MM UGM Yogyakarta, 18 December 2010 Group 3 AP-14 : Bayu Setiaji Nureni Susilowati

1. Corporate Strategy Dr. Amin Wibowo, MBA Takeovers, Restructuring, and Corporate Governance – Chapter 6THEORIES OF MERGERS AND TENDER OFFERSJ. Fred Weston ● Mark L. Mitchell ● J. Harold Mulherin MM UGM Yogyakarta, 18 December 2010 Group 3 AP-14 : Bayu Setiaji Nureni Susilowati Sri Muniati

2. The causes and effects of mergers Why do mergers occurs ? What are the possible effects of merger activity on firm value ? How does the merger process unfold ?

3. Examples of The Merger Process • The merger of Hewlett – Packard and Compaq • The acquisition of TRW by Northrop Grumman

4. HP / Compaq

5. Northrop Grumman / TRW

6. Merger Occurrence : Economies of Scale and Transaction Costs • Size and Returns To Scale • Increase in firm size. • Create economies of scale or synergies. • The larger the scale of operations is, the lower the required investment in inventories is in relation to the average quantity sold. • Return to scale. • source of return to scale is specialization • improve capacity utilization that spreads fixed costs over a larger number of units • distinction from economies of scope (produce • at lower cost because having experience)

7. Transaction Costs and Mergers Ronald Coase (1937) : • Firm size and mergers should be determined by the relative transactions costs within and outside the firm. • Guidance for managers considering a merger decision is weigh (comparative) transaction costs of separate versus merged entitied before proceeding with a merger transaction. • Some possible gains from a merger including costs savings from economies of scale and better capacity utilization, specialization is sometimes better achieved by avoiding merge. (Bigger is not always better)

8. Theories of the Valuation Effects of Mergers and Acquisitions

9. Mergers as Value – Increasing Decisions Coase : • Merger increase value • Firm responds to the appropriate balance between the costs of using the market and the costs of operating internally, such as technological change. Bradley, Desai, and Kim : - Merger create synergies  synergies economies of scale, more effective management, improved production techniques, and the combination of complementary resources.

10. Mergers as Value – Increasing Decisions (Cont’d) Manne, Alchian and Demsetz : • Why a takeover transaction creates value is based on disciplinary motives. • Corporate takeovers as an integral component of the market for corporate control. • The takeover market facilitates competition among different management teams. • An acquisition to remove the existing officers that are viewed as responsible for poor performance.

11. Mergers as Value – Reducing Decisions - Mergers are a source of value reduction • In some models, disciplinary takeovers are a possible response to a value-reducing merger. Jensen : Free cash flow is a source of value-reducing mergers, A firm with high FCF is in excess of the investments required to fund positive NPV projects. Schleifer-Vishny : model of management entrenchment. - Managers make investments that increase the manager’s value to shareholders. • Managers are hesitant to pay out cash to shareholders. • Investment can be in the form of acquisition in which managers overpay but lower the likelihood that they will be replaced.

12. Managerial Hubris and Mergers Richard Roll : - Merger bidding based on managerial hubris. - Markets are strong form efficient (private information does not produce above normal returns) but individual managers are prone to excessive self confidence (excessive optimism) . - The winner’s curse concept : The winner is the bidder who has the highest estimate in distribution, however the winner is cursed by the fact that the bid was, in all likelihood, higher than the asset on firm’s actual value. • The hubris theory : mergers can occur even if they have no effects on value. The bid exceeds the target’s value, the target sells and what is gained by the target shareholders is a wealth transfer from the bidding firm’s owner.

13. Theoretical Predictions of The Patterns of Gains in Takeovers Effect mergers on target, bidder, and combined value. • The value-increasing theories of mergers based on efficiency and synergy predict that the combined value of the two merging firms will increase and, therefore, the merger will have a positive effect on firm value. • The value-decreasing theories make alternative predictions. The agency cost and entrenchment models predict that a merger will have a negative effect on combined firm value. • The hubris theory of takeovers suggest that merger have no effect (zero) on combined firm’s value. Any positive gain borne by target shareholders is merely a wealth transfer from the buyer/bidder.

14. Theoretical Predictions of The Patterns of Gains in Takeovers

15. The Merger Process : The Acquisition of Savannah Foods in 1997 (an example)

16. The Acquisition of Savannah Foods (cont’d)

17. Models of The Takeover Bidding Process

18. The Winner’s Curse • Roll’s hubris hypothesis of mergers : the bidders in a takeover attempt face a potential winner’s curse. • Shading the bid too low would lessen the likelihood completing a wealth-enhancing merger. • Hansen : the root of problem is the lack of full knowledge about the target’s value – knowledge is held by the target firm itself. • A bidder concerned about the value of the target can offer stock rather than cash. • Offer of stock is a contingent payment that internalized the asymmetric information of the target firm.

19. Bidder Costs • The cost of making the acquisition that is borne by bidder. • Hirshleifer and Png (1989) : the presence of bidding costs raises issues strategic interplay between the target firm and potential bidders. Initial bidder make preemptive bid precludes potential bidder to make a competing offer, the target firm can often receive a higher price. • Termination fee as part of the merger agreement, the target firm was paid by a bidder when its deal was terminated. (Officer, 2003) • Chowdry and Jegadeesh (1994) : a toehold helps recoup bidding costs. A potential bidder is whether to obtain an initial stake or toehold prior to actively seeking control of the target firm. The size of the toehold is a function of the expected synergies from the merger.

20. Seller Decisions • Any factor that affects bidders can have indirect and direct effects on sellers, meaning the target firms in takeovers. • Bulow, Huang, and Klemperer (1999) : interactive effects of a bidder ‘s toehold on the price received by the target firm. An initial toehold by one bidder might deter active competition from other bidders and lessen gains to the selling firm. A target firm can counteract this effect by the shapping of auction design. • French and McCormick (1984) : strategy in the face of costly bidding and an endogenous number of bidders. Central insight is in equilibrium, the selling firm bears the costs borne by the bidder. The selling firm might want to limit the number of bidders making detailed evaluations of the value of the seller.

21. An Example of A Takeover Auction

22. Conclusion • Takeover bidding and the conceptual models of the process are complex. • The information costs of valuing the target and determining the strategic fit of potential merger partners make the decision of the buyer and seller in a takeover bid important, yet difficult to specify. • Economies of scale is a general motivation to merger. • Gains to target — all empirical studies show gains are positive. • Gains to acquirer : • Positive — efficiency, synergy, or market power • Zero — overpaying, winner’s curse, hubris • Negative – agencyproblemsor mistakes

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