Mergers & Acquisitions

Buying another firm...

Merger / consolidation
Acquisition of equity / shares
Acquisition of assets

How does takeover fit into above?

M&As: Types
Horizontal
Vertical
Congeneric /concentric mergers
Conglomerate
Tender offers

M&As: Why?

Reasons for M&As

Obtaining specific assets, IP, skills
Tobins Q
Ratio < 1

Synergies
Operational
Economies of scale
Economies of scope

Financial
Reducing cost of capital

Reasons for M&As

Acquisitive growth
Strategic realignment
Technological change, deregulation etc.

Diversification
Risk diversification

Related industries
Unrelated industries
Conglomerates

The diversification argument

Is shareholder risk reduced through
M&As?
Theory and much experimental evidence
suggests: perhaps, but not optimally.

Shareholders can diversify by buying

different shares matching their individual
requirements, whereas an M&A restricts
their freedom of choice

The Conglomerate Discount

Generally found that there is a
conglomerate (diversification) discount
(shares of a listed conglomerate almost always trades at a discount to the
sum of its parts)

Implication:
Unwinding of conglomerate discount through
unbundling usually benefits shareholders
Can sometimes be used as basis for relative valuation

Reasons for M&As

Reduced competition
Market power
Antitrust / competition issues

Acquiring tax benefits

Cash resources in target / low gearing
Cash resources in acquirer (ROE)

Competition Authorities
May block proposed merger on basis of excessive
reduction of competition in relevant industry.

Competition Commission:

statutory body
constituted in terms of the Competition Act, No 89 of
1998. Investigates, evaluates proposed mergers and
acquisitions and makes recommendations to Competition
Tribunal

Competition Tribunal: statutory body that

adjudicates competition matters informed by
findings of Competition Commission

Manager Motives for M&As

Often:
Enlarge firm:
Power and prestige
May be rewarded based on assets of firm
See Barbarians at the Gates (Ross Johnson & RJR
Nabisco)

Reduce risk through diversification:

Diversification may reduce risks in business
Managers have a direct and personal interest in this
(Agency)

Bootstrapping (artificial EPS growth)

Acquiring firm has high P/E ratio
Selling firm has low P/E ratio (due to low
share price)

After merger, acquiring firm has short term

EPS rise
Market cap up if market used acquirer P/E
Long term, acquirer will have slower
earnings growth than otherwise due to
share dilution

Example: Same P/Es

Total earnings
# Shares
EPS
P/E
Share price
# Shares
Market Cap

Acquirer

Target

Acquirer after merger

R 500,000
100,000
R5
10x
R50
100,000
R 5,000,000

R 250,000
50,000
R5
10x
R50
50,000
R 2,500,000

R 750,000
125,000*
R6
10x
R60
125,000*
R 7,500,000

Sum = R 7, 500,000
* Assumptions: one share of A issued for two shares of T, market applies acquirer P/E

Example: Acquirer PE > Target P/E

Total earnings
# Shares
EPS
P/E
Share price
# Shares
Market Cap

Acquirer

Target

Acquirer after merger

R 500,000
100,000
R5
10x
R50
100,000
R 5,000,000

R 250,000
50,000
R5
5x
R25
50,000
R 1,250,000

R 750,000
125,000*
R6
10x
R60
125,000*
R 7,500,000

Sum = R 6,250,000
* Assumptions: one share of A issued for two shares of T, market applies acquirer PE

Example: Acquirer PE < Target P/E

Total earnings
# Shares
EPS
P/E
Share price
# Shares
Market Cap

Acquirer

Target

Acquirer after merger

R 500,000
100,000
R5
5x
R25
100,000
R 2,500,000

R 250,000
50,000
R5
10x
R50
50,000
R 2,500,000

R 750,000
125,000*
R6
5x
R30
125,000*
R 3,750,000

Sum = R 5,000,000
* Assumptions: one share of A issued for two shares of T, market applies acquirer PE

M&A Success Rates

M&As generally have a low success
rate
Often estimated at between 15%
and 25%
Why?

Reasons for Failure

Lack of corporate culture fit
Overoptimistic expectations (Hubris
Hypothesis)- (often driven by egos and empire building)
Overvaluation
Lack of post-merger integration
Regulatory complications
Loss of brand, customers, staff etc.
Excessive diversification / complexity

Resisting (Hostile)Takeovers
Why?
Shareholders
Management

Publically listed companies

Need to notify stock exchange or regulatory
authority of shareholding crosses threshold
10% on JSE
5% in US (reported to the SEC)

Once offer is public: company is put in

play

Resisting Takeovers
Control structures
Ownership restructuring
White knights

Resisting Takeovers
Shark repellents
Supermajority: requires S/H approval by at
least 2/3 vote (sometimes as high as 80%!!) for all
control change transactions

Staggered boards:
only a fraction of the board is
elected in a particular period

Resisting Takeovers
Poison pills:
takeover attempt or change in control
triggers right of existing shareholders
to purchase more shares at discount

Poison puts:
Bondholders can demand retirement
of debt when control changes

Resisting Takeovers
Anti-Greenmail: make company less
attractive to greenmailers by limiting its powers to buy
its own shares

Greenmail: forcing company to buy back a large block

of shares at a premium to avoid being taken over.

Scorched Earth Strategy*:

Sell off attractive assets, and/or take on a lot of debt
to make takeover unattractive

*Aka: Selling the Crown Jewels

Reducing Resistance
Golden Parachute:
Offering management generous benefits to leave the target
company and so remove resistance to takeover.
Can be very costly to shareholders in combined firm,
however

Shareholder Interests
Are take-over defences in the interest of
shareholders and the share price?
Usually take-over resisted on basis of offer
price being too low (shareholders
can/should get more)
But: often has more to do with management
retaining control / jobs than looking after
shareholder interests (agency issues)

Minority shareholders

Valuing Acquisition: Acquirer

Value of target not same for all potential
acquirers. Why?
More potential synergies = higher justifiable
offer
Valuation techniques
Relative
DCF
Liquidation
i.e., all the usual methods

Value of a Merger
V = VAT (VA + VT)
= synergies and savings (the drivers)
Net incremental gains = estimated incremental
cash flows:

FCF = EBIT + Depreciation - Tax - Capital

= Revenue - Cost - Tax - Capital

Cost of Merger
Value of target to acquirer is:
V = VT + V

where V = VAT (VA + VT)

Buy if NPV = V - C > 0

Payment options:
Cash
or
Shares

where C = cost

Cash Acquisition: Costs

Price per share
# of shares

Market value

Acquirer

Target

R20

R10

25

10

R500

R100

Assumptions:
1. Both firms are 100% equity owned
2. Incremental net gain to A from acquiring T is R100
3. T has decided not to sell for less than R150 (R100 firm value +
R50 acquisition premium)

Cash Acquisition: Costs

1. The value of T to A is
V = VT + V = R100 + R100 = R200
2. NPV of the cash acquisition is R200 - R150 = R50
3. After the acquisition, As value increases by R50 to
R550, and firm As shareholders have obtained
R50 out of the R100 merger gains
4. A continues to have 25 shares and each share will
be worth R550/25 = R22, meaning a gain of R2
per share

Acquisition with Shares: Costs

1. Shareholders in T exchange their shares for
shares in the new combined firm
2. The merged business is worth
VAT = VA + VT + V = R500 + R100 + R100 = R700
3. Ts shareholders wanted R150, so they receive
7.5 shares in A (R150/20)
4. AT has 25 + 7.5 = 32.5 shares worth R700, with a
value per share of R700/32.5 = R21.54
5. Was the cost of the acquisition to A R150?

Acquisition with Shares: Costs

1. The 7.5 shares of the merged firm owned by firm
Ts shareholders are worth 7.5 x R21.54 =
R161.55
2. The NPV of the stock acquisition is

NPV = V - C = R200 - R161.55 = R38.45

3. This lower than the NPV of the cash acquisition.
Why?
4. Because Ts shareholders share some of the
gains (but also the losses)

Cash vs. Paper: Implications

Buying with stock if cash resources limited protects
cash flow
Using cash to finance an acquisition (merger) implies
that the cost is unaffected by the merger gains
Tax issues: cash payment may trigger taxes
Distribution of synergy benefits: none to shareholders
in target firm if cash payment
Using stock is preferred if there is potential for
overvaluation or undervaluation of either firm (costs of this
will be shared by both firms shareholders)

Share Price Impacts

Empirical evidence shows that on announcement of a
merger bid:
Share prices of target firms increase
Share prices of acquiring firms remain unchanged
or falls
Total market value of two companies together
increases
Longer term (3-5 years): value more often than not
destroyed

Returns to Sellers
Sellers generally make good returns due to:
Premium to share price offered (usually 10-50%)
Bidding wars (hostile takeover returns > friendly takeovers)
Acquirers often overpay (behavioural finance issue)

Also:
Cash buyers experience greater returns than share
buyers
Targets of failed mergers trade at a higher price

Research findings: Bidder Shareholders

Returns to bidder shareholders tend to be low to
slightly negative if acquisitions/mergers are
successful
Shareholders of unsuccessful bidders often realise
negative returns post the offer process
Bidders with low leverage tend to offer higher
premiums
Better returns are realised on private acquisitions
than public ones

Smaller acquirers realise better returns than larger

ones
Source: de Pamphilis , Merger and Acquisition Basics: All you need to know.

Largest Acquisitions
Aquirer
1 America Online
2 Vodafone Airtouch
3 Verizon Communications
4 Fortis, Banco Santander, RBS
5 Pfizer
6 AT&T
7 Exxon
8 Comcast
9 Sanofi-Synthelabo
10 Bell Atlantic
11 SBC Communications
12 Comcast Corp
13 Pfizer acquires Pharmacia
14 Pfizer acquires Wyeth
15 InBev
16 Vodaphone

Target
Value ($bn)
Time Warner
186.2
Mannesman
185.1
Cellco Partneship
130.1
ABN Amro
100.0
Warner-Lambert
87.3
BellSouth
83.1
Mobil
80.3
AT&T Broadband
76.1
Aventis
73.5
GTE
71.1
Ameritech
68.2
Time Warner Cable
67.6
Pharmacia
64.3
Wyeth
64.2
Anheuser-Busch
60.8
Airtouch Communications
57.4

Date
Method
10/1/2000 Shares
14/11/1999 Shares and debt
2/9/2013 Cash and shares
04/25/2007 Cash and shares
4/11/1999 Shares
5/3/2006 Shares
1/12/1998 Shares
9/7/2001 Shares
26/1/2004 Cash and shares
28/7/1998 Shares
11/5/1998 Shares
2013/02/14 Shares
15/7/2002 Shares
26/1/2009 Shares
11/6/2008 Cash
5/1/1999 Shares

Sources: Bloombergs and Business Insider