Corporate Finance Session 7 – Financing Corporate Acquisitions (focusing on Equity issuance events)
Using the example of Tesla & Solar City. (“Tesla-Solar City” HBS Case)
Link to the case
/!\ Corporate acquisitions don’t always rely on an equity issuance… companies can contract
debt or use their cash to buy the target...
Question is, what is the optimal way of financing the acquisition it for the
acquirer’s capital structure? A.k.a, to make the pie as big as possible?
Market value of Debt & Equity is typically used to value the operating assets of both parties
(as long as companies are publicly listed) + we use Market Value balance sheets to see
whether there is value creation embedded in the acquisition, and who are winners/losers.
+ Studying corporate governance means understanding the systems of incentives and
interests within a company through managers/shareholders … is everyone doing what they
do to create shareholder value? Are the decision-makers truly maximising shareholder value
of the company, or rather something else …? (Always to be kept in mind in an M&A context)
Why does Tesla want to acquire SolarCity, and is there compelling rationale for the
merger? As a Tesla shareholder, what would you think?
- Synergies
- Vertical integration
- But also a family affair (Musk’s cousin runs Solar City) > potential conflict of interests
as boards are intermingled across the 2 companies (Elon Musk holds 20% of SolarCity
as an individual investor already, so he has no/little incentive to try to get a cheaper
price for Tesla or even an overly expensive price for himself …)
- Same cultures and goals means reduced integration costs
o If you’re a Solar City shareholder, you want the highest possible price, but if
you’re a Tesla shareholder you want the lowest possible price…
There being a lot of people who are both makes the math harder
- The M&A operation could be distracting Tesla managers from new, more affordable
models they could produce and need to deliver to scale the company
- Bailing Solar City out after a fall in their Equity/Debt value in line with regulatory
change in the State of Nevada where they’re incorporated + bankruptcy of a few
competitors: are we bailing them out, buying them cheap?
o But what if they end up bankrupt and all I’m buying cheap is actually debt?
- Solar City does, in fact, have a lot of debt — their peculiar Business model [involving
20-year leases on solar plants and gear] depends on the price of oil and is quite risky!
o That makes the cashflows to existing Tesla shareholders more risky …
, - This will matter in the real business world because of the Cost of Financial Distress
which may then apply to Tesla by transfer, because of its acquisition (through Debt
Overhang, Asset Substitution, etc)
- « Solar lease » concept behind the Solar City business model implies a lot of
installation costs now for cashflows that will only fully come through in 20 years
o It is risky and it creates a major funding need …
o They need someone to bail them out > which could be a good opportunity for
Tesla if they have good fundamentals, plus the integration could create some
value long-term though …
Using the market to value acquisitions
- M&A’s goal is always to increase the size of the overall pie, and you want your slice
of the pie to become big enough for the merger to be worth conducting
o You want 2+2 to be equal 5
Example : Acquiring Company A and Target B
- The market always reacts to the announcement of an operation:
o If the acquirer’s stock price goes up, the market believes the acquisition is
good (creates value) for A shareholders — same for the price of B
o If the acquirer’s price goes down, the market believes the acquisition is value-
destroying for A — and same for B
- Stock returns around M&A tell us what the market expects in terms of gains and
losses in shareholder value for acquirer and target
o How to compute the data then?
Weighted sum of new returns/share prices on both stocks of the
new combined entity: is it larger than the weighted sum of prices
before? If yes, the size of the pie is increasing/considering to be
increasing by the market.
o It’s almost always a good thing for the target company: but whether it is a
good thing for the acquirer really depends, and can be seen through share
price delta analysis
Market-value Balance Sheets
- Entreprise value (w/out taking account of any cash the target holds):
o PV of the Capital Cash Flows = PV of the Free Cash Flows +/- all other
financing effects, aka costs & benefits of Capital Structure (tax shields, costs
of financial distress…)
Using the example of Tesla & Solar City. (“Tesla-Solar City” HBS Case)
Link to the case
/!\ Corporate acquisitions don’t always rely on an equity issuance… companies can contract
debt or use their cash to buy the target...
Question is, what is the optimal way of financing the acquisition it for the
acquirer’s capital structure? A.k.a, to make the pie as big as possible?
Market value of Debt & Equity is typically used to value the operating assets of both parties
(as long as companies are publicly listed) + we use Market Value balance sheets to see
whether there is value creation embedded in the acquisition, and who are winners/losers.
+ Studying corporate governance means understanding the systems of incentives and
interests within a company through managers/shareholders … is everyone doing what they
do to create shareholder value? Are the decision-makers truly maximising shareholder value
of the company, or rather something else …? (Always to be kept in mind in an M&A context)
Why does Tesla want to acquire SolarCity, and is there compelling rationale for the
merger? As a Tesla shareholder, what would you think?
- Synergies
- Vertical integration
- But also a family affair (Musk’s cousin runs Solar City) > potential conflict of interests
as boards are intermingled across the 2 companies (Elon Musk holds 20% of SolarCity
as an individual investor already, so he has no/little incentive to try to get a cheaper
price for Tesla or even an overly expensive price for himself …)
- Same cultures and goals means reduced integration costs
o If you’re a Solar City shareholder, you want the highest possible price, but if
you’re a Tesla shareholder you want the lowest possible price…
There being a lot of people who are both makes the math harder
- The M&A operation could be distracting Tesla managers from new, more affordable
models they could produce and need to deliver to scale the company
- Bailing Solar City out after a fall in their Equity/Debt value in line with regulatory
change in the State of Nevada where they’re incorporated + bankruptcy of a few
competitors: are we bailing them out, buying them cheap?
o But what if they end up bankrupt and all I’m buying cheap is actually debt?
- Solar City does, in fact, have a lot of debt — their peculiar Business model [involving
20-year leases on solar plants and gear] depends on the price of oil and is quite risky!
o That makes the cashflows to existing Tesla shareholders more risky …
, - This will matter in the real business world because of the Cost of Financial Distress
which may then apply to Tesla by transfer, because of its acquisition (through Debt
Overhang, Asset Substitution, etc)
- « Solar lease » concept behind the Solar City business model implies a lot of
installation costs now for cashflows that will only fully come through in 20 years
o It is risky and it creates a major funding need …
o They need someone to bail them out > which could be a good opportunity for
Tesla if they have good fundamentals, plus the integration could create some
value long-term though …
Using the market to value acquisitions
- M&A’s goal is always to increase the size of the overall pie, and you want your slice
of the pie to become big enough for the merger to be worth conducting
o You want 2+2 to be equal 5
Example : Acquiring Company A and Target B
- The market always reacts to the announcement of an operation:
o If the acquirer’s stock price goes up, the market believes the acquisition is
good (creates value) for A shareholders — same for the price of B
o If the acquirer’s price goes down, the market believes the acquisition is value-
destroying for A — and same for B
- Stock returns around M&A tell us what the market expects in terms of gains and
losses in shareholder value for acquirer and target
o How to compute the data then?
Weighted sum of new returns/share prices on both stocks of the
new combined entity: is it larger than the weighted sum of prices
before? If yes, the size of the pie is increasing/considering to be
increasing by the market.
o It’s almost always a good thing for the target company: but whether it is a
good thing for the acquirer really depends, and can be seen through share
price delta analysis
Market-value Balance Sheets
- Entreprise value (w/out taking account of any cash the target holds):
o PV of the Capital Cash Flows = PV of the Free Cash Flows +/- all other
financing effects, aka costs & benefits of Capital Structure (tax shields, costs
of financial distress…)
