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Acquisition of shares. Acquisition of assets. Finanza aziendale. Stephen Ross, David Hillier, Randolph Westerfield, Jeffrey Jaffe, Bradford Jordan.
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M e rg e r s and Acq u i s i t i ons

29

PART EIGHT

Chapter

The 2009 consolidation of two British banks, Halifax Bank of Scotland (HBOS) plc and Lloyds TSB plc, was just one of many corporate restructurings that took place as a result of the major downturn in developed economies. To understand the importance of the HBOS–Lloyds TSB consolidation it is necessary to consider both banks in the context of the larger British banking sector. HBOS was Britain’s largest mortgage lender, with a market share of 20 per cent. Lloyds TSB was in a similar position, but slightly smaller, having a market share of 9 per cent. Combining both companies resulted in the largest bank in the UK. The consolidation also led to the British government owning 43.4 per cent of the shares of the new entity, Lloyds Banking Group plc. This was later increased to 65 per cent because of the disastrous state of HBOS’s bad debts. So why did Lloyds TSB merge with HBOS? HBOS was in serious difficulty resulting from significant exposures to short-term funding requirements and bad loan portfolios. Hindsight has shown that Lloyds would have been far better off without the ‘toxic assets’ they inherited from the consolidation. The main reason given by both firms for the merger was cost savings, which were estimated to be £1.5 billion per annum. Of course, the cost savings were only an estimate, and often these estimates are incorrect. Unfortunately for the new Lloyds Banking Group, the markets did not respond well, and in the first week of trading the share price collapsed. How do companies like Lloyds and HBOS determine whether an acquisition or merger is a good idea? This chapter explores the reasons why corporate restructurings, such as mergers, should take place – and, just as important, the reasons why they should not.

29.1  The Basic Forms of Acquisition Acquisitions follow one of three basic forms: (a) merger or consolidation; (b) acquisition of shares; and (c) acquisition of assets.

Merger or Consolidation

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A merger refers to the absorption of one firm by another. The acquiring firm retains its name and identity, and it acquires all of the assets and liabilities of the acquired firm. After a merger, the acquired firm ceases to exist as a separate business entity. A consolidation is the same as a merger except that an entirely new firm is created. In a consolidation both the acquiring firm and the acquired firm terminate their previous legal existence and become part of the new firm. Finanza aziendale Stephen Ross, David Hillier, Randolph Westerfield, Jeffrey Jaffe, Bradford Jordan © 2012 McGraw-Hill Ross_ch29.indd 784

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The Basic Forms of Acquisition

EXAMPLE

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Merger Basics

29.1

Suppose firm A acquires firm B in a merger. Further, suppose firm B’s shareholders are given one share of firm A’s equity in exchange for two shares of firm B’s equity. From a legal standpoint, firm A’s shareholders are not directly affected by the merger. However, firm B’s shares cease to exist. In a consolidation, the shareholders of firm A and firm B exchange their shares for shares of a new firm (e.g., firm C).

Because of the similarities between mergers and consolidations, we shall refer to both types of reorganization as mergers. Here are two important points about mergers and consolidations: 1 A merger is legally straightforward, and does not cost as much as other forms of acquisition. It avoids the necessity of transferring title of each individual asset of the acquired firm to the acquiring firm. 2 The shareholders of each firm must approve a merger.1 Typically, votes of the owners of two-thirds of the shares are required for approval. In addition, shareholders of the acquired firm have appraisal rights. This means that they can demand that the acquiring firm purchase their shares at a fair value. Often the acquiring firm and the dissenting shareholders of the acquired firm cannot agree on a fair value, which results in expensive legal proceedings.

Acquisition of Shares A second way to acquire another firm is to purchase the firm’s voting shares in exchange for cash, or shares of equity and other securities. This process may start as a private offer from the management of one firm to another. At some point the offer is taken directly to the selling firm’s shareholders, often by a tender offer. A tender offer is a public offer to buy shares of a target firm. It is made by one firm directly to the shareholders of another firm. The offer is communicated to the target firm’s shareholders by public announcements such as newspaper advertisements. Sometimes a general mailing is used in a tender offer. However, a general mailing is difficult, because the names and addresses of the shareholders of record are not usually available. The following factors are involved in choosing between an acquisition of shares and a merger: 1 In an acquisition of shares, shareholder meetings need not be held and a vote is not required. If the shareholders of the target firm do not like the offer, they are not required to accept it and need not tender their shares. 2 In an acquisition of shares, the bidding firm can deal directly with the shareholders of a target firm via a tender offer. The target firm’s management and board of directors are bypassed. 3 Target managers often resist acquisition. In such cases, acquisition of shares circumvents the target firm’s management. Resistance by the target firm’s management often makes the cost of acquisition by shares higher than the cost by merger. 4 Frequently a minority of shareholders will hold out in a tender offer, and thus the target firm cannot be completely absorbed. 5 Complete absorption of one firm by another requires a merger. Many acquisitions of shares end with a formal merger.

Acquisition of Assets One firm can acquire another by buying all of its assets. The selling firm does not necessarily vanish, because its ‘shell’ can be retained. A formal vote of the target shareholders is required in an acquisition of assets. An advantage here is that although the acquirer is often left with minority shareholders in an acquisition of shares, this does not happen in an acquisition of

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Chapter 29  Mergers and Acquisitions

FIGURE

Merger or consolidation

29.1

Takeovers

Acquisition

Acquisition of shares

Proxy contest

Acquisition of assets

Going private

Figure 29.1  Varieties of takeover

assets. Minority shareholders often present problems, such as holdouts. However, asset acquisition involves transferring title to individual assets, which can be costly.

A Classification Scheme Financial analysts have typically classified acquisitions into three types: 1 Horizontal acquisition: Here, both the acquirer and acquired are in the same industry. Lloyds TSB’s merger with HBOS in 2009 is an example of a horizontal merger in the banking industry. 2 Vertical acquisition: A vertical acquisition involves firms at different steps of the production process. The acquisition by an airline company of a travel agency would be a vertical acquisition. 3 Conglomerate acquisition: The acquiring firm and the acquired firm are not related to each other. The acquisition of a food products firm by a computer firm would be considered a conglomerate acquisition.

A Note about Takeovers Takeover is a general and imprecise term referring to the transfer of control of a firm from one group of shareholders to another.2 A firm that has decided to take over another firm is usually referred to as the bidder. The bidder offers to pay cash or securities to obtain the equity or assets of another company. If the offer is accepted, the target firm will give up control over its equity or assets to the bidder in exchange for consideration (i.e., its equity, its debt, or cash). Takeovers can occur by acquisition, proxy contests, and going-private transactions. Thus takeovers encompass a broader set of activities than acquisitions, as depicted in Fig. 29.1. If a takeover is achieved by acquisition, it will be by merger, tender offer for shares of equity, or purchase of assets. In mergers and tender offers the acquiring firm buys the voting ordinary shares of the acquired firm. Proxy contests can result in takeovers as well. Proxy contests occur when a group of shareholders attempts to gain seats on the board of directors. A proxy is written authorization for one shareholder to vote for another shareholder. In a proxy contest an insurgent group of shareholders solicits proxies from other shareholders. In going-private transactions a small group of investors purchases all the equity shares of a public firm. The group usually includes members of incumbent management and some outside investors. The shares of the firm are delisted from the stock exchange, and can no longer be purchased in the open market.

29.2 Synergy The previous section discussed the basic forms of acquisition. We now examine why firms are acquired. (Although the previous section pointed out that acquisitions and mergers

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Synergy

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have different definitions, these differences will be unimportant in this, and many of the following, sections. Thus, unless otherwise stated, we shall refer to acquisitions and mergers synonymously.) Much of our thinking here can be organized around the following four questions: 1 Is there a rational reason for mergers? Yes – in a word, synergy. Suppose firm A is contemplating acquiring firm B. The value of firm A is VA and the value of firm B is VB. (It is reasonable to assume that, for public companies, VA and VB can be determined by observing the market prices of the outstanding securities.) The difference between the value of the combined firm (VAB) and the sum of the values of the firms as separate entities is the synergy from the acquisition: Synergy = VAB – (VA + VB)



In words, synergy occurs if the value of the combined firm after the merger is greater than the sum of the value of the acquiring firm and the value of the acquired firm before the merger. 2 Where does this magic force, synergy, come from? Increases in cash flow create value. We define ΔCFt as the difference between the cash flows at date t of the combined firm and the sum of the cash flows of the two separate firms. From the chapters about capital budgeting, we know that the cash flow in any period t can be written as ΔCFt = ΔRevt – ΔCostst – ΔTaxest – ΔCapital Requirementst



where ΔRevt is the incremental revenue of the acquisition, ΔCostst is the incremental costs of the acquisition, ΔTaxest is the incremental acquisition taxes, and ΔCapital Requirementst is the incremental new investment required in working capital and fixed assets. It follows from our classification of incremental cash flows that the possible sources of synergy fall into four basic categories: revenue enhancement, cost reduction, lower taxes, and lower capital requirements. Improvements in at least one of these four categories create synergy. Each of these categories will be discussed in detail in the next section. In addition, reasons are often provided for mergers where improvements are not expected in any of these four categories. These ‘bad’ reasons for mergers will be discussed in Sec. 29.4. 3 How are these synergistic gains shared? In general, the acquiring firm pays a premium for the acquired, or target, firm. For example, if the equity of the target is selling for $50, the acquirer might need to pay $60 a share, implying a premium of $10 or 20 per cent. The gain to the target in this example is $10. Suppose that the synergy from the merger is $30. The gain to the acquiring firm, or bidder, would be $20 (= $30 − $10). The bidder would actually lose if the synergy were less than the premium of $10. A more detailed treatment of these gains or losses will be provided in Sec. 29.6. 4 Are there other motives for a merger besides synergy? Yes. As we have said, synergy is a source of benefit to shareholders. However, the managers are likely to view a potential merger differently. Even if the synergy from the merger is less than the premium paid to the target, the managers of the acquiring firm may still benefit. For example, the revenues of the combined firm after the merger will almost certainly be greater than the revenues of the bidder before the merger. The managers may receive higher compensation once they are managing a larger firm. Even beyond the increase in compensation, managers generally experience greater prestige and power when managing a larger firm. Conversely, the managers of the target could lose their jobs after the acquisition, and they might very well oppose the takeover even if their shareholders would benefit from the premium. These issues will be discussed in more detail in Sec. 29.9.

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Chapter 29  Mergers and Acquisitions

29.3 Sources of Synergy In this section, we discuss sources of synergy.

Revenue Enhancement A combined firm may generate greater revenues than two separate firms. Increased revenues can come from marketing gains, strategic benefits, or market power. Marketing Gains  It is frequently claimed that, because of improved marketing, mergers and acquisitions can increase operating revenues. Improvements can be made in the following areas: 1 Previously ineffective media programming and advertising efforts 2 A weak existing distribution network 3 An unbalanced product mix Strategic Benefits  Some acquisitions promise a strategic benefit, which is more like an option than a standard investment opportunity. For example, imagine that a sewing machine company acquires a computer company. The firm will be well positioned if technological advances allow computer-driven sewing machines in the future. Michael Porter has used the word beachhead to denote the strategic benefits from entering a new industry.3 He uses the example of Procter & Gamble’s acquisition of the Charmin Paper Company as a beachhead that allowed Procter & Gamble to develop a highly interrelated cluster of paper products – disposable nappies, paper towels, feminine hygiene products, and bathroom tissue. Market or Monopoly Power  One firm may acquire another to reduce competition. If so, prices can be increased, generating monopoly profits. However, mergers that reduce competition do not benefit society, and the government regulators may challenge them.

Cost Reduction A combined firm may operate more efficiently than two separate firms. This was one the primary reason for the Lloyds TSB–HBOS merger. A merger can increase operating efficiency in the following ways. Economies of Scale  An economy of scale means that the average cost of production falls as the level of production increases. Fig. 29.2 illustrates the relation between cost per unit and size for a typical firm. As can be seen, average cost first falls and then rises. In other words, the firm experiences economies of scale until optimal firm size is reached. Diseconomies of scale arise after that. Though the precise nature of economies of scale is not known, it is one obvious benefit of horizontal mergers. The phrase spreading overhead is frequently used in connection with economies of scale. This refers to sharing central facilities such as corporate headquarters, top management, and computer systems. Economies of Vertical Integration  Operating economies can be gained from vertical combinations as well as from horizontal combinations. The main purpose of vertical acquisitions is to make co-ordination of closely related operating activities easier. This is probably why most forest product firms that cut timber also own sawmills and hauling equipment. Because petroleum is used to make plastics and other chemical products, the DuPont–Conoco merger was motivated by DuPont’s need for a steady supply of oil. Economies from vertical integration probably explain why most airline companies own airplanes. They may also explain why some airline companies have purchased hotels and car rental companies. Technology Transfer  Technology transfer is another reason for merger. An automobile manufacturer might well acquire an aircraft company if aerospace technology can improve

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Sources of Synergy

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FIGURE

29.2

Cost per unit

Minimum cost

Economies of scale

Diseconomies of scale

Optimal size Size

Figure 29.2  Economies of scale and the optimal size of the firm

automotive quality. This technology transfer was the motivation behind the merger of General Motors and Hughes Aircraft. Complementary Resources  Some firms acquire others to improve usage of existing resources. A ski equipment store merging with a tennis equipment store will smooth sales over both the winter and summer seasons, thereby making better use of store capacity. Elimination of Inefficient Management  A change in management can often increase firm value. Some managers overspend on perquisites and pet projects, making them ripe for takeover. Alternatively, incumbent managers may not understand changing market conditions or new technology, making it difficult for them to abandon old strategies. Although the board of directors should replace these managers, the board is often unable to act independently. Thus a merger may be needed to make the necessary replacements. Mergers and acquisitions can be viewed as part of the labour market for top management. Michael Jensen and Richard Ruback have used the phrase ‘market for corporate control’, in which alternative management teams compete for the rights to manage corporate activities.4

Tax Gains Tax reduction may be a powerful incentive for some acquisitions. This reduction can come from: 1 The use of tax losses 2 The use of unused debt capacity 3 The use of surplus funds Net Operating Losses  A firm with a profitable division and an unprofitable one will have a low tax bill, because the loss in one division offsets the income in the other. However, if the two divisions are actually separate companies, the profitable firm will not be able to use the losses of the unprofitable one to offset its income. Thus, in the right circumstances, a merger can lower taxes. Consider Table 29.1, which shows pre-tax income, taxes and after-tax income for firms A and B. Firm A earns $200 in state 1 but loses money in state 2. The firm pays taxes in state 1 but is not entitled to a tax rebate in state 2. Conversely, firm B turns a profit in state 2 but

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Chapter 29  Mergers and Acquisitions

TA B L E Before merger

29.1

Firm A

Taxable income (C)

After merger Firm B

Firm AB

If state 1

If state 2

If state 1

If state 2

If state 1

If state 2

200

−100

−100

200

100

100

Taxes (C)

  68

0

0

  68

  34

  34

Net income (C)

132

−100

−100

132

66

66

Neither firm will be able to deduct its losses prior to the merger. The merger allows the losses from A to offset the taxable profits from B – and vice versa.

Table 29.1  Tax effect of merger of firms A and B

not in state 1. This firm pays taxes only in state 2. The table shows that the combined tax bill of the two separate firms is always $68, regardless of which state occurs. However, the last two columns of the table show that, after a merger, the combined firm will pay taxes of only $34. Taxes drop after the merger, because a loss in one division offsets the gain in the other. The message of this example is that firms need taxable profits to take advantage of potential losses. These losses are often referred to as net operating losses or NOL for short. Mergers can sometimes bring losses and profits together. However, there are two qualifications to the previous example: 1 Many countries’ tax laws permit firms that experience alternating periods of profits and losses to equalize their taxes by carry-back and carry-forward provisions. For example, a firm that has been profitable but has a loss in the current year may be able to get refunds of income taxes paid in three previous years and can carry the loss forward for 15 years. Thus a merger to exploit unused tax shields must offer tax savings over and above what can be accomplished by firms via carry-overs.5 2 Tax authorities in many countries are likely to disallow an acquisition if its principal purpose is to avoid the payment of taxes. Debt Capacity  There are at least two cases where mergers allow for increased debt and a larger tax shield. In the first case the target has too little debt, and the acquirer can infuse the target with the missing debt. In the second case both target and acquirer have optimal debt levels. A merger leads to risk reduction, generating greater debt capacity and a larger tax shield. We treat each case in turn. Case 1: Unused Debt Capacity  In Chapter 16 we pointed out that every firm has a certain amount of debt capacity. This debt capacity is beneficial, because greater debt leads to a greater tax shield. More formally, every firm can borrow a certain amount before the marginal costs of financial distress equal the marginal tax shield. This debt capacity is a function of many factors, perhaps the most important being the risk of the firm. Firms with high risk generally cannot borrow as much as firms with low risk. For example, a utility or a supermarket – both firms with low risk – can have a higher debt-to-value ratio than can a technology firm. Some firms, for whatever reason, have less debt than is optimal. Perhaps the managers are risk-averse, or perhaps they simply don’t know how to assess debt capacity properly. Is it bad for a firm to have too little debt? The answer is yes. As we have said, the optimal level of debt occurs when the marginal cost of financial distress equals the marginal tax shield. Too little debt reduces firm value. This is where mergers come in. A firm with little or no debt is an inviting target. An acquirer could raise the target’s debt level after the merger to create a bigger tax shield.

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Two ‘Bad’ Reasons for Mergers

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Case 2: Increased Debt Capacity  Let us move back to the principles of modern portfolio theory, as presented in Chapter 10. Consider two equities in different industries, where both equities have the same risk or standard deviation. A portfolio of these two equities has lower risk than that of either equity separately. In other words, the two-equity portfolio is somewhat diversified, whereas each equity by itself is completely undiversified.6 Now, rather than considering an individual buying both equities, consider a merger between the two underlying firms. Because the risk of the combined firm is less than that of either one separately, banks should be willing to lend more money to the combined firm than the total of what they would lend to the two firms separately. In other words, the risk reduction that the merger generates leads to greater debt capacity. For example, imagine that each firm can borrow £100 on its own before the merger. Perhaps the combined firm after the merger will be able to borrow £250. Debt capacity has increased by £50 (= £250 − £200). Remember that debt generates a tax shield. If debt rises after the merger, taxes will fall. That is, simply because of the greater interest payments after the merger, the tax bill of the combined firm should be less than the sum of the tax bills of the two separate firms before the merger. In other words, the increased debt capacity from a merger can reduce taxes. To summarize, we first considered the case where the target had too little leverage. The acquirer could infuse the target with more debt, generating a greater tax shield. Next, we considered the case where both target and acquirer began with optimal debt levels. A merger leads to more debt even here. That is, the risk reduction from the merger creates greater debt capacity and thus a greater tax shield. Surplus Funds  Another quirk in the tax laws involves surplus funds. Consider a firm that has free cash flow. That is, it has cash flow available after payment of all taxes, and after all positive net present value projects have been funded. In this situation, aside from purchasing securities, the firm can either pay dividends or buy back shares. We have already seen in our previous discussion of dividend policy that an extra dividend will increase the income tax paid by some investors. Investors pay lower taxes in a share repurchase.7 However, a share repurchase is not normally a legal option if the sole purpose is to avoid taxes on dividends. Instead, the firm might make acquisitions with its excess funds. Here, the shareholders of the acquiring firm avoid the taxes they would have paid on a dividend.8

Reduced Capital Requirements Earlier in this chapter we stated that, owing to economies of scale, mergers can reduce operating costs. It follows that mergers can reduce capital requirements as well. Accountants typically divide capital into two components: fixed capital and working capital. When two firms merge, the managers will probably find duplicate facilities. For example, if both firms had their own headquarters, all executives in the merged firm could be moved to one headquarters building, allowing the other headquarters to be sold. Some plants might be redundant as well. Or two merging firms in the same industry might consolidate their research and development, permitting some R&D facilities to be sold. The same goes for working capital. The inventory-to-sales ratio and the cash-to-sales ratio often decrease as firm size increases. A merger permits these economies of scale to be realized, allowing a reduction in working capital.

29.4 Two ‘Bad’ Reasons for Mergers Earnings Growth An acquisition can create the appearance of earnings growth, perhaps fooling investors into thinking that the firm is worth more than it really is. Let’s consider two companies, Global Resources and Regional Enterprises, as depicted in the first two columns of Table 29.2. As can

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TA B L E

29.2

Global Resources before merger

Regional Enterprises before merger

Global Resources after merger The market is ‘smart’

The market is ‘fooled’

1.00

1.00

1.43

1.43

Price per share (C)

25.00

10.00

25.00

35.71

Price–earnings ratio

25

10

17.5

25

Number of shares

100

100

140

140

Total earnings (C)

100

100

200

200

2,500

1,000

3,500

5,000

Earnings per share (C)

Total value (C)

Exchange ratio: 1 share in Global for 2.5 shares in Regional.

Table 29.2  Financial positions of Global Resources and Regional Enterprises

be seen, earnings per share are $1 for both companies. However, Global sells for $25 per share, implying a price–earnings (P/E) ratio of 25 (= 25/1). By contrast, Regional sells for $10, implying a P/E ratio of 10. This means that an investor in Global pays $25 to get $1 in earnings, whereas an investor in Regional receives the same $1 in earnings on only a $10 investment. Are investors getting a better deal with Regional? Not necessarily. Perhaps Global’s earnings are expected to grow faster than Regional’s earnings. If this is the case, an investor in Global will expect to receive high earnings in later years, making up for low earnings in the short term. In fact, Chapter 5 argues that the primary determinant of a firm’s P/E ratio is the market’s expectation of the firm’s growth rate in earnings. Now let’s imagine that Global acquires Regional, with the merger creating no value. If the market is smart, it will realize that the combined firm is worth the sum of the values of the separate firms. In this case, the market value of the combined firm will be $3,500, which is equal to the sum of the values of the separate firms before the merger. At these values Global will acquire Regional by exchanging 40 of its shares for 100 shares of Regional, so that Global will have 140 shares outstanding after the merger.9 Global’s share price remains at $25 (= $3,500/140). With 140 shares outstanding and $200 of earnings after the merger, Global earns $1.43 (= $200/140) per share after the merger. Its P/E ratio becomes 17.5 (= 25/1.43), a drop from 25 before the merger. This scenario is represented by the third column of Table 29.2. Why has the P/E dropped? The combined firm’s P/E will be an average of Global’s high P/E and Regional’s low P/E before the merger. This is common sense once you think about it. Global’s P/E should drop when it takes on a new division with low growth. Let us now consider the possibility that the market is fooled. As we just said, the acquisition enables Global to increase its earnings per share from $1 to $1.43. If the market is fooled, it might mistake the 43 per cent increase in earnings per share for true growth. In this case, the price–earnings ratio of Global may not fall after the merger. Suppose the price–earnings ratio of Global remains at 25. The total value of the combined firm will increase to $5,000 (= 25 × $200), and the share price of Global will increase to $35.71 (= $5,000/140). This is reflected in the last column of the table. This is earnings growth magic. Can we expect this magic to work in the real world? Managers of a previous generation certainly thought so, with firms such as LTV Industries, ITT and Litton Industries all trying to play the P/E-multiple game in the 1960s. However, in hindsight it looks as if they played the game without much success. These operators have all dropped out, with few, if any, replacements. It appears that the market is too smart to be fooled this easily.

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A Cost to Shareholders from Reduction in Risk

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Diversification Diversification is often mentioned as a benefit of one firm acquiring another. However, we argue that diversification, by itself, cannot produce increases in value. To see this, recall that a business’s variability of return can be separated into two parts: (a) what is specific to the business, and called unsystematic; and (2) what is systematic, because it is common to all businesses. Systematic variability cannot be eliminated by diversification, so mergers will not eliminate this risk at all. By contrast, unsystematic risk can be diversified away through mergers. However, the investor does not need widely diversified companies such as Unilever to eliminate unsystematic risk. Shareholders can diversify more easily than corporations by simply purchasing equity in different corporations. For example, instead of Air France and KLM merging to form Air France-KLM, the shareholders of Air France could have purchased shares in KLM if they believed there would be diversification gains in doing so. Thus diversification through merger may not benefit shareholders.10 Diversification can produce gains to the acquiring firm only if one of two things is true: 1 Diversification decreases the unsystematic variability at a lower cost than by investors’ adjustments to personal portfolios. This seems very unlikely. 2 Diversification reduces risk and thereby increases debt capacity. This possibility was mentioned earlier in the chapter.

29.5 A Cost to Shareholders from Reduction in Risk In Chapter 22 we used option pricing theory to show that pure financial mergers are bad for shareholders. In this section we shall revisit this idea from an alternative perspective and show that the diversification effects of mergers can benefit bondholders at the expense of shareholders.

The Base Case Consider an example where firm A acquires firm B. Panel I of Table 29.3 shows the net present values of firm A and firm B prior to the merger in the two possible states of the economy. Because the probability of each state is 0.50, the market value of each firm is the average of its values in the two states. For example, the market value of firm A is 0.5 × £80 + 0.5 × £20 = £50



Now imagine that the merger of the two firms generates no synergy. The combined firm AB will have a market value of £75 (= £50 + £25), the sum of the values of firm A and firm B. Further imagine that the shareholders of firm B receive equity in AB equal to firm B’s stand-alone market value of £25. In other words, firm B receives no premium. Because the value of AB is £75, the shareholders of firm A have a value of £50 (= £75 − £25) after the merger – just what they had before the merger. Thus the shareholders of both firms A and B are indifferent to the merger.

Both Firms Have Debt Alternatively, imagine that firm A has debt with a face value of £30 in its capital structure, as shown in Panel II of Table 29.3. Without a merger, firm A will default on its debt in state 2, because the value of firm A in this state is £20, less than the face value of the debt of £30. As a consequence, firm A cannot pay the full value of the debt claim: the bondholders receive only £20 in this state. The creditors take the possibility of default into account, valuing the debt at £25 (= 0.5 × £30 + 0.5 × £20). Firm B’s debt has a face value of £15. Firm B will default in state 1 because the value of the firm in this state is £10, less than the face value of the debt of £15. The value of firm B’s debt is £12.50 (= 0.5 × £10 + 0.5 × £15). It follows that the sum of the value of firm A’s debt and the value of firm B’s debt is £37.50 (= £25 + £12.50).

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TA B L E NPV

29.3

State 1 Probability

0.5

State 2

Market value

0.5

I. Base case (no debt in either firm’s capital structure) Values before merger (£): Firm A

80

20

50

Firm B

10

40

25

90

60

75

Values after merger (£):* Firm AB

II. Debt with face value of £30 in firm A’s capital structure; debt with face value of £15 in firm B’s capital structure Values before merger (£): Firm A

80

20

50

Debt

30

20

25

Equity

50

0

25

Firm B

10

40

25

Debt

10

15

12.50

0

25

12.50

Firm AB

90

60

75

Debt

45

45

45

Equity

45

15

30

Equity Values after merger (£):†

Values of both firm A’s debt and firm B’s debt rise after merger. Values of both firm A’s equity and firm B’s equity fall after merger. *Shareholders in firm A receive £50 of equity in firm AB. Shareholders in firm B receive £25 of equity in firm AB. Thus shareholders in both firms are indifferent to the merger. † Shareholders in firm A receive equity in firm AB worth £20. Shareholders in firm B receive equity in firm AB worth £10. Gains and losses from merger are Loss to equity-holders in firm A: £20 − £25 = −£5 Loss to equity-holders in firm B: £10 − £12.50 = −£2.50 Combined gain to bondholders in both firms: £45.00 − £37.50 = £7.50

Table 29.3  Equity-swap mergers

Now let’s see what happens after the merger. Firm AB is worth £90 in state 1 and £60 in state 2, implying a market value of £75 (= 0.5 × £90 + 0.5 × £60). The face value of the debt in the combined firm is £45 (= £30 + £15). Because the value of the firm is greater than £45 in either state, the bondholders always get paid in full. Thus the value of the debt is its face value of £45. This value is £7.50 greater than the sum of the values of the two debts before the merger, which we just found to be £37.50. Therefore the merger benefits the bondholders. What about the shareholders? Because the equity of firm A was worth £25 and the equity of firm B was worth £12.50 before the merger, let’s assume that firm AB issues two shares to firm A’s shareholders for every share issued to firm B’s shareholders. Firm AB’s equity is £30, so firm A’s shareholders get shares worth £20 and firm B’s shareholders get shares worth £10. Firm A’s shareholders lose £5 (= £20 − £25) from the merger. Similarly, firm B’s shareholders lose £2.50 (= £10 − £12.50). The total loss to the shareholders of both firms is £7.50, exactly the gain to the bondholders from the merger. There are a lot of numbers in this example. The point is that the bondholders gain £7.50 and the shareholders lose £7.50 from the merger. Why does this transfer of value occur? To

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see what is going on, notice that when the two firms are separate, firm B does not guarantee firm A’s debt. That is, if firm A defaults on its debt, firm B does not help the bondholders of firm A. However, after the merger the bondholders can draw on the cash flows from both A and B. When one of the divisions of the combined firm fails, creditors can be paid from the profits of the other division. This mutual guarantee, which is called the co-insurance effect, makes the debt less risky and more valuable than before. There is no net benefit to the firm as a whole. The bondholders gain the co-insurance effect, and the shareholders lose the co-insurance effect. Some general conclusions emerge from the preceding analysis: 1 Mergers usually help bondholders. The size of the gain to bondholders depends on the reduction in the probability of bankruptcy after the combination. That is, the less risky the combined firm is, the greater are the gains to bondholders. 2 Shareholders of the acquiring firm are hurt by the amount that bondholders gain. 3 Conclusion 2 applies to mergers without synergy. In practice, much depends on the size of the synergy.

How Can Shareholders Reduce Their Losses from the Co-insurance Effect? The co-insurance effect raises bondholder values and lowers shareholder values. However, there are at least two ways in which shareholders can reduce or eliminate the co-insurance effect. First, the shareholders in firm A could retire its debt before the merger announcement date and reissue an equal amount of debt after the merger. Because debt is retired at the low pre-merger price, this type of refinancing transaction can neutralize the co-insurance effect to the bondholders. Also, note that the debt capacity of the combined firm is likely to increase, because the acquisition reduces the probability of financial distress. Thus the shareholders’ second alternative is simply to issue more debt after the merger. An increase in debt following the merger will have two effects, even without the prior action of debt retirement. The interest tax shield from new corporate debt raises firm value, as discussed in an earlier section of this chapter. In addition, an increase in debt after the merger raises the probability of financial distress, thereby reducing or eliminating the bondholders’ gain from the co-insurance effect.

29.6 The NPV of a Merger Firms typically use NPV analysis when making acquisitions. The analysis is relatively straightforward when the consideration is cash. The analysis becomes more complex when the consideration is equity.

Cash Suppose firm A and firm B have values as separate entities of £500 and £100, respectively. They are both all-equity firms. If firm A acquires firm B, the merged firm AB will have a combined value of £700 due to synergies of £100. The board of firm B has indicated that it will sell firm B if it is offered £150 in cash. Should firm A acquire firm B? Assuming that firm A finances the acquisition out of its own retained earnings, its value after the acquisition is11 Value of firm A after the acquisition = Value of combined firm − Cash paid = £700 − £150 = £550



Because firm A was worth £500 prior to the acquisition, the NPV to firm A’s equity-holders is £50 = £550 − £500



(29.1)

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TA B L E Before acquisition

29.4

(1)

(2)

After acquisition: firm A (3)

(4)

(5)

Equity† exchange ratio (0.75:1)

Equity† exchange ratio (0.6819:1)

Firm A

Firm B

Cash*

500

100

550

Number of shares

25

10

25

32.5

31.819

Price per share (£)

20

10

22

21.54

22

Market value (VA, VB) (£)

700

700

*Value of firm A after acquisition: cash     VA = VAB − Cash     £550 = £700 − £150 † Value of firm A after acquisition: equity     VA = VAB     £700 = £700

Table 29.4  Cost of acquisition: cash versus equity

Assuming that there are 25 shares in firm A, each share of the firm is worth £20 (= £500/25) prior to the merger and £22 (= £550/25) after the merger. These calculations are displayed in the first and third columns of Table 29.4. Looking at the rise in equity price, we conclude that firm A should make the acquisition. We spoke earlier of both the synergy and the premium of a merger. We can also value the NPV of a merger to the acquirer: NPV of a merger to acquirer = Synergy − Premium



Because the value of the combined firm is £700 and the pre-merger values of A and B were £500 and £100, respectively, the synergy is £100 [= £700 − (£500 + £100)]. The premium is £50 (= £150 − £100). Thus the NPV of the merger to the acquirer is NPV of merger to firm A = £100 − £50 = £50



One caveat is in order. This textbook has consistently argued that the market value of a firm is the best estimate of its true value. However, we must adjust our analysis when discussing mergers. If the true price of firm A without the merger is £500, the market value of firm A may actually be above £500 when merger negotiations take place. This happens because the market price reflects the possibility that the merger will occur. For example, if the probability is 60 per cent that the merger will take place, the market price of firm A will be Market value Probab b ility Market value Probability of firm A of of firm A of no with merger merger without merger merger £530 = £550 × 0.60 + £500 × 0.40



The managers would underestimate the NPV from the merger in Eq. (29.1) if the market price of firm A is used. Thus managers face the difficult task of valuing their own firm without the acquisition.

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Equity Of course, firm A could purchase firm B with equity instead of cash. Unfortunately, the analysis is not as straightforward here. To handle this scenario we need to know how many shares are outstanding in firm B. We assume that there are 10 shares outstanding, as indicated in column 2 of Table 29.4. Suppose firm A exchanges 7.5 of its shares for the entire 10 shares of firm B. We call this an exchange ratio of 0.75:1. The value of each share of firm A’s equity before the acquisition is £20. Because 7.5 × £20 = £150, this exchange appears to be the equivalent of purchasing firm B in cash for £150. This is incorrect: the true cost to firm A is greater than £150. To see this, note that firm A has 32.5 (= 25 + 7.5) shares outstanding after the merger. Firm B shareholders own 23 per cent (= 7.5/32.5) of the combined firm. Their holdings are valued at £161 (= 23% × £700). Because these shareholders receive equity in firm A worth £161, the cost of the merger to firm A’s shareholders must be £161, not £150. This result is shown in column 4 of Table 29.4. The value of each share of firm A’s equity after an equity-for-equity transaction is only £21.54 (= £700/32.5). We found out earlier that the value of each share is £22 after a cash-for-equity transaction. The difference is that the cost of the equity-for-equity transaction to firm A is higher. This non-intuitive result occurs because the exchange ratio of 7.5 shares of firm A for 10 shares of firm B was based on the pre-merger prices of the two firms. However, because the equity of firm A rises after the merger, firm B equity-holders receive more than £150 in firm A equity. What should the exchange ratio be so that firm B equity-holders receive only £150 of firm A’s equity? We begin by defining a, the proportion of the shares in the combined firm that firm B’s shareholders own. Because the combined firm’s value is £700, the value of firm B shareholders after the merger is Value of firm B shareholders after merger: a × £700



Setting a × £700 = £150, we find that a = 21.43%. In other words, firm B’s shareholders will receive equity worth £150 if they receive 21.43 per cent of the firm after merger. Now we determine the number of shares issued to firm B’s shareholders. The proportion, a, that firm B’s shareholders have in the combined firm can be expressed as follows: New shares issued Old shares + New shares issued New shares issued = 25 + New shares issued

α =

Plugging our value of a into the equation yields 0.2143 =



New shares issued 25 + New shares issued

Solving for the unknown, we have New shares = 819 shares



Total shares outstanding after the merger are 31.819 (= + 6.819). Because 6.819 shares of firm A are exchanged for 10 shares of firm B, the exchange ratio is 0.6819:1. Results at the exchange ratio of 0.6819:1 are displayed in column 5 of Table 29.4. Because there are now 31.819 shares, each share of equity is worth £22 (= 00/31.819), exactly what it is worth in the equity-for-cash transaction. Thus, given that the board of firm B

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Chapter 29  Mergers and Acquisitions will sell its firm for £150, this is the fair exchange ratio, not the ratio of 0.75:1 mentioned earlier.

Cash versus Equity In this section we have examined both cash deals and equity-for-equity deals. Our analysis leads to the following question: When do bidders want to pay with cash and when do they want to pay with equity? There is no easy formula: the decision hinges on a few variables, with perhaps the most important being the price of the bidder’s equity. In the example of Table 29.4, firm A’s market price per share prior to the merger was £20. Let’s now assume that at the time firm A’s managers believed the ‘true’ price was £15. In other words, the managers believed that their equity was overvalued. Is it likely for managers to have a different view than that of the market? Yes – managers often have more information than the market does. After all, managers deal with customers, suppliers and employees daily, and are likely to obtain private information. Now imagine that firm A’s managers are considering acquiring firm B with either cash or equity. The overvaluation would have no impact on the merger terms in a cash deal; firm B would still receive £150 in cash. However, the overvaluation would have a big impact on a share-for-share deal. Although firm B receives £150 worth of A’s equity as calculated at market prices, firm A’s managers know that the true value of the equity is less than £150. How should firm A pay for the acquisition? Clearly, firm A has an incentive to pay with equity, because it would end up giving away less than £150 of value. This conclusion might seem rather cynical, because firm A is, in some sense, trying to cheat firm B’s shareholders. However, both theory and empirical evidence suggest that firms are more likely to acquire with equity when their own equities are overvalued.12 The story is not quite this simple. Just as the managers of firm A think strategically, firm B’s managers are likely to think this way as well. Suppose that in the merger negotiations firm A’s managers push for a share-for-share deal. This might tip off firm B’s managers that firm A is overpriced. Perhaps firm B’s managers will ask for better terms than firm A is currently offering. Alternatively, firm B may resolve to accept cash or not to sell at all. And just as firm B learns from the negotiations, the market learns also. Empirical evidence shows that the acquirer’s equity price generally falls upon the announcement of a equity-for-equity deal.13

29.7 Valuation of Mergers in Practice The previous section provided the tools of merger valuation. However, in practice the approach to valuation is significantly more complex and subjective. Mergers and acquisitions have two distinct differences from the typical investment project that a firm will undertake. First, the size of a merger will be significantly larger, which means that the risks of mis-evaluation are substantially higher. If an acquiring firm arrives at the wrong value of a target it may destroy both companies. A good example of this is the Royal Bank of Scotland acquisition of the Dutch bank ABN AMRO in 2007, when the Royal Bank of Scotland (with Fortis Bank and Banco Santander) bought ABN AMRO for £49 billion. The acquisition took place just before the collapse in bank valuations because of the global credit crunch. Two years later, in 2009, the Royal Bank of Scotland revalued the acquisition and reported a resultant £28 billion loss. The bank was subsequently bailed out by the British government, and most of the directors lost their jobs. The second difference is that if the target company is listed on a stock exchange, the share price can be used as an indicator of the value of the target’s equity. While this makes things intuitively easier, because of the run-up in target valuations when takeover bids are rumoured, share price valuations may be too high if the current share price is used. As the previous section shows, this may lead to the wrong bid price being tabled. When considering a potential target for acquisition or merger, both firms should evaluate a variety of scenarios and consider the various embedded options that exist in most firms (see Chapter 8). We suggest that acquiring firms take the following steps to evaluate prospective targets.

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Stage 1: Value the Target as a Stand-Alone Firm The first stage in the valuation process is to consider the target as a stand-alone entity. This is the base-case valuation upon which the merger can be assessed. To value a company requires estimates of future cash flows and the appropriate rates for discounting the cash flows. The initial valuation should then be compared with the current share price of the target to form an initial opinion of the merger.

Stage 2: Calibrate the Valuation It is very unlikely that your initial valuation of the target firm will be equal to its share price, and any differential in valuations needs to be explained. As mentioned in the previous section, share prices may also reflect takeover probabilities and potential takeover premiums. In addition, the share price may not incorporate private information that has been gained as a result of your in-depth analysis. For example, private information could be provided by the management of the target firm if the merger is friendly and fully supported by the target’s board. Alternatively, new information may have been discovered in the course of your investigations. Because the effort in this phase is so great, and the analysis so extensive, it is possible that your valuation may be better than the share price of the market. This is especially true if the target firm is listed on a small exchange or emerging market, where valuations may not be so accurate. If you do not have more information than the market, and there is still a difference between your valuation and the share price, it is highly probable that your valuation is incorrect. In other words, your estimate of future cash flows and discount rates will be different from that of the market. At this point it is strongly recommended that you revisit your assumptions to see whether anything can be improved. It is imperative that you get your assumptions right, because they are the building blocks for the rest of your analysis.

Stage 3: Value the Synergies Whereas stages 1 and 2 focus on your initial valuation of the target, stage 3 concerns your assessment of the benefits of a possible merger or acquisition. To do this, you must value the synergies associated with combining the target and the acquirer. In the same way as you initially valued the target firm, you value synergies by estimating the cash flows generated by the synergies along with the appropriate discount rates. Some synergies are easier to predict, but others are considerably more difficult. For example, synergies that come from tax savings or reductions in fixed costs are easier to predict than increased sales or reductions in variable costs. The future cash flows and the discount rates used in the base-case valuation are likely to be used in valuing risky synergies. For example, you may believe that the proposed merger will lead to a 10 per cent increase in the target’s cash flows in the five years after the merger. Valuing this synergy will require both the pre-acquisition discount rate and the cash flows of the target. In addition, valuing synergies may also require an estimate of the acquiring firm’s cost of capital and expected cash flows. Hence the acquiring firm will want to use the procedures outlined in stages 1 and 2 to value its own equity and calibrate its cost of capital and cash flows. When synergies are valued, it is important to discount cash flows arising from the synergy using the weighted average of both firms’ cost of capital. For example, as a result of the disastrous conditions in the automobile market in 2009, Fiat entered into merger talks with Chrysler. The reason for the merger was that Fiat would have access to the North American car market and Chrysler would be able to increase its presence in Europe. Assume that, as a result of the merger, both companies would increase their pre-tax profits by 10 per cent per year. Given that the gain in each year is proportional to the pre-acquisition cash flows of both firms, the appropriate discount rate would be an equally weighted average of the two firm’s costs of capital. The Fiat–Chrysler example illustrates a case where synergies affect both parties to the merger equally. However, this will not always be the case. If the merger was expected to result in a proportional increase in Fiat’s profits, but not Chrysler’s, then you would use Fiat’s cost of capital to value the synergy.

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Chapter 29  Mergers and Acquisitions Because the major gain from the merger is Fiat’s penetration of the North American market, there will be many strategic options open to the company once it starts operations. Consequently, it might be better to consider valuing the synergy as a strategic option, using the real options methodology in Chapters 8 and 22, instead of the risk-adjusted discount rate method. When a firm expands into a new market, it has the option to expand further if prospects turn out to be more favourable than originally anticipated, and to exit if the situation turns out to be unfavourable. In these situations an investment may be substantially undervalued when such options are ignored.

Stage 4: Value the Merger The final part of the analysis is to add the base-case valuation of the target to the value of the synergies from the merger or acquisition. The rule of thumb is that the merger or acquisition should go ahead if the costs of the merger, which include the bid premium as well as all transaction costs, are lower than the combined value of the merger.

29.8 Friendly versus Hostile Takeovers Mergers are generally initiated by the acquiring, not the acquired, firm. Thus the acquirer must decide to purchase another firm, select the tactics to effect the merger, determine the highest price it is willing to pay, set an initial bid price, and make contact with the target firm. Often the CEO of the acquiring firm simply calls on the CEO of the target and proposes a merger. Should the target be receptive, a merger eventually occurs. Of course, there may be many meetings, with negotiations over price, terms of payment, and other parameters. The target’s board of directors generally has to approve the acquisition. Sometimes the bidder’s board must also give its approval. Finally, an affirmative vote by the shareholders is needed. But when all is said and done, an acquisition that proceeds in this way is viewed as friendly. Of course, not all acquisitions are friendly. The target’s management may resist the merger, in which case the acquirer must decide whether to pursue the merger and, if so, what tactics to use. Facing resistance, the acquirer may begin by purchasing some of the target’s equity in secret. This position is often called a toehold. Regulation in almost every country requires that an institution or individual disclose their holding in a company once a specific percentage ownership threshold is passed. For example, in the UK, an acquiring company must disclose any holdings above 3 per cent and provide detailed information, including its intentions and its position in the target. Secrecy ends at this point, because the acquirer must state that it plans to acquire the target. The price of the target’s shares will probably rise after the disclosure, with the new equity price reflecting the possibility that the target will be bought out at a premium. Although the acquirer may continue to purchase shares in the open market, an acquisition is unlikely to be effected in this manner. Rather, the acquirer is more likely at some point to make a tender offer (an offer made directly to the shareholders to buy shares at a premium above the current market price). The tender offer may specify that the acquirer will purchase all shares that are tendered – that is, turned in to the acquirer. Alternatively, the offer may state that the acquirer will purchase all shares up to, say, 50 per cent of the number of shares outstanding. If more shares are tendered, pro-rating will occur. For example, if, in the extreme case, all of the shares are tendered, each shareholder will be allowed to sell one share for every two shares tendered. The acquirer may also say that it will accept the tendered shares only if a minimum number of shares have been tendered. National regulators normally require that tender offers be held open for a minimum period. This delay gives the target time to respond. For example, the target may want to notify its shareholders not to tender their shares. It may release statements to the press criticizing the offer. The target may also encourage other firms to enter the bidding process. At some point the tender offer ends, at which time the acquirer finds out how many shares have been tendered. The acquirer does not necessarily need 100 per cent of the shares to obtain control of the target. In some companies a holding of 20 per cent or so may be enough for control. In others the percentage needed for control is much higher. Control is a vague term, but you might think of it operationally as control over the board of directors. Shareholders

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elect members of the board, who, in turn, appoint managers. If the acquirer receives enough equity to elect a majority of the board members, these members can appoint the managers whom the acquirer wants. And effective control can often be achieved with less than a majority. As long as some of the original board members vote with the acquirer, a few new board members can gain the acquirer a working majority. Sometimes, once the acquirer gets working control, it proposes a merger to obtain the few remaining shares that it does not already own. The transaction is now friendly, because the board of directors will approve it. Mergers of this type are often called clean-up mergers. A tender offer is not the only way to gain control of a hostile target. Alternatively, the acquirer may continue to buy more shares in the open market until control is achieved. This strategy, often called a street sweep, is infrequently used, perhaps because of the difficulty of buying enough shares to obtain control. Also, as mentioned, tender offers often allow the acquirer to return the tendered shares if fewer shares than the desired number are tendered. By contrast, shares purchased in the open market cannot be returned. Another means to obtain control is a proxy fight – a procedure involving corporate voting. Elections for seats on the board of directors are generally held at the annual shareholders’ meeting, perhaps four to five months after the end of the firm’s fiscal year. After purchasing shares in the target company, the acquirer nominates a slate of candidates to run against the current directors. The acquirer generally hires a proxy solicitor, who contacts shareholders prior to the shareholders’ meeting, making a pitch for the insurgent slate. Should the acquirer’s candidates win a majority of seats on the board, the acquirer will control the firm. And as with tender offers, effective control can often be achieved with less than a majority. The acquirer may just want to change a few specific policies of the firm, such as the firm’s capital budgeting programme or its diversification plan. Or it may simply want to replace management. If some of the original board members are sympathetic to the acquirer’s plans, a few new board members can give the acquirer a working majority. Whereas mergers end up with the acquirer owning all of the target’s equity, the victor in a proxy fight does not gain additional shares. The reward to the proxy victor is simply share price appreciation if the victor’s policies prove effective. In fact, just the threat of a proxy fight may raise share prices, because management may improve operations to head off the fight.

29.9 Defensive Tactics Target firm managers frequently resist takeover attempts. Actions to defeat a takeover may benefit the target shareholders if the bidding firm raises its offer price or another firm makes a bid. Alternatively, resistance may simply reflect self-interest at the shareholders’ expense. That is, the target managers might fight a takeover to preserve their jobs. Sometimes management resists while simultaneously improving corporate policies. Shareholders can benefit in this case, even if the takeover fails. In this section we describe various ways in which target managers resist takeovers. A company is said to be ‘in play’ if one or more suitors are currently interested in acquiring it. It is useful to separate defensive tactics before a company is in play from tactics after the company is in play.

Deterring Takeovers before Being in Play Corporate Charters  The corporate charter refers to the articles of incorporation and corporate by-laws governing a firm. Among other provisions, the charter establishes conditions allowing a takeover. Firms frequently amend charters to make acquisitions more difficult. As examples, consider the following two amendments: 1 Classified or staggered board: In an unclassified board of directors, shareholders elect all of the directors each year. In a staggered board, only a fraction of the board is elected each year, with terms running for multiple years. For example, one-third of the board might stand for election each year, with terms running for three years. Staggered boards increase the time an acquirer needs to obtain a majority of seats on the board. In the previous example, the acquirer can gain control of only one-third of the seats in the first year after acquisition. Another year must pass before the acquirer is able to control two-thirds of the

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Chapter 29  Mergers and Acquisitions seats. Therefore the acquirer may not be able to change management as quickly as it would like. However, some argue that staggered boards are not necessarily effective, because the old directors often choose to vote with the acquirer. 2 Supermajority provisions: Corporate charters determine the percentage of voting shares needed to approve important transactions such as mergers. A supermajority provision in the charter means that this percentage is above 50 per cent. Two-thirds majorities are common, though the number can be much higher. A supermajority provision clearly increases the difficulty of acquisition in the face of hostile management. Many charters with supermajority provisions have what is known as a board out clause as well. Here supermajority does not apply if the board of directors approves the merger. This clause makes sure that the provision hinders only hostile takeovers. Golden Parachutes  This colourful term refers to generous severance packages provided to management in the event of a takeover. The argument is that golden parachutes will deter takeovers by raising the cost of acquisition. However, some authorities point out that the deterrence effect is likely to be unimportant, because a severance package, even a generous one, is probably a small part of the cost of acquiring a firm. In addition, some argue that golden parachutes actually increase the probability of a takeover. The reasoning here is that management has a natural tendency to resist any takeover because of the possibility of job loss. A large severance package softens the blow of takeover, reducing management’s inclination to resist. Golden parachutes are very controversial in economic downturns, as there is nothing the media likes more than to splash an incredibly generous severance package all over the front pages when the company is in financial distress. This has been the case in recent years, when many outgoing executives bowed to public pressure and rescinded their golden parachutes. A good example concerns the chief executives of the Royal Bank of Scotland and HBOS, the big British banks that succumbed to the credit crisis in 2009. Fred Goodwin (RBS) and Andy Hornby (HBOS) gave up their golden parachutes of £1.2 million and £1 million respectively when they left their banks, after intense political and public criticism. Poison Pills  The poison pill is a sophisticated defensive tactic that is common in the US but illegal in Europe. In the event of a hostile bid, a poison pill allows the target firm to issue new shares at a deep discount to every shareholder except the bidder. Perhaps the example of PeopleSoft (PS) will illustrate the general idea. At one point in 2005 PS’s poison pill provision stated that once a bidder acquired 20 per cent or more of PeopleSoft’s shares, all shareholders except the acquirer could buy new shares from the corporation at half price. At the time PS had about 400 million shares outstanding. Should some bidder acquire 20 per cent of the company (80 million shares), every shareholder except the bidder would be able to buy 16 new shares for every one previously held. If all shareholders exercised this option, PeopleSoft would have to issue 5.12 billion (= 0.8 × 400 million × 16) new shares, bringing its total to 5.52 billion. The share price would drop, because the company would be selling shares at half price. The bidder’s percentage of the firm would drop from 20 per cent to 1.45 per cent (= 80 million/5.52 billion). Dilution of this magnitude causes some critics to argue that poison pills are insurmountable. Since poison pills are illegal in many countries, this has led to greater frequency of hostile takeovers, especially by hedge funds looking to take over a company quickly and sell it on at a profit. Outlawing poison pills has also led to some criticism, because acquiring firms can quickly take control of a target firm before other, possibly better, bids are being prepared by other firms.

Deterring a Takeover after the Company Is in Play Greenmail and Standstill Agreements  Managers may arrange a targeted repurchase to forestall a takeover attempt. In a targeted repurchase a firm buys back its own equity from a potential bidder, usually at a substantial premium, with the proviso that the seller promises not to acquire the company for a specified period. Critics of such payments label them greenmail. A standstill agreement occurs when the acquirer, for a fee, agrees to limit its holdings in the target. As part of the agreement the acquirer often promises to offer the target a right of first

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refusal in the event that the acquirer sells its shares. This promise prevents the block of shares from falling into the hands of another would-be acquirer. Greenmail has been a colourful part of the financial lexicon since its first application in the late 1970s. Since then, pundits have commented numerous times on either its ethical or unethical nature. Greenmail is predominantly a strategy undertaken by US firms, and is not common in the rest of the world. White Knight and White Squire  A firm facing an unfriendly merger offer might arrange to be acquired by a friendly suitor, commonly referred to as a white knight. The white knight might be favoured simply because it is willing to pay a higher purchase price. Alternatively, it might promise not to lay off employees, fire managers, or sell off divisions. Management instead may wish to avoid any acquisition at all. A third party, termed a white squire, might be invited to make a significant investment in the firm, under the condition that it vote with management and not purchase additional shares. White squires are generally offered shares at favourable prices. Billionaire investor Warren Buffett has acted as a white squire to many firms, including Champion International and Gillette. Recapitalizations and Repurchases  Target management will often issue debt to pay out a dividend – a transaction called a leveraged recapitalization. A share repurchase, where debt is issued to buy back shares, is a similar transaction. The two transactions fend off takeovers in a number of ways. First, the equity price may rise, perhaps because of the increased tax shield from greater debt. A rise in share price makes the acquisition less attractive to the bidder. However, the price will rise only if the firm’s debt level before the recapitalization was below the optimum, so a levered recapitalization is not recommended for every target. Consultants point out that firms with low debt but with stable cash flows are ideal candidates for ‘recaps’. Second, as part of the recapitalization, management may issue new securities that give management greater voting control than it had before the recap. The increase in control makes a hostile takeover more difficult. Third, firms with a lot of cash are often seen as attractive targets. As part of the recap, the target may use this cash to pay a dividend or buy back equity, reducing the firm’s appeal as a takeover candidate. Exclusionary Self-Tenders  An exclusionary self-tender is the opposite of a targeted repurchase. Here the firm makes a tender offer for a given amount of its own equity while excluding targeted shareholders. In a particularly celebrated case Unocal, a large integrated oil firm, made a tender offer for 29 per cent of its shares while excluding its largest shareholder, Mesa Partners II (led by T. Boone Pickens). Unocal’s self-tender was for $72 per share, which was $16 over the prevailing market price. It was designed to defeat Mesa’s attempted takeover of Unocal by transferring wealth, in effect, from Mesa to Unocal’s other equity-holders. This type of activity is almost non-existent in most countries outside the United States because of the existence of pre-emptive rights. A notable example is Barclays Bank plc and Unicredit Bank, who attempted in 2008 to bypass the pre-emptive rights of existing shareholders in order to raise cash quickly. Not surprisingly, the management of both companies came under intense pressure from institutional shareholders to change their decisions. Asset Restructurings  In addition to altering capital structure, firms may sell off existing assets or buy new ones to avoid takeover. Targets generally sell, or divest, assets for two reasons. First, a target firm may have assembled a hotchpotch of assets in different lines of business, with the various segments fitting together poorly. Value might be increased by placing these divisions into separate firms. Academics often emphasize the concept of corporate focus. The idea here is that firms function best by focusing on those few businesses that they really know. A rise in equity price following a divestiture will reduce the target’s appeal to a bidder. The second reason is that a bidder might be interested in a specific division of the target. The target can reduce the bidder’s interest by selling off this division. Although the strategy may fend off a merger, it can hurt the target’s shareholders if the division is worth more to the target than to the division’s buyer. Authorities frequently talk of selling off the crown jewels or pursuing a scorched earth policy.

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Chapter 29  Mergers and Acquisitions While some targets divest existing assets, others buy new ones. Two reasons are generally given here. First, the bidder may like the target as is. The addition of an unrelated business makes the target less appealing to the acquirer. However, a bidder can always sell off the new business, so the purchase is probably not a strong defence. Second, antitrust legislation is designed to prohibit mergers that reduce competition. Antitrust law is enforced at both country level and regional level. For example, in the UK, mergers are governed by the Takeover Panel (UK regulator) and the European Commission (Europe). A target may purchase a company, knowing that this new division will pose antitrust problems for the bidder. However, this strategy might not be effective because, in its filings with the respective regulatory authorities, the bidder can state its intention to sell off the unrelated business.

29.10 The Diary of a Hostile Takeover: Ryanair plc and Aer Lingus Group plc At the end of 2008 the budget airline Ryanair plc announced a cash offer for its rival, Aer Lingus Group plc. On the date of the announcement, 1 December 2008, Ryanair’s share price was $2.95 and Aer Lingus’ share price was $1.105. The following is a timeline of events in the takeover bid.

1 December 2008: Ryanair Announces a Cash Offer for Aer lingus Group Prior to the cash offer, Ryanair already owned 29.82 per cent of Aer Lingus shares from an earlier takeover attempt. The cash offer was $1.40/share for 100 per cent of Aer Lingus shares, and the proposal was to form one airline group, but with the two companies operating separate brands in a similar way to Air France-KLM. In its opening gambit, Ryanair argued that the offer would benefit Aer Lingus shareholders in the following ways: 1 The offer was a cash offer and not shares. 2 The bid premium was 28 per cent over the average Aer Lingus price ($1.09) in the previous 30 days, and it represented a 25 per cent premium over the closing price of $1.12 on 28 November 2008. The benefits to Aer Lingus employees were given as follows: 1 The Aer Lingus executive share option scheme would receive $137 million in cash. 2 The size of the fleet would double within five years, and 1,000 jobs would be created. 3 The growth prospects of the combined firm would improve promotion prospects and increase job security. The size of the new firm would be comparable to Europe’s big three airlines: Air France-KLM, British Airways Group, and Lufthansa-Swiss. Ryanair also went on the offensive and criticized the performance of Aer Lingus management: 1 The Aer Lingus share price had collapsed from $3.00 in December 2006 to less than $1.00 in November 2008. 2 Aer Lingus long-haul customers had fallen by 7 per cent and short-haul customers had fallen by 2 per cent in 2008. 3 Ryanair forecast that Aer Lingus would have operating losses of $20 million for 2008 and 2009. 4 The firm had wasted $24 million on its defence of Ryanair’s previous offer of $2.80 in December 2006. 5 The basic directors’ fee in Aer Lingus had tripled in three years from $17,500 to $45,000 and the non-executive chairman’s fee had increased fivefold from $35,000 to $175,000.

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6 Short-haul fares had increased by 7 per cent and fuel surcharges were increased five times to an average of $75 per sector. 7 Aer Lingus had suffered repeated strike threats, closed its Shannon base, and opened a poorly performing Belfast base in 2007. It also ordered new A330 aircraft in 2007 when it was most expensive, and then deferred delivery of these to November 2008. In response to the offer, the Aer Lingus board released a statement on the same day arguing that Ryanair’s previous offer for their shares in 2006 failed to achieve antitrust clearance and, as a result, the new offer was not possible. They also stated that Aer Lingus had a strong business, with significant cash reserves, and the Ryanair offer of $1.40 per share significantly undervalued the company. The share price of Aer Lingus jumped 16.7 per cent to $1.29 from $1.105 and Ryanair’s share price fell nearly 5 per cent from $2.9225 to $2.7825 on the day of the announcement. Holding all else constant, the market estimated the probability of success of the takeover as: Share price Probability Share price of Probability of Aer Lingus of Aer Lingus of no with merger merger w ithout merger merger $1.29 = $1.40 × p + $1.105 × (1 − p))



Solving for p gives an initial probability of success as 62.7 per cent.

11 December 2008: Aer Lingus Discusses Ryanair Offer with the Irish Minister for Transport The Aer Lingus board announced that it had met with the Irish Minister of Transport, Noel Dempsey, and made clear that they had unanimously rejected the offer because it would lead to a monopoly in Ireland and contravene competition laws. The Irish government held 25 per cent of Aer Lingus shares and thus was a major shareholder. The chief executive of Aer Lingus, Dermot Mannion, said in a statement afterwards: We had a productive meeting with the Minister today and have committed to give the Government, as well as all other shareholders, a comprehensive rebuttal of Ryanair’s offer after the publication of its Offer Document. Ryanair cannot spin away the fact that Aer Lingus is and will continue to be its fiercest competitor into and out of Ireland. It is offering other Aer Lingus shareholders a mere $525 million, a pathetic sum in the context of the $1.3 billion in cash on the Group’s balance sheet, the substantial value of our fleet and the value of the Heathrow slots. Aer Lingus remains a strong business with significant cash reserves and a robust long-term future. Despite all of Ryanair’s insincere promises, this Offer, if accepted, would be bad for Irish consumers, for Aer Lingus’ shareholders and for everyone who works in the airline. The share price of Aer Lingus at close of day was $1.4975, and the Ryanair share price was $2.925. Why would the Aer Lingus share price be above the bid amount of $1.40? The basic reason is that the market anticipated that Ryanair would have to make an increased bid for the company if it was to be successful in the takeover attempt.

15 December 2008: Ryanair Issues a 184 page Formal Offer Document for Aer Lingus Shares The formal offer document contained essentially the same information as the original announcement. However, Ryanair also personally attacked the management of Aer Lingus. As the offer became increasingly hostile, the chairman of Aer Lingus, Colm Barrington, released the following statement:

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Chapter 29  Mergers and Acquisitions This document contains nothing new. It is the usual stream of invective, spin and misrepresentation that we expect from the people at Ryanair. It also fails to address the recent EU prohibition decision which found emphatically that Ryanair wants to destroy consumer choice. It is a desperate last effort to create an airline monopoly in Ireland, and is clearly not in the interests of Aer Lingus shareholders and the travelling public. Aer Lingus is and will continue to be a strong independent airline. Ryanair clearly needs Aer Lingus but we do not need Ryanair. The Aer Lingus share price at close of day was now $1.4725 and the Ryanair share price was $2.77, a further fall from its starting value of $2.95.

22 December 2008: Aer Lingus Releases a 64-page Defence Document The board of Aer Lingus presented a vigorous argument as to why the $1.40 cash offer from Ryanair was not good for Aer Lingus shareholders. The points they made were as follows: 1 The Aer Lingus business model was successful. Short-haul business had low prices, high return on capital, and a growing business base. Moreover, its expansion into Gatwick airport provided significant growth opportunities in short haul. 2 Aer Lingus was and will be profitable in the future. In contrast to Ryanair’s predictions, the Aer Lingus management argued that it would make a profit for 2008. 3 The balance sheet of Aer Lingus was one of the strongest in the industry. It had $1.3 billion of cash reserves and $803 million of net cash. They argued that Ryanair wanted to spend $525 million to acquire Aer Lingus in order to gain access to the $1.3 billion cash. 4 Ryanair was opportunistically using the dreadful market conditions of late 2008 to profit from the Aer Lingus business model and access its cash resources and assets at a discounted price. 5 The Ryanair offer was flawed, because the previous offer in 2006 fell foul of European antitrust laws, and the current offer was no different. The Aer Lingus share price was now $1.50 and Ryanair’s had grown to $3.085!

6 January 2009: Ryanair Seeks Aer Lingus Shareholder Meeting In a dramatic twist to the saga, Ryanair sought an extraordinary meeting of Aer Lingus shareholders to block changes in the employment contract of the Aer Lingus chairman, Colm Barrington. The company had changed his contract at the turn of the year so that, in the event that Aer Lingus was bought over, he would be due a $2.8 million golden parachute payment if he resigned. Ryanair also announced that only 0.01 per cent of Aer Lingus shareholders (excluding Ryanair itself, which owned 29.82 per cent of Aer Lingus shares) had accepted the cash offer of $1.40 per share. As a result of the extraordinary meeting call, the offer period was extended to 13 February 2009. Aer Lingus’s share price now closed at $1.49, and Ryanair closed even higher at $3.20!

22 January 2009: The Irish Government Announces that it Will not Support the Ryanair Bid One of Aer Lingus’s major shareholders was the Irish government, which owned 25 per cent of the company’s shares. It made a statement that the Ryanair offer greatly undervalues Aer Lingus and a merger on the basis proposed would be likely to have a significant negative impact on competition in the market. Because we live on

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an island, Irish consumers depend heavily on air transport. A monopoly in this area would not be in the best interests of Irish consumers. The offer by Ryanair did not include any proposed remedies for the virtual monopoly that would result if the offer was accepted. Reluctantly, the chief executive of Ryanair, Michael Dempsey, conceded that the offer was no longer feasible: We respect that decision. It means our offer won’t be successful since our 90 per cent acceptance condition can’t be satisfied. Sadly it means the government won’t receive $200m, and there won’t be 1,000 new jobs created in Aer Lingus over the next five years. The closing share price of Aer Lingus on 23 January 2009, was $1.15 and that of Ryanair was $3.11. Clearly, the market felt that the proposed takeover was bad for Ryanair’s shareholders and good for Aer Lingus shareholders. As the probability of the proposed merger became zero, the price of Aer Lingus fell back to its pre-announcement value. The Ryanair–Aer Lingus takeover bid provides many insights into the process of a hostile takeover. First, the bidder will criticize the company in terms of its performance, value, or management. Second, the target firm’s management, if they does not wish to be taken over, will respond in a negative manner and defend their business model and performance. Third, the market will have its own view on the viability and likelihood of a merger. Finally, it is clear that much effort on the part of both management teams was expended over the period. This time could have been spent elsewhere improving the value of each firm’s business operations.

Do Mergers Add Value? 29.11 In Sec. 29.2 we stated that synergy occurs if the value of the combined firm after the merger is greater than the sum of the value of the acquiring firm and the value of the acquired firm before the merger. Section 29.3 provided a number of sources of synergy in mergers, implying that mergers can create value. We now want to know whether mergers actually create value in practice. This is an empirical question, and must be answered by empirical evidence. There are a number of ways to measure value creation, but many academics favour event studies. These studies estimate abnormal equity returns on, and around, the merger announcement date. An abnormal return is usually defined as the difference between an actual equity return and the return on a market index or control group of equities. This control group is used to net out the effect of market-wide or industry-wide influences. Consider Table 29.5, where returns around the announcement days of mergers in the US are reported. The average abnormal percentage return across all mergers from 1980 to 2001 is 0.0135. This number combines the returns on both the acquiring company and the acquired company. Because 0.0135 is positive, the market believes that mergers on average create value. The other three returns in the first column are positive as well, implying value creation in the different subperiods. Many other academic studies have provided similar results. Thus it appears from this column that the synergies we mentioned in Sec. 29.3 show up in the real world. However, the next column tells us something different. Across all mergers from 1980 to 2001 the aggregate dollar change around the day of merger announcement is −$79 billion. This means that the market is, on average, reducing the combined equity value of the acquiring and acquired companies around the merger announcement date. Though the difference between the two columns may seem confusing, there is an explanation. Although most mergers have created value, mergers involving the very largest firms have lost value. The abnormal percentage return is an unweighted average in which the returns on all mergers are treated equally. A positive return here reflects all those small mergers that created value. However, losses in a few large mergers cause the aggregate dollar change to be negative. But there is more. The rest of the second column indicates that the aggregate dollar losses occurred only in the 1998 to 2001 period. While there were losses of −$134 billion in this period, there were gains of $12 billion from 1980 to 1990. And interpolation of the table

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TA B L E Gain or loss to merger (both acquired and acquiring firms)

29.5

Gain or loss to acquiring firms

Abnormal percentage return

Aggregate dollar gain or loss

Abnormal percentage return

1980–2001

0.0135

−$79 billion

0.0110

−$220 billion

1980–1990

0.0241

$12 billion

0.0064

−$4 billion

1991–2001

0.0104

−$90 billion

0.0120

−$216 billion

1998–2001

0.0029

−$134 billion

0.0069

−$240 billion

Time period

Aggregate dollar gain or loss

Source: Modified from S. Moeller, F. Schlingemann and R. Stulz, ‘Wealth destruction on a massive scale? A study of acquiring-firm returns in the recent merger wave’, Journal of Finance (April 2005), Table 1.

Table 29.5  Percentage and dollar returns for mergers

indicates that there were gains of $44 billion (= $134 − $90) from 1991 to 1997. Thus it appears that some large mergers lost a great deal of value from 1998 to 2001. The analysis presented in Table 29.5 considers the effect of mergers on shareholders. It does not consider the effect of mergers on the whole firm, that is, equity and debt. Recall from Sec. 29.5 that mergers may transfer value from equity-holders to debtholders because of the reduction in risk of the combined company. Doukas and Kan14 show this to be the case for cross-border mergers involving US firms, and find that overall firm value is not reduced from this activity. Most research on mergers and acquisitions has focused on US firms. This is largely because the activity has not been particularly common elsewhere. For example, in Europe, merger activity grew significantly only after the introduction of the euro. The exception to this is the UK, where mergers have been commonplace, and come in waves in a similar way to the US. Figure 29.3 presents the total market value of UK mergers over time. There was a massive spike in the late 20th century as the high-tech boom took hold, which then fell after the bubble burst. In recent years mergers across the world have dropped drastically with the disappearance of credit in the financial markets. Admittedly, there has been a consolidation of companies that were forced to merge as a result of financial distress or economic necessity (for example, HBOS with Lloyds TSB, and Merrill Lynch with Bank of America), but on the whole there has been very little interest in acquisitions. When one considers the value benefits of mergers and acquisitions, it is important to remember that every country has a different regulatory and legal framework for dealing with acquisitions. In some places, foreign ownership is allowed only up to a certain pre-specified percentage of shares. This can significantly affect the success of merger bids. Europe is particularly interesting, because although it operates under a cohesive regulation system, corporate cultures are very different across the area. Campo and Hernando15 show that differences in the institutional environment can affect the benefits of mergers and acquisitions. They found that European mergers in regulated industries or those that were under government control were significantly less successful than in unregulated industries. The results in a table such as Table 29.5 should have important implications for public policy, because regulators are always wondering whether mergers are to be encouraged or discouraged. However, the results in that table are, unfortunately, ambiguous. On the one hand, you could focus on the first column, saying that mergers create value on average. Proponents of this view might argue that the great losses in the few large mergers were flukes, not likely to occur again. On the other hand, we cannot easily ignore the fact that, over the entire period, mergers destroyed more value than they created.

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29.3

809

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2000 1800

M&A by British firms in UK M&A by British firms overseas

1600 1400 1200 1000 800 600 400 200

19

87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06

0

Source: UK Office for National Statistics.

Figure 29.3  Pound volume (£ billions) of UK mergers and acquisitions by year

Mergers and acquisitions are often driven by different agenda. For example, the mergers and acquisitions of recent times have been in response to the economic woes facing world economies. Economies of scale and risk reduction are the main factors underlying the mergers of 2008 and later. If you go several years back in time, the mergers and acquisitions were largely a result of growth into new markets and exploitation of different synergies. Naturally, the performance of mergers after 2008 will be very different from earlier periods. Before we move on, some final thoughts are in order. Readers may be bothered that abnormal returns are taken only around the time of the acquisition, well before all of the acquisition’s impact is revealed. Academics look at long-term returns, but they have a special fondness for short-term returns. If markets are efficient, the short-term return provides an unbiased estimate of the total effect of the merger. Long-term returns, while capturing more information about a merger, also reflect the impact of many unrelated events.

Returns to Bidders The preceding results combined returns on bidders and targets. Investors want to separate the bidders from the targets. Columns 3 and 4 of Table 29.5 provide returns for acquiring companies alone. The third column shows that abnormal percentage returns for bidders have been positive for the entire sample period and for each of the individual subperiods – a result similar to that for bidders and targets combined. The fourth column indicates aggregate losses, suggesting that large mergers did worse than small ones. The time pattern for these aggregate losses to bidders is presented in Fig. 29.4. Again, the large losses occurred from 1998 to 2001, with the greatest loss in 2000. Let’s fast-forward a few decades and imagine that you are the CEO of a company. In that position you will certainly be faced with potential acquisitions. Does the evidence in Table 29.5 and Fig. 29.3 encourage you to make acquisitions or not? Again, the evidence is ambiguous. On the one hand, you could focus on the averages in column 3 of the table, probably increasing your appetite for acquisitions. On the other hand, column 4 of the table, as well as the figure, might give you pause.

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Chapter 29  Mergers and Acquisitions

FIGURE

40

29.4

20 0

Billion dollars

−20 −40 −60 −80 −100 −120

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

1985

1984

1983

1982

1981

−160

1980

−140

Years The graph shows the aggregate dollar gain or loss across all acquiring firms each year from 1980 to 2001. Source: Taken from Fig. 1, S. Moeller, F. Schlingemann and R. Stulz, ‘Wealth destruction on a massive scale? A study of acquiring-firm returns in the recent merger wave’, Journal of Finance (April 2005).

Figure 29.4  Yearly aggregate dollar gain or loss for the shareholders of acquiring firms

Target Companies Although the evidence just presented for both the combined entity and the bidder alone is ambiguous, the evidence for targets is crystal-clear. Acquisitions benefit the target’s equityholders. Consider the following chart, which shows the median merger premium over different periods in the United States:16 Time period Premium

1973–1998

1973–1979

1980–1989

1990–1998

42.1%

47.2%

37.7%

34.5%

The premium is the difference between the acquisition price per share and the target’s preacquisition share price, divided by the target’s pre-acquisition share price. The average premium is quite high for the entire sample period and for the various subsamples. For example, a target company selling at $100 per share before the acquisition that is later acquired for $142.1 per share generates a premium of 42.1 per cent. The results are similar in other countries. For example, in the UK, the average premium is 45 per cent.17 Though other studies may provide different estimates of the average premium, all studies show positive premiums. Thus we can conclude that mergers benefit the target shareholders. This conclusion leads to at least two implications. First, we should be somewhat sceptical of target managers who resist takeovers. These managers may claim that the target’s share price does not reflect the true value of the company. Or they may say that resistance will induce the bidder to raise its offer. These arguments could be true in certain situations, but they may also provide cover for managers who are simply scared of losing their jobs after acquisition. Second, the premium creates a hurdle for the acquiring company. Even in a merger with true synergies, the acquiring shareholders will lose if the premium exceeds the value of these synergies.

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The Managers versus the Shareholders Managers of Bidding Firms  The preceding discussion was presented from the shareholders’ point of view. Because, in theory, shareholders pay the salaries of managers, we might think that managers would look at things from the shareholders’ point of view. However, it is important to realize that individual shareholders have little clout with managers. For example, the typical shareholder is simply not in a position to pick up the phone and give the managers a piece of her mind. It is true that the shareholders elect the board of directors, which monitors the managers. However, an elected director has little contact with individual shareholders. Thus it is fair to ask whether managers are held fully accountable for their actions. This question is at the heart of what economists call agency theory. Researchers in this area often argue that managers work less hard, get paid more, and make worse business decisions than they would if shareholders had more control over them. And there is a special place in agency theory for mergers. Managers frequently receive bonuses for acquiring other companies. In addition, their pay is often positively related to the size of their firm. Finally, managers’ prestige is also tied to firm size. Because firm size increases with acquisitions, managers are disposed to look favourably on acquisitions, perhaps even ones with negative NPV. A fascinating study18 compared companies where managers received a lot of options on their own company’s equity as part of their compensation package with companies where the managers did not. Because option values rise and fall in tandem with the firm’s equity price, managers receiving options have an incentive to forgo mergers with negative NPVs. The paper reported that the acquisitions by firms where managers receive lots of options (termed equity-based compensation in the paper) create more value than the acquisitions by firms where managers receive few or no options. Agency theory may also explain why the biggest merger failures have involved large firms. Managers owning a small fraction of their firm’s equity have less incentive to behave responsibly, because the great majority of any losses are borne by other shareholders. Managers of large firms probably have a smaller percentage interest in their firm’s equity than do managers of small firms (a large percentage of a large firm is too costly to acquire). Thus the merger failures of large acquirers may be due to the small percentage ownership of the managers. An earlier chapter of this text discussed the free cash flow hypothesis. The idea here is that managers can spend only what they have. Managers of firms with low cash flow are likely to run out of cash before they run out of good (positive NPV) investments. Conversely, managers of firms with high cash flow are likely to have cash on hand even after all the good investments are taken. Managers are rewarded for growth, so managers with cash flow above that needed for good projects have an incentive to spend the remainder on bad (negative NPV) projects. A paper tested this conjecture, finding that ‘cash-rich firms are more likely than other firms to attempt acquisitions. . . . cash-rich bidders destroy seven cents in value for every dollar of cash reserves held. . . . consistent with the equity return evidence, mergers in which the bidder is cash-rich are followed by abnormal declines in operating performance.’19 The previous discussion has considered the possibility that some managers were knaves – more interested in their own welfare than in the welfare of their shareholders. However, a recent paper entertained the idea that other managers were more fools than knaves. Malmendier and Tate20 classified certain CEOs as overconfident, either because they refused to exercise equity options on their own company’s equity when it was rational to do so, or because the press portrayed them as confident or optimistic. The authors find that these overconfident managers are more likely to make acquisitions than are other managers. In addition, the equity market reacts more negatively to announcements of acquisitions when the acquiring CEO is overconfident. Managers of Target Firms  Our discussion has just focused on the managers of acquiring firms, finding that these managers sometimes make more acquisitions than they should. However, that is only half of the story. Shareholders of target firms may have just as hard a time controlling their managers. While there are many ways in which managers of target firms

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Chapter 29  Mergers and Acquisitions can put themselves ahead of their shareholders, two seem to stand out. First, we said earlier that because premiums are positive, takeovers are beneficial to the target’s shareholders. However, if managers may be fired after their firms are acquired, they may resist these takeovers.21 Tactics employed to resist takeover, generally called defensive tactics, were discussed in an earlier section of this chapter. Second, managers who cannot avoid takeover may bargain with the bidder, getting a good deal for themselves at the expense of their shareholders. Consider Wulf’s fascinating work on mergers of equals (MOEs).22 Some deals are announced as MOEs, primarily because the two firms have equal ownership in and equal representation on the board of directors of the merged entity. AOL and Time Warner, Daimler-Benz and Chrysler, Morgan Stanley and Dean Witter, and Fleet Financial Group and BankBoston are generally held out as examples of MOEs. Nevertheless, authorities point out that in any deal one firm is typically ‘more equal’ than the other. That is, the target and the bidder can usually be distinguished in practice. For example, Daimler-Benz is commonly classified as the bidder and Chrysler as the target in their merger. Wulf finds that targets get a lower percentage of the merger gains, as measured by abnormal returns around the announcement date, in MOEs than in other mergers. And the percentage of the gains going to the target is negatively related to the representation of the target’s officers and directors on the post-merger board. These and other findings lead Wulf to conclude, ‘They [the findings of the paper] suggest that CEOs trade power for premium in merger of equals transactions.’

29.12 Accounting and Tax Considerations Many mergers involve companies in two different countries, which presents many difficulties in assessing the value of acquisitions. This is because accounting and tax rules can be very different across countries. In recent years there has been a concerted effort by accounting standard-setters and regulatory authorities to streamline the administrative and bureaucratic challenges that face merging firms. In the subsequent discussion we shall try to be as generic as possible about the accounting and tax considerations without losing the necessary important detail. However, given the heterogeneity of regulations across countries, it is impossible to be specific about every regulation in place regarding mergers. Accounting systems differ in the US from the rest of the world. In Europe, and many other countries, International Financial Reporting Standards govern the way that companies account for transactions. To improve the efficiency of the accounting treatment of cross-border mergers, the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) have been working together to converge the standards of the two systems. This is an ongoing project, and developments will continue in the future. The main guidance provided by both bodies is that the accounting treatment of any acquisition or merger recognizes the fair value of all assets and liabilities on the acquisition date. The guidance, which is given in IFRS 3 Business Combinations, states that these be presented in such a way as to allow stakeholders to understand the true value of the acquisition or merger. The only exceptions to this rule are leases and insurance contracts, which are valued using the contractual terms at inception of the contract (see Chapter 20). The accounting impact of the merger is evaluated using the acquisition method proposed by IFRS3. Specifically, the following must be done: • Step 1: Identify the acquirer. A separate accounting standard, IAS27 Consolidated and Separate Financial Statements, is used to identify the party that has gained control in the merger transaction. This can be quite difficult, especially when the merger is a merger of equals (MOE). • Step 2: Determine the acquisition date. The acquirer must identify the date on which it gains control of the target. This is normally the date of legal transfer or consolidation of assets and liabilities between the two parties. • Step 3: Recognize and measure the identifiable assets that have been acquired, the liabilities assumed, and any non-controlling interest in the acquiree. The acquirer must recognize all assets and liabilities (excluding goodwill) at fair value. In 2008 an exceptionally important change

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in this standard was introduced. In a break with previous practice, the costs of a merger or acquisition must now be treated as an expense in the financial accounts. Before this, the acquirer would lump the merger costs into the value of the target company, and this would be represented in the statement of financial position. Now, the costs affect the income statement, and this clearly impacts upon the profitability of the acquirer in the period after the acquisition takes place. It has been argued that this accounting change will reduce the frequency of mergers and acquisitions in countries that employ International Financial Reporting Standards. • Step 4: Recognize and measure goodwill or a gain from a bargain purchase as of the acquisition date. In a purchase, an accounting term called goodwill is created. Goodwill is the excess of the purchase price over the sum of the fair market values of the individual assets acquired. The goodwill of a target company will normally be taken from its financial accounts. In some cases a merger or acquisition will take place because the target is in financial distress and the acquiring company is able to get the target’s assets at a discount. This happened during the credit crunch of 2008, when JP Morgan bought Bear Stearns for a deeply discounted price. In such a situation IFRS would require that the acquirer reassess the value of the assets of the target at fair value.

EXAMPLE

Acquisitions and Accounting

29.4

Suppose firm A acquires firm B, creating a new firm, AB. Firm A’s and firm B’s financial positions at the date of the acquisition are shown in Table 29.6. The book value of firm B on the date of the acquisition is £10 million. This is the sum of £8 million in buildings and £2 million in cash. However, an appraiser states that the sum of the fair market values of the individual buildings is £14 million. With £2 million in cash, the sum of the market values of the individual assets in firm B is £16 million. This represents the value to be received if the firm is liquidated by selling off the individual assets separately. However, the whole is often worth more than the sum of the parts in business. Firm A pays £19 million in cash for firm B. This difference of £3 million (= £19 million − £16 million) is goodwill. It represents the increase in value from keeping the firm as an ongoing business. Firm A issued £19 million in new debt to finance the acquisition. The total assets of firm AB increase to £39 million. The buildings of firm B appear in the new statement of financial position at their current market value. That is, the market value of the assets of the acquired firm becomes part of the book value of the new firm. However, the assets of the acquiring firm (firm A) remain at their old book value. They are not revalued upwards when the new firm is created. The excess of the purchase price over the sum of the fair market values of the individual assets acquired is £3 million. This amount is reported as goodwill. Financial analysts generally ignore goodwill, because it has no cash flow consequences. Each year the firm must assess the value of its goodwill. If the value goes down (this is called impairment in accounting speak), the amount of goodwill on the statement of financial position must be decreased accordingly. Otherwise no amortization is required. In a similar way that the accounting treatment of mergers and acquisitions is converging to one basic standard across the world, governments have also attempted to integrate country-level tax laws. The taxation of mergers and acquisitions across national borders can be extremely complex and prohibitive in cost, and this deters many corporations from pursuing cross-border mergers. Each national tax system is different, but in recent years there have been a number of treaties that smooth out these differences. In Europe the main treaty is the Cross-Border Merger Directive, which was fully implemented at the end of 2007 (with the exception of Belgium, which the Commission reported had not fully met the requirements of the Directive). As Chapter 2 attests, the governance systems across Europe are quite varied, and employee participation is stronger in some countries (e.g. Germany, France and Belgium) than in others (e.g. the United Kingdom). Amalgamating the operations of corporations that are based in countries with different governance cultures and taxation systems presents some difficulty. The EU Merger Directive presents a cohesive framework that allows European national taxation systems to operate fully within a broader international context.

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Chapter 29  Mergers and Acquisitions

TA B L E

29.6

Firm A(£m)

Firm B(£m)

Cash

4

Land

16

Buildings Total

Equity 20

0 __

___

20

20

Cash

2

Land Buildings Total

Firm AB(£m)

Equity 10

Cash

6

Debt 19

0

Land

16

Equity 20

8

Buildings

14

Goodwill

 3

___

Total

39

39

__

__

10

10

When the acquisition method is used, the assets of the acquired firm (firm B) appear in the combined firm’s books at their fair market value.

Table 29.6  Accounting for acquisitions: purchase (in £ millions)

29.13 Going Private and Leveraged Buyouts Going-private transactions and leveraged buyouts have much in common with mergers, and it is worth while to discuss them in this chapter. A publicly traded firm goes private when a private group, usually composed of existing management, purchases its equity. As a consequence, the firm’s equity is taken off the market (if it is an exchange-traded equity, it is delisted) and is no longer traded. Thus, in going-private transactions, shareholders of publicly held firms are forced to accept cash for their shares. Going-private transactions are frequently leveraged buyouts (LBOs). In a leveraged buyout the cash offer price is financed with large amounts of debt. Part of the appeal of LBOs is that the arrangement calls for little equity capital. This equity capital is generally supplied by a small group of investors, some of whom are likely to be managers of the firm being purchased. The selling shareholders are invariably paid a premium above market price in an LBO, just as in a merger. As with a merger, the acquirer profits only if the synergy created is greater than the premium. Synergy is quite plausible in a merger of two firms, and we delineated a number of types of synergy earlier in the chapter. However, it is more difficult to explain synergy in an LBO because only one firm is involved. Two reasons are generally given for value creation in an LBO. First, the extra debt provides a tax deduction, which, as earlier chapters suggested, leads to an increase in firm value. Most LBOs are on firms with stable earnings and with low to moderate debt. The LBO may simply increase the firm’s debt to its optimum level. The second source of value comes from increased efficiency, and is often explained in terms of ‘the carrot and the stick’. Managers become owners under an LBO, giving them an incentive to work hard. This incentive is commonly referred to as the carrot. Interest payments from the high level of debt constitute the stick. Large interest payments can easily turn a profitable firm before an LBO into an unprofitable one after the LBO. Management must make changes, either through revenue increases or through cost reductions, to keep the firm in the black. Agency theory, a topic mentioned earlier in this chapter, suggests that managers can be wasteful with a large free cash flow. Interest payments reduce this cash flow, forcing managers to curb the waste. Though it is easy to measure the additional tax shields from an LBO, it is difficult to measure the gains from increased efficiency. Nevertheless, this increased efficiency is considered at least as important as the tax shield in explaining the LBO phenomenon. Academic research suggests that LBOs have, on average, created value. First, premiums are positive, as they are with mergers, implying that selling shareholders benefit. Second, studies indicate that LBOs that eventually go public generate high returns for the management group. Finally, other studies show that operating performance increases after the LBO. However, we cannot be completely confident of value creation, because researchers have difficulty obtaining data about LBOs that do not go public. If these LBOs generally destroy value, the sample of firms going public would be a biased one.

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Divestitures

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Regardless of the average performance of firms undertaking an LBO, we can be sure of one thing: because of the great leverage involved, the risk is huge. On the one hand, LBOs have created many large fortunes. On the other hand, a number of bankruptcies and near-bankruptcies have occurred as well.

29.14 Divestitures This chapter has been concerned primarily with acquisitions, but it is also worth while to consider their opposite – divestitures. Divestitures come in a number of different varieties, the most important of which we discuss next.

Sale The most basic type of divestiture is the sale of a division, business unit, segment, or set of assets to another company. The buyer generally, but not always, pays in cash. A number of reasons are provided for sales. First, in an earlier section of this chapter we considered asset sales as a defence against hostile takeovers. It was pointed out in that section that sales often improve corporate focus, leading to greater overall value for the seller. This same rationale applies when the selling company is not in play. Second, asset sales provide needed cash to liquidity-poor firms. Third, it is often argued that the paucity of data about individual business segments makes large, diversified firms hard to value. Investors may discount the firm’s overall value because of this lack of transparency. Sell-offs streamline a firm, making it easier to value. However, this argument is inconsistent with market efficiency, because it implies that large, diversified firms sell below their true value. Fourth, firms may simply want to sell unprofitable divisions. However, unprofitable divisions are likely to have low values to everyone. A division should be sold only if its value is greater to the buyer than to the seller. There has been a fair amount of research on sell-offs, with academics reaching two conclusions. First, event studies show that returns on the seller’s equity are positive around the time of the announcement of sale, suggesting that sell-offs create value to the seller. Second, acquisitions are often sold off down the road. For example, Kaplan and Weisbach23 found that over 40 per cent of acquisitions were later divested, a result that does not reflect well on mergers. The average time between acquisition and divestiture was about seven years.

Spin-Off In a spin-off a parent firm turns a division into a separate entity and distributes shares in this entity to the parent’s shareholders. Spin-offs differ from sales in at least two ways. First, the parent firm receives no cash from a spin-off: Shares are sent for free to the shareholders. Second, the initial shareholders of the spun-off division are the same as the parent’s shareholders. By contrast, the buyer in a sell-off is most likely another firm. However, because the shares of the division are publicly traded after the spin-off, the identities of the shareholders will change over time. At least four reasons are generally given for a spin-off. First, as with a sell-off, the spin-off may increase corporate focus. Second, because the spun-off division is now publicly traded, stock exchange regulators require additional information to be disseminated – so investors may find it easier to value the parent and subsidiary after the spin-off. Third, corporations often compensate executives with shares of equity in addition to cash. The equity acts as an incentive: good performance from managers leads to share price increases. However, prior to the spin-off, executives can receive equity only in the parent company. If the division is small relative to the entire firm, price movement in the parent’s equity will be related less to the performance of the manager’s division than to the performance of the rest of the firm. Thus divisional managers may see little relation between their effort and equity appreciation. However, after the spin-off the manager can be given equity in the subsidiary. The manager’s effort should directly impact on price movement in the subsidiary’s equity. Fourth, the tax consequences from a spin-off are generally better than from a sale, because the parent receives no cash from a spin-off.

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Carve-Out In a carve-out the firm turns a division into a separate entity and then sells shares in the division to the public. Generally the parent retains a large interest in the division. This transaction is similar to a spin-off, and the first three benefits listed for a spin-off apply to a carve-out as well. However, the big difference is that the firm receives cash from a carve-out, but not from a spin-off. The receipt of cash can be both good and bad. On the one hand, many firms need cash. Michaely and Shaw24 find that large, profitable firms are more likely to use carve-outs, whereas small, unprofitable firms are more likely to use spin-offs. One interpretation is that firms generally prefer the cash that comes with a carve-out. However, small and unprofitable firms have trouble issuing equity. They must resort to a spin-off, where equity in the subsidiary is merely given to their own equity-holders. Unfortunately, there is also a dark side to cash, as developed in the free cash flow hypothesis. That is, firms with cash exceeding that needed for profitable capital budgeting projects may spend it on unprofitable ones. Allen and McConnell25 find that the equity market reacts positively to announcements of carve-outs if the cash is used to reduce debt. The market reacts neutrally if the cash is used for investment projects.

Summary and Conclusions 1 One firm can acquire another in several different ways. The three legal forms of acquisition are merger and consolidation, acquisition of equity, and acquisition of assets. Mergers and consolidations are the least costly from a legal standpoint, but they require a vote of approval by the shareholders. Acquisition by equity does not require a shareholder vote, and is usually done via a tender offer. However, it is difficult to obtain 100 per cent control with a tender offer. Acquisition of assets is comparatively costly, because it requires more difficult transfer of asset ownership. 2 The synergy from an acquisition is defined as the value of the combined firm (VAB) less the value of the two firms as separate entities (VA and VB): Synergy = VAB − (VA + VB)



The shareholders of the acquiring firm will gain if the synergy from the merger is greater than the premium. 3 The possible benefits of an acquisition come from the following: (a) Revenue enhancement (b) Cost reduction (c) Lower taxes (d) Reduced capital requirements 4 Shareholders may not benefit from a merger that is done only to achieve diversification or earnings growth. And the reduction in risk from a merger may actually help bondholders and hurt shareholders. 5 A merger is said to be friendly when the managers of the target support it. A merger is said to be hostile when the target managers do not support it. Some of the most colourful language of finance stems from defensive tactics in hostile takeover battles. Poison pills, golden parachutes, crown jewels and greenmail are terms that describe various anti-takeover tactics. 6 The empirical research on mergers and acquisitions is extensive. On average, the shareholders of acquired firms fare very well. The effect of mergers on acquiring shareholders is less clear. 7 In a going-private transaction, a buyout group, usually including the firm’s management, buys all the shares of the other equity-holders. The equity is no longer publicly traded. A leveraged buyout is a going-private transaction financed by extensive leverage.

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Questions and Problems CONCEPT

  1 The Basic Forms of Acquisition  Describe the three main types of acquisition. Provide a real-life example of each type.

1–13

  2 Synergy  Explain the concept of synergy. Provide a non-financial example of a synergy.   3 Sources of Synergy  Where does synergy come from? Is it possible that costs of new synergies may be more than the benefits? Discuss.   4 Bad Reasons for Mergers  Many explanations and justifications are made by acquiring (and sometimes target) managers for a merger. Review these justifications and discuss whether they are good or bad for shareholders.   5 A Cost to Shareholders in Risk  An argument has been made that financial mergers are bad for shareholders, because bondholders benefit from the reduction in risk. However, are there situations where a financial merger can be good for shareholders?   6 NPV of a Merger  Describe the main uncertainties that are involved in a merger analysis. Are mergers an ideal activity in which to use real option valuation? Discuss some of the ways in which a real option analysis could be used to value a merger.   7 Merger Valuation in Practice  Discuss the main steps that are involved in a merger analysis.   8 Friendly versus Hostile Takeovers  What types of action might the management of a firm take to fight a hostile acquisition bid from an unwanted suitor? How do the target firm shareholders benefit from the defensive tactics of their management team? How are the target firm shareholders harmed by such actions? Explain.   9 Defensive Tactics  Review the various tactics that a target firm’s management may use when trying to deter a hostile takeover attempt. For each tactic provide a balanced discussion of whether they are good or bad for the target’s shareholders. 10 The Diary of a Takeover  Why do you think the Ryanair takeover of Aer Lingus failed? Do you feel that a Ryanair takeover would have been a good thing or a bad thing for Aer Lingus shareholders? Explain. 11 Do Mergers Add Value?  Given the evidence, do you think mergers add value? If so, why do we observe merger waves? If not, why do we see mergers at all? 12 Accounting for Mergers and Takeovers  Explain the acquisition method of accounting for mergers and acquisitions. What effect does expensing merger costs have on the viability of a potential merger or acquisition? 13 Divestitures  Why would a firm wish to sell off its assets? If the sold divisions are so bad, why are buyers found for them?

REGULAR

14–35

14 Mergers  Indicate whether you think the following claims regarding takeovers are true or false. In each case, provide a brief explanation for your answer. (a) By merging competitors, takeovers have created monopolies that will raise product prices, reduce production, and harm consumers. (b) Managers act in their own interests at times, and in reality may not be answerable to shareholders. Takeovers may reflect runaway management. (c) In an efficient market takeovers would not occur, because market prices would reflect the true value of corporations. Thus bidding firms would not be justified in paying premiums above market prices for target firms. (d) Traders and institutional investors, having extremely short time horizons, are influenced by their perceptions of what other market traders will be thinking of equity prospects, and do not value takeovers based on fundamental factors. Thus they will sell shares in target firms despite the true value of the firms.

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Chapter 29  Mergers and Acquisitions (e) Mergers are a way of avoiding taxes, because they allow the acquiring firm to write up the value of the assets of the acquired firm. (f) Acquisitions analysis frequently focuses on the total value of the firms involved. An acquisition, however, will usually affect relative values of equities and bonds, as well as their total value. 15 Merger Rationale  Explain why diversification per se is probably not a good reason for merger. 16 Corporate Split  In May 2005 high-end retailer Nieman Marcus announced plans to sell off its private label credit card business. Unlike other credit cards, private label credit cards can be used only in a particular merchant’s store. Why might a company do this? Is there a possibility of reverse synergy? 17 Poison Pills  Are poison pills good or bad for equity-holders? How do you think acquiring firms are able to get around poison pills? What effect do you think the illegality of poison pills in Europe has had on hostile takeovers? 18 Merger and Taxes  Discuss why it is important for the tax treatment of mergers to be cohesive across countries. 19 Economies of Scale  What does it mean to say that a proposed merger will take advantage of available economies of scale? Suppose Eastern Power and Western Power are located in different time zones. Both operate at 60 per cent of capacity, except for peak periods, when they operate at 100 per cent of capacity. The peak periods begin at 9:00 a.m. and 5:00 p.m. local time and last about 45 minutes. Explain why a merger between Eastern and Western might make sense. 20 Merger Offers  Suppose a company in which you own equity has attracted two takeover offers. Would it ever make sense for your company’s management to favour the lower offer? Does the form of payment affect your answer at all? 21 Merger Profit  Acquiring firm shareholders seem to benefit little from takeovers. Why is this finding a puzzle? What are some of the reasons offered for it? 22 Calculating Synergy  Evan plc has offered £740 million cash for all of the equity in Tanner plc. Based on recent market information, Tanner is worth £650 million as an independent operation. If the merger makes economic sense for Evan, what is the minimum estimated value of the synergistic benefits from the merger? 23 Balance Sheets for Mergers  Consider the following pre-merger information about firm X and firm Y: Firm X

Firm Y

Total earnings (£)

40,000

15,000

Shares outstanding

20,000

20,000

Market

49

18

Book

20

7

Per-share values (£):

Assume that firm X acquires firm Y by paying cash for all the shares outstanding at a merger premium of £5 per share. Assuming that neither firm has any debt before or after the merger, construct the post-merger balance sheet for firm X, assuming the use of (a) pooling of interests accounting methods and (b) purchase accounting methods. 24 Balance Sheets for Mergers  Assume that the following balance sheets are stated at book value. Construct a post-merger balance sheet assuming that Jurion SE purchases Johan GmbH, and both sets of accounts are presented according to International Financial Reporting Standards.

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JURION SE (C)

(C)

Current assets

10,000

Current liabilities

3,100

Non-current assets

14,000

Non-current liabilities

1,900

    

Equity

Total

24,000

19,000

Total

24,000

JOHAN GmbH (C)

(C)

Current assets

3,400

Current liabilities

Non-current assets

5,600

Non-current liabilities

       Total

Equity

9,000

1,600 900 6,500

Total

9,000

The fair market value of Johan’s non-current assets is $12,000 versus the $5,600 book value shown. Jurion pays $17,000 for Johan and raises the needed funds through an issue of long-term debt. Construct the post-merger balance sheet, assuming that the acquisition method of accounting is used. 25 Balance Sheets for Mergers  Silver Enterprises has acquired All Gold Mining in a merger transaction. Construct the balance sheet for the new corporation. The following balance sheets represent the pre-merger book values for both firms: SILVER ENTERPRISES (C) Current assets Goodwill Net non-current assets Total

(C)

2,600

Current liabilities

800

Non-current liabilities

3,900

Equity

7,300

Total

1,800 900 4,600 7,300

ALL GOLD MINING (C) Current assets Goodwill Non-current assets Total

1,100 350 2,800 4,250

(C) Current liabilities Non-current liabilities Equity Total

900 0 3,350 4,250

The market value of All Gold Mining’s non-current assets (excluding goodwill) is $2,800; the market values for current assets and goodwill are the same as the book values. Assume that Silver Enterprises issues $8,400 in new long-term debt to finance the acquisition. 26 Cash versus Equity Payment  Penn NV is analysing the possible acquisition of Teller NV. Both firms have no debt. Penn believes the acquisition will increase its total after-tax annual cash flows by $3.1 million indefinitely. The current market value of Teller is $78 million, and that of Penn is $135 million. The appropriate discount rate for the incremental cash flows is 12 per cent. Penn is trying to decide whether it should offer 40 per cent of its equity or $94 million in cash to Teller’s shareholders. (a) What is the cost of each alternative? (b) What is the NPV of each alternative? (c) Which alternative should Penn choose?

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Chapter 29  Mergers and Acquisitions 27 EPS, P/E and Mergers  The shareholders of Flannery SA have voted in favour of a buyout offer from Stultz Corporation. Information about each firm is given here: Flannery

Stultz

Price–earnings ratio

      5.25

Shares outstanding

  60,000

180,000

21

Earnings (C)

300,000

675,000

Flannery’s shareholders will receive one share of Stultz equity for every three shares they hold in Flannery. (a) What will the EPS of Stultz be after the merger? What will the P/E ratio be if the NPV of the acquisition is zero? (b) What must Stultz feel is the value of the synergy between these two firms? Explain how your answer can be reconciled with the decision to go ahead with the takeover. 28 Merger Rationale  Ziff Electrics (ZE) is a public utility that provides electricity to the whole Yorkshire region. Recent events at its Mile-High Nuclear Station have been discouraging. Several shareholders have expressed concern over last year’s financial statements. Income statement last year (£ millions) Revenue

Balance sheet end of year (£ millions) 110

Assets

400

Fuel

50

Debt

300

Other expenses

30

Equity

100

Interest

30

Net income

0

Recently, a wealthy group of individuals has offered to purchase half of ZE’s assets at fair market price. Management recommends that this offer be accepted, because ‘We believe our expertise in the energy industry can be better exploited by ZE if we sell our electricity generating and transmission assets and enter the telecommunication business. Although telecommunications is a riskier business than providing electricity as a public utility, it is also potentially very profitable.’ Should the management approve this transaction? Why or why not? 29 Cash versus Equity as Payment  Consider the following pre-merger information about a bidding firm (firm B) and a target firm (firm T). Assume that both firms have no debt outstanding.

Shares outstanding Price per share (£)

Firm B

Firm T

1,500

900

34

24

Firm B has estimated that the value of the synergistic benefits from acquiring firm T is £3,000. (a) If firm T is willing to be acquired for £27 per share in cash, what is the NPV of the merger? (b) What will the price per share of the merged firm be assuming the conditions in (a)?

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821

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(c) In part (a), what is the merger premium? (d) Suppose firm T is agreeable to a merger by an exchange of equity. If B offers three of its shares for every one of T ‘s shares, what will the price per share of the merged firm be? (e) What is the NPV of the merger assuming the conditions in (d)? 30 Cash versus Equity as Payment  In problem 30, are the shareholders of firm T better off with the cash offer or the equity offer? At what exchange ratio of B shares to T shares would the shareholders in T be indifferent between the two offers? 31 Effects of a Equity Exchange  Consider the following pre-merger information about firm A and firm B: Firm A

Firm B

Total earnings (DKr)

900

600

Shares outstanding

550

220

40

15

Price per share (DKr)

Assume that firm A acquires firm B via an exchange of equity at a price of DKr20 for each share of B’s equity. Both A and B have no debt outstanding. (a) What will the earnings per share (EPS) of firm A be after the merger? (b) What will firm A’s price per share be after the merger if the market incorrectly analyses this reported earnings growth (that is, the price–earnings ratio does not change)? (c) What will the price–earnings ratio of the post-merger firm be if the market correctly analyses the transaction? (d) If there are no synergy gains, what will the share price of A be after the merger? What will the price–earnings ratio be? What does your answer for the share price tell you about the amount A bid for B? Was it too high? Too low? Explain. 32 Merger NPV  Show that the NPV of a merger can be expressed as the value of the synergistic benefits, ΔV, less the merger premium. 33 Merger NPV  Fly-By-Night Couriers is analysing the possible acquisition of Flash-inthe-Pan Restaurants. Neither firm has debt. The forecasts of Fly-By-Night show that the purchases would increase its annual after-tax cash flow by £600,000 indefinitely. The current market value of Flash-in-the-Pan is £20 million. The current market value of Fly-By-Night is £35 million. The appropriate discount rate for the incremental cash flows is 8 per cent. Fly-By-Night is trying to decide whether it would offer 25 per cent of its equity or £25 million in cash to Flash-in-the-Pan. (a) What is the synergy from the merger? (b) What is the value of Flash-in-the-Pan to Fly-By-Night? (c) What is the cost to Fly-By-Night of each alternative? (d) What is the NPV to Fly-By-Night of each alternative? (e) Which alternative should Fly-By-Night use? 34 Merger NPV  Harrods plc has a market value of £600 million and 30 million shares outstanding. Selfridge Department Store has a market value of £200 million and 20 million shares outstanding. Harrods is contemplating acquiring Selfridge. Harrods’s CFO concludes that the combined firm with synergy will be worth £1 billion, and Selfridge can be acquired at a premium of £100 million.

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Chapter 29  Mergers and Acquisitions (a) If Harrods offers 15 million shares of its equity in exchange for the 20 million shares of Selfridge, what will the equity price of Harrods be after the acquisition? (b) What exchange ratio between the two equities would make the value of equity offer equivalent to a cash offer of £300 million? 35 Mergers and Shareholder Value  Bentley plc and Rolls Manufacturing are considering a merger. The possible states of the economy and each company’s value in that state are shown here: State

Probability

Bentley

Rolls

Boom

0.70

£300,000

£260,000

Recession

0.30

£110,000

£80,000

Bentley currently has a bond issue outstanding with a face value of £140,000. Rolls is an all-equity company. (a) What is the value of each company before the merger? (b) What are the values of each company’s debt and equity before the merger? (c) If the companies continue to operate separately, what are the total value of the companies, the total value of the equity, and the total value of the debt? (d) What would be the value of the merged company? What would be the value of the merged company’s debt and equity? (e) Is there a transfer of wealth in this case? Why? (f ) Suppose that the face value of Bentley’s debt was £100,000. Would this affect the transfer of wealth? CHALLENGE

36 Calculating NPV  Plant AG is considering making an offer to purchase Palmer AG. Plant’s vice-president of finance has collected the following information:

36–37

Plant Price–earnings ratio

Palmer

12.5

9

Shares outstanding

1,000,000

550,000

Earnings (C)

2,000,000

580,000

600,000

290,000

Dividends

Plant also knows that securities analysts expect the earnings and dividends of Palmer to grow at a constant rate of 5 per cent each year. Plant management believes that the acquisition of Palmer will provide the firm with some economies of scale that will increase this growth rate to 7 per cent per year. (a) What is the value of Palmer to Plant? (b) What would Plant’s gain be from this acquisition? (c) If Plant were to offer $18 in cash for each share of Palmer, what would the NPV of the acquisition be? (d) What is the most Plant should be willing to pay in cash per share for the equity of Palmer? (e) If Plant were to offer 100,000 of its shares in exchange for the outstanding equity of Palmer, what would the NPV be?

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(f ) Should the acquisition be attempted? If so, should it be as in (c) or as in (e)? Finanza aziendale Stephen Ross, David Hillier, Randolph Westerfield, Jeffrey Jaffe, Bradford Jordan © 2012 McGraw-Hill Ross_ch29.indd 822

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(g) Plant’s outside financial consultants think that the 7 per cent growth rate is too optimistic, and a 6 per cent rate is more realistic. How does this change your previous answers? 37 Mergers and Shareholder Value  The Chocolate Ice Cream Company and the Vanilla Ice Cream Company have agreed to merge and form Fudge Swirl Consolidated. The two companies are exactly alike except that they are located in different towns. The end-ofperiod value of each firm is determined by the weather, as shown below. There will be no synergy to the merger. State

Probability

Value(£)

Rainy

0.1

100,000

Warm

0.4

200,000

Hot

0.5

400,000

The weather conditions in each town are independent of those in the other. Furthermore, each company has an outstanding debt claim of £200,000. Assume that no premiums are paid in the merger. (a) What are the possible values of the combined company? (b) What are the possible values of end-of-period debt values and equity values after the merger? (c) Show that the bondholders are better off and the equity-holders are worse off in the combined firm than they would have been if the firms had remained separate.

M I N I CA S E

The Birdie Golf–Hybrid Golf Merger Birdie Golf has been in merger talks with Hybrid Golf Company for the past six months. After several rounds of negotiations, the offer under discussion is a cash offer of $550 million for Hybrid Golf. Both companies have niche markets in the golf club industry, and the companies believe a merger will result in significant synergies due to economies of scale in manufacturing and marketing, as well as significant savings in general and administrative expenses. Bryce Bichon, the financial officer for Birdie, has been instrumental in the merger negotiations. Bryce has prepared the following pro forma financial statements for Hybrid Golf assuming the merger takes place. The financial statements include all synergistic benefits from the merger: 2010 (C)

2011 (C)

2012 (C)

2013 (C)

2014 (C)

Sales

800,000,000

900,000,000

1,000,000,000

1,125,000,000

1,250,000,000

Productions costs

562,000,000

630,000,000

700,000,000

790,000,000

875,000,000

Depreciation

75,000,000

80,000,000

82,000,000

83,000,000

83,000,000

Other expenses

80,000,000

90,000,000

100,000,000

113,000,000

125,000,000

EBIT

83,000,000

100,000,000

118,000,000

139,000,000

167,000,000

Interest

19,000,000

22,000,000

24,000,000

25,000,000

27,000,000

Taxable income

64,000,000

78,000,000

94,000,000

114,000,000

140,000,000

Taxes (40%)

25,600,000

31,200,000

37,600,000

45,600,000

56,000,000

Net income

38,400,000

46,800,000

56,400,000

68,400,000

84,000,000

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Chapter 29 Mergers and Acquisitions

Bryce is also aware that the Hybrid Golf division will require investments each year for continuing operations, along with sources of financing. The following table outlines the required investments and sources of financing: 2010 (C)

2011 (C)

2012 (C)

2013 (C)

2014 (C)

Net working capital

20,000,000

25,000,000

25,000,000

30,000,000

30,000,000

Non-current assets

15,000,000

25,000,000

18,000,000

12,000,000

7,000,000

Total

35,000,000

50,000,000

43,000,000

42,000,000

37,000,000

Investments:

Sources of financing: New debt Profit retention Total

35,000,000

16,000,000

16,000,000

15,000,000

12,000,000

0

34,000,000

27,000,000

27,000,000

25,000,000

35,000,000

50,000,000

43,000,000

42,000,000

37,000,000

The management of Birdie Golf feels that the capital structure at Hybrid Golf is not optimal. If the merger take place, Hybrid Golf will immediately increase its leverage with a $110 million debt issue, which would be followed by a $150 million dividend payment to Birdie Golf. This will increase Hybrid’s debt-to-equity ratio from 0.50 to 1.00. Birdie Golf will also be able to use a $25 million tax loss carry-forward in 2011 and 2012 from Hybrid Golf’s previous operations. The total value of Hybrid Golf is expected to be $900 million in five years, and the company will have $300 million in debt at that time. Equity in Birdie Golf currently sells for $94 per share, and the company has 18 million shares of equity outstanding. Hybrid Golf has 8 million shares of equity outstanding. Both companies can borrow at an 8 per cent interest rate. The risk-free rate is 6 per cent, and the expected return on the market is 13 per cent. Bryce believes the current cost of capital for Birdie Golf is 11 per cent. The beta for Hybrid Golf equity at its current capital structure is 1.30. Bryce has asked you to analyse the financial aspects of the potential merger. Specifically, he has asked you to answer the following questions: 1

Suppose Hybrid shareholders will agree to a merger price of $68.75 per share. Should Birdie proceed with the merger?

2

What is the highest price per share that Birdie should be willing to pay for Hybrid?

3

Suppose Birdie is unwilling to pay cash for the merger, but will consider a equity exchange. What exchange ratio would make the merger terms equivalent to the original merger price of $68.75 per share?

4

What is the highest exchange ratio Birdie would be willing to pay and still undertake the merger?

Practical Case Study The HBOS–Lloyds TSB was one of the biggest mergers in European banking history. Both banks had been hit hard by the global banking crisis in 2008, and the British government strongly encouraged them to merge in order to be safe enough to ride out the forthcoming recession. Both companies argued that there would be cost savings, and the merger would be good for both sets of shareholders. However, within months of the merger the British government had to bail out the new Lloyds Banking Group and effectively nationalize it. Carry out your own research into the merger and use the merger techniques in this chapter to ascertain, from an ex ante perspective, whether the merger was good for either set of shareholders. Write a brief report on your analysis.

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Additional Reading

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Relevant Accounting Standards The main accounting standard for mergers and acquisitions is IFRS3 Business Combinations. For restructuring activities the relevant standard is IAS37 Provisions, Contingent Liabilities, and Contingent Assets.

Additional Reading As the size of this chapter attests, the study of mergers, acquisitions and corporate restructuring is huge. Below is a list of recent papers in the area. Naturally, the categorization of papers is not mutually exclusive, and papers do overlap categories. However, hopefully the groupings will aid the reading effort. The Merger, Acquisition and Corporate Restructuring Process Antoniou, A., P. Arbour and H. Zhao (2008) ‘How much is too much: are merger premiums too high?’, European Financial Management, vol. 14, no. 2, pp. 268–287. UK. Betton, S., B.E. Eckbo and K.S. Thorburn (2009) ‘Merger negotiations and the toehold puzzle’, Journal of Financial Economics, vol. 91, no. 2, pp. 158–178. US. Boone, A.L. and J.H. Mulherin (2007) ‘How are firms sold?’, Journal of Finance, vol. 62, no. 2, pp. 847– 875. US. Bouwman, C., K. Fuller and A. Nain (2009) ‘Market valuation and acquisition quality: empirical evidence’, Review of Financial Studies, vol. 22, no. 2, pp. 633–679. US. Dittmann, I., E. Maug and C. Schneider (2008) ‘How Preussag became TUI: a clinical study of institutional blockholders and restructuring in Europe’, Financial Management, vol. 37, no. 3, pp. 571– 598. Germany. Eckbo, B.E. (2009) ‘Bidding strategies and takeover premiums: a review’, Journal of Corporate Finance, vol. 15, no. 1, pp. 10–29. International. Ekkayokkaya, M., P. Holmes and K. Paudyal (2009) ‘The euro and the changing face of European banking: evidence from mergers and acquisitions’, European Financial Management, vol. 15, no. 2, pp. 451– 476. Europe. Faccio, M. and R. Masulis (2005) ‘The choice of payment method in European mergers and acquisitions’, Journal of Finance, vol. 60, no. 3, pp. 1345–1388. Europe. Harford, J. (2005) ‘What drives merger waves?’, Journal of Financial Economics, vol. 77, no. 3, pp. 529 – 560. US. Hodgkinson, L. and G.H. Partington (2008) ‘The motivation for takeovers in the UK’, Journal of Business Finance and Accounting, vol. 35, nos. 1/2, pp. 102–126. UK. Holmen, M. and J. Knopf (2004) ‘Minority shareholder protection and private benefits of control for Swedish mergers’, Journal of Financial and Quantitative Analysis, vol. 39, 167–191. Sweden. Laeven, L. and R. Levine (2007) ‘Is there a diversification discount in financial conglomerates?’, Journal of Financial Economics, vol. 85, no. 2, pp. 331–367. US. Lambrecht, B.M. and S.C. Myers (2007) ‘A theory of takeovers and disinvestment’, Journal of Finance, vol. 62, no. 2, pp. 809–845. Theoretical paper. Luo, Y. (2005) ‘Do insiders learn from outsiders? Evidence from mergers and acquisitions’, Journal of Finance, vol. 60, no. 3, pp. 1951–1982. US. Maksimovic, V. and G. Phillips (2008) ‘The industry life cycle, acquisitions and investment: does firm organisation matter?’, Journal of Finance, vol. 62, no. 2, pp. 673–708. US. Martynova, M. and L. Renneboog (2008) ‘A century of corporate takeovers: what have we learned and where do we stand?’, Journal of Banking and Finance, vol. 32, no. 10, pp. 2148 – 2177. Review paper. Martynova, M. and L. Renneboog (2009) ‘What determines the financing decision in corporate takeovers: cost of capital, agency problems, or the means of payment?’, Journal of Corporate Finance (forthcoming). Europe.

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Chapter 29  Mergers and Acquisitions Rhodes-Kropf, M., D.T. Robinson and S. Viswanathan (2005) ‘Valuation waves and merger activity: the empirical evidence’, Journal of Financial Economics, vol. 77, no. 3, pp. 561–603. US. Rossi, S. and P.F. Volpin (2005) ‘Cross-country determinants of mergers and acquisitions’, Journal of Financial Economics, vol. 74, no. 2, pp. 277–304. International. Wright, M., L. Renneboog, T. Simons and L. Scholes (2006) ‘Leveraged buyouts in the UK and continental Europe: retrospect and prospect’, Journal of Applied Corporate Finance, vol. 18, no. 3, pp. 38 – 55. Europe. Pre-Restructuring Botsari, A. and G. Meeks (2008) ‘Do acquirers manage earnings prior to a share for share bid?’, Journal of Business Finance and Accounting, vol. 35, nos. 5/6, pp. 633–670. UK. Dong, M., D. Hirshleifer, S. Richardson and S.H. Teoh (2006) ‘Does investor misvaluation drive the takeover market?’, Journal of Finance, vol. 61, no. 2, pp. 725–762. US. Field, L.C. and J.M. Karpoff (2002) ‘Takeover defenses of IPO firms’, Journal of Finance, vol. 57, no. 5, pp. 1857–1889. US. Jenkinson, T. and H. Jones (2004) ‘Bids and allocations in European IPO bookbuilding’, Journal of Finance, vol. 59, no. 5, pp. 2309–2338. Europe. Kisgen, D.J., J. Qian and W. Song (2009) ‘Are fairness opinions fair? The case of mergers and acquisitions’, Journal of Financial Economics, vol. 91, no. 2, pp. 179–207. US. Veld, C. and Y.V. Veld-Merkoulova (2008) ‘An empirical analysis of the stockholder–bondholder conflict in corporate spin-offs’, Financial Management, vol. 37, no. 1, pp. 103–124. US. Post-Restructuring Devos, E., P. Kadapakkam and S. Krishnamurthy (2009) ‘How do mergers create value? A comparison of taxes, market power, and efficiency improvements as explanations for synergies’, Review of Financial Studies, vol. 22, no. 3, pp. 1179–1211. US. Draper, P. and K. Paudyal (2008) ‘Information asymmetry and bidders’ gains’, Journal of Business Finance and Accounting, vol. 35, nos. 3/4, pp. 376–405. UK. Hagendorff, J., M. Collins and K. Keasey (2008) ‘Investor protection and the value effects of bank merger announcements in Europe and the US’, Journal of Banking and Finance, vol. 32, no. 7, pp. 1333 –1348. Europe. Masulis, R.W., C. Wang and F. Xie (2007) ‘Corporate governance and acquirer returns’, Journal of Finance, vol. 62, no. 4, pp. 1851–1889. US. Moeller, S.B., F.P. Schlingemann and R.M. Stulz (2005) ‘Wealth destruction on a massive scale? A study of acquiring-firm returns in the recent merger wave’, Journal of Finance, vol. 60, no. 2, pp. 757–782. US. Paul, D.L. (2007) ‘Board composition and corrective action: evidence from corporate responses to bad acquisition bids’, Journal of Financial & Quantitative Analysis, vol. 42, no. 3, pp. 759 –778. US. Rajan, R., H. Servaes and L. Zingales (2000) ‘The cost of diversity: the diversification discount and inefficient investment’, Journal of Finance, vol. 55, no. 1, pp. 35–80. US. Renneboog, L. and P.G. Szilagyi (2008) ‘Corporate structuring and bondholder wealth’, European Financial Management, vol. 14, no. 4, pp. 792–819. Review. Santalo, J. and M. Becerra (2008) ‘Competition from specialized firms and the diversification– performance linkage’, Journal of Finance, vol. 62, no. 2, pp. 851–883. US. Wang, C. and F. Xie (2009) ‘Corporate governance transfer and synergistic gains from mergers and acquisitions’, Review of Financial Studies, vol. 22, no. 2, pp. 829–858. US.

Endnotes 1 Mergers between corporations require compliance with government laws. In virtually all countries the shareholders of each corporation must give their assent. 2 Control can usually be defined as having a majority vote on the board of directors.

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Endnotes

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4 M.C. Jensen and R.S. Ruback, ‘The market for corporate control: the scientific evidence’, Journal of Financial Economics, vol. 11 (1983). 5 Every country’s tax system is different, and almost always complex. The best way to find up-to-date information is by visiting the website of a country’s tax authority. A good site with summary information on many countries’ tax systems is www.worldwide-tax.com. 6 Although diversification is most easily explained by considering equities in different industries, the key is really that the returns on the two equities are less than perfectly correlated – a relationship that should occur even for equities in the same industry. 7 A dividend is taxable to all tax-paying recipients. A repurchase creates a tax liability only for those who choose to sell (and do so at a profit). 8 The situation is actually a little more complex: The target’s shareholders must pay taxes on their capital gains. These shareholders will probably demand a premium from the acquirer to offset this tax. 9 This ratio implies a fair exchange, because a share of Regional is selling for 40 per cent (= $10/$25) of the price of a share of Global. 10 In fact, a number of scholars have argued that diversification can reduce firm value by weakening corporate focus, a point to be developed in a later section of this chapter. 11 The analysis will be essentially the same if new equity is issued. However, the analysis will differ if new debt is issued to fund the acquisition, because of the tax shield to debt. An adjusted present value (APV) approach would be necessary here. 12 The basic theoretical ideas are presented in S. Myers and N. Majluf, ‘Corporate financing and investment decisions when firms have information that investors do not have’, Journal of Financial Economics (1984). 13 For example, see G. Andrade, M. Mitchell and E. Stafford, ‘New evidence and perspectives on mergers’, Journal of Economic Perspectives (Spring 2001); and R. Heron and E. Lie, ‘Operating performance and the method of payment in takeovers’, Journal of Financial and Quantitative Analysis (2002). 14 J. Doukas and O.B. Kan, ‘Does global diversification destroy firm value?’, Journal of International Business Studies (2006). 15 See J.M. Campa and I. Hernando, ‘Shareholder value creation in European M&As’, European Financial Management (2004). 16 Taken from G. Andrade, M. Mitchell and E. Stafford, ‘New evidence and perspectives on mergers’, Journal of Economic Perspectives (Spring 2001), Table 1. 17 A. Antonios, P. Arbour and H. Zhang, ‘How much is too much? Are merger premiums too high?’, European Financial Management (2008). 18 S. Datta, M. Iskandar-Datta and K. Raman, ‘Executive compensation and corporate acquisition decisions’, Journal of Finance (December 2001). 19 From J. Harford, ‘Corporate cash reserves and acquisitions’, Journal of Finance (December 1999), p. 1969. 20 U. Malmendier and G. Tate, ‘Who makes acquisitions? CEO overconfidence and the market’s reaction’, Journal of Financial Economics (2008). 21 However, as stated earlier, managers may resist takeovers to raise the offer price, not to prevent the merger. 22 J. Wulf, ‘Do CEOs in mergers trade power for premium? Evidence From “mergers of equals”’, Journal of Law, Economics, and Organization (Spring 2004). 23 S. Kaplan and M. Weisbach, ‘The success of acquisitions: evidence from divestitures’, Journal of Finance (March 1992). 24 R. Michaely and W. Shaw, ‘The choice of going public: spinoffs vs. carveouts’, Financial Management (Autumn 1995). 25 J. Allen and J. McConnell, ‘Equity carve-outs and managerial discretion’, Journal of Finance (February 1998).

To help you grasp the key concepts of this chapter check out the extra resources posted on the Online Learning Centre at www.mcgraw-hill.co.uk/textbooks/hillier Among other helpful resources there are PowerPoint presentations, chapter outlines and mini-cases.

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