Fundamentals of
Corporate
Finance
Chapter 21
Mergers, Acquisitions,
and Corporate Control
Fifth Edition
Slides by
Matthew Will
McGraw-Hill/Irwin
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved
21- 2
Topics Covered
The Market for Corporate Control
Sensible Motives for Mergers
Dubious Reasons for Mergers
Evaluating Mergers
Merger Tactics
Leveraged Buy-Outs
The Benefits and Costs of Mergers
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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved
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The Merger Market
Methods to Change Management
Proxy
battle for control of the board of directors
Firm purchased by another firm
Leveraged buyout by a group of investors
Divestiture of all or part of the firm’s business
units
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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved
21- 4
Recent Mergers
Acquiring Company
JP Morgan Chase
Proctor & Gamble
Bank of America Corp.
Cingular Wireless
Sprint Corp.
Johnson & Johnson
ChevronTexaco
Anthem Inc.
SBC Corp.
Verizon
McGraw-Hill/Irwin
Payment
($ billions)
Selling Company
Bank One Corp
Gillette Co.
FleetBoston Financial Grp
AT&T Wireless
Nextel Communications
Guidant Corp.
Unocal Corp.
WellPoint Health Networks
AT&T Corp.
MCI
58.8
57.0
49.3
41.0
35.2
25.4
16.4
16.4
16.0
8.5
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved
21- 5
The Merger Market
Tools Used To Acquire Companies
Proxy Contest
Tender Offer
Acquisition
Merger
Leveraged
Buy-Out
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Management
Buy-Out
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Sensible Reasons for Mergers
Economies of Scale
A larger firm may be able to reduce its per unit cost by
using excess capacity or spreading fixed costs across more
units.
Reduces costs
$
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$
$
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Sensible Reasons for Mergers
Economies of Vertical Integration
Control over suppliers “may” reduce costs.
Over integration can cause the opposite effect.
Pre-integration
(less efficient)
Post-integration
(more efficient)
Company
S
S
S
S
S
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Company
S
S
S
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Sensible Reasons for Mergers
Combining Complementary Resources
Merging may results in each firm filling in the
“missing pieces” of their firm with pieces from the
other firm.
Firm A
Firm B
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Sensible Reasons for Mergers
Mergers as a Use for Surplus Funds
If your firm is in a mature industry with few, if
any, positive NPV projects available, acquisition
may be the best use of your funds.
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Dubious Reasons for Mergers
Diversification
Investors
should not pay a premium for
diversification since they can do it themselves.
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Dubious Reasons for Mergers
The Bootstrap Game
Acquiring Firm has high P/E ratio
Selling firm has low P/E ratio (due to low
number of shares)
After merger, acquiring firm has short term
EPS rise
Long term, acquirer will have slower than
normal EPS growth due to share dilution.
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Dubious Reasons for Mergers
The Bootstrap Game
World Enterprises
(before merger)
EPS
Price per share
P/E Ratio
Number of shares
Total earnings
Total market value
20
100,000
$200,000
$4,000,000
Current earnings
per dollar invested
in stock
$0.05
McGraw-Hill/Irwin
$2.00
$40.00
World Enterprises
(after buying Muck
and Slurry)
Muck and Slurry
$2.00
$2.67
$20.00
$40.00
10
15
100,000
150,000
$200,000
$400,000
$2,000,000
$6,000,000
$0.10
$0.067
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Evaluating Mergers
Questions
Is
there an overall economic gain to the
merger?
Do the terms of the merger make the company
and its shareholders better off?
????
PV(AB) > PV(A) + PV(B)
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Evaluating Mergers
Economic Gain
Economic Gain = PV(increased earnings)
=
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New cash flows from synergies
discount rate
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Evaluating Mergers
Example - Given a 20% cost of funds, what is the
economic gain, if any, of the merger listed below?
Cislunar Foods Targetco Combined Company
Revenues
150
20
172
(+2)
Operating Costs
118
16
132
(-2)
Earnings
32
4
40
(+4)
4
Economic Gain =
= $20
.20
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Evaluating Mergers
Estimated net gain
Estimated net gain = DCF valuation of target including synergies
- cash required for acquisition
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Merger Tactics
White Knight - Friendly potential acquirer sought
by a target company threatened by an unwelcome
suitor.
Shark Repellent - Amendments to a company
charter made to forestall takeover attempts.
Poison Pill - Measure taken by a target firm to avoid
acquisition; for example, the right for existing
shareholders to buy additional shares at an
attractive price if a bidder acquires a large holding.
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Leveraged Buy-Outs
Unique Features of LBOs
Large portion of buy-out
financed by debt
Shares of the LBO no longer
trade on the open market
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Leveraged Buy-Outs
Potential Sources of Value in LBOs
Junk
bond market
Leverage and taxes
Other stakeholders
Leverage and incentives
Free cash flow
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