lec 12 merger & acqstn

7/28/2019 Lec 12 Merger & Acqstn

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Lecture 12: Mergers and acquisitions

(M&A)Objectives:

Understand the fundamental theory

underpinning M&AsDiscuss the motives behind M&As

Describe the methods of financing M&As

Apply the various methods of sharevaluation under M&A

Discuss the reasons for merger failure.


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Mergers and Acquisitions

Merger:

is where two companies come together to

combine and share resources to achieve acommon objectives.

Under merger the combining firms remain

joint ownersnew company is created


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Takeover or acquisition:

one firm purchase the assets of another, with

the acquired firm ceasing to be the owners of

that firm. Often it is the larger company which

acquires a smaller one


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Types of M & A

Horizontal merger :

two companies engaged in similar activities are

combined

Vertical merger ;

firms from different points in the same

production process decide to combine Conglomerate merger:

occurs when two businesses in unrelated

industries decide to combine


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Objectives of M&As

Enhance shareholder wealth through

competitive advantage

Empire building


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Theoretical perspective (pages 89-90 hand book)

Question

Is take over targets a way of disciplining managers

who fail to seek the interest of shareholders

(Market for Corporate Control) or are there

motives different from this? From lecture 1(agency problem). Read more on this area.


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Motives of M & A

Economies of scale

to enable benefits of scale to be achieved

To reduce competition

to co-opt an existing competitor in order to

reduce competition

Market powerincrease market share


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Motives of M & A

Sharing complementary resources

bringing together the relative strength of each

firm

New market entry

to facilitate expansion into new market

To reduce riskdiversification


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Motives of M & A

Managerial motive

to avoid being taken over (job security)

to pursue growth in size, status and higher

remuneration

Removal of inefficient Management

-to remove managers who failed tomaximise shareholder wealth


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Methods of Financing Mergers

Cash payment

pay the purchase consideration by cash

Shares

issue of ordinary and preference shares

Loan capital

debentures

convertible loans


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Target Valuation

Methods:

Asset-based methods

Balance sheet or net book values approach

P = Total assets - total liabilities

No of ordinary shares issued

Net realisable values or replacement cost

P = net realisable value - total liabilities



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Target Valuation

Stock market methods:

For listed companies use the share price on

the stock exchange


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Target Valuation

Cash flow methods:

Gordons growth model

Value of share= Dividend received

Rate of returngrowth in dividend

Free cash flow method:PV of future cash flow-total liabilities



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Target Valuation

Dividend Yield = Gross dividend per shareMarket value per share

MV/S = Gross dividend per shareDividend yield

P/E ratio = market value per share

Earning per share

Market value per share = P/E ratio x EPS


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Lecture Example 12.1

CDC Ltd owns a chain of tyre and exhaust fitting garages in the London area. The

company has been approached by ATD plc, with a view to a takeover of CDC Ltd. ATD

plc is prepared to make an offer in cash or a share-for-share exchange. The most recent

accounts of CDC Ltd are summarised below.

Profit and loss account for the year ended 30 November, 20x1

mTurnover 18.7

Profit before interest and tax 6.4

Interest 1.6

Profit before taxation 4.8

Corporation tax 1.2

Net profit after taxation 3.6

Dividend 1.0

Retained profit 2.6


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Balance sheet as at 30 November, 20x1

Fixed Assets

Freehold land and premises at cost 4.6

Less: Accumulated Depreciation 0.6

4.0

Plant and machinery at cost 9.5

Less: Accumulated Depreciation 3.6

5.9

9.9

Current Assets

Stock at cost 2.8

Debtors 0.4

Bank 2.6

5.8Less Creditor amount due within one year

Trade creditors 4.3

Dividends 1.0

Corporation Tax 1.2

6.5

(0.7)

Total assets less current liabilities 9.2

Less Creditor amount due beyond one year

Loans 3.6

5.6

Share capital and reserves

Ordinary 1 shares 2.0

Profit & loss 3.6

5.6


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The accountants for CDC Ltd has estimated the future free cash flow of the company to

be as follows:

20x2 20x3 20x4 20x5 20x6

million 4.4 4.6 4.9 5.0 5.4

(Note: after 20x6 the figure is the same for the following 12 years). The company has a

cost of capital of 10%

CDC Ltd has recently had a professional valuer establish the current resale value of its

assets. The current resale value of each asset was as follows:

Freehold land and premises 18.2

Plant and machinery 4.2

Stock 3.4

The current resale values of the remaining assets are considered to be in line with their

book values.


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A company which is listed on the Stock Exchange and which is in the same business as

CDC Ltd has a gross dividend yield of 5 per cent and a price earning ratio of 11 times.

Assume a standard rate of income tax of 25%. The financial director believes that

replacement costs are 1 million higher than the resale values for both freehold land and

premises, and the plant and machinery, and 0.5 million higher than the resale value o

the stock. The replacement cost of the remaining assets is considered to be in line with

their book values. In addition, the financial director believes the goodwill of the business

has a replacement value of 10 million.

Calculate:

a) Net book value of an ordinary share in CDC Ltd.b) Value of ordinary share in CDC Ltd using the liquidation value methodc) Value of ordinary share in CDC Ltd using the replacement methodd) Value of ordinary share in CDC Ltd using the P/E ratio methode) The value of an ordinary share in CDC Ltd using the free cash flow method


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Target Valuationsolution12.1

a) P = Total assets - total liabilities


P = (9.9 + 5.8)(6.5 + 3.6)

2 = 2.8

b) Net realisable values or replacement cost

P = net realisable value - total liabilities

No of ordinary shares issuedP = (18.2+4.2+3.4+0.4+2.6)-(6.5+3.6)

2 = 9.36


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Target Valuation

c) Replacement cost

P = Assets at Replacement cost - total liabilities No of ordinary shares issued

P = (19.2+5.2+3.9+0.4+2.6+10)-(6.5+3.6)

2=15.6


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Target Valuation

d) P/E ratio = market value per share

Earning per share

Market value per share = P/E ratio x EPS

11 X 3.6

2 19.80


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Target Valuation

e) Cashflow DCF 10% PV

19x2 4.4 0.91 4.0

19x3 4.6 0.83 3.8219x4 4.9 0.75 3.68

19x5 5.0 0.68 3.40

Next 13 yrs 5.4 4.90* 26.4641.36

41.36 -10.1 / 2.0 =15.63


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Failure of M & A

Reasons:

Over-optimisation

Acquirers often pay too much for their targets

as a result of flawed evaluation process that

overestimates the likely benefits;

Failure of integration managementimproper planning and execution of the

integration process.


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Further Reading

Manne, Henry G. (1965) Mergers and the Market

for Corporate Control The Journal of Political

Economy, Vol 73, No 2 (April), pp. 110-120. Siriopoulos, C. et al (2006) Does the Market for

Corporate Control hypothesis explain takeover

targets?Applied Economics Letter, Vol. 13, pp.

557-561.

Sudarsanam, P.S.(1995). The Essence of Mergers

and Acquisitions, Prentice Hall.


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lec 12 merger & acqstn

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