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Week 8: Mergers and Acquisitions (Reasons to acquire (cost reductions…
Week 8: Mergers and Acquisitions
Background and historical trends
Merger
Acquisition: one firm acquires the other
Tender offer: one firms offer to buy the
outstanding stock
of the other firm
at a specific price
Types of M&As
Vertical merger: in the related industry
Conglomerate merger: in unrelated industry (to achieve diversification)
Horizontal merger: in the same industry
Market reaction to a takeover
Acquisition premium: % difference between the
acquisition price
and the
pre-merger price
of a target firm
Law: if shareholders of a target firm are
forced to sell
their shares, they will receive a
fair value
of their shares
Acquirers has to pay a
premium
Target shareholders will enjoy a
gain
Reasons to acquire
cost reductions (however, larger firms are more difficult to manage)
economies of scope
vertical integration: same industry but different stages
economies of scale: savings due to producing in high volume
revenue enhancements
expertise: purchase a talent as an
already functioning unit
by acquiring an existing firm
monopoly gains: mostly
antitrust laws
limit such activity
diversification
(p.12): risk reduction (conglomerate) => lower probability of bankruptcy => lower borrowing cost
liquidity
earnings growth: earnings per share (EPS) of
merged > pre-merged
(i.e: page 14).
P/E ratio
: the lower the ratio, the higher earnings
Managerial motivates to merge
conflicts of interest: managers know they are destroying shareholder value, but
personally gain
from doing so
overconfidence (
hubris hypothesis
): managers believe they are doing the right thing for shareholders
The takeover process (issuing new shares rather than cash)
Valuation
takeover synergies
: any additional value created
amount paid for a target
= target's pre-bid market capitalization + acquisition premium (
outflow
)
from the
bidder's perspective
:
value added
= target stand- alone value + PV(synergies) (
inflow
)
positive NPV project (for bidder) only if:
premium < synergies created
The offer
cash transaction
stock- swap transaction
exchange ratio
: number of bidder shares received in exchange for each target share (
= x/ number of target shares
)
positive NPV investment for the acquiring shareholders if
share price of merged firm > pre- merger price of the acquiring firm
formula: page.23-24 (aggregate level), page 25 (individual level)
x represents aggregate number of shares
maximum
exchange ratio
in a Stock Takeover (example: p.26)
Tax Issues
cash received => tax liability for target shareholders
exchange bidder stock => tax liability is deferred until the target shareholders sell their shares
using cash or issuing < 20% of stock =>
no need approval from shareholders
of acquirer firm (board of directors is enough)
Board and Shareholder Approval
Friendly Takeover (deal with the board of directors)
Hostile Takeover (deal with stockholders or buy enough stock to vote for replacing the board)