Mergers & Acquisitions

Mergers & AcquisitionsLecture aims

To explain the motivation behind mergersTo give a flavor of how mergers are regulated around the worldTo discuss elements of strategyTo present evidence on the success or otherwise of merger activity

Regulation: competition

UK: The Competition Authorities:Secretary of State for Trade and IndustryDirector General of Fair TradingCompetition CommissionEU: European commissionUS: Antitrust LawsSherman Act 1890Clayton Act 1914India: Competition CommissionChina: Anti-Monopoly Law effective from 2008

Regulation: the deal itselfRegulation: the deal itselfUK: City Code on Takeovers and MergersEU: Individual country regulators (see Vernimmen)US: Federal Securities LawsIndia: Securities and Exchange Board of IndiaChina: Shanghai Stock ExchangeMerger motivesThe motivation varies according to the type of deal:horizontal/vertical/conglomerate.

Mergers may be motivated by: macro factorsmicro factorsmanagerial factors

Macro factorsInnovation and technological change: new technologies encourage start-ups, some new firms cannot survive, hence consolidation follows.

Legislative changes: deregulation and privatization leads to mergers

Financial markets: as markets become more important than banks, companies may need to merge to please their shareholders.

Micro factorsEconomies of scale: in R&D, production or distribution.

Improvement in market share: geographic or product

Disciplinary: target undervalued due to managerial factorsManagerial FactorsTop management may seek to takeover other firms because it benefits them not the shareholders.

Reasons: empire-building status power survival hubris free cash flow

StrategyShould the firm establish a toe-hold?-buy a small proportion of the targets equity before making a bid.How small? Consider disclosure, 2% Italy; 3% Germany, UK; 5% China, France, India, Netherlands, Spain, Switzerland, US.

How large a holding makes a bid compulsory? 15% India; 30% China, Germany, Italy, Netherlands, Spain, UK; 33.3% France, Switzerland.

Should the bid be friendly or hostile?Friendly: agreed with target board

Hostile: no agreement, appeal to target shareholders

The choice may affect the price, and the ability to integrate the firms after the deal is complete.

Pre-bid defensesInternal: cost reduction restructuring change ownership structure may include poison pills change management structureExternal: cultivate investors keep analysts informed about strategy improve image make strategic defence investments

Post-bid defences

Everywhere:Revaluations/dividend changesRestructuringWhite knight

US:Greenmail

Financing the dealCashShares bidderCash underwritten share offerLoan stock/debentureConvertible or preference sharesDeferred paymentCash:simplicitymakes bid credibleno dilution of ownership for acquiring shareholderscapital gains tax liability for target shareholderscapital structure effects for the acquirer

Equity:postponement of capital gains tax liabilitytarget shareholders remain part of the businessno cash outflow for acquiring companybut the possibility of bootstrapping

Bootstrapping/the PER gameCrafty and Sloth example from Arnold: Crafty Sloth Earnings $1m $1m Number of shares 10m 10m Earnings per share 10p 10p PE ratio 20 10 Share price $2 $1

If Crafty acquires Sloth:

CraftyEarnings $2mNumber of shares 15mEarnings per share 13.33pPE ratio 20Share price 267p

Are mergers successful?Empirical tests:1. Stock market based based on abnormal returns [Ri-E(Ri)]

2. Firm-level based on post-merger profitability [net income/net assets]

Stock market based - UK

Stock market based - Europe

Stock market based - US

Firm level - UK

Firm level - Europe

Which mergers are successful?A 2004 survey by UBS indicates the following successfactors:Strategic fit: easier to exploit synergies in horizontal dealsSize: smaller firms are easier to integrateOwnership: private acquisitions produce better resultsFinancing: cash deals do better post-acquisitionProfitability: more profitable targets perform better