?The McGraw-Hill Companies,Inc.,2001
22- 1
Irwin/McGraw-Hill
Chapter 22Fundamentals of Corporate FinanceThird Edition
Mergers,
Acquisitions,
and Corporate
Control
Brealey Myers Marcus
slides by Matthew Will
?The McGraw-Hill Companies,Inc.,2001
22- 2
Irwin/McGraw-Hill
Topics Covered
?The Market for Corporate Control
?Sensible Motives for Mergers
?Dubious Reasons for Mergers
?Evaluating Mergers
?Merger Tactics
?Leveraged Buy-Outs
?Mergers and the Economy
?The McGraw-Hill Companies,Inc.,2001
22- 3
Irwin/McGraw-Hill
The Merger Market
?Proxy battle for control of the board of directors
?Firm purchased by another firm
?Leveraged buyout by a group of investors
?Divestiture of all or part of the firm’s business
units
Methods to Change Management
?The McGraw-Hill Companies,Inc.,2001
22- 4
Irwin/McGraw-Hill
Recent Mergers
Y e a r B u y i n g C o m p a n y S e l l i n g C o m p a n y
P a y m e n t
( $ b i l )
1999 M C I Wo r l d C o m S p r i n t 115
1999 V i a c o m CBS 35
1999 A T & T M e d i a O n e G r o u p 54
1999 T r a v e l e r s C i t i c o r p 83
1999 E x x o n M o b i l 80
1999 T o t a l F i n a ( F r a n c e ) E l f A q u i t a i n e ( F r a n c e ) 55
1999 O l i v e t t i ( I t a l y ) T e l e c o m I t a l i a ( I t a l y ) 58
1999 V o d a f o n e ( U K ) A i r T o u c C o m m, 61
1998 B r i t i s h P e t r o l e u m ( U K ) A m o c o C o r p, 48
1998 D a i m l e r - B e n z ( G e r m a n y ) C h r y s l e r 38
1998 Z e n e c a ( U K ) A s t r a ( S w e d e n ) 35
1998 N a t i o n s b a n k C o r p, B a n k A m e r i c a C o r p, 62
1998 Wo r l d C o m I n c, M C I C o m m u n i c a t i o n s 42
1998 N o r w e s t C o r p, We l l s F a r g o & C o, 34
?The McGraw-Hill Companies,Inc.,2001
22- 5
Irwin/McGraw-Hill
The Merger Market
Tools Used To Acquire Companies
Proxy Contest
Acquisition
Leveraged
Buy-Out
Management
Buy-Out
Merger
Tender Offer
?The McGraw-Hill Companies,Inc.,2001
22- 6
Irwin/McGraw-Hill
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
?The McGraw-Hill Companies,Inc.,2001
22- 7
Irwin/McGraw-Hill
Sensible Reasons for Mergers
Economies of Vertical Integration
?Control over suppliers,may” reduce costs.
?Over integration can cause the opposite effect,
Pre-integration
(less efficient)
Company
S
S
S
S
S
S
S
Post-integration
(more efficient)
Company
S
?The McGraw-Hill Companies,Inc.,2001
22- 8
Irwin/McGraw-Hill
Sensible Reasons for Mergers
Combining Complementary Resources
Merging may results in each firm filling in the
“missing pieces” of their firm with pieces from the
other firm.
Firm A
Firm B
?The McGraw-Hill Companies,Inc.,2001
22- 9
Irwin/McGraw-Hill
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.
?The McGraw-Hill Companies,Inc.,2001
22- 10
Irwin/McGraw-Hill
Dubious Reasons for Mergers
?Diversification
?Investors should not pay a premium for
diversification since they can do it themselves.
?The McGraw-Hill Companies,Inc.,2001
22- 11
Irwin/McGraw-Hill
Dubious Reasons for Mergers
The Bootstrap Game
Acquiring Firm has high P/E ratio
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.
?The McGraw-Hill Companies,Inc.,2001
22- 12
Irwin/McGraw-Hill
Dubious Reasons for Mergers
The Bootstrap Game
W o r l d E n t e r p r i s e s
( b e f o r e m e r g e r ) M u c k a n d S l u r r y
W o r l d E n t e r p r i s e s
( a f t e r b u y i n g M u c k
a n d S l u r r y )
EPS 2, 0 0$ 2, 0 0$ 2, 6 7$
P r i c e p e r s h a r e 4 0, 0 0$ 2 0, 0 0$ 4 0, 0 0$
P / E R a t i o 20 10 15
N u m b e r o f s h a r e s 1 0 0,0 0 0 1 0 0,0 0 0 1 5 0,0 0 0
T o t a l e a r n i n g s 2 0 0,0 0 0$ 2 0 0,0 0 0$ 4 0 0,0 0 0$
T o t a l m a r k e t v a l u e 4,0 0 0,0 0 0$ 2,0 0 0,0 0 0$ 6,0 0 0,0 0 0$
C u r r e n t e a r n i n g s
p e r d o l l a r i n v e s t e d
i n s t o c k 0, 0 5$ 0, 1 0$ 0, 0 7$
?The McGraw-Hill Companies,Inc.,2001
22- 13
Irwin/McGraw-Hill
Evaluating Mergers
?Questions
?Is there an overall economic gain to the
merger?
?Do the terms of the merger make the company
and its shareholders better off?
P V ( A B ) > P V ( A ) + P V ( B )
?The McGraw-Hill Companies,Inc.,2001
22- 14
Irwin/McGraw-Hill
Evaluating Mergers
?Economic Gain
Eco n o m ic G a in = P V(in c re a s e d ea rni n g s)
=
New c a sh f lo ws from sy n e rg ies
d is c o u n t r a te
?The McGraw-Hill Companies,Inc.,2001
22- 15
Irwin/McGraw-Hill
Evaluating Mergers
Example - Given a 20% cost of funds,what is the
economic gain,if any,of the merger listed below?
C i s l u n ar F oods T arg etco C o m b i n ed C o m p an y
R ev en u es 150 20 1 7 2 (+ 2 )
O p era t i n g C o s t s 118 16 1 3 2 (-2 )
E arni n g s 32 4 4 0 ( +4 )
E c o n o m i c G a i n = 4,2 0 = $ 20
?The McGraw-Hill Companies,Inc.,2001
22- 16
Irwin/McGraw-Hill
Evaluating Mergers
?Estimated net gain
E s t i m a t e d n e t ga i n = D C F v a l u a t i o n o f t a r ge t i n c l u d i n g s y n e r g i e s
- c a s h r e q u i r e d f o r a c q u i s i t i o n
?The McGraw-Hill Companies,Inc.,2001
22- 17
Irwin/McGraw-Hill
Merger Tactics
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.
?The McGraw-Hill Companies,Inc.,2001
22- 18
Irwin/McGraw-Hill
Leveraged Buy-Outs
Unique Features of LBOs
Large portion of buy-out
financed by debt
Shares of the LBO no longer
trade on the open market
?The McGraw-Hill Companies,Inc.,2001
22- 19
Irwin/McGraw-Hill
Leveraged Buy-Outs
?Junk bond market
?Leverage and taxes
?Other stakeholders
?Leverage and incentives
?Free cash flow
Potential Sources of Value in LBOs
22- 1
Irwin/McGraw-Hill
Chapter 22Fundamentals of Corporate FinanceThird Edition
Mergers,
Acquisitions,
and Corporate
Control
Brealey Myers Marcus
slides by Matthew Will
?The McGraw-Hill Companies,Inc.,2001
22- 2
Irwin/McGraw-Hill
Topics Covered
?The Market for Corporate Control
?Sensible Motives for Mergers
?Dubious Reasons for Mergers
?Evaluating Mergers
?Merger Tactics
?Leveraged Buy-Outs
?Mergers and the Economy
?The McGraw-Hill Companies,Inc.,2001
22- 3
Irwin/McGraw-Hill
The Merger Market
?Proxy battle for control of the board of directors
?Firm purchased by another firm
?Leveraged buyout by a group of investors
?Divestiture of all or part of the firm’s business
units
Methods to Change Management
?The McGraw-Hill Companies,Inc.,2001
22- 4
Irwin/McGraw-Hill
Recent Mergers
Y e a r B u y i n g C o m p a n y S e l l i n g C o m p a n y
P a y m e n t
( $ b i l )
1999 M C I Wo r l d C o m S p r i n t 115
1999 V i a c o m CBS 35
1999 A T & T M e d i a O n e G r o u p 54
1999 T r a v e l e r s C i t i c o r p 83
1999 E x x o n M o b i l 80
1999 T o t a l F i n a ( F r a n c e ) E l f A q u i t a i n e ( F r a n c e ) 55
1999 O l i v e t t i ( I t a l y ) T e l e c o m I t a l i a ( I t a l y ) 58
1999 V o d a f o n e ( U K ) A i r T o u c C o m m, 61
1998 B r i t i s h P e t r o l e u m ( U K ) A m o c o C o r p, 48
1998 D a i m l e r - B e n z ( G e r m a n y ) C h r y s l e r 38
1998 Z e n e c a ( U K ) A s t r a ( S w e d e n ) 35
1998 N a t i o n s b a n k C o r p, B a n k A m e r i c a C o r p, 62
1998 Wo r l d C o m I n c, M C I C o m m u n i c a t i o n s 42
1998 N o r w e s t C o r p, We l l s F a r g o & C o, 34
?The McGraw-Hill Companies,Inc.,2001
22- 5
Irwin/McGraw-Hill
The Merger Market
Tools Used To Acquire Companies
Proxy Contest
Acquisition
Leveraged
Buy-Out
Management
Buy-Out
Merger
Tender Offer
?The McGraw-Hill Companies,Inc.,2001
22- 6
Irwin/McGraw-Hill
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
?The McGraw-Hill Companies,Inc.,2001
22- 7
Irwin/McGraw-Hill
Sensible Reasons for Mergers
Economies of Vertical Integration
?Control over suppliers,may” reduce costs.
?Over integration can cause the opposite effect,
Pre-integration
(less efficient)
Company
S
S
S
S
S
S
S
Post-integration
(more efficient)
Company
S
?The McGraw-Hill Companies,Inc.,2001
22- 8
Irwin/McGraw-Hill
Sensible Reasons for Mergers
Combining Complementary Resources
Merging may results in each firm filling in the
“missing pieces” of their firm with pieces from the
other firm.
Firm A
Firm B
?The McGraw-Hill Companies,Inc.,2001
22- 9
Irwin/McGraw-Hill
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.
?The McGraw-Hill Companies,Inc.,2001
22- 10
Irwin/McGraw-Hill
Dubious Reasons for Mergers
?Diversification
?Investors should not pay a premium for
diversification since they can do it themselves.
?The McGraw-Hill Companies,Inc.,2001
22- 11
Irwin/McGraw-Hill
Dubious Reasons for Mergers
The Bootstrap Game
Acquiring Firm has high P/E ratio
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.
?The McGraw-Hill Companies,Inc.,2001
22- 12
Irwin/McGraw-Hill
Dubious Reasons for Mergers
The Bootstrap Game
W o r l d E n t e r p r i s e s
( b e f o r e m e r g e r ) M u c k a n d S l u r r y
W o r l d E n t e r p r i s e s
( a f t e r b u y i n g M u c k
a n d S l u r r y )
EPS 2, 0 0$ 2, 0 0$ 2, 6 7$
P r i c e p e r s h a r e 4 0, 0 0$ 2 0, 0 0$ 4 0, 0 0$
P / E R a t i o 20 10 15
N u m b e r o f s h a r e s 1 0 0,0 0 0 1 0 0,0 0 0 1 5 0,0 0 0
T o t a l e a r n i n g s 2 0 0,0 0 0$ 2 0 0,0 0 0$ 4 0 0,0 0 0$
T o t a l m a r k e t v a l u e 4,0 0 0,0 0 0$ 2,0 0 0,0 0 0$ 6,0 0 0,0 0 0$
C u r r e n t e a r n i n g s
p e r d o l l a r i n v e s t e d
i n s t o c k 0, 0 5$ 0, 1 0$ 0, 0 7$
?The McGraw-Hill Companies,Inc.,2001
22- 13
Irwin/McGraw-Hill
Evaluating Mergers
?Questions
?Is there an overall economic gain to the
merger?
?Do the terms of the merger make the company
and its shareholders better off?
P V ( A B ) > P V ( A ) + P V ( B )
?The McGraw-Hill Companies,Inc.,2001
22- 14
Irwin/McGraw-Hill
Evaluating Mergers
?Economic Gain
Eco n o m ic G a in = P V(in c re a s e d ea rni n g s)
=
New c a sh f lo ws from sy n e rg ies
d is c o u n t r a te
?The McGraw-Hill Companies,Inc.,2001
22- 15
Irwin/McGraw-Hill
Evaluating Mergers
Example - Given a 20% cost of funds,what is the
economic gain,if any,of the merger listed below?
C i s l u n ar F oods T arg etco C o m b i n ed C o m p an y
R ev en u es 150 20 1 7 2 (+ 2 )
O p era t i n g C o s t s 118 16 1 3 2 (-2 )
E arni n g s 32 4 4 0 ( +4 )
E c o n o m i c G a i n = 4,2 0 = $ 20
?The McGraw-Hill Companies,Inc.,2001
22- 16
Irwin/McGraw-Hill
Evaluating Mergers
?Estimated net gain
E s t i m a t e d n e t ga i n = D C F v a l u a t i o n o f t a r ge t i n c l u d i n g s y n e r g i e s
- c a s h r e q u i r e d f o r a c q u i s i t i o n
?The McGraw-Hill Companies,Inc.,2001
22- 17
Irwin/McGraw-Hill
Merger Tactics
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.
?The McGraw-Hill Companies,Inc.,2001
22- 18
Irwin/McGraw-Hill
Leveraged Buy-Outs
Unique Features of LBOs
Large portion of buy-out
financed by debt
Shares of the LBO no longer
trade on the open market
?The McGraw-Hill Companies,Inc.,2001
22- 19
Irwin/McGraw-Hill
Leveraged Buy-Outs
?Junk bond market
?Leverage and taxes
?Other stakeholders
?Leverage and incentives
?Free cash flow
Potential Sources of Value in LBOs
