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OKAN BAYRAK
Definitions
A merger is a combination of two or more
corporations in which only one corporation
survives and the merged corporations go out
of business.
Statutory merger is a merger where the
acquiring company assumes the assets and
the liabilities of the merged companies
A subsidiary merger is a merger of two
companies where the target company
becomes a subsidiary or part of a subsidiary
of the parent company
Types of Mergers
Horizontal Mergers
- between competing companies
Vertical Mergers
- Between buyer-seller relation-ship companies
Conglomerate Mergers
- Neither competitors nor buyer-seller relationship
History of Mergers and
Acquisitions Activity in United
States
The First Wave 1897-1904
- After 1883 depression
- Horizontal mergers
- Create monopolies
The Second Wave 1916-1929
- Oligopolies
- The Clayton Act of 1914
The Third Wave 1965-1969
- Conglomerate Mergers
- Booming Economy
The Fourth Wave 1981-1989
- Hostile Takeovers
- Mega-mergers
Mergers of 1990’s
- Strategic mega-mergers
Motives and Determinants of
Mergers
Synergy Effect
NAV= Vab –(Va+Vb) – P – E
Where Vab = combined value of the 2 firms
Vb = market value of the shares of firm B.
Va = A’s measure of its own value
P = premium paid for B
E = expenses of the operation
- Operating Synergy
- Financial Synergy
Diversification
Economic Motives
- Horizontal Integration
- Vertical Integration
- Tax Motives
FIRM VALUATION IN
MERGERS AND ACQUISITIONS
Equity Valuation Models
- Balance Sheet Valuation Models
• Book Value: the net worth of a company as shown on the
balance sheet.
• Liquidation Value: the value that would be derived if the firm’s
assets were liquidated.
• Replacement Cost: the replacement cost of its assets less
its liabilities.
FIRM VALUATION IN MERGERS
AND ACQUISITIONS-2
D1 D2 D3
V0 .......
1 k (1 k ) (1 k )
2 3
W here V o = v a lu e o f th e fir m
D i = d iv id e n d in y e a r I
k = d isc o u n t r a te
FIRM VALUATION IN MERGERS
AND ACQUISITIONS-3
The Constant Growth DDM
D 0 (1 g ) D 0 (1 g ) 2
V0 ......
1 k (1 k ) 2
w h e re g = gro w th ra te o f d iv id e n d s.
FIRM VALUATION IN MERGERS
AND ACQUISITIONS-4
Price-Earnings Ratio
P0 1 PVGO
1
E1 k
E/k
P0 E 1 (1 b )
E 1 k ROExb
P0 1 b
E 1 k ROExb
where ROE = Return On Equity
FIRM VALUATION IN MERGERS
AND ACQUISITIONS-5
Cash Flow Valuation Models
- The Entity DCF Model : The entity DCF model values the value of a company as
the value of a company’s operations less the value of debt and other investor claims,
such as preferred stock, that are superior to common equity
. Value of Operations: The value of operations equals the discounted value of
expected future free cash flow.
. Value of Debt
. Value of Equity
FIRM VALUATION IN MERGERS
AND ACQUISITIONS-6
What Drives Cash Flow and Value?
- Fundamentally to increase its value a company must do
one or more of the following:
. Increase the level of profits it earns on its existing
capital in place (earn a higher return on invested
capital).
. Increase the return on new capital investment.
. Increase its growth rate but only as long as the return
on new capital exceeds WACC.
. Reduce its cost of capital.
FIRM VALUATION IN MERGERS
AND ACQUISITIONS-7
E c o n o m ic P r o fit N O P L A T ( I n v e s te d C a p ita l x W A C C )
w h e r e N O P L A T = N e t O p e r a tin g P r o fit L e s s A d ju s te d T a x e s
V a lu e = I n v e s te d C a p ita l+ P r e s e n t V a lu e o f P r o je c te d E c o n o m ic P r o fit
STEPS IN VALUATION
Analyzing Historical Performance
NOPLAT
Return on Investment Capital =
Invested Capital
B P S
W A C C k b (1 - T c ) kp ks
V V V
w h e re
k b = t h e p r e t a x m a r k e t e x p e c t e d y ie ld t o m a t u r it y o n n o n - c a lla b le , n o n c o n v e r t ib le d e b t
T c = t h e m a r g in a l t a x e r a t e f o r t h e e n t it y b e in g v a lu e d
B = t h e m a r k e t v a lu e o f in t e r e s t - b e a r in g d e b t
k p = t h e a f t e r - t a x c o s t o f c a p it a l f o r p r e f e r r e d s t o c k
P = m a r k e t v a lu e o f t h e p r e f e r r e d s t o c k
k s = t h e m a r k e t d e t e r m in e d o p p o r t u n it y c o s t o f e q u it y c a p it a l
S = t h e m a r k e t v a lu e o f e q u it y
k s r f E ( r m ) r f
w h e re rf = t h e ris k - f r e e ra t e o f re t u r n
E (rm ) = t h e e x p e c t e d r a t e o f r e t u r n o n t h e o v e r a l l m a r k e t p o r t f o l io
E (rm )- rf = m a r k e t r i s k p r e m iu m
В = t h e s y s t e m a t ic r i s k o f e q u it y
k s r f E ( F 1 ) r f 1 E ( F 2 ) r f 2 ....
w h e r e E ( F k ) = t h e e x p e c t e d r a t e o f r e t u r n o n a p o r t f o lio t h a t m im ic s t h e k t h f a c t o r a n d is
in d e p e n d e n t o f a ll o t h e r s .
B e ta k = t h e s e n t iv it y o f t h e s t o c k r e t u r n t o t h e k t h f a c t o r .
STEPS IN VALUATION-6
Estimating The Continuing Value
- Selecting an Appropriate Technique
. Long explicit forecast approach
. Growing free cash flow perpetuity formula
. Economic profit technique
Economic Profit T+1 (NOPLATT+1 )( g / ROIC )( ROIC WACC )
CV = +
WACC WACC (WACC g )
where
Economic Profit T+1 = the normalized economic profit in the first year after the explicit
forecast period.
NOPLAT T+1 = the normalized NOPLAT in the first year after the explicit forecast period.
g = the expected growth rate of return in NOPLAT in perpetuity
ROIC = the expected rate of return on net new investment.
WACC = weighted average cost of capital
STEPS IN VALUATION-7
Calculating and Interpreting Results
- Calculating And Testing The Results
- Interpreting The Results Within The
Decision Context
HP-COMPAQ MERGER CASE
The HP/Compaq merger. By The Numbers:
HIGH-END
High-end Unix Servers: Worldwide (2000) High-end Unix servers: US (2000)
Factory Factory
Revenues ($m) Market Share Revenues ($m) Market Share
Hewlett-Packard 512 11.4% Hewlett-Packard 124 6.1%
Compaq 134 3.0% Compaq 66 3.3%
Closest Rival: Sun Microsystems with factory revenues of Closest Rival: Sun Microsystems with factory
$2.1 billion and a 47.1% market share revenues of $1.2 billion and a 60.1% market share
MID-RANGE
Mid-range Unix servers: Worldwide (2000) Mid-range Unix servers: US (2000)
Factory Factory
Revenues ($m) Market Share Revenues ($m) Market Share
Hewlett-Packard 3,673 30.3% Hewlett-Packard 1552 28.2%
Compaq 488 4.0% Compaq 296 5.4%
Closest Rival: Sun Microsystems with $2.8 billion in Market Leader: Sun Microsystems with revenues of $1.7
factory revenue and a 23.5% market share billion and a 30.5% market share)
PERSONAL COMPUTERS
PC Shipments: Worldwide (in thousands of units) PC Shipments: US(in thousands of units)
Hewlett- Hewlett-
Packard Compaq Packard Compaq
Units (q2/01) 2,065 3,590 Units (q2/01) 991 1,332
Share (q2/01) 6.9% 12.1% Share (q2/01) 9.4% 12.7%
Units (q2/00) 2,260 4.011 Units (q2/00) 1,221 2,293
Share(q2/00) 7.4% 13.2% Share(q2/00) 10.7% 20.1%
Growth -8.6% -10.5% Growth -18.8% --21.3%
Accretion/Dilution Analysis
EPS EPS
Accretion/Dilution 2002 2003
Compaq stand-alone 0.67 0.88
HP stand-alone 1.21 1.86
Combined entity pro-forma, excluding proj. synergies 0.74 1.09
Combined entity pro-forma, including proj. synergies 1.05 1.51
Accretion/(Dilution) to Compaq, excluding proj. synergies 11% 24%
Accretion/(Dilution) to Compaq, including proj. synergies 57% 71%