Mergers and Acquisitions

1. Mergers and Acquisitions

2. M&A Market • Market for Corporate Control • Competition for control of firm assets • Associated with Downsizing • “It’s amazing that the basic cause of downsizing is so rarely acknowledged: these companies have more workers than they need or can afford to pay… If we must blame somebody for the layoffs, it ought to be you and me…. I haven’t met one person who would agree to pay AT&T twice the going rate if AT&T would promise to stop laying people off. These companies are responding to the constant pressure from consumers and shareholders.” - Peter Lynch, formerly of Fidelity’s Magellan fund

3. M&A Introduction • Purchase & Sale of Firms or Divisions • Bidder • Company • Raiders • Target • Consideration • Cash or securities offered • Advisors • I-Banks, Consultants, Attorneys, Accountants

4. M&A Types • Friendly - Mgmt support • Hostile - Without mgmt support • Williams Act ’68 made more difficult • Horizontal • 2 Competitors • Vertical • Target in same industry, but different production stage • Conglomerate • 2 Unrelated Firms

5. Taxes • Tax-free acquisition • Business purpose; not solely to avoid taxes • Continuity of equity interest • Target stockholders have an equity interest in the combined firm • Taxable acquisition • Firm purchased with cash • Capital gains • Target stockholders require a higher price to cover the taxes

6. Merger versus Consolidation • Merger • One firm is acquired by another • Acquired firm ceases to exist • Advantage: legally simple • Disadvantage: approval of both stockholders • Consolidation • New firm is created by combining existing firms

7. Takeovers • Control transfers from one group to another • Possible forms • Acquisition • Merger or consolidation • Acquisition of stock • Acquisition of assets • Proxy contest • Going private

8. M&A Motivation • ‘Synergy’ • Whole is worth more than the sum of the parts • Break-up Value • Market Power • Agency Issues, Hubris • Diversification • Avoid takeover attempts

9. Synergy • ΔV = VAB – (VA + VB) • Synergy: ΔV > 0 • Possible sources • ΔCF = ΔRev. - ΔCosts - ΔTaxes - ΔCap Req. • Increase revenue • Reduce costs • Lower taxes or capital requirements

10. Revenue Enhancement • Marketing gains • Advertising • Distribution network • Product mix • Strategic benefits • Market power

11. Cost Reductions • Economies of scale • Lower average cost by spreading overhead • Economies of scope (vertical integration) • Coordinate operations more effectively • Reduced search cost for suppliers or customers • Reduce contracting problems

12. Lower Taxes or Capital Needs • Taxes: • Take advantages of net operating losses • Carry-backs and carry-forwards • IRS can prevent merger if sole purpose is to avoid taxes • Unused debt capacity • Capital Requirements: • Reduce relative to the two firms operating separately

13. Acquisitions • Cash Acquisition • NPV = VB* – cash cost • Value of the combined firm VAB = VA + (VB* - cash cost) • Stock Acquisition • Value of combined firm VAB = VA + VB + V • Cost of acquisition • Depends on # shares given to target stockholders • Depends on post-merger stock price • Example

14. Cash vs. Stock • Sharing gains • Target stockholders don’t participate in stock price appreciation with a cash acquisition • Taxes • Cash acquisitions are generally taxable • Control • Cash acquisitions do not dilute control • Signal • Stock acquisitions indicate your stock is overvalued

15. M&A Valuation • Market values • Only incremental cash flows • Appropriate discount rate • Consider transaction costs

16. After Valuation • Friendly • Work with management • Hostile • Toe-hold or Bear-hug • Open market purchase • Threaten target BOD with tender offer • Proxy Fight • Tender Offer • Defenses • Poison pills/put, greenmail, golden parachute, etc.

17. Defensive Tactics • Corporate charter • Establishes conditions that allow for a takeover • Standstill agreements / Targeted repurchase • Poison pills (share rights plans) • Leveraged buyouts

18. Free-Rider Problem • Purchase toe-hold • Buy from large shareholders • Two-tiered offer

19. Value to Acquirer ~ Target’s value to bidder = $163.9 million Target’s current market value = $ 90.0 million Merger premium = $ 73.9 million • Target - 10 million shares, $9/share

20. Change in Shareholders’ Wealth 0 Acquirer Target $9.00 $16.39 Price Paid for Target 5 10 15 20 Bargaining Range = Synergy

21. Market Reaction • Target shares increase +20% • Bidder shares are stagnant or decrease • Stock offers: -1.5% • Cash offers: unclear • Effect on competitors varies

22. M&A Risk • Overpayment • Winner’s Curse • Operating Risk • Integration issues, culture • Mgmt resources • Continued subsidization of sub-par groups • Financial Risk • Leverage