Finance 7311
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Finance 7311. Market for Corporate Control. Terminology. Target Potential takeover candidate Acquirer (Bidder) Firm doing the ‘taking over’ Merger Friendly combination of two firms Tender Offer (Hostile Takeover) Opposed by target management. Terminology, cont. Leveraged Buyout

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Finance 7311

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Finance 7311

Finance 7311

Market for Corporate Control


Terminology

Terminology

  • Target

    • Potential takeover candidate

  • Acquirer (Bidder)

    • Firm doing the ‘taking over’

  • Merger

    • Friendly combination of two firms

  • Tender Offer (Hostile Takeover)

    • Opposed by target management


Terminology cont

Terminology, cont.

  • Leveraged Buyout

    • Takeover in a highly leveraged transaction

    • Advantages

      • Concentrates ownership in fewer hands

      • Takes cash out of management hands

      • Tax advantage of debt

    • Disadvantages

      • Effect of economic downturn


Terminology cont1

Terminology, cont.

  • Management Buyout

    • Same as LBO, except existing management is major shareholder

  • Proxy Contest

    • Voting by S/H on major corporate transactions

  • Restructuring

    • Significant change in allocation of corporate resources

    • Current management stays on


Defensive tactics

Defensive Tactics

  • Methods used by management to avoid being taken over

    • Poison Pill

    • White Knight

    • Greenmail

    • Just Say No

    • Supermajority Voting

    • Courts: OK if only one ‘bidder’


Selecting and valuing a target

Selecting and Valuing a Target

  • Business Plan or Objective

    • Vertical Integration

    • Excess Capacity

      • Product ==> Distribution

      • Distribution ==> Product

        • (Time Warner; Paramount, previously)

        • (AOL, Time Warner)

    • Strategic: Enter a new market for example

    • Diversification (Later)


Valuation

Valuation

  • PVt = PV of target (stand alone)

  • PVa = PV of acquiring firm (stand alone)

  • PVc = PV of combined firm

  • TP = tender price


Synergy value created

Synergy ==> Value Created

  • PVc - (PVa - PVt) = Total Synergy

  • NPV of acquisition to acquiring firm:

  • PVc - (Pva + PVt) - (TP - PVt)

  • = total synergy - synergy to target


Synergy

Synergy

  • Sources of Synergy?

    • Economies of Scale in

      • Production

      • Distribution

      • Management/Administration

    • Strategic

    • Management: better allocation of resources


Calculation of synergy

Calculation of Synergy

  • Estimate ‘combined’ cash flows and subtract sum of the parts

  • Estimate the change in cash flows

  • Must identify the source of value


Acquisition

Acquisition

  • What is reflected in Target’s current price?

    • Value ‘as is’

    • Value with expected changes (current mgmt)

    • Value ‘in play’

  • How much of a ‘change in control’ premium is already reflected in price?


Acquisition1

Acquisition

  • Acquirer must offer a Premium to induce S/H to tender

  • Must bid less than total value; (Neg NPV)

  • Do other Bidders exist? Is source of value generic or specific?

    • Provision of ‘information’ to market

    • If value highest to you, you can win


Acquisition cont

Acquisition, cont.

  • Strategy:Bid high enough to deter potential bidders, but low enough to retain value

  • Avoid Winner’s Curse

  • Target:

    • Defensive Tactics


Motives or reasons

Motives or Reasons

  • Corporate Raiding

    • Raider buying company for less than value

    • Premiums average 30%

  • Creation of Monopoly Power

    • Hard to test; others should benefit

  • Wealth Transfer from other parties

    • Not much evidence

  • Taxes: May support economics


Motives cont

Motives, cont.

  • Market Inefficiency

    • Firm is Undervalued by Market

    • Information to market

  • Unsuccessful takeovers

    • Target value goes back to preoffer price

    • No perm. Reevaluation of firm

    • Value created in combination


Diversification

Diversification

  • Reduce Risk - may obtain better terms and/or better relationships from:

    • Employees

    • Suppliers

    • Customers

    • Analagous to ‘too much debt’ before

  • Management - much human risk and human capital tied up in firm; S/H?


Diversification evidence

Diversification Evidence

  • Comment & Jarrell (‘95 JFE)

    • Firm performance is increasing in firm focus

  • Lang & Stulz (‘94 JPE)

    • Firms diversify when growth opportunities within industry exhausted

    • Such diversification does not benefit S/H


Diversification evidence1

Diversification Evidence

  • Berger & Ofek (‘95 JFE)

    • Compare stand-alone value of diversified firm segments to specialized firms

    • Diversified firm worth 13% - 15% less than sum of stand alone components

  • Day (‘95 JFE)

    • Examines motives for risk reduction


Day cont

Day, cont.

  • Firms pursue equity variance reducing activities:

    • Higher levels of personal wealth in firm

    • More years invested w/ firm

    • The poorer previous performance

    • CEO specialists invest in similar specialties


Performance changes

Performance Changes

  • Dennis & Denis (‘95 JFE)

    • Turnover

      • Forced

      • Normal

    • Forced: Operating Income/Assets decreases in 3 years prior & increases following

    • Normal: Little difference prior; small improvement afterward


Dennis dennis cont

Dennis & Dennis, cont.

  • Forced resignations are rare

    • 68% preceded by active monitoring by large s/h, b/h or potential acquirers

    • 56% are the target of some form of control activity

  • Boards not so effective in isolation

  • Modern Trend: Outside Directors


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