1. Welcome to class of Mergers and Acquisitions Dr. Satyendra Singh
Professor, Marketing and International Business
University of Winnipeg
CANADA

2. 2

3. Before you acquire a firm: Analyze
Products of the Firm
Bottom up (daily use products), Top down (like a firm, sector…)
Financial Health of the Firm
Earning, Balance sheet, LP account…
Management of the Firm
Reputation, can they take it to the next level
Geographical Exposure
Local vs. international
Stock Market Valuation of the Firm
P/E over time, EPS over time 3

4. Logic of the M&A Strategy
Value Creation through Synergy
Economies of Scale
Economies of Scope
Transferring competencies
Sharing infrastructure
Access to patents, Growth potential, Risk sharing
↑ Debt capacity, ↓ cash flow variability
Combined Cash Flow > Individual
If Market Value < True Value
Needs restructuring; inefficient management
Where is the value coming from? 4

5. Value: Turn the Inefficiency to Efficiency?

6. Value Creation: Financial Perspective
Price per Share (Market, not book)
Growth, risk, market speculation (based on P/E)…
Earning per Share
TTM (Trailing 12 months), Sales side vs buy side
P/E Ratio
If too ↓, suspicious. If too ↑, why? Why buy a company with high P/E  must have reason
Capital structure impacts P/E ratio  leveraged
Everything being identical in the same industry, P/E should be about same
Check P/E from industry sector, FTSE 100
Obtain justifiable values based on the ratios. 6

7. Value Creation: Example 1
Post-merger
Price/share = $80
EPS = $7
P/E = 11.4
Pre-merger
Price/share = $75
EPS = $5
P/E = 15
P/E dropped following merger, so the value of the merger is coming from the current projects rather than its future growth potential 7

8. Value Creation: Example 2
P/E $100/$1 100/2 100/3 100/4 100/5 100/6 100/7 ?!
P/E = Price to earning per share ratio
P/E = 100 is too high  needs justification
P/E match industry level everything being equal
Expect growth  100% increase in EPS  must continue
If P/E drastically different  merger arbitrage
Value  from future growth potential on sustainable basis
For industry (P/E): 8

9. Why do M&As Fail? Premium Paid (shares) > synergy/value
Expensive: bankers, accountant and lawyers
Competitive bidders appear
Arbitrageurs can buy outstanding stocks and force price concession
Lengthening the acquisition process makes it more expensive
As such cash acquisition is riskier
Acquirer takes all the risks
Stock Acquisition – Risk is shared 9

10. Can we create synergy/close the gap?
Firm A B Combined
P $60 $20
Earning $50m $10m $60m
# shares 10m 10m 15 (10+5)
EPS $5 $1
P/E
$60m/#15m = $4/share
Loss of $1 per share ($5-$4)
(+$10 x 10m = $100m premium)
Can we close the gap?)
A agrees to buy B’s share for $30 (ie pay premium of $10/share)
ie Half share of A for every share of B (.5 A = B)
ie B’s 10m share are equivalent to A’s 5m shares, total being 15m shares
ie $1 x 15m =$15m 10

11. PEG Ratio
It is PE Ratio divided by the annual forecast EPS growth percentage
If a firm is growing at 30% a year and has a P/E of 30, PEG would be 1.
PEG > 1  Share cost is ↑ relative to growth expectation
PEG < 1  Share cost is fair relative to growth expectation
***PEG is not scientific*** 11

12. Managerial Motives to M&A
Conflict of Interest
Managers like running large firms due to additional pay and prestige
Overconfidence
Hubris Hypothesis (HH)  pursue merger even if low value because they believe their ability to manage is great enough to succeed.
Unethical Behavior
Managers destroy shareholders’ value for personal gain
As per HH, managers believe they’re doing the right thing for shareholders. 12

13. Period: Major M & A Activities13

14. Recent Mergers 14

15. Recent Mergers… 15

16. Recent Mergers 16

17. Merger of Luxury Brands is common
Buys
for $2b 17

18. M&A can be between state-owned firms too18

19. Types of Takeover… Takeover Merger
Transfer of ownership from 1 firm to another
Merger
Combination of 2 firms into 1 legal entity
Similar-sized firms are combined
So are their names
One may be of the parents’ or a combination
DaimerChrysler
SIRIUS XM
Both shareholders approve the transaction 19

20. Types of Takeover Acquisitions Amalgamation Consolidation
Purchase of 1 firm by another
Larger firm buys smaller firmer, which becomes a subsidiary
Kraft foods buys Cadbury
Amalgamation
Merger that requires fair opinion by an independent expert on the value of the firm’s shares when public minority exists
Consolidation
An entirely new form is created 20

21. Types of M&A Activities
Related
Vertical
Supplier or customers
Horizontal
Competitors
Product extension
Complementary products
Market extension
Complimentary markets
Unrelated
Conglomerate
Everything else 21

22. Friendly Takeover Target firm is willing to be taken over
Investment bank prepares tender offer for the management
Can be initiated by acquirer
Both parties structure the deal to their mutual satisfaction, eg
Capital gain
Acquirer uses target as asset for tax deductions
Graceful exit  environmental, lawsuits…
Agree on initial purchase price; pay later 22

23. Friendly Acquisition Process23

24. Hostile Takeover Transactions bypass the management
Management is opposed to the deal
Acquirer already accumulated 20% of Target’s stock
So, tender offer
is made directly
to shareholders 24

25. Hostile Takeover: Defense Tactics
Shareholders Rights Plan
Poison Pills
Dilute the share by offering more shares and by giving discount (50%) to Target’s shareholders, making it expensive/difficult for Acquirer
Selling Key Assets
Sell the assets that Acquiring firm is interested
Pay large dividends to remove excess cash from Target’s balance sheet
White Knight
Seek out friendly acquirer 25

26. Critical Shareholder %
10% Early Warning
Acquirer is accumulating a position– toehold
20% Takeover Bid
Not allowed further, must tender bid, open to all
50.1% Control (Simple Majority)
Can replace board and control management
66.7% Amalgamation
Shareholders approve amalgamation proposal
90% Minority Squeeze Out
Minority shareholders are forced to tender their shares
 to avoid frustration 26

27. Regulatory Approval… All mergers must be approved by regulators
In the USA, all mergers over $60m must be approved by the government before the proposed takeover occurs
EU Commission has similar process
Emerging Markets
More strict due to colonization 27

28. Governments can interfere to control competition…28

29. Or for national security reasons29

30. But other governments may NOT have the same security concerns!30

31. Merger Arbitrage
Once a tender offer is announced, the uncertainty about whether the takeover will succeed adds volatility to the stock price
This uncertainty creates an opportunity for investors to speculate on the outcome of the deal
It creates volatility
Market share price > offer price (may be more bid)
Market share price = offer price (deal is likely)
Little trade in shares (deal may not go through)
Significant trade in shares (deal is likely) 31

32. Merger Arbitrage Example
Firm A
Price per share = $30
# shares = 10m
Market Capital = $300m
Firm B (Target)
Price per share = $50
# Share = 1m
Market Capital = $50m
A is acquiring B for $60m in A’s Share
(A needs 2m more $30/share  $60m)
ie 2 shares of A for every share of B (2A = B)
Suppose due to volatility, share for B is trading at $55
So buy 1 share of B  $ (exchange it for $60)
Short sell 2 share of A  $ Net gain $5 32

33. Leverage: Impact of Capital Structure on P/E, Assets
Firm B
Invested only $10 K
Borrowed $100 5% (ie $5 K)
# shares = 10,000
COGS (50%) = -$50 K
Depreciation = -$20 K
Operation Income (Pre-tax) = $30 K
Non-operating Income = $2 K
Interest paid = -$5 K
Total Operating Income = $27 K
Tax (30%) = -$8.1 K
Earning after tax = $18.9 K
EPS = $1.89
Analyst  P/E should be 10
So, market share price = $18.90
Market capitalization = $189 K
But B put only $10 K
Equity + Liability = $189 K + $100K
Total Assets = $289 K
Ie. $279 K assets + $10 K cash = $289 K
Firm A
Invested $100 K
Not borrowed, so no liability
# shares = 10,000
COGS (50%) = -$50 K
Depreciation = -$20 K
Operating Income (Pre-tax) = $30 K
Tax (30%) = -$9 K
Interest = 0
Earning after tax = $21 K
EPS = $2.10
Analyst  P/E should be 10
So, market share price = $21
Market capitalization = $210 K
But A put $100 K
Equity + Liability = $210 K + $0
Total Assets (ie mkt value of equity) = $210 K
By borrowing you’ll ↑ assets 33

34. Impact of M&A on Goodwill
Goodwill = Price paid – MV of Target firm Equity
= $1,250 – (MV of target assets – MV of target Liabilities)
= $1,250 – ($2,200 - $1,050) = $100 34

35. Questions?