Week 10

o   Merger (Consolidation)

o   Acquisition of shares

o   Acquisition of assets

1) In a merger, two (or more) corporations come together to combine and share their resources to achieve common objectives.

2) The shareholders of the combined firms often remain as joint owners of the combined entity.

3) A new entity may be formed subsuming the merged firms.

• (Takeover) One firm purchases the assets or shares of another.

• The target firms’ shareholders cease to be owners of that firm.

• The target firm becomes the subsidiary of the acquirer (Led by its own executives).

(Same industry and same stage supply chain (direct competitors))

o   Target and acquirer in the same industry

o   Raises concerns about reduced competition/ rent extractions from customers

o   E.g. Grab-Uber in South East Asia

Goal:

1)Increase market share,

2) eliminate competition,

3)achieve economies of scale,

4)lower costs,

5)expand product offerings and

6) increase geographic reach.

Drawback: However, raise antitrust concerns if the resulting company gains too much market power and becomes a monopoly.

Merge of companies with different stages of the supply chain

o   Upstream downstream acquisitions

o   Forward integration: This type of integration occurs when a company acquires or merges with a business that is closer to the end-user or customer in the supply chain. For example, a manufacturer may acquire a distributor or retailer to ensure that its products are delivered directly to the end customer.

o   Backward integration: This type of integration occurs when a company acquires or merges with a business that is closer to the source of raw materials or inputs in the supply chain. For example, a manufacturer may acquire a supplier of raw materials to ensure a reliable supply of inputs and control over costs.

o   Balanced integration: This type of integration occurs when a company acquires or merges with a business that is both upstream and downstream in the supply chain. For example, a company may acquire both a supplier of raw materials and a distributor of finished goods to ensure control over both ends of the supply chain.

Goal:

• increase efficiency,

• reduce costs,

• gain more control over the supply chain.

Drawbacks:

• However, it can also present risks such as reduced competition and potentially higher prices for consumers.

1) Friendly takeover

2) Hostile takeover

3) Reverse takeover

A friendly takeover occurs when the acquiring company negotiates with the target company's management and board of directors to gain their approval for the acquisition. In a friendly takeover, the target company is usually willing to be acquired and the transaction is conducted cooperatively and mutually beneficial.

A hostile takeover occurs when the acquiring company attempts to take over the target company without the consent of its management and board of directors. The acquiring company may use various tactics to gain control, such as a hostile tender offer or a proxy fight to replace the target company's board of directors. Hostile takeovers can be controversial and often involve legal battles.

A reverse takeover occurs when a private company acquires a public company. In this type of transaction, the private company buys enough public company shares to gain control and then merges with it. This allows the private company to become publicly traded without going through the traditional initial public offering (IPO) process. Reverse takeovers are often used by smaller companies to gain access to public markets quickly and at a lower cost than an IPO.

o   Increases market power: fewer firms in the market.

o   Economies of scale: Increases output of a good or service.

o   Economies of scope: Increased variety of goods produces.

o   Unlock the target´s potential values: e.g., by firing its poor management

Others:

o   Tax (Firms in high-tax country buy firm from low-tax country)

o   Diversification benefits

o   Opportunistic explanations: Acquirer shares being overvalued and/ or target share being undervalued.

o   Overpayment (Reduction in shareholder value)

o   Integration challenges

o   Cultural differences

o   Reputation risks

1) Failure in strategy: e.g. Marconi sold off its defense business to concentrate on telecom equipment at the height of the dot-com bubble

2) Failure in due diligence, i.e. planning post-acquisition integration

o   Little or no post-acquisition planning

o   Cultural differences

o   Lack of knowledge of industry and target

o   Alienating “aquired” employees

o   Failure to communicate

o   Destroy trust

o   Fire the wrong people

3) Private incentives of acquirer CEOS:

o   Increase power/ control

o   Increased compensation: Remuneration + bonus for a successful takeover (Grinstein & Hribar, 2004)

o   Illusion of control: Most CEOS believe the markets under price their firms

o   Jealous CEOS: You want to follow your peers to do M&As (Goel & Thakor, 2010)

o   Excitement

4) Others:

o   Overpayment

o   Unexpected liabilities

o   Regulatory issues

1)    Risk Transfer: Attributing acquiring company risk characteristics to the target firm

2)    Debt subsidies: Subsiding target firm´s shareholders using the strengths of the acquiring firms

3)    Elusive synergies: Misidentifying and misvaluing synergies

12/20% = $60

Value of the Firm = operating income After Tax / Cost of Equity

• No Debt

• Constant operating income

STILL $60 —> We always use the cost of equity from the target company

Takeaway: The costs of equity used for an investment should reflect the risk of the investment and not the risk of the investor who raise the funds

• Assume you use the acquiring firm cost of debt = 4% on the target firm:

• Cost of capital target= (4% + 20%)/2 = 12%

• Value target = 12/12% = $100 -> operating income After tax/ cost of Capital Target

• Where does the $40 premium come from?

• Through this acquisition, you are transferring the wealth of acquiring firm’s shareholders to the target firm’s stockholders.

• Takeaway: Use a cost of capital that reflects the debt capacity of the target firm

Valuing Operating Synergies

Valuing Financial synergies

1) All Cash

2) All stock (“Stock swap” or “share exchange”)

• A issues new shares to be exchanged against B shares

• Exchange ratio = # A shares per B share

3) Hybrids (most common)

Acquiring firms face similar trade-offs when deciding which financing options to use to facilitate their M&As:

o   Most option is to increase leverage.

o   Issue new debt (i.e., bond). e.g., Porsche leveraged up in an attempt to buy VW, a company 82 times its sales.

o   Bank loans to pursue M&A are often expensive (stricter lending conditions).

o   How much the acquirer can leverage up depends on the combined debt capacity of the buyer & target.

o   Also, issue shares to finance M&A

o   Once you leverage up, it is expensive to de-leverage.

o   Particularly important if you consider further acquisitions

• Negotiate with targets management in a friendly environment

• Both sides conduct their own valuation analysis (Usually hire IB or valuation specialist)

• Both board of directors are informed

• Need both board of directors approval

Acquire enough shares to gain control! How many? Depends on company, country,..)

Three ways:

1)    Private negotiation: (Usually with a large shareholder)

2)    Tender offer: Bypass the management and make a direct offer to shareholders to acquire their shares

3)    Creeping tender: Trying to acquire enough shares of the target in an open market (Maybe illegal in shareholder-based countries)

• Propose list of directors at annual shareholders ‘meeting

• Corporate vote —> If win majority you gain control

• ->Cheaper than acquiring control by buying enough shares

  -> But more time-consuming and less likely to succeed.

o   Acquirer shareholders?

o   Target shareholders?

o   Employees? significant job losses; e.g., Motorola Mobility’s job losses of almost 25% within the first year of its acquisition by Google

o   Society? M&A might act as a catalyst for change. Following M&A wave, “low-level” employees doing routine works are fired while “high-level” employees are kept & get more pay →while helping to move the society forward, M&A also deepens inequality.

o   Top execs of acquirer

• Increased remuneration, status and power post-acquisition.

• CEO’s pay and wealth are not affected if the merged firm performs poorly while increases if the merged firm performs well (Harfordand and Li, 2007 JFE)

o   Top execs of targets

• Target CEOs choose between 1) large cash payments and disappear 2) executive positions in the merged firm.

o   Investment banks

o   Strategic fit, due diligence, and effective integration are critical factors for the success of M&As.

o   Corporate governance, regulation, and market conditions can influence M&A activity.

o   M&As can generate significant benefits for shareholders, but the benefits depend on careful planning and execution of the transaction.

o   Measuring the success of M&As is challenging, but poorly executed transactions can result in value destruction.

o   Careful planning, due diligence, and effective integration are essential for maximizing the benefits of M&As

o   M&As are widely used to enhance shareholder wealth and strategic growth

o   M&As typically offer a range of incentives for the management team and CEO to successfully complete the deal

o   This study focuses on the impact on CEO compensation and incentives resulting from M&As

o   M&A bonuses can be structured in a variety of ways, but the most common method is to offer a cash bonus to the CEO if the M&A deal is completed successfully.

o   The study finds that M&A bonuses are positively associated with both the probability of the deal being completed and the abnormal returns to the acquiring firm's shareholders.

o   The authors also find that M&A bonuses are more effective in aligning CEO incentives with shareholder interests when the bonuses are structured as a percentage of CEO salary rather than as a fixed dollar amount.

o   M&A bonuses can also have negative consequences for shareholder value if they encourage the CEO to pursue a deal that is not in the best interests of the company.

o   Overall, the study suggests that M&A bonuses can be an effective tool for aligning CEO incentives with shareholder interests, but they need to be carefully structured to avoid potential negative consequences.

o   M&A activity can result in increased market power and higher prices for consumers.

o   M&As can generate efficiency gains through synergies, but these gains may not be realized if the integration process is poorly executed.

o   The impact of M&As on firm performance is mixed, with some studies finding positive effects and others finding no significant effects or negative effects.

o   The success of M&As depends on various factors, including strategic fit, due diligence, effective integration, and cultural compatibility.

o   M&As can be risky and expensive, and there is a potential for value destruction if transactions are poorly executed.

o   Antitrust regulation can play a role in preventing anticompetitive M&As and promoting competition in the market.

o   More research is needed to understand the impact of M&As on firm performance and the role of antitrust regulation in promoting competition.

o   M&As can provide significant opportunities for value creation through synergies, economies of scale, and increased market power.

o   M&As are complex and risky, and careful planning, due diligence, and effective integration are critical for success.

o   Common pitfalls of M&As include overpayment, cultural differences, ineffective integration, and loss of key talent.

o   Effective integration requires clear communication, cultural alignment, and a well-designed integration plan.

o   Successful M&As require a focus on creating value rather than just completing the transaction, and a willingness to adapt and learn throughout the integration process.

o   Companies should consider the strategic fit, cultural compatibility, and potential for synergies when evaluating M&A opportunities.

o   Companies should also be prepared for the potential challenges of M&As, including regulatory scrutiny, resistance from employees and customers, and the potential for value destruction if the transaction is poorly executed.

o   Overall, M&As can provide significant opportunities for value creation, but success requires careful planning, due diligence, and effective integration.

(a) Potential synergies a company can gain from acquiring another company:

Synergies are the benefits that result from combining two companies that are greater than what either company could achieve independently. In the case of the Sainsbury’s-Asda merger, there are several potential synergies that the combined company could gain:

Cost synergies: The combined company can benefit from economies of scale by leveraging the buying power of both companies, reducing operating costs, and improving supply chain efficiency.

Revenue synergies: The combined company can benefit from cross-selling opportunities, by introducing Sainsbury’s products into Asda stores and vice versa, and by expanding the customer base.

Operational synergies: The combined company can benefit from sharing best practices and improving operational efficiency.

Geographic synergies: The combined company can benefit from expanding its geographic coverage, particularly in areas where either Sainsbury’s or Asda is stronger.

(b) Criticisms of the Sainsbury’s-Asda merger:

The Sainsbury’s-Asda merger faced heavy scrutiny and criticism from competitors, including Tesco and Morrisons, and the Competition and Market Authority (CMA). Some main reasons why the deal received criticisms include:

Reduced competition: The merger would reduce the number of major supermarket chains in the UK from four to three, potentially leading to higher prices for consumers.

Market power: The combined company would have a 31.4% market share, giving it significant market power and potentially harming smaller suppliers.

Store closures: The merger could lead to store closures and job losses, particularly in areas where Sainsbury’s and Asda stores overlap.

Brand dilution: The merger could dilute the brands of both Sainsbury’s and Asda, particularly if the combined company focuses on cost-cutting measures rather than investing in brand differentiation.

(c) Financing options for an acquisition and the impact on the acquirer’s capital structure:

Companies can use various financing options to finance an acquisition, including cash, debt, and equity. In the case of the Sainsbury’s-Asda merger, the payment is a mix of cash and shares. The likely impacts of an acquisition on the acquirer’s capital structure depend on the financing option used. For example:

Cash: Financing the acquisition with cash can lead to a decrease in the acquirer’s cash balance and potentially increase its debt-to-equity ratio.

Debt: Financing the acquisition with debt can increase the acquirer’s leverage and potentially increase its interest expenses, but also offer tax advantages.

Equity: Financing the acquisition with equity can dilute the acquirer’s shares and potentially decrease its earnings per share, but also offer flexibility in the form of stock options and a reduced debt burden.

The choice of financing option depends on various factors, including the acquirer’s financial position, the target’s value, and the expected synergies.