21 - 1
Types of mergers
Merger analysis
Role of investment bankers
Corporate alliances, LBOs,
divestitures, and holding companies
CHAPTER 21
21 - 2
Synergy:
Value of the whole exceeds
sum of the parts. Could arise from:
Operating economies
Financial economies
Differential management efficiency
Increased market power
Taxes (use accumulated losses)
21 - 3
Break-up value
: Assets would
21 - 4
Diversification
Purchase of assets at below
replacement cost
Get bigger using debt-financed
mergers to help fight off takeovers
21 - 5
Five Largest completed and proposed
mergers, as of January 2000
21 - 6
Friendly merger
:
The merger is supported by the
managements of both firms.
Differentiate between
hostile
and
21 - 7
Hostile merger:
Target firm’s management resists
the merger.
Acquirer must go directly to the
target firm’s stockholders try to
get 51% to tender their shares.
Often, mergers that start out
21 - 8
Access to new markets and
technologies
Multiple parties share risks and
expenses
Rivals can often work together
harmoniously
Antitrust laws can shelter
cooperative R&D activities
21 - 9
Net sales
$60.0 $90.0 $112.5 $127.5
Cost of goods sold (60%) 36.0 54.0 67.5 76.5
Selling/admin. expenses
4.5 6.0 7.5 9.0
Interest expense
3.0 4.5 4.5 6.0
EBT
$16.5 $25.5 $ 33.0 $ 36.0
Taxes (40%)
6.6 10.2 13.2 14.4
Net income
$ 9.9 $15.3 $ 19.8 $ 21.6
Retentions
0.0 7.5 6.0 4.5
Cash flow
$ 9.9 $ 7.8 $ 13.8 $ 17.1
Merger Analysis (In Millions)
21 - 10
Estimated cash flows are residuals which
belong to acquirer’s shareholders
.
They are
riskier
than the typical capital
budgeting cash flows. Because fixed
interest charges are deducted, this
increases the volatility of the residual
cash flows.
Conceptually, what is the appropriate
discount rate to apply to target’s
cash flows?
21 - 11
Because the cash flows are risky
equity flows, they should be
discounted using the
cost of equity
rather than the WACC.
The
cash flows reflect the
target’s
business risk
, not the acquiring
company’s.
However, the
merger will affect
the
21 - 12
Terminal Value Calculation
1. First, find the new discount rate:
k
s(Target)
= k
RF
+ (k
M
– k
RF
)b
Target
= 9% + (4%)1.3 = 14.2%.
2. Terminal value =
=
= $221.0 million.
(2004 Cash flow)(1 + g)
k
s
–
g
21 - 13
Net Cash Flow Stream Used in
Valuation Calculation (In Millions)
2001 2002 2003 2004
Annual cash flow
$9.9
$7.8 $13.8 $ 17.1
Terminal value
221.0
Net cash flow
$9.9
$7.8 $13.8 $238.1
Value = + + +
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No. The input estimates would be
different, and different synergies
would lead to different cash flow
forecasts.
Also, a different financing mix or tax
rate would change the discount rate.
21 - 15
Target firm has 10 million shares
outstanding at a price P
0
of $9.00 per
share. What should the offering
price be?
Maximum price =
=
= $16.39/share.
Range = $9 to $16.39/share.
Value of Acquisition
Shares Outstanding
$163.9 million
21 - 16
The offer could range from $9 to
$16.39 per share.
At $9 all the merger benefits would
go to the acquirer’s shareholders.
At $16.39, all value added would go
to the target’s shareholders.
21 - 17
0
5
10
15
20
Change in
Shareholders’
Wealth
Acquirer
Target
Bargaining Range =
Price
Paid for
Target
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Points About Graph
Nothing magic about crossover price.
Actual price would be determined by
bargaining. Higher if target is in
better bargaining position, lower if
acquirer is.
If target is good fit for many acquirers,
other firms will come in, price will be
bid up. If not, could be close to $9.
21 - 19
Acquirer might want to make high
“preemptive” bid to ward off other
bidders, or low bid and then plan to
go up. Strategy.
Do target’s managers have 51% of
stock and want to remain in
control?
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The evidence strongly suggests:
Acquisitions do create value as a
result of economies of scale, other
synergies, and/or better
management.
Shareholders of target firms reap
most of the benefits, i.e., move to
right in merger graph (Slide 21-17),
because of competitive bids.
21 - 21
Arranging mergers
Assisting in defensive tactics
Establishing a fair value
Financing mergers
Risk arbitrage
