MERGERS AND ACQUISITIONS

1. MERGERS AND ACQUISITIONS The Market for Corporate Control

2. M&A Activities • Mergers • Takeovers • LBOs • Compensation • Spin-offs, etc.

3. Definitions • Corporate control -- the power to make investment and financing decisions. • Corporate governance -- the role of the Board of Directors, shareholder voting, proxy fights, etc. and the actions taken by shareholders to influence corporate decisions. • Corporate structure -- the financial organization of the business.

4. Recent Mergers

5. Sensible Reasons for Mergers Economies of Scale A larger firm may be able to reduce its per unit cost by using excess capacity or spreading fixed costs across more units. $ Reduces costs $ $

6. Sensible Reasons for Mergers Economies of Scope or Vertical Integration • Control over suppliers “may” reduce costs. • Over integration can cause the opposite effect. Pre-integration (less efficient) Post-integration (more efficient) Company Company S S S S S S S S

7. Sensible Reasons for Mergers Combining Complementary Resources Merging may result in each firm filling in the “missing pieces” of their firm with pieces from the other firm. Firm A Firm B

8. Sensible Reasons for Mergers Combining Complementary Resources Merging may result in each firm filling in the “missing pieces” of their firm with pieces from the other firm. Firm A Firm B

9. Sensible Reasons for Mergers Mergers as a Use for Surplus Funds If your firm is in a mature industry with few, if any, positive NPV projects available, acquisition may be the best use of your funds.

10. Dubious Reasons for Mergers • Diversification • Investors should not pay a premium for diversification since they can do it themselves • Empire Building • EPS Game • EX: High PE firm buys Low PE firm -- resulting in higher EPS for merged firm (the bootstrap game)

11. Selling firm has low P/E ratio (due to low number of shares) After merger, acquiring firm has short term EPS rise Long term, acquirer will have slower than normal EPS growth due to share dilution. Dubious Reasons for Mergers The Bootstrap Game

12. Dubious Reasons for Mergers The Bootstrap Game

13. Dubious Reasons for Mergers EP Ratio (log scale) World Enterprises (after merger) World Enterprises (before merger) Muck & Slurry .10 .067 .05 Time Now

14. Sensible Reasons for Mergers • Unused Tax Shields • More Debt Capacity • More Tax Shield • Lower BK Costs

15. Sensible Reasons for Mergers • Inefficient Management (Agency Problems) • Management Controls • Capital Markets (mergers, takeovers, LBOs) • Other Managerial Controls • Board of Directors • Labor Markets (External & Internal) • Compensation Incentives (options)

16. Board of Directors • Independent? • Monitoring • Hire/Fire • Compensation • Strategic Planning

17. Estimating Merger Gains • Questions • Is there an overall economic gain to the merger? • Do the terms of the merger make the company and its shareholders better off?

18. Estimating Merger Gains • Economic Gain

19. Example: Snowbird & Alta Snowbird is examining the purchase of Alta, which would become a subsidiary of Snowbird if the merger goes through. The projected cash flow statement for Alta (if merged) is shown on the next slide. These cash flows include all synergistic effects. Alta’s market-determined beta is 1.63. The risk-free rate is 10 percent and the market risk premium is 5 percent. Alta has 10 million shares of stock priced at $6.25. What is the possible economic gain to this merger, if any?

20. Snowbird & Alta

21. Snowbird & Alta Discount Rate

22. Snowbird & Alta Terminal Value Assume: terminal growth rate of 10%

23. Snowbird & Alta Total Firm Value

24. Snowbird & Alta Possible Economic Gain = Merger Value - Pre-merger Value = $92.8 - $6.25 x 10,000,000 = $92.8 - $62.5 = $30.3 million

25. Snowbird & Alta Change in Stockholders’ Wealth Snowbird (Acquirer) Alta (Target) Bargaining Range = Synergy Price Paid for Target $62.5 $92.8

26. Proxy Contest Tender Offer Acquisition Merger Leveraged Buy-Out Management Buy-Out Takeover Methods Tools Used To Acquire Companies

27. Takeover Defenses White Knight - Friendly potential acquirer sought by a target company threatened by an unwelcome suitor. Shark Repellent - Amendments to a company charter made to forestall takeover attempts. Poison Pill - Measure taken by a target firm to avoid acquisition; for example, the right for existing shareholders to buy additional shares at an attractive price if a bidder acquires a large holding.

28. Leveraged Buyouts • The difference between leveraged buyouts and ordinary acquisitions: 1. A large fraction of the purchase price is debt financed. 2. The LBO goes private, and its share is no longer trade on the open market.

29. Leveraged Buyouts • The three main characteristics of LBOs: 1. High debt 2. Incentives 3. Private ownership

30. Leveraged Buyouts 10 Largest LBOs in 1980s and 1997/98 examples

31. Phillips Petroleum Case Philips balance sheet was dramatically changed by its leveraged restructuring (figures in $billions).

32. Spin-offs, etc. • Spin off -- debut independent company created by detaching part of a parent company's assets and operations. • Carve-outs-- similar to spin offs, except that shares in the new company are not given to existing shareholders but sold in a public offering. • Asset Sales-- the sale of the assets of a division to other firms .

33. EXIT (Overcapacity) • Capital Markets • Internal Control Mechanisms • Regulation and Legal System • Product and Factor Markets • (Michael Jensen’s arguments) Is M&A good or bad for economic efficiency?

34. Summary • M&A is Corporate Control Activity • Many Sensible Reasons for Mergers • Measure the Gains to Merger • New cash flows from synergies • Discount rate • DCF Analysis • Other M&A Activities • The Role of M&A Activity for the Economy