Title: Mergers and Acquisitions
1Mergers and Acquisitions
2What is a Merger?
- In a MERGER, two (or more) corporations come
together to combine and share their resources to
achieve common objectives. - The shareholders of the combining firms often
remain as joint owners of the combined entity. - A new entity may be formed subsuming the merged
firms
3What is an Acquisition?
- In an ACQUISITION, one firm purchases the assets
or shares of another. - The acquired firms shareholders cease to be
owners of that firm. - The acquired firm becomes the subsidiary of the
acquirer. - Acquisitions usually take the form of a public
tender offer.
4A Brief History of MA Activity
- MA activity has increased substantially since
the mid-1960s. - The increased takeover activity that started in
the 1980s can be attributed to a number of
factors - The emergence of the high-yield (junk) bond
market that was used to finance a number of that
acquisitions. - The permissive stance toward mergers by the
Justice Department during the Reagan
administration. - Increase in foreign competition, major changes in
certain industries and the deregulation of
transportation, communications, and financial
services (especially in Europe) brought about a
need for a change in the way companies did
business.
5Report Title Statistical Abstract of the U.S.,
2003 Issued By Bureau of CensusPublication
Date December, 2003, Table on Page 511.
6International Merger Activity 1990-2001
1990-1994 1990-1994 1998-2001 1998-2001 1998-2001
All Mergers All Mergers All Mergers All Mergers Cross Border Cross Border Cross Border All Mergers All Mergers All Mergers Cross Border Cross Border Cross Border
Val. Val. Val. Val. Val. Val.
Africa 0.60 3.27 3.27 0.27 0.27 0.86 0.86 2.07 9.98 9.98 0.55 2.39 2.39
Asia 0.37 1.46 1.46 0.03 0.03 0.48 0.48 1.02 3.43 3.43 0.15 0.93 0.93
N. Amer. 2.63 17.92 17.92 0.45 0.45 2.25 2.25 7.42 35.12 35.12 1.43 5.12 5.12
Oceania 2.24 12.98 12.98 1.05 1.05 5.55 5.55 3.17 24.05 24.05 1.48 7.55 7.55
C. S. Amer. 0.04 3.92 3.92 0.02 0.02 2.94 2.94 0.84 8.71 8.71 0.69 6.47 6.47
W. Eur. Euro 1.81 15.55 15.55 0.69 0.69 5.04 5.04 3.97 15.87 15.87 2.08 6.09 6.09
W. Eur. - No Euro 1.49 5.65 5.65 0.96 0.96 3.25 3.25 2.14 6.77 6.77 0.76 4.72 4.72
All 1.19 12.25 12.25 0.27 0.27 2.58 2.58 4.47 17.82 17.82 1.26 4.24 4.24
7Figure 1. Number of Acquisitions by Year and
Region The total sample includes all takeover
announcement that take place between January 1,
1990, and December 31, 1999, available in the
Securities Data Corporation Mergers and
Acquisitions database. Only public companies are
considered, and we exclude LBO deals, spinoffs,
recapitalizations, self-tender and exchange
offers, repurchases, minority stake purchases,
acquisitions of remaining interest, and
privatizations. Second and subsequent bids that
occur within a window of four years relative to
an initial announcement are excluded. Non-US data
includes acquisitions from 55 countries.
8Advisor Ranking Completed Acquisitions, World
Targets 1995-2003
9Basic Facts Mergers
- Generally friendly.
- Require the approval of both management
teams/boards before the stockholders vote. - Mergers are often done in an exchange of
securities. - Common stock of the bidding firm for common stock
of the target firm. - They are not taxable events for the target
stockholders, unless they sell the bidders
stock.
10Basic Facts Tender Offers
- Generally unfriendly.
- Target management by-passed by asking the
stockholders to sell their stock, votes, etc. - Often done for cash.
- Sometimes for new debt securities or stock.
- Are taxable events for the target stockholders
- Strong incentive for the bidding firm to complete
the acquisition quickly, in order to reduce the
probability that a competing bidder will come
along.
11Tender Offer Process
- Start with a public announcement following a 14d
filing with the SEC. - The filing must specify the consideration offered
to the shares of the target firm, the objective
of the merger (acquisition), and the timeline of
events. - The target management has 10 days to respond to
the offer, via a 14d-9 filing.
12Other Issues
- Tendering shares
- Right to withdraw
- Best price rule (a.k.a. fair price rule)
- Collars
- Provides for certain changes in the exchange
ratio conditional on the level of the bidders
stock price around the effective date of the
merger. - Helps insulate target stockholders from
volatility in the bidders stock price by
promising a cash-like payoff at the end of the
bid period. - Competing tender offers
- Contingent payments Earnouts and Contingent
Value Rights (CVRs)
13Estimating Gains and Losses
- On January 1 firm A offers to buy B. On February
1 the acquisition is completed. - If firm As value increased by 2 and Bs value
by 15 during the month what was the mergers
impact? - Answer It depends on each firms beta and how
well the market did over the same period.
14Abnormal Returns
- The abnormal return (AR) for a security i in
period t is defined as
- The cumulative abnormal return (CAR) for a
security i in n period interval ta to tb is
defined as
15Interpreting the CAR
- The period ta to tb is called (misleadingly) the
event window. - If the CAR gt 0 over the event window then the
firms security did better than expected over
that period. If CAR 0 it did as expected and
if CAR lt 0 it did worse than expected.
16CAR Prior to Event Date
- If the CAR is not zero prior to the public
announcement of the event date (t0) this implies
information leaked into the market prior to its
public announcement. - If the CAR up to the event date (ex. t-60 to t0)
is positive the event was good for the securitys
value. If negative it was bad, and if zero had
no impact.
17CAR After the Event Date
- After the event date the CAR should be zero. If
not, then the market has incorrectly forecasted
the events impact on the firms value. - In a large sample, the average CAR across events
should average to zero.
18Stock Price Reactions
- Mergers
- Bidders gain 0
- Targets gain 20
- Tender Offers
- Bidders gain 4
- Targets gain 30
- (Jensen and Ruback, Journal of Financial
Economics, 1985)
19Target Premium
- Why are premiums smaller for targets in mergers?
- Larger premium in tender offers to make target
stockholders as well off after taxes - Could be that some of the cost of the bid is
used to buy off target management (to get them to
cooperate), so the gains to stockholders are
smaller. - Both of the stories imply that the pie is being
divided in different ways, with target
shareholders getting a smaller piece.
20CARs for Takeover Targets
Total takeover value to the target.
Value of resolving uncertainty about the takeover.
Preannouncement information leakage.
21Bidder Premium
- Why are premiums smaller for bidders in mergers?
- Could be that bidders know that tender offers are
more expensive, higher premia required. - Greater chance of competition.
- Higher legal/investment banking fees.
- So they only pursue deals that are likely to have
large potential gains. - There are some deals that remain profitable as
mergers that would not be as hostile tender
offers, so the samples are not comparable
22Gains Improved Managerial Efficiency
- Market for corporate control assumes that
managers act in the interest of the shareholders.
Firms that do not maximize shareholder value are
targets for takeover. - Prediction
- Target share prices experience significant
declines prior to the merger or tender offer. - Managers of target firms are fired after the
takeover.
23Synergy Gains Horizontal Mergers
- Firms producing similar products in similar
markets (i.e., the same industry). - Monopolistic pricing could be gains from
reducing competition - Reduce output, and increase profits
- Demand curve facing the firm becomes less elastic
- Antitrust Division of the Justice Department
the Federal Trade Commission worry about
horizontal mergers. - Monopoly pricing makes consumers worse off
- Efficiency increasing mergers make consumers
better off more output at lower prices.
24Synergy Gains Vertical Mergers
- Upstream firm buys a downstream firm (or visa
versa) - If one firm has a monopoly, can the merged firm
increase profits by charging monopoly prices at
both levels? - NO.
- Are there efficiency gains from internal rather
than external contracting? - It depends there is still an important transfer
pricing problem.
25Synergy Gains Conglomerate Mergers
- Firms in totally different industries
- Perhaps there are efficiencies in management or
some centralized service, but is doubtful today. - May have been more important when centralized
information systems first came into being
(1960s)
26Conglomerate Mergers Diversification
- At first sight diversification may create value.
- Who benefits from diversification?
- Not stockholders (at least directly). They could
do it on their own account by buying the stock of
the two companies, avoiding paying a premium.
Better yet, their holdings wouldnt have to be in
fixed proportions. - May benefit indirectly.
27Diversification Employees
- Other stakeholders
- They are forced to hold undiversified portfolios
of the stock of the bidder/target firm. - It is hard for them to diversify on their own
accounts. - Employees cannot diversify their human capital.
- They may be willing to accept a lower salary
and/or have a larger commitment to the company if
they take less risk. - May ultimately benefit shareholders.
28Diversification Bondholders
- Maybe the combined firm becomes safer.
- But bondholders do not have any decision power!
- The firms debt capacity will be increased if
the firm is more diversified. - Lenders care about total risk, not just
systematic beta risk. - To the extent that there are advantages with debt
financing, shareholders will benefit.
29Diversification Executives
- Managers in small firms may be undiversified for
control purposes, and become too risk averse. - Hence, both inside and outside shareholders may
benefit through diversification. - A merger always changes control in at least one
of the firms. - Good or bad depending on who is losing out and
why. - Fired Bad if you are the one being dismissed.
- Retired Good if you are the one being bought
out.
30Diversification Benefits the Evidence
- Acquirers in diversifying mergers have negative
abnormal returns (-2) in the 80s. - Not in the 90s, instead earn about 0.
- Acquirers in related businesses experience
positive returns of 2, on average. - Targets of hostile bids in late 80s are often
broken up and sold to companies in related
businesses - No evidence that there exists a large advantage
from diversification.
31Conglomerate Mergers Hubris Hypothesis
- Managers commit errors of over-optimism in
evaluating merger opportunities due to excessive
pride, animal spirits or hubris.
32Summary
- From a policy perspective, gains come from either
efficiency gains (good), or from monopolization
(bad). - Management shouldnt care, except that the
probability of antitrust problems increase if the
gains come from monopoly pricing. - Always ask yourself whether it is necessary to
merge to capture the efficiency/pricing gains.
Are other contracting methods better than paying
a premium to buy control? - Diversification by itself should not increase
firm value. - Since corporate control always changes, this may
be the common factor explaining the gains - Managers of target firms are often fired after
the takeover.
33Takeover Defenses
- Successful takeovers
- Target Stockholders gain 20-35 or more
- Unsuccessful takeover
- Target stockholders gain little if not eventually
taken over. - Why defend a firm from a takeover?
34Defense Entrenchment or What?
- Why it might not be entrenchment.
- Target management may try to get a higher bid
from bidder. - Sometimes such negotiations cause a deal to fail.
- Target management may defend the firm while
searching for another bidder willing to pay more. - The delay may inadvertently cause the deal to
fail. - Why it might be entrenchment.
- You know what they say about ducks!
35Takeover Defenses Charter Amendments
- Supermajority Rules.
- 67 or more of votes necessary to approve control
change can be avoided by board. - However, it can be avoided by board ("board out")
- Fair-Price supermajority clause can be avoided
if price is high enough (P/E or P/B). - Staggered Board.
- Only 1/K of board is elected each year, so it
takes K years to turnover board completely.
36Charter Amendments Poison Pills
- Securities that provide shareholder (except
acquirer) with special rights, following the
occurrence of a triggering event such as a tender
offer. - They 'poison' the acquirer if it swallows the
pill. - Poison pills do not have to be approved by
shareholders. - Flip over plans
- Shareholders have the right to buy the shares of
the target at a premium above the market. - In case of a merger they flip-over the
shareholders have then the right to buy the
shares of the bidder at a substantial discount
below market. - Ownership flip-in plans
- If the bidder acquires a threshold, shareholders
(except the bidder) have the right to purchase
shares of the target firm at a discount. - Back-end right plans
- If the bidder acquires a threshold, shareholders
(excluding bidder) can exchange a right plus a
share for cash equal to a back-end price set by
the board of directors of the issuing firm. - Thus, back-end price will then becomes the
minimum effective bid price.
37Defenses Voting Plans
- If a party acquires a substantial block of the
firm's stock, the other shareholders receive more
voting rights.
38Legal/Regulatory Defenses
- State corporation/anti-takeover laws impose rules
that are similar to stringent charter amendments
for all corporations chartered in that state. - Inter-firm litigation can be effective.
- Target charges that bidder failed to disclose
something material in SEC filings.
39Asset Restructuring Defense
- Crown Jewel defense
- Contract to sell attractive assets to a third
bidder contingent on hostile bid - Pac Man defense
- Make competing tender offer for shares of bidder.
40Other Defenses
- Leverage Recapitalization.
- Partial LBO leaving equity holders with much
riskier claims. - ESOPs
- Employees get equity claim in the firm, but
management votes the shares of the stock in the
ESOP. - Golden Parachutes
- Lump sum payments to target management if fired
due to takeover. - Usually small relative to size of deal, so
probably not much deterrence effect. - Aligns the interests of target management with
shareholders.
41Other Defenses Continued
- Greenmail
- Buy back stock (at a premium above the market
price) from large stockholders who may pose a
threat. - Often liked with standstill agreements.
- Shareholders bought out (through greenmail) agree
not to make further investments in the target
company. - Should greenmail be outlawed?
42Valuing Acquisitions
- Evaluating a potential acquisition is similar in
most respects to analyzing the NPV of any other
investment project a firm may be considering. - Some subtle differences
- The value of potential synergies must be added to
the value of the target firm's cash flows. - The target firm's stock price will exceed the
present value of the firm's future cash flows, if
it reflects the possibility that the firm may
eventually be taken over at a premium.