Prof. Ian Giddy New York University Mergers & Acquisitions Hostile & Competitive DBS Bank

Copyright ©2000 Ian H. Giddy M&A 2 Mergers and Acquisitions l “As Is” Value l Merged Value l Competitive Value Concepts: Is firm to be acquired worth more within our company, or alone? To us or to them?

Copyright ©2000 Ian H. Giddy M&A 3 Gains to Target Firm Shareholders l Targets of successful tender offers and mergers earn significantly positive abnormal returns from announcement to completion of merger. Gains range from 16.9% to 34.1%. l Targets of unsuccessful tender offers also gain. But those with no new offers in 2 years lose all previous gains, while those with new offers make further gains. l Targets of unsuccessful mergers appear to lose all positive returns earned after announcement by the time failure becomes known.

Copyright ©2000 Ian H. Giddy M&A 4 Gains to Bidding Firm Shareholders l There are positive returns to successful bidders in tender offers l For successful bidders in mergers, evidence is mixed. It seems that returns are around zero. l For unsuccessful bidders in both tender offers and mergers, returns are negative.

Copyright ©2000 Ian H. Giddy M&A 5 Do Acquisitions Benefit Shareholders? Successful Bids TechniqueTargetBidders Tender offer30%4% Merger20%0 Proxy contest8%na n Note: Abnormal price changes are price changes adjusted to eliminate the effects of marketwide price changes

Copyright ©2000 Ian H. Giddy M&A 6 Do Acquisitions Benefit Shareholders? Unsuccessful Bids TechniqueTargetBidders Tender offer-3%-1% Merger-3%-5% Proxy contest8%na

Equity Valuation: Application to Conrail Prof. Ian Giddy New York University

Copyright ©2000 Ian H. Giddy M&A 8 Case Study: The Acquisition of Conrail l Why merge Conrail and CSX? l What’s Conrail worth? l How was the CSX offer structured? l How would Conrail shareholders react to the offer?

Copyright ©2000 Ian H. Giddy M&A 9 Gains from Conrail Acquisition? Rationale: Firm A should merge with Firm B if [Value of AB > Value of A + Value of B + Cost of transaction] l Synergy l Gain market power l Discipline l Taxes l Financing

Copyright ©2000 Ian H. Giddy M&A 10 What is Conrail Worth? l Stand-alone value  Market value  Comparables  Discounted present value l Value to acquirer l Value in bidding-war context

Copyright ©2000 Ian H. Giddy M&A 11 What is Conrail Worth? l Stand-alone value  Market value: $71.00  Comparables  Discounted present value l Value to acquirer l Value in bidding-war context

Copyright ©2000 Ian H. Giddy M&A 12 What Is The Deal Worth? l Two-tier offer (why?)  Front-end cash offer 40%*$92.50  Back-end stock swap 60%*( *$46.75) l Combined offer 40%*$ %*( *$46.75) =$89.07

Copyright ©2000 Ian H. Giddy M&A 13 What is Conrail Worth? l Stand-alone value  Market value: $71.00  Comparables  Discounted present value l Value to acquirer l Value in bidding-war context

Copyright ©2000 Ian H. Giddy M&A 14 How Much Can a Buyer Pay? Applying the discounted cash flow approach, we need to know: 1.The incremental cash flows to be generated from the acquisition, adjusted for debt servicing and taxes 2.The rate at which to discount the cash flows (required rate of return on equity) l The deadweight costs of making the acquisition (investment banks' fees, etc) l Cost of losing out!

Copyright ©2000 Ian H. Giddy M&A 15 What Gains from the Merger? Restructuring Framework 1 2 Current Market Value 3 Total restructured value Potential value with internal + external improvements Potential value with internal improvements Company’s DCF value Maximum restructuring opportunity Financial structure improvements 4 Disposal/ Acquisition opportunities Operating improvements Current market overpricing or underpricng 5 (Eg Increase D/E)

Copyright ©2000 Ian H. Giddy M&A 16 What's It Worth? Valuation Methods l Book value approach l Market value approach l Ratios (like P/E ratio) l Break-up value l Cash flow value

Copyright ©2000 Ian H. Giddy M&A 17 Estimating Future Cash Flows n Dividends? n Free cash flows to equity? n Free cash flows to firm?

Copyright ©2000 Ian H. Giddy M&A 18 Conrail: Required return k j = R F +  j (k m - R F ) where: k j = 16.15% (required return on company) R F = 6.83% (US Treasury bond)  j = 1.30 (estimated Beta for company) k m = 14% (average S&P return) We can use this required return to evaluate whether a company’s stock is worth buying.

Copyright ©2000 Ian H. Giddy M&A 19 If CSX can produce the following dollar profits for the next four years and beyond, at a discount rate of 16.15%, what is the present value of the cash flow stream? $0 $111 $259 $381…. $1.xxxb = Present Value of cash flow stream $1.xxxb/90.2m shares =$? Per share ….add to $70 to get price could afford Conrail: Value of Synergies?

Copyright ©2000 Ian H. Giddy M&A 20 What is Conrail Worth? l Stand-alone value  Market value: $71.00  Comparables  Discounted present value l Value to acquirer l Value in bidding-war context

Copyright ©2000 Ian H. Giddy M&A 21 Case Study: The Acquisition of Conrail l Could Norfolk Southern make a bid? l How? How much? l Does this change what CSX has to pay? l Answer: Yes! l Result: Conrail shareholders opposed the CSX move and Conrail was split

Copyright ©2000 Ian H. Giddy M&A 22 Equity Valuation : Results l Estimating discount rate l Estimating cash flows l Application to CSX 1 & 2 l Application to NS l Decision? l See spreadsheet: conrail.xls

Copyright ©2000 Ian H. Giddy M&A 23 What's It Worth? Valuation Methods l Book value approach l Market value approach l Ratios (like P/E ratio)  Conrail: $89/4.91=18x  AOL: 150x l Break-up value l Cash flow value

Copyright ©2000 Ian H. Giddy M&A 24 M&A Advisory Services: 1. Role of the Seller's Advisor l Develop list of buyers l Analyze how different buyers would evaluate company l Determine value of the company and advise seller on probable selling price range l Prepare descriptive materials showing strong points l Contact buyers l Control information process l Control bidding process l Advise on the structure of the transaction to give value to both sides l Ensure all nonfinancial terms are settled early l Smooth postagreement documentation

Copyright ©2000 Ian H. Giddy M&A 25 M&A Advisory Services: 2. Role of Buyer's Advisor l Thoroughly review target & subs l Advise on probable price range l Advise on target's receptiveness l Evaluate target's options and anticipate actions l Devise tactics l Consider rival buyers l Recommend financial structure and plan financing l Advise on initial approach and follow-up l Function as liason l Advise on the changing tactical situation l Arrange the purchase of shares through a tender offer l Help arrange long term financing and asset sales

Copyright ©2000 Ian H. Giddy M&A 26 Mergers and Acquisitions: Summary l Mergers & Acquisitions l Divestitures l Valuation Concept: Is a business worth more within our company, or outside it?

Copyright ©2000 Ian H. Giddy M&A 30 Ian Giddy NYU Stern School of Business Tel ; Fax