Mergers and Acquisitions

M&A Market Market for Corporate Control Competition for control of firm assets Associated with Downsizing “It’s amazing that the basic cause of downsizing is so rarely acknowledged: these companies have more workers than they need or can afford to pay… If we must blame somebody for the layoffs, it ought to be you and me…. I haven’t met one person who would agree to pay AT&T twice the going rate if AT&T would promise to stop laying people off. These companies are responding to the constant pressure from consumers and shareholders.” - Peter Lynch, formerly of Fidelity’s Magellan fund

M&A Introduction Purchase & Sale of Firms or Divisions Bidder Company Raiders Target Consideration Cash or securities offered Advisors I-Banks, Consultants, Attorneys, Accountants

Friendly - Mgmt support Hostile - Without mgmt support Williams Act ’68 made more difficult Horizontal 2 Competitors Vertical Target in same industry, but different production stage Conglomerate 2 Unrelated Firms M&A Types

Taxes Tax-free acquisition Business purpose; not solely to avoid taxes Continuity of equity interest Target stockholders have an equity interest in the combined firm Taxable acquisition Firm purchased with cash Capital gains Target stockholders require a higher price to cover the taxes

Merger versus Consolidation Merger One firm is acquired by another Acquired firm ceases to exist Advantage: legally simple Disadvantage: approval of both stockholders Consolidation New firm is created by combining existing firms

Takeovers Control transfers from one group to another Possible forms Acquisition Merger or consolidation Acquisition of stock Acquisition of assets Proxy contest Going private

‘Synergy’ Whole is worth more than the sum of the parts Whole is worth more than the sum of the parts Break-up Value Market Power Agency Issues, Hubris Diversification Avoid takeover attempts M&A Motivation

Synergy ΔV = V AB – (V A + V B ) Synergy: Δ V > 0 Possible sources Δ CF = Δ Rev. - Δ Costs - Δ Taxes - Δ Cap Req. Increase revenue Reduce costs Lower taxes or capital requirements

Revenue Enhancement Marketing gains Advertising Distribution network Product mix Strategic benefits Market power

Cost Reductions Economies of scale Lower average cost by spreading overhead Economies of scope (vertical integration) Coordinate operations more effectively Reduced search cost for suppliers or customers Reduce contracting problems

Lower Taxes or Capital Needs Taxes: Take advantages of net operating losses Carry-backs and carry-forwards IRS can prevent merger if sole purpose is to avoid taxes Unused debt capacity Capital Requirements: Reduce relative to the two firms operating separately

Acquisitions Cash Acquisition NPV = V B * – cash cost Value of the combined firm V AB = V A + (V B * - cash cost) Stock Acquisition Value of combined firm V AB = V A + V B +  V Cost of acquisition Depends on # shares given to target stockholders Depends on post-merger stock price Example

Cash vs. Stock Sharing gains Target stockholders don’t participate in stock price appreciation with a cash acquisition Taxes Cash acquisitions are generally taxable Control Cash acquisitions do not dilute control Signal Stock acquisitions indicate your stock is overvalued

M&A Valuation Market values Only incremental cash flows Appropriate discount rate Consider transaction costs

After Valuation Friendly Work with management Hostile Toe-hold or Bear-hug Open market purchase Threaten target BOD with tender offer Proxy Fight Tender Offer Defenses Poison pills/put, greenmail, golden parachute, etc.

Defensive Tactics Corporate charter Establishes conditions that allow for a takeover Standstill agreements / Targeted repurchase Poison pills (share rights plans) Leveraged buyouts

Free-Rider Problem Purchase toe-hold Buy from large shareholders Two-tiered offer

~ Target’s value to bidder = $163.9 million Target’s current market value = $ 90.0 million Merger premium = $ 73.9 million Target - 10 million shares, $9/share Value to Acquirer

Price Paid for Target Change in Shareholders’ Wealth Acquirer Target Bargaining Range = Synergy $9.00$16.39

Market Reaction Target shares increase +20% Bidder shares are stagnant or decrease Stock offers: -1.5% Cash offers: unclear Effect on competitors varies

M&A Risk Overpayment Winner’s Curse Operating Risk Integration issues, culture Mgmt resources Continued subsidization of sub-par groups Financial Risk Leverage