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Mergers And Acquisituion Essay

2167 words - 9 pages

15PFMC070: Corporate Finance

Autumn 2013

15PFMC070: Corporate Finance
Autumn 2013

Mergers and Acquisitions (I)
Motives
Dr Tolulola Lawal
Department of Financial & Management Studies SOAS, University of London

Module Overview
Investment appraisal
Capital budgeting

The Objective of the Firm

Sources of Finance (I) Debt Financing and Valuation

Efficient Market Risk & Return, and Capital Asset Pricing Model

Sources of Finance (II) Equity Financing and Valuation Dividend Policy

Capital Structure Theory Mergers & Acquisitions

Mergers and Acquisitions
• • • • Motives Target valuation Reasons for frequent failure of M&A Defences against takeovers

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– However, not all not all successful corporations are vertically integrated.
• For example, Microsoft makes the operating system but not the computers.

– Internalisation of transactions

Reasons to Acquire (3)
• Expertise
– Firms often need expertise in particular areas to compete more efficiently. – Particularly with new technologies, hiring experienced workers directly may be difficult. – It may be more efficient to purchase the talent as an already functioning unit by acquiring an existing firm.

Reasons to Acquire (4)
• Monopoly Gains
– Merging with or acquiring a major rival enables a firm to substantially reduce competition within the industry and thereby increase profits. – Most countries have antitrust laws that limit such activity. – While all companies in an industry benefit when competition is reduced, only the merging company pays the associated costs (from, for instance, managing a larger corporation).

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15PFMC070: Corporate Finance

Autumn 2013

Reasons to Acquire (5) and (6 ?)
• Efficiency Gains
– which are often achieved through an elimination of duplication. – Acquirers often argue that they can run the target organisation more efficiently than existing management could.

• Undervalued shares ?
– Acquirers can evaluate their target firms more accurately than most investors

Three “weak” Reasons for Mergers
• Diversification • Earnings Growth (Bootstrapping EPS)
– If there are no synergies or other benefits to the merger, then the growth in EPS is just an artifact of a larger firm and is not true growth (i.e., an accounting illusion).

• Non-Value-Maximising Managerial motives

Economic / Strategic Reasons to Acquire ?
• Diversification (1)
– Risk Reduction • Like a large portfolio, large firms bear less unsystematic risk, so often mergers are justified on the basis that the combined firm is less risky. • Shareholders’ “do-it yourself” diversification may be superior alternative to firm diversification

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15PFMC070: Corporate Finance

Autumn 2013

Economic / Strategic Reasons to Acquire ?
• Diversification (2)
– Debt Capacity and Borrowing Costs
• All else being equal, larger firms are more diversified, and therefore have a lower probability of bankruptcy • A greater stability of earnings will appeal to lenders • Allow them to borrow more than they could have as individual entities Increase leverage >>> Lower the cost of capital

The Bootstrapping fallacy (p 783)
Global Resource’s PER will remain at its pre-acquisition level of 25.

Instead, the PER after the acquisition is weighted average of the two companies pre-acquisition PER’s

1 share in Global for 2.5 shares in Regional Global before Merger 1 25 25 100 100 2500 Regional before merger 1 10 10 100 100 1000 Smart 1.43 25 17.5 140 200 3500 Fooled 1.43 35.71 25 140 200 5000

Table 28.2
EPS Share Price PER Number of shares Total Earnings Total Value

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15PFMC070: Corporate Finance

Autumn 2013

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