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Why firms choose M&A instead of internal
growth?
Types of firms engaging in M&A activities,
ie., which firms are likely to be acquiring,
which acquired, etc
Implications on aggregate merger activity
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Expansion
M&A
Tender Offer
Joint Venture
Sell offs
Spin offs
Split offs
Split ups
Divestitures
Equity carve outs
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Corporate Control
Premium Buy-backs
Standstill agreements
Antitakeover Amendments
Proxy Contests
Changes in Ownership Structure
Exchange Offers
Share Repurchases
Going Private
Leveraged Buy-outs
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Any transaction that forms one economic unit
from two or more previous units.
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A method of effecting a takeover via a public offer
to target firm shareholders to buy their shares.
McDonald’s (MCD) split off of Chipotle Mexican Grill (CMG.B). I first heard
about the McDonald’s split-off of Chipotle in September of 2006.
McDonald’s offered to exchange up to an aggregate of 16,539,967 shares of
Chipotle class B common stock for outstanding shares of McDonald’s
common stock. The exchange offer was designed to permit holders of
McDonald’s common stock to exchange their shares for shares of Chipotle
class B common stock at a 10% discount to the calculated per-share value of
Chipotle class B common stock. Stated another way, for each $1.00 of
McDonald’s common stock accepted in the exchange offer, the tendering
holder would receive approximately $1.11 of Chipotle class B common
stock, based on calculated per-share values, subject to a limit ratio and to
proration.
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A transaction in which a company spins off all of its
subsidiaries to its shareholders and ceases to exist.
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A corporate charter amendment which is intended to
make it more difficult for an unwanted acquirer to
takeover the firm.
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A transaction which provides one class (or more) of
securities with the right or option to exchange part or
all of their holdings for a different class of the firm’s
securities. This enables a change in the capital
structure with no change in investment.
A public corporation buys its own shares, by tender offer, on the open
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The transformation of a public corporation into a
privately held firm. (often via leveraged buy out or
management buy out).
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Globalization and Liberalization of economy.
Intense competitive environment .
Advancement in technical know –how.
Sustain , excel and compete both in
domestic and international market.
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The share holders of two companies deciding to
pool the resources of the companies under a
common entity to do the business activity is called
merger.
Two companies agree to go forward as a single
company rather than separately owned & operated.
Both companies stocks are surrendered and new
stock is issued in its place.
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Top ten acquisition made by Indian
companies.
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To take advantage of economies of scale.
To increase market share, control suppliers
To take tax advantages.
To redirect the firms activities by deploying
surplus cash from one business to finance
profitable growth in another.
To increase size, so as to compete at the global
level.
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Factors contributing to merger waves:
Shocks (e.g., technological change, deregulation, and
escalating commodity prices)
Ample liquidity and low cost of capital
Overvaluation of acquirer share prices relative to target
share prices
Why it is important to anticipate M&A waves:
Financial markets reward firms pursuing promising
opportunities early on and penalize those that follow
later in the cycle.
Acquisitions made early in the wave often earn
substantially higher financial returns than those made
later in the cycle.
Empire building.
To achieve core competency.
To diversify product range
To rehabilitate sick companies.
To take advantage of speedy entry in the market
rather then taking risk in green-field ventures.
To increase returns to the shareholders.
To lower the cost of production
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Strategic Motives
Financial Motives
Organizational Motives
Expansion and growth (less time consuming
and more cost effective)
Dealing with entity of MNCs.
Economies of scale.
Synergy V(AB)>V(A)+V(B)
value merged company > independent value of
Market Penetration
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Deployment of surplus funds.
Increase MC.
Tax benefits.
or
Horizontal integration, where competing firms in the same industry
merge
or
Conglomerate: no clear substitute or complementary relationship.
or
Circular: involves merger of companies which produce different
products that are unrelated and but are marketed through the same
channel
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Two firms producing the same product merge
to achieve economies of scale.
The right size can change over time
McDonald and Douglas aircraft corporations
initially merged to compete with Boeing.
Boeing and McDonald-Douglas merge to compete
with AirBus.
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Decrease in competition
Economies of scale
Better market control
Avoid duplicate facilities
Decrease the WC
Increased monopoly
Tret to small players
No guarantee of the maket
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A firm in industry A Cereal
Companies
sells its output to
industry B.
Grain Farms
Two firms merge to
integrate their
production.
Seed and
Fertilizer
Companies
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A firm in industry A Cereal
Companies
Basic Theorem: you cannot
sells its output to
create monopoly power by a
industry B. verticalGrain
integration. If one
Farms
Two firms merge to industry is monopolized, it
does not increase its
integrate their
monopoly Seed and by vertical
power
production. Fertilizer into a
integration
Companies
competitive industry.
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Cost Reduction
Economies of Control
Better Planning
Monopoly by the input supplier
Price discrimination
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Financial Conglomerates
Do not participate in the operating decisions but
take strategic decisions only. This improves risk,
better results.
Managerial Conglomerates
Takes advantage of unequal management
competence.
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Product Expansion
Covers huge territory
Minimizes risk
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Economies of scale
Avoid unhealthy competition
Synergy
Risk minimization
Consolidation of capacities
Marketing advantages
Financial advantages
Right sizing
Value creation
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Valuation pitfalls
Inaccurate estimation
Overestimating synergy
Hidden liabilities
Implementation delay
Cultural differences
Poor public relations
Conflict of interest
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Efficiency theories
Differential managerial efficiency
Inefficient management
Operating synergy
Pure diversification
Strategic realignment to changing environments
Undervaluation
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Information & Signaling
Agency problems & managerialism
Free Cash Flow Hypothesis
Market Power
Taxes
Redistribution
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Change in the levels of managerial efficiency,
there is social as well as private gain.
In the extreme there will be only one firm in the
economy, leading to problem of coordination
How do they select & how do they pay?
Managerial synergy hypothesis:
Merger is required as excess managerial capacity can not be
released and expansion is not possible
Why to merge? ….. get from outside
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It does not perform up to the potential ie.,
other control group may do the job better.
Assumptions:
Owners are unable to replace the managers
If replacement was the sole motive then even if
it is a subsidiary then the purpose is served.
Managers are replaced after mergers.
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Economies of scale exists & activities that fall
short of achieving the potentials for
economies of scale
Economies Of Scale arise of indivisibilities
Problem that would arise here is:
How to combine good parts & eliminate not
required ones?
All size firms need some amount of corporate
staff.
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Demand for diversification by managers, employees,
preservation of organizational reputation, financial & tax
advantage.
The arguments against are:
Shareholders can diversify across firms
Employees have firm specific knowledge
Owner manager may not like to loose control
Information is accumulated within the firm, its transfer
outside may not be possible or may be done with some noise.
Reputational Capital of the firm is established with that firm
only.
Diversification may increase the debt capacity
This can be achieved through internal growth also
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Demand is increasing faster than before
So need to have more funds, there is
distinction between external & internal
funds
Discussion on tax advantage & leverages
Evidences suggests that the opportunities
have improved
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Strategic planning is concerned with environments not
only the operating decisions.
It says possibilities of Economies of scale or tapping
the underused capacity
They get required capacities: may be managers,
funds…..by acquisition, but timings is important
Mergers is quicker than internal growth
The experiences say NPV from M&A is comparatively smaller.
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Merger happen because A undervalues T
A has insider information
Market Value of the assets VS. Replacement Costs
Inflation
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A company can add capacity easily be merging
than by internal growth
If a firm wishes to add capacity it means that
the Q ratio is high
Eg: q ratio is 0.6, and the merger premium is say
1.5, then the purchase price is 0.9 (1.5*0.6)ie., 10
percent below the replacement cost.
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If the tender offer is unsuccessful, then the share value
of T is going to go up. This leads to:
Sitting on a gold mine (T is undervalued; revalue)
Kick in the pant (inspires T to implement a more effective
business strategy)
It may be acquired by somebody else who applies some
special resources in T
Researchers say: if T will not get any offer for another 5
years after unsuccessful bid, the share prices are going
to fall back to the pre-offer level
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Signalling Theory:
This was first developed for labour markets, says it is
less expensive if you hire high skilled labourers, hence
the level of education was the signal of the cost on
training & Education
Also signals the capacity of the organization.
Ross connects this to the Capital Structure theory
Nature of firms investment policy is signaled through its capital
structure
Managers compensation is tied to the capital structure
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Less perquisites, if managers were owners
Costs are:
Cost of monitoring
Cost of structuring a set of contracts
Cost of bonding the guarantee that the agents
will make optimum decisions
Residual loss – welfare loss arising from the
divergence of decisions.
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Compensation tied to the performance and in
turn to the agency problems
Stock market says: if there is low priced
stock to change the behaviour of the
managers
When these does not work out there may be
an external control exercised
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Some say Mergers are sign of agency problems
Managers feel that their compensation is
related to the size of the firm, so wants to
expand using low hurdle rate, but not so.
This theory says that if there is agency
problem & there is mergers, the merger
activity is a sign of the agency problem of
inefficient, external investment by managers
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Managers commit error of over optimism in
valuation due to pride, animal spirits or hubris
When A values T, and the valuation of assets is
below the market price no offer is made
This theory says that:
Market is in strong form ie., Stock prices reflects all
information (pub./non-pub.)
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When agency costs are large takeovers helps to
reduce them
Hypothesis by Jenson: payout of FCF can serve as
an important role in dealing with the conflict
between the managers & the shareholders.
FCF is the cash flow in excess of the amounts
required to fund all the projects that have
positive NPV, when discounted at the applicable
cost of capital
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This reduces the amount of resources under the
control of the managers thereby reducing their
power.
They are under monitoring when they seek more
funds.
Issue debt for stock, managers can effectively
use the future cash flows, but this reduces the
growth
He also says: increased leverage involves cost,
increase in risk of bankruptcy.
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There is agency problem with this also: ie.,
to benefit shareholders, bondholders are put
into risk
Therefore he says: Optimal debt/equity ratio
is where the marginal cost of debt equals
marginal benefits of debt
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Evidences:
Firms with positive FCF, stock prices will increase
with unexpected increase in the payouts and
decrease with the unexpected decreases in payouts
This do not apply to the firms with more profitable
projects than cash flow to fund them
This theory does not apply to growth firms
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M & A happens to increase the market share
But does not say how increased market share
will lead to EOS or synergy or social gain
Internal expansion also can be a solution?
Will the buying price is economical than expansion?
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Sale & lease back transfers the tax credit,
mitigate tax incentives for mergers
Carryover of Net Operating Losses
Substitution of Capital Gains for ordinary income
Other Tax Incentives
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Redistribution of source of value among the
shareholders
No evidence that the shareholders gain
Breech of trust may lead to demand for wages
(reduce the cost due to the competitiveness, no
competition in merger)
Managerial inefficiency
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