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Mergers and Divestitures

This document summarizes key aspects of mergers and divestitures discussed in Chapter 21, including the reasons mergers may occur, types of mergers, the role of investment bankers, and methods for analyzing potential mergers. Mergers are aimed to create value through synergies or break-up value. Management must determine an appropriate price for the target company between what shareholders would accept and the maximum the acquirer estimates the target is worth. Investment bankers assist with various merger-related functions including arranging deals and establishing fair value.

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22 views16 pages

Mergers and Divestitures

This document summarizes key aspects of mergers and divestitures discussed in Chapter 21, including the reasons mergers may occur, types of mergers, the role of investment bankers, and methods for analyzing potential mergers. Mergers are aimed to create value through synergies or break-up value. Management must determine an appropriate price for the target company between what shareholders would accept and the maximum the acquirer estimates the target is worth. Investment bankers assist with various merger-related functions including arranging deals and establishing fair value.

Uploaded by

roshan9786
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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CHAPTER 21

Mergers and Divestitures


 Types of mergers
 Merger analysis
 Role of investment bankers
 Corporate alliances
 LBOs, divestitures, and holding
companies
21-1
Why do mergers occur?
 Synergy: Value of the whole exceeds sum
of the parts. Could arise from:
 Operating economies
 Financial economies
 Differential management efficiency
 Increased market power
 Taxes (use accumulated losses)
 Break-up value: Assets would be more
valuable if sold to some other company.
21-2
What are some questionable
reasons for mergers?
 Diversification
 Purchase of assets at below
replacement cost
 Get bigger using debt-financed
mergers to help fight off takeovers

21-3
What is the difference between a
“friendly” and a “hostile” takeover?
 Friendly merger:
 The merger is supported by the managements of
both firms.
 Hostile merger:
 Target firm’s management resists the merger.
 Acquirer must go directly to the target firm’s
stockholders try to get 51% to tender their
shares.
 Often, mergers that start out hostile end up as
friendly when offer price is raised.

21-4
Merger analysis:
Post-merger cash flow statements
2003 2004 2005 2006
Net sales $60.0 $90.0 $112.5 $127.5
- Cost of goods sold 36.0 54.0 67.5 76.5
- Selling/admin. exp. 4.5 6.0 7.5 9.0
- Interest expense 3.0 4.5 4.5 6.0
EBT 16.5 25.5 33.0 36.0
- Taxes 6.6 10.2 13.2 14.4
Net Income 9.9 15.3 19.8 21.6
Retentions 0.0 7.5 6.0 4.5
Cash flow 9.9 7.8 13.8 17.1

21-5
What is the appropriate discount rate
to apply to the target’s cash flows?
 Estimated cash flows are residuals which
belong to acquirer’s shareholders.
 They are riskier than the typical capital
budgeting cash flows. Because fixed
interest charges are deducted, this increases
the volatility of the residual cash flows.
 Because the cash flows are risky equity
flows, they should be discounted using the
cost of equity rather than the WACC.

21-6
Discounting the target’s cash flows
 The cash flows reflect the target’s
business risk, not the acquiring
company’s.
 However, the merger will affect the
target’s leverage and tax rate, hence
its financial risk.

21-7
Calculating terminal value
 Find the appropriate discount rate
kS(Target) = kRF + (kM – kRF)βTarget
= 9% + (4%)(1.3) = 14.2%
 Determine terminal value
 TV2006 = CF2006(1 + g) / (kS – g)
= $17.1 (1.06) / (0.142 – 0.06)
=$221.0 million

21-8
Net cash flow stream
2003 2004 2005 2006
Annual cash flow $9.9 $7.8 $13.8 $ 17.1
Terminal value 221.0
Net cash flow $9.9 $7.8 $13.8 $238.1

 Value of target firm


Solve for NPV = $163.9 million

21-9
Would another acquiring
company obtain the same value?
 No. The input estimates would be
different, and different synergies would
lead to different cash flow forecasts.
 Also, a different financing mix or tax rate
would change the discount rate.

21-10
The target firm has 10 million shares
outstanding at a price of $9.00 per share.
What should the offering price be?

The acquirer estimates the maximum price


they would be willing to pay by dividing the
target’s value by its number of shares:

Max price = Target’s value / # of shares


= $163.9 million / 10 million
= $16.39

Offering range is between $9 and $16.39 per


share.
21-11
Making the offer
 The offer could range from $9 to
$16.39 per share.
 At $9 all the merger benefits would
go to the acquirer’s shareholders.
 At $16.39, all value added would go
to the target’s shareholders.
 Acquiring and target firms must
decide how much wealth they are
willing to forego.
21-12
Shareholder wealth in a merger
Shareholders’ Bargaining
Wealth Range

Acquirer Target

$9.00 $16.39
Price Paid
for Target
0 5 10 15 20
21-13
Shareholder wealth
 Acquirer might want to make high
“preemptive” bid to ward off other
bidders, or low bid and then plan to go up.
It all depends upon their strategy.
 Do target’s managers have 51% of stock
and want to remain in control?
 What kind of personal deal will target’s
managers get?

21-14
Do mergers really create value?
 The evidence strongly suggests:
 Acquisitions do create value as a result
of economies of scale, other synergies,
and/or better management.
 Shareholders of target firms reap most
of the benefits, because of competitive
bids.

21-15
Functions of Investment Bankers
in Mergers
 Arranging mergers
 Assisting in defensive tactics
 Establishing a fair value
 Financing mergers
 Risk arbitrage

21-16

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