Mergers and Acquisitions

Mergers and Acquisitions External growth and restructuring
of firms.
Jyoti Gupta
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Market for corporate control
•Mergers and acquisitions are part of the broader market for corporate control. It is not only acquisition of company by another, it includes spin-offs, divestitures, restructurings of capital structure, buy-outs and buy out of public companies by groups of private investors. The ordinary mergers involve combination of two established firms.
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Mergers
•Horizontal mergers: between two firms in the same line of business. Acquisition by Altadis of Régie des Tabacs du Maroc, Acquisition, Total-Fina and Elf etc. Alcatel and Lucent which merged officially on the 1 December 2006.•Vertical Mergers:companies at different stages of production; Disney and ABC television. •Conglomerate merger: unrelated line of business; Vivendi and Seagram.
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Rationale of mergers
•The rationale behind any merger operation is to create value for the shareholders. This also supposes that all other stakeholders would be better-off if the merger operation is carried through.
•All other motives are secondary.
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Motives for mergers (Efficiency
gains)
•Economies of scale.
•Increased revenues/ increased market share •Improved productivity through cost cutting •Surplus funds.
•Economies of scope.
•Reusability of information.
•Reputational spill over.
•Better product mix.
•Resource transfer by overcoming information asymmetry or by combining scarce resouces.
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Strategic reasons
•Increased competition
•Domino effect.
•Too big to fail.
•Empire building.
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M&A process
•Many firms have a pro-active approach to M & A operations as a source of growth, value creation and restructuring.
•They could be friendly or hostile. In case the firms are listed, the operations are subject to clearance from regulatory authorities. The authorities want to make sure that the operation will not lead to creation of a monopoly. The case Schnieder and Legrange, the European Commission refused the merger between the two.
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M&A process
•In the case of listed companies, the acquiring company makes a take-over bid for the target company. An offer is made to the shareholders of the company (cash,
exchange of shares, or a mix of the two).
•In a friendly bid, the Board of Directors of the two companies agree to the proposition. The Board
recommends to shareholders to accept the offer by the acquiring company. The post merger strategy is jointly agreed upon.
•In a hostile bid, the target company board recommends to the shareholders to refuse the offer.
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M&A Process (A pro-active approach by
Acquiring company)
•Clear definition of objectives and goals.
• A preliminary analysis of possible target companies.
•Estimation of possible synergies, timing and probability.
•Valuation of the target company, stand alone and as a merged company.
•Preparation of an offer, including a due diligence report from the investment bank.
•Final offer.
•Negotiation and settlement.
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Role of the investment banks
•The investment banks play an important role in the M&A operations.•The aquiring company and the target company would normally appoint an investment bank (may be more than one) as advisers in the operation.
•They advise at all stages of the operations, which includes the valuation, synergy valuation, structure of the deal, carry out the due diligence, provide funding gurantee, funding and post merger
support in putting the new business model in place.
•These operations represent a significant part of their revenues.•Most investment banks have M&A departments, which are often divided in sectors (Telecommunications, agro, commodities etc).•The investment banks often are at the source of operation, advising companies on the likely targets.
•These operations are called pitching; preparing the necessary documents to present to potential acquirers.
•They represent a significan part of the revenues.
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Due Diligence (an example)
•Material Adverse Effect:
•This clause in the due diligence document can enable the Acquiring company to walk away from the deal even once the final offer is
made.
•The Bank of America (BofA) purchase of Merrill Lynch, is a good example.
•The Bof A agreed to buy Merrill Lynch for $50 billion in stocks,or $29 share, in December 2008.
•Once the offer was made, the BA executives started having doubts, as ML started to show losses. By the end of the month, the losses exceeded $13 billion.
•Most of the losses were coming from trading department, ans also the wealth management unit.
•BofA executives discussed the possibility citing «Material Adverse Effect »clause to severe the contract.
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Merger gains and costs
•Gain = PV(A+B) –PV(A)-PV(B)
•PV(A), PV(B) and PV(A+B), being the values of the firms A , B stand alone and the two firms if they merge. Merger is justified only if there is a synergy gain.
•Cost to the acquiring firm A is given by
cost=Cash paid-PV(B).
•The synergy gain is usually shared between the acquiring firm and the shareholders of the target firm.
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Paid in stocks: example
•Bidder or Acquiring company, share price 200, number of shares 200; PV(A) =40000
•Target company B, share price 100, number of shares 100, PV(B) = 10000
•New Company after merger (A+B), has 260 shares, shares are trading at 230, PV(A+B)= 59800. The
synergy gains as estimated by the market is 9800.
• A pays the shareholders of B, 60 shares of A. An exchange ratio of 60/100 ,ie0.6 shares of A for each
share of B.
•Cost to the shareholders of A of the operation =60/260 x59800=13800-10000=3800.
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Merger accounting, an example
•We look at two companies A and B
•Company A is the acquirer and the company B is the target.
•The balance sheets are given. The Shareholders equity of the target company B is 1000.
•Company A pays a premium of 500 to the shareholders of B. The purchase price is 1500. It might be paying for the intangible assets, which are not in the balance sheet.
•Under the purchase method, the accountant takes of this by creating
a new asset called goodwill and assigns 500 to it in the balance
sheet of the merged company.
•The shareholders equity of the merged company = 2800 + 1000 + 500 = 4300. The equity of the merged company goes by the value of the premium paid.
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Goodwill and Taxation •Goodwill are not allowed to be amortized.
•Suppose the goodwill (premium paid over the book value) is €10 million.
•As long as the goodwill is estimated to be at least €10 million, it stays on the balance sheet and it has no
impact on the company’s earnings.
•The company is obliged each year to estimate the fair value of the goodwill.
•If the estimated value falls below the €10 million, the amount shown in the balance sheet must be adjusted downward and the write-off deducted from the year’s
earnings. The example of AOL, write-off $54 billion.
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Tax Considerations
•An acquisition may be either taxable or tax-free.
•In general, if the payment is in cash, the acquisition is considered as taxable.
•Investors pay capital gains tax.
•If payment is essentially in shares, the operation is considered to be tax free, as they are simply exchanging shares.
•The tax status of the acquisition also effects the tax paid by the merged firm afterwards.
•In the case of a taxable acquisition, the assets of the selling firm are revalued, the write-up or write-down is treated as taxable gain or taxable loss. The depreciation is calculated on the basis of the restated asset values.
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Tax considerations: an example
•The Norman Shipping Company buys a tanker for $20 million.This is the only asset owned by the company. It is depreciated over 20 years linearly; yearly depreciation = $1 million. The Norman was acquired by Pat Shipping corporation after 10 years for $15 million. What would be tax liabilities if it was a taxable merger or a tax-free merger?
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Takeover defenses
•Given the increasing number of firms which are likely to be target, management team try to develop tactics and weapons of defense. These are used in the case of hostile take-over bids. •Increasingly, govenments are intervening to stop foreign companies taking over national companies ( Sanofi Synthelabo, Danone, Arcelor).
•Major motivation being, firstly managers believe their jobs will be at risk, secondly they would like to obtain a higher price from the bidders.
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Merger and antitrust law
•Most countries have antitrust laws, which forbids acquisitions if it leads to the lessening of competition and creation of monopolies.•In the US, the Clayton Act (1914), forbids an acquisition whenever the effect may limit and restrict competition.
•The European Community has strict antitrust laws. An acquisition is forbidden if it leads to the creation of a company which holds more than 50 percent of market in any one European country or more 30 % of the Euopean market.
•The proposed merger between GDF and Suez is being scrutinized by the European Antitrust commission on the question of monopoly.•The investment banks should ensure that the merger will not be prohibited as part of the due diligence.
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M&A:General observations
•The analysis of the M&A operations in the past gives some interesting results:
The sellers generally do better than buyers.
The average gain of the shareholders of the target company was around 16 percent.
The shareprices of the acquiring company decline on average.
Studies show that a significant proportion of M&A operations destroy value.
The question is why ? This is explained by behavioral finance. The
managers of acquiring companies may be driven by hubris or
overconfidence in their ability to run the target company than the existing managers.
Another explanation is based on signalling effect of an merger
announcement; the firm can grow by greenfield investment or acquisition.
The acquisition is justified when the overall market is not growing. Therefore the firm value might drop simply because the market interprets that the
sector growth is limited.
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Observations
•Why sellers get higher returns:
–Premium paid because of competition
–Get a share of the estimated synergy
–Target management may put obstacles, white knight, antitrust law, poison pill to push the
price up.
The other major winners are of course the
investment banks, lawyers, accountants,
arbitrageurs etc.
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Take-over bid by Sanofi-Synthélbo for
Aventis(25 January 2004)•Objective: Strategic project for a sustainable strong growth and profitability.
•The details were as follows:
•An offer based on exchange of shares and cash payment: 5 SS shares + 69€for 6 Aventis shares.
• A supplementary offer (cash or exchange) cash offer: purchase of Aventis share for 60.43€. Exchange offer: Exchange 35 SS shares for 34 shares of Aventis.•Shareholders were given the possibility to choose a mix of the above two possibilities.
•The overall offer was based on 81 % of exchange of shares and 19 % in cash.
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