copyright ©1999 ian h. giddy m&a 1. prof. ian giddy new york university mergers &...

Prof. Ian GiddyNew York University

Mergers & Acquisitions

Copyright ©1999 Ian H. Giddy M&A 3

Mergers and Acquisitions

Mergers & Acquisitions Divestitures Valuation

Concept: Is a division or firm worth more within the company, or outside it?


Corporate Finance

CORPORATE FINANCE

DECISONS

CORPORATE FINANCE

DECISONS

INVESTMENTINVESTMENT RISK

MANAGEMENT

RISK

MANAGEMENTFINANCINGFINANCING

CAPITAL

PORTFOLIO

M&ADEBT EQUITY

TOOLS

MEASUREMENT


Principles of Financial Management

Invest in projects that yield a return greater than the minimum acceptable hurdle rate. The hurdle rate should be higher for riskier projects and reflect the

financing mix used - owners’ funds (equity) or borrowed money (debt) Returns on projects should be measured based on cash flows

generated and the timing of these cash flows; they should also consider both positive and negative side effects of these projects.

Choose a financing mix that minimizes the hurdle rate and matches the assets being financed.

If there are not enough investments that earn the hurdle rate, return the cash to stockholders. The form of returns - dividends and stock buybacks - will depend

upon the stockholders’ characteristics Minimize unnecessary financial risks.

Objective: Maximize the Value of the Firm


The Market for Corporate Control

When you buy shares, you get dividends; and potential control rights

There is a market for corporate control—that is, control over the extent to which a business is run in the right way by the right people.

This market is constrained byGovernmentManagementSome shareholders

Example:

Allied Signal’s attempts

to acquire AMP, which is

located in Pennsylvania


The Market for Corporate Control

M&A&D situations often arise from conflicts: Owner vs manager ("agency problems" Build vs buy ("internalization") Agency problems arise when owners' interests and

managers' interests diverge. Resolving agency problems requires Monitoring & intervention, or Setting incentives, or Constraining, as in bond covenants

Resolving principal-agent conflicts is costly Hence market price may differ from potential

value of a corporation


“Internalization”: Is an activity best done within the company, or outside it?

Issue: why are certain economic activities conducted within firms rather than between firms?

As a rule, it is more costly to build than to buy—markets make better decisions than bureaucrats

Hence there must be some good reason, some synergy, that makes an activity better if done within a firm

Eg: the production of proprietary information Often, these synergies are illusory


Takeovers as a Solution to “Agency Problems”

There is a conflict of interest between shareholders and managers of a target company—Eg poison pill defenses

Individual owners do not have suffcient incentive to monitor managers

Corporate takeover specialists, Eg KKR, monitor the firm's environment and keep themselves aware of the potential value of the firm under efficient management

The threat of a takeover helps to keep managers on their toes—often precipitates restructuring.


Goal of Acquisitions and Mergers

Increase size - easy! Increase market value - much

harder!


Value Changes In An Acquisition

175

250

75

5050

4030

10

Final value ofcombined company

Initial valueplus gains

Profit on saleof assets

Synergies and/or operatingimprovements

Value ofacquired company asa separateentity

Value ofacquiringcompanywithoutacquisition

Gain inshareholdervalue

Takeover premium

Taxes on sale of assets


Goals of Acquisitions

Rationale: Firm A should merge with Firm B if

[Value of AB > Value of A + Value of B + Cost of transaction]

Synergy Gain market power Discipline Taxes Financing


Goals of Acquisitions

Rationale: Firm A should merge with Firm B if

[Value of AB > Value of A + Value of B + Cost of transaction] Synergy

Eg Martell takeover by Seagrams to match name and inventory with marketing capabilities

Gain market power Eg Atlas merger with Varity. (Less important with open borders)

Discipline Eg Telmex takeover by France Telecom & Southwestern Bell (Privatization) Eg RJR/Nabisco takeover by KKR (Hostile LBO)

Taxes Eg income smoothing, use accumulated tax losses, amortize goodwill

Financing Eg Korean groups acquire firms to give them better access to within-group

financing than they might get in Korea's undeveloped capital market


M&A Program Must be Part of Long-Range Strategic Planning:

What’s our business? Company’s capabilities and limitations? Our mission?

Key trends in the business environment? Corporate flexibility to meet critical changes and

challenges? Competitive analysis? Relationships with suppliers, customers,

complementary firms? Internal performance measurement system? Reward

system? Organization and funding for implementation? Where do we want to go, and how are we going to get

the resources to get there?

Example: M

errill

Lynch and the I

nternet

Example: M

errill

Lynch and the I

nternet


Developing an Acquisition Strategy

Define your acquisition objectives Establish specific acquisition critieria Select a good team of advisors Focus on the company’s “wish list” Is it the right target? Is the market going to like the deal? Why? What is the business vision that justifies it? How much dilution is the buyer’s stock price will there

be? What will it take after the deal to make it work?

Example: Ciba SC and Allie

d Colliods

Example: Ciba SC and Allie

d Colliods


Rigorous Search Procedures

What are our weaknesses and how do we have to improve?

What companies can help us or how can we help them?

How can we build a group of complementary business groups that will give strength to one another?

Example: IB

M and e-commerc

e

Example: IB

M and e-commerc

e


1. Manage preacquisition phase Instruct staff on secrecy requirements Evaluate your own company Identify value-adding approach

Understand industry structure, and strengthen core businessCapitalize on economics of scaleExploit technology or skills transfer

2. Screen Candidates Identify knockout criteria Decide how to use investment banks Prioritize opportunities Look at public companies, divisions of companies, and

privately held companies

Steps in a Successful Merger and Acquisition Program - Step 1 and 2


Steps in a Successful Merger and Acquisition Program - Step 3 to 53. Value remaining candidates Know exactly how you will recoup the takeover premium Identify real synergies Decide on restructuring lan Decide on financial engineering opportunities

4. Negotiate Decide on maximum reseervation price and stick to it Understand background and incentives of the other side Understand vlue that might be paid by a third party Establish negotiation strategy Conduct due diligence

5. Manage postmerger integration Move as quickly as possible Carefully manage the process


Case Study: Sterling Drug

Questions: What was Kodak’s acquisition strategy? What was the motivation for the bid for

Sterling Drug? What were the potential sources of

synergy? What would you expect to happen to the

value of Kodak’s shares? Of its debt?

copyright ©1999 ian h. giddy m&a 1. prof. ian giddy new york university mergers &...

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