AFU 07303: Corporate Finance

Mergers and Acquisitions

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On completion of this session, you should
be able to:
 Understand why firms engage in mergers
and acquisitions
 Calculate the value of a merger to the
acquiring company
 Understand the financing issues associated
with mergers and other forms of corporate
restructuring,
 Understand the possible agency problems
between managers and shareholders
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MERGERS:
 Merger may be defined as the
combination of two or more
independent business corporations
into a single enterprise, usually involving
the absorption of one or more firms by
dominant firm.
 A corporate merger is the combination of
the assets and liabilities of two firms to
form a single business entity.

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ACQUISITIONS:
 Is characterized by the purchase of smaller
company by a much larger one.
This combination of unequal‟s can produce the same
benefits as a merger, but it does not necessarily
have to be mutual decision (Hostile takeovers)
 Acquisition may be defined as an act of
one enterprise of acquiring directly or
indirectly of shares, voting rights,
assets or control over the
management of another enterprise
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 Types of merger
 Horizontal mergers combine firms in the
same business (most mergers like this)
 Vertical mergers firms at
combine
different stages of production in the
same “industry”. Eg Manufacturer merging
with a supplier
 Conglomerate mergers combine firms in
different industries. Eg. Pipeline Industry
merging with high technology company 5
 Production reasons
for acquisition
 Expanding capacity.
 Economies of scale.
 Combining complementary resources
 Acquiring technology.
 Vertical integration, for quality control
or supply reasons.
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 Marketing reasons
for acquisition
 Expanding market share.

 Extending product range.

 Gaining entry to new markets.

 Eliminating competition.

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Miscellaneous reasons
for acquisition
 Target company‟s shares or assets
„under-priced‟.
 Acquirer‟s shares „overvalued‟.
 Applying superior management skills to
the acquiree‟s business.
 Preventing a competitor from acquiring
the target company.

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Miscellaneous reasons
for acquisition
 Making the acquiring company itself
less attractive to a predator.
 Tax benefits (such as the ability to
utilise tax losses).
 Diversifying business risk.
 Empire building.

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 Ownership reasons
for selling
 The owner wants to diversify risk.

 The owner wants to reduce inheritance

tax on death.

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Management reasons for selling
 Manager(s) about to retire, with no
obvious successor.

 Poor business prospects under the

control of the present management,
possibly following an expansion or a
change of direction.

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Reasons for selling part of a group
 Vendor company needs extra source of
finance.

 No longer fits with core business or

strategy of vendor group.

 Makes vendor less attractive to a

predator.

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Agency problem: managers versus shareholders

 Managers will be anxious to diversify away

most of their company’s ‘unique risk’.
 Hence, managers may undertake
acquisitions to reduce their company’s
total risk
 But shareholders are able to diversify away
firm specific risk more cheaply simply
by holding a portfolio of shares

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 Valuation of Companies
 Various ways
 Unlevered/Ungeared firm (All equity firms)

 Levered/Geared firm

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 Bargaining
 Both buyer and seller may have in mind
a range of suitable prices.

 If they overlap, a deal should be

possible, although the range may alter
during the bargaining process

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 Payment by cash or share issue?
 The shareholders of the target company
and the bidding company are likely to
have different views about the
advantages of an offer of cash or
shares.

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 Viewpoint of the target firm’s
shareholders
Value of Liquidity Capital Interest in
offer Gains target firm
Tax

Cash Certain Improved Payable Lost

Shares Uncertain Unchanged Delayed Diluted

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 Viewpoint of the bidding firm‟s
shareholders
Likely Firm Firm Transaction Interest in
success liquidity gearing costs to bidding
firm firm

Cash Known if Squeezed May Negligible Unchanged

reasonably may need increase
priced to borrow

Shares Depends Slightly Depends Share issue Diluted

on size of reduced on costs
bidding target's
firm. debt level

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Example
 Consider the following information for two all-equity
firms, A and B;
Firm A Firm B

Shares Outstanding 2000 6000

Prize per share (TZS) 40 30

 Firm A estimates that the value of the synergistic

benefit from acquiring Firm B is TZS 6000. Firm B
indicated that it would accept a cash purchase offer
of TZS 35 per share. Should Firm A proceed?

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 Suggested Solution
 The total value of Firm B to Firm A is the premerger value
of B plus the TZS 6000 gain from the merger.
 The premerger value of B is TZS 30 X 6000= TZS 180,000
 So the total value is TZS 180,000+ TZS 6000=TZS
186,000
 At TZS 35 per share, Firm A is paying TZS 35 X 6000= TZS
210,000
 The merger therefore has a negative NPV OF TZS 186,000-
TZS 210,000= - TZS 24,000
 Thus at TZS 35 per share, Firm B is not attractive merger
partner.
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 Human consequences
 Making a merger work takes a great
deal of management time and
effort.
 Employees may lose their jobs
 Employees could be demoted
 Employees may have to relocate

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 Restructuring via demerging
 There are three main ways of
restructuring a company via a
demerger:
 sell offs,
 spin-offs,
 management buy-outs.

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 Sell-offs
 Assets usually sold for cash to an
existing business.
 Sell-off is the rapid selling of
securities such as stocks, bonds and
commodities.
 A sell-off may occur for many reasons,
such as the sell-off of a company's
stock after a disappointing earnings
report. 23
 Spin-offs
 Is the creation of an independent
company through the sale or
distribution of new shares of an
existing business or division of a parent
company.

 Effectively, part of a business is

floated off as a separate business
(normally quoted). 24
 Spin-offs
 A company will spin off a unit to rid itself
of an underperforming part of its
business.
 If the core part of the business is
underperforming, the company may spin off
a new, up-and-coming area of its business to
give the new subsidiary a better chance to
flourish and reach its full value. In addition,
the parent company now can focus on its
core competencies. 25
 Management buy-outs (MBO‟s)
 The management team arranges to buy
an equity stake in the business.
 Venture capitalists back them by putting
up the rest of the purchase price.
 The normal ‘plan’ is to float the firm on
the Stock Exchange at some future point,
repaying most of the initial finance
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 Mergers & Acquisition Further
Examples
MOMENTUM plc has been evaluating NOBLE plc as a takeover
candidate. It has been estimated that cost savings of TZS
4,000 million per annum can be achieved, estimated to be
worth TZS 48,000 million on a present value basis by merging
the companies. MOMENTUM‟s management are concerned that
NOBLE‟s share price has recently increased from TZS 200 to
TZS 250 as a result of speculation that a bid would occur. With
MOMENTUM shares currently trading at TZS 500,
MOMENTUM‟s finance director has proposed that one of its
shares should be offered for every two of those of NOBLE.
While the market will not be surprised by a bid from some
source there has no speculation that MOMENTUM is interested
in NOBLE. 27
 Mergers & Acquisition Further
Examples
MOMENTUM has 600 million shares outstanding and NOBLE
500 million.
Required:
a. Identify the net cost of the takeover on the proposed
terms
b. Given the expected cost savings would this be profitable
takeover for MOMENTUM on the terms specified
c. Estimate the value of MOMENTUM‟s shares immediately
following the takeover, assuming the market also
anticipates cost savings of TZS 48,000 million.

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 MERGERS AND AQUISITION

THANK YOU FOR LISTENING

 The End

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