Mergers And Acquisitions

MERGERS AND ACQUISITIONS- AN INTRODUCTION

BY VARUN PRABHU

WHY ARE YOU HERE

• To learn the basics of mergers and acquisitions• To acquire knowledge about specialist M&A

firms• To know how to valuate a business• To learn how to control brand considerations

after a merger• To know the effects of mergers on

management

AGENDA• What is a M&A?• Differentiating M & A• Common Ways of Business Valuation• How Do We Get Finance?• Specialist M&A Advisory Firms• What Motives Lie Behind?• Effects on Management• Brand Building or Brand Destroying?• Factors of the Merger Movement• Merger Waves• Cross Border M & A• Major M&A’s

WHAT IS A M&A?

• An aspect of corporate strategy, corporate finance and strategic management.

• Deals with buying, selling, combining of different companies that can– Aid– Finance– Help

a growing company in a given industry grow rapidly without having to create a new business entity.

ACQUISITION

• Purchase of one company by another company.

Company 1 Company 2

Newly Formed Company

TYPES OF ACQUISITIONS

• Depending upon– Acquiree or merging is or isn’t listed in public

markets.– How the communication is done and received by

the target.

THE FIRST CLASSIFICATION

ACQUISITION

PUBLIC (IF ACQUIREE LISTED IN PUBLIC

MARKETS)

PRIVATE (IF ACQUIREE NOT LISTED IN PUBLIC

MARKETS

THE SECOND CLASSIFICATION

ACQUISITION

FRIENDLY HOSTILE

CONFIDENTIALITY BUBBLE

• Quite normal for M&A deal communication to take place in a so called ‘confidentiality bubble’.

• Here information flows are restricted due to confidentiality agreements.

FRIENDLY ACQUISITIONS

• Companies cooperate in negotiations.• Synonymous to merger of equals.

HOSTILE ACQUISITIONS

• Takeover target unwilling to be purchased.• It can also be if the acquiree company has no

prior knowledge of offer.• Hostile takeovers do turn friendly in the end.

Most of the times.• For the above thing to happen, offer is usually

improved.

REVERSE TAKEOVERS

• Acquisition usually refers to purchase of smaller firm by larger firm.

• Sometimes, smaller firm acquire management control of a larger / longer established company.

• Keep its name for combined entity.• Known as reverse takeover.

REVERSE MERGER

• Another type of acquisition.• Is a deal enabling a private company to become a public

company.• The deal enables private company by listing in a short

time period.• Occurs when a private company has strong prospects and

is eager to raise financing, buys a publicly listed shell company.

• Usually the public one is one with– No business– Limited assets

SOME STATISTICS

• Achieving acquisition successfully has proven to be tough.

• Various studies show 50% of them are unsuccessful.

• Process very complex, many dimensions influence its outcome.

• Variety of structures used in securing asset control.

• Different tax and regulatory implications

THE ACQUISITION PROCESS

• Buyer buys shares of target company• Ownership control conveys effective control over assets, but

since company is going concern, liabilities come as well.• Buyer buys assets of target company.• Cash target receives from sell-off is paid back to its

shareholders by– Dividend– Through liquidation

• If buyer buys out entire assets, then target company = empty shell.

• Buyer often cherry picks his assets

SOME OTHER TERMS

• There are some other terms used as well like:– Demergers– Spin-off– Spin-out

• Sometimes used to indicate a situation where one company splits into two, generating a 2nd company separately listed on a stock exchange.

DIFFERENTIATING MERGERS AND ACQUISITIONS

• Both terms are often used synonymously.• They mean slightly different things in reality.

ACQUISITIONS FIRST

• When one company takes over another, clearly establishes as its new owner.

• Legal View: target ceases to exist.• Buyer swallows target• Buyer’s stock continues to be traded.

MERGERS NEXT

• Happens when two firms agree to go forward as a single new company rather than remain separate.

• Often precisely termed as merger of equals.• Firms are often of same size.• Both companies stock surrendered• New company stock put into place instead.• Example: 1999 merger of Glaxo Wellcome and

SmithKline Beecham, both firms ceased to exist and a new firm GlaxoSmithKline was created.

MERGERS IN PRACTICE

• Actually the principle of mergers of equals don’t really happen.

• Usually one company buys another.• Simply allow acquired firm to pronounce it as a merger,

though technically it is an acquisition.• Being purchased always portends negative connotations.• Therefore, they term it as merger, makes takeover more

acceptable.• Example : takeover of Chrysler by Daimler-Benz in 1999.• Purchase deal also a merger -> friendly takeovers.• Hostile takeovers -> mainly acquisitions.

COMMON WAYS OF BUSINESS VALUATION

• Asset Valuation• Historical Earnings Valuation• Future Maintainable Earnings Valuation• Relative Valuation• Discounted Cash Flow Valuation

ASSET VALUATION• Valuations are made for:

– Excess or restricted cash– Other non-operating assets and liabilities– Lack of marketability discount– Control premium– Above or below market leases– Excess salaries in case private companies

• Typical adjustments include:– Working capital adjustment– Deferred capital expenditures– Cost of goods sold adjustment– Non recurring professional fees and costs– Certain non operating income/expense items

VALUATION OF INTANGIBLE ASSETS

• Can be made for intangible assets like:– Patents– Copyrights– Software– Trade secrets– Customer relationships

• Uses either– Present value model– Estimating the costs to recreate it

• Process time consuming and costly• Often necessary for financial reporting and intellectual property transactions.• Stock markets give only an indirect value.• Can be regarded as difference between its market capitalization and its book

value.

VALUATION OF MINING PROJECTS

• Process of determining the value of a mining property.• Sometimes required for:

– Initial Public Offers– Fairness opinions– Litigations– Mergers and acquisitions– Shareholder related matters

• Fair market value is standard value.• CIMVal Standards are recognized standards for mining

project valuations.

HISTORICAL EARNINGS VALUATION

• Uses EPS (Earnings Per Share) values for valuation of stock.

• Figures can be used for forecasting performance by visiting free financial sites such as Yahoo Finance.

RELATIVE VALUATION• Generic term that refers to the notion of comparing asset price to market

value of similar assets.• Presumably spot pricing anomalies on securities market.• Compare certain financial ratios such as:

– Price to book value– Price to earnings– EV/EBITDA– Mainly statistical and historical

• Compare national or industry stock performance to economic and market fundamentals like:– GDP growth– Interest rate– Inflation forecasts– Earnings growth– National equity index

DISCOUNTED CASH FLOW METHOD

• Abbreviated as DCF• Uses concepts of time value of money• All future cash flows are estimated and discounted to give their

present values(PV’s).• Sum of all future values, is net present value (NPV).• Widely used in investment finance, real estate development,

corporate financial management• Most commonly used method is exponential discounting.• Other methods are:

– Hyperbolic discounting• Discount rate used is Weighted Average Cost of Capital (WACC).

METHODS OF PROJECT APPRAISAL

• Equity Approach– Flow To Equity Approach

• Entity Approach– Adjusted Present Value Approach– Weighted Average Cost Of Capital Approach

• Total Cash Flow Approach

SHORTCOMINGS OF DCF• Commercial banks have widely used DCF for construction projects.• These have following shortcomings:

– Discount rate assumptions rely on market for competing investments, rates change drastically over time.

– Straight line assumptions generally based upon historic increases in market rent but never factors in the cyclical nature of many real estate markets.

• Sometimes leads to overvaluation of assets• Powerful method of valuation though not devoid of shortcomings• Merely a mechanical tool, makes it subject to axiom of garbage in

garbage out• small changes in input can lead to large changes in company value.• To avoid we can use simple annuity.

THE VALUATION PROFESSIONALS

• Professionals who do business valuations use a combination of some of them.

• Information in balance sheet or income statement is obtained using the following accounting measures:– Notice to Reader– Review Engagement– Audit

• Accurate business valuation most important aspect of M&A.

• Major impact on value of business sold for.

HOW DO WE GET FINANCE?

• We can differentiate mergers and acquisitions by the way they are financed.

• Various methods of financing include:– Cash– Stock

THINK STRATEGIC!!!!

• With pure cash deals, no doubt on real bid value.

• Contingency of share payment removed.,• Cash offer preempts competitors.

TAXES

• Should be evaluated with counsel of – Competent tax advisors– Competent accounting advisors

CASH V/S SHARES

• With a share deal, buyer’s capital structure might be affected and control of new company modified.

• If issuance of shares necessary, shareholders might prevent capital increase.

• Risk removed with cash transaction.• In cash deal, balance sheet of buyer will be

modified, liquidity ratios might decrease.• In stock transactions, lower profitability ratios

might show.

THE CASH DEAL

• If buyer pays cash, there are 3 main financing options:– Cash on Hand: consumes financial slack. May decrease

debt rating. No major transaction costs,– Issue of debt: consumes financial slack. May decrease debt

rating. Increases cost of debt. Transaction costs include underwriting or closing costs of 1% to 3% of face value.

– Issue of stock: increases financial slack, may improve debt rating, reduce cost of debt, transaction costs include fees for preparation of proxy statement, an extraordinary shareholder meeting, registration.

THE STOCK DEAL

• If buyer pays with stock:– Issue of Stock– Shares in Treasury: increases financial slack,

improve debt rating, reduce cost of debt, transaction costs include brokerage fees if shares repurchased in market otherwise no major costs.

LETS GENERALIZE…

• Stock will create flexibility.• Transaction costs also to be considered but

tend to have greater impact.• Remember:

Buyers tend to offer stock when they believe their shares are overvalued and cash when undervalued.

SPECIALIST M&A ADVISORY FIRMS

• Provided usually by– Full service investment banks

• Recently, specialized M&A firms have emerged.

• Sometimes referred to as Transition Companies.

• Assisting business referred to as companies in transition.

WHAT MOTIVES LIE BEHIND?• Economy of scale• Economy of scope• Cross selling• Synergy• Taxation• Geographical or other diversifications• Resource transfer• Vertical integration• Absorption of similar businesses under single management.• Manager’s hubris• Empire building• Manager’s compensation.

ECONOMY OF SCALE

• Combined company can often reduce its fixed costs

• Can remove duplicate departments• Lower company costs• Increase profit margins.

ECONOMY OF SCOPE

• Relates to efficiencies primarily associated with demand side changes

• Increasing/decreasing scope of marketing and distribution

INCREASED MARKET SHARE

• Assumes that buyer will be absorbing a major competitor.

• Thus increase revenue/market share to set prices.

SYNERGY

• Managerial economics such as increased opportunity of managerial specializations.

• Purchasing economies due to increased order size and associated bulk buying discounts.

CROSS SELLING

• A bank buying a stock broking firm• Manufacturer acquiring and selling

complementary products.

TAXATION

• Profitable company can buy a loss maker to use target’s loss as their advantage by reducing their tax liability.

• But there are certain regulations to follow.

GEOGRAPHICAL DIVERSIFICATION

• Designed to smooth company earnings• Smoothens stock price• Gives conservative investors more confidence• But does not always deliver value to

shareholders.

RESOURCE TRANSFER

• Resources unevenly distributed across firms.• Can create value by– Overcoming information asymmetry– Combining scarce resources

VERTICAL INTEGRATION

• Occurs when an upstream firm merges with a downstream firm.

• One reason is externality problem.• Common example is double marginalization

EFFECTS ON MANAGEMENT

• M&A according to some studies destroy leadership continuity in target companies.

• Target companies lose 21% of their executives each year following an acquisition.

BRAND CONSIDERATIONS• M&A’s often create brand problems.• 4 different approaches:

– Keep one name and discontinue other. Ex: United Airlines and Continental Airlines Merger.

– Keep one name and demote other: Caterpillar Inc. keeping Bucyrus International.

– Keep both names and use together: Pricewaterhouse Coopers.– Discard both legacy names and adopt new one:

• merger of Bell Atlantic and GTE which became Verizon Communications. This merger was successful.

• Merger of Yellow Freight and Roadway Corporation which became YRC Worldwide. This merger was partially successful, brand value lost.

• Factors range from political to tactical.• Ego as well as rational factors drive choice.• Rational factors : brand value, costs involved with changing brands.

THE MERGER MOVEMENT

• Predominantly a US phenomenon.• Short run factors: desire to keep prices high,• Long run factors: reduction of transportation

and production costs.

MERGER WAVESPERIOD NAME FACET

1897 – 1904 FIRST WAVE HORIZONTAL MERGERS

1916 – 1929 SECOND WAVE VERTICAL MERGERS

1965 – 1969 THIRD WAVE DIVERSIFIED CONGLOMERATE MERGERS

1981 – 1989 FOURTH WAVE CONGENERIC MERGERS; HOSTILE TAKEOVERS; CORPORATE RAIDING

1992 – 2000 FIFTH WAVE CROSS BORDER MERGERS

2003 – 2008 SIXTH WAVE SHAREHOLDER ACTIVISM, LEVERAGED BUYOUTS,

PRIVATE EQUITY

CROSS BORDER M&A’S

• Large M&A deals cause domestic currency of target corporation to appreciate by 1%

• Rise of globalization increased the necessity for MAIC trust accounts and securities cleaning services.

• In 1997 alone there were 2333 cross border M&A transactions, with a total of approx. $298 billion.

MAJOR M&A’SRANK YEAR PURCHASER PURCHASERD TRANSACTION

VALUE (IN MIL. USD)

1 2008 INBEV INC. ANHEUSER-BUSCH

COMPANIES INC.

52000

2 2004 JP MORGAN CHASE & CO

BANK ONE CORP

58761

3 2002 PFIZER INC. PHARMACIA CORPORATION

59515

4 2000 SPIN-OFF: NORTEL

NETWORKS CORPORATION

59974

5 2009 PFIZER INC. WYETH 68000

QUESTIONS?

BIBLIOGRAPHY

• www.en.wikipedia.org

THANK YOU