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- - - - - - - - Chapter 17 - - - - - - - -

- - - - - - - - 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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  1. - - - - - - - - Chapter 17- - - - - - - - International Takeovers and Restructuring ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1

  2. Background • Significant proportion of total takeover activity has an international dimension ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 2

  3. 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

  4. 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

  5. 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

  6. 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

  7. 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

  8. 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

  9. 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

  10. 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

  11. 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

  12. 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

  13. 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

  14. 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

  15. 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

  16. 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

  17. 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

  18. 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

  19. 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

  20. 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

  21. 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

  22. 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

  23. 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

  24. 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

  25. 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

  26. 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

  27. 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

  28. 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

  29. 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

  30. 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

  31. 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

  32. 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

  33. 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

  34. 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

  35. 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

  36. 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

  37. 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

  38. 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

  39. 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

  40. 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

  41. 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

  42. 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

  43. Cost of equity and cost of capital • Capital asset pricing model (CAPM) ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 43

  44. 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

  45. 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

  46. 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

  47. 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

  48. 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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