Lecture 8
Mergers, Acquisitions,
Takeovers, Buyouts and
Corporate Governance
(Ch 29)
1
Learning Outcomes
Be able to define the various terms
associated with M&A activity
Understand the various reasons for
mergers and whether those reasons
are in the best interest of
shareholders
Understand the various methods for
paying for an acquisition
Understand the relationship
between treats of takeover and
agency problem
2
Lecture Outline
Forms of Acquisitions
Synergy and its Sources
Financial Side Effects of
Acquisitions
The NPV of a Merger
Do Mergers Add Value?
Treats of Takeover reduces Agency
Problem
3
The Basic Forms of Acquisitions
There are three basic legal
procedures that one firm can use to
acquire another firm:
Merger or Consolidation
Acquisition of Stock
Acquisition of Assets
The Basic Forms of Acquisitions 4
Merger versus Consolidation
Merger
One firm is acquired by another
Acquiring firm retains name and
acquired firm ceases to exist
Advantage – legally simple
Disadvantage – must be approved by
stockholders of both firms
Consolidation
Entirely
new firm is created from
combination of existing firms
The Basic Forms of Acquisitions 5
Acquisition of stock
Acquire a firm by purchasing voting
shares of the firm’s stock
Tender offer: public offer to buy shares
No stockholder vote required
Can deal directly with stockholders,
even if management is unfriendly
But may be delayed if some target
shareholders hold out for more money
The Basic Forms of Acquisitions 6
Acquisition of Asset
An asset acquisition is the purchase
of a company by buying its assets
instead of its stock.
The Basic Forms of Acquisitions 7
Acquisition Classifications
Horizontal – both firms are in the same
industry
Vertical – firms are in different stages of
the production process
Conglomerate – firms are unrelated
The Basic Forms of Acquisitions 8
Synergy
Traditionally, acquisitions deliver value
when they allow for scale economies or
market power, better products and
services in the market, or learning from
the new firms.
V = VAB – (VA + VB) and V > 0
Synergy
Sources of Synergy
Revenue Enhancement
Marketing Gains
• Effective media programming and
advertising efforts;
• Stronger distribution network;
• A more balanced product mix.
Strategic Benefits
Example: Procter & Gamble’s acquisition of
the Charmin Paper Company
Market or Monopoly Power
Sources of Synergy 10
Sources of Synergy
Cost Reduction
Replacement of ineffective managers
Economy of scale or scope
Tax Gains
Net operating losses
Unused debt capacity
Reduced Capital Requirements
Sources of Synergy 11
Synergy
Most acquisitions fail to create value
for the acquirer.
The main reason lies in failures to
integrate two companies after a
merger.
Intellectual capital often walks out
the door when acquisitions are not
handled carefully.
Synergy 12
The Failed Merger of Mercedes & Chrysler
https://mwmblog.com/2019/12/01/the-failed-merger-of-mercedes-chrysler/
On May. 7, 1998, makers of the luxury auto car, Mercedes-
Benz, announced a $36 billion merger with the Chrysler
Corporation: the biggest acquisition by a foreign buyer of
any U.S. company in history.
The merger was supposed to be a win-win for both
parties. The move was supposed to raise Benz’s market
share in the U.S. auto market. Chrysler was supposed to
improve its vehicles with exposure to Benz car expertise
and also lower its costs.
Mistakes Were Made:
Cultural Differences
Empire Building
Lack of Cooperation
Lack of Due Diligence
A cumulation of these mistakes led to the Mercedes
Chrysler merger being one of the biggest merger and
acquisition mistakes of all time.
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Calculating Value
Avoiding Mistakes
Do not ignore market values
Estimate only Incremental cash flows
Use the correct discount rate
Do not forget transactions costs
Sources of Synergy
Synergy
Suppose firm A is contemplating
acquiring firm B.
The synergy from the acquisition is
Synergy = VAB – (VA + VB)
Alternatively, the synergy can be
determined from the standard discounted
cash flow model: T
S
DCFt
Synergy = (1 + R)t
t=1
Synergy 15
A Cost to Stockholders from Reduction
in Risk
The Base Case
If two all-equity firms merge, there is no
transfer of synergies to bondholders, but if…
Both Firms Have Debt
The coinsurance effect will transfer value from
shareholders to bondholders.
How Can Shareholders Reduce their
Losses from the Coinsurance Effect?
Retire debt pre-merger and/or increase post-
merger debt usage.
A Cost to Stockholders from Reduction in Risk 16
The NPV of a Merger
Typically, a firm would use NPV
analysis when making
acquisitions.
The analysis is straightforward
with a cash offer, but it gets
complicated when the
consideration is stock.
The NPV of a Merger 17
Cash Acquisition
The NPV of a cash acquisition is:
NPV = (V + ΔV) – cash cost
B
= VB* – cash cost
where VB* = VB + ΔV
Value of the combined firm is:
V
AB = VA + (VB* – cash cost)
= VA + NPV
18
Cash Acquisition:
Example
a. VT= 1,400($26) ; V = 5,500
Cash cost = 1,400($29)
NPV = 1,400($26) + $5,500 – 1,400($29) = $1,300
b. Share price = VBT / no. of share of B
V = V + NPV = [2,900($39) + $1,300] = 114,400
BT B
114,400 /2,900 = $39.45
c. ($29-26) x 1400 = $4200 19
Stock Acquisition
Value of combined firm
V
AB = VA + VB + V
Cost of acquisition
Depends on the number of shares given
to the target stockholders
Exchange ratio: no. of shares used to
acquire one share of target firm
Depends on the price of the combined
firm’s stock after the merger
Actual cost= no. shares offered x
stock price after merger
NPV of acquisition = (VB + ΔV) – actual cost
20
Stock Acquisition: Example
Suppose firm B is willing to be acquired
if firm A offer 8 new shares.
Firm A and firm B have values as
separate entities of $500 and $100,
respectively.
They are both all-equity firms. There are
25 shares in firm A and 10 shares in firm
B.
If firm A acquires firm B, the merged
firm AB will have a combined value of
$700 due to synergies.
21
Stock Acquisition: Example
VAB = $700 = VA + VB + V
= $500+ 100+ V (thus V = $100)
Exchange ratio = 8 / 10 = 0.8:1
Share price after merger: $700/(25+8) = $21.21
The actual cost of acquisition:$21.21*8= $169.68
So, actual cost calculation could be generalized as:
[VAB /(original no. of share + new no. of share)]*new no. of share
NPV of acquisition = (VB + ΔV) – actual cost
= $100 +100 -169.68 = $30.32
What exchange ratio would make the actual cost of
stock acquisition be $153.13?
Let x be the no. of new shares offered.
[$700/(25 + x)] * x = 153.13, X = 7 exchange ratio = 0.7
22
Maximum Price Offer & Maximum
Exchange
Refer to previous example.
Ratio: Example
What is the maximum cash offer that Firm A could make for each share of
firm B?
What is the maximum exchange ratio Firm A could offer in a stock acq.?
To make economic sense, the NPV should be >0
NPV of acquisition = (VB + ΔV) – Acq cost > 0
(VB + ΔV) = $100 +100 = $200 > Acq cost
i.e. Acq cost < $200
Maximum cash offer:
Cash cost should be <$200
Given Firm B has 10 shares, max cash offer per share is $200/10 = $20
If Firm A pays $20 for Firm B, it is paying full price (i.e. V B) plus paying B’s
shareholders for all the synergy gains created (i.e. ΔV), leaving none for Firm
A shareholders, making it a zero-NPV project.
Maximum exchange ratio Firm A could offer in a stock acq:
To generate a positive NPV, Actual cost should be <$200
Actual cost = [V
AB /(original no. of share + new no. of share)]*new no. of
share < $200
[$700/(25 + x)] * x <$200, X <10
So the maximum exchange ratio is 10/ 10 = 1:1
23
Cash vs. Stock Acquisition
Considerations when choosing
between cash and stock
Sharing gains – target
stockholders do not participate in
stock price appreciation with a
cash acquisition
Taxes – cash acquisitions are
generally taxable
Control – cash acquisitions do not
dilute control
Two Financial Side Effects of Acquisitions 24
Do Mergers Add Value?
Shareholders of bidding firms earn a
small excess return in a tender offer,
but none in a straight merger:
Anticipated gains from mergers may
not be achieved. (Or losses are
beyond expectation)
Bidding firms are generally larger, so
it takes a larger dollar gain to get
the same percentage gain.
Do Mergers Add Value 25
Do Mergers Add Value?
Management may not be acting in
stockholders’ best interest.
Takeover market may be competitive.
Announcement may not contain new
information about the bidding firm.
Do Mergers Add Value 26
The Agency Problem
Agency relationship
Principal hires an agent to represent
his/her interest
Stockholders (principals) hire managers
(agents) to run the company
Agency problem
Conflict
of interest between principal
and agent
The Agency Problem 27
Managerial Goals
Managerial goals may be different
from shareholder goals
Higher salary
Survival
Independence
Increased growth and size are not
necessarily equivalent to increased
shareholder wealth
The Agency Problem 28
Managing Managers
Managerial compensation
Incentives can be used to align
management and stockholder interests
The incentives need to be structured
carefully to make sure that they achieve
their intended goal
Corporate control
Thethreat of a takeover may result in
better management
The Agency Problem 29
Key Concepts and Skills
What are the different methods for
achieving a takeover?
How do we account for acquisitions?
What are some of the reasons cited
for mergers? Which of these may be
in stockholders’ best interest and
which generally are not?
What are agency problems, and why
do they exist within a corporation?
*VFX= visual effect
Source:http://
labs.imdb.com/news/
ni57946406/
Think about it
Why Mr Tse after selling 60% of his company finally became a
shareholder of a listed company?!
Why did See Corp not use cash but issue stock to acquire Mr Tse’s
company? How to determine which alternative is better?
“As a private company, Tse’s company showed net losses” – Does it
make sense for See Corp to acquire a loss making company?
31
Next Week
Issuing Equity:
Initial Public Offerings and
Rights Offer (Ch20)
32
