This document provides an overview of the principles of valuation for mergers and acquisitions. It discusses key terms like mergers, acquisitions, and types of M&A deals. It also outlines common motives for M&A like strategic gains, financial benefits, and managerial motives. The mechanics of an M&A deal including antitrust laws and accounting treatment are summarized. The document uses the AOL-Time Warner merger as a case study, outlining the motives and valuation of the two companies at the time of the announced deal.

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The Principles of Valuation of Merges and Takeovers
AOL-Time Warner Analysis
Chompunud Phiromjit 15659
Thi Trang Nhung Nguyen 15714
Thien Ai Nguyen 15838

2. +
Agenda
 Definition
 Types of Merger and Acquisition
 Motives for Merger and Acquisition
 Mechanics of a Merger
 Merger Gains and Cost
 Q&A
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Definition
 Merger: Two relative equal-sized companies mutually decide
to pool their interest to form a single corporation
3
3

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Definition
 Acquisition: when companies purchase one another, sometimes under
hostile circumstance
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Types of M&A
Pfizer
$64.5 Billion
Wyeth
Horizontal Merger
 Combination of two firms in the same lines of businesses
Pharmaceuticals Industry Computer Industry
Hewlett-
Packard
$87 Billion
Compaq
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Types of M&A
Vertical Merger
 Combination of two firms at different stages of production
Source of
Raw Materials
Buyer
Consumer
Supplied content to consumers
through properties
distributed such information via its
internet service
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Types of M&A
Conglomerate Merger
 Combination of two firms in unrelated lines of businesses
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Motives for M&A (1)
STRATEGIC MOTIVES
Extension
In term of geography,
products or market
Consolidation
Increase scale,
efficiency and market
power
Capabilities
Enhance
technological know-
how
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Achieving Economies of scale
(Horizontal merger)
Industry consolidation
Complementary Resources
(AOL vs Time Warner)
Marketing gains
- Media program
- Balanced product mix
- Distribution network

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Motives for M&A (2)
FINANCIAL MOTIVES
Financial
efficiency
Strong balance
sheet (Cash rich) vs
Weak balance
sheet (High debt)
Tax efficiency
Reducing the
combined tax
burden
Asset stripping or
unbundling
Selling off bits of the
acquired company
to maximize asset
value
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Surplus fund Net Operating
Losses
Unused Debt
Capacity
Asset Write-ups

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Motives for M&A (3)
MANAGERIAL MOTIVES
Personal
ambition
Financial
incentives,
boosting personal
reputation
Bandwagon effect
-Avoiding being
deemed
conservative
manager
-Pressure of
shareholders
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Eliminating
inefficiency
A nature resulted
from poor
management

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In case of AOL and Time Warner
A dominant players in entertainment contents distribution
Lacked of material for making its internet presence
A dominant in Internet service Provider
Increased competition
The demise of dial-up
Substitution of broadband
Under the pressure to diversify and differentiate its content
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The advanced technology possessed by rivals
Loss 100$ for thriving internet performance.
Established 1983
1991: Renamed America Online
1992: In NASDAQ
Share price: Increased 8 times (1992-
1999)
April 2, 2000: the first Internet firm to join
the Fortune 500, ranking at 337

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In case of AOL and Time Warner
THE MOTIVES TO BE CONSIDERED
Complementary resources
12
Dial-up infrastructure Content
Dominance in ISP
Dominance in Entertainment
content
Consolidation market power

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Mechanics of a Merger
Antitrust Law
Clayton Act of 1914 - forbids an acquisition whenever
“in any line of commerce or in any section of the
country” the effect “maybe substantially to lessen
competition or to tend to create a monopoly”
STOP
Justice
Department
The Federal
Trade
Commission
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Mechanics of a Merger
Antitrust Law : AOL and Time Warner
 27th July 2000 : AOL and Time Warner combined control 20
percent of the nation's cable lines and 40 percent of the
Internet access market.
 4th Sep 2000 : FTC is preparing to block the merger unless
the two companies agree to keep cable lines open to
competitors
 14th Dec 2000 : FTC approves AOL's merger with Time
Warner but commissioners still wrestle over potential
conditions to the deal
 11th Jan 2001 : FTC clears the way for the merger.
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Merger Accounting : Purchase method
Mechanics of a Merger
Balance Sheet of A
NWC 20
FA
80
30 D
70 E
100
100
Balance Sheet of B
NWC 1
FA 9
0 D
10 E
10 10
Balance Sheet of AB
NWC
21
FA
89
Goodwill 8
30 D
88 E
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Tax Consideration
Mechanics of a Merger
Taxable Tax-free
CASH
SHARE

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Evaluating bids
 Cost of merger: premium that buyer pays over the seller’s
stand-alone value, equals Target shareholders’ gain
 Stand-alone value
- Intrinsic/present value (PV)
- Market value (MV) (May be wrong estimated)
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Merger Gains and Costs
SynergyPVPVPVPVGain ABBAAB  )(
 


T
t
t
t
r
CF
Synergy
1 )1(
NPV = Acquirer’s gain
Synergies
NPV
Cost Cost = Target firm’s gain
CostGainNPV 
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Cost of merger when financing by cash
BPVCashpaidCost 
)( BAB PVcashpaidPVCostGainNPV 
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Cost of merger when financing by stock
 N: Number of shares offered for buying
 x: B’s fraction of combined firm
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BAB PVPNCost 
BAB PVxPVCost 

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Case study: Company valuation
The four most commonly used techniques are:
 1.Discounted cash flow (DCF) analysis
 Free cash flow to the firm model
 Free cash flow to equity model
 Adjusted present value model
 Option-pricing models: Real option analysis
 2.Multiples method
 3.Market valuation
 4.Comparable transactions method
Copyright © 2013 CFA Institute
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FCFF vs. FCFE Approaches to
Equity Valuation
 1
FCFE
Equity value
1





t
t
t
r
22


 

1 )1(t
t
t
WACC
FCFF
valueFirm
FCFF: Free Cash Flow for Firm
FCFE: Free Cash Flow for Equity

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1
1
FCFF
Firm value
WACC
Equity value Firm value Debt value
FCFE
Equity value


 


g
r g
MV(Debt) MV(Equity)
WACC (1 Tax rate)
MV(Equity) MV(Debt) MV(Equity) MV(Debt)
      
           
          
r rd
23
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WACC : Weighted Average Cost Of Capital
g: growth in FCFF till infinite
Single-Stage Free Cash Flow Model

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Determine FCFF
Some possible ways
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 FCFF NI NCC Int 1– Tax rate – FCInv – WCInv  
 
   
FCFF EBIT 1– Tax rate Dep – FCInv – WCInv
FCFF EBITDA 1– Tax rate Dep Tax rate – FCInv – WCInv
 
 
 FCFF CFO Int 1– Tax rate – FCInv 

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Case study: Company valuation
 AOL (in million)
Y1999 Y1999
capital expenditures 355 Beta 1.69
CFO 1099 tax rate 0.39
Int exp 638 Cost of debt after tax 0.05
Debt ratio 0.003
Rm-Rf 0.057
Cost of equity 0.05
WACC 0.6896
FCFF (t=0) (with CFO) 1133.18
g 0.01 0.02 0.03 0.04 0.05 0.06 0.07
Firm value 8115.61 8821.48 9644.00 10614.69 11777.55 13195.91 14964.36
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Case study: Company valuation
 TWX (in million)
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Y1999 Y1999
capital expenditures 2231 Beta 2.043
CFO 3953 tax rate 0.44
Int exp 1913 Cost of debt after tax 0.05
Debt ratio 0.81
Rm-Rf 0.057
Cost of equity 0.171
WACC 0.0730
FCFF (t=0)(with CFO) 2793.28
g 0.01 0.02 0.03 0.04 0.05 0.06 0.07
Firm value 44765.12 53734.58 66873.70 87970.47 127394.28 227364.98 988829.93

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AOL TWX
 Market value (Jan 2000)
185.3 billion
 Value evaluated (in million)
 Market value (Jan 2000)
83.7 billion
 Value evaluated (in million)
g 0.05 0.06
Firm
value 11777.55 13195.91
g 0.05 0.06
Firm
value 127394.28 227364.98
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Case study: AOL–Time Warner Merger
 Announced: Jan 10, 2000; Approved: Jan 11, 2001
 Aim: “Create the world’s first fully integrated media and
communication company for the internet century”
 AOL and Time Warner will each become subsidiaries of AOL
Time Warner,
 Structured as Stock combination, valued at $350billion
 AOL had higher market capitalization => it owned 55% of new
company
 AOL – Time Warner to trade under ticker AOL
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Case study: AOL – TWX (Cont)
 Valuing at the time of announcement (Jan 10, 2000)
 http://money.cnn.com/2000/01/10/deals/aol_warner/
 Assuming market’s right => Using market value:
 = 0.45 * 350bil – 83.7bil = 73.8bil
 Gain =
= 350bil – (185.3bil + 83.7bil) = 81
 NPV = Gain – Cost = 7.2bil
BAB PVxPVCost 
)( BAABAB PVPVPVPV 
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Case study: AOL - TWX
 Intrinsic value
with g=5% (until forever), then
PV(A) = 11.78bil
PV(B) = 128.18bil
 = 0.45 * 350bil – 127.4bil =
30.1bil
 Gain =
= 350bil – (11.78bil + 127.4bil) = 210.82
 NPV = Gain – Cost = 180.72bil
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BAB PVxPVCost 
)( BAABAB PVPVPVPV 

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Case study: AOL Time Warner- Story
ends in Books as disaster
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Q & A
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Reference
Book
 Brealey R.A., Myers S.C., Allen F. (2011) Principles of Corporate Finance,10th edition, McGraw Hill,
P.792-816
 Stephen, A.Ross, Randolph W.Westerfield (2002) Fundamentals of Corporate Finance, 6th Edition,
McGaw Hill, P.846-854
 Newyork University (Fall 2009), AOL-Time Warner: Leadership in Organizations, Newyork University
 David Hillier, M.Grinblatt, S.Titman (2012) Financial Markets and Corporate Strategy, 2nd Edition, McGraw
Hill, P.646-675.
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Reference
Website
 Hewlett-Packard (2001) Hewlett-Packard and Compaq agree to merge, creating $87 billion global technology leader,
Available from http://www8.hp.com/us/en/hp-news/press-release.html?id=230610#.U3-QKFiSxy8 [Accessed 21 May
2014]
 Investopedia (2009) The wonderful world of Mergers , Available from
http://www.investopedia.com/articles/stocks/09/merger-acquisitions-types.asp [Accessed 15 May 2014]
 Washingtonpost (2005) Timeline: AOL and Time Warner, Available from http://www.washingtonpost.com/wp-
dyn/content/article/2005/10/28/AR2005102800747_pf.html [Accessed 20 May 2014]
 Federal Communications Commission (2014) America Online-Time Warner Merger Page, Available from
http://www.fcc.gov/encyclopedia/america-online-time-warner-merger-page [Accessed 20 May 2014]
 Boston College (2005) Valuation Techniques, Available from
http://www.bc.edu/clubs/bcfa/docs/vault/Valuation%20Techniques.pdf [Accessed 23 May 2014]
 CFA Institute (2010) Free Cash Flow Valuation, Available from
http://www.cfainstitute.org/learning/products/publications/inv/Documents/equity_chapter4.pptx [Accessed 21 May 2015]
 Business Insider (2009) Chart of the day: AOL Time Warner’s Marriage Made in Hell, Available from
http://www.businessinsider.com/chart-of-the-day-time-warner-aol-2009-5 , [Accessed 19 May 2014]

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 The Newyork times (2009) 10th Anniversary of AOL-Time Warner Merger, Available from
http://www.nytimes.com/interactive/2010/01/11/business/20100111-merger-timeline.html?_r=0 [Accessed 19 May
2014]
 McGraw Hill (2007) Behavioral Corporate Finance, Available from http://highered.mcgraw-
hill.com/sites/dl/free/0072848650/315497/Chap10.ppt [Accessed 18 May 2014]
 Imaa Institute (?) Statistics Merger and Acquisition, Available from http://www.imaa-institute.org/statistics-mergers-
acquisitions.html#TopMergersAcquisitions_Worldwide [Accessed 18 May 2014]
 CNN (2000) That’s AOL folks, Available from http://money.cnn.com/2000/01/10/deals/aol_warner/ [Accessed 20
May 2014]