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21-2 Mergers, Acquisitions and Corporate Control The Number of Mergers in the United States ( )

21-3 Types of Mergers Horizontal Merger A merger between two firms in the same line of business (former competitors) Vertical Merger A merger between companies at different stages of production Conglomerate Merger A merger between companies in unrelated lines of business

21-4 Sensible Reasons for Mergers Economies of Scale Economies of Vertical Integration Combining Complementary Resources Mergers as a Use for Surplus Funds

21-5 Economies of Scale With economies of scale, a larger firm may be able to reduce its per unit cost. How?

21-6 Economies of Vertical Integration  Control over suppliers “may” reduce costs.  Over-integration can cause the opposite effect. Pre-integration (less efficient) Company S S S S S S S Post-integration (more efficient) Company S

21-7 Combining Complementary Resources Merging may result in each firm filling in the “missing pieces” of their firm with pieces from the other firm. Firm A Firm B Example: A small firm may have a valuable patent, but lack the engineering and sales organization necessary to produce and market it on a large scale. It could be acquired by a larger firm with those capacities already in place.

21-8 Use for Surplus Funds If your firm is in a mature industry with few, if any, positive NPV projects available, acquisition may be the best use of your funds. What might this imply about the pre- and post- acquisition PVGO?

21-9 Dubious Reasons for Mergers Diversification The Bootstrap Game

21-10 Diversification  Diversification  Investors should not pay a premium for diversification since they can do it themselves.

21-11 The Bootstrap Game Acquiring Firm has high P/E ratio Selling firm has low P/E ratio (due to low number of shares) After merger, acquiring firm has short term EPS rise Long term, acquirer will have slower than normal EPS growth due to share dilution.

21-12 The Bootstrap Game: Example

21-13 The Form of the Acquisition Merger – When the acquiring firm buys all the assets and all the liabilities of the other firm and combines them into one firm Tender Offer – The acquiring firm buys all the stock of the target firm Asset Purchase – When the acquiring firm buys only the assets of the target. The target continues to exist as firm with cash instead of assets

21-14 Evaluating Mergers  Ask:  Is there an overall economic gain to the merger?  Do the terms of the merger make the company and its shareholders better off? Synergy

21-15 Financing Mergers Mergers Financed by Cash Mergers Financed by Stock

21-16 Evaluating Mergers

21-17 Evaluating Mergers: Example Given a 20% cost of funds, what is the economic gain, if any, of the merger listed below? (GenPharm acquires Biotex) Which of the “sensible reasons” for a merger is this merger most likely based on?

21-18 The Market for Corporate Control 1.Proxy Contests 2.Takeovers 3.Leveraged Buyouts 4.Divestures, Spin-Offs or Carve-Outs

21-19 Proxy Contests Proxy The right to vote another shareholder’s shares Proxy Contests Takeover attempt in which outsiders compete with management for shareholders’ votes Proxy Access (2010) Problem with Proxy Contests?

21-20 Takeovers Tender Offer: a direct offer of purchase to current shareholders, without consulting with management How can management react to a tender offer?

21-21 Takeover Defensive Tactics White Knight Shark Repellent Poison Pill

21-22 Leveraged Buy-Outs (LBO) Large portion of buy-out financed by debt Shares of the LBO no longer trade on the open market Leveraged Buyout vs. Management Buyout

21-23 Potential Gains from an LBO  Junk bond market  Leverage and taxes  Other stakeholders  Leverage and incentives  Free cash flow

21-24 Divestitures, Spin-Offs, and Carve-Outs Divestiture When a firm sells some of the assets to another entity as a going concern Spin-Off The process of a business separating the ongoing operations of a unit of that business and giving the shareholders of the parent firm shares of the unit Carve-Outs Similar to a spin-off, but issues shares of the new firm to the public

21-25 Benefits and Cost of Mergers Who usually benefits from a merger? Who usually loses in a merger?