 Under the deal Cytopia shareholders will be offered 1 YM share for every Cytopia shares.  The agreed offer represents a share price offer of cents per Cytopia share (last traded cents (October 5, 2009).  By 11:30am on October 6, price was (23.81% increase)  It values the takeover offer at $14 million. (market cap of $9m on October 5, 2009)

 Should the share price increase to cents? (stock closed at 11 cents on Oct 6)  If yes by when (same day/ following day)  If not then why not?  Does market capitalisation have any implication? ◦ The market cap on October 5, 2009 was only $9m  Does share ownership have any implication? ◦ Around 30% shares are owned by the management

 A merger is a combination of two or more businesses (companies) ◦ Statutory merger: when the assets and/or liabilities of the target company are acquired ◦ Subsidiary merger: the target company becomes a subsidiary of the acquirer company (parent)

 Mergers are performed for a variety of reasons, most of them involve an attempt to improve a firm’s competitive advantage in the market.  Focus on the use of financial statement analysis to evaluate whether a merger creates value for the acquiring firm’s shareholders

There are a number of reasons why a firm may choose to merge with or acquire another one, including: ◦ Economies of scale ◦ Improving target management ◦ Combining complimentary resources ◦ Capturing tax benefits from acquiring a loss making company  Cytopia has an accumulated loss of $63.52m (never made a profit)

 Providing low-cost financing to target  Creating value through restructuring and breakups  Penetrating new markets  Increasing product-market rents  Diversification

 Conglomerate merger – in booming economies ◦ Middle of the 20 th century  Horizontal merger – create monopolies ◦ late 19 th and early part of 20 th century  Hostile takeover ◦ During 1980s  Vertical merger  The M&A in the late 20 th and early 21 st century about strategic benefits (mega mergers)

The Arcelor-Mittal merger ( ) serves as a great real-life example to examine some of the issues related to M&A. ArcelorMittal continued to explore growth opportunities in 2007, with 35 acquisition transactions. Refer to Zephyr database for information on Australian and global M&A

 Unique geographical and product diversification,  Upstream and downstream integration  Reduction in exposure to risk and cyclicality Mergers and acquisitions have historically been a key pillar of ArcelorMittal’s strategy to which it brings unique experience, particularly in terms of integration. Instead of creating new capacity, mergers and acquisitions increase industry consolidation and create synergies.

 Viterra’s bid price represented around 30% premium to target shareholders.  Initial market reactions were significantly positive for ABB.  Viterra will now acquire 100 per cent of ABB for $1.6 billion as announced on 9 September  Shareholders were offered $4.35 a share in cash, plus a 41-cent-a-share ABB Grain special dividend, as well as Viterra shares for each ABB Grain share.

The form of payment is an important financing decision. ◦ Capital structure effects  If debt financing is used, analysis should be conducted to see if the increase in financial leverage is excessive. ◦ Information problems  Asymmetric information levels between management and shareholders may cause investors to misinterpret the form of financing. ◦ Control and the form of payment  Using stock to finance M&A dilutes the ownership and control of the acquiring firm.

 Synergy is the additional value that is generated by combining two firms, creating opportunities that would not been available to these firms operating independently.

Operating synergies. Operating synergies are those synergies that allow firms to increase their operating income from existing assets, increase growth or both. We would categorize operating synergies into four types. Economies of scale Greater pricing power Combination of different functional strengths, Higher growth in new or existing markets,

 May arise from the merger, allowing the combined firm to become more cost-efficient and profitable.  In general economies of scales occur in mergers of firms in the same business (horizontal mergers)  E.g two banks coming together to create a larger bank or two steel companies combining to create a bigger steel company.

 Greater Pricing Power that results from reduced competition and higher market share result in higher margins and operating income.  This synergy is also more likely to show up in mergers of firms in the same business and should be more likely to yield benefits when there are relatively few firms in the business to begin with.  Thus, combining two firms is far more likely to create an oligopoly with pricing power

 Would be the case when a firm with strong marketing skills acquires a firm with a good product line.  This can apply to wide variety of mergers since functional strengths can be transferable across businesses.

 This would be case, for instance, when a US consumer products firm acquires an emerging market firm, with an established distribution network and brand name recognition, and uses these strengths to increase sales of its products.

 Financial synergies the payoff can take the form of either higher cash flows or a lower cost of capital (discount rate) or both.

 A combination of a firm with excess cash, or cash slack, (and limited project opportunities) and a firm with high-return projects (and limited cash) can yield a payoff in terms of higher value for the combined firm.  The increase in value comes from the projects that can be taken with the excess cash that otherwise would not have been taken.  This synergy is likely to show up most often when large firms acquire smaller firms, or when publicly traded firms acquire private businesses.

 When two firms combine, their earnings and cash flows may become more stable and predictable. This, in turn, allows them to borrow more than they could have as individual entities, which creates a tax benefit for the combined firm. This tax benefit usually manifests itself as a lower cost of capital for the combined firm.

 Arise either from the acquisition taking advantage of tax laws to write up the target company’s assets or from the use of net operating losses to shelter income.  Thus, a profitable firm that acquires a money-losing firm may be able to use the net operating losses of the latter to reduce its tax burden.  Alternatively, a firm that is able to increase its depreciation charges after an acquisition will save in taxes and increase its value.

 Most Important Question is whether synergy can be valued and, if so, what that value should be.  Some argue synergy is too nebulous to be valued and that any systematic attempt to do so requires so many assumptions that it is pointless.  If this is true, a firm should not be willing to pay large  premiums for synergy if it cannot attach a value to it.  The other school of thought is that we have to make our best estimate of how much value synergy will create in any acquisition before we decide how much to pay for it, even though it requires assumptions about an uncertain future.

 What form is the synergy expected to take? ◦ Will it reduce costs as a percentage of sales and increase profit margins ? (Economies of Scale) ◦ Will it increase future growth (e.g., when there is increased market power) ◦ Or the length of the growth period?  When will the synergy start affecting cash flows? ◦ Synergies seldom show up instantaneously ◦ Since the value of synergy is the present value of the cash flows created by it, the longer it takes for it to show up, the lesser its value.

Synergy, to have an effect on value, has to influence one of the four inputs into the valuation process –  Higher cash flows from existing assets (cost savings and economies of scale),  Higher expected growth rates (market power, higher growth potential),  Longer growth period (from increased competitive advantages), or  A lower cost of capital (higher debt capacity).

 First, we value the firms involved in the merger independently, by discounting expected cash flows to each firm at the weighted average cost of capital for that firm.  Second, we estimate the value of the combined firm, with no synergy, by adding the values obtained for each firm in the first step.  Third, we build in the effects of synergy into expected growth rates and cash flows and we revalue the combined firm with synergy. The difference between the value of the combined firm with synergy and the value of the combined firm without synergy provides a value for synergy.

 The value of a business is determined by decisions made by the managers of that business on where to invest its resources, how to fund these investments and how much cash to return to the owners of the business.  When we value a business, we make implicit or explicit assumptions about both who will run that business and how they will run it.

 When valuing an existing company, private or public, where there is already a management in place, we are faced with a choice.  We can value the company run by the incumbent managers and derive to a status quo value.  On the Contrary, we can also revalue the company with a hypothetical “optimal” management team and estimate an optimal value.  The difference between the optimal and the status quo values can be considered the value of controlling the business.