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    6772 - Lecture 5 IIMC M & A

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    The document discusses mergers and acquisitions (M&As) and provides an overview of several key theories and empirical studies related to M&A performance and shareholder returns. It finds that on average, M&As result in small positive combined returns for target and acquiring firms. However, target firms typically experience large gains while acquiring firms may see small losses, depending on the deal structure and payment method. The document also examines factors that influence the magnitude and direction of shareholder returns in M&As.

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    6772 - Lecture 5 IIMC M & A

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    The document discusses mergers and acquisitions (M&As) and provides an overview of several key theories and empirical studies related to M&A performance and shareholder returns. It finds that on average, M&As result in small positive combined returns for target and acquiring firms. However, target firms typically experience large gains while acquiring firms may see small losses, depending on the deal structure and payment method. The document also examines factors that influence the magnitude and direction of shareholder returns in M&As.

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    The document discusses mergers and acquisitions (M&As) and provides an overview of several key theories and empirical studies related to M&A performance and shareholder returns. It finds that on average, M&As result in small positive combined returns for target and acquiring firms. However, target firms typically experience large gains while acquiring firms may see small losses, depending on the deal structure and payment method. The document also examines factors that influence the magnitude and direction of shareholder returns in M&As.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    63 views23 pages

    6772 - Lecture 5 IIMC M & A

    Uploaded by

    api-3699305
    The document discusses mergers and acquisitions (M&As) and provides an overview of several key theories and empirical studies related to M&A performance and shareholder returns. It finds that on average, M&As result in small positive combined returns for target and acquiring firms. However, target firms typically experience large gains while acquiring firms may see small losses, depending on the deal structure and payment method. The document also examines factors that influence the magnitude and direction of shareholder returns in M&As.

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    of 23

    Measuring Returns and

    Choice of Payments
    Lecture 2
    Sanjay Banerji
    Principle Theory
    Value •Transaction cost efficiency – mergers
    Increasing optimize transaction costs
    •Synergy – scale, best practices, etc.
    •Disciplinary – takeovers can be used to
    replace poor management
    •Incentive effects

    Value •Management entrenchment – firm invests


    Reducing to increase managers’ value to
    shareholders
    •Agency costs of free cash flow – managers
    reinvest FCF inefficiently back into firm

    Value •Hubris – winner of takeover contest is firm


    that most overvalues target
    Neutral
    Gains and Losses in M&As
    Combined Gains to Gains to
    Theory Gains Target Bidder
    Efficiency/ Non-
    Positive Positive
    Synergy Negative
    Agency
    More
    Costs/ Negative Positive
    Negative
    Entrenchment

    Hubris Zero Positive Negative


    Issues in Empirical Studies
    • Attempt to determine effects of M&As
    – Measurement of combined returns to target and
    bidder shareholders
    – Factors affecting magnitude of returns
    – Measurement of post-merger performance
    • Tests of alternative theories
    • Determine whether or not total value is
    enhanced by mergers
    • Guides to management for merger planning
    Combined Returns in M&As
    • Measure combined returns to explain
    cause of mergers
    – Positive: synergy and efficiency
    – Negative: agency costs, managerial
    entrenchment
    – Zero: redistribution of wealth from bidder
    (hubris)
    • Bulk of event study evidence suggests
    mergers have positive returns on average
    Combined Returns in M&As

    Research Target Bidder Comb.


    Paper Year Window Return Return Return
    Bradley et al 1988 -5,+5 31.8% 1.0% 7.4%
    Kaplan, 1992 -5,+5 26.9% -1.5% 3.7%
    Weisbach
    Servaes 1991 -1, 23.6% -1.1% 3.7%
    resolv
    e
    Andrade et 2001 -1,+1 16.0% -0.7% 1.8%
    al
    Target Returns in M&A
    • Targets almost always experience large gain in
    shareholder wealth – effects usually stem from
    merger effects and not revaluation of target firms
    • Cash deals usually create more target wealth –
    possibly due to taxes
    • Multiple bidders result in higher returns for target
    • Target share prices have a positive run-up in
    period prior to takeover announcement
    • Takeover premiums reflect bidder’s strategy of
    making large preemptive bid
    Target Returns in M&As
    (Method of Payment)

    Research
    Paper Year Window Cash Mixed Stock
    Huang, 1987 -1,0 29.3 23.3% 14.4%
    Walkling %
    Asquith et 1990 -1,027.5 32.2% 13.9%
    al %
    Servaes 1991 -1, 26.7 21.1% 20.5%
    resolve %
    Andrade et 2001 -1,+1 20.1 NA 13.0%
    al %
    Target Returns in M&As
    (Single vs. Multiple Bidders)

    Research
    Paper Year Window Single Multiple
    Bradley et al 1988 -20,+1 24.0% 26.0%

    Servaes 1991 -1, 20.8% 30.5%


    resolve

    Schwert 1996 -42,-1 13.4% 12.7%


    Target Returns in M&As
    (Target Premiums Received)
    Research
    Paper Year Base Price Date Premium
    Bradley 1980 41 before offer 49%
    Jarrell et al 1988 30 before offer 53%
    Jennings, 1993 10 before offer 23%
    Mazzeo
    Cotter, 1994 30 before rumor 47%
    Zenner
    Betton, 2000 60 before offer 51%
    Eckbo
    Bidder Returns in M&As
    • Bidder returns are more negative in stock deals
    than cash deals
    • Returns to bidder are lower in deals with multiple
    bidders
    • Do bad bidders become good targets? (Mitchell
    and Lehn, 1990)
    – More negative market reaction to a deal, the more
    likely firm is future takeover target
    – “Takeovers can be both a problem and a solution”
    Bidder Returns in M&As
    (Method of Payment)

    Research
    Paper Year Window Cash Mixed Stock
    Travlos 1987 -10,+10 -0.1% NA -1.6%
    Asquith et 1990 -1,0 0.2% -1.5% -2.4%
    al
    Servaes 1991 -1, 3.4% -3.5% -5.9%
    resolve
    Andrade et 2001 -1,+1 0.4% NA -1.5%
    al
    Bidder Returns in M&As
    (Single vs. Multiple Bidders)

    Research
    Paper Year Window Single Multiple
    Bradley et al 1988 -20,+1 2.8% -0.4%

    Servaes 1991 -1, -0.4% -2.97%


    resolve

    Schwert 1996 -42,-1 1.9% 0.2%


    Summing UP of Gains and Losses

    What is the stock price reaction when takeovers are


    announced?

    • Target shareholders gains are substantial (from 10%


    to 53%)

    • Bidder shareholders
    • Gains have decreased over time
    • Non-significant returns on average

    Hence: Combined market values of target and


    bidder go up
    Summing Up Contd.
    Method of Payment affects announcement results
    • Stock payments reduce the stock returns of bidders and target:
    – If stock is used to acquire bidders stock falls in 1.47%
    – If cash is used to acquire bidders stock increases slightly (around 0.24%)
    • Consistent with the idea that use of stock by bidder firm signals overvaluation

    Evidence consistent with managerial “empire-building”


    • Announcement returns lowest for acquiring firms
    • … in which management has smaller stakes
    • … that have under-performed their industries
    • … buying outside (vs. inside) their main business (-3.9% vs. +2.9%)
    • … that “buy growth” (returns 7% lower)
    A problem
    • In the fall of 1997 the Bank of New York (BNY) offered to exchange 1.575
    shares of BNY common stock, plus $15 in cash per common share of Irving
    Bank Corporation. 1987 data for each company are as follows:
    »
    » Irving BNY
    » Net Income $118 $153.5

    • Common shares (fully diluted) 18.391 m 33.092 m


    • Pre-announcement stock price $ 39.337 $31.526
    •
    • Questions:
    • 1. What are the gains and (losses) to each group of shareholder under the
    assumption that the combined entity is worth $300 million more than its
    original parts. That is, how do you expect the stock price of BNY and Irving to
    react upon announcement of the deal?

    • 2. What should be the increase in the value of the combined entity that has to
    take place in order to justify the acquisition from the point of view of BNY
    shareholders.
    Solution
    – (a)
    – Irving BNY_____
    – Pre-announcement price 39.337 31.526
    – Shares 18.391 33.092
    – -----------------------------------------
    – Market value 723.45 1,043.26

    – Synergy = $300m, Cash payment = 18.391 x 15 = $275.87m

    – Value of the combined firm:, VC = 723.45 + 1,043.26 + 300 – 275.87 = 1,790.84

    – The share of the combined firm that goes to the Irving =

    – [ 28.966 /(28.966 + 33.092)]X 1,790.84= $835.30


    – The total sum (in the form of stock + cash) that goes to Irving’s shareholders =
    835.30 + 275.87 = 1,111.20
    – Irving shareholders gain = 1,111.20 - 723.45 = 387.80
    – or 387.80/18.39 = 21.09 per share
    – BNY shareholders gain = Synergy – gains of the IBC shareholders, = -87.80
    – Synergy = -87.80 + 387.80 = 300.00
    Solution
    • For break-even synergy, (VI  VBNY  S  P)  VBNY  0
    • where, = share that goes to the shareholders of
    BNY.= 33.092
     .53
    62.052
    • From the equation, we get ,the break-even value of
    synergy:
    (1   )
    S  VBNY  VI  P  .88(1043.26)  275.87  723.45  $470.48

    • Main point: Unless synergy is sufficient, and gains


    and losses from M and A are unevenly distributed,
    One party gains at the expense of the other party.
    – Example of a Merger process
    – Reasons given for the merger
    • Economies of scale in PC industry
    • Projected synergies of $2.5 billion
    • Strategic response to conditions in computer and
    information technology sectors
    – Market reaction to 9/3/01 announcement
    • Hewlett-Packard declined 19%
    • Compaq fell by 10%
    – Major events in the merger process
    • CEOs initiated discussion in June 2001 – firms
    then undertook extensive due diligence
    • Consulting firms McKinsey and Accenture were
    involved in the analysis of the merger
    • Goldman Sachs (HP) and Salomon Smith Barney
    (Compaq) were engaged in July 2001, to provide
    financial advice
    • Members of Hewlett and Packard families
    threatened to vote against the merger
    • Shareholders approve in May 2002
    Example I contd.
    – Major events in the merger process
    • 2/22/02 – Northrop releases letter sent to TRW
    proposing a merger
    • 3/3/02 – TRW rejected $47 stock offer
    • TRW sought other bidders and considered
    implementing a split-up
    • Northrop increased offer
    • 7/2/02 – announced merger agreement for $60
    stock
    • Example II
    – Deal began as a hostile bid by Northrop and evolved
    into merger
    – Reasons given for the merger
    • Economies of scale in defense industry
    • Complementary product mix
    – Market reaction to initial announcement (2/22/02)
    • TRW increased 26.4% (speculation that there may be more
    potential bidders, or that TRW would get a higher price from
    NG )
    • NG dropped by 6.7%
    Example II Continued.
    – Major events in the merger process
    • 2/22/02 – Northrop releases letter sent to TRW
    proposing a merger
    • 3/3/02 – TRW rejected $47 stock offer
    • TRW sought other bidders and considered
    implementing a split-up
    • Northrop increased offer
    • 7/2/02 – announced merger agreement for $60
    stock

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