8/8/2019 MA&CR mod1

1/59

8/8/2019 MA&CR mod1

2/59

KISS may turn a toad to a prince

investors may bankroll the princess who wish

to pay double for the right KISS

They were princes, when purchased, after a

KISS they became toads.

2

8/8/2019 MA&CR mod1

3/59

Why firms choose M&A instead of internal

growth?

Types of firms engaging in M&A activities, ie.,

which firms are likely to be acquiring, which

acquired, etc

Implications on aggregate merger activity

3

8/8/2019 MA&CR mod1

4/59

Expansion

M&A

Tender Offer

Joint Venture

Sell offs

Spin offs

Split offs

Split ups

Divestitures

Equity carve outs

4

8/8/2019 MA&CR mod1

5/59

Corporate Control

Premium Buy-backs

Standstill agreements

Antitakeover Amendments

Proxy Contests

Changes in Ownership Structure

Exchange Offers

Share Repurchases

Going Private

Leveraged Buy-outs

5

8/8/2019 MA&CR mod1

6/59

Any transaction that forms one economic unit

from two or more previous units.

6

The purchase of a controlling interest in a firm,

generally via a tender offer for the target

shares.

8/8/2019 MA&CR mod1

7/59

A method of effecting a takeover via a public offer

to target firm shareholders to buy their shares.

7

A combination of subsets of assets contributed by 2 or

more business entities for a specific business purpose

and limited duration. Each of the venture partners

continues to exist as a separate firm, and the joint

venture represents a new business enterprise.

8/8/2019 MA&CR mod1

8/59

8

A transaction in which a company distributes in a prorata basis all the shares it owns in a subsidiary to its

own shareholders. Creates a new public company with

(initially) the same proportional equity ownership asthe parent company.

The creation of an independent company through the

sale or distribution of new shares of anexisting business/division of a parent company.

Example: Ocwen & Ocwen Solutions named asAltisource

Portfolio Solutions

8/8/2019 MA&CR mod1

9/59

A transaction in which some, but not all, parent company shareholders receive shares in a

subsidiary in return for relinquishing their parent company shares.

McDonalds (MCD) split off of Chipotle Mexican Grill (CMG.B). I first heard

about the McDonalds split-off of Chipotle in September of 2006.

McDonalds offered to exchange up to an aggregate of 16,539,967 shares of

Chipotle class B common stock for outstanding shares of McDonalds

common stock. The exchange offer was designed to permit holders of

McDonalds common stock to exchange their shares for shares of Chipotle

class B common stock at a 10% discount to the calculated per-share value of

Chipotle class B common stock. Stated another way, for each $1.00 of

McDonalds common stock accepted in the exchange offer, the tendering

holder would receive approximately $1.11 of Chipotle class B common

stock, based on calculated per-share values, subject to a limit ratio and to

proration.

9

8/8/2019 MA&CR mod1

10/59

10

A transaction in which a company spins off all of its

subsidiaries to its shareholders and ceases to exist.

A corporate action in which a single company splits into

two or more separately run companies. Shares of the

original company are exchanged for shares in the new

companies, with the exact distribution of shares

depending on each situation. This is an effective way to

break up a company into several independent

companies. After a split-up, the original company

ceases to exist.

8/8/2019 MA&CR mod1

11/59

Sale of a segment of a company (assets, a product line,

a subsidiary) to a third party for cash/or securities.

11

A transaction in which a company spins off all of its

subsidiaries to its shareholders and ceases to exist.

A transaction in which a parent firm offers some of a

subsidiarys common stock to the general public, to bring

in a cash infusion to the parent without loss of control.

8/8/2019 MA&CR mod1

12/59

A voluntary contract by a large block shareholder (or

former large block holder bought out in a negotiated

repurchase) not to make further investment in the

target company for a specified period of time.

12

Repurchasing the stock of a large block holder (anunwanted acquirer) at a premium over market price.

8/8/2019 MA&CR mod1

13/59

An attempt by a dissident group of shareholders to gain

representation on a firms Board of Directors.

13

A corporate charter amendment which is intended tomake it more difficult for an unwanted acquirer to

takeover the firm.

8/8/2019 MA&CR mod1

14/59

A public corporation buys its own shares, by tender

offer, on the open market, or in a negotiated buy

back from a large block holder. 14

A transaction which provides one class (or more) ofsecurities with the right or option to exchange part

or all of their holdings for a different class of the

firms securities. This enables a change in the capitalstructure with no change in investment.

8/8/2019 MA&CR mod1

15/59

The purchase of a company by a small group of

investors, financed largely by debt. Usually entailsgoing private.

15

The transformation of a public corporation into aprivately held firm. (often via leveraged buy out or

management buy out).

8/8/2019 MA&CR mod1

16/59

Globalization and Liberalization of economy.

Intense competitive environment .

Advancement in technical know how.

Sustain , excel and compete both indomestic and international market.

16

8/8/2019 MA&CR mod1

17/59

The share holders of two companies deciding topool the resources of the companies under a

common entity to do the business activity is called

merger. Two companies agree to go forward as a single

company rather than separately owned & operated.

Both companies stocks are surrendered and newstock is issued in its place.

17

8/8/2019 MA&CR mod1

18/59

Top ten acquisition made by Indian

companies.

acquirer target co country

targeted

deal value

$ million

industries

Tata Steel Corus group UK 12000 Steel

Hindal Co Novels CANADA 5982 Steel

Videocon Daewoo Elec co. KOREA 729 Steel

Dr. Reddys labs Beta Pharmatical GERMAN 597 Pharma

Suzlon Energy Hansen Group BELGIUM 565 Energy

HPCL Kenya PetroleumRefinery ltd

KENYA 500 Oil Gas

Rambaxy Labs Terapia s a ROMANIA 324 Pharma

Tata Steel Nat steel SINGAPOR

E

293 Steel

Videocon Thomson FRANCE 290 Electronics

VSNL Teleg lobe CANADA 239 Telecom

18

8/8/2019 MA&CR mod1

19/59

To take advantage of economies of scale.

To increase market share, control suppliers

To take tax advantages.

To redirect the firms activities by deploying

surplus cash from one business to finance

profitable growth in another.

To increase size, so as to compete at the global

level.

19

8/8/2019 MA&CR mod1

20/59

Factors contributing to merger waves:

Shocks (e.g., technological change, deregulation, andescalating commodity prices)

Ample liquidity and low cost of capital

Overvaluation of acquirer share prices relative to targetshare prices

Why it is important to anticipate M&A waves:

Financial markets reward firms pursuing promisingopportunities early on and penalize those that followlater in the cycle.

Acquisitions made early in the wave often earnsubstantially higher financial returns than those made

later in the cycle.

8/8/2019 MA&CR mod1

21/59

Empire building.

To achieve core competency.

To diversify product range

To rehabilitate sick companies.

To take advantage of speedy entry in the market

rather then taking risk in green-field ventures.

To increase returns to the shareholders.

To lower the cost of production

21

8/8/2019 MA&CR mod1

22/59

Strategic Motives

Financial Motives

Organizational Motives

8/8/2019 MA&CR mod1

23/59

Expansion and growth (less time consuming

and more cost effective)

Dealing with entity of MNCs.

Economies of scale.

Synergy V(AB)>V(A)+V(B)

value merged company > independent value of

company A & company B leading to higher EPS.

Market Penetration

23

8/8/2019 MA&CR mod1

24/59

Deployment of surplus funds.

Fund raising capacity (increase asset base)

Increase MC.

Tax planning (acquire a sick company)

Creating shareholder value.

Operating economies (savings on OH & other OE)

Tax benefits.

Revival of sick units.

8/8/2019 MA&CR mod1

25/59

Superior Management.

Ego satisfaction.

Retention of managerial talent. Removal of inefficient management

8/8/2019 MA&CR mod1

26/59

Growth orientation (escape from small home market to

achieve the economies of scale)

Access to inputs

Unique advantages : To exploit company`s brands,

reputation, design, production & management

capabilities

Defensive strategies : To avoid countrys political and

economic instability, to circumvent protective barriers

Client needs

Opportunism

8/8/2019 MA&CR mod1

27/59

Merger activity is an example of integration taking place within

industries. This can be:

Vertical integration, where firms at different stages in the production

chain merge (Forward & Backward)

or

Horizontal integration, where competing firms in the same industry

merge

or

Conglomerate: no clear substitute or complementary relationship.

or

Circular: involves merger of companies which produce different

products that are unrelated and but are marketed through the same

channel

27

8/8/2019 MA&CR mod1

28/59

Two firms producing the same product merge

to achieve economies of scale.

The right size can change over time

McDonald and Douglas aircraft corporations

initially merged to compete with Boeing.

Boeing and McDonald-Douglas merge to compete

with AirBus.

28

8/8/2019 MA&CR mod1

29/59

Decrease in competition

Economies of scale

Better market control

Avoid duplicate facilities

Decrease the WC

Increased monopoly

Tret to small players

No guarantee of the maket

29

8/8/2019 MA&CR mod1

30/59

A firm in industry A sells

its output to industry B.

Two firms merge to

integrate their

production.

30

Seed andFertilizer

Companies

Grain Farms

Cereal

Companies

8/8/2019 MA&CR mod1

31/59

A firm in industry A

sells its output to

industry B.

Two firms merge to

integrate theirproduction.

31

Seed andFertilizer

Companies

Grain Farms

Cereal

CompaniesBasic Theorem: you cannot

create monopoly power by avertical integration. If one

industry is monopolized, it

does not increase its

monopoly power by verticalintegration into a

competitive industry.

8/8/2019 MA&CR mod1

32/59

Cost Reduction

Economies of Control

Better Planning

Monopoly by the input supplier

Price discrimination

32

8/8/2019 MA&CR mod1

33/59

Financial Conglomerates

Do not participate in the operating decisions but

take strategic decisions only. This improves risk,better results.

Managerial Conglomerates

Takes advantage of unequal management

competence.

33

8/8/2019 MA&CR mod1

34/59

Product Expansion

Covers huge territory

Minimizes risk

34

8/8/2019 MA&CR mod1

35/59

Economies of scale

Avoid unhealthy competition

Synergy

Risk minimization

Consolidation of capacities

Marketing advantages

Financial advantages

Right sizing

Value creation

35

8/8/2019 MA&CR mod1

36/59

Valuation pitfalls

Inaccurate estimation

Overestimating synergy

Hidden liabilities

Implementation delay

Cultural differences

Poor public relations

Conflict of interest

36

8/8/2019 MA&CR mod1

37/59

Efficiency theories

Differential managerial efficiency

Inefficient management

Operating synergy

Pure diversification

Strategic realignment to changing environments Undervaluation

37

8/8/2019 MA&CR mod1

38/59

Information & Signaling

Agency problems & managerialism

Free Cash Flow Hypothesis

Market Power

Taxes

Redistribution

38

8/8/2019 MA&CR mod1

39/59

Change in the levels of managerial efficiency,

there is social as well as private gain.

In the extreme there will be only one firm in the

economy, leading to problem of coordination

How do they select & how do they pay?

Managerial synergyhypothesis:

Merger is required as excess managerial capacity can not be

released and expansion is not possible

Why to merge? .. get from outside

39

8/8/2019 MA&CR mod1

40/59

It does not perform up to the potential ie.,

other control group may do the job better.

Assumptions:

Owners are unable to replace the managers

If replacement was the sole motive then even if

it is a subsidiary then the purpose is served.

Managers are replaced after mergers.

40

8/8/2019 MA&CR mod1

41/59

Economies of scale exists & activities that

fall short of achieving the potentials for

economies of scale

Economies Of Scale arise of indivisibilities

Problem that would arise here is:

How to combine good parts & eliminate not

required ones?

All size firms need some amount of corporate

staff.41

8/8/2019 MA&CR mod1

42/59

Demand for diversification by managers, employees,

preservation of organizational reputation, financial & taxadvantage.

The arguments against are:

Shareholders can diversify across firms

Employees have firm specific knowledge

Owner manager may not like to loose control

Information is accumulated within the firm, its transfer

outside may not be possible or may be done with some noise.

Reputational Capital of the firm is established with that firm

only.

Diversification may increase the debt capacity

This can be achieved through internal growth also

42

8/8/2019 MA&CR mod1

43/59

Demand is increasing faster than before

So need to have more funds, there is

distinction between external & internal funds

Discussion on tax advantage & leverages

Evidences suggests that the opportunities

have improved

43

8/8/2019 MA&CR mod1

44/59

Strategic planning is concerned with environments not

only the operating decisions.

It says possibilities of Economies of scale or tappingthe underused capacity

They get required capacities: may be managers,

funds..by acquisition, but timings is important

Mergers is quicker than internal growth

The experiences say NPV from M&A is comparatively smaller.

44

8/8/2019 MA&CR mod1

45/59

Merger happen because A undervalues T

A has insider information

Market Value of the assets VS. Replacement Costs

Inflation

Inflation depressed the stock prices between 1970 & 1982

Replacement cost of the assets were high compared to the

historical book values

Qratio is the ratio of the market value of the shares

to the replacement cost of the assets represented by

these shares. declined.

45

8/8/2019 MA&CR mod1

46/59

A company can add capacity easily be merging

than by internal growth

If a firm wishes to add capacity it means that

the Q ratio is high

Eg: q ratio is 0.6, and the merger premium is say

1.5, then the purchase price is 0.9 (1.5*0.6)ie., 10

percent below the replacement cost.

46

8/8/2019 MA&CR mod1

47/59

If the tender offer is unsuccessful, then the share value

of T is going to go up. This leads to:

Sitting on a gold mine (T is undervalued; revalue)

Kick in the pant (inspires T to implement a more effective

business strategy)

It may be acquired by somebody else who applies some

special resources in T

Researchers say: if T will not get any offer for another 5years after unsuccessful bid, the share prices are going

to fall back to the pre-offer level

47

8/8/2019 MA&CR mod1

48/59

Signalling Theory:

This was first developed for labour markets, says it is

less expensive if you hire high skilled labourers,

hence the level of education was the signal of thecost on training & Education

Also signals the capacity of the organization.

Ross connects this to the Capital Structure theory

Nature of firms investment policy is signaled through its

capital structure

Managers compensation is tied to the capital structure48

8/8/2019 MA&CR mod1

49/59

Less perquisites, if managers were owners

Costs are:

Cost of monitoring

Cost of structuring a set of contracts

Cost of bonding the guarantee that the agents

will make optimum decisions

Residual loss welfare loss arising from the

divergence of decisions.

49

8/8/2019 MA&CR mod1

50/59

Compensation tied to the performance and inturn to the agency problems

Stock market says: if there is low priced

stock to change the behaviour of the

managers

When these does not work out there may be

an external control exercised

50

8/8/2019 MA&CR mod1

51/59

Some say Mergers are sign of agency problems

Managers feel that their compensation is

related to the size of the firm, so wants to

expand using low hurdle rate, but not so.

This theory says that if there is agency

problem & there is mergers, the merger

activity is a sign of the agency problem of

inefficient, external investment by managers

51

8/8/2019 MA&CR mod1

52/59

Managers commit error of over optimism invaluation due to pride, animal spirits or hubris

When A values T, and the valuation of assets is

below the market price no offer is made

This theory says that:

Market is in strong form ie., Stock prices reflects all

information (pub./non-pub.)

52

8/8/2019 MA&CR mod1

53/59

When agency costs are large takeovers helps to

reduce them

Hypothesis by Jenson: payout of FCF can serve as

an important role in dealing with the conflict

between the managers & the shareholders.

FCF is the cash flow in excess of the amounts

required to fund all the projects that havepositive NPV, when discounted at the applicable

cost of capital

53

8/8/2019 MA&CR mod1

54/59

This reduces the amount of resources under the

control of the managers thereby reducing their

power.

They are under monitoring when they seek morefunds.

Issue debt for stock, managers can effectively

use the future cash flows, but this reduces the

growth

He also says: increased leverage involves cost,

increase in risk of bankruptcy.

54

8/8/2019 MA&CR mod1

55/59

There is agency problem with this also: ie.,

to benefit shareholders, bondholders are put

into risk

Therefore he says: Optimal debt/equity ratio

is where the marginal cost of debt equals

marginal benefits of debt

55

8/8/2019 MA&CR mod1

56/59

Evidences:

Firms with positive FCF, stock prices will increase

with unexpected increase in the payouts and

decrease with the unexpected decreases in payouts

This do not apply to the firms with more profitable

projects than cash flow to fund them

This theory does not apply to growth firms

56

8/8/2019 MA&CR mod1

57/59

M & A happens to increase the market share

But does not say how increased market share

will lead to EOS or synergy or social gain

Internal expansion also can be a solution?

Will the buying price is economical than expansion?

This may lead to undue concentration, leadingto monopoly

57

8/8/2019 MA&CR mod1

58/59

Sale & lease back transfers the tax credit,

mitigate tax incentives for mergers

Carryover of Net Operating Losses

Substitution of Capital Gains for ordinary income

Other Tax Incentives

58

8/8/2019 MA&CR mod1

59/59

Redistribution of source of value among the

shareholders

No evidence that the shareholders gain

Breech of trust may lead to demand for wages

(reduce the cost due to the competitiveness, no

competition in merger)

Managerial inefficiency