Mergers and Acquisitions

Sanjay Banerji
Lecture 1
 Questions:
• For M&A to be profitable to stakeholders, it must create value
through synergies.
• The questions are:
• (a) How do we measure value of the synergy generated by the
target ? How is offer price related to the value of acquisitions?
• (b) Once a value of target is identified by the bidder, how does the
bidder arrange financing? Cash or stock or financing the purchase
by debt? Does the choice of payments affect the valuation? How
gains from synergy distributed between targets and bidder?
• (c) How does an acquiring firm choose a bidding strategy in a
scenario where it faces (i) numerous shareholders, (ii) other
potential bidders and (iii) possibly anti-takeover measures by target
management in the context of hostile takeovers?
 The Merger Process
• Examples demonstrate many complexities in
negotiating deals
– Bidder considerations:
• Pay cash or stock
• Deal with management or shareholders
• May buy initial stake, either in open market or secretly
• How to deal with the potential competitor
– Target considerations:
• Decision to sell
• Decision to seek competing bids or seek termination fee in
initial bid
Example of the Bidding Process: Savannah Foods
(a sugar refiner)

• Example
• Merger process began in March 1996
– SF’s board of directors requested
management develop a plan to improve
shareholder value
– Plan: maximize value of core sugar business
and consider acquisitions in related areas
– Discussions with acquisition candidates and
merger partners in summer 1996 produced no
formal actions
 Example Contd.
• Savannah discussed merger with two possible
partners in late 1996
• Flo-Sun reached deal to buy SF (7/15/97)
– Shareholders of SF to own 41.5% of new entity
– SF price fell 15.7% to $15.75 at announcement
– Shareholder lawsuits arose over terms
• Imperial Holly, a sugar refining company, made
a competing bid
– IH contacted investment banking firm, Lehman
Brothers, to develop acquisition strategies
– IH made competing offer for SF for $18.75 per share
(70% in cash and 30% in stock)
 Example Contd.
• Flo-Sun upped bid on 9/4/1997
– SF would own 45% of new firm
– Shareholders would also receive $4 in cash
• SF asked both bidders to submit final offers on
9/8/97
– IH upped bid to $20.25 per share
– Flo-sun stood by most recent offer
• SF executed merger agreement with IH on
9/12/97
– Ended previous agreement with Flo-Sun
– Paid $5 million termination fee to Flo-Sun
Bidding Strategies with Dispersed
Shareholders
• When proposing a tender offer, a bidder faces “the free-rider”
problem from target shareholders

• What is the free-rider problem?

Although tendering might preferable from the point of view of

all the shareholders considered, for each small shareholder
who has no impact on the probability of success of the
takeover, it pays not to tender and hopes everyone else
does

If everyone thinks this way, the offer will ultimately fail,

because individual investors are free-riding on the others
What is the free-rider problem?
Define:
PT = Price per share offered to the shareholders of the target
company
P0 = Price per share of the target firm before the
announcement
∆ = Present value of the increase in the target's cash-flow if the
bid is successful

After a successful takeover of 50% of the shares the price of the

remaining target firm's shares will raise to:
Δ
P* = P0 +
n0
where n0 is the number of outstanding target shares

Let’s see an example…

 Example
Δ
• P0 = $50, PT = $60 for 50% of the shares and that = $20
n0
• Conditional bid: if less than 50% of the shares tendered, the
offer will be cancelled

Question:
What should a shareholder do: tender or not tender?

Outcome of the Offer

Individual Decision Successful Unsuccessful
Tender 65 (=60 x 1/2+ 70 x 1/2) 50
Not Tender 70 50
Remarks
 The shareholder is better off not tendering
 Free-rider problem
• Although tendering is preferable from the point of view of
all the shareholders considered, for each small
shareholder who has no impact on the probability of
success, it pays not to tender and hopes everyone else
does
 If everyone thinks this way, the offer will ultimately fail,
because individual investors are free-riding on the others
 Basic issue
• How can the bidder benefit, and still make others
tender?
We explore a few possibilities next…
 Possibility 1
Make the offer to investors who have a direct impact on the outcome of
the offer, (i.e., make an offer to companies where large
shareholders are important)
Example
Assume that, if the large shareholder does not tender, the probability of a
successful offer falls to 25%. If she tenders, the probability is 100%.

The expected profit for the large investor is:

Large Shareholder Expected cash flow

Tender 60
Not Tender 55 (=70 x 1/4 + 50 x 3/4)
 Remarks:
 Large shareholder now has impact on probability of success of
the offer
 If she does not tender, there is only a 25% chance that the offer
will be successful and that he gets $70.
 Large shareholder has an incentive to tender
 Offer will be successful and the bidder will benefit
 Risk arbitrageurs
• Buy shares in the open market in hopes of profiting when the shares
are tendered
• Help to make the takeover more likely to occur
• Misleading name; they perform a risky activity
 Possibility 2:
Make unconditional bids

Example
Buy any amount of shares tendered at $60 per share
(unconditional bids) up to 50% of the shares.

Outcome of the Offer

Individual Decision Successful Unsuccessful
Tender 65(=60 x 1/2 + 70 x1/2) 60
Not Tender 70 50
 Remarks
• What is the difference with the initial case?
– Not an obvious strategy for the small shareholder
– Should tender if they believe offer will be unsuccessful and not
tender if they believe the offer will succeed!
• Bidder loses if the offer does not succeed

Aside: Different types of bids

• Conditional: Not binding unless a minimum number of shares are
tendered
• Restricted: Bidder may not be obliged to buy more than a pre-
specified number of shares
• Any-or-all: Unconditional & unrestricted offers
• Two-tier bid (see next)
 Possibility 3
Make a two-tier takeover bid (front-loading)

Example
Offer $80 for 50% of the shares. If the offer succeeds, you will
force a take-out merger of the remaining 50% of the shares
for $40 per share. The decision matrix for the small individual
shareholders is as follows:

Outcome of the Offer

Individual Decision Successful Unsuccessful
Tender 60 (=80 x 1/2+40 x1/2) 50
Not Tender 40 50
 Remarks:
• The two-tier offer guarantees that in successful bids the non-
tendering shareholder will be worse off

• Several countries (Canada, most European) view two-tiered

offers as coercive and restrict these through “fair-price” and
mandatory bid rules

• A “fair-price” rule stipulates that the back end of the offer

cannot be lower than the front-end. Bids for >20% of shares
often trigger a mandatory bid for all target shares

• In the US, the “good business judgement” rule allows front-

end loading. However, most listed firms have adopted their
own fair-price charter restrictions
 Possibility 4
Accumulate prior holdings (toeholds)

• US regulations require open market purchasers of

stock to file a 13D report to the SEC in which they
must state their intentions as soon as their holdings
reach 5% of the outstanding shares
• Accumulating shares before making a public tender
offer, the bid becomes profitable even if the bidder
must pay the full price for the purchases in the tender
offer