Mergers and AcquisitionsMasaryk University 2022 1
Mergers & Acquisitions
Andrej Bajic
Mergers and AcquisitionsMasaryk University 2022 2
What is M&A: mergers and acquisitions are part of what is often referred to
as “the market for corporate control”.
Participants
of M&A
A buyer, the acquirer or bidder.
A seller, the target firm.
Types of mergers
Mergers classified by
means of payments
The target shareholders
can receive stock as
payment.
The target shareholders
can receive cash as
palyment.
Average Acquisition Premium and Stock Price Reactions to
Mergers
Horizontal merger: if the target and
acquirer are in the same industry.
Vertical merger: if the target’s industry
buys or sells to the acquirer’s industry.
Conglomerate merger: if the target and
acquirer operate in unrelated industries.
Premium Paid over
Premerger Price
Announcement Price Reaction
Target Acquirer
43%
15% 1%
Merger waves
• Merger waves—peaks of heavy activity
followed by quiet troughs of few
transactions.
• Merger activity is greater during
economic expansions than during
contractions and correlates with bull
markets.
28.1. Background and Historical Trends
Mergers and AcquisitionsMasaryk University 2022 3
28.2. Market Reaction to a Takeover
1. Why do acquirers pay a premium?
2. Why does the price of the target rise less than the premium offered?
3. Why does the acquirer not experience a large price increase?
QUESTIONS
1 2 3
In most U.S. states, the law requires
that when existing shareholders of a
target firm are forced to sell their
shares, they receive a fair value for
their shares.
As a consequence, a bidder is
unlikely to acquire a target
company for less than its
current market value
In practice, most acquirers pay a
premium on the current market
value.
Mergers and AcquisitionsMasaryk University 2022 4
WORLDWIDE M&A FALLS 34%, THIRD QUARTER M&A FALLS BELOW US$1 TRILLION
Worldwide M&A activity totaled US$2.8 trillion during the first nine months of 2022 a decrease of 34% compared to year-ago levels and
largest year-over-year percentage decline since 2009. The third quarter of 2022 marked the first quarter to fall below US$1 trillion since
the second quarter of 2020. By number of worldwide deals, nearly 40,300 deals were announced during the first nine months of 2022,
a decrease of 17% compared to year ago levels and a two-year low.
PRIVATE EQUITY-BACKED M&A DOWN 25%, ACCOUNTS FOR RECORD 23% OF M&A
Private Equity-backed buyouts accounted for a record 23% of M&A activity during the first nine months of 2022. Overall value reached
US$654.2 billion, a decrease of 25% compared to a year ago. Nearly 8,600 private equity backed deals were announced during the first
nine months, a decrease of 26% compared to last year at this time. Special Purpose Acquisition Companies (SPAC) announced 144 initial
business combinations during the first nine months of 2022, totaling US$81.1 billion, or 3% of overall value. SPAC business
combinations accounted for 10% of activity during the first nine months of 2021.
US TARGET M&A DOWN 40%, ACCOUNTS FOR 42% OF DEAL MAKING
MAKINGM&A activity for US targets totaled US$1.2 trillion during the first nine months of 2022, a decrease of 40% compared to the
level of activity seen during the first nine months of 2021 and the slowest period months for US deal making in two years. US deal
making accounted for 42% of overall worldwide M&A during the first nine months of 2022, down from 46% a year ago.
EUROPEAN M&A DOWN 24%; ASIA PACIFIC DECLINES 30%
European target M&A totaled US$712.2 billion during the first nine months of 2022, a decrease of 24% compared to 2021 levels and a
two-year low. Asia Pacific deal making totaled US$621.1 billion during the first nine months of 2022, a 30% decrease and the slowest
first nine months since 2020.
TECHNOLOGY ACCOUNTS FOR RECORD 22% OF DEAL MAKING
Deal making in the Technology sector totaled US$609.1 billion during the first nine months of 2022, a decrease of 30% compared to
2021 levels and accounting for a record 22% of overall value. The number of technology deals decreased 22% compared to year ago
levels. Energy & Power M&A accounted for 13% of overall M&A, down 14% compared to a year ago. Industrials deal making accounted
for 12% of activity during the first nine months of 2022, a 30% decrease compared to a year ago.
CROSS-BORDER M&A DECLINES 38%
Cross-border M&A activity totaled US$930.1 billion during the first nine months of 2022, a 38% decrease compared to a year ago and
the slowest first nine months for cross-border M&A since 2020. The Technology, Energy & Power and Financials sectors accounted for
42% of cross-border deals during the first nine months of 2022, up from 40% a year ago.
MEGA DEALS FALL 30%; DEALS BETWEEN US$1-US$5 BILLION DOWN 43%
The value of worldwide M&A between US$1 and US$5 billion totaled US$770.6 billion during the first nine months of 2022, a decrease
of 43% compared to a year ago and a two-year low. Twenty-nine deals greater US$10 billion totaled US$618.7 billion during the first
nine months of 2022, a 30% decrease compared to 2021 levels and the lowest period for mega deals, by value, in two years.
01
02
03
04
05
06
07
Global Announced M&A
Global Announced M&A - Deal Size Composition
(US$bil)
28.2. Market Reaction to a Takeover - Market Overview: Global Mergers & Acquisitions
Review (as of Q3 2022)
Mergers and AcquisitionsMasaryk University 2022 5
28.2. Market Reaction to a Takeover - Market Overview: M&A Scorecard
Mergers and AcquisitionsMasaryk University 2022 6
Top Global Announced M&A Transactions
Global Announced M&A - Macro Industry Composition
Global M&A Rankings
Global Announced Cross-Border M&A
28.2. Market Reaction to a Takeover - Market Overview: Transaction Overview
Mergers and AcquisitionsMasaryk University 2022 7
28.2. Market Reaction to a Takeover - Market Overview: Multiples Comparison – Relative
Valuation Appetite
Exit Multiples - 2022 Average Rank Value to EBITDA by Macro
Industry
Bid Premium - 2022 Avg Premium to 4 Week Stock Price by
Macro Industry
Global Rank Value to EBITDA Exit Multiples
Global Bid Premium to 4-Week Stock Price
Mergers and AcquisitionsMasaryk University 2022 8
28.2. Market Reaction to a Takeover - Twitter Takeover Timeline
October 27. – Deal is completed
(Price at close $53,70)
Premium = 40,87%
February 1. – Musk starts buying Twitter shares
(Price at close $38,12)
Mergers and AcquisitionsMasaryk University 2022 9
28.3. Reason for M&A
Economies of
scale is savings
from producing
goods in high
volume.
Economies of scope,
which are savings that
come from combining
the marketing and
distribution of
different types of
related products
1. Economies of scale
Another justification
acquirers cite for paying
a premium for a target
is efficiency gains,
which are often
achieved through an
elimination of
duplication
2. Efficiency gains
6. Operating losses
When it incurs a
loss, the
government does
not rebate taxes.
5. Economies of scope
3. Vertical integration
Vertical integration
refers to the merger
of two companies in
the same industry
that make products
required at different
stages of the
production cycle.
7. Diversification
Direct risk reduction,
lower cost of debt or
increased debt
capacity, and
liquidity
enhancement
4. Expertise
Firms often need
expertise in
particular areas to
compete more
effectively.
8. Earnings growth
Combine two companies
with the result that the
earnings per share of the
merged company exceed
the premerger earnings
per share of either
company
9. Monopoly gains
Merging with or
acquiring a major rival
enables a firm to
substantially reduce
competition within the
industry and thereby
increase profits
Mergers and acquisitions are motivated by the goal to mitigate the weaknesses of either business and to bolster their combined strengths, to
remove a competitor or threat within their industry, or to undergo a period of exponential growth in a short space of time. The most common
reasons why M&A happen are listed and explained below:
Mergers and AcquisitionsMasaryk University 2022 10
28.3. Reason for M&A – Economies of Scale and Scope
A large company can enjoy economies of scale, or savings from
producing goods in high volume, that are not available to a small
company.
Stride Rite’s acquisition of sports shoemaker Saucony in 2005, one
motivation was to reduce Saucony’s manufacturing costs because, due to
its larger size, Stride Rite could negotiate superior manufacturing
contracts in China.
Economies of scope, benefit are savings that come from combining the
marketing and distribution of different types of related products.
Many analysts believed that Kraft’s decision in 2009 to purchase the
British chocolate maker Cadbury was motivated by a desire to expand
Kraft’s snack foods into emerging markets where Cadbury already had a
large presence. There may also be costs associated with size.
Economics of scale
definition
Economics of scale
example
Economics of scope
definition
Economics of scope
example
Chief among these is that larger firms are
more difficult to manage. In a small firm,
the CEO is often close to the firm’s
operations. He or she can keep in touch
with the firm’s largest customers and
most important personnel, thereby
keeping abreast of changing market
conditions and potential problems.
Because they receive information quickly,
small firms are often able to react in a
timely way to changes in the economic
environment.
Drawbacks
Economics of
scale benefits
✓ Efficient production
✓ Reduction in promotion costs
✓ Buy in bulk
✓ Reduction in logistics costs
✓ Cheaper capital
✓ Spread risk
Economies of
scale
Economies
of scope
Accumulated
volume in
production
-> lower price per
unit
Reusing a resource
from one
business/country in
additional
business/countries
≠
Mergers and AcquisitionsMasaryk University 2022 11
28.3. Reason for M&A – Vertical Integration
Definiton
• Vertical integration refers to the merger of two
companies in the same industry that make products
required at different stages of the production cycle.
• A company might conclude that it can enhance its
product if it has direct control of the inputs required
to make the product. Similarly, another company
might not be happy with how its products are being
distributed, so it might decide to take control of its
distribution channels.
• The principal benefit of vertical integration is
coordination. By putting two companies under
central control, management can ensure that both
companies work toward a common goal.
1. Netflix’s shift from licensing shows and movies
from major studios to producing its own original
content is an example of vertical integration.
2. Oil companies are often vertically integrated.
They generally own all stages of the production
process, from the oil fields to the refineries and
so on, even down to the gas stations that
distribute their primary product—gasoline.
Many also have divisions that prospect for new
oil.
• Consequently, not all successful
corporations are vertically
integrated. A good example is
Microsoft Corporation. Microsoft has
chosen to make the operating
system that the vast majority of
computers use, but not the
computers themselves.
• Many experts have argued that a key
factor in Microsoft’s early success
over rivals IBM and Apple was its
decision not to integrate vertically.
1 2 3
Examples Drawbacks
Mergers and AcquisitionsMasaryk University 2022 12
28.3. Reason for M&A: Acquiring Expertise
Challenges in fulfilling the expertise requirement
• Hiring experienced workers with the
appropriate talent might be difficult with an
unfamiliar, new technology.
Expertise requirement
• Firms often need expertise in
particular areas to compete
more effectively.
• The expertise requirement
can be fulfilled by a firm
entering the labor market and
attempt to hire personnel
with the required skills
Example
• U.K. builder Amec bought a large stake in Spie Batignolles, a French contractor, to gain local contacts and expertise in the
French building industry.
• Such mergers are common in high-tech industries. Networking firm Cisco Systems is known for its strategy of buying young
start-up firms that have developed promising new networking technologies.
Possible solution in fulfilling the
expertise requirement
• A more efficient solution may
be to purchase the talent as
an already functioning unit by
acquiring an existing firm
Mergers and AcquisitionsMasaryk University 2022 13
28.3. Other reason for M&A – brief
MONOPOLY GAINS EFFICIENCY GAINS
OPERATING LOSSES EARNING GROWTHDIVERSIFICATION
• Merging with or acquiring a major rival enables a firm to
substantially reduce competition within the industry and thereby
increase profits.
• Society as a whole bears the cost of monopoly strategies, so most
countries have antitrust laws that limit such activity.
• The extent to which these laws are enforced tends to vary across
countries and over time depending on the policy of current leaders.
• Acquirers cite for paying a premium for a target is efficiency gains,
which are often achieved through an elimination of duplication.
• Acquirers also often argue that they can run the target organization
more efficiently than existing management could.
• Unhappy investors typically sell their stock, so the stock of a
corporation with an inept chief executive trades at a discount
relative to the price at which it would trade if it had more capable
leadership.
• When a firm makes a profit, it must pay
taxes on the profit. However, when it
incurs a loss, the government does not
rebate taxes.
• Thus, it might appear that a
conglomerate has a tax advantage over a
single-product firm simply because losses
in one division can be offset by profits in
another division.
• The benefits of diversification are
frequently cited as a reason for a
conglomerate merger.
• The justification for these benefits
comes in three forms: direct risk
reduction, lower cost of debt or
increased debt capacity, and liquidity
enhancement
• It is possible to combine two
companies with the result that the
earnings per share of the merged
company exceed the premerger
earnings per share of either company,
even when the merger itself creates
no economic value.
Other main reasons for engaging into M&A transaction:
Mergers and AcquisitionsMasaryk University 2022 14
Merger “Arbitrage”
The Offer
Valuation
• Valuation approaches
− Compare the target to other comparable companies
− Projection of the expected cash flows that will result from
the deal, and valuing those cash flows
• Second approach to valuation requires making a projection of the
expected cash flows that will result from the deal, and valuing
those cash flows.
𝐴𝑚𝑜𝑢𝑛𝑡 𝑝𝑎𝑖𝑑
= 𝑇𝑎𝑟𝑔𝑒𝑡`𝑠 𝑃𝑟𝑒 𝐵𝑖𝑑 𝑀𝑎𝑟𝑘𝑒𝑡 𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛
+ 𝐴𝑐𝑞𝑢𝑖𝑠𝑖𝑡𝑖𝑜𝑛 𝑃𝑟𝑒𝑚𝑖𝑢𝑚
𝑉𝑎𝑙𝑢𝑒 𝐴𝑐𝑞𝑢𝑖𝑟𝑒𝑑 = 𝑇𝑎𝑟𝑔𝑒𝑡 𝑆𝑡𝑎𝑛𝑑 𝐴𝑙𝑜𝑛𝑒 𝑉𝑎𝑙𝑢𝑒 + 𝑃𝑉 𝑆𝑦𝑛𝑒𝑟𝑔𝑖𝑒𝑠
Tax and Accounting Issues
• Tax liability is deferred until the target shareholders sell their new shares of bidder
stock for a stock swap purchase.
• Higher depreciable basis (when purchased directly) reduces future taxes through
larger depreciation charges.
• Any goodwill created could also be amortized for tax purposes over 15 years.
Board and Shareholder Approval
• In a friendly takeover, the target board of directors supports the merger, negotiates with potential
acquirers, and agrees on a price that is ultimately put to a shareholder vote.
• In a hostile takeover, the board of directors (together with upper-level management) fights the
takeover attempt. To succeed, the acquirer must garner enough shares to take control of the target
and replace the board of directors.
28.4. Valuation and the Takeover Process
• Once the acquirer has completed the valuation
process, it is in the position to make a tender offer.
• A bidder can use either of two methods to pay for a
target: cash or stock.
• Because there is the uncertainty of the deal being
completed, the stock price of the target company typically
sells at a price below the acquisition price.
Mergers and AcquisitionsMasaryk University 2022 15
Valuation Methodologies
ComparableValuation Intrinsic Valuation
Share Price Broker Target
• Current trading of a
company on the
stock exchange (if
listed)
• Based on efficient
market hypothesis
• Current valuation of
research analysts
covering the stock
• Research analysts
analyze and value a
company in detail
based on publicly
available
information
Trading Transaction
• Company valuation
based on trading
levels of a peer
group
• Public market
valuation
• Comparability
between companies
as key limiting factor
• Company valuation
based on precedent
transactions
• Transaction based
approach
• Specific character of
precedents a
challenge
Trading Transaction
• Values a company by
discounting
expected future cash
flows
• Explicit longer-term
forecasts
• Discount rate and
terminal value
assumptions are key
• Leveraged buyout
valuation with focus
on returns
• Dividend discount
model
• IDW S1 Valuation
used e.g. in merger/
squeeze out
situations
• Applied in specific
situations
ComparableValuation
“How much would other farmers pay on the market
for my cow?”
“How much is paid for similar cows?” “How much does my cow generate for me?”
28.4. Valuation and the Takeover Process - Valuation Methodologies: Approach to Asset
Valuation
Mergers and AcquisitionsMasaryk University 2022 16
Exchange
Ratio
Tender Offer
Valuation
• Once the acquirer has completed the valuation
process, it is in the position to make a tender
offer.
• A bidder can use either of two methods to pay for
a target: cash or stock.
• The “price” offered is determined by the
exchange ratio.
• A stock-swap merger is a positive-NPV
investment for the acquiring shareholders if the
share price of the merged firm (the acquirer’s
share price after the takeover) exceeds the
premerger price of the acquiring firm.
𝐴 + 𝑇 + 𝑆
𝑁𝐴 + 𝑥
>
𝐴
𝑁𝐴
= 𝑃𝐴
𝐸𝑥𝑐ℎ𝑎𝑛𝑔𝑒 𝑟𝑎𝑡𝑖𝑜 =
𝑥
𝑁 𝑇
<
𝑃𝑇
𝑃𝐴
(1 +
𝑆
𝑇
)
28.4. Valuation and the Takeover Process - the Offer
Mergers and AcquisitionsMasaryk University 2022 17
28.4. Valuation and the Takeover Process – Example: Maximum Exchange Ratio in a Stock
Takeover
Problem
• At the time Sprint announced plans to acquire Nextel in December 2004, Sprint stock was trading for $25 per share and Nextel stock was
trading for $30 per share.
• If the projected synergies were $12 billion, and Nextel had 1.033 billion shares outstanding, what is the maximum exchange ratio Sprint could
offer in a stock swap and still generate a positive NPV?
• What is the maximum cash offer Sprint could make?
Solution
• Nextel’s premerger market cap was T = 1.033 * 30 = $31 billion. Thus using equation for exchange ratio from previous slide,
𝐸𝑥𝑐ℎ𝑎𝑛𝑔𝑒 𝑟𝑎𝑡𝑖𝑜 <
𝑃 𝑇
𝑃𝐴
1 +
𝑆
𝑇
=
30
25
1 +
12
31
= 1.665
• That is, Sprint could offer up to 1.665 shares of Sprint stock for each share of Nextel stock and generate a positive NPV.
• For a cash offer, given synergies of $12 billion/1.033 billion shares = $11.62 per share, Sprint could offer up to $30 + 11.62 = $41.62.
• Note that this cash amount equals the cash value of the exchange offer: $25 * 1.665 = $41.62.
Mergers and AcquisitionsMasaryk University 2022 18
Takeover Defense
Strategies
Staggered
Boards
Poison Pills
White
Knights
Other Defensive
Strategies
Golden
Parachutes
Recapitalization
Golden Parachutes
• A golden parachute is an extremely
lucrative severance package that is
guaranteed to a firm’s senior managers in
the event that the firm is taken over and
the managers are let go.
Recapitalization
• Recapitalization is a strategy in which a
company changes its capital structure to
make itself less attractive as a target.
Other Defensive Strategies
• A corporation’s charter can require a
supermajority (sometimes as much as 80%)
of votes to approve a merger.
• It can also restrict the voting rights of very
large shareholders.
• Finally, a firm can require that a “fair” price
be paid for the company, where the
determination of what is “fair” is up to the
board of directors or senior management.
Poison Pills
• A poison pill is a rights offering that gives
existing target shareholders the right to buy
shares in the target at a deeply discounted
price once certain conditions are met.
White Knights
• When a hostile takeover appears to be
inevitable, a target company will
sometimes look for another, friendlier
company to acquire it. This company that
comes charging to the target’s rescue is
known as a white knight.
• One variant on the white knight defense is
the white squire defense.
Poison Pills
• In a typical staggered board, every director
serves a three-year term and the terms are
staggered so that only one-third of the
directors are up for election each year.
• Thus, even if the bidder’s candidates win
board seats, it will control only a minority
of the target board.
For a hostile takeover to succeed, the acquirer must go around the target board and appeal directly to the target shareholders. The acquirer can do this by making an
unsolicited offer to buy target stock directly from the shareholders (a tender offer). The acquirer will usually couple this with a proxy fight: The acquirer attempts to
convince target shareholders to unseat the target board by using their proxy votes to support the acquirers’ candidates for election to the target board. Target companies
have a number of strategies available to them to stop this process.
28.5. Takeover Defense
Mergers and AcquisitionsMasaryk University 2022 19
Because target shareholders can purchase shares at less than the market price, the
rights offering dilutes the value of any shares held by the acquirer.
This dilution makes the takeover so expensive for the acquiring shareholders that they
choose to pass on the deal.
Because the original poison pill goes into effect only in the event of a complete takeover
(that is, a purchase of 100% of the outstanding shares), one way to circumvent it is to not
do a complete takeover.
Most poison pills now specify that if a raider acquires more than a trigger amount
(typically 20%) of the target shares (but chooses not to execute a complete takeover by
purchasing all outstanding shares), existing shareholders—with the exception of the
acquirer—have the right to buy more shares in the target at a discounted price.
By adopting a poison pill, a company effectively entrenches its management
by making it much more difficult for shareholders to replace bad managers,
thereby potentially destroying value.
Poison pill
Rights offering that gives existing
target shareholders the right to buy
shares in the target at a deeply
discounted price once certain
conditions are met.
28.5. Takeover Defense - Poison Pills
Mergers and AcquisitionsMasaryk University 2022 20
Competition
The Leveraged
Buyout
The Freezeout
Merger
Toeholds
The Free Rider Problem
Why does the price of the acquiring company not rise at the announcement of the takeover and why the bidder is forced to pay a premium for the
target? You might imagine that the people who do the work of acquiring the corporation and replacing its management will capture the value created by
the merger. Based on the average stock price reaction, it does not appear that the acquiring corporation generally captures this value. Instead, the
premium the acquirer pays is approximately equal to the value it adds, which means the target shareholders ultimately capture the value added by the
acquirer.
28.6. Who Gets the Value Added from a Takeover?
Mergers and AcquisitionsMasaryk University 2022 21
28.6. Who Gets the Value Added from a Takeover? - Example: Leveraged Buyout
Problem
• FAT Corporation stock is currently trading at $40 per share. There are 20 million shares outstanding, and the company has no debt. You are a partner in a firm that
specializes in leveraged buyouts. Your analysis indicates that the management of this corporation could be improved considerably.
• If the managers were replaced with more capable ones, you estimate that the value of the company would increase by 50%.
• You decide to initiate a leveraged buyout and issue a tender offer for at least a controlling interest—50% of the outstanding shares.
• What is the maximum amount of value you can extract and still complete the deal?
• Currently, the value of the company is $40 * 20 million = $800 million, and you estimate you can add an additional 50%, or $400 million.
• If you borrow $400 million and the tender offer succeeds, you will take control of the company and install new management.
• The total value of the company will increase by 50% to $1.2 billion. You will also attach the debt to the company, so the company will now have $400 million in debt.
• The value of the equity once the deal is done is the total value minus the debt outstanding:
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 = 1200 − 400 = $800 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
• The value of the equity is the same as the premerger value. You own half the shares, which are worth $400 million, and paid nothing for them, so you have captured the
value you anticipated adding to FAT.
• What if you borrowed more than $400 million? Assume you were able to borrow $450 million. The value of equity after the merger would be:
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 = 1200 − 450 = $750 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
• This is lower than the premerger value. Recall, however, that in the United States, existing shareholders must be offered at least the premerger price for their shares.
Because existing shareholders anticipate that the share price will be lower once the deal is complete, all shareholders will tender their shares.
• This implies that you will have to pay $800 million for these shares, and so to complete the deal, you will have to pay 800 - 450 = $350 million out of your own pocket. In the
end, you will own all the equity, which is worth $750 million.
• You paid $350 million for it, so your profit is again $400 million. Thus, you cannot extract more value than the value you add to the company by taking it over.
Solution