39 Mergersandtakeovers

A Mergers, takeovers and joint ventures

In the modern business tworld, the ownership of companics often changes. This can happen in
different ways:
a merger: this is vhen two compaies jon together to form a new one (e.g. Exxon and
Mobil, America Online and Tme Warner).
a takeoyer or acquisition: this is when one company buys another one (e.g, Vodałone and
Mannesmann, Daimler-Benz and Chrysler). This can happen in wo ways. Firstly, a
company can otfer to buy all the shareholders' shares at a certain price (higher than the
market pricel during a limited period of tine. This is called a takeover bid. Secondly, a
company can buy as many shares as possıble on the stock market, hoping to gain a
majority. This is called a raid.

Invesment banks have mergers and acquisitions

(M&A) departments that advise companics involved
BOARD
in mergers and takeovers.
ROOM
Companies can also work together without a
change of ownership. For examplc, when two or
more companies decide to work together for a
speehe projcct or product, this is called a joint
venture. An cxample is Sony Ericsson, wich makes
mobile phones.

"Well the merger is over, now

the takeOver starts."

B Hostile or friendly?
There are two rypes of takeover bid. If a company's board of directors agrees to a
takeover. it is a friendly bid (and if the sharcholders agree to sell, it becomes a friendiy
takeover). If the company does not want to be raken over, i is a hostile bid (and if
successful, a hostile takeover). Companics have various ways of defending themselves
against a hostile bid. They can try to nd a white knight - another conpany that they
would prefer to be bought by. Or they can use che poison pill defence ('eat me and youll
die!') which involves issuing new shares at a big discount. This reduces the holding ot the
company attempting the takeOver, and makes the takeover much more expensive.

CIntegration
Horizontal integration is when a company gets bigger hy acquiring comperitors in the
same cld of acrivity. Vertical intcgration is acquiring companies involved in other parts
of the supply chain, usually to make cost savings. There are two possibilities: backward
integration is acquiring supplhers of raw materials or components; forward integration is
buying distributors or rerail outlets. Cumpanies can also buy busincsses in completely
different elds, which is known as diversi cation. This can be donc ro reduce the risk
involved in operating in only one industry - but diversifying into completcly different
industries is a risk itselt.
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 39.1 Complete the sentences. Look at A opposite to help you.

1 lwant to work n the nergers and department ot an i)vestment bank m

New York.
2 Beverage Partners Worldwide is a berween the (Coca-Cola and Nestle
companies, making ready-to-drink tets and cottees.
3 Atter their -*****oeeeetenswe*nee . Union Bank of Switzerland and Swiss Bank Corporation had
combincd assers of S600bn.
4 We started with a . buying all thestocksavailableon thestockevchange.
That got us 15%% of their stocks. Then we made a .
es****es.o**** oftering 20"% above the
market price. and bought another 40°% of the company.

39.2 Conplete the sentences. Look ar B opposite to help you.

Telccom talia is boking for a ........ ..(0 rSCUe it 'rom

......
takcover by ríval Olivetti.
Hrerrirtpr ISentttIpfhsper ffry tttfrstternpterre e,etpeTihPisstrpteshs tarsf tsrgsysar fStTPrf.

Colonial has agreed to a takeover by Commonwealth Bank.

reis,7ieerseaseehs
HICPHL.
1 metes etf
stevstrP/tyh Hevtts etrrerte usttt1ptetre pfhtthaprnprtthyfFeeugreet
fftesese

3
Mackenzice Financial Corp is planning a huge rights issue as a ..to ghtoff
C.I. FundManagcment'stakeover offer.

39.3 \harch the newspaper headlines (1-5) with theprocesses(a-e). Look ar ( opposite to help you.

1 a horizontal integration
Shell Purchases 30 Gas Stations b vertical inregration
C torwarst integratKon
d backward integration
2
Hotel Chain to Buy Furniture e diversiication

Manufacturer to Supply Its New Hotels

3
Electrical Retailer Dixons Bids
for High Street Competitor Currys
rmereheertmrrtrfte eryrırgpetffpr*bhiussettrrmieteeyr ys.ut lrETtt- eeftTis

Coca-Cola Acquires Columbia

Pictures for $700 Million
rerret!tpgh*oerretsfresorrtrrtrrrfrrtyfStiVHEIpobyrs

5
BP Now Controls the Entire Supply
Chain, From the Oil Re nery to the
Petrol Pump
erffstripp g Jitit2#. rtttPheeetsrgsthatse.lhhe

Over to you
Look at some nancial newspapers or websites. What kind of takeover bids are taking place
in your country?
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 40Leveraged
buyouts
A Conglomerates
A series of takeovers can resulr in a parent company controlling a number of subsidiaries:
smaller companies that it owns. When the subsidiaries operate in many different business
areas, the company is known as a conglomerate.

But large conglomerates can become inefhcient. Top executives often lcave after hostile
takeovers, and too much diversi cation neans the company is no longer concentrating on
its core business: its central and most important activity. Takeovers do not always result
in synergy: combined production or productivity thar is greater than the sum of the
separate parts. In fact, statistics show that most mergers and acquisitions rcduce rarher
than increase a companv's valuc.

An inefhcient conglomerate whose pro rs are too low can have a low stock price, and irs
market capitalization - the total market price of all its ordinary shares - can fall below
che value of its ansets, including land, buildings and pension funds. If this happens, it
becomes pro table for another company ro buy thc conglomerate and either split it up
and scll it as individual mpanies, ar close the companies and sell che asscts. This
practice, common in the USA but rare in Europe or Asia, is called asset-stripping. Ir
shows that stock nnarkets are not always ef cicnt (sec Unit 30), and that companies can
somerines be undervalued or underpriccd: the price of their shares on the stock market
can be too low. Sone peopke argue that asset-stripping is a good way of using capita!
more ctfhciently:; others argue that it is an unfortunatc activity that destroys companies
and jobs.

B Raiders
lf corporate riders - individuals or conpanies that want to take over other companies –
borrow noney to do s0, Usually by issuing bonds, the takeover is called a leveragcd
buyout or LBO. Leveragcd means largely nanced by borrowed capiral. Afrer the
takeover, the raider sclls subsidiarics of tlhc company in order to pay back rhe
bondholders.
Bonds issued to pay for cakeovers are usually called junk bonds because they are riskv: it
may not he pussible to scll the subsidiarics at a pro t. But, because of the risk, these
bonds pay a high interest rate, so some investors are happy to buy them.

Somctimes a company's owN MAnagers want O

buv the company. and re-organize it. This is a
managemcnt buyout or MBO. If the buyout is
inanced by issuing preference shares and
convertibles, this is called niczzanine nancing
GARDS
as it is, in a sense. halfway between debt and
FoR ALLOCCĄSIONS
eyuirv. (Sce Unir 28 for another use of
'mezzanine nancing'.) BuyoUTS
TakéoVER

IMERGERS|VFLOATaTion

BanKRUFTcY
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 40.1 March the words in che box with the de nitiusns below. Lk at A and B opposite to help you.

asset-stripping core business leveragcd marker capitalization

parent company subsidiaries syncrgy

1 a company that owns or controls one or more othercompanics

2 the main activity of a company
3 buyıng a company in order to sell some of its assets
4 companies partly or whully owned by another compary
5 havinga lot of borrowcd money compared to one's own funds
6 the total value of a company on the stock exchange
7 rwo things working together that produce an effect greater than the sum of their individual
effects

40.2 Match the rwo parts of the sentences. Look at A and B opposite to help you.
1 Large conglomerates formed by takeovers
2 If a conglomerate diversi es and docsn't concentrate on its core business,
3 An inefhcient conglomerate's stock market value
4 If a company is worth less than its assets,
5 Raiders do not need to have very much moncy of their own if
a can be less than the sale value of all its assets.
b can beconne inef cknt, especially if they are very diversi ed.
c they use leverage, and issue junk bonds.
d there might not be synergies among all its different aciviies.
c vou can make a proht by buying it and selling the parts.

40.3 Pur the scquencc of events in the correct order. The frSt stage is a. Iook at B opposite ro heln you.

a Corporate raiders calculate that a large company is undervalucd.

b Investors buy the bonds becausc they pay a high interest ratc.
c The new owners sell some of the company's subsidiaries.
d The new owncrs repay the bondholders.
e The rajders buy the company.
f The raiders issuc bonds to raise capital to huv the company.

a 2 3

Over to you
What are the most diversi ed conglomerates you know of? Are they successful? Why do
you think this is?
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 47Flaicial
planning
Financing new investments
Alia Rahal works in the fnancial planning
department of a large manutacturing company:
Financial planning involves calculating whecher
new projcts would be pro table. We have to
calculate the probable rate of return: the amount
of income we'd receive cach year from the
investment, expressed as a percentage of the total
amount invested. f we're going to hnance a
projcct with our owIn )0ney, the rate of return
must be ar least as high as we could ger by
depositing thc money iu a bank instead, or bv
making another risk-free investment, ike buying
gOvernment bonds.
Sf we need to borrow money to nance a
hew investment, its projected rate of
return has to be higher than the cost of
capital - the amount we have to pay to
borrow the moncy.

B Discountedcash ows
IWe usually calculate the discounted cash ow value of an investnment. This mcans
discounting or reducing future cash tlows to get their present values – in orher words,
calculating the present value ol money to be received in the futurc. This is because the
value of noncy deereaseSover tine. Firstly, there's nearly always in arion, so cash will
have lower purchasing power in the furure: you'll be able to buy less with the same
unount of money. And seOndly, it you had the mony now, yOu could get incone by
using or investing it. The return we could ger by investing the mnoney in other ways is thc
opportunity cost of capital. So waiting tor money is also a cost. This is the time valuc of
money: how much more it is worth to receive moncy now rather than in the furure.

Comparing investment returns

lf we have to choose among possible investnents in new projccts, we work out the net
present value (NPV) of each project by adding up all the expected cash lows, discounted
to their present value, minus the initial investment. To do this, we have to sclect a
discount rate or capitalization rate. This is usually the interest rate we pay for borrowing
the capital, but we could increase it if there's a lot of uncertainty or risk.

Discounting sounds complicated, but it isn't. It's the opposite of compounding interest.
For example, if you invest $1,000 ar 10% for ive years, it will yield 1.61 times its
original value. So you get back Š1.610, ineuding S61O compound interest. A discount
rate of 10% has a discount factor of one divided by 1.6l, which is 0.62. So S620 invested
now will be worch $I,000 in ve vears if it's invested at 10%.

When we're comparing alternative investmenrs, we also calculate the internal rate of
return (lRR). Thats the interest rate or discount rate that gives a net present value of zero
in today's noney values. In other words, the present value of the cash that we're going to
Teceive from an investme is the sane as the present value of borrowing rhat cash. We
norally choose che investnent with the highest IRR.'
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 41.1 Match thc words in the box with the dehnitions bclow. Lonk at A, B and C oppsite to hclp you.

discount rate discounted cash Alow internal rate of return

purchasing power rate ot rcturn tine value of money

1 a series of future earnings convcrted to thct vaue today

2 the annual percentage amount of inconc received from an investnent
3 the interest rate an investment carns when the present value of all costs cquals the present
value of all returns
4 the difference between the value of moncy held now, and its value if it is received in the
future, becausc it could be invested during that period
5 the value of money, neasured by the quantity (and quality) of pruducts and services it can
uy
6 che intcrest rate used to calculate the present valuc of future cash lkows

41,2 Are che following statenents true or false? Fnd reasons tor your answers in A and Bopposite.
1 Ifs company uses its on monev for a new project, chere is no opportuniy cost of capital.
2 A project nanced hy horrowed moncy requres a rate of return higher than thc Ost of
capital.
3 Becausc of in ation, moncy will usualiy he worth more in the futurc than at the presT.
4 The longer you have to wait for investmcnt returas, the lcss cheir prcsent value is.

41.3 March the two parts of the sentences. Iook at B and C opposite to help you.
1 Future cash ows are usually discounted
2 If a project sccms to be particularly risky or uncertain,
3 Moncy you possess now is worth morc than money received in the future, because
4 The net present value of a project is the sum of all the retnrns it is expectcd to provide,
5 When choosing among potential investments,
a buşinesses look for the onc with the highest internal rate of reurn.
b by the cost of the capita! involved in the investment.
c discounted to thcir current valuc.
d it can earn interest in that time, and there might be in ation.
e you can increase thc discount rate you use in your calculations.

Over to you
What return can a company get on risk-free investments in your country today? What is
the minimum rate of return a company would require on an uncertain new investmcnt?
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