M&As

VALUE CREATION THROUGH MERGING : ANALYSIS AND IMPLICATIONS…

A VARIETY OF MOTIVES COULD DRIVE A FIRM TOWARD A MERGER, BUT THE OVERRIDING GOAL SHOULD BE MAXIMIZATION OF THE  SHAREHOLDERS’ WEALTH (SHARE PRICE).

OTHER SPECIFIC MERGER MOTIVES INCLUDE GROWTH OR DIVERSIFICATION, SYNERGY, FUND RAISING, INCREASED MANAGERIAL SKILL OR TECHNOLOGY, TAX CONSIDERATIONS, INCREASED OWNERSHIP LIQUIDITY, AND DEFENSE AGAINST TAKEOVER.

THE ASSERTION THAT MERGER ACTIVITY CREATES WEALTH FOR THE SHAREHOLDER CANNOT BE MAINTAINED WITH CERTAINTY. ONLY IF THE MERGER PROVIDES SOMETHING THAT THE INVESTOR CANNOT DO ON HIS OR HER OWN CAN A MERGER OR ACQUISITION BE OF FINANCIAL BENEFIT.

IN MANY WAYS, THE DECISION TO REORGANIZE A CORPORATION IS NO DIFFERENT FROM OTHER INVESTMENT AND FINANCING DECISIONS : IN A NUTSHELL, CORPORATION REORGANIZATIONS SHOULD BE EVALUATED BY COMPARING THE PRESENT VALUE OF BENEFITS WITH THE PRESENT VALUE OF COST *

HOWEVER, DETERMINING THE VALUE OF A FIRM IS A DIFFICULT TASK…IN ADDITION TO PROJECTING THE FIRM’S FUTURE PROFITABILITY, WHICH IS THE CORNERSTONE IN VALUATION, THE ACQUIRER MUST CONSIDER THE EFFECTS OF JOINING 2 BUSINESSES INTO A SINGLE OPERATION.

WHAT MAY REPRESENT A GOOD INVESTMENT MAY NOT BE A GOOD MERGER !

IN ESTIMATING A FIRM’S WORTH SEVERAL FACTORS ARE FREQUENTLY CONSIDERED, INCLUDING :

  1. THE FIRM’S BOOK VALUE.
  2. ITS APPRAISAL VALUE.
  3. THE STOCK MARKET VALUE OF A FIRM’S COMMON SHARE.
  4. ITS CHOP-SHOP VALUE. ( THE « CHOP-SHOP » APPROACH ATTEMPS TO IDENTIFY MULTI-INDUSTRY COMPANIES THAT ARE UNDERVALUED AND WOULD BE WORTH MORE IF SEPARATED INTO THEIR PARTS. THIS APPROACH CONCEPTUALIZES THE PRACTICE OF ATTEMPTING TO BUY ASSETS BELOW THEIR REPLACEMENT COST).
  5. THE PRESENTVALUE OF FUTURE FREE CASH FLOWS.

 

 

THE FOLLOWING PROCEDURES SOMETIMES  ARE USED TO VALUE ACQUISITIONS :

  1. ASSUME AN INFINITE LIFE FOR THE TARGET COMPANY AND USE THE PERPETUITY MODEL :
  • ACQUISITION VALUE OF TARGET COMPANY = [(OCF/Ka)]- MARKET VALUE OF LIABILITIES ASSUMED.

 

  • WHERE :
  • OCF  IS OPERATING CASH FLOW
  • OCF = EBIT ( 1 -T ) + DEPRECIATION
  • Ka IS THE TARGET’S WACC

2. ASSUME AN INFINITE LIFE FOR THE TARGET COMPANY AND USE THE CONSTANT-GROWTH MODEL :

  • ACQUISITION VAKUE OF TARGET COMPANY = [OCF1 / (Ka - g)] - MARKET VALUE OF LIABILITIES ASSUMED.

 

  • WHERE :
  • OCF1 IS THE EXPECTED OPERATING CASH FLOW ONE YEAR FROM NOW.
  • g IS THE EXPECTED GROWTH RATE OF OCF.

3. ESTIMATE THE TARGET’S ANNUAL CASH FLOWS (CF) FOR A FINITE PLANNING HORIZON, SAY 5 TO 15 YEARS :

  • ACQUISITION VALUE OF TARGET COMPANY = Sigma t=1 to n OF [CFt/ ( 1 + Ka )t] – MARKET VALUE OF LIABILITIES ASSUMED + PRESENT VALUE OF TERMINAL VALUE.

 

  • WHERE :
  • CF = OCF – INCREASE IN NWC – CAPITAL EXPENDITURES
  • NWC = NET WORKING CAPITAL
  • CAPITAL EXPENDITURES ARE INVESTMENTS IN FIXED ASSETS NECESSARY TO GENERATE THE OPERATING CASH FLOW.

 

WHY MIGHT MERGER ACTIVITIES CREATE WEALTH ?

MERGERS RESULT FROM THE COMBINING OF FIRMS. TYPICALLY, THE ACQUIRING COMPANY PURSUES AND ATTEMPTS TO MERGE WITH THE TARGET COMPANY, EITHER ON A FRIENDLY OR HOSTILE BASIS. THE FOUR BASIC TYPES OF MERGERS ARE :

  1. HORIZONTAL.
  2. VERTICAL.
  3. CONGENERIC.
  4. CONGLOMERATE.

NUMEROUS EMPIRICAL STUDIES HAVE BEEN PERFORMED THAT ATTEMPT TO DETERMINE HOW SHAREHOLDERS HAVE BEEN AFFECTED BY MERGERS.

  1. MOST STUDIES THAT EXAMINE THE MERGER’S EFFECT ON SHAREHOLDERS AGREE THAT TARGET FIRM SHAREHOLDERS GAIN WHEN THE MERGER IS ANNOUNCED. THE GAIN IS LARGEST WHEN THE MERGER INVOLVES AN UNFRIENDLY ATTEMPT BY THE ACQUIRER TO GAIN CONTROL, BUT IS ALSO LARGE FOR FRIENDLY MERGERS.
  2. MOST STUDIES SHOW THAT GAINS TO SHAREHOLDERS OF ACQUIRING FIRMS ARE NOT NEARLY AS LARGE AS GAINS TO TARGET SHAREHOLDERS. IN FACT, MANY STUDIES SHOW THAT ACQUIRING FIRM SHAREHOLDERS DO NOT GAIN AT ALL AT THE TIME OF THE MERGER ANNOUNCEMENT. THIS HAS REAWAKENED THE POPULIST CRY THAT SUCH MERGERS DO NOT CREATE NEW WEALTH, THAT THEY MERELY REPRESENT THE TRADING OF EXISTING ASSETS- REARRANGING THE DECK CHAIRS ON THE TITANIC…

IF THE EXCHANGE RATIO IS THE NUMBER OF SHARES OF THE COMBINED COMPANIES OFFERED BY THE ACQUIRER FOR ONE SHARE OF THE TARGET COMPANY  AND THE ACQUISITION PREMIUM THE ACQUISITION PAYMENT IN EXCESS OF THE TARGET COMPANY’S MARKET VALUE :

 

  1. MARKET VALUE OF TARGET BEFORE MERGER = (TARGET’S PERCENTAGE OF COMBINED COMPANIES) x (MARKET VALUE OF COMBINED COMPANIES).
  2. MARKET VALUE OF ACQUIRER BEFORE MERGER = (ACQUIRER’S PERCENTAGE OF COMBINED COMPANIES) x (MARKET VALUE OF COMBINED COMPANIES).
  3. THE BREAK-EVEN EXCHANGE RATIO ( WITHOUT SYNERGY ) = TARGET COMPANY’S STOCK PRICE / ACQUIRING COMPANY’S STOCK PRICE.

AT WWW.OFF-THERECORDMESSAGING.COM WE DO BELIEVE THAT M&As ARE GOOD FOR INDUSTRIAL EFFICIENCY AND THAT TAKEOVERS ARE A RADICAL SOLUTION FOR REMEDYING POOR PERFORMANCE AND SAFEGUARDING AGAINST ECONOMIC MEDIOCRITY.

PHLDUCX

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