MERGERS & ACQUISITIONSOutline• M&A trends• Market Reaction to a Takeover• Reasons to Acquire• Takeover DefensesTwenty 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 QuarterHistorical 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 equityTypes 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 industriesAcquisition 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 mergerCompetition 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 groupStock acquisition -24.2%*Cash acquisition 18.5%*Mixed acquisition -9.6%All acquisitions -6.5%(Source: Loughran and Vijh, 2001)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.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 CostsSynergies• 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• A cost associated with an increase in size is that larger firms are more difficult to managecross selling. hard to predictExpertise• 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 firmMonopoly 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 mergersReplacing 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 managersTax Savings• A conglomerate may have a tax advantage over a single-product firm because losses in one division can offset profits in another divisionExample: 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