21- 1 mcgraw hill/irwin copyright © 2009 by the mcgraw-hill companies, inc. all rights reserved...

21- 1

McGraw Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Fundamentals of Corporate

Finance

Sixth Edition

Richard A. Brealey

Stewart C. Myers

Alan J. Marcus

Slides by

Matthew Will

Chapter 21

McGraw Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved

Mergers, Acquisitions and Corporate Control

21- 2

Topics Covered

Sensible Motives for Mergers Dubious Reasons for Mergers The Mechanics of a Merger Evaluating Mergers The Market for Corporate Control Proxy Contests Takeovers Leveraged Buyouts Divestitures, Spin-Offs and Carve-Outs The Benefits and Costs of Mergers

21- 3

Mergers (1962-2007)N

umbe

r of

Dea

ls

2007

21- 4

Recent Mergers

Industry Acquiring Company Selling Company Payment ($ bil)

BankingRoyal Bank of Scotland, Fortis, Santander ABN Amro 101.0

Telecoms AT&T Bellsouth 72.7

Electricity Enel and Acconia Endesa 58.7

Offshore drilling Transocean Global Santa fe 53.0

Banking Banca Intesa Sanpaolo IMI 37.7

Banking Bank of America MBNA 35.8

Oil Conoco PhillipsBurlington Resources 35.4

Steel Mittal Steel Arcelor 32.2

Telecoms Telefonica O2 31.7

Medical devices Boston Scientific Guidant 27.9

Banking WachoviaGolden West Financial 25.5

Construction/Airports Ferrovial BAA 21.8

Banking Bank of America LaSalle Bank 21.0

Pharmaceuticals Bayer Schering 20.6

21- 5

Sensible Reasons for Mergers

Economies of Scale

A larger firm may be able to reduce its per unit cost by using excess capacity or spreading fixed costs across more units.

$ $$Reduces costsReduces costs

21- 6

Sensible Reasons for Mergers

Economies of Vertical Integration Control over suppliers “may” reduce costs. Over integration can cause the opposite effect.

Pre-integration (less efficient)

Company

S

S

S

S

S

S

S

Post-integration (more efficient)

Company

S

21- 7

Sensible Reasons for Mergers

Combining Complementary ResourcesMerging may results in each firm filling in the “missing pieces” of their firm with pieces from the other firm.

Firm A

Firm B

21- 8

Sensible Reasons for Mergers

Mergers as a Use for Surplus Funds

If your firm is in a mature industry with few, if any, positive NPV projects available, acquisition may be the best use of your funds.

21- 9

Dubious Reasons for Mergers

Diversification Investors should not pay a premium for

diversification since they can do it themselves.

21- 10

Dubious Reasons for Mergers

The Bootstrap Game

Acquiring Firm has high P/E ratio

Selling firm has low P/E ratio (due to low number of shares)

After merger, acquiring firm has short term EPS rise

Long term, acquirer will have slower than normal EPS growth due to share dilution.

21- 11

Dubious Reasons for Mergers

The Bootstrap Game

World Enterprises (before merger) Muck and Slurry

World Enterprises (after buying Muck

and Slurry)

EPS $2.00 $2.00 $2.67Price per share $40.00 $20.00 $40.00P/E Ratio 20 10 15Number of shares 100,000 100,000 150,000 Total earnings $200,000 $200,000 $400,000Total market value $4,000,000 $2,000,000 $6,000,000

Current earnings per dollar invested in stock $0.05 $0.10 $0.067

21- 12

The Mechanics of a Merger

Forms of Acquisition “Merge” – When the acquiring firm buys all the

assets and all the liabilities of the other firm and combines them into one firm.

“Tender Offer” - The acquiring firm buys all the stock of the target firm.

“Asset Purchase” – When the acquiring firm buys only the assets of the target. The target continues to exist as a firm with cash instead of assets.

21- 13

Evaluating Mergers

Questions Is there an overall economic gain to the merger? Do the terms of the merger make the company

and its shareholders better off?

????

PV(AB) > PV(A) + PV(B)

21- 14

Evaluating Mergers

Economic Gain

Economic Gain = PV(increased earnings)

= New cash flows from synergies

discount rate

21- 15

Evaluating Mergers

Example - Given a 20% cost of funds, what is the economic gain, if any, of the merger listed below?

Cislunar Foods Targetco Combined Company

Revenues 150 20 172 (+2)

Operating Costs 118 16 132 (-2)

Earnings 32 4 40 (+4)

Economic Gain =4

.20= $20

21- 16

Evaluating Mergers

Estimated net gain

Estimated net gain = DCF valuation of target including synergies

- cash required for acquisition

21- 17

The Merger Market

Proxy battle for control of the board of directors Firm purchased by another firm Leveraged buyout by a group of investors Divestiture of all or part of the firm’s business

units

Methods to Change Management

21- 18

The Merger Market

Tools Used To Acquire Companies

Proxy Contest

Acquisition

Leveraged Buy-Out

Management Buy-Out

Merger

Tender Offer

21- 19

Merger Tactics

White Knight - Friendly potential acquirer sought by a target company threatened by an unwelcome suitor.

Shark Repellent - Amendments to a company charter made to forestall takeover attempts.

Poison Pill - Measure taken by a target firm to avoid acquisition; for example, the right for existing shareholders to buy additional shares at an attractive price if a bidder acquires a large holding.

21- 20

Leveraged Buy-Outs

Unique Features of LBOs

Large portion of buy-out financed by debt

Shares of the LBO no longer trade on the open market

21- 21

Leveraged Buy-Outs

Junk bond market Leverage and taxes Other stakeholders Leverage and incentives Free cash flow

Potential Sources of Value in LBOs

21- 22

Divestitures, Spin-Offs, and Carve Outs

Divestiture – When a firm sells some of the assets to another entity as a going concern.

Spin Off – The process of a business separating the ongoing operations of a unit of that business and giving the shareholders of the parent firm shares of the unit. The unit and parent function as separate entities.

Carve Outs – Similar to a spin off, but the carve out issues shares of the new firm to the public.

21- 23

Benefits and Cost of Mergers

Who Usually Benefits from the merger? Shareholders of the target Lawyers & Brokers The executives of the acquiring firm

Who Usually Losses a merger? Shareholders of the acquirer due to overpayment Executives on the target All employees due to restructuring

21- 24

Web Resources