with Downsizing “It’s amazing that the basic cause of downsizing

is so rarely acknowledged: these companies have more workers than they need or can afford to pay… If we must blame somebody for the layoffs, it ought to be you and me…. I haven’t met one person who would agree to pay AT&T twice the going rate if AT&T would promise to stop laying people off. These companies are responding to the constant pressure from consumers and shareholders.”

- Peter Lynch, formerly of Fidelity’s Magellan fund

M&A Introduction Purchase & Sale of Firms or Divisions Bidder

Company Raiders

Target Consideration

Cash or securities offered Advisors

I-Banks, Consultants, Attorneys, Accountants

Friendly - Mgmt support Hostile - Without mgmt support

Williams Act ’68 made more difficult

Horizontal 2 Competitors

Vertical Target in same industry, but different

production stage Conglomerate

2 Unrelated Firms

M&A Types

Taxes Tax-free acquisition

Business purpose; not solely to avoid taxes Continuity of equity interest

Target stockholders have an equity interest in the combined firm

Taxable acquisition Firm purchased with cash Capital gains

Target stockholders require a higher price to cover the taxes

Merger versus Consolidation

Merger One firm is acquired by another Acquired firm ceases to exist Advantage: legally simple Disadvantage: approval of both

stockholders

Consolidation New firm is created by combining

existing firms

Takeovers Control transfers from one group to

another Possible forms

Acquisition Merger or consolidation Acquisition of stock Acquisition of assets

Proxy contest Going private

‘Synergy’ Whole is worth more than the sum of

the parts Break-up Value Market Power

Agency Issues, Hubris Diversification Avoid takeover attempts

M&A Motivation

Synergy ΔV = VAB – (VA + VB)

Synergy: ΔV > 0 Possible sources

Δ CF = Δ Rev. - Δ Costs - Δ Taxes - Δ Cap Req.

Increase revenue Reduce costs Lower taxes or capital requirements

Revenue Enhancement Marketing gains

Advertising Distribution network Product mix

Strategic benefits Market power

Cost Reductions Economies of scale

Lower average cost by spreading overhead

Economies of scope (vertical integration) Coordinate operations more effectively Reduced search cost for suppliers or

customers Reduce contracting problems

Lower Taxes or Capital Needs

Taxes: Take advantages of net operating losses

Carry-backs and carry-forwards IRS can prevent merger if sole purpose is to

avoid taxes Unused debt capacity

Capital Requirements: Reduce relative to the two firms operating

separately

Acquisitions Cash Acquisition

NPV = VB* – cash cost Value of the combined firm VAB = VA + (VB* -

cash cost)

Stock Acquisition Value of combined firm VAB = VA + VB + V Cost of acquisition

Depends on # shares given to target stockholders Depends on post-merger stock price

Example

Cash vs. Stock Sharing gains

Target stockholders don’t participate in stock price appreciation with a cash acquisition

Taxes Cash acquisitions are generally taxable

Control Cash acquisitions do not dilute control

Signal Stock acquisitions indicate your stock is

overvalued

M&A Valuation Market values Only incremental cash flows Appropriate discount rate Consider transaction costs

After Valuation Friendly

Work with management Hostile

Toe-hold or Bear-hug Open market purchase Threaten target BOD with tender offer

Proxy Fight Tender Offer

Defenses Poison pills/put, greenmail, golden parachute,

etc.

Defensive Tactics Corporate charter

Establishes conditions that allow for a takeover

Standstill agreements / Targeted repurchase

Poison pills (share rights plans) Leveraged buyouts

Free-Rider Problem Purchase toe-hold Buy from large shareholders Two-tiered offer

~ Target’s value to bidder = $163.9 million

Target’s current market value = $ 90.0 million

Merger premium = $ 73.9 million

Target - 10 million shares, $9/share

Value to Acquirer

Price Paid for Target0 5 10 15 20

Change in Shareholders’

Wealth

Acquirer Target

Bargaining Range = Synergy

$9.00 $16.39

Market Reaction Target shares increase +20% Bidder shares are stagnant or decrease

Stock offers: -1.5% Cash offers: unclear

Effect on competitors varies

M&A Risk Overpayment

Winner’s Curse

Operating Risk Integration issues, culture Mgmt resources Continued subsidization of sub-par groups

Financial Risk Leverage