Mergers and Acquisitions Bidder firm (acquiring firm) – – the the company making an offer to buy the stock or assets of another firm Target firm (acquired firm) – – the the firm that is being sought • There are three basic legal procedures that one firm can use to acquire another firm: 1. Merger – Merger – The complete absorption of one company by another (assets (assets and liabilities), Acquiring firm retains name and acquired firm ceases to exist , Consolidation – Entirely Entirely new firm is created from combination of existing firms. • Advantage Advantage – – legally simple and relatively cheap. • Disadvantage – must must be approved by a majority vote of the shareholders of both firms, usually requiring the cooperation of both sets of management 2. Acquisition of Stock – Stock – A firm can be acquired by another firm or individual(s), purchasing voting voting shares of the firm’s stock, – stock, – Tender Tender offer – offer – public public offer to buy shares of a target firm, – firm, – No No stockholder vote required, – required, – Can Can deal directly with stockholders, even if management is unfriendly, – unfriendly, – May May be delayed if some target shareholders hold out for more, money – money – complete complete absorption requires a merger 3. •Acquisition •Acquisi tion of Assets – Assets – One firm buys most or all of another’s assets., – A A formal vote of the target stockholders is required, – required, – Transferring Transferring titles can make the process costly. The selling firm may remain in business. Classifications • Horizontal acquisition acquisi tion – both both firms are in the same industry, – industry, – both both firms are in direct competition and share the same product lines and markets. • Ver tical tical acquisition – acquisition – firms firms are in different stages of the production process, – process, – customer customer and company or a supplier and company, – Think Think of a cone supplier merging with an ice cream maker, • Conglomerate acquisition acquisi tion – – firms firms are unrelated Synergy Suppose firm A is contemplating acquiring firm B. The synergy from the acquisition is Synergy = VAB – ( (VA + VB) Synergy occurs if the value of the combined firm after the merger is greater than the sum of the value of the acquiring firm and the value of the acquired firm before the merger. The synergy of an acquisition can be determined from the standard discounted cash flow model:
Revenue Enhancement – Marketing Marketing gains changes in advertising efforts, changes in the distribution network, changes in the product mix Strategic benefits – acquisitions acquisitions that allow a firm to enter a new industry that may become a platform for further expansion Market power – power – reduction reduction in competition or increase in market share Cost Reduction – Economy Economy of scale >the average cost of producti on falls as the level of production increases. – Economies Economies of vertical integration > coordinating closely related activities – Technology Technology transfer – Complementary Complementary resources > improving usage of existing resources. – Replacement Replacement of ineffective managers > If management is not doing its job well, or others may be able to do the job job beder, acquisitions are one one way to replace management Tax Gains – Net Net operating losses – losses – a a firm with losses and not paying taxes may be adractive to a firm with significant tax liabilities – Debt Debt Capacity - adding debt can provide important tax savings • Unused debt capacity - target has too lidle debt, and the acquirer can infuse the target with the mi ssing debt., • Increased debt capacity - A merger leads to risk reduction, generating greater debt capacity. Reduced Capital Requirements – fixed fixed assets and working capital Earnings Growth – If If there are no synergies or other benefits to the merger, then the growth in EPS is just an artifact of a larger firm and is not tr ue growth (i.e., an accounting illusion). – An An acquisition may give the appearance of growth in EPS without actually changing cash flows. This happens when the bidder’s stock price is higher than the target’s, target’s, so that fewer shares are are outstanding aaer the acquisition than before. Diversification – A A fir m’s m’s adempt at diversification diversification does not create value because stockholders could buy the stock of both firms, probably more cheaply. – The The reduction in ri sk from a merger may actually help bondholders and hurt stockholders. A Cost to Stockholders from Reduction in Risk The Base Case – If If two all-equity firms merge, there is no transfer of synergies to bondholders. Thus, the stockholders of both firms are indifferent to the merger. merger. Both Firms Have Debt – Debt – Stockholders Stockholders in Firm A receive stock in Firm AB worth $20. – $20. – Stockholders Stockholders in Firm B r eceive stock in Firm AB worth $10. – Gains – Gains and losses from the merger are: • Loss to stockholders in Firm A: $20 − $25 = −$5 • Loss to stockholders in Firm B: $10 − $12.50 = −$2.50 • Combined gain to bondholders in both firms: $45.00 − $3ti.50 $3 ti.50 = $ti.50. Coinsurance effect - When one of the divisions of the combined firm fails, creditors can be paid from the profits of the other division. division. It makes the debt less risky and more valuable than before. – before. – Stockholders Stockholders are hurt by the amount that bondholders gain. gain. How Can Shareholders Reduce their Losses from the Coinsurance Effect? Retire debt pre-merger and/or increase postmerger debt usage The NPV of a Merger Typically, a firm would use NPV analysis when making acquisitions. The analysis is straighcorward with a cash offer, but it gets complicated when the consideration is stock. stock.
Cash Acquisition 1. Firm B is offered $150 in cash. – Value Value of Firm A aaer the acquisition (VA*) = Value of combined firm – firm – Cash Cash paid = $ti00 - $150 = $550 – Price Price per share = $550/25 = $22 NPV of a merger= VA* - VA = $550 - $500 = $50
– Firm Firm A should make the acquisition 2. Synergy = VAB – VAB – (VA (VA + VB) = $ti00 – $ti00 – ($500+$100) ($500+$100) = $100 – Premium Premium = amount paid above the stand-alone value = Cash paid – paid – VB VB = $150-100 = $50 – NPV NPV of a merger = Synergy – Synergy – Premium Premium = $100 - $50 = $50 – NPV NPV of a merger = Synergy – Synergy – (Cash (Cash paid – paid – VB VB ) = VB + Synergy – Synergy – Cash paid Stock Acquisition Firm A could purchase Firm B with common stock. – stock. – Depends Depends on the number of shares given to the target stockholders, – stockholders, – Depends Depends on the price of the combined firm’s firm’s stock after themerger • Case 1: – Exchange Exchange ratio = 0.75:1, Firm A exchanges 7.5 of its shares for the entire 10 shares of Firm B. – Aaer Aaer merger, Firm A share outstanding = 25 + 7.5 = 32.5 – Firm Firm B shareholders shareholders = 7.5/32.5 = 23 percent of the combined firm – Total Total value of Firm B shareholders after the merger = $700 × 23%= $161 > $150 – Price Price per share = 700/32.5 = $21.54
Case 2: – What What should the exchange ratio be so that Firm B stockholders receive only $150 of Firm A’s stock? – α – α = the proportion of the shares in the combined firm that Firm B’s stockholders own.
– Aaer – Aaer merger, value of Firm B shareholders = α × $700 = $150, thus α = 21.43% – New New shares issued = 6.819 shares – The The exchange ratio = 0.6819 : 1 – Total Total share outstandings = 25+6.819 = 31.819 – Price Price per share = $700/31.819 = $22 Considerations when choosing between cash and stock: – There There is no easy formula. – The – The most important is the price of the bidder’s stock. – stock. – Both theory and empirical evidence suggest suggest that firms are more likely to acquire with stock when their own stocks are overvalued. – overvalued. – Empirical Empirical evidence shows that the acquirer’s stock price generally falls upon the announcement announcement of a stock-for-stock deal. Do Mergers Add Value? Event studies - es7mate abnormal stock returns around the merger announcement announcement date. – date. – Abnormal Abnormal return - th e difference between an actual stock return and the return on a market index. Both acquired and acquiring firms – firms – The The average abnormal percentage return across all mergers from 1980 to 2001 is 1.35 percent. – percent. – However, the aggregate dollar change around the day of merger announcement announcement is −$79 billion. – Although Although most m ergers have created value, mergers involving the very largest firms have lost value. – value. – Overall, the results are ambiguous. Acquiring firms (bidding firms) – firms) – Abnormal Abnormal percentage returns for Acquiring firms have been positive for the entire sample period and for each of the individual subperiods. – subperiods. – The The aggregate dollar change around the day of merger announcement is −$220 billion, suggesting that large mergers did worse than small ones. – ones. – Again, Again, the evidence is ambiguous. Acquired companies (target firms) > acquisitions benefit stockholder. The premium is the difference between the acquisition price per share and the target’s preacquisition share price, divided by the target’s preacquisition share share price. Managers versus Stockholders Managers of bidding firms – firms – Agency Agency theory for mergers - because firm size increases with acquisitions, managers are disposed to look favorably on acquisitions, even ones with a negative NPV. – The The merger failures of large acquirers may be due to the small percentage ownership ownership of the managers. managers. • Managers of target firms – Fear Fear of displacement may lead managers to reject bids, thereby giving up premiums for stockholders. stockholders.
