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Lecture Fundamentals of financial management - Chapter 21: Mergers and divestitures

Chapter 21 - Mergers and divestitures. This chapter presents the following content: Types of mergers; merger analysis; role of investment bankers; corporate alliances; LBOs, divestitures, and holding companies; | CHAPTER 21 Mergers and Divestitures Types of mergers Merger analysis Role of investment bankers Corporate alliances LBOs, divestitures, and holding companies Why do mergers occur? Synergy: Value of the whole exceeds sum of the parts. Could arise from: Operating economies Financial economies Differential management efficiency Increased market power Taxes (use accumulated losses) Break-up value: Assets would be more valuable if sold to some other company. What are some questionable reasons for mergers? Diversification Purchase of assets at below replacement cost Get bigger using debt-financed mergers to help fight off takeovers What is the difference between a “friendly” and a “hostile” takeover? Friendly merger: The merger is supported by the managements of both firms. Hostile merger: Target firm’s management resists the merger. Acquirer must go directly to the target firm’s stockholders try to get 51% to tender their shares. Often, mergers that start out hostile end up as friendly when offer price is raised. Reasons why alliances can make more sense than acquisitions Access to new markets and technologies Multiple parties share risks and expenses Rivals can often work together harmoniously Antitrust laws can shelter cooperative R&D activities Merger analysis: Post-merger cash flow statements 2003 2004 2005 2006 Net sales $60.0 $90.0 $112.5 $127.5 - Cost of goods sold 36.0 54.0 67.5 76.5 - Selling/admin. exp. 4.5 6.0 7.5 9.0 - Interest expense 3.0 4.5 4.5 6.0 EBT 16.5 25.5 33.0 36.0 - Taxes 6.6 10.2 13.2 14.4 Net Income 9.9 15.3 19.8 21.6 Retentions 0.0 7.5 6.0 4.5 Cash flow 9.9 7.8 13.8 17.1 What is the appropriate discount rate to apply to the target’s cash flows? Estimated cash flows are residuals which belong to acquirer’s shareholders. They are riskier than the typical capital budgeting cash flows. Because fixed interest charges are deducted, this increases the volatility of the residual cash flows. Because the cash flows are risky equity flows, they should be | CHAPTER 21 Mergers and Divestitures Types of mergers Merger analysis Role of investment bankers Corporate alliances LBOs, divestitures, and holding companies Why do mergers occur? Synergy: Value of the whole exceeds sum of the parts. Could arise from: Operating economies Financial economies Differential management efficiency Increased market power Taxes (use accumulated losses) Break-up value: Assets would be more valuable if sold to some other company. What are some questionable reasons for mergers? Diversification Purchase of assets at below replacement cost Get bigger using debt-financed mergers to help fight off takeovers What is the difference between a “friendly” and a “hostile” takeover? Friendly merger: The merger is supported by the managements of both firms. Hostile merger: Target firm’s management resists the merger. Acquirer must go directly to the target firm’s stockholders try to get 51% to tender their shares. Often, mergers that start out hostile end up as friendly .