Lecture 12: Mergers and acquisitions (M&A)

1. Lecture 12: Mergers and acquisitions (M&A) Objectives: • Understand the fundamental theory underpinning M&As • Discuss the motives behind M&As • Describe the methods of financing M&As • Apply the various methods of share valuation under M&A • Discuss the reasons for merger failure.

2. Mergers and Acquisitions • Merger: • is where two companies come together to combine and share resources to achieve a common objectives. • Under merger the combining firms remain • joint owners • new company is created

3. Mergers and Acquisitions • Takeover or acquisition: • one firm purchase the assets of another, with the acquired firm ceasing to be the owners of that firm. Often it is the larger company which acquires a smaller one

4. Types of M & A • Horizontal merger : • two companies engaged in similar activities are combined • Vertical merger ; • firms from different points in the same production process decide to combine • Conglomerate merger: • occurs when two businesses in unrelated industries decide to combine

5. Mergers and Acquisitions Objectives of M&As • Enhance shareholder wealth through competitive advantage • Empire building

6. Mergers and Acquisitions Theoretical perspective (pages 89-90 hand book) Question Is take over targets a way of disciplining managers who fail to seek the interest of shareholders (Market for Corporate Control) or are there motives different from this? From lecture 1 (agency problem). Read more on this area.

7. Motives of M & A • Economies of scale • to enable benefits of scale to be achieved • To reduce competition • to co-opt an existing competitor in order to reduce competition • Market power • increase market share

8. Motives of M & A • Sharing complementary resources • bringing together the relative strength of each firm • New market entry • to facilitate expansion into new market • To reduce risk • diversification

9. Motives of M & A • Managerial motive • to avoid being taken over (job security) • to pursue growth in size, status and higher remuneration Removal of inefficient Management -to remove managers who failed to maximise shareholder wealth

10. Methods of Financing Mergers • Cash payment • pay the purchase consideration by cash • Shares • issue of ordinary and preference shares • Loan capital • debentures • convertible loans

11. Target Valuation Methods: • Asset-based methods • Balance sheet or net book values approach P = Total assets - total liabilities No of ordinary shares issued • Net realisable values or replacement cost P = net realisable value - total liabilities No of ordinary shares issued

12. Target Valuation Stock market methods: • For listed companies use the share price on the stock exchange

13. Target Valuation Cash flow methods: Gordon’s growth model Value of share= Dividend received Rate of return – growth in dividend Free cash flow method: PV of future cash flow-total liabilities No of ordinary shares issued

14. Target Valuation Dividend Yield = Gross dividend per share Market value per share MV/S = Gross dividend per share Dividend yield P/E ratio = market value per share Earning per share Market value per share = P/E ratio x EPS

19. Target Valuation – solution12.1 a) P = Total assets - total liabilities No of ordinary shares issued P = (9.9 + 5.8) – (6.5 + 3.6) 2 = £2.8 b) Net realisable values or replacement cost P = net realisable value - total liabilities No of ordinary shares issued P = (18.2+4.2+3.4+0.4+2.6)-(6.5+3.6) 2 = 9.36

20. Target Valuation c)Replacement cost • P = Assets at Replacement cost - total liabilities • No of ordinary shares issued • P = (19.2+5.2+3.9+0.4+2.6+10)-(6.5+3.6) • 2 =15.6

21. Target Valuation d) P/E ratio = market value per share Earning per share Market value per share = P/E ratio x EPS 11 X 3.6 2 • 19.80

22. Target Valuation e) Cashflow DCF 10% PV 19x2 4.4 0.91 4.0 19x3 4.6 0.83 3.82 19x4 4.9 0.75 3.68 19x5 5.0 0.68 3.40 Next 13 yrs 5.4 4.90* 26.46 41.36 41.36 -10.1 / 2.0 =15.63

23. Failure of M & A Reasons: • Over-optimisation • Acquirers often pay too much for their targets as a result of flawed evaluation process that overestimates the likely benefits; • Failure of integration management • improper planning and execution of the integration process.

24. Further Reading • Manne, Henry G. (1965) “Mergers and the Market for Corporate Control” The Journal of Political Economy, Vol 73, No 2 (April), pp. 110-120. • Siriopoulos, C. et al (2006) “Does the Market for Corporate Control hypothesis explain takeover targets?” Applied Economics Letter, Vol. 13, pp. 557-561. • Sudarsanam, P.S.(1995). The Essence of Mergers and Acquisitions, Prentice Hall.

25. Thank you all for listening to me