2. Mergers and Acquisitions
In this lecture we will discuss
possible motives for takeovers or
mergers
what is involved in a
merger/takeover
whether takeovers/mergers create
value
3. Introduction
Takeover
Merger
‘the combining of two business entities
under common ownership’, Arnold,
p865
In practice most business
amalgamations are usually
takeovers
4. 3 main types of business integration
o horizontal takeovers (including cross-
border takeovers)
companies in similar lines of activity
o vertical takeovers
companies from different stages of the
production line
o backward
o forward
o conglomerate takeovers
companies in different lines of activity
5. Some Major Takeovers
(1988 - 2004)
Year Bidder Target Value (£m) Type
1988 BP Britoil 2,323 Vertical Back.
1988 Nestlé Rowntree 2,666 Horizontal
1995 Glaxo Welcome 9,150 Horizontal
1995 Hanson Eastern 2,400 Conglomerate
Electricity
1996 Granada Forte 3,600 Horizontal
2000 GlaxoWelcome SmithKline 38,600 Horizontal
Beecham
2002 National Grid Lattice 8,400 Horizontal
Group
2004 Morrisons Safeway 2,900 Horizontal
6. More Takeovers
(2000 - 2010)
Year Bidder Target Value Sh
(£m) Value?
2000 RBS NatWest 23,600 Yes
2000 France Orange 25,000 No
Telecom
2001 Bank of Halifax 30,000 Yes
Scotland then
no
2004 Santander Abbey 9,000 ?
2007 RBS ABN AMRO 49,000 No
2008 HBOS Lloyds 12,000 No
2010 Kraft Cadbury 11,500 ?
See Independent article on Studynet
7. Do mergers/takeovers create
shareholder value?
For the target company?
For the acquiring company?
‘Indeed, mergers and acquisitions seldom
live up to their promise of delivering
strategic benefits, easy growth and a boost
in the value of the acquirer's shares. To be
sure, some do work. According to
academics, as many as 35 per cent do. But
that still means more than 60 per cent of
deals fall flat chasing the elusive goal
reached by a minority.’
Independent Business, Jan 2009
8. Objectives of takeovers/mergers
To increase wealth, i.e. generate
positive NPVs
through either:
1. increasing incremental cash flows
or
2. reducing the level of risk for existing
cash flows (thus causing a reduction in
the discount rate)
10. Economic justifications
Synergistic effects i.e. value of
combined entity is greater than the
sum of the values of the individual
entities
• PV(A+B) = PV(A) + PV(B) + extra
• market power
• economies of scale
• R&D
• entry to new markets
11. Economic justifications
Increase in market power
horizontal integration can reduce
competition
vertical integration can ensure a final
market or create barriers to entry
conglomerate mergers can involve
cross-subsidisation
12. Economic justifications
Economies of scale
linked to production
or through lowering the costs of inputs
improved communications and reduced
bargaining costs
administration, R&D, purchasing
through increased size
13. Economic justifications
Research and development activities
Entry to new markets/industries
Particular expertise
customer service, billing procedures
14. Financial Justifications
Financial synergy (lower costs of
capital, reduced risk of bankruptcy)
through diversification
Bootstrapping - increasing EPS by
acquiring companies with lower PE
ratios than their own
15. Bootstrapping
Firm A earnings = £1m, share capital
10m ordinary shares trading at £2
EPSA = 10p PEA ratio = 20
Firm B earnings = £1m, share capital
10m ordinary shares trading at £1
EPSB = 10p PEB ratio = 10
16. Bootstrapping
o A acquires B
o The offer is 1 share of A for 2 shares of B
o Results in earnings of the group of £2m
with issued share capital of 15m shares
o EPS is thus 13.33p and if the market
believes that the new entity has the
same earnings potential and growth
as Firm A, i.e. a PE ratio of 20, then the
price of these shares should be:
o PA/13.33 = 20, PA will be £2.67
17. Managerial Motives
Managers may have different
objectives from shareholders
(Agency problem)
Empire building
Status
Power
Remuneration
Hubris (Roll 1986)
excessive self-confidence/arrogance
18. Managerial Motives
Can result in wealth being
transferred from shareholders of the
acquiring company to shareholders
of the target
20. Financing Takeovers/Mergers
Takeovers/mergers are open
market transactions
Amount to be paid is a matter of
judgement
Method of financing must be both
attractive to target shareholders
and acceptable to acquirer
21. Methods
Cash
Ordinary Shares in bidder firm
Loan stocks of bidder firm
Cash and ordinary shares tend to be
the preferred methods
Bidder will have to take into account
the effect on capital structure
Cash may have to be raised from a
rights issue
22. Cash vs shares
Cash: acquiring company’s
shareholders retain same level of
control over their company
Shares: shareholders of the
acquired company can maintain an
interest through the combined
entity
23. Cash
Kraft and Cadbury
£8.40 a share
£11.5 bn
cash and shares
Kraft had to borrow £7 bn to finance the
deal
24. Bid premium
a substantial sum over the pre-bid
share price of the target to make
the offer attractive to the target
shareholders
ABN AMRO valued at 50bn euros
Barclays bid 68 bn euros
RBS paid 71 bn euros
on average 30% to 50% of pre-bid
value
26. Stages of a bid
Firm appoints advisers
Identify a target
Value the target
Make approach to the target
Notify shareholders
Negotiation
Recommendation to shareholders
27. Stages of a bid
Initial offer is open for 21 days
Revised offer open for 14 days after
Maximum period for bid is 60 days
28. Regulation of Mergers in UK
Competition Commission (formerly
Monopolies and Mergers Commission)
a statutory body
reviews all activity that
accounts for +25% of market
or involves purchase of assets £70m+
concerned with the outcome of the
merger/takeover
Takeover Panel
a self-regulatory body
deal with conduct of the takeover/merger
29. Rules
A 3% stake must be disclosed to
the company
A stake of over 30% triggers a bid
makes it difficult for another party to
bid successfully
A holding of 90% of the shares
means the acquirer can force sale of
remaining 10%
31. Are mergers/takeovers
successful?
Mergers/acquisitions are investments
Success should mean the generation of positive
NPVs
Research
Acquisitions often fail to create value for the
shareholders in the bidding company
Some researchers have found significant gains to S/
Hs of target firms
KPMG Report 1999 – 83% of cross border
mergers failed to create value for shareholders
in acquiring firm
33. Further reading
Arnold, G. Corporate Financial Management,
Chapter 23
Robbins, M. Independent Business Tuesday,
20 January 2009 Was ABN the worst
takeover deal ever?