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Mergers and Acquisitions
Good But for Who?
What is a Merger?
• In a MERGER, two (or more) corporations
come together to combine and share their
resources to achieve common objectives.
• The shareholders of the combining firms
often remain as joint owners of the
combined entity.
• A new entity may be formed subsuming
the merged firms
What is an Acquisition?
• In an ACQUISITION, one firm purchases
the assets or shares of another.
• The acquired firm’s shareholders cease to
be owners of that firm.
• The acquired firm becomes the subsidiary
of the acquirer.
• Acquisitions usually take the form of a
public tender offer.
A Brief History of M&A Activity
• M&A activity has increased substantially since the mid1960s.
• The increased takeover activity that started in the 1980s
can be attributed to a number of factors:
– The emergence of the high-yield (junk) bond market that was
used to finance a number of that acquisitions.
– The permissive stance toward mergers by the Justice
Department during the Reagan administration.
– Increase in foreign competition, major changes in certain
industries and the deregulation of transportation,
communications, and financial services (especially in Europe)
brought about a need for a change in the way companies did
business.
Report Title: Statistical Abstract of the U.S., 2003: Issued By: Bureau of Census
Publication Date: December, 2003, Table on Page: 511.
International Merger Activity
1990-2001
1990-1994
All Mergers
Cross Border
$ Val.
#
1998-2001
All Mergers
$ Val.
#
Cross Border
$ Val.
#
$ Val.
#
Africa
0.60%
3.27%
0.27%
0.86%
2.07%
9.98%
0.55%
2.39%
Asia
0.37%
1.46%
0.03%
0.48%
1.02%
3.43%
0.15%
0.93%
N. Amer.
2.63%
17.92%
0.45%
2.25%
7.42%
35.12%
1.43%
5.12%
Oceania
2.24%
12.98%
1.05%
5.55%
3.17%
24.05%
1.48%
7.55%
C. & S.
Amer.
0.04%
3.92%
0.02%
2.94%
0.84%
8.71%
0.69%
6.47%
W. Eur. –
Euro
1.81%
15.55%
0.69%
5.04%
3.97%
15.87%
2.08%
6.09%
W. Eur. No Euro
1.49%
5.65%
0.96%
3.25%
2.14%
6.77%
0.76%
4.72%
All
1.19%
12.25%
0.27%
2.58%
4.47%
17.82%
1.26%
4.24%
600
500
400
300
200
100
0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
Non-US
US
Figure 1. Number of Acquisitions by Year and Region
The total sample includes all takeover announcement that take place between January 1,
1990, and December 31, 1999, available in the Securities Data Corporation Mergers and
Acquisitions database. Only public companies are considered, and we exclude LBO
deals, spinoffs, recapitalizations, self-tender and exchange offers, repurchases, minority
stake purchases, acquisitions of remaining interest, and privatizations. Second and
subsequent bids that occur within a window of four years relative to an initial
announcement are excluded. Non-US data includes acquisitions from 55 countries.
Advisor Ranking
Completed Acquisitions, World Targets 1995-2003
Financial Advisor
Full to
Each Eligible Advisor
Goldman Sachs & Co
Morgan Stanley
Merrill Lynch & Co Inc
Credit Suisse First Boston
JP Morgan
Citigroup
UBS
Lazard
Lehman Brothers
Deutsche Bank AG
Dresdner Kleinwort Wasserstein
Rothschild
Bear Stearns & Co Inc
BNP Paribas SA
Banc of America Securities LLC
Societe Generale
ABN AMRO
CIBC World Markets Inc
CreditAgricole-CreditLyonnais
HSBC Holdings PLC
ING
Greenhill & Co, LLC
RBC Capital Markets
Houlihan Lokey Howard & Zukin
Cazenove & Co
Ranking Value inc.
Net Debt
of Target ($ Mil)
Mkt.
Share
Rank
Number of
Deals
6,302,786.8
5,044,998.3
4,364,761.1
3,810,234.0
3,725,925.8
3,260,949.4
2,237,270.0
2,062,914.1
1,759,323.9
1,472,016.3
1,267,086.8
1,136,145.3
1,032,622.3
483,022.1
448,977.4
368,078.5
368,014.6
303,636.5
266,713.6
251,841.8
240,037.8
239,028.5
236,195.8
205,479.2
190,181.1
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
34.6
27.7
23.9
20.9
20.4
17.9
12.3
11.3
9.7
8.1
7.0
6.2
5.7
2.7
2.5
2.0
2.0
1.7
1.5
1.4
1.3
1.3
1.3
1.1
1.0
2,428
2,294
2,103
3,240
2,607
2,598
2,032
1,301
1,277
1,754
804
1,126
569
535
587
700
914
644
349
641
543
116
575
676
160
Subtotal with Financial Advisor
Subtotal without Financial Advisor
16,289,044.0
1,942,090.0
-
89.4
10.7
33,616
63,028
Industry Total
18,231,133.9
-
100.0
96,644
Basic Facts – Mergers
• Generally friendly.
• Require the approval of both management
teams/boards before the stockholders vote.
• Mergers are often done in an exchange of
securities.
– Common stock of the bidding firm for common stock
of the target firm.
• They are not taxable events for the target
stockholders, unless they sell the bidder’s stock.
Basic Facts – Tender Offers
• Generally unfriendly.
– Target management by-passed by asking the
stockholders to sell their stock, votes, etc.
• Often done for cash.
– Sometimes for new debt securities or stock.
• Are taxable events for the target stockholders
• Strong incentive for the bidding firm to complete
the acquisition quickly, in order to reduce the
probability that a competing bidder will come
along.
Tender Offer Process
• Start with a public announcement following
a 14d filing with the SEC.
• The filing must specify the consideration
offered to the shares of the target firm, the
objective of the merger (acquisition), and
the timeline of events.
• The target management has 10 days to
respond to the offer, via a 14d-9 filing.
Other Issues
•
•
•
•
Tendering shares
Right to withdraw
Best price rule (a.k.a. fair price rule)
Collars
– Provides for certain changes in the exchange ratio conditional on
the level of the bidder’s stock price around the effective date of
the merger.
– Helps insulate target stockholders from volatility in the bidder’s
stock price by promising a cash-like payoff at the end of the bid
period.
• Competing tender offers
• Contingent payments: Earnouts and Contingent Value
Rights (CVRs)
Estimating Gains and Losses
• On January 1 firm A offers to buy B. On
February 1 the acquisition is completed.
• If firm A’s value increased by 2% and B’s
value by 15% during the month what was
the merger’s impact?
• Answer: It depends on each firm’s beta
and how well the market did over the
same period.
Abnormal Returns
• The abnormal return (AR) for a security i in
period t is defined as:
ARit  rit  rft   i  rmt  rft  .
• The cumulative abnormal return (CAR) for
a security i in n period interval ta to tb is
defined as:
tb
CARit   ARit .
t  ta
Interpreting the CAR
• The period ta to tb is called (misleadingly)
the “event window.”
• If the CAR > 0 over the event window then
the firm’s security did better than expected
over that period. If CAR = 0 it did as
expected and if CAR < 0 it did worse than
expected.
CAR Prior to Event Date
• If the CAR is not zero prior to the public
announcement of the event date (t0) this
implies information leaked into the market
prior to its public announcement.
• If the CAR up to the event date (ex. t-60 to
t0) is positive the event was good for the
security’s value. If negative it was bad,
and if zero had no impact.
CAR After the Event Date
• After the event date the CAR should be
zero. If not, then the market has
incorrectly forecasted the event’s impact
on the firm’s value.
• In a large sample, the average CAR
across events should average to zero.
Stock Price Reactions
• Mergers
– Bidders gain 0%
– Targets gain 20%
• Tender Offers
– Bidders gain 4%
– Targets gain 30%
(Jensen and Ruback, Journal of Financial Economics, 1985)
Target Premium
• Why are premiums smaller for targets in
mergers?
– Larger premium in tender offers to make target
stockholders as well off after taxes
– Could be that some of the ‘cost’ of the bid is used to
buy off target management (to get them to
cooperate), so the gains to stockholders are smaller.
• Both of the stories imply that the ‘pie’ is being
divided in different ways, with target
shareholders getting a smaller piece.
CARs for Takeover Targets
Total takeover value
to the target.
0.4
0.35
Value of resolving
uncertainty about the
takeover.
0.3
0.25
Preannouncement
information
leakage.
0.2
0.15
0.1
0.05
-0.05
US TARGETS
UK TARGETS
97
90
83
76
69
62
55
48
41
34
27
20
13
6
-1
-8
-15
-22
-29
-36
-43
-50
-57
-64
-71
-78
-85
-92
-99
-106
-113
-120
0
Bidder Premium
• Why are premiums smaller for bidders in
mergers?
– Could be that bidders know that tender offers are
more expensive, higher premia required.
– Greater chance of competition.
– Higher legal/investment banking fees.
• So they only pursue deals that are likely to have large
potential gains.
• There are some deals that remain profitable as mergers that
would not be as hostile tender offers, so the samples are not
comparable
Gains: Improved Managerial
Efficiency
• Market for corporate control assumes that
managers act in the interest of the
shareholders. Firms that do not maximize
shareholder value are targets for takeover.
• Prediction:
– Target share prices experience significant
declines prior to the merger or tender offer.
– Managers of target firms are fired after the
takeover.
Synergy Gains: Horizontal
Mergers
• Firms producing similar products in similar
markets (i.e., the same industry).
• Monopolistic pricing: could be gains from
reducing competition:
• Reduce output, and increase profits
• Demand curve facing the firm becomes less elastic
• Antitrust Division of the Justice Department &
the Federal Trade Commission worry about
horizontal mergers.
– Monopoly pricing makes consumers worse off
– Efficiency increasing mergers make consumers better
off: more output at lower prices.
Synergy Gains: Vertical Mergers
• Upstream firm buys a downstream firm (or visa
versa)
• If one firm has a monopoly, can the merged firm
increase profits by charging monopoly prices at
both levels?
– NO.
• Are there efficiency gains from internal rather
than external contracting?
– It depends there is still an important transfer pricing
problem.
Synergy Gains: Conglomerate
Mergers
• Firms in totally different industries
• Perhaps there are efficiencies in
management or some centralized service,
but is doubtful today.
• May have been more important when
centralized information systems first came
into being (1960’s)
Conglomerate Mergers
Diversification
• At first sight diversification may create
value.
• Who benefits from diversification?
– Not stockholders (at least directly). They
could do it on their own account by buying the
stock of the two companies, avoiding paying a
premium. Better yet, their holdings wouldn’t
have to be in fixed proportions.
– May benefit indirectly.
Diversification: Employees
• Other stakeholders
– They are forced to hold undiversified
portfolios of the stock of the bidder/target firm.
– It is hard for them to diversify on their own
accounts.
• Employees cannot diversify their human capital.
• They may be willing to accept a lower salary
and/or have a larger commitment to the company if
they take less risk.
• May ultimately benefit shareholders.
Diversification: Bondholders
• Maybe the combined firm becomes safer.
• But bondholders do not have any decision
power!
– The firm’s debt capacity will be increased if the firm is
more diversified.
– Lenders care about total risk, not just systematic beta
risk.
• To the extent that there are advantages with
debt financing, shareholders will benefit.
Diversification: Executives
• Managers in small firms may be undiversified for
control purposes, and become too risk averse.
• Hence, both inside and outside shareholders
may benefit through diversification.
• A merger always changes control in at least one
of the firms.
– Good or bad depending on who is losing out and why.
• Fired: Bad if you are the one being dismissed.
• Retired: Good if you are the one being bought out.
Diversification Benefits the
Evidence
• Acquirers in diversifying mergers have negative
abnormal returns (-2%) in the 80’s.
• Not in the 90’s, instead earn about 0%.
• Acquirers in related businesses experience
positive returns of 2%, on average.
• Targets of hostile bids in late 80’s are often
broken up and sold to companies in related
businesses
• No evidence that there exists a large advantage
from diversification.
Conglomerate Mergers: Hubris
Hypothesis
• Managers commit errors of over-optimism
in evaluating merger opportunities due to
excessive pride, animal spirits or hubris.
Summary
• From a policy perspective, gains come from either
efficiency gains (good), or from monopolization (bad).
• Management shouldn’t care, except that the probability
of antitrust problems increase if the gains come from
monopoly pricing.
• Always ask yourself whether it is necessary to merge to
capture the efficiency/pricing gains. Are other
contracting methods better than paying a premium to
buy control?
• Diversification by itself should not increase firm value.
• Since corporate control always changes, this may be the
common factor explaining the gains
– Managers of target firms are often fired after the takeover.
Takeover Defenses
• Successful takeovers:
– Target Stockholders gain 20-35% or more
• Unsuccessful takeover:
– Target stockholders gain little if not eventually
taken over.
• Why defend a firm from a takeover?
Defense: Entrenchment or What?
• Why it might not be entrenchment.
– Target management may try to get a higher
bid from bidder.
• Sometimes such negotiations cause a deal to fail.
– Target management may defend the firm
while searching for another bidder willing to
pay more.
• The delay may inadvertently cause the deal to fail.
– Why it might be entrenchment.
• You know what they say about ducks!
Takeover Defenses: Charter
Amendments
• Supermajority Rules.
– 67% or more of votes necessary to approve
control change can be avoided by board.
– However, it can be avoided by board ("board
out")
– Fair-Price: supermajority clause can be
avoided if price is high enough (P/E or P/B).
• Staggered Board.
– Only 1/K of board is elected each year, so it
takes K years to turnover board completely.
Charter Amendments: Poison Pills
• Securities that provide shareholder (except acquirer) with special
rights, following the occurrence of a triggering event such as a
tender offer.
– They 'poison' the acquirer if it swallows the pill.
• Poison pills do not have to be approved by shareholders.
– Flip over plans:
• Shareholders have the right to buy the shares of the target at a premium
above the market.
• In case of a merger they flip-over: the shareholders have then the right to
buy the shares of the bidder at a substantial discount below market.
– Ownership flip-in plans:
• If the bidder acquires a threshold, shareholders (except the bidder) have the
right to purchase shares of the target firm at a discount.
– Back-end right plans:
• If the bidder acquires a threshold, shareholders (excluding bidder) can
exchange a right plus a share for cash equal to a back-end price set by the
board of directors of the issuing firm.
• Thus, back-end price will then becomes the minimum effective bid price.
Defenses: Voting Plans
• If a party acquires a substantial block of
the firm's stock, the other shareholders
receive more voting rights.
Legal/Regulatory Defenses
• State corporation/anti-takeover laws
impose rules that are similar to stringent
charter amendments for all corporations
chartered in that state.
• Inter-firm litigation can be effective.
– Target charges that bidder failed to disclose
something material in SEC filings.
Asset Restructuring Defense
• Crown Jewel defense
– Contract to sell attractive assets to a third
bidder contingent on hostile bid
• Pac Man defense
– Make competing tender offer for shares of
bidder.
Other Defenses
• Leverage Recapitalization.
– Partial LBO leaving equity holders with much riskier claims.
• ESOPs
– Employees get equity claim in the firm, but management votes
the shares of the stock in the ESOP.
• Golden Parachutes
– Lump sum payments to target management if fired due to
takeover.
– Usually small relative to size of deal, so probably not much
deterrence effect.
– Aligns the interests of target management with shareholders.
Other Defenses Continued
• Greenmail
– Buy back stock (at a premium above the
market price) from large stockholders who
may pose a threat.
– Often liked with “standstill agreements.”
• Shareholders bought out (through greenmail)
agree not to make further investments in the target
company.
– Should greenmail be outlawed?
Valuing Acquisitions
• Evaluating a potential acquisition is similar in
most respects to analyzing the NPV of any other
investment project a firm may be considering.
• Some subtle differences:
– The value of potential synergies must be added to
the value of the target firm's cash flows.
– The target firm's stock price will exceed the present
value of the firm's future cash flows, if it reflects the
possibility that the firm may eventually be taken over
at a premium.