1.  Mergers Principles of Corporate Finance Brealey and Myers Sixth Edition Slides by Matthew Will Chapter 33 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill

2. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 2 Topics Covered  Sensible Motives for Mergers  Some Dubious Reasons for Mergers  Estimating Merger Gains and Costs  The Mechanics of a Merger  Takeover Battles  Mergers and the Economy

3. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 3 1997 and 1998 Mergers

4. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 4 Sensible Reasons for Mergers Economies of Scale A larger firm may be able to reduce its per unit cost by using excess capacity or spreading fixed costs across more units. $ $ $ Reduces costs

5. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 5 Sensible Reasons for Mergers Economies of Vertical Integration  Control over suppliers “may” reduce costs.  Over integration can cause the opposite effect.

6. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 6 Sensible Reasons for Mergers Economies of Vertical Integration  Control over suppliers “may” reduce costs.  Over integration can cause the opposite effect. Pre-integration (less efficient) Company S S S S S S S

7. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 7 Sensible Reasons for Mergers Economies of Vertical Integration  Control over suppliers “may” reduce costs.  Over integration can cause the opposite effect. Pre-integration (less efficient) Company S S S S S S S Post-integration (more efficient) Company S

8. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 8 Sensible Reasons for Mergers Combining Complementary Resources Merging may result in each firm filling in the “missing pieces” of their firm with pieces from the other firm. Firm A Firm B

9. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 9 Sensible Reasons for Mergers Combining Complementary Resources Merging may result in each firm filling in the “missing pieces” of their firm with pieces from the other firm. Firm A Firm B

10. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 10 Sensible Reasons for Mergers Mergers as a Use for Surplus Funds If your firm is in a mature industry with few, if any, positive NPV projects available, acquisition may be the best use of your funds.

11. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 11 Dubious Reasons for Mergers  Diversification  Investors should not pay a premium for diversification since they can do it themselves.

12. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 12 Dubious Reasons for Mergers The Bootstrap Game Acquiring Firm has high P/E ratio

13. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 13 Dubious Reasons for Mergers The Bootstrap Game Acquiring Firm has high P/E ratio Selling firm has low P/E ratio (due to low number of shares)

14. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 14 Dubious Reasons for Mergers The Bootstrap Game Acquiring Firm has high P/E ratio Selling firm has low P/E ratio (due to low number of shares) After merger, acquiring firm has short term EPS rise

15. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 15 Dubious Reasons for Mergers The Bootstrap Game Acquiring Firm has high P/E ratio Selling firm has low P/E ratio (due to low number of shares) After merger, acquiring firm has short term EPS rise Long term, acquirer will have slower than normal EPS growth due to share dilution.

16. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 16 Dubious Reasons for Mergers Earnings per dollar invested (log scale) Now Time.10.067.05 Muck & Slurry World Enterprises (before merger) World Enterprises (after merger)

17. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 17 Estimating Merger Gains  Questions  Is there an overall economic gain to the merger?  Do the terms of the merger make the company and its shareholders better off? ????

18. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 18 Estimating Merger Gains  Economic Gain

19. © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 33- 19 Takeover Defenses White Knight - Friendly potential acquirer sought by a target company threatened by an unwelcome suitor. Shark Repellent - Amendments to a company charter made to forestall takeover attempts. Poison Pill - Measure taken by a target firm to avoid acquisition; for example, the right for existing shareholders to buy additional shares at an attractive price if a bidder acquires a large holding.