Mergers and Acquisitions

Mergers and Acquisitions

In this lecture we will discuss possible motives for takeovers or

mergers what is involved in a

merger/takeover whether takeovers/mergers create

value

Introduction

Takeover Merger

‘the combining of two business entities under common ownership’, Arnold, p865

In practice most business amalgamations are usually takeovers

3 main types of business integration

o horizontal takeovers (including cross-border takeovers)

companies in similar lines of activityo vertical takeovers

companies from different stages of the production line

o backwardo forward

o conglomerate takeoverscompanies in different lines of activity

Some Major Takeovers(1988 - 2004)

Year Bidder Target Value (£m) Type

1988 BP Britoil 2,323 Vertical Back.

1988 Nestlé Rowntree 2,666 Horizontal

1995 Glaxo Welcome 9,150 Horizontal

1995 Hanson Eastern Electricity

2,400 Conglomerate

1996 Granada Forte 3,600 Horizontal

2000 GlaxoWelcome SmithKlineBeecham

38,600 Horizontal

2002 National Grid Lattice Group

8,400 Horizontal

2004 Morrisons Safeway 2,900 Horizontal

More Takeovers(2000 - 2010)

Year Bidder Target Value (£m)

ShValue?

2000 RBS NatWest 23,600 Yes

2000 France Telecom

Orange 25,000 No

2001 Bank of Scotland

Halifax 30,000 Yes then no

2004 Santander Abbey 9,000 ?

2007 RBS ABN AMRO 49,000 No

2008 HBOS Lloyds 12,000 No

2010 Kraft Cadbury 11,500 ?

See Independent article on Studynet

Do mergers/takeovers create shareholder value?

For the target company? For the acquiring company? ‘Indeed, mergers and acquisitions seldom

live up to their promise of delivering strategic benefits, easy growth and a boost in the value of the acquirer's shares. To be sure, some do work. According to academics, as many as 35 per cent do. But that still means more than 60 per cent of deals fall flat chasing the elusive goal reached by a minority.’

Independent Business, Jan 2009

Objectives of takeovers/mergers

To increase wealth, i.e. generate positive NPVs

through either:1. increasing incremental cash flowsor2. reducing the level of risk for existing

cash flows (thus causing a reduction in the discount rate)

Motives for takeovers

Economic justifications Financial motives Managerial motives

Economic justifications

Synergistic effects i.e. value of combined entity is greater than the sum of the values of the individual entities

• PV(A+B) = PV(A) + PV(B) + extra

• market power• economies of scale• R & D

• entry to new markets

Economic justifications

Increase in market power horizontal integration can reduce

competition vertical integration can ensure a final

market or create barriers to entry conglomerate mergers can involve

cross-subsidisation

Economic justifications

Economies of scale linked to production or through lowering the costs of inputs improved communications and reduced

bargaining costs administration, R&D, purchasing

through increased size

Economic justifications

Research and development activities

Entry to new markets/industries

Particular expertise customer service, billing procedures

Financial Justifications

Financial synergy (lower costs of capital, reduced risk of bankruptcy) through diversification

Bootstrapping - increasing EPS by acquiring companies with lower PE ratios than their own

Bootstrapping

Firm A earnings = £1m, share capital 10m ordinary shares trading at £2EPSA = 10p PEA ratio = 20

Firm B earnings = £1m, share capital 10m ordinary shares trading at £1

EPSB = 10p PEB ratio = 10

Bootstrappingo A acquires B o The offer is 1 share of A for 2 shares of Bo Results in earnings of the group of £2m

with issued share capital of 15m shareso EPS is thus 13.33p and if the market

believes that the new entity has the same earnings potential and growth as Firm A, i.e. a PE ratio of 20, then the price of these shares should be:

o PA/13.33 = 20, PA will be £2.67

Managerial Motives

Managers may have different objectives from shareholders (Agency problem) Empire building Status Power Remuneration

Hubris (Roll 1986) excessive self-confidence/arrogance

Managerial Motives

Can result in wealth being transferred from shareholders of the acquiring company to shareholders of the target

Takeover of Cadbury by Kraft

List the likely motives:

Financing Takeovers/Mergers

Takeovers/mergers are open market transactions

Amount to be paid is a matter of judgement

Method of financing must be both attractive to target shareholders and acceptable to acquirer

Methods

Cash Ordinary Shares in bidder firm Loan stocks of bidder firm Cash and ordinary shares tend to be

the preferred methods

Bidder will have to take into account the effect on capital structure

Cash may have to be raised from a rights issue

Cash vs shares

Cash: acquiring company’s shareholders retain same level of control over their company

Shares: shareholders of the acquired company can maintain an interest through the combined entity

Cash

Kraft and Cadbury £8.40 a share £11.5 bn cash and shares Kraft had to borrow £7 bn to finance the

deal

Bid premium

a substantial sum over the pre-bid share price of the target to make the offer attractive to the target shareholders

ABN AMRO valued at 50bn eurosBarclays bid 68 bn eurosRBS paid 71 bn euros

on average 30% to 50% of pre-bid value

Transaction costs

Advisers’ fees Underwriters’ fees Arrangement fees Legal costs Accounting costs Stock exchange fees Public relations bills RBS and ABN – 660million euros

Stages of a bid

Firm appoints advisers Identify a target Value the target Make approach to the target Notify shareholders Negotiation Recommendation to shareholders

Stages of a bid

Initial offer is open for 21 days Revised offer open for 14 days after Maximum period for bid is 60 days

Regulation of Mergers in UK

Competition Commission (formerly Monopolies and Mergers Commission) a statutory body reviews all activity that

accounts for +25% of market or involves purchase of assets £70m+

concerned with the outcome of the merger/takeover

Takeover Panel a self-regulatory body deal with conduct of the takeover/merger

Rules

A 3% stake must be disclosed to the company

A stake of over 30% triggers a bid makes it difficult for another party to

bid successfully A holding of 90% of the shares

means the acquirer can force sale of remaining 10%

Takeovers - Some Defences

Pre-bid defence Circulation of victim co. shareholders Profit announcements / forecasts Dividend increase announcements Revaluation of assets “White Knight” defence “Pac Man” defence “Poison Pill” defence

Are mergers/takeovers successful?

Mergers/acquisitions are investments Success should mean the generation of positive

NPVs Research

Acquisitions often fail to create value for the shareholders in the bidding company

Some researchers have found significant gains to S/Hs of target firms

KPMG Report 1999 – 83% of cross border mergers failed to create value for shareholders in acquiring firm

Arnold’s ten golden rules

Arnold, exhibit 23.25

Further reading

Arnold, G. Corporate Financial Management, Chapter 23

Robbins, M. Independent Business Tuesday, 20 January 2009 Was ABN the worst takeover deal ever?

Kraft and Cadburys

£11.5 billion

Unilever and Ben and Jerry’s

$326million