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Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved Mergers, Acquisitions, and Corporate Control

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Page 1: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Chapter 21Fundamentals of

Corporate

Finance

Fifth Edition

Slides by

Matthew Will

McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

Mergers, Acquisitions, and Corporate Control

Page 2: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 2

Topics Covered

The Market for Corporate ControlSensible Motives for MergersDubious Reasons for MergersEvaluating MergersMerger TacticsLeveraged Buy-OutsThe Benefits and Costs of Mergers

Page 3: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 3

The Merger Market

Proxy battle for control of the board of directorsFirm purchased by another firmLeveraged buyout by a group of investorsDivestiture of all or part of the firm’s business

units

Methods to Change Management

Page 4: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 4

Recent Mergers

Acquiring Company Selling CompanyPayment

($ billions)

JP Morgan Chase Bank One Corp 58.8Proctor & Gamble Gillette Co. 57.0Bank of America Corp. FleetBoston Financial Grp 49.3Cingular Wireless AT&T Wireless 41.0Sprint Corp. Nextel Communications 35.2Johnson & Johnson Guidant Corp. 25.4ChevronTexaco Unocal Corp. 16.4Anthem Inc. WellPoint Health Networks 16.4SBC Corp. AT&T Corp. 16.0Verizon MCI 8.5

Page 5: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 5

The Merger Market

Tools Used To Acquire Companies

Proxy Contest

Acquisition

Leveraged Buy-Out

Management Buy-Out

Merger

Tender Offer

Page 6: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 6

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 costsReduces costs

Page 7: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 7

Sensible Reasons for Mergers

Economies of Vertical IntegrationControl 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

Page 8: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 8

Sensible Reasons for Mergers

Combining Complementary ResourcesMerging may results in each firm filling in the “missing pieces” of their firm with pieces from the other firm.

Firm A

Firm B

Page 9: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 9

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.

Page 10: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 10

Dubious Reasons for Mergers

DiversificationInvestors should not pay a premium for

diversification since they can do it themselves.

Page 11: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 11

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.

Page 12: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 12

Dubious Reasons for Mergers

The Bootstrap Game

World Enterprises (before merger) Muck and Slurry

World Enterprises (after buying Muck

and Slurry)

EPS $2.00 $2.00 $2.67Price per share $40.00 $20.00 $40.00P/E Ratio 20 10 15Number of shares 100,000 100,000 150,000 Total earnings $200,000 $200,000 $400,000Total market value $4,000,000 $2,000,000 $6,000,000

Current earnings per dollar invested in stock $0.05 $0.10 $0.067

Page 13: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 13

Evaluating Mergers

QuestionsIs there an overall economic gain to the

merger?Do the terms of the merger make the company

and its shareholders better off?

????PV(AB) > PV(A) + PV(B)

Page 14: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 14

Evaluating Mergers

Economic Gain

Economic Gain = PV(increased earnings)

= New cash flows from synergies

discount rate

Page 15: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 15

Evaluating Mergers

Example - Given a 20% cost of funds, what is the economic gain, if any, of the merger listed below?

Cislunar Foods Targetco Combined Company

Revenues 150 20 172 (+2)

Operating Costs 118 16 132 (-2)

Earnings 32 4 40 (+4)

Economic Gain =4

.20= $20

Page 16: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 16

Evaluating Mergers

Estimated net gain

Estimated net gain = DCF valuation of target including synergies

- cash required for acquisition

Page 17: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 17

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.

Page 18: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 18

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

Page 19: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 19

Leveraged Buy-Outs

Junk bond marketLeverage and taxesOther stakeholdersLeverage and incentivesFree cash flow

Potential Sources of Value in LBOs

Page 20: Chapter 21 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

21- 20

Web Resources

www.cfonews.com

cnn.com

www.mergerstat.com

http://biz.yahoo.com/me

www.mareport.com

www.corporateaffiliations.com

Click to access web sitesClick to access web sites

Internet connection requiredInternet connection required


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