Mergers and Acquisitions

Mergers and Acquisitions

31.10.2022

8 Mergers and Acquisitions

Terminology & History
Sources of Takeover Gains
Advantages & Disadvantages of Diversification
Empirical Evidence
Valuing Acquisitions
Financing Acquisitions
Management Defences

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 Mergers and Acquisitions

Reading List

Mandatory:
Hillier et al. (2012)[Ch. 20], Eckbo (2014)
Voluntary:
Eckbo et al. (2020)
Background:
Atanassov (2013), Andrade et al. (2001), Cai et al. (2011), Hasbrouck (1985), Moeller
et al. (2004), Ravenscraft and Scherer (1987), Wang (2018)

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Mergers and Acquisitions

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Terminology & History

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 Mergers and Acquisitions Terminology & History

Introduction

Mergers and/or Acquisitions are huge corporate investments

Potential to create or destroy value is large
Historically bad deals
Daimler-Benz & Chrysler (1998) - loss at least 30 bn USD - Source:
Click here
Microsoft & Nokia (2013) - loss at least 8 bn USD - Source: Click
here
Historically good deals
Google & Android (2005) - cost only 5 mn USD - Source: Click here
Walt Disnes & Pixar (2006) - cost 7.4 bn USD - Source: Click here
Important to study M&As carefully!

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 Mergers and Acquisitions Terminology & History

Terminology & Definitions

Merger: A merger is a transaction that combines two firms into

one new firm.
Acquisition: An acquisition is the purchase of one firm by another
firm or an individual/group of individuals.
Acquirer: Acquiring party, or bidder, taking over the target.
Target: Target firm or acquired firm.
Takeover premium: The difference between the prior share price
and the amount offered.
Often, lines between mergers and acquisitions are not clear cut →
Usage of M&A terminology
Tender Offer: Is an offer to purchase a certain number of shares
at a specific price and on a specific date, generally for cash.

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 Mergers and Acquisitions Terminology & History

Types of Deals
Friendly takeover
An offer made directly to the target firm’s management or board of
directors. Usually, target and acquirer management negotiate deal
characteristics.
Example: CVS health corp. acquiring health insurer Aetna Inc. Source:
Click here
Hostile takeover
The acquirer bypasses the target’s management and approaches the target
company’s shareholders directly with a tender offer for the purchase of their
shares. Sometimes, after a failed negotiation with target management.
Example 1: Sanofi acquisition of Genzyme. After unsuccessful friendly
takeover negotiations, Sanofi approached shareholders directly. Source:
Click here
Example 2: Kraft Heinz attempted acquisition of Unilever. After
unsuccessful friendly takeover negotiations, Kraft offered Unilever’s
shareholders a premium of 18% on their shares. The bid was
unsuccessful. Source: Click here

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 Mergers and Acquisitions Terminology & History

Types of Deals

Figure: Types of Deals.

Source: Hillier et al. (2012)

Categories are not mutually exclusive

Example: Elon Musk (attempted) purchase of Twitter
Strategic: Software complementarities between Tesla and Twitter?
Financial: Musk thinking Twitter is undervalued?
Conglomerate: Musk diversifying into the media industry?

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Terminology & Definitions

The greatest takeover activity occurred in the 1960s, 1980s,

1990s, and 2000s.
1960s: Known as the conglomerate wave
1980s: Known for hostile takeovers
1990s: Known for “strategic” or “global” deals
2000s: Marked by consolidation in many industries and the larger
role played by private equity

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 Mergers and Acquisitions Terminology & History

History & Merger Waves

Figure: History & Merger Waves

Source: Eckbo (2014)

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 Mergers and Acquisitions Terminology & History

Recent Deals I/II

Figure: Recent Deals 2010s

Top 20 deals in 2010s. †: Pending. Source: Click here

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 Mergers and Acquisitions Terminology & History

Recent Deals II/II

Figure: Recent Deals 2020s

Top 20 deals in 2020s. †: Pending. Source: Click here

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 Mergers and Acquisitions Terminology & History

Largest Conglomerates

Figure: Largest Conglomerates.

World’s largest conglomerates as of April 16, 2021, based on market value (in
billion U.S. dollars) Source: Click here
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 Mergers and Acquisitions Sources of Takeover Gains

Mergers and Acquisitions

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Sources of Takeover Gains

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 Mergers and Acquisitions Sources of Takeover Gains

Sources of Takeover Gains

Taxes
Financial synergies
Operating synergies
Industry effects
Management inefficiencies

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 Mergers and Acquisitions Sources of Takeover Gains

Taxes

Vary substantially across countries! Here only the main forces

which may be at play
Acquisition of Loss-Maker
Combined firm needs to pay taxes on consolidated profits
Reduction of the tax burden for the stand-alone firm =⇒ Value
increase
Realization of book value increase
Consolidated firm can increase target’s book value to fair value
With higher total assets =⇒ higher depreciation =⇒ higher
depreciation tax shield
Leverage effects
Typical transaction results in increased leverage
Interest tax shield

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 Mergers and Acquisitions Sources of Takeover Gains

Financial Synergies

Conglomerate may provide advantage of Internal Capital Markets

Conglomerates can provide funding for investment projects that
independent (smaller) firms would not have been able to fund
using outside capital markets.
To the extent that positive NPV projects receive funding they
would not have otherwise received, conglomerates create value.

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 Mergers and Acquisitions Sources of Takeover Gains

Operating Synergies

Horizontal merger benefits

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.
Elimination of competition
Vertical merger benefits
Economies of Vertical Integration - Control over suppliers can
reduce costs.
Combining Complementary Resources - Merging may result in
each firm filling in the “missing pieces” of their firm with pieces from
the other firm

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Industry Effects

Mergers as a use for surplus funds: If firm is in a mature industry

with few, positive NPV projects available =⇒ Acquisition may be
the best use of funds.
Industry Consolidation
Biggest opportunities to improve efficiency may be in industries with
too many firms.
Often triggers a wave of mergers and acquisitions =⇒ force
companies to cut capacity and employment =⇒ release capital for
reinvestment elsewhere in the economy.

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 Mergers and Acquisitions Sources of Takeover Gains

Management Inefficiencies

Disciplinary takeovers
Poor management may waste money, make poor decisions,
conduct improper risk/return investments, and harm the value of the
company =⇒ Acquiring the inefficient firm and replacing
management creates value
Even without a new management team, managerial incentives
usually change after takeovers
Management buyouts: Top manangement buys firms and takes privat
=⇒ managers become owners with increased equity stake
New shareholders/board change contracts with managers
Takeovers outcome of management inefficiency problems
Driven by managers’ desire to grow the “empire”
Driven by managers’ desire to hide bad organic performance by
acquiring good performing entities

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 Mergers and Acquisitions Advantages & Disadvantages of Diversification

Mergers and Acquisitions

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Advantages & Disadvantages of Diversification

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 Mergers and Acquisitions Advantages & Disadvantages of Diversification

Advantages of Diversification

Diversification enhances the flexibility of the organization.

The internal capital market avoids some of the information
problems inherent in an external capital market.
Diversification reduces the probability of bankruptcy for any given
level of debt and increases the firm’s debt capacity.
Competitors find it more difficult to uncover proprietary information
from diversified firms.
Diversification is advantageous if it allows the firm to utilize its
organization more effectively.

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 Mergers and Acquisitions Advantages & Disadvantages of Diversification

Disadvantages of Diversification

Diversification can eliminate a valuable source of information

which may, among other things, make it difficult to compensate the
division heads of large diversified firms efficiently.
Managers may find it difficult to cut back optimally on losing
divisions when they can subsidize the losers out of the profits from
their winners.

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 Mergers and Acquisitions Empirical Evidence

Mergers and Acquisitions

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Empirical Evidence

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Empirical Evidence - Announcement Reaction

The share prices of target firms almost always react favorably to

merger and tender offer bids.
The bidder’s share price sometimes goes up and sometimes goes
down, depending on the circumstances.
The combined market values of the shares of the target and
bidder go up, on average, around the time of the announced bids.

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Empirical Evidence - Announcement Reaction

Figure: Announcement Returns.

Source: Eckbo (2014)
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Empirical Evidence - Low bidder announcement

returns
Low bidder return = Acquisitions provide no benefits to acquiring shareholders?
Not necessarily...
Relative size:
Bidder is usually 10x size of target =⇒ Bidder return is automatically 1/10
of target return
Bidder announcement returns increasing in relative size of the target
(Moeller et al. (2004))
Anticipation of deal activity
Many studies focus on narrow windows of CAR, e.g., (-1,+1) window
CAR measure only unanticipated component of total economic benefits
For target: Being acquired is a very rare/one-time event =⇒ anticipating it
by market difficult
For bidder: Most bidders are frequent acquirers =⇒ market anticipates
some future acquisition activity =⇒ attenuates announcement returns
Bidder returns significantly higher after long periods without acquisition
(Cai et al. (2011))

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Empirical Evidence - Low bidder announcement

returns

Announcement of takeover bid may provide new information about

the bidder itself
Example
Suppose the acquirer expects tightened competition. Today’s value
$1000, but in the future (without merger) $500.
With the merger, the expected value of the acquirer will be $1500.
Suppose the bid is unlikely to win, with a bid-winning probability of
10%
Announcement return will be negative, as expected bidder value is
90% *$500+10%* $1500=$600
True gain of acquisition (+$500) obscured by revelation of bad news
(-$500)
Wang (2018): On average revelation effect -5% + average
acquirer gain +4% = average bidder announcement return -1%
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Empirical Evidence - Method of Payment

Bidder firms may pay for acquisition with cash or offering equity
stakes in their own firms (or comibnation of both)
Equity bids are associated with significantly worse annoucment
returns for bidder (Moeller et al. (2004))
Two potential reasons
Bidding firm more likely to use equity (cash) whenever it thinks its
equity is overvalued (undervalued) =⇒ equity offers reveal
negative information to the market
Cash offer signals that bidder is able to get backing from financial
institution =⇒ Equity offers reveal negative information about
bidder’s creditworthiness

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Empirical Evidence - Takeovers and Corporate

Innovation
Does the threat of an unwanted takeover promote or stifle
corporate innovation activity?
Agency view: Without a market for corporate control, manager’s
put little effort into innovation =⇒ Threat of takeover spurs
innovation
Undervaluation of hard-to-assess payoffs from R&D investments
=⇒ threat of becoming a target, reduces incentives to invest in
innovation
Evidence is more in line with corporate innovation being spurred
by an active M&A market (see Eckbo (2014) for details)
E.g., Atanassov (2013): Decline in innovation for firms
incorporated in states that pass antitakeover laws, relative to firms
in states that do not
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Empirical Evidence - Efficiency Gains

Do target firms perform better after a deal?
Ravenscraft and Scherer (1987): On average, acquired firms have
significantly worse post-merger profitability than non-acquired
control firms
Does acquisition cause worse performance? Not necessarily...
Often there is wealth transfer from targets to acquirer (transfer of
equipment, property, intellectual properties to acquirer at favorable
prices)
Bad performing firms become targets in the first place =⇒ targets
would (potentially) performed even worse without merger
(Hasbrouck (1985))
Andrade et al. (2001): Combined target and acquirer operating
margins improve post merger
Mergers in 60s and 70s (Ravenscraft and Scherer (1987)):
Diversification driven mergers =⇒ no improvements of profitability
Mergers in 80s: Mergers disciplining managers =⇒ improvements
of profitability
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 Mergers and Acquisitions Valuing Acquisitions

Mergers and Acquisitions

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Valuing Acquisitions

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 Mergers and Acquisitions Valuing Acquisitions

Valuing Acquisitions

Generally, an acquisition is not too different from standard

investments projects/stock investments =⇒ standard techniques
necessary - NPV, scenario analysis, multiple analysis, real option
Differences
For public targets, the current share price is a good benchmark for
current value of target
Acquiring firm needs to offer a takeover premium to convince
existing equity holders to sell
Implies: Combination of two firms has to generate additional value -
“synergies”
Current share price of target = Current operating value + Expected
Takeover Premium * Takeover Probability

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 Mergers and Acquisitions Valuing Acquisitions

Guide to Valuing Synergies

1 Valuation of Target as a Stand-Alone Firm:
-Estimate CFs, define appropriate discount rate, multiples
2 Compare to stock price and investigate differences:
-Share price also includes takeover probabilities and takeover
premiums
-Bidder may have information market does not have (often
provided from target firm in pre-negoation in friendly takeovers)
3 Value the synergies:
-estimation of CF synergies
-estimatation of cost of capital effects (diversification & new
WACC)
-real option of increasing/decreasing scale
4 Value the acquisition:
-Stand-alone target value + synergies
-If target can be acquired for less =⇒ positive NPV
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 Mergers and Acquisitions Financing Acquisitions

Mergers and Acquisitions

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Financing Acquisitions

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 Mergers and Acquisitions Financing Acquisitions

Financing Acquisitions

Acquisitions paid either in cash, equity, or both.

Figure: Method of Payment.

Source: Eckbo et al. (2020)

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 Mergers and Acquisitions Financing Acquisitions

Financing Acquisitions

Since early 2000s, cash is dominant payment method. Reasons...

Substantially less public firms since 1997 =⇒ offering equity is
harder for private firms
Increased preference for cash payments

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 Mergers and Acquisitions Financing Acquisitions

Considerations about Methods of Payments

Taxes
Capital gains tax liability for target shareholders
When target shareholders are paid in cash, capital gains tax is due
Not the case if they receive bidder shares
If they want, they could still sell bidder shares =⇒ all else equal
target shareholders would like to receive equity
Tax gains from leverage: Cash gains are usually financed by an
increase in debt =⇒ tax shield
Capital Structure
If firm is underlevered (overlevered) relative to optimal leverage
ratio =⇒ use acquisition and debt issuance (equity) to move
closer to optimal level

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 Mergers and Acquisitions Financing Acquisitions

Considerations about Methods of Payments

Information
Borrowing capacity: Target and/or bidder have a lot of intangible
assets =⇒ hard to value & difficult to use as collateral =⇒ harder
to get financing from financial institutions =⇒ more (less) likely to
use equity (cash) in transaction
If bidder thinks its equity is overvalued, more (less) likely to use
equity (cash)
Bargaining & Bidding: Huge topic on its own. Unfortunately, no
time to cover it here. If you are interested check out Eckbo et al.
(2020)

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 Mergers and Acquisitions Management Defences

Mergers and Acquisitions

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Management Defences

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Management Defences-Strategies
Example of takeover defences of incumbent managers
Greenmail
Buying back bidder’s equity at a premium
E.g., existing large shareholder demands actions or will acquire firm -
instead of implementing changes, firm buys back shares at premium
Staggered boards and supermajority rules
Some firms have supermajority rules when it comes to corporate
control: require 75% or even 90% of votes for major corporate
changes
Usual board member tenure 3y, but staggered. In a given year, only
1/3 of board can be replaced
Poison Pills - Some form of “wealth transfer” from acquiring shareholders to
target shareholders
E.g., Netflix in 2012 - Source: Click here
Activist investor Carl Icahn acquired almost 10% stake.
Netlix announced a “shareholder rights plan” =⇒ gives “regular”
investors the right to purchase new stocks at a discount if one
investors acquires a 10% state
Makes it more expensive to accumulate substantial stake
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Management Defences

Trade-off
Effective defences entrench management =⇒ weakens incentives
from market for corporate control
Shields management from corporate raiders: Long-term
investments may take long to realize value. If short-term
undervaluation triggers takeover, reduces incentives to invest
long-term
Evidence generally shows that takeovers promote corporate
innovation (slides “Empirical Evidence - Takeovers and Corporate
Innovation”)

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 Mergers and Acquisitions Management Defences

Conclusion

M&As are huge investments and substantial for value creation of

corporations
Reasons to conduct a merger range from financial and operating
synergies to the desire to replace inefficient incumbent managers
At announcement, target returns are usually positive, while bidder
returns are mixed =⇒ announcement also reveals info of
target/bidder, affecting valuation
Evidence on the efficiency of mergers is mixed, but more in line
with an active M&A market increasing efficiency

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 Mergers and Acquisitions Management Defences

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