MERGERS ACQUISITIONS Outline M A trends Market Reaction to a Takeover Reasons to Acquire Takeover Defenses Twenty Largest Merger Transactions 1998 2008 Historical Trends The global takeover market is highly active averaging more than 1 trillion per year in transaction value Merger Waves Peaks of heavy M A activity followed by quiet troughs with few transactions Merger Waves Percentage of Public Companies Taken Over Each Quarter Historical Trends There were distinct takeover waves in the 1960s 1980s 1990s and 2000s 1960s Known as the conglomerate wave 1980s Known for hostile takeovers 1990s Known for the strategic or global deals 2000s Marked by consolidation in many industries and the larger role played by private equity Types of Mergers Horizontal merger Target and acquirer are in the same industry Vertical merger Target s industry buys from or sells to acquirer s industry Conglomerate merger Target and acquirer operate in unrelated industries Acquisition Premium On average acquirers pay a premium of 43 over the pre merger price of the target On the day when a bid is announced target shareholders on average enjoy an abnormal return gain of 15 Acquirer shareholders see an average abnormal return of 1 but half receive a price decrease This evidence suggests that the premium the acquirer pays is approximately equal to the synergies in the merger This means that the target shareholders ultimately capture almost all the value from the merger Competition and Takeover Premia Why do acquirers choose to pay so large a premium The most likely explanation is the competition that exists in the takeover market Once an acquirer starts bidding on a target company and it becomes clear that a significant gain exists other potential acquirers may submit their own bids The result is effectively an auction in which the target is sold to the highest bidder Source Andrade Mitchell Stafford 2001 5 year average post merger acquirer return relative to control group Stock acquisition Cash acquisition Mixed acquisition use this because under this kind of condition stock price is overvalued and as time goes by the stock price will be revised and using cash means managements think stock is undervalued All acquisitions Source Loughran and Vijh 2001 24 2 18 5 9 6 6 5 Acquisition Premium Why do acquirers pay a premium over the market value for a target company Why does the acquirer not consistently experience a price increase Why are acquisitions by stock negatively received What are potential reasons for long run negative performance of acquisitions Motivations for Mergers Economic Motivations Synergies Acquiring Expertise Monopoly Gains Market Power Replace Inefficient Management Taxes Dubious Reasons Diversification Boost EPS Reduce Financing Costs Synergies Synergies are by far the most common stated reason Synergies usually fall into two categories cost reductions and revenue enhancements Cost reduction synergies are more common Easier to achieve and predict as they usually result from layoffs of overlapping employees and divisions Can come from e g economies of scale and economies of scope Revenue enhancement synergies are much harder to predict and achieve cross selling hard to predict A cost associated with an increase in size is that larger firms are more difficult to manage Expertise Firms often need expertise in particular areas to compete more efficiently Hiring experienced workers directly may be difficult particularly when employees need new technology skills It may be more efficient to purchase the talent as an already functioning unit by acquiring an existing firm Monopoly Gains Merging with a major rival may enable a firm to substantially reduce competition within the industry and thereby increase profits Most countries have antitrust laws that try to limit these mergers Replacing Inefficient Management Acquirers often think that they can run the target organization more efficiently than the existing management Particularly in the 1980s many takeovers were motivated by a desire to replace inefficient managers These takeovers were hostile i e resisted by the management Often initiated by Private Equity funds Ways to improve the management include Increase leverage to reduce free cash flow problems Stronger pay incentives for managers Tax Savings A conglomerate may have a tax advantage over a singleproduct firm because losses in one division can offset profits in another division Example Taxes for a Merged Corporation Consider two firms Ying Corporation and Yang Corporation Both corporations will either make 50 million or lose 20 million every year with equal probability However their profits are perfectly negatively correlated That is any year Yang Corporation earns 50 million Ying Corporation loses 20 million and vice versa Assume a corporate tax rate of 34 What are the total expected after tax profits of both firms when they are two separate firms What are the expected after tax profits if the two firms are combined into one corporation called Ying Yang Corporation but are run as two independent divisions Assume it is not possible to carry back or carry forward any losses Example Taxes for a Merged Corporation In the profitable state Ying Corporation must pay corporate taxes so after tax profits are 50 1 0 34 33 million No taxes are owed when the firm reports losses so the after tax profits in the unprofitable state are 20 million Thus the expected after tax profits of Ying Corporation are 33 0 5 20 0 5 6 5 million Because Yang Corporation has identical expected profits its expected profits are also 6 5 million Thus the total expected profit of both companies operated separately is 13 million Example Taxes for a Merged Corporation If the firms are combined their total profits in any year would always be 50 million 20 million 30 million so the after tax profit will always be 30 1 tax rate The merged corporation Ying Yang Corporation would have after tax profits of 30 1 0 34 19 8 million Thus Ying Yang Corporation has significantly higher after tax profits than the total stand alone after tax profits of Ying Corporation and Yang Corporation This is because the losses on one division reduce the taxes on the other division s profits Diversification Risk Reduction Large firms bear less unsystematic risk so mergers are often justified on the basis that the combined firm is less risky But this argument ignores the fact that investors can achieve the benefits of diversification themselves by