Copyright ©1999 Ian H. Giddy M&A 1

Prof. Ian Giddy New York University Mergers & Acquisitions

Copyright ©1999 Ian H. Giddy M&A 3 Mergers and Acquisitions l Mergers & Acquisitions l Divestitures l Valuation Concept: Is a division or firm worth more within the company, or outside it?

Copyright ©1999 Ian H. Giddy M&A 4 Corporate Finance CORPORATE FINANCE DECISONS CORPORATE FINANCE DECISONS INVESTMENT RISK MANAGEMENT RISK MANAGEMENT FINANCING CAPITAL PORTFOLIO M&A DEBTEQUITY TOOLS MEASUREMENT

Copyright ©1999 Ian H. Giddy M&A 5 Principles of Financial Management l Invest in projects that yield a return greater than the minimum acceptable hurdle rate.  The hurdle rate should be higher for riskier projects and reflect the financing mix used - owners’ funds (equity) or borrowed money (debt)  Returns on projects should be measured based on cash flows generated and the timing of these cash flows; they should also consider both positive and negative side effects of these projects. l Choose a financing mix that minimizes the hurdle rate and matches the assets being financed. l If there are not enough investments that earn the hurdle rate, return the cash to stockholders.  The form of returns - dividends and stock buybacks - will depend upon the stockholders’ characteristics l Minimize unnecessary financial risks. Objective: Maximize the Value of the Firm

Copyright ©1999 Ian H. Giddy M&A 6 The Market for Corporate Control When you buy shares, you get dividends; and potential control rights There is a market for corporate control— that is, control over the extent to which a business is run in the right way by the right people. This market is constrained by  Government  Management  Some shareholders Example: Allied Signal’s attempts to acquire AMP, which is located in Pennsylvania

Copyright ©1999 Ian H. Giddy M&A 7 The Market for Corporate Control l M&A&D situations often arise from conflicts: l Owner vs manager ("agency problems" l Build vs buy ("internalization") l Agency problems arise when owners' interests and managers' interests diverge. Resolving agency problems requires  Monitoring & intervention, or  Setting incentives, or  Constraining, as in bond covenants l Resolving principal-agent conflicts is costly l Hence market price may differ from potential value of a corporation

Copyright ©1999 Ian H. Giddy M&A 8 “Internalization”: Is an activity best done within the company, or outside it? Issue: why are certain economic activities conducted within firms rather than between firms? l As a rule, it is more costly to build than to buy—markets make better decisions than bureaucrats l Hence there must be some good reason, some synergy, that makes an activity better if done within a firm l Eg: the production of proprietary information l Often, these synergies are illusory

Copyright ©1999 Ian H. Giddy M&A 9 Takeovers as a Solution to “Agency Problems” l There is a conflict of interest between shareholders and managers of a target company—Eg poison pill defenses l Individual owners do not have suffcient incentive to monitor managers l Corporate takeover specialists, Eg KKR, monitor the firm's environment and keep themselves aware of the potential value of the firm under efficient management l The threat of a takeover helps to keep managers on their toes—often precipitates restructuring.

Copyright ©1999 Ian H. Giddy M&A 10 Goal of Acquisitions and Mergers l Increase size - easy! l Increase market value - much harder!

Copyright ©1999 Ian H. Giddy M&A 11 Goal: Market Value Addition Definition It is a measure of shareholder value creation Methodology It is the change in the market value of invested capital ( debt and equity) minus the change in the book value of invested capital

Copyright ©1999 Ian H. Giddy M&A 12 Value Changes In An Acquisition Final value of combined company Initial value plus gains Profit on sale of assets Synergies and/ or operating improvements Value of acquired company as a separate entity Value of acquiring company without acquisition Gain in shareholder value Takeover premium Taxes on sale of assets

Copyright ©1999 Ian H. Giddy M&A 13 Goals of Acquisitions 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 ©1999 Ian H. Giddy M&A 14 Goals of Acquisitions Rationale: Firm A should merge with Firm B if [Value of AB > Value of A + Value of B + Cost of transaction] l Synergy  Eg Martell takeover by Seagrams to match name and inventory with marketing capabilities l Gain market power  Eg Atlas merger with Varity. (Less important with open borders) l Discipline  Eg Telmex takeover by France Telecom & Southwestern Bell (Privatization)  Eg RJR/Nabisco takeover by KKR (Hostile LBO) l Taxes  Eg income smoothing, use accumulated tax losses, amortize goodwill l Financing  Eg Korean groups acquire firms to give them better access to within-group financing than they might get in Korea's undeveloped capital market

Copyright ©1999 Ian H. Giddy M&A 15 M&A Program Must be Part of Long- Range Strategic Planning: l What’s our business? Company’s capabilities and limitations? Our mission? l Key trends in the business environment? l Corporate flexibility to meet critical changes and challenges? l Competitive analysis? l Relationships with suppliers, customers, complementary firms? l Internal performance measurement system? Reward system? l Organization and funding for implementation? l Where do we want to go, and how are we going to get the resources to get there? Example: Merrill Lynch and the Internet

Copyright ©1999 Ian H. Giddy M&A 16 Developing an Acquisition Strategy l Define your acquisition objectives l Establish specific acquisition critieria l Select a good team of advisors l Focus on the company’s “wish list” l Is it the right target? l Is the market going to like the deal? Why? l What is the business vision that justifies it? l How much dilution is the buyer’s stock price will there be? l What will it take after the deal to make it work? Example: Ciba SC and Allied Colliods

Copyright ©1999 Ian H. Giddy M&A 17 Rigorous Search Procedures l What are our weaknesses and how do we have to improve? l What companies can help us or how can we help them? l How can we build a group of complementary business groups that will give strength to one another? Example: IBM and e-commerce

Copyright ©1999 Ian H. Giddy M&A Manage preacquisition phase l Instruct staff on secrecy requirements l Evaluate your own company l Identify value-adding approach Understand industry structure, and strengthen core business Capitalize on economics of scale Exploit technology or skills transfer 2. Screen Candidates l Identify knockout criteria l Decide how to use investment banks l Prioritize opportunities l Look at public companies, divisions of companies, and privately held companies Steps in a Successful Merger and Acquisition Program - Step 1 and 2

Copyright ©1999 Ian H. Giddy M&A 19 Steps in a Successful Merger and Acquisition Program - Step 3 to 5 3. Value remaining candidates l Know exactly how you will recoup the takeover premium l Identify real synergies l Decide on restructuring lan l Decide on financial engineering opportunities 4. Negotiate l Decide on maximum reseervation price and stick to it l Understand background and incentives of the other side l Understand vlue that might be paid by a third party l Establish negotiation strategy l Conduct due diligence 5. Manage postmerger integration l Move as quickly as possible l Carefully manage the process

Copyright ©1999 Ian H. Giddy M&A 20 Case Study: Sterling Drug Questions: l What was Kodak’s acquisition strategy? l What was the motivation for the bid for Sterling Drug? l What were the potential sources of synergy? l What would you expect to happen to the value of Kodak’s shares? Of its debt?

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Copyright ©1999 Ian H. Giddy M&A 25 Ian Giddy NYU Stern School of Business Tel ; Fax