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- - - - - - - - Chapter 17 - - - - - - - -. International Takeovers and Restructuring. Background. Significant proportion of total takeover activity has an international dimension. Main reasons for large increase in foreign M&A activity Europe is moving toward a common market

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chapter 17
- - - - - - - - Chapter 17- - - - - - - -

International Takeovers and Restructuring

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1

background
Background
  • Significant proportion of total takeover activity has an international dimension

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 2

slide3
Main reasons for large increase in foreign M&A activity
    • Europe is moving toward a common market
    • Globalization and increased intensity of international competition
    • Rapid technological change
    • Consolidation of major industries

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 3

historical and empirical data
Historical and Empirical Data
  • U.S. acquisitions of foreign businesses
  • Foreign acquisitions of U.S. companies

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 4

slide5
Dollar values of foreign acquisitions of U.S. targets have exceeded U.S. acquisitions of foreign targets
  • For 25 largest cross border transactions in history completed as of 12/31/99
    • Transactions involving U.S. targets amounted to $305.1 billion
    • Transactions involving U.S. acquirers amounted to $105.4 billion
    • Transactions involving only foreign companies amounted to $229.6 billion

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 5

slide6
Major reasons for cross border transactions
    • Combine complementary capabilities
    • Strengthen distribution networks
    • Achieve critical mass required for new approaches to R&D, production, etc.
  • Industry characteristics related to M&A pressures
    • Telecommunications
      • Technological change
      • Deregulation
      • Efforts to develop a global presence

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 6

slide7
Media
    • Technological change in content and delivery
    • Overlap in content of different media outlets
    • Attractive and glamorous industry
  • Financial
    • Globalization
    • Serve clients globally
  • Chemicals, pharmaceuticals
    • High amount of R&D
    • Rapid imitation
    • Rapid changes in technology
    • High risks due to competitive pressures

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 7

slide8
Autos, oil & gas, industrial machinery
    • Advantage of size — critical mass
    • Global excess capacity
    • Oil price and supply instability
  • Utilities
    • Deregulation
    • Geographic expansion
    • Broadening of managerial capabilities
  • Food, retailing
    • Slower growth
    • Seek growth in new international markets
  • Natural resources, timber
    • Exhausting sources of supply
    • Match raw material supplies with manufacturing capacity

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 8

forces driving cross border mergers
Forces Driving Cross Border Mergers
  • Growth
    • Most important motive
    • U.S. highly regarded by foreign markets
    • U.S. firms have looked abroad to countries in relatively earlier faster-growing stages of life cycle — especially U.S. food companies
    • Enable medium-sized firms to attain size necessary to improve their competitiveness
    • Achieve size necessary for economies of scale; for effective global competition

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 9

slide10
Technology
    • Impact on international mergers
      • Technologically superior firm may exploit its technological advantage worldwide
      • Technologically inferior firm may acquire technologically superior target to enhance competitive position
    • Technological superiority tends to be more portable
      • No cultural baggage
      • Acquirer may select technologically inferior target — improve target competitive position and profitability
      • Buy into foreign markets to exploit their technological knowledge advantage

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 10

slide11
Value increasing acquisitions
    • Acquiring firm may have an advantage in general management functions such as planning and control or research and development
    • Specific management functions such as marketing or labor relations tend to be environment specific
      • Not readily transferable
      • May explain predominance of U.K. and Canada as international merger partners of U.S.

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 11

slide12
Extend advantages in differentiated products
    • Strong correlation between multinationalization and product differentiation
    • Firms that have developed a reputation for superior products in domestic market may also find acceptance for their products in foreign markets

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 12

slide13
Roll-ups — combine firms in fragmented industries
  • Consolidation — adjust to worldwide excess capacity
  • Government policy
    • Circumvent tariffs and quotas on imports or exports
    • Avoid restrictions that may protect a large lucrative market
    • Environmental and other regulations can increase cost of building de novo facilities
    • Response to changes in government policy and regulations

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 13

slide14
Exchange rates
    • Affect prices of foreign acquisitions, cost of doing business abroad
    • Affect value of repatriated profits to the parent
    • Exchange rate risk management becomes important

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 14

slide15
Political/Economic stability
    • Can alleviate or exacerbate higher risks inherent in operating abroad
    • Political factors
      • Changes in administrations in power
      • Likelihood of government intervention
      • Risk of expropriation
      • War vs. peace

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 15

slide16
Economic factors
    • Low or at least predictable inflation
    • Labor relations climate
    • Stability of exchange rates
    • Depth and breadth of financial markets
    • Transportation and communications networks
  • U.S. market attractive to foreign investors in terms of political/economic factors

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 16

slide17
To follow clients
    • Importance of long-term client relationships
    • Example: Financial firms expand abroad to retain clients who have expanded abroad
  • Diversification
    • Provide diversification
      • Product line
      • Geographically
    • Systematic risk reduction possible if world economies are not perfectly correlated

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 17

premiums paid
Premiums Paid
  • Foreign bidders pay higher premiums to acquire U.S. companies than premiums paid in all acquisitions
  • Harris and Ravenscraft (1991)
    • Sample of companies between 1970-1987
    • Foreign bidder pays higher premia by 10 percentage points
    • High foreign currency values led to increased premia

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 18

slide19
Foreign buyers concentrate on R&D intensive industries when they buy U.S. firms — intensity is 50% higher than in purely domestic transactions
    • U.S. bidders earn only normal returns in both domestic and cross-border acquisitions
  • For period 1987-1998, premiums in foreign acquisitions exceeded all acquisitions by about 5 percentage points

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 19

slide20
Possible reasons
    • Foreign buyers may offer higher premium to preempt potential domestic bidders
    • U.S. targets have less knowledge of foreign buyers and need higher premiums to resolve uncertainty
    • If foreign currencies are strong, can afford to pay more in dollars
    • If prospective future exchange rate movements favor the U.S. dollar, foreign firms must pay more in dollars

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 20

event returns
Event Returns
  • General results
    • Similar results as domestic transactions
    • Targets receive large abnormal returns
    • Buyers earn nonsignificant returns

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 21

slide22
Doukas and Travlos (1988)
    • Positive abnormal returns for U.S. multinational enterprises with no previous operation in target firm\'s country
    • Positive but not significant when U.S. firms expand internationally for first time
    • Negative but not significant for U.S. firms that have already been operating in target\'s home country
    • Greatest benefits from foreign acquisitions when there is simultaneous diversification across industry and geography

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 22

slide23
Harris and Ravenscraft (1991)
    • Sample of 1,273 U.S. firms acquired in 1970-1987
    • 75% of cross-border transactions, buyer and seller not in related industries
    • Takeovers more frequent in R&D intensive industries than are domestic transactions
    • Percentage gain to U.S. targets of foreign buyers significantly higher than targets of U.S. buyers
    • Cross-border effects positively related to weakness of U.S. dollar

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 23

slide24
Kang (1993)
    • Japanese takeovers of U.S. firms
    • Significant wealth gains for both Japanese bidders and U.S. targets
    • Returns increase with
      • Leverage of bidder
      • Bidder\'s ties to financial institutions
      • Depreciation of dollar in relation to Japanese yen

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 24

slide25
Dewenter (1995)
    • Controls for relative corporate wealth and levels of investments in different countries
    • Finds no significant relationship between exchange rate levels and foreign investment relative to domestic investments in U.S. chemical and retail industries

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 25

slide26
Eun, Kolodny, and Scheraga (1996)
    • 225 foreign acquisitions of U.S. firms during 1979-1990
    • For eleven-day window, [-5,+5], CAR was a positive 37.02% and significant for whole sample of U.S. targets
    • Firms acquired by firms from other countries than Japan had CARs between 35% and 37%

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 26

slide27
Cakici, Hessel, and Tandon (1996)
    • 195 foreign acquisitions of U.S. firms during 1983-1992
    • Sample compared to 112 U.S. acquisitions of foreign firms
    • Foreign acquiring firms experienced positive and significant CARs of 0.63% for event period [0,+1] and 1.96% for period [-10,+10]
    • U.S. acquirers had negative but not significant CARs of -0.36% for event period [0,+1] and -0.25% for period [-10,+10]

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 27

slide28
Doukas (1995)
    • 234 U.S. bidding firms involved in 463 international acquisitions during 1975-1989
    • Study relationship between bidders\' gains and its q ratios
    • Value maximizing firms (q ratios > 1), CAR was positive and significant 0.41% for window [-1,0]
    • Overinvested firms (q ratio < 1), CAR was negative and insignificant -0.18%
    • Negative relationship between dollar exchange rate and level of foreign direct investment
    • Method of payment and industry relatedness not significant

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 28

slide29
Seth, Song, and Pettit (1999)
    • 100 cross-border acquisitions of U.S. targets during 1981-1990
    • For event window [-10,+10], CAR for acquirers was an insignificant 0.11%, CAR for targets was significant 38.3%

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 29

international joint ventures
International Joint Ventures
  • Advantages
    • May be only feasible method of obtaining raw materials
    • May involve different capabilities and link together complementary skills
    • Local partners may reduce risks involved in operating in foreign country
    • May be necessary to overcome foreign government restrictions

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 30

slide31
May enhance advantages found in domestic joint ventures such as economies of scale and may provide basis for faster growth rate
    • Knowledge acquisition potentials can be substantial
  • Disadvantages
    • Provide information which makes partner a future competitor
    • Different cultures may increase tensions normally found in joint ventures

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 31

slide32
Principles for management of successful collaborations
    • Should involve complementary capabilities
    • Contracts should make it easy to terminate relationship
    • Control and ultimate decision makers should be specified
    • Formulate terms under which one company can buy out other
    • Activities and information flows should be tied into normal communications structures

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 32

slide33
Criteria for evaluation of performance should be defined
  • Allocation of rewards and responsibilities under different types of outcomes should be considered

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 33

slide34
Chen, Hu, and Shieh (1991)
    • Sample of 88 international joint ventures
    • Significant positive portfolio excess returns when U.S. firms invest relatively small amounts in joint venture
    • Excess returns no longer significant when firms make relatively large investments

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 34

slide35
Mangum, Kim, and Tallman (1996)
    • Summary data on investments by 7 foreign steel makers in U.S. joint ventures
    • In-depth case studies of 7 joint ventures
      • Foreign partners mainly form Japan
      • Initial motive was availability of foreign capital for modernizing U.S. steel industry
      • Another main objective was transfer superior process technologies of Asian partners to American plants
      • Tension from cross-cultural differences
      • Joint ventures generally successful
      • Only joint venture that experienced great difficulties — NKK of Japan and National Steel Corporation of the U.S.

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 35

cost of capital in foreign acquisitions and investments
Cost of Capital in Foreign Acquisitions and Investments
  • Main concepts
    • Fundamental international parity or equilibrium relationships — related to cost of debt of domestic and foreign firm
    • Issues of whether global capital markets are integrated or segmented — related to cost of equity capital in different countries

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 36

slide37
Cost of Debt Relationships
    • International parity relationships assume perfect and efficient markets
      • Financial markets are perfect
      • Goods market are perfect
      • Future is known with certainty
      • Markets are in equilibrium

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 37

slide38
Interest rate parity theorem (IRPT)
    • Ratio of forward and spot exchange rates equal current ratio of foreign and domestic nominal interest rates

where Xf = current forward exchange rate expressed as number of foreign currency units (FC) per dollarX0 = current spot exchange rate expressed as FC per dollarRf0 = current foreign nominal interest rateRd0 = current domestic nominal interest rateEf = current forward exchange rate expressed as dollars per FCE0 = current spot exchange rate expressed as dollars per FC

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 38

slide39
Forward parity theorem (FPT)
    • Current forward foreign exchange rates should be unbiased predictors of future spot rates
    • Current forward rate, Xf , should equal future spot rate, X1

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 39

slide40
Purchasing power parity theorem (PPPT)
    • Expression of the law of one price
    • In competitive markets, exchange-adjusted prices of identical tradable goods and financial assets must be equal worldwide (taking account of information and transaction costs)

where Tf = 1 + foreign country inflation rateTd = 1 + domestic inflation rate

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 40

slide41
International Fisher relation (IFR)
    • Nominal interest rates reflect anticipated rate of inflation

where T = 1 + rate of inflationr = real rate of interestRn = nominal rate of interest

    • If other parity relations hold, real rates will be the same across countries, but nominal rates will differ by the countries\' inflation factors

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 41

slide42
Notes on parity relationships
    • In the shortrun, many real world frictions cause departures from parity conditions
    • In the longrun, international financial markets move toward parity relationships
    • Hedging foreign exchange risk
      • Futures markets
      • Borrowing in foreign markets for foreign projects
      • Conducting manufacturing operations in multiple countries
      • Making sales in multiple countries

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 42

cost of equity and cost of capital
Cost of equity and cost of capital
  • Capital asset pricing model (CAPM)

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 43

slide44
Market definition
    • Integrated global markets — investments are made globally and systematic risk is measured relative to world market index
    • Segmented capital markets — investments are predominantly made in particular segment or country and systematic risk is measured relative to domestic index
  • World is moving toward a globally integrated capital market

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 44

slide45
There is still a home bias phenomenon — investors place only a relatively small part of their funds abroad
    • Extra costs of obtaining and digesting information
    • Greater uncertainty associated with foreign investments

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 45

slide46
If capital markets are not fully integrated
    • Gains from international diversification
    • Multinational corporation (MNC) would apply to foreign investment a lower cost of capital than would a local (foreign) company
    • MNC will have a cost of equity capital related to beta measured with respect to markets in which it operates

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 46

slide47
Procedure
    • Cost of equity for a foreign investment in nominal foreign currency terms should reflect risk differential above cost of debt borrowing in that foreign country
    • Cost of capital calculated based on an estimated leverage ratio and tax rate
    • Cash flows expressed in foreign currency units (FC) discounted by the FC cost of capital gives present value expressed in FC
    • Present value in FC can be converted to dollars at the spot exchange rate to give net present value of investment in dollars

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 47

slide48
Similar alternate procedure
    • Begin with expected cash flows in FC
    • Adjust expected cash flows by risk factors that reflect foreign country\'s risk
    • Convert risk-adjusted expected FC cash flows to dollars over time by using expected foreign exchange rates at time t based on interest rate parity and relative inflation rates
    • Discount dollar cash flows by WACC of U.S. firm

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 48

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