Click to edit Master title style Corporate Financial Management II (#2, 3)

Corporate Financial Management II2 Mergers & Acquisitions Acquisition = (Big and Complex) Capital Budgeting Project Substantiation of Merger (Net Advantage to Merging): NAM = [V AB - (V A +V B )] - P B - Expenses Valuation: DCF and Comparative Analysis Methods; Break-up Valuation Chapter 21

Corporate Financial Management II3 Valid Reasons for Mergers  Synergy: Value of the whole exceeds sum of the parts. Could arise from: Operating economies Financial economies Differential management efficiency Taxes (use of accumulated losses)  Break-up value: Assets would be more valuable if broken up and sold to other companies.

Corporate Financial Management II4 Questionable Reasons for Mergers  Diversification.  Purchase of assets at below replacement cost (or “cheap” refinancing).  Acquire other firms to increase size, thus making it more difficult to be acquired.

Corporate Financial Management II5 Do Mergers Really Create Value?  According to empirical evidence, acquisitions do create value as a result of economies of scale, other synergies, and/or better management.  Shareholders of target firms reap most of the benefits, that is, the final price is close to full value (i.e. P B > NAM). Target management can always say no. Competing bidders often push up prices.

Corporate Financial Management II6 Hostile and Friendly Mergers  Friendly merger - Supported by managements of both firms.  Hostile merger - Target firm’s management resists the merger; Acquirer must go directly to the target firm’s stockholders, try to get 51% to tender their shares, or get proxies. Often, mergers that start out hostile end up as friendly, when offer price is raised.

Corporate Financial Management II7 Defensive Tactics  Changing by-laws (staggered election of directors, supermajority voting)  Legal (filing on antitrust or other issues)  Unloading cash (acquisitions, stock repurchase, investments, leveraging)  Capital-related (issue rights, special classes of stock, friendly shareholder)  Tactical (counter tender, poison pills)

Corporate Financial Management II8 Forms of Transaction  Merger or Consolidation Combination of balance sheets Has to be approved by both companies  Purchase of Stock Open market or tender offer  Purchase of Assets By-passes minority shareholders and avoids hidden liabilities Tends to be complicated and costly

Corporate Financial Management II9 Accounting for Mergers  Pooling of interests: Assumes a merger among equals. New balance sheet is merely the sum of the two existing balance sheets. No income statement effects other than summing the two income statements.  Purchase: Assets of the acquired firm are “written up” to reflect purchase price if it is greater than the net asset value => Goodwill is created. Goodwill amortized and expensed over time, reducing future reported earnings.

Corporate Financial Management II10 Merger Valuation  Comparative Methods Merger Premium Earnings (Cash Flow, EBIT) Multiples Book Value Multiples Price per Unit of Resource (natural resources, customers...)  DCF Valuation Prepare pro-forma statements forecasting incremental cash flows expected to result from merger.

Corporate Financial Management II11 Financial Distress Firm cannot meet obligations (this can mean repayment, covenant or rating) => 1) Try to renegotiate terms of loan 2) Find cash (refinance loan, sell assets) 3) File for bankrupcy  Reorganization,  Liquidation. Chapters 22

Corporate Financial Management II12 Causes of Distress  Management  External Economic Factors  Structural Financial and Operating Factors  Operational, Regulatory, Legal Risks

Corporate Financial Management II13 Early Detection of Distress  Who cares to know? Management, Shareholders Lenders, Bondholders Other Stakeholders (business partners, sometimes regulators...)  Tools: Credit Analysis, Multiple Discri- minant Analysis, Agency Ratings, Market Developments, Business News

Corporate Financial Management II14 Reorganization Outs. Bankrupcy  Usually cheaper than in bankrupcy: Issue new securities for existing securities, or Modify the terms of outstanding securities (maturity, covenants), or Repurchase a specific issue.  Reporting, reputation, benefits.  Use incentives (eg. holdout problem).

Corporate Financial Management II15 International Finance Earlier, most companies acted just in their home markets. Today, a number of companies are multinational (i.e. operating in two or more countries). Others trade with foreign companies, use foreign currencies etc. Chapters 17

Corporate Financial Management II16 Why Firms Expand Internationally  To seek new markets.  To seek new supplies of raw materials.  To gain new technologies.  To gain production efficiencies.  To avoid political and regulatory obstacles.  To reduce risk by diversification.

Corporate Financial Management II17 Main Distinctions  Currency differences  Economic and legal differences  Language differences  Cultural differences  Government roles  Political risk

Corporate Financial Management II18 Asset Based Financing  With traditional financing, investors look to the entire cash flow of the firm for a return on their investment.  Asset-based financing limits this to cash flows from a specific pool of assets (recourse or nonrecourse).  Lease Financing, Project Financing, Limited Partnership Financing... Chapter 18

Corporate Financial Management II19 Leasing  The lessee uses the asset and makes the lease, or rental, payments.  The lessor owns the asset and receives the rental payments.  The lease decision is a financing decision for the lessee and an investment decision for the lessor.

Corporate Financial Management II20 Lease Types  Operating Lease Normally short-term and cancelable; maintenance included  Financial Lease Normally long-term and noncancelable; no maintenance  Sale and Leaseback  Combination, Leveraged, Synthetic...

Corporate Financial Management II21 Economic Impact  Leasing is a substitute for debt. As such, leasing uses up a firm’s debt capacity.  Net Advantage to Leasing facilitates comparasion with borrow and buy

Corporate Financial Management II22 Leasing Highlights  In a perfect environment, leasing is zero- sum. Why, then, is it so popular? Provision of maintenance services. Risk reduction for the lessee (project life, resid. value, oper. risk, obsolence) - Portfolio risk reduction enables lessor to better bear these risks. Cost of borrowing, altern. financing. Bankrupcy considerations. By-passing debt covenants, disclosure.

Corporate Financial Management II23 Working Capital Management  Net Working Capital = Current Assets - Current Liabilities  Establishing Working Capital Policy: Level of each current asset; How current assets are financed.  Day-to-day control of: Cash, Inventory, Receivables, Short-term liabilities.  Cash Conversion Cycle Chapter 16

Corporate Financial Management II24 Liquidity Management  Tradeoff between maintaining adequate liquidity, and profitability. Cash earns no interest, so why hold it? Transactions: Must have some cash to pay current bills. Precaution (“Safety stock”): Mitigated by credit lines and marketable securities. Compensating balances: For loans and/or services provided. Speculation: To take advantage of bargains, take discounts, etc. (May be solved by credit line, marketable securities).

Corporate Financial Management II25 WC Management Toolbox  Have sufficient cash on hand to meet the needs, but not one dollar more. Increase forecast accuracy, centralize processing; Synchronize inflows and outflows; Hold securities, negotiate lines of credit instead of holding cash; Wire transfers (minimize float), zero balance and remote disbursement accounts, cash pooling.  Optimize Cash Conversion Cycle (Inventory management, Receivable management, Trade Credit)