Lecture 12: Mergers and acquisitions (M

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Lecture 12 Mergers and acquisitions (MA)

• Objectives
• Understand the fundamental theory underpinning
  MAs
• Discuss the motives behind MAs
• Describe the methods of financing MAs
• Apply the various methods of share valuation
  under MA
• Discuss the reasons for merger failure.

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Mergers and Acquisitions

• Merger
• is where two companies come together to combine
  and share resources to achieve a common
  objectives.
• Under merger the combining firms remain
• joint owners
• new company is created

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Mergers and Acquisitions

• Takeover or acquisition
• one firm purchase the assets of another, with the
  acquired firm ceasing to be the owners of that
  firm. Often it is the larger company which
  acquires a smaller one

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Types of M A

• Horizontal merger
• two companies engaged in similar activities are
  combined
• Vertical merger
• firms from different points in the same
  production process decide to combine
• Conglomerate merger
• occurs when two businesses in unrelated
  industries decide to combine

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Mergers and Acquisitions

• Objectives of MAs
• Enhance shareholder wealth through competitive
  advantage
• Empire building

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Mergers and Acquisitions

• Theoretical perspective (pages 89-90 hand book)
• Question
• Is take over targets a way of disciplining
  managers who fail to seek the interest of
  shareholders (Market for Corporate Control) or
  are there motives different from this? From
  lecture 1 (agency problem). Read more on this
  area.

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Motives of M A

• Economies of scale
• to enable benefits of scale to be achieved
• To reduce competition
• to co-opt an existing competitor in order to
  reduce competition
• Market power
• increase market share

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Motives of M A

• Sharing complementary resources
• bringing together the relative strength of each
  firm
• New market entry
• to facilitate expansion into new market
• To reduce risk
• diversification

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Motives of M A

• Managerial motive
• to avoid being taken over (job security)
• to pursue growth in size, status and higher
  remuneration
• Removal of inefficient Management
• -to remove managers who failed to maximise
  shareholder wealth

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Bid Strategies and Tactics

• Bid strategy
• a plan to acquire another company in order to
  achieve the predetermined business and corporate
  strategy objectives of the acquirer.
• Appoint a team of top managers to handle the
  merger (A team). In the case of complex mergers
  outside experts are appointed and co-opted into
  the A team

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Bid Strategies

• Functions of A team
• Bid opportunities identification
• Target evaluation
• Crating bid tactics
• Planning and making approach to selected targets
• Assessing the target response

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Bid Strategies

• Functions
• Defining the lines of attack if the bid becomes
  hostile.
• Day-to- day conduct of the bid
• Communication with the media, important
  shareholders and regulatory authorities

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Bid Strategies and Tactics

• Objectives of bid tactics
• To win control of the target
• To minimise the control premium paid to target
  shareholders
• To minimise transaction cost
• To smooth post-acquisition integration.

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Defensive Measures

• Employees share option scheme
• use of employee share option will lead to
  employees resisting the takeover
• Circulating shareholders - this involves sending
  circulars to shareholders arguing
• bids not in the long-term interest of shareholder
• share price offered is too low
• disclose profit forecast, assets valuation

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Defensive Measures

• Making the company unattractive to bidders
• take a poison pill e.g convertible debt may be
  converted into equity causing the acquirer to
  incur greater cost
• crown jewel e.g sale of a prized assets of the
  business
• golden parachutes purchase of certain assets
  which bidding company does not want

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Defensive Measures

• Making the company unattractive to bidders
• golden parachutes e.g. purchase of certain
  assets which bidding company does not want
  (dividend payments) results in reduction in cash
  balances
• Pac-man defence involves launching a counterbid
  for the predator company

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Defensive Measures

• Making the company unattractive to bidders
• White Knight (involves seeking another company (a
  white knight) with which to combine
• Referral to the Competition Commission
• - government appointed body which considers the
  effects of mergers on level of competition

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Methods of Financing Mergers

• Cash payment
• pay the purchase consideration by cash
• Shares
• issue of ordinary and preference shares
• Loan capital
• debentures
• convertible loans

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Methods of Financing Mergers

• Advantages of Cash payment
• certain and clearly understood by the target
  company
• improves the chances of a successful bid
• Disadvantages of cash payment
• raising the necessary cash can be difficult for
  the bidding company where the target company is
  large

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Methods of Financing Mergers

• Advantages of purchase by Shares
• a voids strain on the cash position of the
  company
• Disadvantages of purchase by Shares
• expensive way of raising capital
• low gearing

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Target Valuation

• Methods
• Asset-based methods
• Balance sheet or net book values approach
• P Total assets - total liabilities
• No of ordinary shares issued
• Net realisable values or replacement cost
• P net realisable value - total liabilities
• No of ordinary shares issued

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Target Valuation

• Stock market methods
• For listed companies use the share price on the
  stock exchange

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Target Valuation

• Cash flow methods
• Gordons growth model
• Value of share Dividend received
• Rate of return growth in dividend
• Free cash flow method
• PV of future cash flow-total liabilities
• No of ordinary shares issued

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Target Valuation

• Dividend Yield Gross dividend per share
• Market value per
  share
• MV/S Gross dividend per share
• Dividend yield
• P/E ratio market value per share
• Earning per share
• Market value per share P/E ratio x EPS

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Target Valuation solution12.1

• a) P Total assets - total liabilities
• No of ordinary shares issued
• P (9.9 5.8) (6.5 3.6)
• 2
  2.8
• b) Net realisable values or replacement cost
• P net realisable value - total liabilities
• No of ordinary shares issued
• P (18.24.23.40.42.6)-(6.53.6)
• 2
  9.36

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Target Valuation

• c) Replacement cost
• P Assets at Replacement cost - total
  liabilities
• No of ordinary shares issued
• P (19.25.23.90.42.610)-(6.53.6)
• 2
  15.6

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Target Valuation

• d) P/E ratio market value per share
• Earning per share
• Market value per share P/E ratio x EPS
• 11 X 3.6
• 2
• 19.80

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Target Valuation

• e) Cashflow DCF 10 PV
• 19x2 4.4 0.91
  4.0
• 19x3 4.6 0.83 3.82
• 19x4 4.9 0.75 3.68
• 19x5 5.0 0.68 3.40
• Next 13 yrs 5.4 4.90 26.46
  
  41.36
• 41.36 -10.1 / 2.0 15.63

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Failure of M A

• Reasons
• Over-optimisation
• Acquirers often pay too much for their targets as
  a result of flawed evaluation process that
  overestimates the likely benefits
• Failure of integration management
• improper planning and execution of the
  integration process.

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Further Reading

• Manne, Henry G. (1965) Mergers and the Market
  for Corporate Control The Journal of Political
  Economy, Vol 73, No 2 (April), pp. 110-120.
• Siriopoulos, C. et al (2006) Does the Market for
  Corporate Control hypothesis explain takeover
  targets? Applied Economics Letter, Vol. 13, pp.
  557-561.
• Sudarsanam, P.S.(1995). The Essence of Mergers
  and Acquisitions, Prentice Hall.

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Divestment

• Divestment involves
• the sale of part of a company and is opposite to
  acquisition.
• Arithmetic behind divestment, or reverse synergy
  argues that 5-1 is worth more than 4.
• In other words, part of the business can be sold
  off at a greater value than its current worth to
  the company

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Forms of Divestment

• Sell-off
• selling off part of a business to a party usually
  for cash.
• Reason
• to divest less profitable, non-core business unit
  to ease cash flow problems

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Forms of Divestment

• Spin-off
• a new company is created with assets transferred
  to it and a new management to run it. No change
  in ownership
• Reasons
• create a clearer management structure and
  strategic vision to increase efficiency and
  effectiveness.

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Drawbacks of divestment

• Loss of economies of scale
• A smaller firm may find it harder to raise finance

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Thank you all for listening to me