ch26 - Chapter 26 Mergers LBOs Divestitures and Holding...

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Chapter 26 Mergers, LBOs, Divestitures, and Holding Companies ANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS The BOC questions lead us through a verbal discussion of mergers and merger analysis. This is a useful exercise, but it does not explain the type of quantitative analysis that a financial analyst would need to go through to evaluate a potential merger. For a quantitative analysis, we recommend going through the BOC model. 26-1 Horizontal : In the same business. Example: Exxon merging with Mobil Oil. Vertical : One is a supplier to the other. Example: DuPont buying Conoco to get a supply of oil. Congeneric : The businesses are somewhat related. Example: Citigroup (principally a bank) buying Salomon Smith Barney (an investment banker/stock brokerage operation). Conglomerate : The firms are in unrelated businesses. Example: GE buying NBC. Justice Department intervention would depend on this question: Would the merger be likely to reduce competition materially? Horizontal mergers are the most likely to be blocked, with vertical mergers next. Congeneric mergers are less likely to be attacked, and conglomerate mergers rarely raise antitrust questions. 26-2 Synergy is the situation where two firms merge and the merged firm has higher cash flows than the sum of the cash flows from the two merger partners. Synergy generally results from economies of scale or scope. For example, bank mergers often result in lower costs as duplicate offices are closed and redundant people are laid off. Mergers like that between AOL and Time Warner were supposed to result in increased revenues because Time Warner’s media properties were supposed to be delivered can to AOL’s huge customer base. Expected synergy is measured either by the expected increase in free cash flow resulting from the merger or by the expected increase in market value of the equity, which depends on the expected increase in cash flow. The expected synergy is allocated by negotiations. If the target firm has many potential suitors, then it will probably capture most of the synergies. On the other hand, if the acquiring firm has many potential acquisitions, then it may be able to offer a low price and capture most of the synergy. Empirical studies indicate that targets get more of the synergies than acquirers, but that result may be more the result of inadequate tests than actual synergy allocations. Since we don’t know what cash flows the two firms would have had without the merger, we cannot have full confidence that poor ex post results really indicate a bad merger. For example, AOL Time Warner’s market value has gone down since their merger, but the decline might have been even greater absent the merger. Synergies are to a large extent case-specific.
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ch26 - Chapter 26 Mergers LBOs Divestitures and Holding...

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