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MERGERS AND ACQUISITIONS The Market for Corporate Control M&A Activities Mergers Takeovers LBOs Compensation Spin-offs, etc. Definitions Corporate control -- the power to make investment and financing decisions.

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mergers and acquisitions

MERGERS AND ACQUISITIONS

The Market for Corporate Control

m a activities
M&A Activities
  • Mergers
  • Takeovers
  • LBOs
  • Compensation
  • Spin-offs, etc.
definitions
Definitions
  • Corporate control -- the power to make investment and financing decisions.
  • Corporate governance -- the role of the Board of Directors, shareholder voting, proxy fights, etc. and the actions taken by shareholders to influence corporate decisions.
  • Corporate structure -- the financial organization of the business.
sensible reasons for mergers
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

$

$

sensible reasons for mergers6
Sensible Reasons for Mergers

Economies of Scope or 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

sensible reasons for mergers7
Sensible Reasons for Mergers

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

sensible reasons for mergers8
Sensible Reasons for Mergers

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

sensible reasons for mergers9
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.

dubious reasons for mergers
Dubious Reasons for Mergers
  • Diversification
    • Investors should not pay a premium for diversification since they can do it themselves
  • Empire Building
  • EPS Game
    • EX: High PE firm buys Low PE firm -- resulting in higher EPS for merged firm (the bootstrap game)
dubious reasons for mergers11

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.

Dubious Reasons for Mergers

The Bootstrap Game

dubious reasons for mergers12
Dubious Reasons for Mergers

The Bootstrap Game

dubious reasons for mergers13
Dubious Reasons for Mergers

EP Ratio

(log scale)

World Enterprises (after merger)

World Enterprises (before merger)

Muck & Slurry

.10

.067

.05

Time

Now

sensible reasons for mergers14
Sensible Reasons for Mergers
  • Unused Tax Shields
  • More Debt Capacity
    • More Tax Shield
    • Lower BK Costs
sensible reasons for mergers15
Sensible Reasons for Mergers
  • Inefficient Management (Agency Problems)
  • Management Controls
    • Capital Markets (mergers, takeovers, LBOs)
  • Other Managerial Controls
    • Board of Directors
    • Labor Markets (External & Internal)
    • Compensation Incentives (options)
board of directors
Board of Directors
  • Independent?
  • Monitoring
  • Hire/Fire
  • Compensation
  • Strategic Planning
estimating merger gains
Estimating Merger Gains
  • Questions
    • Is there an overall economic gain to the merger?
    • Do the terms of the merger make the company and its shareholders better off?
example snowbird alta
Example: Snowbird & Alta

Snowbird is examining the purchase of Alta, which

would become a subsidiary of Snowbird if the merger

goes through. The projected cash flow statement for Alta

(if merged) is shown on the next slide. These cash flows

include all synergistic effects.

Alta’s market-determined beta is 1.63. The risk-free rate

is 10 percent and the market risk premium is 5 percent.

Alta has 10 million shares of stock priced at $6.25. What

is the possible economic gain to this merger, if any?

snowbird alta21
Snowbird & Alta

Discount Rate

snowbird alta22
Snowbird & Alta

Terminal Value

Assume: terminal growth rate of 10%

snowbird alta23
Snowbird & Alta

Total Firm Value

snowbird alta24
Snowbird & Alta

Possible

Economic Gain = Merger Value - Pre-merger Value

= $92.8 - $6.25 x 10,000,000

= $92.8 - $62.5

= $30.3 million

snowbird alta25
Snowbird & Alta

Change in

Stockholders’

Wealth

Snowbird (Acquirer)

Alta (Target)

Bargaining Range

= Synergy

Price Paid for Target

$62.5

$92.8

takeover methods

Proxy Contest

Tender Offer

Acquisition

Merger

Leveraged Buy-Out

Management Buy-Out

Takeover Methods

Tools Used To Acquire Companies

takeover defenses
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.

leveraged buyouts
Leveraged Buyouts
  • The difference between leveraged buyouts and ordinary acquisitions:

1. A large fraction of the purchase price is debt financed.

2. The LBO goes private, and its share is no longer trade on the open market.

leveraged buyouts29
Leveraged Buyouts
  • The three main characteristics of LBOs:

1. High debt

2. Incentives

3. Private ownership

leveraged buyouts30
Leveraged Buyouts

10 Largest LBOs in 1980s and 1997/98 examples

phillips petroleum case
Phillips Petroleum Case

Philips balance sheet was dramatically changed by its leveraged restructuring (figures in $billions).

spin offs etc
Spin-offs, etc.
  • Spin off -- debut independent company created by detaching part of a parent company's assets and operations.
  • Carve-outs-- similar to spin offs, except that shares in the new company are not given to existing shareholders but sold in a public offering.
  • Asset Sales-- the sale of the assets of a division to other firms .
exit overcapacity
EXIT (Overcapacity)
  • Capital Markets
  • Internal Control Mechanisms
  • Regulation and Legal System
  • Product and Factor Markets
      • (Michael Jensen’s arguments)

Is M&A good or bad for economic efficiency?

summary
Summary
  • M&A is Corporate Control Activity
  • Many Sensible Reasons for Mergers
  • Measure the Gains to Merger
    • New cash flows from synergies
    • Discount rate
    • DCF Analysis
  • Other M&A Activities
  • The Role of M&A Activity for the Economy