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Mergers and Acquisitions
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
Introduction

   Takeover
   Merger
       ‘the combining of two business entities
        under common ownership’, Arnold,
        p865
   In practice most business
    amalgamations are usually
    takeovers
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
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
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
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
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)
Motives for takeovers

   Economic justifications
   Financial motives
   Managerial motives
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
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
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
Economic justifications
   Research and development activities

   Entry to new markets/industries

   Particular expertise
       customer service, billing procedures
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
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
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
Managerial Motives

   Managers may have different
    objectives from shareholders
    (Agency problem)
       Empire building
       Status
       Power
       Remuneration
   Hubris (Roll 1986)
       excessive self-confidence/arrogance
Managerial Motives

   Can result in wealth being
    transferred from shareholders of the
    acquiring company to shareholders
    of the target
Takeover of Cadbury by Kraft

List the likely motives:
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
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
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
Cash
   Kraft and Cadbury
       £8.40 a share
       £11.5 bn
       cash and shares
       Kraft had to borrow £7 bn to finance the
        deal
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
Transaction costs
   Advisers’ fees
   Underwriters’ fees
   Arrangement fees
   Legal costs
   Accounting costs
   Stock exchange fees
   Public relations bills
   RBS and ABN – 660million euros
Stages of a bid
   Firm appoints advisers
   Identify a target
   Value the target
   Make approach to the target
   Notify shareholders
   Negotiation
   Recommendation to shareholders
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
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
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%
Takeovers - Some Defences
   Pre-bid defence
   Circulation of victim co. shareholders
   Profit announcements / forecasts
   Dividend increase announcements
   Revaluation of assets
   “White Knight” defence
   “Pac Man” defence
   “Poison Pill” defence
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
Arnold’s ten golden rules
   Arnold, exhibit 23.25
Further reading
Arnold, G. Corporate Financial Management,
  Chapter 23


Robbins, M. Independent Business Tuesday,
  20 January 2009 Was ABN the worst
  takeover deal ever?
Kraft and Cadburys




               £11.5
               billion
Unilever and Ben and Jerry’s




                         $326million

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Pcf (2) 4_mergers_and_acquisitions[2] ms

  • 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)
  • 9. Motives for takeovers  Economic justifications  Financial motives  Managerial motives
  • 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
  • 19. Takeover of Cadbury by Kraft List the likely motives:
  • 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
  • 25. Transaction costs  Advisers’ fees  Underwriters’ fees  Arrangement fees  Legal costs  Accounting costs  Stock exchange fees  Public relations bills  RBS and ABN – 660million euros
  • 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%
  • 30. Takeovers - Some Defences  Pre-bid defence  Circulation of victim co. shareholders  Profit announcements / forecasts  Dividend increase announcements  Revaluation of assets  “White Knight” defence  “Pac Man” defence  “Poison Pill” defence
  • 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
  • 32. Arnold’s ten golden rules  Arnold, exhibit 23.25
  • 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?
  • 34. Kraft and Cadburys £11.5 billion
  • 35. Unilever and Ben and Jerry’s $326million