1 (of 22) fin 468: intermediate corporate finance topic 10–mergers and acquisitions larry schrenk,...
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1 (of 22)
FIN 468: Intermediate Corporate Finance
Topic 10–Mergers and Acquisitions
Larry Schrenk, Instructor
Corporate Control DefinedWhat is Corporate Control?
Monitoring, supervision and direction of a corporation or other business organization
Changes in corporate control occur through: Acquisitions (purchase of additional resources
by a business enterprise):1. Purchase of new assets2. Purchase of assets from another company3. Purchase of another business entity (merger)
Consolidation of voting power Divestiture Spinoff
Corporate Control Transactions
Statutory: Acquired firm is consolidated into acquiring firm with no further separate identity.
Subsidiary: Acquired firm maintains its own former identity.
Consolidation: Two or more firms combine into a new corporate identity.
Merger & Acquisition Transaction CharacteristicsAttitude of target management to a takeover
attempt Friendly Deals vs. Hostile Transactions
Method of payment used to finance a transaction Pure stock exchange merger: issuance of new
shares of common stock in exchange for the target’s common stock
Cash offer
Mixed offerings: a combination of cash and securities
Mergers by Business Concentration
Horizontal: between former intra-industry competitors Attempt to gain efficiencies of scale/scope and
benefit from increased market power Susceptible to antitrust scrutiny Market extension merger
Vertical: between former buyer and seller Forward or backward integration Creates an integrated product chain
Conglomerate: between unrelated firms Product extension mergers vs. pure conglomerate
mergers Popular in the 60’s as the idea of portfolio
diversification was applied to corporations
History of Merger Waves
Five merger waves in the U.S. history Merger waves positively related to high economic growth. Concentrated in industries undergoing changes Regulatory regime determines types of mergers in each wave. Usually ends with large declines in stock market values
First wave (1897-1904): period of “merging for monopoly”. Horizontal mergers possible due to lax regulatory environment Ended with the stock market crash of 1904
Second wave (1916-1929): period of “merging for oligopoly” Antitrust laws from early 1900 made monopoly hard to
achieve. Just like first wave, intent to create national brands Ended with the 1929 crash
History of Merger Waves Third wave (1965-1969): conglomerate merger
wave Celler-Kefauver Act of 1950 could be used against
horizontal and vertical mergers. Result of portfolio theory applied to corporations:
conglomerate empires were formed: ITT, Litton, Tenneco Stock market decline of 1969
Fourth wave (1981-1989): spurred by the lax regulatory environment of the time Junk bond financing played a major role during this
wave: LBOs and MBOs commonplace. Hostile “bust-ups” of conglomerates from previous wave Antitakeover measures adopted to prevent hostile
takeover attempts. Ended with the fall of Drexel, Burnham, Lambert
History of Merger Waves
Fifth wave (1993 – 2001): characterized by friendly, stock-financed mergers Relatively lax regulatory environment: still open to
horizontal mergers Consolidation in non-manufacturing service sector:
healthcare, banking, telecom, high tech Explained by industry shock theory: Deregulation
influenced banking mergers and managed care affected health care industry.
Sixth wave (2003-Present) Consolidation continues Record volume in 2005
Industrial Distribution of Worldwide Announced Mergers and Acquisitions, Value in $ Millions, 2004 v. 2003
Motives for Merger
Geographic (internal and international) expansion in markets with little competition may increase shareholders’ wealth. External expansion provides an easier
approach to international expansion. Joint ventures and strategic alliances give
alternative access to foreign markets. Profits are shared.
Synergy, market power, and strategic mergers Operational, managerial and financial
merger-related synergies
Operational Synergies
Economies of scale: Merger may reduce or eliminate overlapping resources 1995 merger between Chemical Bank and Chase
Manhattan Bank resulted in elimination of 12,000 positions.
Economies of scope: involve some activities that are possible only for a certain company size. The launch of a national advertising campaign Economies of scale/scope most likely to be realized in
horizontal mergers. Resource complementarities: Merging firms
have operational expertise in different areas. One company has expertise in R&D, the other in
marketing. Successful in both horizontal and vertical mergers
Managerial Synergies and Financial Synergies
Managerial synergies are effective when management teams with different strengths are combined. For example, expertise in revenue growth and
identifying customer trends paired with expertise in cost control and logistics
Financial synergies occur when a merger results in less volatile cash flows, lower default risk, and a lower cost of capital.
Managerial Synergies and Financial Synergies
Market power is a benefit often pursued in horizontal mergers. Number of competitors in industry declines If the merger creates a dominant firm, as in the Office
Depot-Staples merger’s attempt to create market power and set prices
Other strategic reasons for mergers: Product quality in vertical mergers Defensive consolidation in a mature or declining
industry: consolidation in the defense industry
Cross-Border (International) M&A
One company’s acquisition of the assets of another is observed worldwide.
Countries differ not only with respect to how frequently takeover attempts are launched, but also how often these are friendly versus hostile bids how often these are cross-border deals (involving a bidder
and a target firm in different countries) the average control premium offered the likelihood that payment will be made strictly in cash.
Geographic Distribution of WorldwideAnnounced Mergers and Acquisitions, 2004 v. 2003
Methods of Payment
Negotiated Mergers Contact is initiated by the potential acquirer or by target
firm.
Open Market Purchases Buy enough shares on the open market to obtain
controlling interest without engaging in a tender offer
Proxy Fights Proxy for directors: attempt to change management
through the votes of other shareholders Proxy for proposal: attempt to gain voting control over
corporate control, antitakeover amendments (shark repellents, golden parachutes, white knights, poison pills
Methods of Payment
Tender Offers: an open and public solicitation for shares
Open Market Purchases, Tender Offers and Proxy Fights could be combined to launch a “surprise attack” Acquirer accumulates a number of shares
(‘foothold”) without having to file 13-d form with SEC
Friendly vs. Hostile Takeovers
Friendly mergers are negotiated
Hostile takeovers are opposed by management Bear hug – go to board Tender offer – direct to shareholders Proxy fight – vote by shareholders
Hostile Takeover Defenses
Pre-offer (shark repellants) Poison pills – increase shares Poison puts – bondholders Charter amendments
Staggered board Voting provisions Fair price amendments Golden parachutes
Hostile Takeover Defenses
Post-offer “Just Say No” defense Litigation Greenmail Share repurchase
LBO Leveraged recap “Crown Jewel” defense “Pac-Man” defense White Knight/Squire defense
Major US Antitrust LegislationLegislation (Year) Purpose of Legislation
Sherman Antitrust Act (1890) Prohibited actions in restraint of trade, attempts to
monopolize an industry Violators subject to triple damageVaguely worded and difficult to implement
Clayton Act(1914) Prohibited price discriminations, tying arrangements,
concurrent service on competitor’s board of directors Prohibited the acquisition of a competitor’s stock in order to lessen competition
Federal Trade Commission Act(1914) Created FTC to enforce the Clayton Act
Granted cease and desist powers to the FTC, but not criminal prosecution powers
Celler-Kefauver Act(1950) Eliminated the “stock acquisition” loophole in the Clayton
Act Severely restricts approval for horizontal mergers
Hart-Scott-Rodino Act(1976)
FTC and DOJ can rule on the permissibility of a merger prior to consummation.
Concentration Classifications
Herfindahl-Hirschman Index Demonstrates the relationship
between corporate focus and shareholder wealth
HHI is computed as the sum of the squared percentages - the proportion of revenues derived from each line of business
Determination of Anti-competitiveness
Since 1982, both DOJ and FTC have used Herfindahl-Hirschman Index (HHI) to determine market concentration HHI = sum of squared market shares of all
participants in a certain market (industry)
1000 1800 HHI Level
Not Concentrated Moderately Concentrated Highly Concentrated
The Williams Act (1968)
Ownership disclosure requirements Section 13-d must be filed within 10 days of acquiring
5% of shares of publicly traded companies. Raises the issue of “parking” shares
Tender offer regulations Shareholders of target company have the opportunity
to evaluate the terms of the merger. Section 14-d-1 for acquirer and section 14-d-9 by target
company (recommendation of management for shareholders regarding the tender offer)
Minimum tender offer period of 20 days All shares tendered must be accepted for tender.
Other Legal Issues
Sarbanes-Oxley Act of 2002 primarily targeted accounting practices, it also
mandated significant changes in how, and how much, information companies must report to investors.
Laws Affecting Corporate Insiders SEC rule 10-b-5 outlaws material misrepresentation of
information for sale or purchase of securities. Rule 14-e-3 addresses trading on inside information in
tender offers. The Insider Trading Sanctions Act, 1984 awards triple
damages. Section 16 of Securities and Exchange Act
Requires insiders to report any transaction in shares of their affiliated corporations.
Other Legal Issues
State Antitrust Laws Include anti-takeover and anti-bust up
provisions Fair price provisions disallow two-tiered tender
offers. All shareholders receive the same price for their shares, regardless of when they are tendered.
Cash-out statutes forbid partial tender offers. Provisions usually used in conjunction
with each other
Merger Analysis
Acquirer sees target undervalued. Many junk bond-financed deals of the 1980s had one of
the following two outcomes: “Busting up” the target for greater value than acquisition price Restructuring the target to increase corporate focus. Sell non-core
businesses to pay acquisition cost
Tax-considerations for the merger: Tax loss carry-forward of the target company used to
offset future taxes; resulting in increased cash flow. 1986 change in tax code limits the use of tax loss
carry-forward. Merging may yield lower borrowing costs for the
merged company. Cash flows of the two businesses are less risky when
combined, leading to lower probability of bankruptcy and lower default risk premium
Non-Value-Maximizing Motives
Agency problems: Management’s (disguised) personal interests are often driver of mergers and acquisitions. Managerialism theory of mergers: Managerial
compensation often tied to corporation size
Free cash flow theory of mergers: Managers invest in projects with negative NPV to build corporate empires.
Hubris hypothesis of corporate takeovers: Management of acquirer may overestimate capabilities and overpay for target company in belief they can run it more efficiently.
Agency cost of overvalued equity
Non-Value-Maximizing Motives
Diversification Coinsurance of debt: the debt of
each combining firm is now insured with cash flows from two businesses
Internal capital markets: created when the high cash flows (cash cow) businesses of a conglomerate generate enough cash flow to fund the “rising star” businesses
Shareholder Wealth Effects and Transaction Characteristics
Target returns – stockholders almost always experience substantial wealth gains
Acquirer returns – less conclusive than those for target shareholders
Combined returns – slightly positive
Corporate Restructuring
Divestiture - occurs when the assets and/or resources of a subsidiary or division are sold to another organization.
Equity carve-out - partial sale to outsiders
Spin-off - a parent company creates a new company with its own shares by spinning off a division or subsidiary. Existing shareholders receive a pro rata distribution
of shares in the new company.
Split-off - similar to a spin-off, in that a parent company creates a newly independent company from a subsidiary, but ownership of company transferred to only certain existing shareholders in exchange for their shares in the parent
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