Mergers & Acquisitions

• Same kind of business
• Benefits from economies of scale and synergies
• Government regulation due to fear of monopoly power

• Firms of different stage of production/operation
• Benefits from information- and transaction efficiency (e.g. inventory, production, prices, procurement)

• Firms in unrelated type of business
• 3 types:
  • Product extension
  • Geographic market extension
  • Pure conglomerate mergers

• Investment companies (e.g. Mutual funds)
  • Diversify PF risk
• Financial conglomerates
  • Provide funds
• Managerial conglomerates
  • Control operating decisions
• Concentric companies
  • Related business

• Statutory merger
  • Basic form
  • Requires legal procedures (e.g. percentage of vote from shareholders, board approval)
  • A+B=A, A+B=B or A+B=C
• Short-form merger
  • Streamlined legal procedures
  • No shareholder approval required
  • Typically interest >90%
• Holding company
  • Subsidiaries as seperate legal entities
  • Holding has controlling interest 25-50%

• Buying stock of takeover targets after public announcement and holding shares until deal is closed
• Bet that deal will be completed
• Bear deal risk

Existing shareholders can hold their shares until deal is closed to receive the offered price or they can sell their shares to a risk arbitrageur. His annual return would be:

\(r=(1+{Offered Price-Actual Price \over Actual Price})^{365 \over Days}-1\)

See chart

See chart

Topics:

• Historical development
• Merger waves
• Factors motivating & driving merger waves

1. Horizontal mergers 1895-1904
2. Vertical mergers 1922-1929
3. Conglomerate mergers 1965-1970
4. Deal decade 1981-1989
5. Strategic mergers 1992-2000

• Technological change (e.g. telephone, internet)
• Economies of scale
• Globalization and free trade
• Legal and regulatory changes (e.g. deregulation)
• Periods of high economic growth
• Favorable stock prices and economic conditions
• Input price volatility (e.g. oil industry)
• Finance innovations (e.g. junk bonds)

1895-1904

• Technological, infrastructure and managerial improvements (e.g. railroads, electricity)
• New products
• Economies of scale
• Availability of financiers and insurances

Cause of end: Recession 1903, anti-competitive merger ruling 1904

1922-1929

• Innovations in transportation (motor vehicle), communication (radio), merchandising (mass distribution)
• Product and market extension
• Consolidation of fragmented industries

Cause of end: Economic slowdown 1929

1965-1970

• Diversification
• Product extension
• Price earnings game
• Rise of management theroy

Cause of end: Antitrust laws, punitive tax laws, decline in stock prices

Buyer with a hight P/E ratio combines with a firm with a lower P/E ratio, the earnings per share (EPS) of the buyer will rise

Might work in the short run but never in the long run

See example p. 174-176

1981-1989

• Prospering economy and stock market
• Increasing international competition (steel, auto)
• New industries, technological and managerial innovations
• Increasing hostile takeovers
• Financial innovations (LBO, Bust-up acquisitions)

Cause of end: Government actions, takeover defenses, recession

• Purchase of firm with substantial share of dept (Strong incentive due to large ROE)
• Replacement of top management
• Improve operations and reduce dept
• Sell firm through IPO

• Seller's business parts are worth more as seperate entities than the whole
• Divesting segments after acquisition
• Use proceeds to reduce dept which were used to finance the transaction

1992-2000

• Technology (computer, internet, fiber optics)
• Globalization
• Deregulation
• Positive economic conditions (low interest rates, rising stock prices and P/E ratios)
• Upcoming stock-for-stock transactions

Cause of end: Burst of internet bubble

• Leds to greater capacity utilization, lower firm costs and reduced customer prices
• Followed by increase in merger activity, reorganizations and combined wealth (+3.5%)

Topics:

• Why do mergers occur?
• How can takeovers create value?
• Performance of M&A transactions
• Value split between acquirer & target
• Reasons for M&A transactions
• Strategy influences M&A outcomes

• Diversify or expand
• Restructure, redeploy assets or exit

See chart

• Maturing products (lifecycle)
• Regulatory or antitrust restriction
• Value creation (through horizontal, vertical mergers or diversification)
• If impossible to create internal: Acquisition of resources or capabilities

• Strategic focus
• Correction of mistakes (of divestitures)
• Correction of market valuation of assets (underevalued)
• Subsidization of inefficient units
• Optimizing financial leverage
• Respond to capital market discipline
• Gain financing

1. Rent-seeking behavior
   • Bargaining and market power, economies of scale / -scope
2. Transaction costs
   • Information and contract costs, controlling
   • Make or buy decision, specialization gain
   • Coase framework: Firm must decide between internal or external production
3. Managerial hubris & market mania
   • Excessive self-confidence of managers: Think they can manage everything
   • Fear of falling short
4. Overevaluation & information asymmetry
   • Stock market run-up results in overevaluation
   • Managers have information advantage: Inside values differ from market valuation
   • Hold stocks as "acquisition currency" for share-for-share-deals

Value increasing

• Mergers optimize transaction costs
  • Appropriate balance of internal operations and external markets
• Mergers create synergies (Bradley/Desai/Kim 1983/88)
  • Economies of scale, effective management, production, financial service
• Takeovers are disciplinary (Manne 1965)
  • Remove poor management, improve performance, competition between different management teams

Value reducing

• Agency costs of FCF (Jensen 1986)
  • Managers reinvest FCF, this can lead to value reducing mergers
• Managerial entrenchment (Shleifer/Vishny 1989)
  • Increase manager's "value" to shareholders

Value neutral

• Managerial hubris (Roll 1986)
  • Excessive self confidence
• Winner's course problem
  • Manager that most overevaluates target wins bid
• Mergers can occur even if there is no value effect
  • Wealth transfer from buyer's to seller's shareholders if bid is higher than target value

See table

1. Free-rider problem
2. Preemptive bidding
3. Winner's curse problem
4. Bidding costs
5. Limitation of number of bidders

• If many small shareholders, each considers himself not decisive for the success of tender offer
• Shareholder refuse to tender
• Solution:
  • Large shareholders
  • Acquirer buys toehold
  • Two-tier offers

High initial bid

• Low chances for competitors
• Competitors may avoid bid

• Lack of full knowledge about target's value (asymmetric information)
• Bidder pays too much
• Solution:
  • Stock instead of cash offer (risk sharing)

Costs of making an acquisition

1. Preemptive bidding
2. Termination fee (break-up fee)
   • Compensation for bidder if initial agreement is terminated
3. Toehold (initial stake)
   • Secret buying of shares (e.g. 5%)
   • Deter competitors from making bids

Toehold

→ Seller can counteract by designing a favourable auction

Seller's costs

Costs: \(C={1 \over n}[E(V)-E(B)]\)

Number of bidders (n) influences seller costs:

\(E(B)=E(V)-n \times C\)

→ Seller can limit the number of bidders

1. Combined returns positive (on average)

• Mostly from Synergy and efficiency
• But hubris, agency costs and managerial entrenchment possible

2. Target returns positive (almost always)

• Cash deals > stock deals
• Multiple bidders → higher return

3. Target stock run-ups (prior to announcement)

• Toehold, rumours, insider trading

4. Higher premium from preemptive bids (proven)