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Mergers and Acquisitions Dr. J.D. Han King’s College, University of Western Ontario.

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Presentation on theme: "Mergers and Acquisitions Dr. J.D. Han King’s College, University of Western Ontario."— Presentation transcript:

1 Mergers and Acquisitions Dr. J.D. Han King’s College, University of Western Ontario

2 I. Two Latest Phenomena of Corporate Financing 1) Traditionally, debts in corporate financing have been more important than Equities. 2) The recent surge in Mergers and Acquisitions (M & A) has raised D/E ratio through LBOs.

3 Sources of External Corporate Financing in U. S. : * In Canada, equity financing has a larger share. Why?

4 II. Why is debt financing more important than equity financing? Firm’s view point -With tax (deductible interest expenses), cost of debt is lower than cost of equity -Equities are more vulnerable for hostile take- over Investor’s viewpoint -Debts are safer than equities in terms of “Principal-Agent Problem”.

5 1. Two major objectives of M & A: Improved Management: -A change in management and thus to an enhanced EFFINCIENCY -A just credible threat will wake up the stale management. Synergy

6 2. Target for M & A: How do you know whether a firm’s management is stale? Free Cash Flow Theory by Michael C. Jensen at HBS “Agency Cost of Free Cash Flow, Corporate Finance and Takeovers”, American Economic Review (1986)

7 * * Free Cash Flows as a Litmus Test Definition of FCF: Free Cash Flows = Cash Receipts - Cash Expenditures - Profitable (Constructive) Investment Opportunities Observation: FCF are the likely object of the Management’s abuse and the Principal-Agent Problem

8 *** Jensen’s FCF Theory in Reverse Gear Dictum “ The Larger the Free Cash Flow of a Firm, the More Severe the Principal-Agent Problem, and thus the Larger the Potential Benefits from M & A and Corporate Restructuring” Prediction We can also identify which firm is likely to be a target of M & A.

9 3. M & A and LBO: How does an Increased Indebtedness enhance Corporate Efficiency? 1) Debt contracts have a better monitoring and less moral hazards. 2) Reduced Equities increase - ROE - Management’s Financial Rewards -> “Incentive-Compatible”

10 *Numerical Example of an Increased Indebtedness enhancing Management’s Rewards Restructuring is “Leveraged” Buyout (of Shareholders) by Management Before Restructuring Debt-Equity Ratio = 0/1 = 0 CapitalProfits Equity 1Shareholders’ share$9,000 Equity 2Manager’s share$1,000 Total$10,000 *assume interest rate =10%; rate of returns on capital =100% After Restructuring Debt –Equity Ratio = 9 CapitalProfits DebtsShareholders’ share $9,000$ 900 Equity 2Manager’s share $1,000$9,100 Total$10,000 *Note: Manager’s profit share has increased by 810%.

11 4. Two Structural Changes as Prerequisites for a Surge of M & A Lowering Legal Barriers -Weakening of Anti-Trust Act(USA) Competition Act(Canada) Development of Financial Institutions, Market & Debt Instruments - Investment Banks, Securities Houses, Junk Bonds, (Debt-Equity) Swap, etc.

12 5. Who are the Big Players? Securities Firms Banks’ M & A Division of Investment Banking Department For instance - Morgan Stanley - Goldman Sachs - Salomon Smith Barney - Merrill Lynch - Donald Trump; Drexel Burnham, Campeu Co., T. Boone Pickens (Mesa Petrolium)

13 6. Pros and Cons of M& A 1) Pros: Advocate for M & A M & A enhances Efficiency of Corporate Management with synergy effect (evidence) Share price of Target Firm goes up by 30-50% before and after M & A Natural Part of Globalization Trend Strategy for Survival from International Competition

14 2) Criticism of M & A (1) Zero Sum Game for the entire economy: gains for shareholders come from someone’s loss a) Government Loss of Tax Revenues in LBO b) Wage Concessions after M & A c) Bond holders’ loss: Increased leverage - Increased Default Risk - Decreased Bond Price d) Consumers’ loss: Increased monopoly power - Higher price (2) Economic Frailty (= Bankruptcy risk + Increased Interdependency) (3) M & A could be costly: A High Transactions Cost

15 (3) A Costly M & A: “ Shark Repellants” -Setting up costly barriers against M & A Green Mail -bribe to a raider away Scorch Earth or Crow Jewel - make yourself unattractive Poison Pills - sell stock under market price in case of danger Golden Parachute - big severance package for leaving executives

16 IV. Canadian Context M & A will continue to increase M & A take on Globalization trends

17 Source: Crosbie & Company Inc. Historical Canadian Mergers & Acquisition Announcements Value in $ Billions Announcements 1,400 1,200 1, $210 $180 $150 $120 $90 $60 $30 0 Announcements

18 M & A at Canadian Cross-Border

19 M & A Resulting in Efficiency: CanadianCases

20 Classic Study Case of M & A – The Company’s objective is to build value for its investors through the acquisition of underperforming businesses( with a large amount of Free Cash Flow) financed largely with debts borrowed from third party lenders. Performances. - Acquired Celestica for C$750mm in October, 1996 which now has a market value of C$4.6 billion. - Onex announces a bid for Air Canada and Canadian Airlines during a time when the industry is struggling. 3. Case Studies Case Study I) Excellent Execution - Onex Corporation

21 Case Study - Excellent Execution - Onex Corporation Stock Price Performance September 29, September 30, /29/199404/20/199511/07/199505/29/199612/16/199607/08/199701/27/199808/17/199803/09/199909/27/1999 Onex Corp Sub Vtg Oct 1/96: Onex acquires Celestica for C$750mm Nov 13/96: ProSource completes IPO of US$48mm Oct 1/98: Onex announces SoftBank acquisition May 29/98: Onex sold ProSource Inc. to AmeriServe Food Distribution for C$123mm Jan 29/99: Onex announces LCS Industries acquisition Mar 11/99: Onex announces that it will sell 23% of its stake in Sky Chefs to LSG Mar 25/99: Onex announces C$1.5bn Telecom Fund with Telefonica May 11/99: Onex purchases American Buildings Aug 24/99: Onex announces bid for Air Canada and Canadian Airlines

22 Case Study 3 - High Yield Debt - Rogers Communications Stock Price Performance September 29, September 30, /29/199404/20/199511/07/199505/29/199612/16/199607/08/199701/27/199808/17/199803/09/199909/27/1999 Rogers Communications Inc Cl B Nov 11/95: Rogers Cablesystems announces two new high yield debt issues of US$150mm and US$125mm Jan 16/96: Issues US$100mm high yield debt Jan 25/96: Issues C$75mm high yield debt July 17/97: Two new high yield debt issues of US$330mm and C$165mm announced May 21/98: Rogers sells local telephone services to Metronet for C$1bn July 12/99: Microsoft makes C$600mm investment in Rogers; Aug 16/99: Completes sale of 33% interest of Rogers Cantel to AT&T Corp and BT PLC for C$1.4bn Sep 9/99: Rogers repurchases C$1.3bn in debt


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