Mergers and Acquisitions
Mergers and Acquisitions
Mergers and Acquisitions
Mergers and Acquisitions
List of Questions Week 1 – Overview of takeover process ....................... 9 What is a merger and what is an acquisition? Are these definitions important? ................ 9 What is the main purpose of M&A?.................................................................................... 9 What are two economic theories about the efficacy of takeovers for corporate shareholders? .................................................................................................................... 9 What are the key drivers of M&A success ......................................................................... 9 What criteria can we measure outcomes against? .......................................................... 10 What are some emerging/disruptive (i.e. disruptive to existing practice) ideas in M&A)? 10 What is the current state of the M&A market? ................................................................. 10 What is the winners curse? .............................................................................................. 10
Week 2 – M&A activity and outcomes ......................... 11 In a very general sense, is M&A successful? Studies?.................................................... 11 What are some popular explanations for buyer share price decline post-merger? .......... 11 According to Brealy and Myers (1996) what two issues are among the most major unresolved questions in finance? ..................................................................................... 11 What are some features of the last few merger waves? .................................................. 11 What is typical of all merger waves 1900-present?.......................................................... 11 What are four broad theories that attempt to predict M&A activity? How are these related and what are the shortcomings of using these to explain the wave phenomenon ........... 12 Explanations for M&A activity fit into which four categories? ........................................... 13 What are the 3 categories of M&A results (wrt value)? .................................................... 13 What is the right metric for judging M&A outcomes? ....................................................... 13 How do we measure abnormal returns? .......................................................................... 13 What is the predicted return? What are the three methods for estimating predicted returns? ............................................................................................................................ 14 How is the residual calculated?........................................................................................ 14 What measures do we use in the context of M&A analysis? What is the formal test of these? .............................................................................................................................. 14 Why do we measure combined returns and what conclusions can generally be made from studies?.................................................................................................................... 16 What conclusions can be made about LT performance? Why is this hard to quantify? .. 16 What is an accounting study as opposed to an event study? What difficulties to we have with assessing the operating performance of acquirers ................................................... 16 What fundamental problem is there with using event studies to judge M&A outcomes? . 17
Week 3 – Strategy and M&A ......................................... 18 Page 2 of 58
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What is the overall framework for strategy? ..................................................................... 18 Generally speaking, what two dimensions should formulating strategy take? ................. 18 What 4 tools exist for formulating strategy? ..................................................................... 18 What is the experience curve? What strategy does it suggest? ...................................... 18 What is the product life cycle? Relationship to M&A? ...................................................... 19 What is the product portfolio balance? ............................................................................. 19 What is Porters’ Five Forces? .......................................................................................... 20 What is the product-market matrix / strength-market matrix? .......................................... 20 What is the key characteristic of business goals that is necessary to facilitate progress? ......................................................................................................................................... 20 What is the goal of M&A (2 goals) in the context of a firm’s strategy? ............................. 20 Broadly speaking, what two choices does the M&A decision framework set out? ........... 20 What are 5 key types of acquisitions?.............................................................................. 21 When is organic growth a good idea? .............................................................................. 21 When is inorganic growth a good idea? ........................................................................... 21 What are 3 considerations in choosing a decision path for inorganic growth? ................ 21 What are 4 common types of inorganic growth? .............................................................. 21 What are 3 considerations in choosing a decision path for corporate restructuring? ...... 22 What are 4 common types of corporate restructuring? .................................................... 22 What is the research evidence on JVs. alliances and minority interests? ....................... 22 What is the evidence of divestitures/other sellside transactions? Why and when esp? .. 22 What about recapitalisation transactions? Contrary to EMH?.......................................... 22
Week 4 – Valuation ........................................................ 23 Why do we undertake valuation in M&A? What is the relevant decision rule? ................ 23 What is the process of valuation using trading multiples? ............................................... 23 What types of trading multiples exist?.............................................................................. 23 What are the advantages and disadvantages of using trading multiples? ....................... 24 What filters are commonly used in choosing comparable companies? ........................... 24 What is the matching principle wrt mults? ........................................................................ 25 How do we handle one-off activities How do we handle minority interests? .................... 25 What are the advantages and disadvantages of using transaction multiples? ................ 25 What is a definition of DCF? ............................................................................................ 25 When is DCF most suitable?............................................................................................ 25 What is the formula for unlevered free cash flow? ........................................................... 25
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What is a definition of WACC? What is the WACC formula? ........................................... 26 What is the TV formula?................................................................................................... 26 What are some considerations as to why fundamental equity value may be different from market equity value in an IPO scenario? ......................................................................... 26 What are some key sensitivities for DCF valuations? ...................................................... 27 What are the advantages and disadvantages of DCF valuation? .................................... 27 What is an LBO analysis? What are its four steps? ......................................................... 27 What is a leveraged recap? ............................................................................................. 27 How is a final valuation derived using all these methods ................................................. 28 What are factors affecting the takeover premium? .......................................................... 28
Week 5 – Valuing synergies, liquidity and control ..... 29 What are synergies? ........................................................................................................ 29 What is the difference between cash and scrip?.............................................................. 29 What are the two types of synergies? Formula ................................................................ 29 What are the common types of synergies in place? ........................................................ 29 What are the 4 categories of revenue enhancement synergies? Arguments + counterarguments for each .............................................................................................. 29 What are the 4 categories of cost reduction synergies? Arguments + counterarguments for each ............................................................................................................................ 30 What are two categories of financial synergies? .............................................................. 30 What two categories of tax reduction synergies exist? .................................................... 30 What is the appropriate RADR for each level of riskiness of synergy? ............................ 30 What is the formula for synergy value based on a multiple? ........................................... 31 How do you work out EPS accretion/dilution in a scrip deal? .......................................... 31 What are some types of real options synergies ............................................................... 31 Why use real option analysis? ......................................................................................... 31 What is the Black-Scholes formula? ................................................................................ 31 Wrt illiquidity and control, what is the formular for max payment for a target? ................ 31 What is the formula for net price? .................................................................................... 31 What must discounts and premiums always be compared wrt? ...................................... 32 What is a minority discount? ............................................................................................ 32 What kind of an option is liquidity? What are its two value drivers? ................................ 32 What is control? ............................................................................................................... 32 What kind of option is control? When is it in/out of the money? Where does it derive value?............................................................................................................................... 32
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What are three reasons why liquidity and control may interact? ...................................... 32
Week 8 – Deal types, the form of payment and financing ........................................................................ 34 General framework of deal design – 3 aspects ................................................................ 34 Implications of the general framework ............................................................................. 34 Factors influencing financing methods ............................................................................. 34 Research insights – (1) most deals use (2) smaller deals generally use (3) stock is generally used when the market is................................................................................... 35 Accepted wisdom – What does the choice between cash/scrip mean for targets/bidders ......................................................................................................................................... 35 (Zhang, 2001) – cash generally used more in what type of deals ................................... 35 (Martin, 1996) – relationship between Q ratio and scrip/cash choice .............................. 35 Graph of CAR by payment method .................................................................................. 35 Reasons for cash offers realising greater returns – (1) tax (2) agency (3) asymmetry .... 35
Week 9 – Exchange ratios and contingent payments 36 What is an exchange ratio?.............................................................................................. 36 Buyer’s maximum exchange rato ..................................................................................... 36 Target’s minimum exchange ratio .................................................................................... 36 Win-loss boundaries......................................................................................................... 37 3 factors that determine setting the ER (within the WW zone)......................................... 37 What is a contingent payment? ........................................................................................ 37 What is an earnout? ......................................................................................................... 37 Advantages and disadvantages of using earnouts .......................................................... 37 How are earnouts valued? ............................................................................................... 38 Decision rules for buyer and target wrt earnouts ............................................................. 38
Week 10 – Risk management in M&A transactions ... 39 Value at Risk (VaR) – how does it move over the deal’s life............................................ 39 What is risk management – 3 aspects, basically, what is it ............................................. 39 RM before announcement................................................................................................ 39 DM between announcement and deal close .................................................................... 39 DM after the deal closes .................................................................................................. 39 How to decide between fixed-shares and fixed-value? Wrt your share price dropping? . 39 What is a collar? Benefits of using a collar ...................................................................... 39 Fixed exchange ratio without collar .................................................................................. 39
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Fixed value deal ............................................................................................................... 40 How do collars add value? ............................................................................................... 40 When does the target/bidder benefit? .............................................................................. 40 Floating collars ................................................................................................................. 40 Fixed collars ..................................................................................................................... 41 Analysis of collars – width is based on, empirical analysis and pros and cons table ....... 41 Are collars needed? ......................................................................................................... 42 [Contingent value rights NOT ASSESSABLE] ................................................................. 42 Why use CVRs ................................................................................................................. 42
Week 11 – The Australian Merger Process ................. 43 What are the ways control may be achieved (in order of most common)? ...................... 43 What is the main source of regulation of takeovers in Australia, what is its objective and what does it contain? ....................................................................................................... 43 What are the acceptable methods of acquiring >20% according to ch6? ........................ 43 What conditions exist for the bidder to compulsorily acquire the minority stake (squeeze out minorities)?................................................................................................................. 43 What exceptions exist to the 20% rule? ........................................................................... 43 Without announcing a formal takeover bid: ...................................................................... 44 Table of key shareholding thresholds .............................................................................. 44 What regulation exists wrt foreign takeover? ................................................................... 44 What regulation exists wrt competition?........................................................................... 44 What are the main differences between on-market vs off-market vs scheme of arrangement ..................................................................................................................... 44 What is an off-market bid ................................................................................................. 45 Can OMB include conditions? What conds are most common? ...................................... 45 Consideration – what can be offered? What minimum price provision exists? Is the bidder constrained in which groups of shareholders it offers benefits to? .................................. 45 What must be included in the Bidders Statement? .......................................................... 45 What must be included in the Target Statement? ............................................................ 46 Outline of steps in an off-market bid ................................................................................ 46 When can the name of shareholders be requested? ....................................................... 47 What regulations exist wrt offers/ ..................................................................................... 47 What regulations exist wrt offer period ............................................................................. 47 What regulations exist wrt buying shares outside the bid? .............................................. 47 What regulations exist wrt increasing consideration of the offer? .................................... 47
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What regulations exist wrt extending the offer period? .................................................... 48 What regulations exist wrt declaring an offer unconditional? ........................................... 48 Can the bidder sell shares in the target during the offer? ................................................ 48 What must happen when a bid is received? .................................................................... 48 What are directors’ duties once deal is announced? ....................................................... 48 What must directors consider in assessing the offer?...................................................... 48 What are four defensive responses (aka frustrating actions) ........................................... 49 What is a scheme of arrangement ................................................................................... 49 Scheme - key steps.......................................................................................................... 49 Scheme timeline............................................................................................................... 50 What must an explanatory statement include? ................................................................ 50 What are the key considerations in deciding between a scheme and a takeover? ......... 50 Comparison of schemes and takeovers ........................................................................... 51
Week 12 – Merger arbitrage ......................................... 52 What is arbitrage? ............................................................................................................ 52 How much risk is there in arbitrage according to classic finance theory? ........................ 52 In what way do merger arbitrageurs sell insurance?........................................................ 52 Under what circumstances will the error term and the market term (in CAPM) become correlated? ....................................................................................................................... 52 Are MAeurs generally profitable? What 2 reasons exist or this ....................................... 52 What arb characteristics are there? ................................................................................. 53 What do arbs do after the announcement? ...................................................................... 53 What do target shareholders do after announcement? .................................................... 53 What is one way to characterise the dilemma faced by target shareholders? ................. 53 Cash deal arb ................................................................................................................... 53 What impact does a floating exchange ratio have on merger arbs .................................. 53 What is the main driver of arbitrage profits? .................................................................... 53 What constraints exist on arbitrage? ................................................................................ 53 Merger arb in action ......................................................................................................... 54
Week 13 – Takeover defences ..................................... 55 Buyer’s decision rule – when will a buyer ‘attack’ ............................................................ 55 How do investors react to takeover defences .................................................................. 55 Manager’s motives for bid resistance............................................................................... 55 From target’s perspective – bid resistance a good or bad thing? .................................... 55
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3 types of defence tactics and aims of each .................................................................... 55 List of all defence tactics discussed ................................................................................. 55 Financial defensive measures – main + alternative view ................................................. 56 Possible financial defensive measures ............................................................................ 56 Greenmail – what, two different views of greenmails, wealth effects of greenmail .......... 56 Pac man defence ............................................................................................................. 56 White knight and white squire .......................................................................................... 56 Anti-takeover amendments .............................................................................................. 56 Poison pills ....................................................................................................................... 57 When would shareholders want to rescind anti-takeover devices ................................... 57 Poison puts ...................................................................................................................... 57 Golden parachutes ........................................................................................................... 57 Rationale for golden parachutes? Optimal structure ........................................................ 57
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Week 1 – Overview of takeover process Relevant readings Bruner Ch1 – Done? No What is a merger and what is an acquisition? Are these definitions important? A business transaction where there is a combination of two or more companies, causing one or more companies to lose their corporate existence in the process A business transaction where the shares and or control in a company is taken over by a person who previously did not possess such shareholding or control Definition is not important as the terms can be used interchangeably and they both usually have the same legal effect What is the main purpose of M&A? M&A is an instrument of corporate renewal utilised to increase return on capital. Often occurs in the context of renewing growth when a business has reached a maturity or decline phase of its life cycle. Important to ensuring the return on capital exceeds the cost of capital. What are two economic theories about the efficacy of takeovers for corporate shareholders? 1. Neoclassical theory – acquisitions are value enhancing activities in which rational managers work to maximise shareholder wealth by e.g. cost savings, increased monopoly power 2. Managerial theory – Basically, managers act out of their own interest. Views takeovers as extensions of managers’ own personal interests for the purpose of increasing managers wealth or prestige (ie from managing a larger company a. “hubris-type argument (hubris = excessive pride or self confidence) - don’t care if the deal is creating value for shareholders Neither theory completely explains why we have successful and unsuccessful outcomes. Best to take one and two together to explain efficacy of takeovers What are the key drivers of M&A success Success in M&A I driven by both the structure of the M&A opportunity once faces, as well as the conduct by which one pursues it. Structure of the opportunity 1. Economics – eg risk vs return, CFs, NPV, accretive effects, financing effects 2. Strategy – threat/opportunity, industry position of parties, acquire capabilities/capacities and improve strategic position 3. Organisation – ability to integrate company structure/culture fit (e.g. US/JP clt clash) 4. Brand – creating and preserving brand value throughout M&A, M&A personal brand (e.g. CEO), compatibility of reputations 5. Laws define opportunities (eg big 4 banks) Conduct (ie strategy, tactics behaviour) 1. Quality of target search which relies on quality of advice from IB which relies on contracts and good info 2. Due diligence a. The search for risk b. Should seek to reveal info, not just fact checking 3. Negotiation and bidding a. Negotiation tactics will have an impact on price and terms
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b. Eg chairman of the board who is expected to have strong business connections and is expected to use these to maximise the likelihood of a friendly takeover c. Good IBs with good tactics d. Winner’s curse (auctions and deal frenzy) 4. Laws( eg ACCC, FIRB) – degree of regulatory certainty is very important; lobbying ! Conduct drives structure; structure also drives conduct, They both drive outcomes. ! Post-merger integration phase most important phase ! Every deal is unique! No definite set of drivers. Always look to all circumstances What criteria can we measure outcomes against? 1. Creation of market value a. Change in share values net of changes in the market 2. Financial stability a. Changes in debt rating and bankruptcy probability 3. Improved strategic position a. E.g. improved competitive position, acquiring new capabilities, improved agility 4. Improved M&A process a. Experience gained from successfully completing deals What are some emerging/disruptive (i.e. disruptive to existing practice) ideas in M&A)? 1. A deal is a system a. All parts of a deal need to fit together harmoniously b. Looking at the deal as a system allows side effects to be emphasised c. The ‘system’ view admits the possibility that there may be many great deal structures that satisfy objectives – there is no one optimum deal 2. Optionality a. Real options valuation 3. Valuation a. Determining fairness of price b. Better valuation gives deal designers better view of risk/reward c. Good valuation mitigates effect of any market inefficiency 4. Behavioural effects a. Considering BE highlights possible deviation from value-maximising options i. Esp true in hostile transactions 5. Good governance a. Recent corporate collapses and associated volatility a good reminder of this i. Focus on wrong aims by mgmt value destructing What is the current state of the M&A market? GFC produced decline in M&A through market instability, freezing of credit markets Moving forward, recapitalisation of balance sheets through large number of equity raisings could lead to new wave. What has changed since the GFC? Deals need to be far more well-structured and motivated by clear rationale. Significant increase in due diligence conducted by boards What is the winners curse? • Winning bid is highest and therefore erodes the most value from transaction
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Week 2 – M&A activity and outcomes NB: Did not look at the various views on M&A in ch6 In a very general sense, is M&A successful? Studies? Strong opinion among executives, consultants and journalists that most M&A destroys value. But event studies not necessarily supportive of this view. Studies suggest that M&A creates value (IRR > disc rate) for the COMBINED entity in the vast majority of cases. • Mixed authority for buyer success o In many cases (two-thirds), IRR = disc rate (i.e. buyers break even) " But Bruner warns buyer beware! (structure deals carefully, avoid overpaying, in many cases sholders will get the average rate of return but many failures as M&A is littered with pitfalls – wide variation around the excess return of zero) • Targets generally do well. (average abnormal 20-30% return) •
It is possible that we do not have enough information to tell.
What are some popular explanations for buyer share price decline post-merger? Shleifer and Vishny (2001) – buying firms tend to acquire with stock when they believe their shares are overvalued. Post-merger decline is a correction in the market’s valuation of the buyer Mitchell and Mulherin (1996) – decline is signal of economic turbulence in the industry rather than the acquisition itself Asquith, Bruner, and Mullins (1983) – size effect – the smaller the target, the smaller the returns to the buyer. Why? Because gains must be split According to Brealy and Myers (1996) what two issues are among the most major unresolved questions in finance? 1. Timing of merger activity – why are we concerned about merger timing? a. Waves follow random work and show no regularity in terms of period 2. Occurrence in waves - Why are we concerned about waves What are some features of the last few merger waves? Latest wave – consolidation (when businesses in the same market merge together instead of competing for profits) in the mining industry 2003-2007 PE merger wave. Many LBOs due to cheap debt. PE activity mainly financial buyers (i.e. ST profit-making ventures) as opposed to strategic buyers (init for the LT to realise gains from synergies etc 1992-2000 Strategic merger wave – mergers targeted to synergies What is typical of all merger waves 1900-present? " "
All waves (1900-present) end in a recession and with more regulation Waves correlated to periods of high economic growth (Nelson, 1959) where financial conditions and stock prices are favourable (Weston, 1961) o OR where the market has gone into a period of irrationally and where the stock market is mis-valued (Shleifer and Vishny 2003)
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"
" " "
Waves often occur in periods of technological change (e.g. the telephone and the internet 1992-2000 especially!) (or e.g. Nokia trying to keep up with Apple by buying Asian smartphone manufacturer) Periods of financing innovation (e.g. cheap financing) Periods of input price volatility (e.g. the oil industry) Periods of legal and regulatory changes (e.g. deregulation or accounting)
What are four broad theories that attempt to predict M&A activity? How are these related and what are the shortcomings of using these to explain the wave phenomenon 1. Economic a. Response to industry shocks (Nelson, 1959) i. Generally an initially negative thing for a business but carries a need to reform (through mergers) ii. E.g. deregulation, industry growth rate, industry concentration, technological development b. Operational synergies i. Elimination of common costs ii. Economies of scale iii. Economies of scope iv. Improved capacity utilisation v. Transaction cost economies vi. Network externalities vii. Economies of learning c. Financial synergies i. Do shareholders benefit from reduced risk? 2. Strategic a. Acquisition of capabilities i. Corporate functions ii. Management information iii. R&D (e.g. pharmaceuticals buying research firms), product design iv. Manufacturing v. Marketing, sales and distribution b. Monopoly, competitive positioning and “rent seeking” behaviour (having enough market power to influence prices i. Generally not effective in the long-term 3. Finance theory a. Overvaluation of stocks and asymmetric information i. Markets are sometimes irrational ii. What mangers know / what everyone else believes 1. E.g. if managers know their stock is overvalued b. Agency costs and the correction of corporate governance problems i. More takeovers when target managers are making bad decisions 1. Depressed stock price due to bad deals c. Managerial incentives to increase size d. Rationalisation of a business e. Diversification of a business 4. Behavioural a. Hubris or managerial pride i. Managers not acting in the best interest of firms (BUT does not explain M&A waves) b. Winners curse (i.e. bidding to the point where you lose) c. Market manias (e.g. internet stock boom – valuations go out the window) d. Overconfidence All inter-related in each case All explain why we have M&A but doesn’t explain the wave phenomenon of M&A. But still a good lens for predicting future M&A activity
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Mergers and Acquisitions
List of Questions Week 1 – Overview of takeover process ....................... 9 What is a merger and what is an acquisition? Are these definitions important? ................ 9 What is the main purpose of M&A?.................................................................................... 9 What are two economic theories about the efficacy of takeovers for corporate shareholders? .................................................................................................................... 9 What are the key drivers of M&A success ......................................................................... 9 What criteria can we measure outcomes against? .......................................................... 10 What are some emerging/disruptive (i.e. disruptive to existing practice) ideas in M&A)? 10 What is the current state of the M&A market? ................................................................. 10 What is the winners curse? .............................................................................................. 10
Week 2 – M&A activity and outcomes ......................... 11 In a very general sense, is M&A successful? Studies?.................................................... 11 What are some popular explanations for buyer share price decline post-merger? .......... 11 According to Brealy and Myers (1996) what two issues are among the most major unresolved questions in finance? ..................................................................................... 11 What are some features of the last few merger waves? .................................................. 11 What is typical of all merger waves 1900-present?.......................................................... 11 What are four broad theories that attempt to predict M&A activity? How are these related and what are the shortcomings of using these to explain the wave phenomenon ........... 12 Explanations for M&A activity fit into which four categories? ........................................... 13 What are the 3 categories of M&A results (wrt value)? .................................................... 13 What is the right metric for judging M&A outcomes? ....................................................... 13 How do we measure abnormal returns? .......................................................................... 13 What is the predicted return? What are the three methods for estimating predicted returns? ............................................................................................................................ 14 How is the residual calculated?........................................................................................ 14 What measures do we use in the context of M&A analysis? What is the formal test of these? .............................................................................................................................. 14 Why do we measure combined returns and what conclusions can generally be made from studies?.................................................................................................................... 16 What conclusions can be made about LT performance? Why is this hard to quantify? .. 16 What is an accounting study as opposed to an event study? What difficulties to we have with assessing the operating performance of acquirers ................................................... 16 What fundamental problem is there with using event studies to judge M&A outcomes? . 17
Week 3 – Strategy and M&A ......................................... 18 Page 2 of 58
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What is the overall framework for strategy? ..................................................................... 18 Generally speaking, what two dimensions should formulating strategy take? ................. 18 What 4 tools exist for formulating strategy? ..................................................................... 18 What is the experience curve? What strategy does it suggest? ...................................... 18 What is the product life cycle? Relationship to M&A? ...................................................... 19 What is the product portfolio balance? ............................................................................. 19 What is Porters’ Five Forces? .......................................................................................... 20 What is the product-market matrix / strength-market matrix? .......................................... 20 What is the key characteristic of business goals that is necessary to facilitate progress? ......................................................................................................................................... 20 What is the goal of M&A (2 goals) in the context of a firm’s strategy? ............................. 20 Broadly speaking, what two choices does the M&A decision framework set out? ........... 20 What are 5 key types of acquisitions?.............................................................................. 21 When is organic growth a good idea? .............................................................................. 21 When is inorganic growth a good idea? ........................................................................... 21 What are 3 considerations in choosing a decision path for inorganic growth? ................ 21 What are 4 common types of inorganic growth? .............................................................. 21 What are 3 considerations in choosing a decision path for corporate restructuring? ...... 22 What are 4 common types of corporate restructuring? .................................................... 22 What is the research evidence on JVs. alliances and minority interests? ....................... 22 What is the evidence of divestitures/other sellside transactions? Why and when esp? .. 22 What about recapitalisation transactions? Contrary to EMH?.......................................... 22
Week 4 – Valuation ........................................................ 23 Why do we undertake valuation in M&A? What is the relevant decision rule? ................ 23 What is the process of valuation using trading multiples? ............................................... 23 What types of trading multiples exist?.............................................................................. 23 What are the advantages and disadvantages of using trading multiples? ....................... 24 What filters are commonly used in choosing comparable companies? ........................... 24 What is the matching principle wrt mults? ........................................................................ 25 How do we handle one-off activities How do we handle minority interests? .................... 25 What are the advantages and disadvantages of using transaction multiples? ................ 25 What is a definition of DCF? ............................................................................................ 25 When is DCF most suitable?............................................................................................ 25 What is the formula for unlevered free cash flow? ........................................................... 25
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What is a definition of WACC? What is the WACC formula? ........................................... 26 What is the TV formula?................................................................................................... 26 What are some considerations as to why fundamental equity value may be different from market equity value in an IPO scenario? ......................................................................... 26 What are some key sensitivities for DCF valuations? ...................................................... 27 What are the advantages and disadvantages of DCF valuation? .................................... 27 What is an LBO analysis? What are its four steps? ......................................................... 27 What is a leveraged recap? ............................................................................................. 27 How is a final valuation derived using all these methods ................................................. 28 What are factors affecting the takeover premium? .......................................................... 28
Week 5 – Valuing synergies, liquidity and control ..... 29 What are synergies? ........................................................................................................ 29 What is the difference between cash and scrip?.............................................................. 29 What are the two types of synergies? Formula ................................................................ 29 What are the common types of synergies in place? ........................................................ 29 What are the 4 categories of revenue enhancement synergies? Arguments + counterarguments for each .............................................................................................. 29 What are the 4 categories of cost reduction synergies? Arguments + counterarguments for each ............................................................................................................................ 30 What are two categories of financial synergies? .............................................................. 30 What two categories of tax reduction synergies exist? .................................................... 30 What is the appropriate RADR for each level of riskiness of synergy? ............................ 30 What is the formula for synergy value based on a multiple? ........................................... 31 How do you work out EPS accretion/dilution in a scrip deal? .......................................... 31 What are some types of real options synergies ............................................................... 31 Why use real option analysis? ......................................................................................... 31 What is the Black-Scholes formula? ................................................................................ 31 Wrt illiquidity and control, what is the formular for max payment for a target? ................ 31 What is the formula for net price? .................................................................................... 31 What must discounts and premiums always be compared wrt? ...................................... 32 What is a minority discount? ............................................................................................ 32 What kind of an option is liquidity? What are its two value drivers? ................................ 32 What is control? ............................................................................................................... 32 What kind of option is control? When is it in/out of the money? Where does it derive value?............................................................................................................................... 32
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What are three reasons why liquidity and control may interact? ...................................... 32
Week 8 – Deal types, the form of payment and financing ........................................................................ 34 General framework of deal design – 3 aspects ................................................................ 34 Implications of the general framework ............................................................................. 34 Factors influencing financing methods ............................................................................. 34 Research insights – (1) most deals use (2) smaller deals generally use (3) stock is generally used when the market is................................................................................... 35 Accepted wisdom – What does the choice between cash/scrip mean for targets/bidders ......................................................................................................................................... 35 (Zhang, 2001) – cash generally used more in what type of deals ................................... 35 (Martin, 1996) – relationship between Q ratio and scrip/cash choice .............................. 35 Graph of CAR by payment method .................................................................................. 35 Reasons for cash offers realising greater returns – (1) tax (2) agency (3) asymmetry .... 35
Week 9 – Exchange ratios and contingent payments 36 What is an exchange ratio?.............................................................................................. 36 Buyer’s maximum exchange rato ..................................................................................... 36 Target’s minimum exchange ratio .................................................................................... 36 Win-loss boundaries......................................................................................................... 37 3 factors that determine setting the ER (within the WW zone)......................................... 37 What is a contingent payment? ........................................................................................ 37 What is an earnout? ......................................................................................................... 37 Advantages and disadvantages of using earnouts .......................................................... 37 How are earnouts valued? ............................................................................................... 38 Decision rules for buyer and target wrt earnouts ............................................................. 38
Week 10 – Risk management in M&A transactions ... 39 Value at Risk (VaR) – how does it move over the deal’s life............................................ 39 What is risk management – 3 aspects, basically, what is it ............................................. 39 RM before announcement................................................................................................ 39 DM between announcement and deal close .................................................................... 39 DM after the deal closes .................................................................................................. 39 How to decide between fixed-shares and fixed-value? Wrt your share price dropping? . 39 What is a collar? Benefits of using a collar ...................................................................... 39 Fixed exchange ratio without collar .................................................................................. 39
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Fixed value deal ............................................................................................................... 40 How do collars add value? ............................................................................................... 40 When does the target/bidder benefit? .............................................................................. 40 Floating collars ................................................................................................................. 40 Fixed collars ..................................................................................................................... 41 Analysis of collars – width is based on, empirical analysis and pros and cons table ....... 41 Are collars needed? ......................................................................................................... 42 [Contingent value rights NOT ASSESSABLE] ................................................................. 42 Why use CVRs ................................................................................................................. 42
Week 11 – The Australian Merger Process ................. 43 What are the ways control may be achieved (in order of most common)? ...................... 43 What is the main source of regulation of takeovers in Australia, what is its objective and what does it contain? ....................................................................................................... 43 What are the acceptable methods of acquiring >20% according to ch6? ........................ 43 What conditions exist for the bidder to compulsorily acquire the minority stake (squeeze out minorities)?................................................................................................................. 43 What exceptions exist to the 20% rule? ........................................................................... 43 Without announcing a formal takeover bid: ...................................................................... 44 Table of key shareholding thresholds .............................................................................. 44 What regulation exists wrt foreign takeover? ................................................................... 44 What regulation exists wrt competition?........................................................................... 44 What are the main differences between on-market vs off-market vs scheme of arrangement ..................................................................................................................... 44 What is an off-market bid ................................................................................................. 45 Can OMB include conditions? What conds are most common? ...................................... 45 Consideration – what can be offered? What minimum price provision exists? Is the bidder constrained in which groups of shareholders it offers benefits to? .................................. 45 What must be included in the Bidders Statement? .......................................................... 45 What must be included in the Target Statement? ............................................................ 46 Outline of steps in an off-market bid ................................................................................ 46 When can the name of shareholders be requested? ....................................................... 47 What regulations exist wrt offers/ ..................................................................................... 47 What regulations exist wrt offer period ............................................................................. 47 What regulations exist wrt buying shares outside the bid? .............................................. 47 What regulations exist wrt increasing consideration of the offer? .................................... 47
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What regulations exist wrt extending the offer period? .................................................... 48 What regulations exist wrt declaring an offer unconditional? ........................................... 48 Can the bidder sell shares in the target during the offer? ................................................ 48 What must happen when a bid is received? .................................................................... 48 What are directors’ duties once deal is announced? ....................................................... 48 What must directors consider in assessing the offer?...................................................... 48 What are four defensive responses (aka frustrating actions) ........................................... 49 What is a scheme of arrangement ................................................................................... 49 Scheme - key steps.......................................................................................................... 49 Scheme timeline............................................................................................................... 50 What must an explanatory statement include? ................................................................ 50 What are the key considerations in deciding between a scheme and a takeover? ......... 50 Comparison of schemes and takeovers ........................................................................... 51
Week 12 – Merger arbitrage ......................................... 52 What is arbitrage? ............................................................................................................ 52 How much risk is there in arbitrage according to classic finance theory? ........................ 52 In what way do merger arbitrageurs sell insurance?........................................................ 52 Under what circumstances will the error term and the market term (in CAPM) become correlated? ....................................................................................................................... 52 Are MAeurs generally profitable? What 2 reasons exist or this ....................................... 52 What arb characteristics are there? ................................................................................. 53 What do arbs do after the announcement? ...................................................................... 53 What do target shareholders do after announcement? .................................................... 53 What is one way to characterise the dilemma faced by target shareholders? ................. 53 Cash deal arb ................................................................................................................... 53 What impact does a floating exchange ratio have on merger arbs .................................. 53 What is the main driver of arbitrage profits? .................................................................... 53 What constraints exist on arbitrage? ................................................................................ 53 Merger arb in action ......................................................................................................... 54
Week 13 – Takeover defences ..................................... 55 Buyer’s decision rule – when will a buyer ‘attack’ ............................................................ 55 How do investors react to takeover defences .................................................................. 55 Manager’s motives for bid resistance............................................................................... 55 From target’s perspective – bid resistance a good or bad thing? .................................... 55
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3 types of defence tactics and aims of each .................................................................... 55 List of all defence tactics discussed ................................................................................. 55 Financial defensive measures – main + alternative view ................................................. 56 Possible financial defensive measures ............................................................................ 56 Greenmail – what, two different views of greenmails, wealth effects of greenmail .......... 56 Pac man defence ............................................................................................................. 56 White knight and white squire .......................................................................................... 56 Anti-takeover amendments .............................................................................................. 56 Poison pills ....................................................................................................................... 57 When would shareholders want to rescind anti-takeover devices ................................... 57 Poison puts ...................................................................................................................... 57 Golden parachutes ........................................................................................................... 57 Rationale for golden parachutes? Optimal structure ........................................................ 57
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Week 1 – Overview of takeover process Relevant readings Bruner Ch1 – Done? No What is a merger and what is an acquisition? Are these definitions important? A business transaction where there is a combination of two or more companies, causing one or more companies to lose their corporate existence in the process A business transaction where the shares and or control in a company is taken over by a person who previously did not possess such shareholding or control Definition is not important as the terms can be used interchangeably and they both usually have the same legal effect What is the main purpose of M&A? M&A is an instrument of corporate renewal utilised to increase return on capital. Often occurs in the context of renewing growth when a business has reached a maturity or decline phase of its life cycle. Important to ensuring the return on capital exceeds the cost of capital. What are two economic theories about the efficacy of takeovers for corporate shareholders? 1. Neoclassical theory – acquisitions are value enhancing activities in which rational managers work to maximise shareholder wealth by e.g. cost savings, increased monopoly power 2. Managerial theory – Basically, managers act out of their own interest. Views takeovers as extensions of managers’ own personal interests for the purpose of increasing managers wealth or prestige (ie from managing a larger company a. “hubris-type argument (hubris = excessive pride or self confidence) - don’t care if the deal is creating value for shareholders Neither theory completely explains why we have successful and unsuccessful outcomes. Best to take one and two together to explain efficacy of takeovers What are the key drivers of M&A success Success in M&A I driven by both the structure of the M&A opportunity once faces, as well as the conduct by which one pursues it. Structure of the opportunity 1. Economics – eg risk vs return, CFs, NPV, accretive effects, financing effects 2. Strategy – threat/opportunity, industry position of parties, acquire capabilities/capacities and improve strategic position 3. Organisation – ability to integrate company structure/culture fit (e.g. US/JP clt clash) 4. Brand – creating and preserving brand value throughout M&A, M&A personal brand (e.g. CEO), compatibility of reputations 5. Laws define opportunities (eg big 4 banks) Conduct (ie strategy, tactics behaviour) 1. Quality of target search which relies on quality of advice from IB which relies on contracts and good info 2. Due diligence a. The search for risk b. Should seek to reveal info, not just fact checking 3. Negotiation and bidding a. Negotiation tactics will have an impact on price and terms
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b. Eg chairman of the board who is expected to have strong business connections and is expected to use these to maximise the likelihood of a friendly takeover c. Good IBs with good tactics d. Winner’s curse (auctions and deal frenzy) 4. Laws( eg ACCC, FIRB) – degree of regulatory certainty is very important; lobbying ! Conduct drives structure; structure also drives conduct, They both drive outcomes. ! Post-merger integration phase most important phase ! Every deal is unique! No definite set of drivers. Always look to all circumstances What criteria can we measure outcomes against? 1. Creation of market value a. Change in share values net of changes in the market 2. Financial stability a. Changes in debt rating and bankruptcy probability 3. Improved strategic position a. E.g. improved competitive position, acquiring new capabilities, improved agility 4. Improved M&A process a. Experience gained from successfully completing deals What are some emerging/disruptive (i.e. disruptive to existing practice) ideas in M&A)? 1. A deal is a system a. All parts of a deal need to fit together harmoniously b. Looking at the deal as a system allows side effects to be emphasised c. The ‘system’ view admits the possibility that there may be many great deal structures that satisfy objectives – there is no one optimum deal 2. Optionality a. Real options valuation 3. Valuation a. Determining fairness of price b. Better valuation gives deal designers better view of risk/reward c. Good valuation mitigates effect of any market inefficiency 4. Behavioural effects a. Considering BE highlights possible deviation from value-maximising options i. Esp true in hostile transactions 5. Good governance a. Recent corporate collapses and associated volatility a good reminder of this i. Focus on wrong aims by mgmt value destructing What is the current state of the M&A market? GFC produced decline in M&A through market instability, freezing of credit markets Moving forward, recapitalisation of balance sheets through large number of equity raisings could lead to new wave. What has changed since the GFC? Deals need to be far more well-structured and motivated by clear rationale. Significant increase in due diligence conducted by boards What is the winners curse? • Winning bid is highest and therefore erodes the most value from transaction
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Week 2 – M&A activity and outcomes NB: Did not look at the various views on M&A in ch6 In a very general sense, is M&A successful? Studies? Strong opinion among executives, consultants and journalists that most M&A destroys value. But event studies not necessarily supportive of this view. Studies suggest that M&A creates value (IRR > disc rate) for the COMBINED entity in the vast majority of cases. • Mixed authority for buyer success o In many cases (two-thirds), IRR = disc rate (i.e. buyers break even) " But Bruner warns buyer beware! (structure deals carefully, avoid overpaying, in many cases sholders will get the average rate of return but many failures as M&A is littered with pitfalls – wide variation around the excess return of zero) • Targets generally do well. (average abnormal 20-30% return) •
It is possible that we do not have enough information to tell.
What are some popular explanations for buyer share price decline post-merger? Shleifer and Vishny (2001) – buying firms tend to acquire with stock when they believe their shares are overvalued. Post-merger decline is a correction in the market’s valuation of the buyer Mitchell and Mulherin (1996) – decline is signal of economic turbulence in the industry rather than the acquisition itself Asquith, Bruner, and Mullins (1983) – size effect – the smaller the target, the smaller the returns to the buyer. Why? Because gains must be split According to Brealy and Myers (1996) what two issues are among the most major unresolved questions in finance? 1. Timing of merger activity – why are we concerned about merger timing? a. Waves follow random work and show no regularity in terms of period 2. Occurrence in waves - Why are we concerned about waves What are some features of the last few merger waves? Latest wave – consolidation (when businesses in the same market merge together instead of competing for profits) in the mining industry 2003-2007 PE merger wave. Many LBOs due to cheap debt. PE activity mainly financial buyers (i.e. ST profit-making ventures) as opposed to strategic buyers (init for the LT to realise gains from synergies etc 1992-2000 Strategic merger wave – mergers targeted to synergies What is typical of all merger waves 1900-present? " "
All waves (1900-present) end in a recession and with more regulation Waves correlated to periods of high economic growth (Nelson, 1959) where financial conditions and stock prices are favourable (Weston, 1961) o OR where the market has gone into a period of irrationally and where the stock market is mis-valued (Shleifer and Vishny 2003)
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Waves often occur in periods of technological change (e.g. the telephone and the internet 1992-2000 especially!) (or e.g. Nokia trying to keep up with Apple by buying Asian smartphone manufacturer) Periods of financing innovation (e.g. cheap financing) Periods of input price volatility (e.g. the oil industry) Periods of legal and regulatory changes (e.g. deregulation or accounting)
What are four broad theories that attempt to predict M&A activity? How are these related and what are the shortcomings of using these to explain the wave phenomenon 1. Economic a. Response to industry shocks (Nelson, 1959) i. Generally an initially negative thing for a business but carries a need to reform (through mergers) ii. E.g. deregulation, industry growth rate, industry concentration, technological development b. Operational synergies i. Elimination of common costs ii. Economies of scale iii. Economies of scope iv. Improved capacity utilisation v. Transaction cost economies vi. Network externalities vii. Economies of learning c. Financial synergies i. Do shareholders benefit from reduced risk? 2. Strategic a. Acquisition of capabilities i. Corporate functions ii. Management information iii. R&D (e.g. pharmaceuticals buying research firms), product design iv. Manufacturing v. Marketing, sales and distribution b. Monopoly, competitive positioning and “rent seeking” behaviour (having enough market power to influence prices i. Generally not effective in the long-term 3. Finance theory a. Overvaluation of stocks and asymmetric information i. Markets are sometimes irrational ii. What mangers know / what everyone else believes 1. E.g. if managers know their stock is overvalued b. Agency costs and the correction of corporate governance problems i. More takeovers when target managers are making bad decisions 1. Depressed stock price due to bad deals c. Managerial incentives to increase size d. Rationalisation of a business e. Diversification of a business 4. Behavioural a. Hubris or managerial pride i. Managers not acting in the best interest of firms (BUT does not explain M&A waves) b. Winners curse (i.e. bidding to the point where you lose) c. Market manias (e.g. internet stock boom – valuations go out the window) d. Overconfidence All inter-related in each case All explain why we have M&A but doesn’t explain the wave phenomenon of M&A. But still a good lens for predicting future M&A activity
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