Mergers and Divestitures,Types of MergersMerger AnalysisRole of Investment BankersCorporate AlliancesPrivate Equity Investments and Divestitures,Chapter 21,21-1,What are some good reasons for mergers?,Synergy: value of the whole exceeds sum of the parts. Could arise from:Operating economiesFinancial economiesDifferential management efficiencyIncreased market powerTaxes (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?,DiversificationPurchase of assets at below-replacement costGet bigger using debt-financed mergers to help fight off takeovers,21-3,What is the difference between a “friendly” and a “hostile” merger?,Friendly merger The merger is supported by the managements of both firms.Hostile mergerTarget firms management resists the merger.Acquirer must go directly to the target firms stockholders and 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,21-5,Why is interest expense included in the analysis?,Debt associated with a merger is more complex than the single issue of new debt associated with a normal capital project. Acquiring firms often assume the debt of the target firm, so old debt at different coupon rates is often part of the deal.The acquisition is often financed partially by debt. If the subsidiary is to grow in the future, new debt will have to be issued over time to support the expansion.,21-6,Why are earnings retentions deducted in the analysis?,If the subsidiary is to grow, not all income may be assumed by the parent firm. Like any other company, the subsidiary must reinvest some its earnings to sustain growth.,21-7,What is the appropriate discount rate to apply to the targets cash flows?,Estimated cash flows are residuals which belong to the acquirers 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.,21-8,Discounting the Targets Cash Flows,The cash flows reflect the targets business risk, not the acquiring companys.However, the merger will affect the targets leverage and tax rate, hence its financial risk.,21-9,Calculating Continuing Value,Find the appropriate discount rate,21-10,Determine continuing value,Cash Flow Stream,Value of target firmEnter CFs in calculator CFLO register, and enter I/YR = 14.2%. Solve for NPV = $163.9 million,21-11,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.,21-12,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 targets value by its number of shares:Offering range is between $9 and $16.39 per share.,21-13,Making the Offer,The offer could range from $9 to $16.39 per share.At $9 all the merger benefits would go to the acquirers shareholders.At $16.39, all value added would go to the targets shareholders.Acquiring and target firms must decide how much wealth they are willing to forego.,21-14,Shareholder Wealth in a Merger,21-15,Shareholder Wealth,Nothing magic about crossover price from the graph.Actual price would be determined by bargaining. Higher if target is in better bargaining position, lower if acquirer is.If target is good fit for many acquirers, other firms will come in, price will be bid up. If not, could be close to $9.,21-16,Shareholder Wealth,Acquirer might want to make high “preemptive” bid to ward off other bidders, or make a low bid and then plan to increase it. It all depends upon its strategy.Do targets managers have 51% of stock and want to remain in control?What kind of personal deal will targets managers get?,21-17,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.,21-18,Functions of Investment Bankers in Mergers,Arranging mergersAssisting in defensive tacticsEstablishing a fair valueFinancing mergersRisk arbitrage,21-19,