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 KISS may turn a toad to a prince

 investors may bankroll the princess who wish
to pay double for the right KISS
 They were princes, when purchased, after a
KISS they became toads.

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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.

The purchase of a controlling interest in a firm,

generally via a tender offer for the target shares.

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A method of effecting a takeover via a public offer
to target firm shareholders to buy their shares.

A combination of subsets of assets contributed by 2 or

more business entities for a specific business purpose
and limited duration. Each of the venture partners
continues to exist as a separate firm, and the joint
venture represents a new business enterprise.
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 A transaction in which a company distributes in a pro
rata basis all the shares it owns in a subsidiary to its
own shareholders. Creates a new public company with
(initially) the same proportional equity ownership as
the parent company.

The creation of an independent company through the

sale or distribution of new shares of an
existing business/division of a parent company.

Example: Ocwen & Ocwen Solutions named as Altisource

Portfolio Solutions 8
A transaction in which some, but not all, parent company shareholders receive shares in a
subsidiary in return for relinquishing their parent company 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.

A corporate action in which a single company splits into

two or more separately run companies. Shares of the
original company are exchanged for shares in the new
companies, with the exact distribution of shares
depending on each situation. This is an effective way to
break up a company into several independent
companies. After a split-up, the original company
ceases to exist.
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 A transaction in which a company spins off all of its
subsidiaries to its shareholders and ceases to exist.

Sale of a segment of a company (assets, a product line,

a subsidiary) to a third party for cash/or securities.

A transaction in which a parent firm offers some of a

subsidiary’s common stock to the general public, to bring

in a cash infusion to the parent without loss of control.

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 Repurchasing the stock of a large block holder (an
unwanted acquirer) at a premium over market price.

A voluntary contract by a large block shareholder (or former large block

holder bought out in a negotiated repurchase) not to make further

investment in the target company for a specified period of time.

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 A corporate charter amendment which is intended to
make it more difficult for an unwanted acquirer to
takeover the firm.

An attempt by a dissident group of shareholders to gain

representation on a firm’s Board of Directors.

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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

market, or in a negotiated buy back from a large block holder.

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 The transformation of a public corporation into a
privately held firm. (often via leveraged buy out or
management buy out).

The purchase of a company by a small group of investors,

financed largely by debt. Usually entails going private.

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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

company A & company B leading to higher EPS.

 Market Penetration

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 Deployment of surplus funds.

 Fund raising capacity (increase asset base)

 Increase MC.

 Tax planning (acquire a sick company)

 Creating shareholder value.

 Operating economies (savings on OH & other OE)

 Tax benefits.

 Revival of sick units.

 Superior Management.
 Ego satisfaction.
 Retention of managerial talent.
 Removal of inefficient management
 Growth orientation (escape from small home market to
achieve the economies of scale)
 Access to inputs
 Unique advantages : To exploit company`s brands,
reputation, design, production & management
capabilities
 Defensive strategies : To avoid country’s political and
economic instability, to circumvent protective barriers
 Client needs
 Opportunism
Merger activity is an example of ‘integration’ taking place within
industries. This can be:
 Vertical integration, where firms at different stages in the production
chain merge (Forward & Backward)

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

 Inflation depressed the stock prices between 1970 & 1982

 Replacement cost of the assets were high compared to the
historical book values
Q ratio is the ratio of the market value of the shares to
the replacement cost of the assets represented by
these shares. – declined.

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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?

 This may lead to undue concentration, leading

to monopoly

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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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