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
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
Cross Border M & A
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
a growing company in a given industry grow rapidly without having to create a new business entity.
Purchase of one company by another company.
Newly Formed Company
TYPES OF ACQUISITIONS
Acquiree or merging is or isn’t listed in public markets.
How the communication is done and received by the target.
THE FIRST CLASSIFICATION
PRIVATE (IF ACQUIREE NOT LISTED IN PUBLIC MARKETS
PUBLIC (IF ACQUIREE LISTED IN PUBLIC MARKETS)
THE SECOND CLASSIFICATION
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.
Companies cooperate in negotiations.
Synonymous to merger of equals.
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.
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.
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
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
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:
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.
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.
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 GlaxoWellcome 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
Historical Earnings Valuation
Future Maintainable Earnings Valuation
Discounted Cash Flow Valuation
Valuations are made for:
Excess or restricted cash
Other non-operating assets and liabilities
Lack of marketability discount
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:
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
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.
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
Mainly statistical and historical
Compare national or industry stock performance to economic and market fundamentals like:
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:
Discount rate used is Weighted Average Cost of Capital (WACC).
METHODS OF PROJECT APPRAISAL
Flow To Equity 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
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:
With pure cash deals, no doubt on real bid value.
Contingency of share payment removed.,
Cash offer preempts competitors.
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.
Stock will create flexibility.
Transaction costs also to be considered but tend to have greater impact.
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
Geographical or other diversifications
Absorption of similar businesses under single management.
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.
Managerial economics such as increased opportunity of managerial specializations.
Purchasing economies due to increased order size and associated bulk buying discounts.
A bank buying a stock broking firm
Manufacturer acquiring and selling complementary products.
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.
Designed to smooth company earnings
Smoothens stock price
Gives conservative investors more confidence
But does not always deliver value to shareholders.
Resources unevenly distributed across firms.
Can create value by
Overcoming information asymmetry
Combining scarce resources
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.
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.
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.