1 / 22

Mergers and Acquisitions

Mergers and Acquisitions. Dr. J.D. Han King’s College, University of Western Ontario. I. Two Latest Phenomena of Corporate Financing. 1) Traditionally, debts in corporate financing have been more important than Equities. 2) The recent surge in Mergers and Acquisitions

summer
Download Presentation

Mergers and Acquisitions

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Mergers and Acquisitions Dr. J.D. Han King’s College, University of Western Ontario

  2. I. Two Latest Phenomena of Corporate Financing 1) Traditionally, debts in corporate financing have been more important than Equities. 2) The recent surge in Mergers and Acquisitions (M & A) has raised D/E ratio through LBOs.

  3. Sources of External Corporate Financingin U. S. : 1970-1985 * In Canada, equity financing has a larger share. Why?

  4. II. Why is debt financing more important than equity financing? • Firm’s view point -With tax (deductible interest expenses), cost of debt is lower than cost of equity -Equities are more vulnerable for hostile take-over • Investor’s viewpoint -Debts are safer than equities in terms of “Principal-Agent Problem”.

  5. 1. Two major objectives of M & A: • Improved Management: -A change in management and thus to an enhanced EFFINCIENCY -A just credible threat will wake up the stale management. • Synergy

  6. 2. Target for M & A: How do you know whether a firm’s management is stale? Free Cash Flow Theory by Michael C. Jensen at HBS “Agency Cost of Free Cash Flow, Corporate Finance and Takeovers”, American Economic Review (1986)

  7. * * Free Cash Flows as a Litmus Test • Definition of FCF: Free Cash Flows = Cash Receipts - Cash Expenditures - Profitable (Constructive) Investment Opportunities • Observation: FCF are the likely object of the Management’s abuse and the Principal-Agent Problem

  8. *** Jensen’s FCF Theory in Reverse Gear • Dictum “ The Larger the Free Cash Flow of a Firm, the More Severe the Principal-Agent Problem, and thus the Larger the Potential Benefits from M & A and Corporate Restructuring” • Prediction We can also identify which firm is likely to be a target of M & A.

  9. 3. M & A and LBO:How does an Increased Indebtedness enhance Corporate Efficiency? 1) Debt contracts have a better monitoring and less moral hazards. 2) Reduced Equities increase • ROE • Management’s Financial Rewards -> “Incentive-Compatible”

  10. Before Restructuring Debt-Equity Ratio = 0/1 = 0 Capital Profits Equity 1 Shareholders’ share $9,000 $9,000 Equity 2 Manager’s share $1,000 $1,000 Total $10,000 $10,000 *assume interest rate =10%; rate of returns on capital =100% After Restructuring Debt –Equity Ratio = 9 Capital Profits Debts Shareholders’ share $9,000 $ 900 Equity 2 Manager’s share $1,000 $9,100 Total $10,000 $10,000 *Note: Manager’s profit share has increased by 810%. *Numerical Example of an Increased Indebtedness enhancing Management’s RewardsRestructuring is “Leveraged” Buyout (of Shareholders) by Management

  11. 4. Two Structural Changes as Prerequisites for a Surge of M & A • Lowering Legal Barriers -Weakening of Anti-Trust Act(USA) Competition Act(Canada) • Development of Financial Institutions, Market & Debt Instruments - Investment Banks, Securities Houses, Junk Bonds, (Debt-Equity) Swap, etc.

  12. 5. Who are the Big Players? • Securities Firms • Banks’ M & A Division of Investment Banking Department • For instance - Morgan Stanley - Goldman Sachs - Salomon Smith Barney - Merrill Lynch - Donald Trump; Drexel Burnham, Campeu Co., T. Boone Pickens (Mesa Petrolium)

  13. 6. Pros and Cons of M& A1) Pros: Advocate for M & A • M & A enhances Efficiency of Corporate Management with synergy effect (evidence) Share price of Target Firm goes up by 30-50% before and after M & A • Natural Part of Globalization Trend • Strategy for Survival from International Competition

  14. 2) Criticism of M & A (1) Zero Sum Game for the entire economy: gains for shareholders come from someone’s loss a) Government Loss of Tax Revenues in LBO b) Wage Concessions after M & A c) Bond holders’ loss: Increased leverage - Increased Default Risk - Decreased Bond Price d) Consumers’ loss: Increased monopoly power - Higher price (2) Economic Frailty (= Bankruptcy risk + Increased Interdependency) (3) M & A could be costly: A High Transactions Cost

  15. (3) A Costly M & A: “ Shark Repellants” -Setting up costly barriers against M & A • Green Mail -bribe to a raider away • Scorch Earth or Crow Jewel - make yourself unattractive • Poison Pills - sell stock under market price in case of danger • Golden Parachute - big severance package for leaving executives

  16. IV. Canadian Context • M & A will continue to increase • M & A take on Globalization trends

  17. Historical Canadian Mergers & Acquisition Announcements 1,400 1,200 1,000 800 600 400 200 0 $210 $180 $150 $120 $90 $60 $30 0 Announcements Value in $ Billions Announcements 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Source: Crosbie & Company Inc.

  18. M & A at Canadian Cross-Border

  19. M & A Resulting in Efficiency: CanadianCases

  20. 3. Case StudiesCase Study I) Excellent Execution - Onex Corporation • Classic Study Case of M & A • The Company’s objective is to build value for its investors through the acquisition of underperforming businesses( with a large amount of Free Cash Flow) financed largely with debts borrowed from third party lenders. • Performances. - Acquired Celestica for C$750mm in October, 1996 which now has a market value of C$4.6 billion. -Onex announces a bid for Air Canada and Canadian Airlines during a time when the industry is struggling.

  21. Case Study - Excellent Execution - Onex Corporation Stock Price Performance September 29, 1994 - September 30, 1999 May 11/99: Onex purchases Mar 25/99: Onex announces American Buildings 30.00 C$1.5bn Telecom Fund Mar 11/99: Onex announces with Telefonica that it will sell 23% of its stake in Sky Chefs to LSG 25.00 Jan 29/99: Onex announces LCS Industries acquisition Aug 24/99: Onex 20.00 announces bid Nov 13/96: ProSource for Air Canada completes IPO of US$48mm and Canadian Airlines 15.00 Oct 1/96: Onex acquires May 29/98: Onex sold Celestica for C$750mm ProSource Inc. to 10.00 Oct 1/98: Onex AmeriServe Food announces Distribution for SoftBank acquisition C$123mm 5.00 09/29/1994 04/20/1995 11/07/1995 05/29/1996 12/16/1996 07/08/1997 01/27/1998 08/17/1998 03/09/1999 09/27/1999 Onex Corp Sub Vtg

  22. Case Study 3 - High Yield Debt - Rogers Communications Stock Price Performance September 29, 1994 - September 30, 1999 Sep 9/99: Rogers repurchases 35.00 C$1.3bn in debt Nov 11/95: Rogers Cablesystems July 12/99: Microsoft makes C$600mm announces two new high yield investment in Rogers; Aug 16/99: Completes debt issues of US$150mm and US$125mm sale of 33% interest of Rogers Cantel to AT&T Corp and BT PLC for C$1.4bn 25.00 Jan 25/96: Issues C$75mm high yield debt July 17/97: Two new high yield debt issues of US$330mm 15.00 and C$165mm announced May 21/98: Rogers sells local Jan 16/96: Issues US$100mm telephone services to high yield debt Metronet for C$1bn 5.00 09/29/1994 04/20/1995 11/07/1995 05/29/1996 12/16/1996 07/08/1997 01/27/1998 08/17/1998 03/09/1999 09/27/1999 Rogers Communications Inc Cl B

More Related