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Megers & Acquisitions

Megers & Acquisitions. Three Areas of Study 1. Determining if a Merger creates value (then developing an offer price) 2. Evaluating M&A offers in the market place (your case analysis assignment) 3. M&A Strategies (biggest area of “talk”). Megers & Acquisitions. Three Areas of Study

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Megers & Acquisitions

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  1. Megers & Acquisitions • Three Areas of Study • 1. Determining if a Merger creates value (then developing an offer price) • 2. Evaluating M&A offers in the market place (your case analysis assignment) • 3. M&A Strategies (biggest area of “talk”)

  2. Megers & Acquisitions • Three Areas of Study • 1. Determining if a Merger creates value (then developing an offer price) • 2. Evaluating M&A offers in the market place (your case analysis assignment) • 3. M&A Strategies (biggest area of “talk”) • Today - Cover both • Part 1 & 3 via lecture • Part 2 via example

  3. Recent Mergers

  4. Sensible Reasons for Mergers • Economies of Scale • A larger firm may be able to reduce its per unit cost by using excess capacity or spreading fixed costs across more units. $ Reduces costs $ $

  5. Sensible Reasons for Mergers • Economies of Vertical Integration • Control over suppliers “may” reduce costs. • Over integration can cause the opposite effect.

  6. Sensible Reasons for Mergers • 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

  7. Sensible Reasons for Mergers • Economies of Vertical Integration • Control over suppliers “may” reduce costs. • Over integration can cause the opposite effect. Pre-integration (less efficient) Post-integration (more efficient) Company Company S S S S S S S S

  8. Sensible Reasons for Mergers • Combining Complementary Resources • Merging may results in each firm filling in the “missing pieces” of their firm with pieces from the other firm. Firm A Firm B

  9. Sensible Reasons for Mergers • Combining Complementary Resources • Merging may results in each firm filling in the “missing pieces” of their firm with pieces from the other firm. Firm A Firm B

  10. Sensible Reasons for Mergers • Mergers as a 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.

  11. Dubious Reasons for Mergers • The Bootstrap Game

  12. Dubious Reasons for Mergers Earnings per dollar invested (log scale) World Enterprises (after merger) World Enterprises (before merger) Muck & Slurry .10 .067 .05 Time Now

  13. Dubious Reasons for Mergers • Diversification • Investors should not pay a premium for diversification since they can do it themselves.

  14. M&A • Q: Does M&A create Value? • A: if PVAB > PVA + PVB • Q: If M&A creates value, Why? • A: Synergies • -Admin • -Dup services • -lower COC

  15. M&A • Q: Does M&A create Value? • A: if PVAB > PVA + PVB • Q: If M&A creates value, Why? • A: Synergies Tricks • -Admin -excuse to change D/E • -Dup services -diversification • -lower COC

  16. M&A • Q: How Much Should A Firm Pay in a M&A?

  17. M&A • Q: How Much Should A Firm Pay in a M&A? • A: Theory • Gain = PVAB - (PVA + PVB) • A must pay B part of the gain

  18. M&A • Q: How Much Should A Firm Pay in a M&A? • A: Theory • Gain = PVAB - (PVA + PVB) • A must pay B part of the gain • A: Reality • A usually pays B all of the gain, plus more. • Why?

  19. M&A • Q: How Much Should A Firm Pay in a M&A? • A: Theory • Gain = PVAB - (PVA + PVB) • A must pay B part of the gain • A: Reality • A usually pays B all of the gain, plus more. • Why? • Premium Paid by A = (Cash - MVB) + (MVB - PVB)

  20. M&A • Type of Takeovers • Hostile • Friendly • LBO • Going Private • Greenmail • White Knight

  21. Takeover Defenses • White Knight - Friendly potential acquirer sought by a target company threatened by an unwelcome suitor. • Shark Repellent - Amendments to a company charter made to forestall takeover attempts. • Poison Pill - Measure taken by a target firm to avoid acquisition; for example, the right for existing shareholders to buy additional shares at an attractive price if a bidder acquires a large holding.

  22. M&A • Who Usually Benefits from M&A? • Shareholders of B • Lawyers & Brokers • Execs in A • Who Usually Losses in M&A? • Sharehpolders of A (overhead) • Execs in B • Employees

  23. M&A Analysis • Steps for M&A Market Analysis • Briefly describe the financial & stretegic history of the company • Determine pre-announcement value • Describe M&A offer • Determine merged value (examine synergies) • Compare values, offer, & market prices • Predict success of M&A • Recommend a strategy for investors and shareholders • Provide a summary analysis

  24. Disney / Cap Cities Deal • History - News, Annual Report, 10k, etc. • (Library & My Web page) • (use spreadsheets to present financial facts) • (include appendix with actual copies of info) • (reference your sources) • (present both original & typed summary data) • (remember to annualize data)

  25. Disney / Cap Cities Deal • Announcement of Offer • Disney offers to acquire Cap Cities/ABC. • Disney will exchange each share of Cap Cities for one share of Disney plus $65 cash. • Disney will issue $10bil in new debt to finance the deal.

  26. Fact Sheet ** Disney Market Rd 7.25% 8.0 % EPS $ 2.50 $ 2.33 Forecasted N.E. @ 14% growth rate Forecasted N.E. @ EPSx#New Shares

  27. Disney / Cap Cities Deal Discount Rates • rA =rd(1-Tc)(D) + re(E) • (V) (V) Disney CC/ABC New Firm ra 22.97% (M&M) rd 7.25% (given by market) re 24.53% (given by perpetuity formula) EPS re - g Sh Pr = solve for re rd = given

  28. Disney / Cap Cities Deal Discount Rates • rA =rd(1-Tc)(D) + re(E) • (V) (V) Disney CC/ABC New Firm ra 22.97% 18.92% rd 7.25% 7.25% re 24.53% 19.31% Disney CC/ABC New Firm ra 22.97% 18.92% rd 7.25% 7.25% re 24.53% 19.31% EPS re - g Sh Pr = solve for re rd = given

  29. Disney / Cap Cities Deal Discount Rates Disney CC/ABC New Firm ra 22.97% 18.92% 14.80% rd 7.25% 7.25% 8.00% re 24.53% 19.31% 17.97% EPS re - g rA =rd(1-Tc)(D) + re(E) (V) (V) Sh Pr = solve for re rd = given

  30. Disney / Cap Cities Deal • Derive data for the unlevered firm & Calculate the Theoretical New Firm Values Market Theory Disney CC/ABC New Firm New Firm VL 32.40 bil 15.30 bil 52.60 bil NOIU g 20% 14% rEU VU GOAL

  31. Disney / Cap Cities Deal Value of the Firm (M&M) NOIu rEU - g + (Tax rate)debt VL= Solve for rEU VU NOIu = EPSU x # of shares or NOIu = (EPSL x # of sh) + (debt)(rD)(1-Tax Rate)

  32. Disney / Cap Cities Deal NOIu = (EPSL x # of sh) + (debt)(rD)(1-Tax Rate) Disney NOIu = (2.60x.520) + (2.6)(.0725)(1- .34) = $1.47 bil CC/ABC NOIu = (5.10x.154) + (.5)(.0725)(1 - .34) = $.81 bil New Firm NOIu = (2.33x.674) + (13.1)(.08)(1 - .34) = $2.26 bil

  33. Disney / Cap Cities Deal Disney NOIu rEU - g + (Tax rate)debt VL= 1.47 rEU - .20 + (.34) 2.6 VL= Solve for rEU 1.47 .2468 - .20 = $ 31.41 bil rEU = 24.68 % VU=

  34. Disney / Cap Cities Deal CC/ABC NOIu rEU - g + (Tax rate)debt VL= 0.81 rEU - .14 + (.34) 0.5 VL= Solve for rEU 0.81 .1935 - .14 = $ 15.14 bil rEU = 19.35 % VU=

  35. Disney / Cap Cities Deal New Firm (market) NOIu rEU - g + (Tax rate)debt VL= 2.26 rEU - .1787 + (.34) 13.1 VL= Solve for rEU 2.26 .2258 - .1787 = $ 47.98 bil rEU = 22.58 % VU=

  36. Disney / Cap Cities Deal Market Theory Disney CC/ABC New Firm New Firm VL 32.40 bil 15.30 bil 52.60 bil NOIU 1.47 bil 0.81 bil 2.26 bil 2.26 bil g 20% 14% 17.87%-Avg based on NOIU rEU 24.68 % 19.35 % 22.58 % VU 31.41 bil 15.14 bil 47.98 bil

  37. Disney / Cap Cities Deal • New Firm (Theory) • rEU = Weighted Avg of Disney & CC/ABC rEU • rEU = 24.68 x ( 31.41 ) + 19.35 x ( 15.14 ) • (31.41+15.14) (31.41+15.14) • rEU = 22.92 %

  38. Disney / Cap Cities Deal • New Firm (Theory) • rEU = Weighted Avg of Disney & CC/ABC rEU • rEU = 24.68 x ( 31.41 ) + 19.35 x ( 15.14 ) • (31.41+15.14) (31.41+15.14) • rEU = 22.92 % • g = Weighted Avg of Disney & CC/ABC g • g = 20 x ( 31.41 ) + 14 x ( 15.14 ) • (31.41+15.14) (31.41+15.14) • g = 18.02 %

  39. Disney / Cap Cities Deal Market Theory Disney CC/ABC New Firm New Firm VL 32.40 bil 15.30 bil 52.60 bil NOIU 1.47 bil 0.81 bil 2.26 bil 2.26 bil g 20% 14% 17.87% 18.02 % rEU 24.68 % 19.35 % 22.58 % 22.92 % VU 31.41 bil 15.14 bil 47.98 bil

  40. Disney / Cap Cities Deal • New Firm (Theory) NOIu rEU - g + (Tax rate)debt VL= VU = 46.12 bil 2.26 .2292 - .1802 + (.34) 13.1 VL= VL= $ 50.58 bil

  41. Disney / Cap Cities Deal Market Theory Disney CC/ABC New Firm New Firm VL 32.40 bil 15.30 bil 52.60 bil50.58 bil NOIU 1.47 bil 0.81 bil 2.26 bil 2.26 bil g 20% 14% 17.87% 18.02 % rEU 24.68 % 19.35 % 22.58 % 22.92 % VU 31.41 bil 15.14 bil 47.98 bil 46.12 bil

  42. Disney / Cap Cities Deal • New Firm (Theory) VL = 50.58 Debt Value = 13.1 Equity value = 50.58 - 13.1 = $ 37.48 bil Price per Share = 37.48 / .674 = $55.60

  43. Disney / Cap Cities Deal Comparative Equity Values ($ bil) Disney CC/ABC New Firm Market (pre) $29.8 $14.8 Market (post) M&M (pre) $29.8 $14.8 M&M (post)

  44. Disney / Cap Cities Deal Comparative Equity Values ($ bil) Disney CC/ABC New Firm Market (pre) $29.8 $14.8 Market (post) $ 39.51 M&M (pre) $29.8 $14.8 M&M (post) $ 37.48

  45. Disney / Cap Cities Deal Comparative Equity Values ($ sh pr) Disney CC/ABC New Firm Market (pre) $57.63 $96.13 Market (post) $ 58.63 M&M (pre) $57.63 $96.13 M&M (post) $ 55.60

  46. Disney / Cap Cities Deal • Predicted Success of Offer • Cap Cities Market Price = 116 1/4 • Cap Cities Offer = 123 5/8 = (58 5/8 + 65) • Offer will succeed

  47. Disney / Cap Cities Deal • Predicted Success of Offer • Cap Cities Market Price = 116 1/4 • Cap Cities Offer = 123 5/8 = (58 5/8 + 65) • Offer will succeed • Cap Cities Market Price = 116 1/4 • (Theory) Value of Offer = 120.60 = (55.60 + 65) • Offer should succeed

  48. Disney / Cap Cities Deal • Analysis Summary • The market is accurately valuing the offer to Cap Cities/ABC at around 116 (123 is too high) • While both firms were properly valued prior to the offer, Disney is now overvalued • Cap Cities stockholders should take the offer and cash out at the inflated market value • Disney stock holders should sell at the inflated price • The market is over reacting to Disney’s offer by pushing up Disney’s stock price. The primary cause is probably an inflated opinion of Disney’s growth opportunities

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