Mergers and Acquisitions Activity, Rationale, and Negotiation 1RW Melicher

Merger Waves or Activity Five Major Merger Waves in U.S.: Late 1800s (consolidations in basic industries) 1920s (stock market boom fueled consolidations) 1960s (conglomerate mergers) 1980s (use of junk bonds in LBOs & MBOs) Late 1990s to Today (strategic alliances) 2

Explanations of M&A Activity Hubris (managerial psychology—urge to merger is driven by pride & perceived power) Market Manias (role of mass behavior--market bubbles, merger fads, “deal frenzy,” etc.) Overvaluation of Stocks (information asymmetry) Agency Costs & Governance Problems (corrective M&A activity to reduce managerial self-interests) Competitive Positioning & Industry Shocks (monopolistic powers & changes in demand) 3

Rationale for Mergers Synergy Tax Considerations Purchase of Assets below Replacement Costs Diversification Managers’ Personal Incentives Breakup Value 4

Types of Mergers Horizontal (combining of firms in same line of business) Vertical (merging with suppliers, producers, or customers) Congeneric (combining of related firms but not direct competitors) Conglomerate (combining unrelated firms) Financial (focus on restructuring & breakup values) 5

Friendly Vs. Hostile Takeovers Mergers may be between equals, but more likely there is an acquirer and a target Friendly Merger (BODs and CEOs of both firms desire to merge in order to share potential synergies) Hostile Takeover (occurs when a target resists a takeover attempt often resulting in the acquirer making a “tender offer” directly to the target’s shareholders) 6

Form of Payment & Financing Cash Offers (occur in majority of transactions & are dominant in smaller acquisitions) Stock Offers (occur more frequently in larger transactions and stock offers occur more frequently when stock prices are relatively high) Stock tends to be used when a deal is friendly, the buyer’s stock price is buoyant, ownership is not concentrated, & deals are larger in size Cash tends to be used in tender offers where deals typically are hostile 7

Negotiating the Deal Friendly Merger Negotiation (one where potential synergy benefits are expected by combining the two firms) A successful friendly merger is often the result of sharing synergy benefits Understanding the other party’s point of view is important in getting the deal done 8

Negotiating the Deal (cont’d) Both parties should establish a range of values for the target firm (using DCF and relative valuation methods) Establish an “opening” or “asking” price and a “walk-away” or “reservation” price Negotiations are more likely to be successful if there is a “Zone of Potential Agreement” (ZOPA) where the range of prices overlap 10

Negotiating the Deal (cont’d) Hostile Merger Negotiation (occurs when the target firm resists the merger) Direct negotiations cease & acquirer turns directly to target’s stockholders requesting they “tender” their shares at a specific price A “Tender Offer” involves the offering of a “Control Premium” to the target’s stockholders “Transactions” Multiples may reflect both friendly mergers & hostile takeovers that use tender offers 11