- Merger: Combination of two companies in which only one survives (A + B = A)
- Consolidation: Combination of two companies into one new one (A + B = C)
- Tender offer: Offer made directly to shareholders (usually in hostile takeover)
- Acquisition: Basically any deal
- Statutory merger: Merger under state laws under which acquirer is incorporated
- Subsidiary merger: Target is kept as a separate firm owned by acquirer
- Fairness opinion: External valuation
- Joint venture: Combine different firms resources into new firm for joint project
- Strategic alliance: Agree to pursue common strategic objective while remaining separate firms
- Classes of tests:
- Weak: Price after > Price before ?
- Semi: Return merged firm > Return benchmark?
- Strong: Return merged firm > Return separate firm?
- Assumption: Markets are semi strong efficient: All public information incorporated in price. After the announcement, markets perfectly value M&A value according to available information
- Thus: Abnormal returns at announcement time accurately reflect value of M&A
- Abnormal Returns: Returns during the announcement window (time of announcement) minus the returns the stock usually exhibits, measured in clean, merger free period.
- Market Method Abnormal Returns: Do a regression, abnormal returns are the changes in alpha of in the regression (excludes general market movements).
- Cumulative Abnormal Returns (CAR): To average out exogenous effects that might affect any one company on announcement day, the abnormal returns of many firms over many acquisitions are summed up to calculate CAR and thus the average merger value.
- Statistical test: Calculate statistical significance of CAR (t test).
- Absolute dollar returns: CAR * market capitalization
- Alternatives: Accounting studies, executive interviews, clinical studies
- Target: Strong positive CAR
- Acquirer: CAR ≈ 0
- Total effect is positive
- Research on profitability using absolute dollar returns instead of percentages
- Compare 1998-2001 merger wave with 1980s
- Much bigger losses in 1998-2001, driven by few extreme failures (bottom of the distribution)
- Usual factors do not explain large losses, large losses might have been caused by overvalued equity (dot com boom)
- Complementary fit: Compensate some weakness
- Supplementary fit: Reinforce strength
- Conglomerate mergers: Buy outside of own line of business (just for financial returns)
- Congeneric mergers: Buy related but not in same business (e.g. vertical merger)
- Firms that can not grow from the inside might buy growth outside
- The P/E Game: Buy firm with low price / earnings ratio. Acquirer will exhibit short term earnings per share rise, might trick investors into believing the company is actually growing
- Combined firms more valuable than separated (1 + 1 = 3)
- Financial synergies: Lower cost of capital
- New investment opportunities
- Tax benefits: Using the others tax losses
- Coinsurance (spread risk)
- Better credit quality, implicit 'too big to fail', etc.
- Operating synergies
- Revenue enhancements (e.g. through greater bargaining power)
- Cost savings (e.g. economies of scale)
- Measured by combined CAR of target & acquirer
- Economies of scale: Spreading overhead
- Economies of scope: Related additional costs at lower marginal cost since they use the same parts
- Greater purchasing power (horizontal integration)
- Measuring industry concentration: Herfindalh–Hirschman Index (HHI)
- If HHI > 1,800 & change through acquisition > 50 governments will intervene
- Information & transaction efficiency (Vertical acquisition)
- Disciplinary motives (buy badly run firms)
- Agency cost of free cash flow: Money would be better off with shareholders since they have no agency cost
- Managerial entrenchment: Managers ran out of investment opportunities and just do an acquisition
- Managerialism: Managers pursue their own goals
- Hubris: Managers prone to overconfidence
- Winners curse: The highest valuation wins bid, favors overvaluations
| Theory | Combined gains | Gains to target | Gains to bidder |
|---|---|---|---|
| Synergy | Positive | Positive | Non-Negative |
| Agency Cost/Entrenchment | Negative | Positive | Strong Negative |
| Hubris | Zero | Positive | Negative |
- Grow outside of current industry (Conglomerate)
- Poor track record
- Purely financial gains (coinsurance, lower distress cost, etc.)
- Same effect as if shareholders had built a diversified portfolio by themselves
- Higher agency costs since conglomerates are harder to analyze
- Complete conglomerates perform worse (conglomerate discount), however related diversification can do well
- Diversification can also be seen as a symptom, discount is effect of these underlying issues
- Serial acquirers: Some firms buy a lot and specialize in being good at it
| Internal | External |
|---|---|
| Board of directors and management | Market for Corporate Control |
| Control and incentive systems | Activist investors |
| Corporate culture and values | Market for Managers |
| Bonding mechanisms | Laws and regulations |
| Takeover Defenses |
- Small shareholders 'free ride' on monitoring efforts of larger shareholders
- Small shareholders will not sell below the higher expected post merger price
- Individual decision does not affect success of offer and they can fully benefit from the offer
- Result: Limits acquirer gain, too few takeovers
- Solution: Toehold: Gain foot in the door through open market first, then tender all others
- Facilitate takeovers, restrain opportunistic managerial behavior, minimize other costs and inefficiencies
- Protect minority shareholders
- Mandatory bid rule: Once acquirer owns certain percentage of shares it must make a tender offer to all shareholders
- Minority shareholders can exit on fair terms
- Principle of equal treatment: All shareholders must be treated equally
- Squeeze out rule: Once the acquirer owns a certain percentage it can force minority shareholders to sell to acquire 100%
- Freeze out rule: Once the acquirer owns a certain percentage minority shareholders can only sell to acquirer
- Sell out rule: Majority shareholder must buy minority shares at fair price
- Disclosure of changes in ownership & control: Companies must inform regulators & public investors if one shareholder acquirers substantial share
- Target company’s board neutrality: Decision is transferred to shareholders
- Takeover defense measures: Reduce undesired takeovers
- Examine link between different laws in different countries and M&A activity
- Hypothesis (all confirmed)
- Investor protection positively correlates M&A activity
- Investor protection positively correlates hostile takeovers
- Difference in investor protection between countries negatively correlates with M&A between these two countries
- Implication: Market for corporate control is no substitute for legal protection but a compliment
- Contractual relationship
- Strategic alliance
- Joint venture
- Minority investment
- M&A
- Determinants of best transaction option:
- Benefits from relationship
- Need for control
- Risk aversion
- Divesture / Asset sales: Parent exchanges assets for cash
- Spin off: Create new company and give shareholders stock in that company
- Equity cave outs: IPO Subsidiary for cash
- Split offs: Create new company and give some shareholders stock of one company and some stock of the other
- Tracking stock: Keep Subsidiary but create stock that tracks subsidiary performance. Sell it for cash.
- Sale of minority interest / joint venture interest
- Financial restructuring
- Determinants of best restructuring option:
- Relationship to core business
- Need for control
- Need for cash
- Whether business can function as separate entity
- Does it pay? Yes, correcting past mistakes
- Poison pills: Give existing shareholders options with really low strike prices that can only be exercised if one shareholder acquires significant ownership
- Shark repellents: Defensive corporate charter amendments
- Supermajority provision: More than 51% majority needed (e.g. 90%)
- Staggered Boards: Only 1/3rd of board elected per year, takes 2 years to gain control
- Authorization of Stock: Some stock has more voting rights
- Incorporate in a state with Anti takeover laws
- Greenmail + Standstill: Target buys acquirer share at large premium, acquirer agrees to not buy more shares
- Restructuring: Do what the bidder would do, remove takeover motive
- Litigation: Antitrust, Inadequate disclosure, fraud
- Press campaigns
- White Knight Defense: Find friendly merger
- White Squire Defense: Find buyer for big block of shares
- Pac Man: Buy acquirer
- Why resist a takeover? Entrenchment? Bargaining strategy?
- Stock price decline on introduction of defense measures
- Golden parachute: Generous severance package if manager is fired due to takeover
- Stock price increase on introduction of parachute
- Search information rather than transactions
- Public information is already priced, need private information
- Information filtering is key
- Invest in your network
- First hand info is good info
- Gatekeepers and 'river guides' affect information dissemination and search process
- Internal setup must match external environment
- Persistence and effort pay
‘Know what you are buying’
- Risk and opportunities.
- The past, present, and the future.
- The firms and its partners.
- The financial condition and the business that generated it.
- Internal and external conditions
- Basic data of target and Refined opinions of experts.
- First proposal
- Letter of intent
- Deal contract signed
- Closing
- Fact-based
- Inquisitive
- Knowledge-focused
- System-focused
- Undertaken with initiative
- Managed to take enough time
- Multidisciplinary
- Drawn from both formal and informal resources
- Careful to avoids surprises
- Written and well documented
- Negotiation: Private one on one
- Auction: Public sale
- Negotiations pay similar to auctions
‘negotiations take place under the threat of an auction.’
- Think like an investor
- Intrinsic value is unobservable
- Difference between price and intrinsic value is opportunity
- There are many different estimators, exercise many to get a range of good values
- Think critically, triangulate carefully
- Establish motive for acquisition
- Choose target
- Value considering motive
- Decide on method of payment
- Find similar firms and compare prices
- Size, age, products, trends
- Scale by price / sales, price / book, price earnings ratios and take average
- Advantages: Simple, public data, used in legal cases, can value companies not traded
- Disadvantages: Hard to find comparable firms, ratios might widely differ
- Find similar transactions and compare prices
- Calculate premium paid for other transactions and compare
- Predict cash flows from past data for the next few years
- FCF = EBIT*(1 - T) - Net Reinvestment
- Tax shield already included in discount rate, no need to include it twice
- Calculate NPV of cash flows
- Discount rate = WACC
- Equity value = firm value - debt value
- Sensitivity analysis: Check for changes in different factors
- Undervaluation
- Target firm should trade well below estimated value
- Standalone value: No premium
- Diversification & risk reduction
- Cashflow correlation should be low
- Standalone value: No premium
- Synergy
- Operational: Savings or growth
- Financial: Tax savings, debt capacity, cash slack
- Premium may include NPV of synergies
- Market for corporate control
- Target is badly managed
- Premium up to value of optimally run firm
- Managerial hubris
- Target charms CEO ego
- No premium
- Acquirer has to raise money for acquisition
- Choice Debt v. Equity depends on leverage ration and debt capacity of acquirer
- Usually a mix of debt and equity is used.
- There are three ways of payment:
- Pay cash
- Issue stock to the public and then pay cash
- Issue stock to target shareholders and swap for target stock
- Need to determine exchange ratio
- Post merger stock price must exceed pre merger price for positive NPV
- where
$P_T$ and$P_A$ is the share prices of target and acquirer,$V_T$ is the value of the target and$S$ the value of the synergies.
- Method depends on:
- Cash at hand
- Value of stock
- Tax considerations
- Exchange ratio =
$$\frac{P_T}{P_A} * (1+ \frac{S}{V_T})$$ - NPV of merger for acquirer
$$NPV_A = \Delta PV_{AT} - (Price Paid - PV_T)$$ - In a cash transaction the price paid is the amount of cash paid. In a stock transaction, the price paid is
$x * PV_{AT}$ , where$x$ is the share of the combined firm that is given to target shareholders and$PV_{AT}$ is the value of the combined firm.
- In a cash deal, the acquirer assumes the entire risk of the transaction
- In a stock swap, both parties share the risks of the transaction
- Stock swaps are cheaper if the acquirer is overvalued
- Pessimistic managers prefer payment with stock
- Optimistic managers prefer cash
- Stock transactions send a negative market signal (believe in overvalued stock and risky transaction)
- Stock swaps can have a fixed number of stocks or a fixed value of stocks
- In a fixed value transaction, the pre-closing market risk is entirely borne by the acquirer while the operating risk is shareholders
- In a fixed number transaction all risks are shared
- Pre closing risk:
- Share price might fluctuate and significantly influence actual price
- Fixed collar offer: Set minimum and maximum price after which parties might walk away
- Floating collar offer: Modify exchange ratio if price moves out of bounds
- Post closing risks:
- Expected synergies might not materialize:
- Earn outs:
- Payment in two tranches, first tranche fixed, second tranche usually tied to firm performance.
- Contingent value right:
- Security issued by acquirer that pays if the share price falls below a specified point.
- Can be traded and is easy to issue to many people
- Asset deal:
- Purchase assets of firm, not firm itself
- Cash for asset:
- Firm pays of liabilities and is dissolved, cash distributed to shareholders
- Shareholders do not vote but are cashed out
- Stock for assets:
- Target shareholders must vote on such a deal
- Advantages / Disadvantages
- Acquirer can 'cherry pick'
- Non specified assets and eventual tax benefits are lost
- Stock acquisitions
- Actual purchase of company
- Advantages / Disadvantages:
- Entire firm including all licenses and tax benefits gets transferred
- Tax considerations:
- Target shareholders have to tax cash payments directly, stock payments only after they sell the stock.
- M&A activity clusters in time
- First wave 1897-1904
- The ‘monopolization wave’
- Strong stock market and technological innovation
- Mainly horizontal mergers
- Ended by market crash & new regulations
- Second wave 1916-1929
- The ‘oligopoly wave’
- Booming stock market and technological innovation
- Vertical integration
- Ended by 1929 crash
- Third wave 1965-1969
- The ‘conglomerate wave’
- Strong stock market and heightened regulations against horizontal mergers
- Conglomerate mergers
- Ended by 1971 recession and anti conglomerate rules
- Fourth wave 1984-1989
- The ‘refocusing wave’
- Growing capital market innovation and deregulation
- Invention of LBO, PE speciality firm
- Many hostile deals
- Ended by 1990 recession
- Fifth wave 1994-2001
- Rising stocks and industry specific stocks
- Invention of venture capital
- Many strategic buyers
- Ended by burst of internet bubble 2001
- Sixth wave 2004-2007
- The ‘private equity wave’
- High stocks, low interest, financial innovation
- Growth in PE
- LBO and cross boarder
- Ended by 2007 credit crunch and 2008 recession
- Four ways of explanation:
- Markets are rational but managers are irrational
- Hubris
- Markets are irrational but managers are rational
- When markets overvalue firms, managers use their stock to buy firms
- Markets and managers are irrational
- Market manias where everybody buys
- Markets and managers are rational
- Agency cost reduction
- Seeking monopoly, competitive position & rents
- Deal with industry shocks
- Mitchel and Mulherin (1996)
- Measure relationship of industry shocks and M&A activity
- Takeovers & restructuring as messenger of industry shocks
- Spillover effects of takeover announcements to rival firms might be due to anticipation of restructuring, not to an increase in market power
- Post takeover failure might be caused by industry shock, not the takeover itself
- Firms in same industry are poor benchmark as they also experience shock
- Proxy for broad industry shock:
- Difference between sales growth of industry and growth in other industries
- Proxy for specific industry shocks:
- Deregulation
- Energy dependence
- foreign competition
- R&D / Sales ratio
- Harford (2005)
- Waves are triggered by deregulation & capital liquidity
- Control for capital liquidity eliminates predicting power of market book ratios
- Merger waves are cause by shocks and liquidity
- Cross boarder deals are likely:
- related to the buyer’s core industry
- paid in cash
- targeted at manufacturing firms with low intangible assets
- Geographical proximity increases likelihood of cross boarder M&A
- Economic areas increase M&A activity
- Investor protection increases M&A activity
- M&A leads to convergence in international corporate governance
- Cross boarder M&A pays more on average
- But gains go to target, foreign bidders also pay more
- However, both findings might be due to deal characteristics, not cross boarder element by itself
This is how you study? NICE! hahahha