University of Sussex

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University of Sussex

• Finance Course
• Corporate Finance Principles and Practice

Mergers and Takeovers
Heather Stone FCCA
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Terminology

• Merger agreement to combine between two sets of
  shareholders
• Takeover acquisition of one company by another
• Types of takeover
• Horizontal
• Vertical
• Conglomerate
• Cross border

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Reasons for acquisitions

• Synergy
• Economies of scale
• Elimination of inefficient management
• Entry to new markets
• Provide critical mass
• Providing growth
• Increase market share and power

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Financial reasons

• Financial synergy
• Target undervaluation
• Tax considerations
• Increasing EPS

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Managerial reasons

• Agency theory
• Increase in personal pay and power
• More security against being taken over and lose
  their jobs

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Case against acquisitions

• Refer to Competition Commission
• Contested bid
• Benefits rarely materialise
• Cost of takeover
• Cultural differences
• Complicated tax or legal matters

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Valuation of target companies

• Stock market valuation
• Number of shares times market value
• Asset based valuation
• Book Value
• Net realisable value
• Income based methods
• Capitalised earnings
• PE ratio
• Dividend Growth model
• Discounted Cash Flow

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Capitalised Earnings

• Annual maintainable expected earnings
• Allowing for any expected synergy
• Divided by required earnings yield
• This can be calculated as PE ratio divided by
  share price
• Uncertainty surrounding determination of earnings

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PE Ratio valuation

• Published PE ratio
• Divided by distributable earnings
• Variation in PE ratios leads to wide variation in
  calculation

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Dividend Growth Model

• Determine shareholders required return
• Determine expected dividend growth rate
• Insert in formula for Dividend Growth Model
• Gives Market Valuation
• Problem with determining expected dividend growth
  rate

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Discounted Cash Flow Valuation

• Maximum willing to pay would be difference
  between pre and post acquisition cash flows
• Discount cash flows to present value
• Problem with estimating cash flows
• What discount rate should be used?

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Financing Acquisitions

• Cash offers
• Share for share offers
• Vendor placings
• Security packages
• Debentures loan stock
• Convertible bonds
• Preference shares
• Mixed bids

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Pre Bid Defences

• Make too expensive to buy
• Improve efficiency
• Divestments of low profit assets
• Good investor relations
• Restructure equity
• Management retrenchment
• Cross holdings

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Post bid defences

• Pre emptive circulation to shareholders
• Formulation of defence document
• Profit announcements and forecasts
• Dividend increase announcements
• Revaluation of assets
• Search for white knight
• Pac-man defence

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Divestments

• May need to reduce size or raise capital
• Sell offs
• Spin offs (demerger)
• Management buyouts