24 Chapter Mergers, Corporate Control, and Corporate Governance
2007 Thomson South-Western
Corporate Control Defined
What is Corporate Control? Monitoring, supervision and direction of a corporation or other business organization Changes in corporate control occur through: Acquisitions (purchase of additional resources by a business enterprise):
1. Purchase of new assets 2. Purchase of assets from another company 3. Purchase of another business entity (merger)
Consolidation of voting power Divestiture Spinoff
Corporate Control Transactions
Statutory: Acquired firm is consolidated into acquiring firm with no further separate identity. Subsidiary: Acquired firm maintains its own former identity. Consolidation: Two or more firms combine into a new corporate identity.
LBOs, MBOs, and DualClass Recapitalization
Going Private Transactions
LBOs (public shares of a firm are bought and taken private through the use of debt) MBOs (an LBO initiated by the firm's management)
Dual-Class Recapitalization
Methods of Acquisition
Negotiated Mergers
Contact is initiated by the potential acquirer or by target firm. Buy enough shares on the open market to obtain controlling interest without engaging in a tender offer Proxy for directors: attempt to change management through the votes of other shareholders Proxy for proposal: attempt to gain voting control over corporate control, antitakeover amendments (shark repellents, golden parachutes, white knights, poison pills
Open Market Purchases Proxy Fights
Methods of Acquisition (Continued)
Tender Offers: an open and public solicitation for shares Open Market Purchases, Tender Offers and Proxy Fights could be combined to launch a "surprise attack"
Acquirer accumulates a number of shares (`foothold") without having to file 13-d form with SEC
Divestitures and SpinOffs
Divestiture - occurs when the assets and/or resources of a subsidiary or division are sold to another organization. Spin-off - a parent company creates a new company with its own shares by spinning off a division or subsidiary. Existing shareholders receive a pro rata distribution of shares in the new company. Split-off similar to a spin-off, in that a parent company creates a newly independent company from a subsidiary, but ownership of company transferred to only certain existing shareholders in exchange for their shares in the parent
Mergers by Business Concentration
Horizontal: between former intra-industry competitors
Attempt to gain efficiencies of scale/scope and benefit from increased market power Susceptible to antitrust scrutiny Market extension merger
Vertical: between former buyer and seller
Forward or backward integration Creates an integrated product chain
Conglomerate: between unrelated firms
Product extension mergers vs. pure conglomerate mergers Popular in the 60's as the idea of portfolio diversification was applied to corporations
Other Concentration Classifications
Degree of overlapping business Change in corporate focus Herfindahl Index
demonstrates the relationship between corporate focus and shareholder wealth. HI is computed as the sum of the squared percentages - the proportion of revenues derived from each line of business
Merger and Acquisition Transaction Characteristics
Method of payment used to finance a transaction Pure stock exchange merger: issuance of new shares of common stock in exchange for the target's common stock Mixed offerings: a combination of cash and securities Attitude of target management to a takeover attempt Friendly Deals vs. Hostile Transactions Accounting treatment used for recording a merger With the implementation of FASB Statements 141 and 142, one standard method of accounting for mergers
Target liabilities remain unchanged, but target assets are "written up" to reflect current market values, and the equity of the target is revised upward to incorporate the purchase price paid. The revised values are then carried over to the surviving firm's financial statements. Goodwill is created if the restated values of the target lead to a situation in which its assets are less than its liabilities and equity
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Merger and Intangible Assets Accounting
Target firm has 3.2 million shares at $25 per share. Acquirer pays a 20% premium ($30 per share) to expand in the geographic area where target firm operates. Transaction value 3.2 million shares x $30/share = $96,000,000. Net asset value of target company is $72,000,000. Current Assets $22,000,000 Restated fixed assets $120,000,000 less liabilities $70,000,000 Net Asset Value $72,000,000 Acquirer pays $24,000,000 for intangible assets. Purchase price paid $96,000,000 less Net asset value $72,000,000 Goodwill $24,000,000 Goodwill will remain on the balance sheet as long as the firm can
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Shareholder Wealth Effects and Transaction Characteristics
Target returns stockholders almost always experience substantial wealth gains Acquirer returns less conclusive than those for target shareholders Combined returns Mode of payment Cash transactions Stock transactions Tax hypothesis: target shareholders must be awarded a
capital gains tax premium in cash offers, which is not required in a stock offer. ward off other potential bidders for a target offer a substantial initial takeover premium in the form of cash.
Preemptive bidding hypothesis: acquirers wishing to
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Returns to Other Security Holders
Bonds Convertible Nonconvertible Preferred stock Convertible Nonconvertible
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International Mergers and Acquisitions
One company's acquisition of the assets of another is observed worldwide. Countries differ not only with respect to how frequently takeover attempts are launched, but also
how often these are friendly versus hostile bids how often these are cross-border deals (involving a bidder and a target firm in different countries) the average control premium offered the likelihood that payment will be made strictly in cash.
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Geographic Distribution of Worldwide Announced Mergers and Acquisitions, 2004 v. 2003
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Industrial Distribution of Worldwide Announced Mergers and Acquisitions, Value in $ Millions, 2004 v. 2003
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Value Maximizing Strategies
Geographic (internal and international) expansion in markets with little competition may increase shareholders' wealth.
External expansion provides an easier approach to international expansion. Joint ventures and strategic alliances give alternative access to foreign markets. Profits are shared.
Synergy, market power, and strategic mergers
Operational, managerial and financial mergerrelated synergies
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Operational Synergies
Economies of scale: Merger may reduce or eliminate overlapping resources
1995 merger between Chemical Bank and Chase Manhattan Bank resulted in elimination of 12,000 positions.
Economies of scope: involve some activities that are possible only for a certain company size.
The launch of a national advertising campaign Economies of scale/scope most likely to be realized in horizontal mergers.
Resource complementarities: Merging firms have operational expertise in different areas.
One company has expertise in R&D, the other in marketing. Successful in both horizontal and vertical mergers
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Managerial Synergies and Financial Synergies
Managerial synergies are effective when management teams different with strengths are combined.
For example, expertise in revenue growth and identifying customer trends paired with expertise in cost control and logistics
Financial synergies occur when a merger results in less volatile cash flows, lower default risk, and a lower cost of capital.
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Managerial Synergies and Financial Synergies
Market power is a benefit often pursued in horizontal mergers.
Number of competitors in industry declines If the merger creates a dominant firm, as in the Office Depot-Staples merger's attempt to create market power and set prices
Other strategic reasons for mergers:
Product quality in vertical mergers Defensive consolidation in a mature or declining industry: consolidation in the defense industry
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Cash Flow Generation and Financial Mergers
Acquirer sees target undervalued.
Many junk bond-financed deals of the 1980s had one of the following two outcomes:
"Busting up" the target for greater value than acquisition price Restructuring the target to increase corporate focus. Sell non-core businesses to pay acquisition cost
Tax-considerations for the merger:
Tax loss carry-forward of the target company used to offset future taxes; resulting in increased cash flow. 1986 change in tax code limits the use of tax loss carryforward.
Merging may yield lower borrowing costs for the merged company.
Cash flows of the two businesses are less risky when combined, leading to lower probability of bankruptcy and lower default risk premium
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NonValueMaximizing Motives
Agency problems: Management's (disguised) personal interests are often driver of mergers and acquisitions.
Managerialism theory of mergers: Managerial compensation often tied to corporation size Free cash flow theory of mergers: Managers invest in projects with negative NPV to build corporate empires. Hubris hypothesis of corporate takeovers: Management of acquirer may overestimate capabilities and overpay for target company in belief they can run it more efficiently. Agency cost of overvalued equity
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NonValueMaximizing Motives
Diversification
Coinsurance of debt: the debt of each combining firm is now insured with cash flows from two businesses Internal capital markets: created when the high cash flows (cash cow) businesses of a conglomerate generate enough cash flow to fund the "rising star" businesses
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History of Merger Waves
Five merger waves in the U.S. history
Merger waves positively related to high economic growth. Concentrated in industries undergoing changes Regulatory regime determines types of mergers in each wave. Usually ends with large declines in stock market values
First wave (1897-1904): period of "merging for monopoly".
Horizontal mergers possible due to lax regulatory environment Ended with the stock market crash of 1904
Second wave (1916-1929): period of "merging for oligopoly"
Antitrust laws from early 1900 made monopoly hard to achieve. Just like first wave, intent to create national brands Ended with the 1929 crash
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History of Merger Waves (Continued)
Third wave (1965-1969): conglomerate merger wave
Celler-Kefauver Act of 1950 could be used against horizontal and vertical mergers. Result of portfolio theory applied to corporations: conglomerate empires were formed: ITT, Litton, Tenneco Stock market decline of 1969
Fourth wave (1981-1989): spurred by the lax regulatory environment of the time
Junk bond financing played a major role during this wave: LBOs and MBOs commonplace. Hostile "bust-ups" of conglomerates from previous wave Antitakeover measures adopted to prevent hostile takeover attempts. Ended with the fall of Drexel, Burnham, Lambert
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Fifth Merger Wave
Fifth wave (1993 2001): characterized by friendly, stock-financed mergers
Relatively lax regulatory environment: still open to horizontal mergers Consolidation in non-manufacturing service sector: healthcare, banking, telecom, high tech Explained by industry shock theory: Deregulation influenced banking mergers and managed care affected health care industry.
Merger activity: unprecedented transaction value for both US and non-US mergers
In 2000, aggregate merger value hit $3.4 trillion: $1.8 trillion in US and $1.6 trillion outside US. Declined in 2001 to $1.7 trillion and only $1.2 trillion in 2002
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Major US Antitrust Legislation
Purpose of Legislation Prohibited ac...