Mergers and Acquisitions Lecture 1 Vikram Singh Sankhala
Forms of Restructuring
Changes in Ownership structure
Mergers and Acquisitions
Sell - offs
Spin – offs
Split - offs
Split – ups
Equity Carve outs
Premium Buy Backs
Changes in Ownership Structure
Mergers and Acquisitions Merger A transaction where two firms agree to integrate their operations on a relatively coequal basis because they have resources and capabilities that together may create a stronger competitive advantage Acquisition A transaction where one firm buys another firm with the intent of more effectively using a core competence by making the acquired firm a subsidiary within its portfolio of businesses Takeover An acquisition where the target firm did not solicit the bid of the acquiring firm
A horizontal Merger involves two firms operating in the same kind of Business Activity.
Thus a merger between two steel firms would represent a Horizontal Merger.
Vertical Mergers involve different stages of Production Operations.
Oil Industry – production, refining, marketing.
Pharmaceutical Drugs – Development, Production and Marketing.
Involves Firms engaged in unrelated type of Business Activities.
Three types of Conglomerate Mergers
Product Extension Mergers
Broaden the Product lines of the firm
Geographic Market Extension Merger
Involves two firms whose operations had been conducted in non overlapping Geographic areas.
Pure Conglomerate Merger
Involves unrelated Business Activities that would not qualify as either product extension or market extension mergers.
One party – generally a corporation seeking controlling interest in another corporation – asks the stockholders of the firm it is seeking to control to submit, or tender their shares in the firm.
A company mails a letter to the directors of the takeover target announcing the acquisition proposal and requiring the directors to make a quick decision on the bid.
If approval cannot be obtained, the acquiring company can appeal directly to the stockholders by means of a tender offer, unless the management and directors of the target firm hold enough stock to retain control.
The target firm may seek to elicit an offer from a partner it considers more desirable – a white knight
Involve the intersection of only a small fraction of the activities of the companies involved and usually for a limited duration of ten to fifteen years or less
A spin off creates a new legal company
Its shares are distributed on a pro rata basis to existing shareholders of the parent company.
Existing shareholders have the same proportion of ownership in the new entity as in the original one.
A variation on the spin offs is the Split offs.
A portion of the existing shareholders receives stock in a subsidiary in exchange for parent company stock.
Still a variation in the spin off is the split up.
The entire firm is broken into a series of spin offs so that the parent no longer exists and only the new offspring survive.
The sale of a portion of the firm to an outside third party.
Cash or equivalent consideration is received by the diveswting firm.
Typically the buyer is an existing firm, so that no new legal entity results.
An equity carve out involves the sale of a a portion of the firm via an equity offering to outsiders.
New shares of equity are sold to outsiders which gives them ownership of a portion of the previously existing firm.
A new legal entity is created.
Premium buy backs
Anti takeover amendments
Premium buy backs
Represent the repurchase of a substantial stock holder’s interest at a premium above the market price ( called greenmail)
Voluntary contract in which the stockholder who is bought out agrees not to make further attempts to take over the company in the future.
When a standstill agreement is made without a buyback, the substantial stockholder simply agrees not to increase his or her ownership which presumably would put him or her in an effective control position.
Anti Takeover Amendments
Changes to the corporate bye laws to make an acquisition of the company more difficult or expensive.
Supermajority voting provisions requiring a high percentage of stockholders to approve a merger.
Staggered terms for Directors
These can delay the change of control for a number of years.
These award large termination payments to existing management if the control of the firm is changed and management is terminated.
An outside group seeks to obtain representation on the firm’s board of Directors.
The outsiders are referred to as dissidents or insurgents
The insiders are incumbents or existing board of directors.
Proxy contests are often regarded as directed against the existing management.
Changes in ownership structure
Exchange of debt or preferred stock for common stock
Or common stock for more senior claims
Corporation buys back some fraction of its outstanding shares of common stock.
Tender offers may be made for share Repurchase
The entire equity interest in a previously public corporation is purchased by a small group of investors.
When the transaction is initiated by the members of the incumbent management, it is referred to as management buy out (MBO).
When financing from third parties involves substantial borrowing by the private company, such transactions are referred to as Leveraged Buy outs (LBOs)
Issues raised by Restructuring
Are they good or bad for the economic health of the3 nation.
Do they divert energies of the managers from bona fide econmic activity to financial manipulation.
Do they use up Financial resources which otherwise would be employed in ‘real’ investment activities.
Issues raised by Restructuring
Why has such heightened economic activity been a Phenomenon of the last twenty years.
Early Merger Movements
All of the Merger movements occurred when the economy experience3de sustained high rates of growth and coincided with particular developments in Business Environments
Mergers represent resource allocation and reallocation processes in the economy.
Firms respond to new investment and profit activities arising out of changes in economic conditions and technological innovations impacting industries.
Mergers rather than internal growth may sometimes expedite the adjustment process and in some cases be more efficient in terms of resource utilization.
1895-1904 Merger Movement
Consisted mainly of horizontal mergers
Resulted in high concentration in many industries including heavy manufacturing industries.
Period of rapid economic expansion.
Movement peaked in 1899 and almost ended in 1903
Downturn in 1901
Declined further by 1903 when the economy went into recession.
Major changes in econmic infrastructure and production technologies.
Completion of trans continental railroad system
The advent of Electricity
Increased use of coal
Development of National Economic market
Transformation of regional firms into national firms
Economies of Scale
Reasons for success
Astute Business Leadership
Rapid Technological and Managerial improvement
Development of New Products
Entry into new sub division of Industry
Promotion of Quality Brandnames
Commercial exploitation of Research
Reasons for Failure
Lack of efforts to realize economies of scale by modernizing plant and equipment
Increase in Overhead Costs
Lack of flexibility due to large size.
Inadequate supply of talent to manage a large group of plants.
The 1922-1929 Merger movement
Began with the upturn in Business Activity in 1922.
Ended with the severe economic slowdown in 1929.
Public utilities and Banking companies were most active.
About 60 per cent of the mergers occurred in the still fragmented food processing, chemicals and Mining sectors.
A large proportion of the mergers represented product extension mergers as in the cases of IBM, General foods and Allied Chemical
Market extension mergers in food retailing, department stores, motion picture theaters
Vertical Mergers in the mining and metals industries
Motivational factors of these mergers
Major developments in
The 1940-47 Merger Movement
Second world war and early post war years were accompanied by rapid growth of economy and an upsurge in merger activity.
Not very significant changes in Technological and Business environments
Merger movement was much smaller than the previuos ones
Circumvent price controls and allocations
Merger activity reached its highest level.
After 1969, economy slowed down
So did the number of mergers
Most acquirers were small or medium sized firms
Largest single category of firms was from the aerospace industry
This industry was subject to wide fluctuations in total market demand and
Abrupt and major shifts in product mix
Merger Trends since 1976
Following recession in 1974-75, the US economy entered into a long period of expansion during which M&As trended upwards
Have been concentrated in Service Industries as Commercial and Investment Banking, Finance, insurance, wholesale, retail, broadcasting healthcare and in the natural resources area.
Involved consolidation within the industry
Market extension and
Pure conglomerate acquisitions
Divestitures became a substantial portion of acquisition activity.
Effects on Concentration
Macro – Concentration
Micro - Concentration
High rates of divestitures is one of the reasons why not affected aggregate concentration in the economy.
Share of assets of the largest 200 US Corporations to the assets of all non financial corporations.
Historically the measure has been the share of the four largest firms of industry sales, assets, employment or the value added in Manufacturing
When the four firm concentration ratio exceeds 40 per cent, one view holds that competition in the Industry may be diminished to some extent
Concentration has stayed relatively constant during 1960s and 1970s.
Risk Arbitrage in M&A Activity
Arbitrageurs take advantage of temporary price discrepancies between Markets.
Buying the stock of takeover targets after a merger is publicly announced and holding the stock until the deal is officially consummated.
Purchases at a discount to its eventual value at the close of the merger.
By taking a position in the stock of target firms, risk arbitrageurs are , in effect, betting that the merger will be successful
Traditionally arbitrageurs have responded to announced takeover bids.
They evaluate the offer and assess its probability of success relative to the value of the target
Information is the principal raw material inj the arbitrage business
Arbitrageurs have in some cases attempted to anticipate takeover bids to establish their stock position in advance of any public announcement, thus increasing their potential return.