02a Slides - Success

Mergers & Acquisitions – Slide Set Session 2
Does M&A create value?
Michael H. Grote
©Frankfurt–School.de 1
Schedule
share price developments around announcement
explaining unsatisfactory bidder returns
the target takes it all
pre-emptive and killer acquisitions
revelation effect
long-term and other studies
overview of other success drivers
example: Salesforce acquires Tableau
example: BASF buys CIBA
Acquisition of CIBA by BASF on September 15, 2008
announcement
180%
170% ~ transaction value for

160% BASF shareholders:
€ -0.9 bn to € -1.4 bn
150%
140%
BASF
130%
CIBA
120% DAX
(-1;+1)
110%
100%
90%
80%
01.09.2008
02.09.2008
03.09.2008
04.09.2008
05.09.2008
08.09.2008
09.09.2008
10.09.2008
11.09.2008
12.09.2008
15.09.2008
16.09.2008
17.09.2008
18.09.2008
19.09.2008
22.09.2008
23.09.2008
24.09.2008
25.09.2008
26.09.2008
29.09.2008
30.09.2008
example: SAP buys Concur
©Frankfurt–School.de
5
example: banking battle for ABN Amro
180%
160%
140%
120%
100%
80%
60%
07.11.2006
07.12.2006
07.01.2007
07.02.2007
07.03.2007
07.04.2007
07.05.2007
07.06.2007
07.07.2007
07.08.2007
07.09.2007
07.10.2007
ABN Amro Banco Santander Fortis RBS Barclays
example: BASF buys Engelhard
Acquisition of Engelhard by BASF on January 3, 2006

announcement
135%
130% ~ transaction value for

BASF shareholders:
125%
€ -1.3 bn
120%
BASF
115% Engelhard
DAX
110%
105%
100%
95% (-1;+1)
90%
15.12.2005
16.12.2005
19.12.2005
20.12.2005
21.12.2005
22.12.2005
23.12.2005
26.12.2005
27.12.2005
28.12.2005
29.12.2005
30.12.2005
02.01.2006
03.01.2006
04.01.2006
05.01.2006
06.01.2006
09.01.2006
10.01.2006
11.01.2006
12.01.2006
13.01.2006
example: Bayer buys Monsanto
announcement
Bayer shareholders
lost ~ €19.6 bn
between April 20 and
May 31, 2016.
rumors and/or
toehold acquisition
general pattern: targets win, acquirers not
Source: Betton, Sandra / Eckbo, B. Espen (2000):

Toeholds, Bid Jumps, and Expected Payoffs in
Takeovers, Review of Financial Studies, Vol. 13, No.
4, pp. 841-882
9
target shareholders are often happy…
source: Refinitiv 2022

target takes it all
 cumulative abnormal returns in m&a processes
period
(days around merger announcement)
[-1;+1] [-20; close]
combined 1,8% 1,9%
target 16,0% 23,8%
acquirer -0,7% -3,8%

frame denotes statistical significance at 1 percent level
source: Andrade, G. et al. (2001), Journal of Economic Perspectives, Vol. 15 (2), pp. 103-120
Schedule
why acquirer returns are not satisfying
Overview
 hubris
 principal agent problems in acquiring firms
 competing bidders
 free rider problem
 pre-emptive & „killer“ acquisitions
 revelation effect
acquirers - managerial hubris?
„Many managements apparently were overexposed in

impressionable childhood years to the story in which the imprisoned
handsome prince is released from a toad’s body by a kiss from a
beautiful princess.
Consequently, they are certain their managerial kiss will do
wonders for the profitability of the target company. We’ve observed
many kisses but very few miracles.
Nevertheless, many managerial princesses remain serenely
confident about the future potency of their kisses even after their
corporate backyards are knee deep in unresponsive toads.”
Warren Buffet, Berkshire Hathaway Annual Report 1981
motives for overbidding?
possible explanation might indeed be principal agent problems in

bidder firms (empire building etc.)
if mergers could be sorted by true underlying motivations, it may be
that those which are undertaken for good reasons do benefit acquirers,
but in the average statistics, these are cancelled out by mergers
undertaken for less benign reasons
furthermore, the mere presence of competing bidders (or the

potential for them to appear) could allow targets to extract full value
from the eventual winner
however, not many contests with more than one bidder
synergy likely to occur uniquely between specific partners – there
should be little possibilities for competing bidders
Schedule
target takes it all
 in general: „the target takes it all“ - problem
 for poorly acting managers the „market for corporate control“

should be a disciplining threat –
 however, if m&a transactions largely benefit the shareholder

of the target
 potential acquirers may not try to acquire!
 underlying „free rider problem“ (Grossman / Hart 1980)
Grossman, Sanford J. and Oliver D. Hart, 1980, Takeover Bids, The Free Rider Problem, and the Theory
of the Corporation, Bell Journal of Economics 11, (Spring), pp. 42-64
free rider – basic setting
 badly managed firm
 100% free flow of shares, i.e.

action of one shareholder will not influence final outcome
 current share price 30€
 a potential acquirer („raider“) will make profits by

 buying a controlling stake (50%) at 45€ (offer price)
 restructure the firm
 and sell the shares again at 60€
(price under raider‘s new management)
©Frankfurt–School.de Grossman / Hart 1980 18

free rider – the model
shareholder‘s state of the shareholder‘s

alternative environment payoff
payoff = 30
payoff = 45
payoff = 30
payoff = 60
free rider – benefits target shareholders
 given that more than 50% hand in their shares at 45€

 alternative of handing in shares and getting 45€ for it immediately
or
 not handing in shares, lean back and wait until the raider has
restructured the firm -- and sell at 60€
 if offer price is not very close to the new price, it is best to free ride on
the raider‘s efforts to restructure the firm
 target shareholders extract potential benefits

 only deals with high target shareholder gains, low acquirer gains
 … bad news for acquirers!
20
why there are takeovers at all?
raider and shareholders differ in their valuations – i.e. estimations

about the discounted value of the raider‘s new strategy (PN):
when a raider estimates a higher PN than the target‘s shareholders, the
takeover will take place
 hybris hypothesis; economic disturbance hypothesis
but
rely on luck to bring a raider who values the dividend stream of the firm
more than the shareholders do is unwise – better:
create a divergence between the value of the dividend stream to a

raider and its value to shareholders
ways to incentivise raiders
 (1) dilution
shareholders could write a corporate charter permitting any successful
raider to reduce the value of the postraid company by a certain
amount,
which the raider is permitted to pay to himself, e.g.,
via high salary,
new shares to herself,
sell assets below value to own company,
sell output to raider at low prices,
mostly: merging the firm with own firm under favourable
conditions for raider
voluntary dilution of property rights: commonly seen as undesirable
– but encourages takeovers and thus shareholder value maximization
dilution
let the charter allow a maximal level of dilution, given by D euros

the value to a shareholder from retaining her shares in the event that a
raid succeeds is: PN – D
thus, if the raider offers the tender price B, and shareholders think that
the raid will succeed, they will tender as long as
B ≥ PN – D
 i.e., the raider has to pay a reduced price to get control of the firm
dilution
shareholders realize that by permitting more dilution they increase the

threat of a raid, which
is good because it makes status quo management more efficient,
but
lowers the tender price they receive in the event of a raid, which
is bad for them
optimal degree of dilution depends on circumstances, but in any case

is positive
toeholds
suppose the potential acquirer can buy a „toehold“ in the open market
before announcement of bid
fraction of shares α at price PT
toehold limited by disclosure regulations (Germany: 3%)
using other techniques (e.g., Cash Settled Total Return Equity Swaps)
does not mitigate much, new rules since February 2012 (§25a WpHG)
in Germany
(see also Baums & Sauter 2009; Zeitschrift für das gesamte Handelsrecht und
Wirtschaftsrecht, Vol. 173, pp. 454-503)
toeholds: the mechanism
 assume bid B=PN

 minimum toehold necessary to overcome the free rider problem given
by payoff for bidder (C = transaction cost)
 payoff = PN – αPT - (1- α)B - C
= α(PN - PT) - C
C
 positive if 
PN  PT
free rider and blockholder
 what happens in the case of a non-atomistic target shareholder

structure?
 quite common, especially when considering hedge fund entry after

bid is made
 model setup:
 N shareholders with blocks of shares; N is small
 strategic interaction between shareholders
 acceptance of merger requires majority of m shareholders

 if only m-1 accept, bid fails
Source: van Haltern, Jörn and Maug, Ernst (2006); see Officer
 each shareholder is confronted with the following game:

 a = number of acceptances
a<m-1 a>m-1 a=m-1

Accept PT B B
Reject PT PN PT
Probability P(a<m-1) P(a>m-1) P(a=m-1)
 when only a<m-1 shareholders accept the bid  no takeover

 when a>m-1 of the N-1 other shareholders accept the bid, there will be
a takeover
 when a=m-1 then one shareholder will be pivotal, i.e. she decides
whether the bid will take place or not
 empirical research shows that acquiring private targets yields better

announcement returns for bidding firms
Schedule
pre-emptive acquisitions
 how could shareholder value maximized while bidders’ share price is

reduced?
 it’s the counterfactual!
 by preempting the rival firm’s bid, the acquiring firm prevents a larger
profit loss, which could result from a competitor merging with the same
target
 the merger itself may reduce the acquirer’s value because of the high
price paid for the target
 however, the loss would be even greater if another firm would buy the
target – thus, overpaying would be a rational, value-maximizing
strategy
„killer“ acquisitions
 some acquisitions take place to eliminate future competition
 MENLO PARK, CALIF. – February 19, 2014 – Facebook today

announced that it has reached a definitive agreement to acquire
WhatsApp, a rapidly growing cross-platform mobile messaging
company, for a total of approximately $16 billion, including $4
billion in cash and approximately $12 billion worth of Facebook
shares. The agreement also provides for an additional $3 billion in
restricted stock units to be granted to WhatsApp’s founders and
employees that will vest over four years subsequent to closing.
 WhatsApp’s six-month revenue for the first half of 2014 totaled $15.9
million and the company incurred a staggering net loss of $232.5
million. It had 55 employees.
 Cunningham, Ederer, and Ma (JPE, 2021) conclude that about 6

percent of pharma acquisitions are “killer acquisitions,” where the
acquisition eliminates entry by a potential competitor
 ‘Big Tech’ companies have all engaged in large numbers of

acquisitions of smaller start-ups.
 Google has acquired 270 companies from 2001-2019
 Microsoft has made over 100 acquisitions in the last ten years,
including acquisitions of Skype, Nokia Devices, LinkedIn and
GitHub
 Amazon has made a similar number of acquisitions including its
purchase of Whole Foods
 Facebook has acquired 90 companies, mainly start-ups
 many of these mergers could have positive economic benefits

 but provide a strategic means for dominant firms to solidify and protect
their dominance
 even a negative share price reaction could mean a better result than
letting this firm grow and intensify the competition in the long-term
 few of these mergers were investigated or challenged by the antitrust

agencies
 present merger law is ill-equipped to address the tech firms’
acquisition of start-ups when the motive is to insulate themselves from
future competitive threats
Schedule
focus on bidder returns
back to the assumptions for assessing returns:
 ∆ stand-alone value of bidder = 0

(see slides at end of session one)
Why do acquirers pursue takeovers if they do not overtly benefit from the
deals?
 anticipation effect (market “reacts” before transaction)

 revelation effect (market reassess acquirers’ stand-alone value)
acquisitions reveal information
about acquirers
assumption: firm maximizes its value by optimal takeover decisions

 market cannot perfectly assess a firm
 but can partly infer value from the firm’s actions
 markets learn from merger announcements about acquirer’s stand-alone

value ( SAP & Business Objects 2007)
• negative revelation effect would confound gains from the acquisition, i.e.
synergies
insights from failed transactions
 „exogenously“ (well, more or less) failed bids allow for assessment

of new stand-alone value of acquirers
what if… antitrust stops Bayer in Oct 2017?
?
‐4% on
average!
hypothetical scenario:
antitrust blocks Bayer‐
Monsanto deal
acquirers are doing not so bad
Wang (Journal of Financial Economics, 2018), finds:
 M&As on average create significant value for both, acquirers and targets
(2/3 for the acquirer)
 only 15% of exogenously failed bids show combined firm value increases
upon bid termination
 revelation effect about -5%; synergy gains about +4%
 average announcement return -1% for acquirers
 probably corporate governance less of a problem…
30 minutes in-class case
you are now randomly assigned to a group of about 5 students,

not related to the large project. this is a non-graded exercise.
task:
find a recent transaction with at least one listed firm, explain this
very briefly (1 slide)
find share prices and a fitting share index, look around
announcement date and a longer period
normalize this to 100 percent and plot it (1-2 slides)
has this transaction been a success or not? for whom? try to
make sense of the share price reaction (1 slide)
combining the values of the two companies, has the transaction
increased shareholder value (1 slide)
be ready to show your findings in a two minutes presentation in class
Schedule
success of m&a
 long-term event studies
 there are a number of methodological concerns with long-

term event studies
 expected returns are very hard to justify for periods of a
couple of years
 model of expected returns becomes crucial: three-year
expected returns can easily range from 30 percent to 65
percent, depending on the model used
 if long-term expected returns can only be roughly estimated,

then estimates of long-term abnormal returns are necessarily
imprecise
success of m&a
 long-term event studies
 Mitchell and Stafford 2000, Journal of Business, report three-

year post-merger abnormal returns for 2,068 acquiring firms,
value-weighted:
 full sample: -1,4%

 financed with stock: -4.3%
 financed without stock: 3.6%
none is statistically significant even
at the 5% level
success of m&a
 long-term operating performance studies
 focus on development of accounting measures of profitability

after merger (return on assets, operating margins)
 Ravenscraft and Scherer 1989, Journal of Industrial
Economics, data of 471 firms from 1975-1977
 find that the target lines of business suffer a loss

in profitability following the merger
 conclude that mergers destroy value on average in the longer
run
success of m&a
 Loughran and Vijh 1997, Journal of Finance, separately

calculate long-term abnormal returns for acquiring firms
using stock financing and those paying with cash
 finding is:
 acquiring firms using stock financing have abnormal returns
of -24.2% over the five-year period after the merger
 acquiring firms using paying cash have abnormal returns of
+18.5% in the same period
that percentage is smaller in other studies, but still positive
success of m&a
 bondholder wealth effects in m&a transactions
 Billet, King and Mauer 2004, Journal of Finance, examine the

effects of m&a announcements on the prices of 3,901 bonds
of target and acquiring firms in 940 deals from 1979 to 1997
 below investment grade target bonds earn significantly
positive (excess) announcement period returns
 larger when target‘s rating is below the acquirer‘s, when the
combination is anticipated to decrease target risk or leverage
 acquiring firm bonds earn negative (excess) announcement
period returns
 correlation between excess returns of stock- and bondholders
tend to be positive – no wealth transfers
success of m&a
 abnormal returns to rivals of acquisition targets
 Song and Walkling 2000, Journal of Financial Economics test

the so-called ‚acquisitions probability hypothesis‘, which
asserts that rivals of initial acquisition targets earn abnormal
returns because of the increased probability that they will
become targets themselves
 141 targets with 2459 rival firms from 1982 to 1991
 on average, rival firms earn positive abnormal returns
regardless of the form and outcome of the acquisition
 significant increase of abnormal returns with the magnitude
of surprise about initial acquisition (as measured by the
length of the no-deal phase before)
success of m&a
 abnormal returns to rivals of acquisition targets
 lessons from Song and Walkling 2000
 calculation of abnormal returns for initial acquisition is

disturbed by reaction of rival firms
 when calculating expected value with the help of peer group
or stock market index,
 ususally a sub-index (industry-index) is used
 attention! - might be influenced by transaction
 use of larger index might offer insights as well
success of m&a
 again: a zillion studies on m&a success out
 now ‚meta-studies‘ occur, showing the main results of the

studies and comparing inputs to the studies
 similar Tichy 2001, Working Paper Vienna, on long-run
abnormal returns
 compares the results of abnormal bidder return studies,
before and after the announcement of m&a transactions
(up to 100 months before and 80 months after):
success of m&a – meta studies
abnormal returns of bidder above month

before or after announcement
abnormal returns
month before / after announcement

success of m&a
 on average, the studies find negative long-run

abnormal returns of m&a transactions
 still a lot of work (academic and in practice) to be done…
Schedule
learning about transactions
press & analyst communication
explicit
communication
advise: deal with implicit
signals in corporate
communication
capital
direct judgement
transaction impossible
market
participants
signals / implicit
communication academic
deal characteristics: research
target features,
means of payment, etc.
drivers of bidder returns
although public targets seem to be the clear winners, bidder

announcement returns show consistent patterns as well
important drivers of capital market’s reactions seem to be the

transaction’s characteristics – the implicit signals
empirical research findings on acquirer share price reactions can be

grouped in four sources
 acquirer characteristics
 deal characteristics
 target characteristics
 exogenous factors
acquirer characteristics
characteristic effect underlying hypothesis
…high debt has a disciplining effect on

leverage management
management of large firms more

…high market
prone to suffer hubris & thus pay
capitalization
higher premiums
…high cash cash is low-hurdle financing source –

holdings no one has to be convinced that
project is value enhancing
…equity linked
managers‘ personal objectives are
management
aligned with shareholders
compensation
deal characteristics
…cash (for management trusts acquisition;

public targets) acquirer share not overvalued
…equity (for signaling to market that share is

public targets) currently overvalued
…equity (for new blockholder results in increased

private targets) monitoring of acquirer
larger distance results in less control;

…cross
border market entry positive
deal characteristics
…hostile less information available; less

takeover synergies due to integration problems
…competing target shareholders benefit from

bidders bidding competition
diversification not beneficial for

…diversifying
shareholders but for managers in the
acquisitions
first hand
target & exogenous characteristics
…non-public no free-rider problem; illiquidity of non

target
target public targets leads to price discounts

exogenous
…hot merger high degree of optimism in market,

market autocorrelation
Mergers & Acquisitions – Slide Set Session 2
-- END OF SESSION 2 --
Michael H. Grote

02a Slides - Success

Uploaded by

Copyright:

Available Formats

You might also like

02a Slides - Success

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

02a Slides - Success

Uploaded by

Copyright:

Available Formats

Mergers & Acquisitions – Slide Set Session 2

Does M&A create value?

share price developments around announcement

explaining unsatisfactory bidder returns

the target takes it all

pre-emptive and killer acquisitions

long-term and other studies

overview of other success drivers

170% ~ transaction value for

Acquisition of Engelhard by BASF on January 3, 2006

130% ~ transaction value for

Source: Betton, Sandra / Eckbo, B. Espen (2000):

source: Refinitiv 2022

 cumulative abnormal returns in m&a processes

[-1;+1] [-20; close]

combined 1,8% 1,9%

target 16,0% 23,8%

acquirer -0,7% -3,8%

share price developments around announcement

explaining unsatisfactory bidder returns

the target takes it all

pre-emptive and killer acquisitions

long-term and other studies

overview of other success drivers

„Many managements apparently were overexposed in

Warren Buffet, Berkshire Hathaway Annual Report 1981

possible explanation might indeed be principal agent problems in

furthermore, the mere presence of competing bidders (or the

share price developments around announcement

explaining unsatisfactory bidder returns

the target takes it all

pre-emptive and killer acquisitions

long-term and other studies

overview of other success drivers

 in general: „the target takes it all“ - problem

 for poorly acting managers the „market for corporate control“

 however, if m&a transactions largely benefit the shareholder

 underlying „free rider problem“ (Grossman / Hart 1980)

 badly managed firm

 100% free flow of shares, i.e.

 current share price 30€

 a potential acquirer („raider“) will make profits by

©Frankfurt–School.de Grossman / Hart 1980 18

shareholder‘s state of the shareholder‘s

 given that more than 50% hand in their shares at 45€

 target shareholders extract potential benefits

raider and shareholders differ in their valuations – i.e. estimations

create a divergence between the value of the dividend stream to a

let the charter allow a maximal level of dilution, given by D euros

shareholders realize that by permitting more dilution they increase the

optimal degree of dilution depends on circumstances, but in any case

 assume bid B=PN

 payoff = PN – αPT - (1- α)B - C

 what happens in the case of a non-atomistic target shareholder

 quite common, especially when considering hedge fund entry after

 acceptance of merger requires majority of m shareholders

 each shareholder is confronted with the following game:

a<m-1 a>m-1 a=m-1