Corporate Finance Chapter10
Corporate Finance Chapter10
Corporate Finance Chapter10
1. INTRODUCTION
Mergers and acquisitions (M&A) are complex, involving many parties. Mergers and acquisitions involve many issues, including - Corporate governance. - Form of payment. - Legal issues. - Contractual issues. - Regulatory approval. M&A analysis requires the application of valuation tools to evaluate the M&A decision.
July 2012 U.S. Airways proposes merger to bankrupt AMR. April 2012 AMR and U.S. Airways begin merger discussions. September 2012
November 2012 U.S. Airways proposes merger, with its shareholders owning 30% of the new company. Details of the merger are worked out. Merger filed with the FTC under HartScott-Rodino Act. February 2013
AMR creditors encourage AMR to merge with another airline, instead of emerging from bankruptcy alone.
Company A
Company X
Company C
Company B
Company Y
Company X
- A friendly transaction is when the target company board of directors endorses the merger or acquisition offer.
Horizontal merger
Vertical merger
Conglomerate merger
Creating Value
Cross-Border Mergers
Dubious Motives
Earnings Number of shares Earnings per share P/E Price per share Market value of stock
Copyright 2013 CFA Institute
Assumptions: Exchange ratio: One share of Company One for two shares of Company Two Market applies weighted average P/E to the post-merger company. Company One Company Two
Earnings Number of shares Earnings per share P/E Price per share
$2,000 million
$500 million
$2,500 million
9
Factors include
- Need for capital. - Need for resources. - Degree of competition and the number of competitors.
10
Conglomerate Horizontal
11
Horizontal Mergers may be undertaken to achieve economies of scale in research, production, and marketing to match the low cost and price performance of other companies (domestic and foreign). Large companies may acquire smaller companies to improve management and provide a broader financial base.
12
13
4. TRANSACTION CHARACTERISTICS
14
FORM OF AN ACQUISITION
In a stock purchase, the acquirer provides cash, stock, or combination of cash and stock in exchange for the stock of the target firm.
15
METHOD OF PAYMENT
Cash offering - Cash offering may be cash from existing acquirer balances or from a debt issue. Securities offering - Target shareholders receive shares of common stock, preferred stock, or debt of the acquirer. - The exchange ratio determines the number of securities received in exchange for a share of target stock. Factors influencing method of payment: - Sharing of risk among the acquirer and target shareholders. - Signaling by the acquiring firm. - Capital structure of the acquiring firm.
Based on data from Mergerstat Review, 2006. FactSet Mergerstat, LLC (www.mergerstat.com).
16
MINDSET OF MANAGERS
Friendly merger: Offer made through the targets board of directors
Approach target management.
17
A friendly merger is one in which the board negotiates and accepts an offer.
A hostile merger is one in which the board of the target firm attempts to prevent the merger offer from being successful.
18
5. TAKEOVERS
Takeover defenses are intended to either prevent the transaction from taking place or to increase the offer.
- Pre-offer mechanisms are triggered by changes in control, generally making the target less attractive.
- Post-offer mechanisms tend to address ownership of shares and reduce the hostile acquirers power gained from its ownership interest in the target.
19
TAKEOVER DEFENSES
Pre-Offer Takeover Defense Mechanisms Post-Offer Takeover Defense Mechanisms
Leveraged recapitalization
Crown jewels defenses Pac-Man defense White knight defense White squire defense
20
6. REGULATION
Antitrust Law
Regulation of Mergers and Acquisitions
Securities Law
21
Gave the FTC and the Justice Department an opportunity to review and challenge mergers in advance
22
ANTITRUST
The European Commission reviews combinations for antitrust issues. Regulatory bodies besides the FTC may review combinations (e.g., U.S. Federal Communications Commission, Federal Reserve Bank, state insurance commissions). If the combination involves companies in different countries, it may require approvals by all countries regulatory bodies.
23
THE HHI
The HerfindalhlHirschman Index (HHI) is a measure of concentration within an industry and is often used by regulators to evaluate the effects of a merger.
The HHI is constructed as the sum of the squared market shares of the firms in the industry: n 2 Output of firm i HHI = 100 Total sales or output of the market i
HHI Concentration Level and Possible Government Action Post-Merger HHI Concentration Change in HHI Government Action Less than 1,000 Not concentrated Any amount No action Between 1,000 and 1,800 Moderately concentrated 100 or more Possible challenge More than 1,800 Highly concentrated 50 or more Challenge
24
EXAMPLE: HHI
Consider an industry that has six companies. Their respective market shares are as follows: Company Market Share A 25% B 15% C 15% D 15% E 15% F 15% 100%
25
EXAMPLE: HHI
Market Company Share A B C 25% 15% 15% HHI Before 625 225 225 Market Company Share A B C 25% 15% 15% HHI After 625 225 225
D
E F Total
15%
15% 15% 100%
225
225 225 1125
D
E+F Total
15%
30% 100%
225
900 1575
The industry would be considered moderately concentrated before and after the combination of E and F, and The change in the HHI is 450, which may result in a government challenge.
26
27
7. MERGER ANALYSIS
The discounted cash flow (DCF) method is often used in the valuation of the target company.
The cash flow that is most appropriate is the free cash flow (FCF), which is the cash flow after capital expenditures necessary to maintain the company as an ongoing concern.
The goal is to estimate future FCF. - We can use pro forma financial statements to estimate FCF - We use a two-stage model when we can more accurately estimate growth in the near future and then assume a somewhat slower growth out into the future.
28
Calculate Unlevered Net Income Net income + Net interest after tax
Calculate FCF NOPLAT + Noncash charges Change in working capital Capital expenditures
29
30
EXAMPLE: FCF
Net income
Plus Equals Plus Equals Plus Minus Minus Equals Net interest after tax Unlevered net income Change in deferred taxes Net operating profit minus adjusted taxes Depreciation Change in working capital Capital expenditures Free cash flow
$40.00
1.65 $41.65 3.00 $44.65 10.00 6.00 20.00 $28.65
31
32
33
34
XYZ Company
Earnings Cash flow Book value of equity Sales $10 million $12 million $50 million $100 million
Average of Comparables
P/E of comparables P/CF of comparables P/BV of comparables P/S of comparables 30 times 25 times 2 times 2.5 times
If the typical takeover premium is 20%, what is the XYZ Companys value in a merger using the comparable company approach?
35
Comparables Multiples
Earnings Cash flow Book value of equity Sales $10 million $12 million $50 million $100 million 30 25 2 2.5 Average =
Estimated takeover price of the XYZ Company = $237.5 million 1.2 = $285 million
36
37
38
MNO Company
Earnings Cash flow Book value of equity $10 million $12 million $50 million
Sales
$100 million
P/S of comparables
3 times
Estimate the value of the MNO Company using the comparable transaction analysis, giving the cash flow multiple 70% and the other methods 10% each.
39
Earnings
Cash flow Book value of equity Sales
$10 million
$12 million $50 million $100 million
15
20 5 3
$150 million
$240 million $250 million $300 million
Value of MNO = 0.7 $240 + 0.1 $150 + 0.1 $250 + 0.1 $300 Value = $238 million
40
41
EVALUATING BIDS
The acquiring firm shareholders want to minimize the amount paid to target shareholders, not paying more than the pre-merger value of the target plus the value of the synergies.
The target shareholders want to maximize the gain, accepting nothing below the pre-merger market value.
42
(10-8)
VA* = VA + VT + S C
where VA* = post-merger value of the combined companies VA = pre-merger value of the acquirer C = cash paid to target shareholders
(10-9)
43
44
Big shareholders get $17 million $20 million = 85% of the gain
3. Value of Big Company post-merger = $400 million + $15 million + $20 million $18 million = $417 million
45
46
47
48
9. CORPORATE RESTRUCTURING
A divestiture is the sale, liquidation, or spin-off of a division or subsidiary.
Equity Carve-Out
Spin-Off
Divestiture
Split-Off
49
- Reverse synergy
- Financial or cash flow needs
50
FORMS OF DIVESTITURE
51
10. SUMMARY
An acquisition is the purchase of some portion of one company by another, whereas a merger represents the absorption of one company by another.
There are number of motives for a merger or acquisition; some are justified, some are dubious.
52
SUMMARY (CONTINUED)
A merger transaction may take the form of a stock purchase or an asset purchase.
- The decision of which approach to take will affect other aspects of the transaction.
The method of payment for a merger may be cash, securities, or a mixed offering with some of both. Hostile transactions are those opposed by target managers, whereas friendly transactions are endorsed by the target companys managers. There are a variety of both pre- and post-offer defenses a target can use to ward off an unwanted takeover bid.
53
SUMMARY (CONTINUED)
Pre-offer defense mechanisms include poison pills and puts, incorporation in a jurisdiction with restrictive takeover laws, staggered boards of directors, restricted voting rights, supermajority voting provisions, fair price amendments, and golden parachutes. Post-offer defenses include just say no defense, litigation, greenmail, share repurchases, leveraged recapitalization, crown jewel defense, Pac-Man defense, or finding a white knight or a white squire.
SUMMARY (CONTINUED)
Three major tools for valuing a target company are discounted cash flow analysis, comparable company analysis, and comparable transaction analysis.
In a merger bid, the gain to target shareholders is the takeover premium. The acquirer gain is the value of any synergies created by the merger, minus the premium paid to target shareholders.
The empirical evidence suggests that merger transactions create value for target company shareholders, yet acquirers tend to accrue value in the years following a merger. A divestiture is a transaction in which a company sells, liquidates, or spins off a division or a subsidiary. A company may divest assets using a sale to another company, a spin-off to shareholders, or a liquidation.
55