Tài chính doanh nghiệp - Chapter 10: Mergers and acquisitions

Chapter 10Mergers and AcquisitionsPresenter’s namePresenter’s titledd Month yyyy1. IntroductionMergers and acquisitions (M&A) are complex, involving many parties.Mergers and acquisitions involve many issues, includingCorporate 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. Copyright © 2013 CFA Institute2Example of a merger:AMR and U.S. Airways April 2012U.S. Airways proposes merger to bankrupt AMR.July 2012AMR creditors encourage AMR to merge with another airline, instead of emerging from bankruptcy alone.September 2012AMR and U.S. Airways begin merger discussions.November 2012U.S. Airways proposes merger, with its shareholders owning 30% of the new company.February 2013Details of the merger are worked out.Merger filed with the FTC under Hart-Scott-Rodino Act.Copyright © 2013 CFA Institute32. Mergers and acquisitions DefinitionsCompanyACompanyBCompanyCCompany XCompanyYCompanyXCopyright © 2013 CFA Institute4Merger with ConsolidationAcquisitionMergers and Acquisitions DefinitionsParties to the acquisitions:The target company (or target) is the company being acquired.The acquiring company (or acquirer) is the company acquiring the target.Classified based on endorsement of parties’ management:A hostile takeover is when the target company board of directors objects to a takeover offer.A friendly transaction is when the target company board of directors endorses the merger or acquisition offer.Copyright © 2013 CFA Institute5Mergers and Acquisitions DefinitionsClassified by the relatedness of business activities of the parties to the combination:Copyright © 2013 CFA Institute6TypeCharacteristicExampleHorizontal mergerCompanies are in the same line of business, often competitors.Walt Disney Company buys Lucasfilm (October 2012).Vertical mergerCompanies are in the same line of production (e.g., supplier–customer).Google acquired Motorola Mobility Holdings (June 2012).Conglomerate mergerCompanies are in unrelated lines of business.Berkshire Hathaway acquires Lubrizol (2011).3. Motives for mergerCopyright © 2013 CFA Institute7Creating ValueSynergyGrowthIncreasing market powerAcquiring unique capabilities or resourcesUnlocking hidden valueCross-Border MergersExploiting market imperfectionsOvercoming adverse government policyTechnology transferProduct differentiationFollowing clientsDubious MotivesDiversificationBootstrapping earningsManagers’ personal incentivesTax considerationsExample: Bootstrapping earningsCompany OneCompany TwoCompany One Post-AcquisitionEarnings$100 million$50 million$150 millionNumber of shares 100 million50 million125 millionEarnings per share$1$1$1.20P/E201020Price per share$20$10$24Market value of stock$2,000 million$500 million$3,000 millionCopyright © 2013 CFA Institute8Assumptions:Exchange ratio: One share of Company One for two shares of Company TwoMarket applies pre-merger P/E of Company One to post-merger earnings.Bootstrapping earnings is the increase in earnings per share as a result of a merger, combined with the market’s use of the pre-merger P/E to value post-merger EPS.Example: Bootstrapping earningsCompany OneCompany TwoCompany One Post-AcquisitionEarnings$100 million$50 million$150 millionNumber of shares 100 million50 million125 millionEarnings per share$1$1$1.20P/E201016.67Price per share$20$10$20Market value of stock$2,000 million$500 million$2,500 millionCopyright © 2013 CFA Institute9Assumptions:Exchange ratio: One share of Company One for two shares of Company TwoMarket applies weighted average P/E to the post-merger company. Motives and the Industry’s Life CycleThe motives for a merger are influenced, in part, by the industry’s stage in its life cycle.Factors includeNeed for capital.Need for resources.Degree of competition and the number of competitors.Growth opportunities (organic vs. external).Opportunities for synergy.Copyright © 2013 CFA Institute10Mergers and the Industry Life CycleIndustry Life Cycle StageIndustry DescriptionMotives for MergerTypes of MergersPioneering developmentIndustry exhibits substantial development costs and has low, but slowly increasing, sales growth.Younger, smaller companies may sell themselves to larger companies in mature or declining industries and look for ways to enter into a new growth industry.Young companies may look to merge with companies that allow them to pool management and capital resources.Conglomerate HorizontalRapid accelerating growthIndustry exhibits high profit margins caused by few participants in the market.Explosive growth in sales may require large capital requirements to expand existing capacity.Conglomerate HorizontalCopyright © 2013 CFA Institute11Mergers and the Industry Life CycleIndustry Life Cycle StageIndustry DescriptionMotives for MergerTypes of MergersMature growthIndustry experiences a drop in the entry of new competitors, but growth potential remains.Mergers may be undertaken to achieve economies of scale, savings, and operational efficiencies.HorizontalVerticalStabilization and market maturityIndustry faces increasing competition and capacity constraints.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.HorizontalCopyright © 2013 CFA Institute12Mergers and the Industry Life CycleIndustry Life Cycle StageIndustry DescriptionMotives for MergerTypes of MergersDeceleration of growth and declineIndustry faces overcapacity and eroding profit margins.Horizontal mergers may be undertaken to ensure survival. Vertical mergers may be carried out to increase efficiency and profit margins. Companies in related industries may merge to exploit synergy.Companies in this industry may acquire companies in young industries.HorizontalVerticalConglomerateCopyright © 2013 CFA Institute134. Transaction characteristicsForm of the TransactionStock purchaseAsset purchaseMethod of PaymentCashSecuritiesCombination of cash and securitiesAttitude of ManagementHostileFriendlyCopyright © 2013 CFA Institute14Form of an AcquisitionIn a stock purchase, the acquirer provides cash, stock, or combination of cash and stock in exchange for the stock of the target firm.A stock purchase needs shareholder approval.Target shareholders are taxed on any gain.Acquirer assumes target’s liabilities.In an asset purchase, the acquirer buys the assets of the target firm, paying the target firm directly. An asset purchase may not need shareholder approval.Acquirer likely avoids assumption of liabilities.Copyright © 2013 CFA Institute15Method of PaymentCash offeringCash offering may be cash from existing acquirer balances or from a debt issue.Securities offeringTarget 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.Copyright © 2013 CFA Institute16Based on data from Mergerstat Review, 2006. FactSet Mergerstat, LLC (www.mergerstat.com).Mindset of ManagersFriendly merger: Offer made through the target’s board of directorsCopyright © 2013 CFA Institute17Approach target management. Enter into merger discussions.Perform due diligence.Enter into a definitive merger agreement.Shareholders and regulators approve.Hostile merger: Offer made directly to the target shareholdersTypesBear hugTender offerProxy fightHostile vs. Friendly mergersThe classification of a merger as friendly or hostile is from the perspective of the board of directors of the target company.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.Copyright © 2013 CFA Institute185. TakeoversTakeover 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 acquirer’s power gained from its ownership interest in the target.Copyright © 2013 CFA Institute19Takeover defensesPre-Offer Takeover Defense MechanismsPoison pills (flip-in pill and flip-over pill)Poison putsIncorporation in a state with restrictive takeover lawsStaggered board of directorsRestricted voting rightsSupermajority voting provisionsFair price amendmentsGolden parachutesPost-Offer Takeover Defense Mechanisms“Just say no” defenseLitigationGreenmailShare repurchaseLeveraged recapitalization“Crown jewels” defenses“Pac-Man” defenseWhite knight defenseWhite squire defenseCopyright © 2013 CFA Institute206. RegulationRegulation of Mergers and AcquisitionsAntitrust LawSecurities LawCopyright © 2013 CFA Institute21Antitrust Law: United StatesCopyright © 2013 CFA Institute22Sherman Antitrust Act (1890)Made combinations, contracts, and conspiracies in restraint of trade or attempts to monopolize illegalClayton Antitrust Act (1914)Outlawed specific business practicesCeller–Kefauver Act (1950)Closed loopholes in the Clayton ActHart–Scott–Rodino Antitrust Improvements Act (1976)Gave the FTC and the Justice Department an opportunity to review and challenge mergers in advanceAntitrustThe 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.Copyright © 2013 CFA Institute23The HHI Copyright © 2013 CFA Institute24HHI Concentration Level and Possible Government ActionPost-Merger HHIConcentrationChange in HHIGovernment ActionLess than 1,000Not concentratedAny amountNo actionBetween 1,000 and 1,800Moderately concentrated100 or morePossible challengeMore than 1,800Highly concentrated50 or moreChallengeExample: HHIConsider an industry that has six companies. Their respective market shares are as follows:What is the likely government action, if any, if Companies E and F combined?Copyright © 2013 CFA Institute25CompanyMarket ShareA25%B15%C15%D15%E15%F15%100%Example: HHICompanyMarket ShareHHI BeforeCompanyMarket ShareHHI AfterA25%625A25%625B15%225B15%225C15%225C15%225D15%225D15%225E15%225E+F30%900F15%225Total100%1125Total100%1575Copyright © 2013 CFA Institute26The 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.Securities Laws: United StatesWilliams Act (1968): Requires public disclosure when a party acquires 5% or more of a target’s common stock.Specifies rules and restrictions pertaining to a tender offer.Copyright © 2013 CFA Institute277. Merger analysisThe 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 FCFWe 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.Copyright © 2013 CFA Institute28Estimating Free Cash Flow (FCF)Copyright © 2013 CFA Institute29Calculate Net Interest after Tax(Interest expense – Interest income) × (1 – Tax rate)Calculate Unlevered Net IncomeNet income + Net interest after taxCalculate NOPLATUnlevered net income + Change in deferred taxesCalculate FCFNOPLAT + Noncash charges – Change in working capital – Capital expendituresExample: FCF for the ABC CompanyNet income$40Interest expense$5Interest income$2Copyright © 2013 CFA Institute30Change in deferred taxes$3Depreciation$10Change in working capital$6Capital expenditures$20From the pro forma income statementFrom the pro forma income statementAssumedTax rate =45%What is ABC’s free cash flow?Suppose analysts have constructed pro forma financial statements for the ABC Company and report the following:Example: FCFNet income$40.00PlusNet interest after tax1.65Equals Unlevered net income$41.65PlusChange in deferred taxes3.00EqualsNet operating profit minus adjusted taxes$44.65PlusDepreciation10.00MinusChange in working capital6.00MinusCapital expenditures20.00EqualsFree cash flow$28.65Copyright © 2013 CFA Institute31Discounted Cash Flow (DCF) and the Terminal ValueWe can estimate the terminal value:Assuming a constant growth after the initial few years orAssuming a multiple (based on comparables) of pro forma FCF for the last estimated year.Copyright © 2013 CFA Institute32The DCF methodAdvantages of using the DCF method:The model allows for changes in cash flows in the future. The cash flows and estimated value are based on forecasted fundamentals.The model can be adapted for different situations.Disadvantages of using the DCF method:For a rapidly growing company, the FCF and net income may be misaligned (e.g., higher-than-normal capital expenditure).Estimating future cash flows is difficult because of the uncertainty.Estimating discount rates is difficult, and these rates may change over time.The terminal value estimate is sensitive to the assumptions and model used.Copyright © 2013 CFA Institute33Comparable Company AnalysisCopyright © 2013 CFA Institute34Select Comparable CompaniesPublicly traded companies that are similar to the subject companySame or similar industryCalculate Relative Value MeasuresEnterprise value multiplesPrice multiplesApply Metrics to Target Judgment needed to select appropriate metricEstimate Takeover PriceTakeover premium addedExample: Comparable Company AnalysisSuppose an analyst has gathered the following information on the target company, the XYZ Company:If the typical takeover premium is 20%, what is the XYZ Company’s value in a merger using the comparable company approach?Copyright © 2013 CFA Institute35XYZ CompanyAverage of ComparablesEarnings$10 millionP/E of comparables30 timesCash flow$12 millionP/CF of comparables25 timesBook value of equity$50 millionP/BV of comparables2 timesSales$100 millionP/S of comparables2.5 timesExample: Comparable Company AnalysisAssuming that the average of the values from the different multiples is most appropriate:Copyright © 2013 CFA Institute36Comparables’ MultiplesEstimated Stock ValueEarnings$10 million×30$300 millionCash flow$12 million×25$300 millionBook value of equity$50 million×2$100 millionSales$100 million×2.5$250 millionAverage = $237.5 millionEstimated takeover price of the XYZ Company = $237.5 million × 1.2 = $285 millionComparable Company AnalysisAdvantagesProvides reasonable estimate of the target company’s valueReadily available inputsEstimates based on market’s value of company attributesDisadvantagesSensitive to market mispricingSensitive to estimate of the takeover premium, and historical premiums may not be accurate to apply to subsequent mergersDoes not consider specific changes that may be made in the target post-mergerCopyright © 2013 CFA Institute37Comparable Transaction AnalysisCollect Information on Recent Takeover Transactions of Comparable CompaniesCalculate Multiples for Comparable CompaniesEstimate Takeover Value Based on MultiplesCopyright © 2013 CFA Institute38Example: Comparable Transaction AnalysisMNO CompanyAverage of Multiples of Comparable TransactionsEarnings$10 millionP/E of comparables15 timesCash flow$12 millionP/CF of comparables20 timesBook value of equity$50 millionP/BV of comparables5 timesSales$100 millionP/S of comparables3 timesCopyright © 2013 CFA Institute39Suppose an analyst has gathered the following information on the target company, the MNO Company:Estimate the value of the MNO Company using the comparable transaction analysis, giving the cash flow multiple 70% and the other methods 10% each. Example: Comparable Transaction AnalysisComparables’ Transaction MultiplesEstimated Stock ValueEarnings$10 million×15$150 millionCash flow$12 million×20$240 millionBook value of equity$50 million×5$250 millionSales$100 million×3$300 millionCopyright © 2013 CFA Institute40 Comparable Transaction AnalysisAdvantagesDoes not require specific estimation of a takeover premiumBased on recent market transactions, so information is current and observedReduces litigation riskDisadvantagesDepends on takeover transactions being correct valuationsThere may not be sufficient transactions to observe the valuationsDoes not include value of changes to be made in targetCopyright © 2013 CFA Institute41Evaluating BidsThe 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.Copyright © 2013 CFA Institute42Evaluating bids: FormulasTarget shareholders’ gain = Premium = PT – VT (10-7)wherePT = price paid for the target companyVT = pre-merger value of the target companyAcquirer’s gain = Synergies – Premium = S – (PT – VT) (10-8)whereS = synergies created by the business combinationVA* = VA + VT + S – C (10-9)whereVA* = post-merger value of the combined companiesVA = pre-merger value of the acquirerC = cash paid to target shareholders Copyright © 2013 CFA Institute43Example: Evaluating BidsSuppose that the Big Company has made an offer for the Little Company that consists of the purchase of 1 million shares at $18 per share. The value of Little Company stock before the bid was made public was $15 per share. Big Company stock is trading at $40 per share, and there are 10 million shares outstanding. Big Company estimates that it is likely to reduce costs through economics of scale with this merger of $2 million per year, forever. The appropriate discount rate for these gains is 10%. What are the synergistic gains from this merger?What parties, if any, share in these gains? What is the estimated value of the Big Company post-merger?Copyright © 2013 CFA Institute44Example: Evaluating Bids Synergistic gains = $2 million  0.10 = $20 millionDivision of gains: First calculate the gains for each party and then evaluate the division.Target shareholders gain = $18 million – $15 million = $3 millionAcquirer’s gain = $20 million – 3 million = $17 millionLittle shareholders get $3 million  $20 million = 15% of the gainBig shareholders get $17 million  $20 million = 85% of the gainValue of Big Company post-merger = $400 million + $15 million + $20 million – $18 million = $417 millionCopyright © 2013 CFA Institute45Effects of Price and Payment MethodThe more confidence in the realization of synergies,the greater the chance that the acquiring firm will pay cash andthe more the target company shareholders will prefer stock.The greater the use of stock in a deal, the greater the burden of the risks borne by the target shareholders andthe greater the potential benefits accrue to the target shareholders.The greater the confidence of the acquiring firm managers in estimating the value of the target, the more likely the acquiring firm is to offer cash.Copyright © 2013 CFA Institute468. Who benefits from Mergers?Mergers create value for the target company shareholders in the short run.Acquirers tend to overpay in merger bids.The transfer of wealth is from acquirer to target company shareholders.Roll: Overpayment results from “hubris.”Acquirers tend to underperform in the long run.They are unable to fully capture any synergies or other benefit from the merger.Copyright © 2013 CFA Institute47Mergers that create valueBuyer is strong.Transaction premiums are relatively low.Number of bidders is low.Initial market reaction to the news is favorable.Copyright © 2013 CFA Institute489. Corporate restructuringA divestiture is the sale, liquidation, or spin-off of a division or subsidiary.Copyright © 2013 CFA Institute49Parent companyEquity Carve-OutSpin-OffSplit-OffDivestitureLiquidationReasons for RestructuringCompanies generally increase in size with a merger or acquisition.Restructuring, which includes divestitures, generally follows periods of merger and acquisitions.Reasons for restructuring:Change in strategic focusPoor fitReverse synergyFinancial or cash flow needsCopyright © 2013 CFA Institute50Forms of divestitureSale to another company:Direct sale of assets Creation of a separate entity and the sale of interests in that entity (i.e., an equity carve-out) Spin-off: Parent company’s shareholders receive shares of stock Split-offs are similar to a spin-off, but only some shareholders receive shares in the new entity in exchange for shares in the parent company’s stock.Liquidation: Breaking up the entity and selling off its assets piecemealCopyright © 2013 CFA Institute5110. SummaryAn acquisition is the purchase of some portion of one company by another, whereas a merger represents the absorption of one company by another.Mergers may be a statutory merger, a subsidiary merger, or a consolidation.Horizontal mergers occur among peer companies engaged in the same kind of business, vertical mergers occur among companies along a given value chain, and conglomerates are formed by companies in unrelated businesses.Merger activity has historically occurred in waves.Waves have typically coincided with a strong economy and buoyant stock market activity. Merger activity tends to be concentrated in a few industries, usually those undergoing changes.There are number of motives for a merger or acquisition; some are justified, some are dubious.Copyright © 2013 CFA Institute52Summary (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 company’s managers. There are a variety of both pre- and post-offer defenses a target can use to ward off an unwanted takeover bid.Copyright © 2013 CFA Institute53Summary (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.Antitrust legislation prohibits mergers and acquisitions that impede competition.The Federal Trade Commission and Department of Justice review mergers for antitrust concerns in the United States. The European Commission reviews transactions in the European Union.The Herfindahl–Hirschman Index (HHI) is a measure of market power based on the sum of the squared market shares for each company in an industry.The Williams Act is the cornerstone of securities legislation for M&A activities in the United States.Copyright © 2013 CFA Institute54Summary (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.Copyright © 2013 CFA Institute55