Samenvatting SFM
Lecture 1: Introduction to M&As
The market for corporate control
● Acquirer = buyer of the firm
● Target = seller of the firm
Merger waves = peaks of heavy activity followed by quiet troughs of few transactions in the
takeover market
Types of mergers
● Horizontal merger = the target and acquirer are in the same industry on the same
level of the supply chain
● Vertical merger = a merger that occurs when two companies in different stages of
production join together to form a single company
● Conglomerate merger = the target and acquirer operate in unrelated industries
Method of payment
1. Cash = the target’s shareholders receive a cash payment for their stock (from the
acquirer)
● The most common and simplest form
● The identity and ownership structure of the acquirer remains unchanged
● The acquirer is often/always much bigger than the target
● The acquirer must compensate the tax that the shareholders have to pay on
their capital gains
2. Stock swap = the target’s shareholders are swapping ‘old stock’ (=stock from the
target’s company) for new stock in either the acquirer’s firm or newly created firm
● Both the acquirer and target company share the post-M&A outcome (e.g. if
the stock of the new company goes up then this benefits both parties)
● It takes more time to complete the deal, higher transaction costs, potential
misvaluation,...
● Handy for the target if its shareholders do not want to recognize any taxable
gains in the near future
3. Debt = exchange of the target’s stock for debt (instruments)
● This can be beneficial to the seller’s shareholders since they don’t pay
income tax until they receive the debt payments
● If the acquirer were to enquire bankruptcy, the seller’s shareholder would
simply be categorized among other creditors to be paid out of any remaining
assets, therefore the shareholders of the target company should be sure the
acquirer has a healthy financial condition
Acquisition premium = the premium paid by the acquirer in a takeover, it is the percentage
difference between the acquisition price and the pre-merger price of a target firm
● The average premium paid by acquirers is 43%
● When the bid is announced, the target’s stock price will rice on average with 15%
● Acquirer’s shareholders only see a gain of 1% on average
,Reasons to acquire
On the level of the company
1. Synergies = a beneficial effect when 2 (or more) companies combine together
-> Synergies usually fall into 2 categories
● Cost reduction (most common and easier to achieve by laying off
overlapping employees and elimination of redundant resources)
● Revenue enhancement
2. Economies of scale = savings a large company can gain by producing goods in
high volume
3. Economies of scope = savings gained by making different products and therefore
able to split the costs of the different departments (such as distribution, marketing,
administration) between the different products
Kind of gains
1. Monopoly gains = when a company merges with or acquires a major rival to reduce
competition within the industry and thereby increases its profits
● Most countries have antitrust laws to prevent this kind of activity
● All companies benefit when the competition is reduced, only the merging
company pays the associated costs => there is a lack of convincing evidence
for monopoly gains as a result of this kind of merger/acquisition
2. Efficiency gains = gains achieved by elimination of duplication
● The acquirer believes that they can run the target more efficiently than the
existing management
3. Tax savings from operating losses = a conglomerate merger may have a tax
advantage because losses in one division can offset profits in another division
Diversification
1. Risk reduction
● Larger firms bear less unsystematic risk (=risk specific to a company), so
mergers are justified on the basis that the combined firm is less risky
2. Debt capacity and borrowing costs
● Larger firms are more diversified => lower probability of bankruptcy
● With a merger, a firm can increase leverage and thereby lower its cost of
capital
3. Asset allocation
● A conglomerate may benefit by being able to quickly reallocate assets across
industries
● Possibility to redeploy managerial talent where it is most needed
● Agency costs may lead to the opposite result: profitable divisions may
subsidize money-losing ones
4. Liquidity
● The shareholders of a private company often have a disproportionate share of
their wealth invested in the private company
● The liquidity the bidder provides to the owners of a private firm can be
valuable => important incentive for the target shareholders to agree on the
takeover
,Earnings growth
● A merger of 2 companies may result in higher earnings per share, even if the merger
itself creates no economic value
● The PE-ratio reflects this absence of economic value
Managerial motives to merge
● Conflicts of interest: a manager may prefer to run a larger company due to additional
pay and prestige
● Overconfidence: overconfident managers believe their ability to manage is great
enough to succeed a merger that has a low chance of creating value (=Roll’s “hubris
hypothesis”)
Valuation and the Takeover Process
Price paid for a target = target’s pre-bid market capitalization + premium paid
● The takeover is a positive NPV (Net Present Value) project if the pre-bid market
capitalization is viewed as the stand-alone value of the target and when the premium
paid does not exceed the synergies (=additional value created)
The offer
Once the acquirer has completed the valuation process, it is in the position to make a tender
offer
Stock swap merger
● Positive NVP when the share price of the merged firm exceeds the pre-merger price
of the acquiring firm
Legenda:
● A = pre-merger value of acquirer
● T = pre-merger value of target
● S = created synergies
● Na = number of shares outstanding from the acquirer
● Nt = number of shares outstanding from the target
● Pa = price of one share from the acquirer
● Pt = price of one share from the target
If the acquirer issues ‘x’ shares to pay for the target, the acquirer’s share price increases
when:
‘X’ gives the maximum number of new shares the acquirer can offer and still achieve a
positive NPV, we express this by using the exchange ratio:
, Interpretation of exchange ratio (let’s say it is equal to 5):
● “The acquirer could offer up to 5 of its stock for each of the target’s stock and still
generate a positive NPV.”
Merger Arbitrage
= the increasing volatility due to uncertainty about whether the takeover will succeed
● Risk-Arbitrageurs = traders who speculate on the outcome of a deal once the
takeover offer is announced
● Merger-Arbitrage spread = difference between a target’s stock price and the implied
offer price
Tax and accounting issues
-> How the acquirer pays for the target affects the taxes of both the target shareholders and
the combined firm:
● Tax liability for target shareholders: when the acquirer decides to pay in cash the
target’s shareholders will have to pay a capital gains tax on the difference between
the price they paid for their shares and the price they paid when they first bought the
shares
● Deferred tax liability: occurs when the acquirer pays for the takeover entirely by using
its stock, the target’s shareholders do not have to pay tax until they decide to sell
their new shares
● Step up = increase in the book value of the target’s assets to the purchase price
when the acquirer purchases these assets directly instead of purchasing the target’s
stock
● The goodwill created by an acquisition or merger can be amortized over 15 years
Board and Shareholder Approval
-> For a merger to succeed, both the target’s and acquirer’s board of directors must approve
the deal and put the question to a vote to the shareholders of the target
1. Friendly Takeover
= the target’s board of directors supports a merger, negotiates with potential
acquirers, and agrees on a price that is put to a shareholder vote
2. Hostile takeover
= the acquirer (individual or organization) purchases a large fraction of the target’s
stock and in doing so gets enough votes to replace the target’s board of directors
-> Corporate raider = the acquirer in a hostile takeover
-> For a hostile takeover to succeed, the acquirer must go around the target’s board
and appeal directly to the target shareholders
-> Proxy fight = the acquirer attempts to convince the target’s shareholders to
unseat the target’s board
Takeover defenses
Lecture 1: Introduction to M&As
The market for corporate control
● Acquirer = buyer of the firm
● Target = seller of the firm
Merger waves = peaks of heavy activity followed by quiet troughs of few transactions in the
takeover market
Types of mergers
● Horizontal merger = the target and acquirer are in the same industry on the same
level of the supply chain
● Vertical merger = a merger that occurs when two companies in different stages of
production join together to form a single company
● Conglomerate merger = the target and acquirer operate in unrelated industries
Method of payment
1. Cash = the target’s shareholders receive a cash payment for their stock (from the
acquirer)
● The most common and simplest form
● The identity and ownership structure of the acquirer remains unchanged
● The acquirer is often/always much bigger than the target
● The acquirer must compensate the tax that the shareholders have to pay on
their capital gains
2. Stock swap = the target’s shareholders are swapping ‘old stock’ (=stock from the
target’s company) for new stock in either the acquirer’s firm or newly created firm
● Both the acquirer and target company share the post-M&A outcome (e.g. if
the stock of the new company goes up then this benefits both parties)
● It takes more time to complete the deal, higher transaction costs, potential
misvaluation,...
● Handy for the target if its shareholders do not want to recognize any taxable
gains in the near future
3. Debt = exchange of the target’s stock for debt (instruments)
● This can be beneficial to the seller’s shareholders since they don’t pay
income tax until they receive the debt payments
● If the acquirer were to enquire bankruptcy, the seller’s shareholder would
simply be categorized among other creditors to be paid out of any remaining
assets, therefore the shareholders of the target company should be sure the
acquirer has a healthy financial condition
Acquisition premium = the premium paid by the acquirer in a takeover, it is the percentage
difference between the acquisition price and the pre-merger price of a target firm
● The average premium paid by acquirers is 43%
● When the bid is announced, the target’s stock price will rice on average with 15%
● Acquirer’s shareholders only see a gain of 1% on average
,Reasons to acquire
On the level of the company
1. Synergies = a beneficial effect when 2 (or more) companies combine together
-> Synergies usually fall into 2 categories
● Cost reduction (most common and easier to achieve by laying off
overlapping employees and elimination of redundant resources)
● Revenue enhancement
2. Economies of scale = savings a large company can gain by producing goods in
high volume
3. Economies of scope = savings gained by making different products and therefore
able to split the costs of the different departments (such as distribution, marketing,
administration) between the different products
Kind of gains
1. Monopoly gains = when a company merges with or acquires a major rival to reduce
competition within the industry and thereby increases its profits
● Most countries have antitrust laws to prevent this kind of activity
● All companies benefit when the competition is reduced, only the merging
company pays the associated costs => there is a lack of convincing evidence
for monopoly gains as a result of this kind of merger/acquisition
2. Efficiency gains = gains achieved by elimination of duplication
● The acquirer believes that they can run the target more efficiently than the
existing management
3. Tax savings from operating losses = a conglomerate merger may have a tax
advantage because losses in one division can offset profits in another division
Diversification
1. Risk reduction
● Larger firms bear less unsystematic risk (=risk specific to a company), so
mergers are justified on the basis that the combined firm is less risky
2. Debt capacity and borrowing costs
● Larger firms are more diversified => lower probability of bankruptcy
● With a merger, a firm can increase leverage and thereby lower its cost of
capital
3. Asset allocation
● A conglomerate may benefit by being able to quickly reallocate assets across
industries
● Possibility to redeploy managerial talent where it is most needed
● Agency costs may lead to the opposite result: profitable divisions may
subsidize money-losing ones
4. Liquidity
● The shareholders of a private company often have a disproportionate share of
their wealth invested in the private company
● The liquidity the bidder provides to the owners of a private firm can be
valuable => important incentive for the target shareholders to agree on the
takeover
,Earnings growth
● A merger of 2 companies may result in higher earnings per share, even if the merger
itself creates no economic value
● The PE-ratio reflects this absence of economic value
Managerial motives to merge
● Conflicts of interest: a manager may prefer to run a larger company due to additional
pay and prestige
● Overconfidence: overconfident managers believe their ability to manage is great
enough to succeed a merger that has a low chance of creating value (=Roll’s “hubris
hypothesis”)
Valuation and the Takeover Process
Price paid for a target = target’s pre-bid market capitalization + premium paid
● The takeover is a positive NPV (Net Present Value) project if the pre-bid market
capitalization is viewed as the stand-alone value of the target and when the premium
paid does not exceed the synergies (=additional value created)
The offer
Once the acquirer has completed the valuation process, it is in the position to make a tender
offer
Stock swap merger
● Positive NVP when the share price of the merged firm exceeds the pre-merger price
of the acquiring firm
Legenda:
● A = pre-merger value of acquirer
● T = pre-merger value of target
● S = created synergies
● Na = number of shares outstanding from the acquirer
● Nt = number of shares outstanding from the target
● Pa = price of one share from the acquirer
● Pt = price of one share from the target
If the acquirer issues ‘x’ shares to pay for the target, the acquirer’s share price increases
when:
‘X’ gives the maximum number of new shares the acquirer can offer and still achieve a
positive NPV, we express this by using the exchange ratio:
, Interpretation of exchange ratio (let’s say it is equal to 5):
● “The acquirer could offer up to 5 of its stock for each of the target’s stock and still
generate a positive NPV.”
Merger Arbitrage
= the increasing volatility due to uncertainty about whether the takeover will succeed
● Risk-Arbitrageurs = traders who speculate on the outcome of a deal once the
takeover offer is announced
● Merger-Arbitrage spread = difference between a target’s stock price and the implied
offer price
Tax and accounting issues
-> How the acquirer pays for the target affects the taxes of both the target shareholders and
the combined firm:
● Tax liability for target shareholders: when the acquirer decides to pay in cash the
target’s shareholders will have to pay a capital gains tax on the difference between
the price they paid for their shares and the price they paid when they first bought the
shares
● Deferred tax liability: occurs when the acquirer pays for the takeover entirely by using
its stock, the target’s shareholders do not have to pay tax until they decide to sell
their new shares
● Step up = increase in the book value of the target’s assets to the purchase price
when the acquirer purchases these assets directly instead of purchasing the target’s
stock
● The goodwill created by an acquisition or merger can be amortized over 15 years
Board and Shareholder Approval
-> For a merger to succeed, both the target’s and acquirer’s board of directors must approve
the deal and put the question to a vote to the shareholders of the target
1. Friendly Takeover
= the target’s board of directors supports a merger, negotiates with potential
acquirers, and agrees on a price that is put to a shareholder vote
2. Hostile takeover
= the acquirer (individual or organization) purchases a large fraction of the target’s
stock and in doing so gets enough votes to replace the target’s board of directors
-> Corporate raider = the acquirer in a hostile takeover
-> For a hostile takeover to succeed, the acquirer must go around the target’s board
and appeal directly to the target shareholders
-> Proxy fight = the acquirer attempts to convince the target’s shareholders to
unseat the target’s board
Takeover defenses
