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Mergers and Acquisitions
Arzac, Chapter 9
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Mergers many people including Warren Buffett have expressed skepticism of
the power of mergers: Many managements apparently were overexposed in
impressionable childhood years to the story in which theimprisoned handsome prince is released from a toads body by a
kiss from a beautiful princess. Consequently, they are certain theirmanagerial kiss will do wonders for the profitability of CompanyT(arget) Investors can always buy toads at the going price fortoads. If investors instead bankroll princesses who wish to paydouble for the right to kiss the toad, those kisses had better packsome real dynamite. Weve observed many kisses but very fewmiracles. Nevertheless, many managerial princesses remain
serenely confident about the future potency of their kisses evenafter their corporate backyards are knee-deep in unresponsivetoads We have tried occasionally to buy toads at bargain priceswith results that have been chronicled in past reports. Clearly ourkisses fell flat. We have done well with a couple of princes butthey were princes when purchased. At least our kisses didnt turnthem into toads. And, finally, we have occasionally been quitesuccessful in purchasing fractional interests in easily identifiable
princes at toadlike prices.
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M&As changing forces driving mergers:
technological change
globalization and freer trade deregulation
economies of scale, scope, and technological catch-up
change in industry organization
individual entrepreneurship
macroeconomic factors** Weston, Siu, and Johnson (2001)
mergers vs. tender offers
types
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Control of Decision Powers
compensation arrangements
proxy contest premium buy-backs (greenmail)
takeover defenses
stakeholder relationships ethics and reputation
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Theories of Mergers
efficiency increases (restructuring)
operating synergies financial synergy
information
hubris agency problems
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Pattern of Gains Related to Takeover Theories
(with value changes referring to movements in prices of securities of firms)
Motive Total Gains Gains to Target Gains to Acquirer
Efficiency and/or synergy + + +
Hubris 0 + -
Agency problems - + -
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Example 1 Assume the buyer acquires a debt-free target for
$100 cash, the targets tax basis in the assets is $40,
the target shareholders basis in the stock is $15, andthe fair MV of the stock was $70 prior to theacquisition. Let the corporate tax rate be 40%, thepersonal tax rate on capital gains be 20%, andassume that all the gain to the seller is classified as
capital gain and the buyers price in excess of thetargets basis is allocated to goodwill. Look at theproceeds to the target using both a stock purchaseand an asset purchase.
Review Example 2 and 3 in the text.
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Returns in M&As Kaplan and Weisbach (1992), Servaes (1991),
and Mulherin and Boone (2000)
mergers in banking industry
Becher (2000) looked at because of increasednumber of bank mergers that occurred aroundindustry deregulation
evidence that bank mergers created wealth
target returns
bidder returns
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Value of Mergers VC = VA + VT + Synergies Cash Premium = PT VT Premium = pc*m + cash Acquirers Gain = Synergies Premium Acquirers Gain + Sellers Gain = Synergies pC = VC/ (n + m)
or pC = (VA + VT + Synergies Cash)/(n + m)where n = # of old shares of acquirerand m = # of shares issued to target shareholders Break-Even Synergies = Premium = mpA + Cash VT GainA = Synergy - Premium
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Accretion/Dilution Analysis alternate way to look at the impact of the
merger to the shareholders of the acquirer
find pro-forma EPS for merged firm for yearprior to merger and then years after also
for share exchange, combine NI and divide by
new number of shares outstanding if new EPS is > EPS of acquirer, then there is
accretion if new EPS < EPS of acquirer, then thereis dilution
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Merger Analyses
terms of the merger
financing the merger break-even synergies
financial model of the merger
accretion-dilution analysis free cash-flow valuation
stress-testing and scenario analysis
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Balance Sheet XYZ Inc. as of 12/31/2004
Cost Fair Value
Current Assets
Cash and marketable securities 14,000 14,000
Accounts Receivable 86,702 81,523Inventories
Raw Materials 34,671 45,123
Works in Progress 18,790 19,342
Finished Goods 70,415 85,457
123,876 149,922
Other Current Assets 11,500 11,500
Total Current Assets 236,078 256,945
Investments 25,460 38,634Net PP&E 987,234 1,470,381
Intangible Assets 265,211 143,782
Total Assets 1,513,983 1,909,742
Current Liabilities
ST Debt and Current LTD 43,784 42,512
Accounts Payable 56,234 54,318
Accrued Expenses 2,840 2,840
Taxes Payable 8,128 8,128
LT Debt 335,578 310,456
Deferred Income Taxes 8,561 8,561
Total Liabilities 455,125 426,815
Preferred Stock 249,870 229,455
Common Stock and Retained Earnings 808,988 1,253,472
Total Net Worth 1,058,858 1,482,927
Total Liabilities and Equity 1,513,983 1,909,742
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Balance Sheet XYZ Inc. as of 12/31/2004
ABC XYZ Eliminations and Adjustments
Current Assets Debit Credit Consolidat
Cash and marketable securities 34,021 14,000 48,021Accounts Receivable 196,032 81,523 277,555
Inventories 298,723 149,922 448,645
Other Current Assets 30,044 11,500 41,544
Total Current Assets 558,820 256,945 815,765
Investments 1,554,230 38,634 1,500,000 92,864
Net PP&E 3,568,229 1,470,381 5,038,610
Intangible Assets
Goodwill 246,528 246,528Other 789,541 143,782 933,323
Total Assets 6,470,820 1,909,742 7,127,090
Current Liabilities
ST Debt and Current LTD 67,834 42,512 110,346
Accounts Payable 108,340 54,318 162,658
Accrued Expenses 4,567 2,840 7,407
Taxes Payable 12,690 8,128 20,818
LT Debt 1,890,450 310,456 2,200,906
Deferred Income Taxes 32,189 8,561 40,750
Total Liabilities 2,116,070 426,815 2,542,885
Preferred Stock 229,455 229,455
Common Stock and Retained Earnings 4,354,750 1,253,472 1,500,000 246,528 4,354,750
Total Net Worth 4,354,750 1,482,927 4,584,205
Total Liabilities and Equity 6,470,820 1,909,742 7,127,090
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Bs acquisition of T
B T
Pre-announcement stock price $ 30 $ 22
Net income (million) $ 80 $ 37.50
Shares outstanding (million) 40 15
EPS $ 2.00 $ 2.50
P/E 15 8.8
Market value (million) $1200 $330