Mergers and Acquisitions

AFM · Chapter 15

Mergers and Acquisitions

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1 Introduction

In this chapter we will discuss briefly the reasons why a company may wish to merge with, or take over, another company, and consider associated issues.

In the subsequent chapter we will look at the valuation of mergers and acquisitions.

2 The objectives of takeovers or mergers

Takeovers or mergers should increase shareholders wealth via:

Acquiring the target company at an undervalue
Synergistic benefits:
1. Economic efficiency gains
  1. economies of scale (volume related savings)
  2. economies of scope (complementary resources)
2. Financial synergy
  1. reduced total risk will not benefit well-diversified shareholders (the systematic risk is not reduced by diversification) but reducing total risk may reduce insolvency risks and hence borrowing costs
  2. increased asset backing may bolster borrowing capacity
  3. exploiting tax losses sooner
3. Market power
  1. acquiring monopolistic powers (e.g. eliminate competition)
  2. acquisition of a scarce resource
  3. dynamic management
  4. innovative product
  5. cash mountain
  6. to enter a new market quickly

3 Predator issues on takeover

The investment decision
1. How much is the target worth to the predator?
2. Are the target shareholders willing to sell?
3. What economic / industry and company assumptions underline the valuation?
The financing decision
1. Matching
  1. has the predator adequate surplus cash / borrowing capacity / ability to issue shares?
  2. can the group service the new finance required for the acquisition?
2. Cost
  1. will the use of cash or shares change the predator’s capital structure for better or worse?
3. Capital providers
  1. will any existing debt covenants or existing shareholder expectations be affected?
  2. could the predator issue convertibles to delay control dilution issues?
  3. is the current dividend policy desirable / sustainable after the acquisition?
  4. will the EPS be affected, and does it matter?
Market issues - often target companies are over-valued because of:
1. Over optimism with regard to economies of scale
2. The victim’s share price anticipating synergistic gains
3. The victim’s share price may be ‘bid up’ in an auction

4 Target issues on takeover

What is the target worth to the predator – can we extract maximum value?
What is the target worth to us?
Do we want to sell?
What is the after personal tax value of the offer?
If the offer is in shares, are they attractive?

When asked how acceptable a cash offer or a share-for-share offer is, work through both lists above. For the target's shareholders, cash has a known value but may leave them with tax to pay on their gain, while shares keep them invested in the enlarged company and its risks. For the predator, the cash has to be found: whether it has surplus cash or borrowing capacity, whether the group can service any new debt, and what the extra borrowing does to its gearing — which is the case for offering shares instead, or a mix of cash and shares.

4.1 Market issues

The target company shareholders are the ones who must approve the offer. Generally, most of the benefits on a takeover accrue to the target company shareholders.

4.2 Defensive tactics

provide more information
1. contest the offer on terms of being a poor offer, having no obvious advantage, and / or employee opposition
2. issue forecasts to indicate that the sale of the shares is not a good option
3. revalue the assets
4. advertise (subject to the City Code – see below)
lobby to have the offer referred to the Competition Commission
stop shares falling into the predators hands
1. find a White Knight (an alternative bidder who would be more acceptable)
2. arrange a management buyout
Poison Pill tactics: the target builds in a tripwire to make itself less attractive. E.g. create a new class of stock which automatically becomes redeemable at a high price in the event of a take-over.