The Takeoer Process
Points to remember
M&As refer to
- Traditional mergers and acquisitions
- Takeovers
- Corporate restructuring
- Change in corporate control
- Changes in the ownership structure of firms
The 10 Change Forces
-Technological change
-Economies of scale, economies of scope, complementarity, and the need to catch up technologically
-Globalization and freer trade
-Changes in industry organization
-New industries
-Deregulation and regulation
-Favourable economic and financial conditions for much of the past two decades
-Negative trends in certain individual economies and industries
-Widening inequalities in income and wealth
-Relatively high valuations for equities during the 1990s
Terminology
Merger
Negotiated deals
Mutuality of negotiations
Mostly friendly
Tender offers
Offer made directly to the shareholders
Hostile - when offer is made without approval of the board
Restructuring — changes in organization structure or policies to alter the firm’s approach to achieving its long-term objectives.
Types of Mergers
Horizontal mergers
Mergers - Legal Framework of USA
Statutory merger — formal legal procedures
Short-form merger — streamlined legal procedures when ownership is 90%
Holding company — parent company has a controlling interest
Tender Offers
Bidder seeks target's shareholders approval
Minority shareholders
Terms may be "crammed down"
May be subject to "freeze-in"
Minority has the right to bring legal actions
Kinds of tender offers and provisions
Conditional vs. unconditional
Restricted vs. unrestricted
"Any-or-all" tender offer
Contested offers
Two-tier offers
Three-piece suitor
Risk Arbitrage in M&A Activity
In mergers and acquisitions, risk arbitrage is the practice of being long in the target stock and short in the bidder stock.
The position implies that arbitrageurs are betting that the merger will be successful.
Nature of the arbitrage industry
Information gathering and analysis is the principal raw material
Some arbitragers attempt to anticipate takeover bids and acquire stock before public announcement also.
Combination between firms in same business activity
Rationale
Economies of scale and scope
Synergies such as combining of best practices
Government regulation due to potential anticompetitive effects
Vertical mergers
Combinations between firms at different stages
Rationale is information and transaction efficiency
Conglomerate mergers
Combination of firms in unrelated types of business activity
Distinctions between conglomerate and nonconglomerate firms
- Investment companies — diversify to reduce portfolio risk
- Financial diversified — provide funds and expertise on generic management functions of planning and control
- Concentric diversified — combine with firms in less related activities to broaden market potentials
Risk Arbitrage in M&A Activity
Usually, long in the target stock and short in the bidder stock
Nature of the arbitrage industry
Information gathering and analysis is the principal raw material
Arbitragers attempt to anticipate takeover bids
Arbitrage funds
Abritrage funds invest in multiple merger parties to diversify the risk.
To minimise risk, funds undertke intensive research and do not investment on rumours.
They invest in 10-20 transactions at a given time.
They aim to give annual returns of 10% or greater and also to provide returns uncorrelated with overall stock market returns.
Summary
This chapter has summarized some basic terminology and concepts, providing a foundation of further knowledge and understanding of M&As.
Main risk is whether deals are completed
Showing posts with label Points-to-Refresh. Show all posts
Showing posts with label Points-to-Refresh. Show all posts
Monday, November 12, 2007
M&A - Points to Refresh Weston's Book Ch.2
The legal and Regulatory Framework
The takeover laws are closely interlinked with securities laws.
Federal Securities Laws of USA
8 main statutes
# Securities Act of 1933
# Securities Exchange Act of 1934
# Public Utility Holding Company Act of 1935
# Trust Indenture Act of 1939
# Investment Company Act of 1940
# Investment Advisers Act of 1940
# Securities Investor Protection Act of 1970
# Sarbanes-Oxley Act of 2002 (SOA)
Relevance of of the various Acts.
The Securities Act of 1933 insists on information.
Section 5 prevents the public offering and sale of securities without a registration statement.
Section 8 provides for registration and permits the statement to automatically become effective 20 days after it is filed with the SEC. However, SEC has the power to issue a stop order.
Securities Exchange Act of 1934 — basis of later amendments applicable to takeover activities.
SEC imposes periodic disclosure requirements under Section 13 of Securities Exchange Act of 1934. One of the forms, Form 8-K is to be filed whenever specified events occur.
Section 14 governs proxy solicitation.
The takeover laws are closely interlinked with securities laws.
Federal Securities Laws of USA
8 main statutes
# Securities Act of 1933
# Securities Exchange Act of 1934
# Public Utility Holding Company Act of 1935
# Trust Indenture Act of 1939
# Investment Company Act of 1940
# Investment Advisers Act of 1940
# Securities Investor Protection Act of 1970
# Sarbanes-Oxley Act of 2002 (SOA)
Relevance of of the various Acts.
The Securities Act of 1933 insists on information.
Section 5 prevents the public offering and sale of securities without a registration statement.
Section 8 provides for registration and permits the statement to automatically become effective 20 days after it is filed with the SEC. However, SEC has the power to issue a stop order.
Securities Exchange Act of 1934 — basis of later amendments applicable to takeover activities.
SEC imposes periodic disclosure requirements under Section 13 of Securities Exchange Act of 1934. One of the forms, Form 8-K is to be filed whenever specified events occur.
Section 14 governs proxy solicitation.
M&A - Points to Refresh Weston's Book Ch.5
Strategy
Nature of Strategy
Strategy defines the central plans, policies and culture of an organization in a long-term horizon.
A more broader definition will be strategies define objectives (mission), goals (vision), plans, policies, and cultures of an organization over along time period.
Mission is the objective concerned with the customers.
Vision is one of the goals that excites everybody in the organization and hence it is emphasized, talked about, publicized and closely monitored.
Strategic planning is a dynamic process that requires inputs from all segments of the organization
Acquisition and restructuring policies and decisions should be part of the company's overall strategic plans and processes
Ultimate responsibility for strategic planning resides in the top executive group
Essential elements in strategic planning
Assessment of changes in the environments
Evaluation of company capabilities and limitations
Assessment of expectations of stakeholders
Analysis of company, competitors, industry, domestic economy, and international economies
Formulation of the missions, goals, and policies for the master strategy
Development of sensitivity to critical environmental changes
Formulation of organization performance measurements and benchmarks
Formulation of long-range strategy programs
Formulation of mid-range programs and short-run plans
Organization, funding, and other methods to implement all of the preceding elements
Information flow and feedback system for continued repetition of above activities and for adjustments and changes at each stage
Review and evaluation of above processes
Diversity in Strategic Planning Processes
Monitoring environments
Continuous monitoring of external environments
Should encompass both domestic and international dimensions
Include analysis of economic, technological, political, social, and legal factors
Stakeholders
Take into account individuals and groups that have interests in the organization and its actions
Stakeholders include customers, stockholders, creditors, employees, governments, communities, media, political groups, educational institutions, financial community, and international entities
Organization cultures
Corporate cultures affect strategic thinking and planning
Failure to mesh divergent cultures is a major obstacle to successful merger integration
Alternative strategy methodologies/Tools/Models
SWOT or WOTS UP - inventory and analysis of organizational strengths, weaknesses, environmental opportunities and threats
Gap analysis - assessment of goals versus forecasts or projections
Top-down or Bottom-up - relate to company forecasts versus aggregation of forecasts of segments
Computer models - opportunity for detail and complexity
Competitive analysis - assess customers, suppliers, new entrants, products, and product substitutability
Synergy - look for complementarities
Logical incrementalism - well-supported moves from current bases
Muddling through - incremental changes selected from a small number of policy alternatives
Comparative histories - learn from the experiences of others
Delphi technique - iterated opinion reactions from selected groups
Discussion group technique - stimulating ideas by unstructured discussions aimed at consensus decisions
Adaptive processes - periodic reassessment of environmental opportunities and organization capability adjustments required
Environmental scanning - continuous analysis of all relevant environments
Intuition - insights of brilliant managersEntrepreneurship - creative leadership
Discontinuities - crafting strategy from recognition of trend shifts
Brainstorming - free-form repeated exchange of ideas
Game theory - logical analysis of competitor actions and reactions
Game playing - assign roles and simulate alternative scenarios
Alternative Analytical Frameworks Employed in Strategy Formulation
Product life cycles - introduction, growth, maturity, decline stages with changing opportunities, threats
Learning curve - costs decline with cumulative volume experience resulting in first mover competitive advantages
Competitive analysis - industry structure, rivals' reactions, supplier and customer relations, product positioning, complementor company analysis
Cost leadership - low-cost advantages
Product differentiation - develop product configurations that achieve customer preference
Value chain analysis - controlled cost outlays to add product characteristics valued by customers
Niche opportunities - specialize to particular needs or interests of customer groups
Product breadth - carryover of organizational capabilitiesCorrelations with profitability - statistical studies of factors associated with high profitability measures
Market share - high market share associated with competitive superiority
Product quality - customer allegiance and price differentials for higher quality
Technological leadership - keep at frontiers of knowledge
Relatedness matrix - unfamiliar markets and products involve greatest riskFocus matrix - narrow versus broad product families
Growth/share matrix - aim for high market share in high growth markets
Attractiveness matrix - aim to be strong in attractive industries
Global matrix - aim for competitive strength in attractive countries
Approaches to Formulating Strategy
Boston Consulting Group Approach
Experience curve
Product life cycle
Product portfolio balance
Recent approaches
Impact of the Internet and other technological innovations
Performance measurements - cash flow return on investment (CFROI)
Michael Porter Approach (1980, 1985, 1987)
Select attractive industry — Five Forces Diagram (Competitive Advantage, 1985, p. 5)
Develop competitive advantage through cost leadership, product differentiation, or focus
Develop attractive value chains
Eclectic and Adaptive Processes
Strategy decisions as ill-structured problems
Match resources to investment opportunities under environmental uncertainty
Compounded by uncertain actions and reactions of competitors
Iterative solution methodology.
Decision steps:
State objectives
Define environment
Analyze strengths/weaknesses relative to environment
Assess potential in environment
Compare potential to objectives
If gap, search for alternative ways to close gap
Select alternatives for analysis
Cost/benefit analysis of alternatives
Tentative selection — formulate plans and actions
Repeat process from several viewpoints (research, production, marketing, financial, etc.) and all over system standpoint
Commit resources to implement plan
Competitive reactions
Follow-up to compare performance to plan
Repeat comparison of objectives and potential
Goal is effective alignment to changing environments
Evaluation of Alternative Approaches to Strategy
All are eclectic in actual practice
Computerization ties approaches closer together
Results of strategy viewed differently:
Firms can develop and implement strategic planning and diversification strategies to obtain competitive advantage
Adaptive process approach — competitive advantage not permanent; planning as a continual learning and adjustment process
Formulating a Acquisition/Merger Strategy
Requires continuing reassessment
Industry analysis
Competitor analysis
Supplier analysis
Customer analysis
Substitute products
Complementors
Technology changes
Societal factors
Goal/capability analysis
Are current goals, policies appropriate?
Do goals, policies match resources?
Does timing of goals/policies reflect ability of firm to change?
Work out strategic alternatives
May not include current strategy
Choose best
Mergers represent one set of alternatives
Firm's strengths/weaknesses relative to present/future industry conditions
Connection between strategic planning and mergers
Diversification strategy may be necessary if firm must alter product-market mix or capabilities to reduce or close strategic gap
Both involve evaluation of current capabilities relative to those needed to reach objectives
Related diversification involves lower risks
Nature of Strategy
Strategy defines the central plans, policies and culture of an organization in a long-term horizon.
A more broader definition will be strategies define objectives (mission), goals (vision), plans, policies, and cultures of an organization over along time period.
Mission is the objective concerned with the customers.
Vision is one of the goals that excites everybody in the organization and hence it is emphasized, talked about, publicized and closely monitored.
Strategic planning is a dynamic process that requires inputs from all segments of the organization
Acquisition and restructuring policies and decisions should be part of the company's overall strategic plans and processes
Ultimate responsibility for strategic planning resides in the top executive group
Essential elements in strategic planning
Assessment of changes in the environments
Evaluation of company capabilities and limitations
Assessment of expectations of stakeholders
Analysis of company, competitors, industry, domestic economy, and international economies
Formulation of the missions, goals, and policies for the master strategy
Development of sensitivity to critical environmental changes
Formulation of organization performance measurements and benchmarks
Formulation of long-range strategy programs
Formulation of mid-range programs and short-run plans
Organization, funding, and other methods to implement all of the preceding elements
Information flow and feedback system for continued repetition of above activities and for adjustments and changes at each stage
Review and evaluation of above processes
Diversity in Strategic Planning Processes
Monitoring environments
Continuous monitoring of external environments
Should encompass both domestic and international dimensions
Include analysis of economic, technological, political, social, and legal factors
Stakeholders
Take into account individuals and groups that have interests in the organization and its actions
Stakeholders include customers, stockholders, creditors, employees, governments, communities, media, political groups, educational institutions, financial community, and international entities
Organization cultures
Corporate cultures affect strategic thinking and planning
Failure to mesh divergent cultures is a major obstacle to successful merger integration
Alternative strategy methodologies/Tools/Models
SWOT or WOTS UP - inventory and analysis of organizational strengths, weaknesses, environmental opportunities and threats
Gap analysis - assessment of goals versus forecasts or projections
Top-down or Bottom-up - relate to company forecasts versus aggregation of forecasts of segments
Computer models - opportunity for detail and complexity
Competitive analysis - assess customers, suppliers, new entrants, products, and product substitutability
Synergy - look for complementarities
Logical incrementalism - well-supported moves from current bases
Muddling through - incremental changes selected from a small number of policy alternatives
Comparative histories - learn from the experiences of others
Delphi technique - iterated opinion reactions from selected groups
Discussion group technique - stimulating ideas by unstructured discussions aimed at consensus decisions
Adaptive processes - periodic reassessment of environmental opportunities and organization capability adjustments required
Environmental scanning - continuous analysis of all relevant environments
Intuition - insights of brilliant managersEntrepreneurship - creative leadership
Discontinuities - crafting strategy from recognition of trend shifts
Brainstorming - free-form repeated exchange of ideas
Game theory - logical analysis of competitor actions and reactions
Game playing - assign roles and simulate alternative scenarios
Alternative Analytical Frameworks Employed in Strategy Formulation
Product life cycles - introduction, growth, maturity, decline stages with changing opportunities, threats
Learning curve - costs decline with cumulative volume experience resulting in first mover competitive advantages
Competitive analysis - industry structure, rivals' reactions, supplier and customer relations, product positioning, complementor company analysis
Cost leadership - low-cost advantages
Product differentiation - develop product configurations that achieve customer preference
Value chain analysis - controlled cost outlays to add product characteristics valued by customers
Niche opportunities - specialize to particular needs or interests of customer groups
Product breadth - carryover of organizational capabilitiesCorrelations with profitability - statistical studies of factors associated with high profitability measures
Market share - high market share associated with competitive superiority
Product quality - customer allegiance and price differentials for higher quality
Technological leadership - keep at frontiers of knowledge
Relatedness matrix - unfamiliar markets and products involve greatest riskFocus matrix - narrow versus broad product families
Growth/share matrix - aim for high market share in high growth markets
Attractiveness matrix - aim to be strong in attractive industries
Global matrix - aim for competitive strength in attractive countries
Approaches to Formulating Strategy
Boston Consulting Group Approach
Experience curve
Product life cycle
Product portfolio balance
Recent approaches
Impact of the Internet and other technological innovations
Performance measurements - cash flow return on investment (CFROI)
Michael Porter Approach (1980, 1985, 1987)
Select attractive industry — Five Forces Diagram (Competitive Advantage, 1985, p. 5)
Develop competitive advantage through cost leadership, product differentiation, or focus
Develop attractive value chains
Eclectic and Adaptive Processes
Strategy decisions as ill-structured problems
Match resources to investment opportunities under environmental uncertainty
Compounded by uncertain actions and reactions of competitors
Iterative solution methodology.
Decision steps:
State objectives
Define environment
Analyze strengths/weaknesses relative to environment
Assess potential in environment
Compare potential to objectives
If gap, search for alternative ways to close gap
Select alternatives for analysis
Cost/benefit analysis of alternatives
Tentative selection — formulate plans and actions
Repeat process from several viewpoints (research, production, marketing, financial, etc.) and all over system standpoint
Commit resources to implement plan
Competitive reactions
Follow-up to compare performance to plan
Repeat comparison of objectives and potential
Goal is effective alignment to changing environments
Evaluation of Alternative Approaches to Strategy
All are eclectic in actual practice
Computerization ties approaches closer together
Results of strategy viewed differently:
Firms can develop and implement strategic planning and diversification strategies to obtain competitive advantage
Adaptive process approach — competitive advantage not permanent; planning as a continual learning and adjustment process
Formulating a Acquisition/Merger Strategy
Requires continuing reassessment
Industry analysis
Competitor analysis
Supplier analysis
Customer analysis
Substitute products
Complementors
Technology changes
Societal factors
Goal/capability analysis
Are current goals, policies appropriate?
Do goals, policies match resources?
Does timing of goals/policies reflect ability of firm to change?
Work out strategic alternatives
May not include current strategy
Choose best
Mergers represent one set of alternatives
Firm's strengths/weaknesses relative to present/future industry conditions
Connection between strategic planning and mergers
Diversification strategy may be necessary if firm must alter product-market mix or capabilities to reduce or close strategic gap
Both involve evaluation of current capabilities relative to those needed to reach objectives
Related diversification involves lower risks
M&A - Points to Refresh Weston's Book Ch.6 Theories of Mergers
Ch.6 Theories of Mergers and Tender Offers
You may not fully understand these brief points if you have not studied the text.
The theories and models are covered under the following classifications.
A. Theories explaining why mergers occur.
B. Theories of valuation effects of mergers and acquisitions
C. Theoretical predictions of the pattern of gains in takeovers.
D. Models of Merger Process
E. Models of Bidding Process
Theories or models under the classifications
A. Theories explaining why mergers occur.
- 1. Size and returns to scale
- 2. Transaction costs and mergers
B. Theories of valuation effects of mergers and acquisitions
- 1. Theories that posit that value increases
------ a. Transaction cost efficiency - Coase
-------b. Synergy
-------c. Disciplinary
- 2. Theories that posit that value reduces
-------a. Agency costs of free cash flows - Jensen
-------b. Management entrenchment - Shleifer and Vishny
- 3. Theories that argue that value is neutral
-------a. Hubris ----------Roll
C. Theoretical predictions of the pattern of gains in takeovers.
D. Models of Merger Process
---Negotiation - When is it done in public domain?
E. Models of Bidding Process
- 1. How to avoid winner's curse
- 2. Effects of Bidding costs
- 3. Role of toehold.
- 4. Whether to pay in cash or in stock
From the seller's perspective
- 5. How to react to initial bid?
- 6. Is it beneficial to accept termination fee in the MOU?
- 7. Should it seek competing bids and go for auction?
Various theories and models in little more detail
Economies of scale — Mergers allow a reorganization of production processes so that plant scale may be increased to obtain economies of scale.
Economies of scope
Organization capital
Organization reputation
Human capital resources
Generic managerial capabilities
Industry-specific managerial capabilities
Nonmanagerial human capital
Models of the Takeover Process
Economic — competition vs. market power
Auction types — Dutch, English
Forms of games
Types of equilibria — pooling, separating, sequential
Types of bids — one, multiple
Bidding theory — preemptive; successive bids
Framework
Total gains for both target and acquirer
Positive, if the following are present in the transaction
Efficiency improvement
Synergy
Increased market power
Zero if
Hubris
Winner's curse
Acquiring firm overpays
Negative, if
Agency problems
Mistakes or bad fit
Gains to target — all empirical studies show gains are positive
Gains to acquirer
----Positive — efficiency, synergy, or market power
----Negative — overpaying, hubris, agency problems, or mistakes
Sources of Value Increases from M&As
Efficiency increases
Unequal managerial capabilities
Better growth opportunities
Critical mass
Better utilization of fixed investments
Operating synergy
Economies of scale
Economies of scope
Vertical integration economies
Managerial economies
Diversification motives - Why firms diversify?
Demand for diversification by managers/employees because they make firm-specific investments
Diversification for preservation of organization capital
Diversification for preservation of reputational capital
Diversification and financial synergy
Diversification can increase corporate debt capacity, decrease present value of future tax liabilities
Diversification can decrease cash flow variability following merger of firms with imperfectly correlated cash flow streams
Diversification discount - A Problem
Studies find that the average diversified firm has been worth less than a portfolio of comparable single-segment firms
Reasons
External capital markets allocate resources more efficiently than internal capital markets
Rivalry between segments may result in subsidies to underperforming divisions within a firm
Managers of multiple activities are not well informed about each segment
Securities analysts may be less likely to follow multiple segment firms
Performance of managers of segments cannot be adequately evaluated without external market measures
Financial synergies
Complementarities between merging firms in matching the availability of investment opportunities and internal cash flows
Lower cost of internal financing — redeployment of capital from acquiring to acquired firm's industry
Increase in debt capacity which provides for greater tax savings
Economies of scale in flotation of new issues and lower transaction costs of financing
Circumstances favoring merger over internal growth
Lack of opportunities for internal growth
Lack of managerial capabilities and other resources
Potential excess capacity in industry
Timing may be important — mergers can achieve growth and development of new areas more quickly
Other firms may be competing for investments in traditional product lines
Strategic realignments
Acquire new management skills
Less time to acquire requisite capabilities for new growth opportunities or to meet new competitive threats
The q-ratio
Ratio of the market value of the firm's securities to the replacement costs of its assets
High q-ratio reflects superior management
Depressed stock prices or high replacement costs of assets cause low q-ratios
Undervaluation theory
Acquiring firm (A) seeks to add capacity; implies (A) has marginal q-ratio > 1
More efficient for (A) to acquire other firms in industry that have q-ratios < 1 than building a new facility
Still more points are to be posted
You may not fully understand these brief points if you have not studied the text.
The theories and models are covered under the following classifications.
A. Theories explaining why mergers occur.
B. Theories of valuation effects of mergers and acquisitions
C. Theoretical predictions of the pattern of gains in takeovers.
D. Models of Merger Process
E. Models of Bidding Process
Theories or models under the classifications
A. Theories explaining why mergers occur.
- 1. Size and returns to scale
- 2. Transaction costs and mergers
B. Theories of valuation effects of mergers and acquisitions
- 1. Theories that posit that value increases
------ a. Transaction cost efficiency - Coase
-------b. Synergy
-------c. Disciplinary
- 2. Theories that posit that value reduces
-------a. Agency costs of free cash flows - Jensen
-------b. Management entrenchment - Shleifer and Vishny
- 3. Theories that argue that value is neutral
-------a. Hubris ----------Roll
C. Theoretical predictions of the pattern of gains in takeovers.
D. Models of Merger Process
---Negotiation - When is it done in public domain?
E. Models of Bidding Process
- 1. How to avoid winner's curse
- 2. Effects of Bidding costs
- 3. Role of toehold.
- 4. Whether to pay in cash or in stock
From the seller's perspective
- 5. How to react to initial bid?
- 6. Is it beneficial to accept termination fee in the MOU?
- 7. Should it seek competing bids and go for auction?
Various theories and models in little more detail
Economies of scale — Mergers allow a reorganization of production processes so that plant scale may be increased to obtain economies of scale.
Economies of scope
Organization capital
Organization reputation
Human capital resources
Generic managerial capabilities
Industry-specific managerial capabilities
Nonmanagerial human capital
Models of the Takeover Process
Economic — competition vs. market power
Auction types — Dutch, English
Forms of games
Types of equilibria — pooling, separating, sequential
Types of bids — one, multiple
Bidding theory — preemptive; successive bids
Framework
Total gains for both target and acquirer
Positive, if the following are present in the transaction
Efficiency improvement
Synergy
Increased market power
Zero if
Hubris
Winner's curse
Acquiring firm overpays
Negative, if
Agency problems
Mistakes or bad fit
Gains to target — all empirical studies show gains are positive
Gains to acquirer
----Positive — efficiency, synergy, or market power
----Negative — overpaying, hubris, agency problems, or mistakes
Sources of Value Increases from M&As
Efficiency increases
Unequal managerial capabilities
Better growth opportunities
Critical mass
Better utilization of fixed investments
Operating synergy
Economies of scale
Economies of scope
Vertical integration economies
Managerial economies
Diversification motives - Why firms diversify?
Demand for diversification by managers/employees because they make firm-specific investments
Diversification for preservation of organization capital
Diversification for preservation of reputational capital
Diversification and financial synergy
Diversification can increase corporate debt capacity, decrease present value of future tax liabilities
Diversification can decrease cash flow variability following merger of firms with imperfectly correlated cash flow streams
Diversification discount - A Problem
Studies find that the average diversified firm has been worth less than a portfolio of comparable single-segment firms
Reasons
External capital markets allocate resources more efficiently than internal capital markets
Rivalry between segments may result in subsidies to underperforming divisions within a firm
Managers of multiple activities are not well informed about each segment
Securities analysts may be less likely to follow multiple segment firms
Performance of managers of segments cannot be adequately evaluated without external market measures
Financial synergies
Complementarities between merging firms in matching the availability of investment opportunities and internal cash flows
Lower cost of internal financing — redeployment of capital from acquiring to acquired firm's industry
Increase in debt capacity which provides for greater tax savings
Economies of scale in flotation of new issues and lower transaction costs of financing
Circumstances favoring merger over internal growth
Lack of opportunities for internal growth
Lack of managerial capabilities and other resources
Potential excess capacity in industry
Timing may be important — mergers can achieve growth and development of new areas more quickly
Other firms may be competing for investments in traditional product lines
Strategic realignments
Acquire new management skills
Less time to acquire requisite capabilities for new growth opportunities or to meet new competitive threats
The q-ratio
Ratio of the market value of the firm's securities to the replacement costs of its assets
High q-ratio reflects superior management
Depressed stock prices or high replacement costs of assets cause low q-ratios
Undervaluation theory
Acquiring firm (A) seeks to add capacity; implies (A) has marginal q-ratio > 1
More efficient for (A) to acquire other firms in industry that have q-ratios < 1 than building a new facility
Still more points are to be posted
M&A - Points to Refresh Weston's Book Ch.8
Chapter 8. Empirical Tests of M&A Performance
Main topics of the chapter
Evidence on the combined return to target and bidder shareholders in M&A transactions.
Factors found to affect the magnitude of target returns
Factors found to affect the magnitude of bidder returns
Takeover Regulation and Takeover Hostility
Long-Term Stock Price Performance following Mergers
Efficiency versus Market Power
Effects of Concentration
The combined returns in mergers and acquisitions
Are mergers net positive value investments?
Mergers theories based on synergy and efficiency predict that the combined return in a merger is positive.
Theories based on the agency costs of free cash flow and managerial entrenchment argue that mergers destroy wealth and predict that the combined returns in a merger are negative.
Roll’s(1986) hubris hypothesis suggested that any wealth gain target firms merely represents redistribution from bidders and predicts that the net merger gains are zero.
Event study evidence
Early evidence by Jensen and Ruback [1983].
Found that mergers created wealth for target shareholders and were roughly a break-even endeavour for bidders.
This evidence was generally taken to indicate that mergers created wealth.
Roll (1986) observed that bidders are often much larger than targets.
Hence combined return is to be calculated by determining the size-weighted return.
Results of studies that were done after Roll’s criticism.
Bradley, Desai, and Kim (1988)
Kaplan and Weisbach (1992)
Servaes (1991)
Mulherin and Boone(2000)
Andrade, Mitchell, and Stafford (2001)
Main topics of the chapter
Evidence on the combined return to target and bidder shareholders in M&A transactions.
Factors found to affect the magnitude of target returns
Factors found to affect the magnitude of bidder returns
Takeover Regulation and Takeover Hostility
Long-Term Stock Price Performance following Mergers
Efficiency versus Market Power
Effects of Concentration
The combined returns in mergers and acquisitions
Are mergers net positive value investments?
Mergers theories based on synergy and efficiency predict that the combined return in a merger is positive.
Theories based on the agency costs of free cash flow and managerial entrenchment argue that mergers destroy wealth and predict that the combined returns in a merger are negative.
Roll’s(1986) hubris hypothesis suggested that any wealth gain target firms merely represents redistribution from bidders and predicts that the net merger gains are zero.
Event study evidence
Early evidence by Jensen and Ruback [1983].
Found that mergers created wealth for target shareholders and were roughly a break-even endeavour for bidders.
This evidence was generally taken to indicate that mergers created wealth.
Roll (1986) observed that bidders are often much larger than targets.
Hence combined return is to be calculated by determining the size-weighted return.
Results of studies that were done after Roll’s criticism.
Bradley, Desai, and Kim (1988)
Kaplan and Weisbach (1992)
Servaes (1991)
Mulherin and Boone(2000)
Andrade, Mitchell, and Stafford (2001)
M&A - Points to Refresh - Weston's Book Ch.22
Implementation and Management Guides for M&As
General guidelines for successful M&A activity
M&A program must be part of long-range strategic planning
Recognize that in seeking new opportunities for value enhancement, internal investments and restructuring can be used in conjunction with external investments and M&A activity
Know the industry and its competitive environment as basis for making projections for the future
Be sure that elements of relatedness are present,
Combine firms with relatively unique relationships that other firms cannot match
Avoid multiple bids that could drive up price of target excessively
Acquired unit should be worth more as part of acquirer firm than alone or with some other firm
Recognize appropriate times to be a buyer — at times prices may get too high
Communicate as soon as possible when major investment and restructuring decisions are made; continued communications through implementation process
Top executives must be involved in M&A activity and in other major investment programs
Strong emphasis on maintaining and enhancing managerial rewards and incentives in postmerger period; incentives must exist in order that management of all companies combined in merger stay and contribute to combined company
Top management must be involved in postmerger coordination
Future promotions must not use distinctions based on employment in historical components of company;
if employees have to be separated, it should be done in most enlightened way possible (e.g., assistance with placement activities, insurance coverage)
Managing integration of cultures and coordinating all systems and informal processes of the combining firm should be a top priority
Wishful thinking about potential merger benefits should be avoided; if acquiring firm pays too much, the result will be a negative net present value investment
Restructuring and renewal requirements for an organization should be continuously reassessed in the firm's strategic planning processes
A good deal becomes a bad deal if you overpay
Why Mergers Fail?
1. Pay too much
2. Overoptimistic expected synergies
3. No business logic to the deal.
4. Businesses unrelated.
5. Did not understand what they bought.
6. Unduly hyped by investment bankers, consulting firms, and/or lawyers
7. Underestimated regulatory delays or prohibitions
8. Hubris of top executives – ambition to run a bigger firm and increase salary
9. Top executives want to cash out stock options
10.Culture clashes
11. Ineffective integration – poorly planned, poorly executed, too slow, too fast
12. Suppression of effective business systems of target firms, destroying the basis of their prior success.
13. Too much debt – future interest payments burden
14. Too much short term debt – repayment before synergies are realised
15. Power struggles or incompatibility in board room
16.Mergers of equals - delay requisite decisions
17. Target resistance – white knights, scorched earth, antitrust
18. Multiple bidders cause overpayment
19. Hostile takeovers prevent obtaining sufficient information, fail to uncover basis incompatibilities
20. Basic industry problems such as overcapacity (auto, steel, telecoms)
The Acquisition Process
Strategy formulation
Economics of the industry
Organization system
Multiple strategies for value growth
Search processes
Economic basis — synergy potentials
Restructuring potentials
Due diligence – legal and business
Cultural factors
Valuation
Negotiation
Deal structuring
Implementation and integration
Reviews and renewal process
Acquisition Process in More Detail
Strategy formulation
Formulate firm's strategies
Articulate goals
Assess strengths and weaknesses in relationship to goals
Eliminate weaknesses
Identify resources and capabilities needed to enforce strengths
Iterative procedure because of dynamic environmental changes in competitive thrusts
Economics of the industry
Firm defined by business economic characteristics of its industry
Consumer versus producer products
Durable versus nondurable
Product versus services versus information
Stage in life cycle
Tangible versus intangible
Pace of technological and other changes
Business activity greatly influenced by increased dynamism of economic, political, and cultural environments
Industry have characteristics that influence responses to change
Some industries are impacted more than others by rates of growth in gross domestic product (GDP)
Nature of industry may influence relative advantage of large and small firms
Industry characteristics influence opportunities for industry roll-ups or need for consolidations
Organization system
Organization structure consistent with firm's strategies and operations
Resources and capabilities consistent with market-product activities
Information flow systems related to performance measurements
Compensation systems based on contributions to value creation
Clear strategic vision and strong organization framework required to embrace expanded and new activities
Operational efficiency
Solid basis for adding capabilities and resources
Align more effectively to changes and opportunities by acquisitions
Multiple strategies for value growth
Internal growth — product expansion and new product programs
Alliance and joint ventures — extend possibilities with smaller investment needs
Licensing from other firms — provides additional revenues with small incremental direct costs
Divestitures — harvest successes or correct mistakes; increased focus
Carve-outs plus spin-offs — source of funds and increased corporate focus
Financial engineering — use of debt and share repurchases may enhance value
Search processes
Ongoing activity of firm
Firm should have dedicated business development group — core group that builds up experience and expertise on acquisition process
Surveillance of firm's environment
Employees — source of research information on potential acquisition candidates
Customers — information on products and market effectiveness
Competitors — information of best practices in relation to industry
Suppliers — information on product improvements and opportunities for vertical integration of operations
Trade shows and technical forums
Financial analysts and market analysts — knowledge about best practices
Economic basis — synergy potentials
Economic reasons
Internet sector — growth driven by new technologies, new information systems, and new distribution systems
Formulate new concepts and expand it rapidly by acquisitions — Yahoo, Amazon Inc.
Acquisition of critical set of technological capabilities — Cisco Systems, Oracle
Deregulation
Reflects new technologies and intensified competition
Competitive pressures on incumbent firms; acquisitions to reinvent itself
Excess capacity and intense product competition
Stimulate acquisitions such as in automobile industry
Stimulate alliances, joint ventures, and mergers
Globalization
Strong pressure for cross-border mergers
Bargain acquisitions in countries suffering economic reversals
Industry roll-ups
Consolidation of highly fragmented industry
Industry characteristic favorable for roll-up
Initial fragmentation
Substantial industry annual revenues
Companies with robust cash flows
Economies of scale
Restructuring potentials
Improvement in collection period for receivables
Reduction in inventory costs
Control of fixed asset investments by improved models of production management and material flows
Savings in management of financing forms and sources
Innovative dividend policy through use of share repurchases
Leveraging best practices to achieve efficiency increases
Improvement of products, and development of new products
Effective utilization of investments
Improvement in asset and liability management
Due diligence — both legal and business
Examine all aspects of prospective partners
Make sure there are no legal problems such as pension funding, environmental or product liabilities
Assess accounting records
Assess maintenance and quality of equipment
Assess possibility of maintaining cost controls
Evaluate potentials for product improvements or superiorities
Evaluate management relationships, shortcomings, and needs
Evaluate how two management systems will fit together
Assess any new developments that will benefit firm or require adjustments
Cultural factors
Corporate culture
Defined by organization's values, traditions, norms, beliefs, and behavior patterns
Articulated in formal statements of organization values and aspirations
Expressed in informal relationships and networks
Reflected in company's operating style
Corporate culture is conveyed by the kinds of behavior that are rewarded in an organization
Firm must manage its own corporate culture effectively before engaging in merger activity
Firm must recognize cultural factors in planning for external growth
Due diligence must include full coverage of cultural factors
End solutions
Recognize cultural differences and respect them
Exchange executives across organization
Ultimately, cultures may move toward similarity
Differences may be valued as sources of increased efficiency
Valuation
Valuation analysis to provide disciplined procedure for arriving at a price
Price too low — target may resist and seek other bidders
Price too high — premium may never be recovered
Mergers increase value when value of combined firm is greater than adding premerger values of independent entities
Negotiation (Coming to an Agreement)
Principled negotiation
Use standards of fairness in seeking to meet interests of both parties
Produce agreements that build good future relationships
Negotiation strategy and techniques
Good preparation
Assess strengths and weaknesses
Identify resources and capabilities required
Develop solid quantification of firm's BATNA (best alternative to a negotiated agreement)
Realistic identification of gains, synergies, and their sources
Analyze value relationships
Comparable companies and comparable transactions
Discounted cash flows
Premium paid must have sound foundation in estimates of synergy and savings
Deal structuring
Understand tax consequences of combining firms
Understand true economic consequences of accounting treatment
Consider method of payment — cash, stock, debt, and combinations
Cash reduces uncertainty for seller, but has tax consequences
Stock makes actual return to seller dependent on future outcome of combination
Assess use of explicit contingency payout, and formulation of standards for bonus or penalty
Implementation
Implementation Capability is a condition for thinking about M&As
Firm must have implemented all aspects of effective operations before it can effectively combine organizations
Must have shareholder value orientation
Must have strategies and organization structures compatible with its multiple business units
Firm must formulate advance integration plans that can effectively accomplish goals of M&A processes
Companies should seek mergers that further their corporate strategy
Strengthen weaknesses
Fill gaps
Extend capabilities
Develop new growth opportunities
Integration leadership is required
Must have management experience
Must have experience with external constituencies
Must have credibility with various integrating participants
Must have good communications plans
Provide early, frequent, and clear integration messages
Address clearly concerns of employees
Cross-functional teams should be created to devote attention to integration issues
Firm must balance between speed and disruption
Reviews and renewal processes
Firm must continuously adjust to new opportunities and challenges
Must monitor change forces in environment in which firm operates
Must recognize impacts of competitors
Firm must have broad strategy that guides success in its business markets
Rules for Successful Mergers
Drucker's merger rules (1981)
Drucker five commandments
Acquirer must contribute something to acquired firm
Common core of unity required
Acquirer must respect business of acquired firm
Acquirer must provide top management to acquired firm within a year or so of merger
Managements in both firms should receive promotions across entities within first year of merger
Simplification of Drucker rules
Merging companies must be related in some way
Well-structured incentives must be offered to managers of both firms — acquiring firm must be prepared to replace departing key managers in target firm
Drucker rules may be unduly restrictive if interpreted too literally
Additional commentaries to Drucker rules
Relatedness necessary; complementarities are also important
Relatedness/complementarities apply to general management functions and to specific managerial capabilities
Negative returns will result if acquirer pays too much
Greater uncertainty in merger than in internal investments
Recovery of premium paid must be based on real economies — operating and/or financial
Anslinger and Copeland (1996)
- Studied 21 successful acquirers of two types
- Diversified corporate acquirers
- Financial buyers such as leveraged buyout firms
Seven key principles of success
Acquire companies with track record of innovative operating strategies
Capable managerial talent is most important for creating value
Use strong incentive compensation systems such as stock purchase programs so top managers have large part of their net worth in company
Link compensation incentives to future changes in cash flows
Push pace of change to make turnarounds happen within first two years of merger
Develop information and feedback systems that promote continuing dynamic relationships among owners, managers, and the board
Acquiring firms must use executives with expertise and demonstrated experience as deal makers
General guidelines for successful M&A activity
M&A program must be part of long-range strategic planning
Recognize that in seeking new opportunities for value enhancement, internal investments and restructuring can be used in conjunction with external investments and M&A activity
Know the industry and its competitive environment as basis for making projections for the future
Be sure that elements of relatedness are present,
Combine firms with relatively unique relationships that other firms cannot match
Avoid multiple bids that could drive up price of target excessively
Acquired unit should be worth more as part of acquirer firm than alone or with some other firm
Recognize appropriate times to be a buyer — at times prices may get too high
Communicate as soon as possible when major investment and restructuring decisions are made; continued communications through implementation process
Top executives must be involved in M&A activity and in other major investment programs
Strong emphasis on maintaining and enhancing managerial rewards and incentives in postmerger period; incentives must exist in order that management of all companies combined in merger stay and contribute to combined company
Top management must be involved in postmerger coordination
Future promotions must not use distinctions based on employment in historical components of company;
if employees have to be separated, it should be done in most enlightened way possible (e.g., assistance with placement activities, insurance coverage)
Managing integration of cultures and coordinating all systems and informal processes of the combining firm should be a top priority
Wishful thinking about potential merger benefits should be avoided; if acquiring firm pays too much, the result will be a negative net present value investment
Restructuring and renewal requirements for an organization should be continuously reassessed in the firm's strategic planning processes
A good deal becomes a bad deal if you overpay
Why Mergers Fail?
1. Pay too much
2. Overoptimistic expected synergies
3. No business logic to the deal.
4. Businesses unrelated.
5. Did not understand what they bought.
6. Unduly hyped by investment bankers, consulting firms, and/or lawyers
7. Underestimated regulatory delays or prohibitions
8. Hubris of top executives – ambition to run a bigger firm and increase salary
9. Top executives want to cash out stock options
10.Culture clashes
11. Ineffective integration – poorly planned, poorly executed, too slow, too fast
12. Suppression of effective business systems of target firms, destroying the basis of their prior success.
13. Too much debt – future interest payments burden
14. Too much short term debt – repayment before synergies are realised
15. Power struggles or incompatibility in board room
16.Mergers of equals - delay requisite decisions
17. Target resistance – white knights, scorched earth, antitrust
18. Multiple bidders cause overpayment
19. Hostile takeovers prevent obtaining sufficient information, fail to uncover basis incompatibilities
20. Basic industry problems such as overcapacity (auto, steel, telecoms)
The Acquisition Process
Strategy formulation
Economics of the industry
Organization system
Multiple strategies for value growth
Search processes
Economic basis — synergy potentials
Restructuring potentials
Due diligence – legal and business
Cultural factors
Valuation
Negotiation
Deal structuring
Implementation and integration
Reviews and renewal process
Acquisition Process in More Detail
Strategy formulation
Formulate firm's strategies
Articulate goals
Assess strengths and weaknesses in relationship to goals
Eliminate weaknesses
Identify resources and capabilities needed to enforce strengths
Iterative procedure because of dynamic environmental changes in competitive thrusts
Economics of the industry
Firm defined by business economic characteristics of its industry
Consumer versus producer products
Durable versus nondurable
Product versus services versus information
Stage in life cycle
Tangible versus intangible
Pace of technological and other changes
Business activity greatly influenced by increased dynamism of economic, political, and cultural environments
Industry have characteristics that influence responses to change
Some industries are impacted more than others by rates of growth in gross domestic product (GDP)
Nature of industry may influence relative advantage of large and small firms
Industry characteristics influence opportunities for industry roll-ups or need for consolidations
Organization system
Organization structure consistent with firm's strategies and operations
Resources and capabilities consistent with market-product activities
Information flow systems related to performance measurements
Compensation systems based on contributions to value creation
Clear strategic vision and strong organization framework required to embrace expanded and new activities
Operational efficiency
Solid basis for adding capabilities and resources
Align more effectively to changes and opportunities by acquisitions
Multiple strategies for value growth
Internal growth — product expansion and new product programs
Alliance and joint ventures — extend possibilities with smaller investment needs
Licensing from other firms — provides additional revenues with small incremental direct costs
Divestitures — harvest successes or correct mistakes; increased focus
Carve-outs plus spin-offs — source of funds and increased corporate focus
Financial engineering — use of debt and share repurchases may enhance value
Search processes
Ongoing activity of firm
Firm should have dedicated business development group — core group that builds up experience and expertise on acquisition process
Surveillance of firm's environment
Employees — source of research information on potential acquisition candidates
Customers — information on products and market effectiveness
Competitors — information of best practices in relation to industry
Suppliers — information on product improvements and opportunities for vertical integration of operations
Trade shows and technical forums
Financial analysts and market analysts — knowledge about best practices
Economic basis — synergy potentials
Economic reasons
Internet sector — growth driven by new technologies, new information systems, and new distribution systems
Formulate new concepts and expand it rapidly by acquisitions — Yahoo, Amazon Inc.
Acquisition of critical set of technological capabilities — Cisco Systems, Oracle
Deregulation
Reflects new technologies and intensified competition
Competitive pressures on incumbent firms; acquisitions to reinvent itself
Excess capacity and intense product competition
Stimulate acquisitions such as in automobile industry
Stimulate alliances, joint ventures, and mergers
Globalization
Strong pressure for cross-border mergers
Bargain acquisitions in countries suffering economic reversals
Industry roll-ups
Consolidation of highly fragmented industry
Industry characteristic favorable for roll-up
Initial fragmentation
Substantial industry annual revenues
Companies with robust cash flows
Economies of scale
Restructuring potentials
Improvement in collection period for receivables
Reduction in inventory costs
Control of fixed asset investments by improved models of production management and material flows
Savings in management of financing forms and sources
Innovative dividend policy through use of share repurchases
Leveraging best practices to achieve efficiency increases
Improvement of products, and development of new products
Effective utilization of investments
Improvement in asset and liability management
Due diligence — both legal and business
Examine all aspects of prospective partners
Make sure there are no legal problems such as pension funding, environmental or product liabilities
Assess accounting records
Assess maintenance and quality of equipment
Assess possibility of maintaining cost controls
Evaluate potentials for product improvements or superiorities
Evaluate management relationships, shortcomings, and needs
Evaluate how two management systems will fit together
Assess any new developments that will benefit firm or require adjustments
Cultural factors
Corporate culture
Defined by organization's values, traditions, norms, beliefs, and behavior patterns
Articulated in formal statements of organization values and aspirations
Expressed in informal relationships and networks
Reflected in company's operating style
Corporate culture is conveyed by the kinds of behavior that are rewarded in an organization
Firm must manage its own corporate culture effectively before engaging in merger activity
Firm must recognize cultural factors in planning for external growth
Due diligence must include full coverage of cultural factors
End solutions
Recognize cultural differences and respect them
Exchange executives across organization
Ultimately, cultures may move toward similarity
Differences may be valued as sources of increased efficiency
Valuation
Valuation analysis to provide disciplined procedure for arriving at a price
Price too low — target may resist and seek other bidders
Price too high — premium may never be recovered
Mergers increase value when value of combined firm is greater than adding premerger values of independent entities
Negotiation (Coming to an Agreement)
Principled negotiation
Use standards of fairness in seeking to meet interests of both parties
Produce agreements that build good future relationships
Negotiation strategy and techniques
Good preparation
Assess strengths and weaknesses
Identify resources and capabilities required
Develop solid quantification of firm's BATNA (best alternative to a negotiated agreement)
Realistic identification of gains, synergies, and their sources
Analyze value relationships
Comparable companies and comparable transactions
Discounted cash flows
Premium paid must have sound foundation in estimates of synergy and savings
Deal structuring
Understand tax consequences of combining firms
Understand true economic consequences of accounting treatment
Consider method of payment — cash, stock, debt, and combinations
Cash reduces uncertainty for seller, but has tax consequences
Stock makes actual return to seller dependent on future outcome of combination
Assess use of explicit contingency payout, and formulation of standards for bonus or penalty
Implementation
Implementation Capability is a condition for thinking about M&As
Firm must have implemented all aspects of effective operations before it can effectively combine organizations
Must have shareholder value orientation
Must have strategies and organization structures compatible with its multiple business units
Firm must formulate advance integration plans that can effectively accomplish goals of M&A processes
Companies should seek mergers that further their corporate strategy
Strengthen weaknesses
Fill gaps
Extend capabilities
Develop new growth opportunities
Integration leadership is required
Must have management experience
Must have experience with external constituencies
Must have credibility with various integrating participants
Must have good communications plans
Provide early, frequent, and clear integration messages
Address clearly concerns of employees
Cross-functional teams should be created to devote attention to integration issues
Firm must balance between speed and disruption
Reviews and renewal processes
Firm must continuously adjust to new opportunities and challenges
Must monitor change forces in environment in which firm operates
Must recognize impacts of competitors
Firm must have broad strategy that guides success in its business markets
Rules for Successful Mergers
Drucker's merger rules (1981)
Drucker five commandments
Acquirer must contribute something to acquired firm
Common core of unity required
Acquirer must respect business of acquired firm
Acquirer must provide top management to acquired firm within a year or so of merger
Managements in both firms should receive promotions across entities within first year of merger
Simplification of Drucker rules
Merging companies must be related in some way
Well-structured incentives must be offered to managers of both firms — acquiring firm must be prepared to replace departing key managers in target firm
Drucker rules may be unduly restrictive if interpreted too literally
Additional commentaries to Drucker rules
Relatedness necessary; complementarities are also important
Relatedness/complementarities apply to general management functions and to specific managerial capabilities
Negative returns will result if acquirer pays too much
Greater uncertainty in merger than in internal investments
Recovery of premium paid must be based on real economies — operating and/or financial
Anslinger and Copeland (1996)
- Studied 21 successful acquirers of two types
- Diversified corporate acquirers
- Financial buyers such as leveraged buyout firms
Seven key principles of success
Acquire companies with track record of innovative operating strategies
Capable managerial talent is most important for creating value
Use strong incentive compensation systems such as stock purchase programs so top managers have large part of their net worth in company
Link compensation incentives to future changes in cash flows
Push pace of change to make turnarounds happen within first two years of merger
Develop information and feedback systems that promote continuing dynamic relationships among owners, managers, and the board
Acquiring firms must use executives with expertise and demonstrated experience as deal makers
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