CHAPTER21

MergersandDivestituresTypesofmergersMergeranalysisRoleofinvestmentbankersCorporatealliancesLBOs,divestitures,andholdingcompaniesWhydomergersoccur?Synergy:Valueofthewholeexceedssumoftheparts.Couldarisefrom:OperatingeconomiesFinancialeconomiesDifferentialmanagementefficiencyIncreasedmarketpowerTaxes(useaccumulatedlosses)Break-upvalue:Assetswouldbemorevaluableifsoldtosomeothercompany.Whataresomequestionablereasonsformergers?DiversificationPurchaseofassetsatbelowreplacementcostGetbiggerusingdebt-financedmergerstohelpfightofftakeoversWhatisthedifferencebetweena“friendly”anda“hostile”takeover?Friendlymerger:Themergerissupportedbythemanagementsofbothfirms.Hostilemerger:Targetfirm’smanagementresiststhemerger.Acquirermustgodirectlytothetargetfirm’sstockholderstrytoget51%totendertheirshares.Often,mergersthatstartouthostileendupasfriendlywhenofferpriceisraised.ReasonswhyalliancescanmakemoresensethanacquisitionsAccesstonewmarketsandtechnologiesMultiplepartiessharerisksandexpensesRivalscanoftenworktogetherharmoniouslyAntitrustlawscansheltercooperativeR&DactivitiesMergeranalysis:

Post-mergercashflowstatements

2003

2004

2005

2006Netsales $60.0 $90.0 $112.5 $127.5-Costofgoodssold 36.0 54.0 67.5 76.5-Selling/admin.exp. 4.5 6.0 7.5 9.0-Interestexpense 3.0

4.5

4.5

6.0EBT 16.5 25.5 33.0 36.0-Taxes 6.6

10.2

13.2

14.4NetIncome 9.9 15.3 19.8 21.6 Retentions 0.0

7.5

6.0

4.5 Cashflow 9.9 7.8 13.8 17.1Whatistheappropriatediscountratetoapplytothetarget’scashflows?Estimatedcashflowsareresidualswhichbelongtoacquirer’sshareholders.Theyareriskierthanthetypicalcapitalbudgetingcashflows.Becausefixedinterestchargesarededucted,thisincreasesthevolatilityoftheresidualcashflows.Becausethecashflowsareriskyequityflows,theyshouldbediscountedusingthecostofequityratherthantheWACC.Discountingthetarget’scashflowsThecashflowsreflectthetarget’sbusinessrisk,nottheacquiringcompany’s.However,themergerwillaffectthetarget’sleverageandtaxrate,henceitsfinancialrisk.CalculatingterminalvalueFindtheappropriatediscountrate

kS(Target)=kRF+(kM–kRF)βTarget =9%+(4%)(1.3)=14.2%DetermineterminalvalueTV2006 =CF2006(1+g)/(kS–g) =$17.1(1.06)/(0.142–0.06) =$221.0millionNetcashflowstream

2003

2004

2005

2006Annualcashflow $9.9 $7.8 $13.8

$17.1Terminalvalue

221.0Netcashflow $9.9 $7.8 $13.8

$238.1ValueoftargetfirmEnterCFsincalculatorCFLOregister,andenterI/YR=14.2%.SolveforNPV=$163.9millionWouldanotheracquiringcompanyobtainthesamevalue?No.Theinputestimateswouldbedifferent,anddifferentsynergieswouldleadtodifferentcashflowforecasts.Also,adifferentfinancingmixortaxratewouldchangethediscountrate.Thetargetfirmhas10millionsharesoutstandingatapriceof$9.00pershare.Whatshouldtheofferingpricebe?Theacquirerestimatesthemaximumpricetheywouldbewillingtopaybydividingthetarget’svaluebyitsnumberofshares:

Maxprice =Target’svalue/#ofshares =$163.9million/10million =$16.39Offeringrangeisbetween$9and$16.39pershare.MakingtheofferTheoffercouldrangefrom$9to$16.39pershare.At$9allthemergerbenefitswouldgototheacquirer’sshareholders.At$16.39,allvalueaddedwouldgotothetarget’sshareholders.Acquiringandtargetfirmsmustdecidehowmuchwealththeyarewillingtoforego.ShareholderwealthinamergerShareholders’WealthAcquirerTargetBargainingRangePricePaidforTarget$9.00$16.3905101520ShareholderwealthNothingmagicaboutcrossoverpricefromthegraph.Actualpricewouldbedeterminedbybargaining.Higheriftargetisinbetterbargainingposition,lowerifacquireris.Iftargetisgoodfitformanyacquirers,otherfirmswillcomein,pricewillbebidup.Ifnot,couldbecloseto$9.ShareholderwealthAcquirermightwanttomakehigh“preemptive”bidtowardoffotherbidders,orlowbidandthenplantogoup.Italldependsupontheirstrategy.Dotarget’smanagershave51%ofstockandwanttoremainincontrol?Whatkindofpersonaldealwilltarget’smanagersget?Domergersreallycreatevalue?Theevidencestronglysuggests:Acquisitionsdocreatevalueasaresultofeconomiesofscale,othersynergies,and/orb