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MERGERS AND ACQUISITIONS

PERFORMANCE
VALUE CREATION vs. WEALTH
DESTRUCTION

Session 1
PGP 2014-16, IIM Indore

Group Activity



Groups of 5
Submit the group details by 22nd September, 2015
Assume the role of an investment banker
Identify a potential M&A deal
I.
II.
III.
IV.
V.
VI.

Not yet under consideration
Cannot include deals that have already happened
Potential target(s) and potential bidder(s): Based on the understanding of
competitive landscape and industry analysis
Represent Buy-side or Sell-side
Valuation, other analysis, deal structure (payment), deal financing
Prepare a pitch book (more in session 13)

• Report – 1 page summary on points III and IV, and economic rationale for the
deal
• Submit before the start of session 13 (Deadline –to be announced)

• Pitch book presentation & Submission – After Session 15 (Date to be
announced)

The Market for Corporate Control
• A market where alternative owners compete for the rights to manage
companies
• Shareholders can exercise their right to sell/ not sell - to the highest bidder

• Why are Takeovers needed?
• Build or Buy: Enter new market, acquire new customers, build new
technology, etc. through internal investments or through purchase
• Apple vs. Microsoft

• Firm value maximization

Surging M&A deal volumes

Table 1: M&A Activity in India from 1991 -2012
This table presents M&A activity in India from 1991 to 2012, based on different filtering criteria, i.e., a.
all deals, b. only deals by non-financial companies, and c. deals by non-financial companies above a
certain deal value. We have considered only the completed deals by Indian acquirers.
No filter
All Non-fin
Non-fin>= $0.25mn
Domestic & Cross Border
Cross Border
Sum of
Sum of
Sum of
Sum of
Value of
No of Value of
No of
Value of
Value of
Year
Deals
Deals
Deals
Deals
Deals No of Deals
Deals No of Deals
1991
30.642
7
0.65
4
0.65
1
0.65
1
1992
12.399
13
0
10
0
0
0
0
1993
972.495
12
229.56
9
229.56
4
208
1
1994
1040.324
31 148.234
10
148.234
4
17.673
2
1995
1393.298
90 1154.87
70
1154.427
29
127.503
8
1996
1291.358
32 1264.099
22
1263.939
8
12.929
3
1997
642.735
38 633.714
31
633.714
10
72.602
3
1998
252.497
55 195.769
43
195.649
21
14.141
3
1999
2296.235
180 2088.058
123
2087.707
63
17.046
5
2000
5474.729
397 5059.244
239
5057.666
91
2659.984
23
2001
2586.376
256 1662.417
184
1661.838
79
139.928
13
2002
5775.1
242 4238.507
164
4238.032
73
1641.511
14
2003
3160.42
325 2873.709
195
2873.192
99
831.786
30
2004
2843.381
360 2314.734
214
2314.01
75
966.092
31
2005
23071.72
591 6839.829
351
6839.079
136
1677.368
44
2006
21048.35
647 15912.88
402 15912.332
143
4894.745
64
2007
20933.29
738 13339.68
468 13338.551
198
8004.525
85
2008
20402.59
718 12548.14
457 12547.113
168
7716.865
62
2009
11813.88
629 8368.249
334
8367.685
118
832.989
29
2010
33695.68
619 22698.99
377 22697.238
141 17263.221
53
2011
12994.26
498 9290.498
303
9290.203
93
6357.782
32
2012
9954.258
443 5978.475
259
5977.866
85
3478.237
31

Metals,
Mining,
Auto,
IT & ITES,
M/c,
Telecom,
Chem,
Textiles

Yet M&As don’t create value
• Or so says the popular wisdom

• The sobering reality is that only about 20 per cent of all
mergers really succeed. Most mergers typically erode
shareholder wealth…the cold, hard reality that most mergers
fail to achieve any real financial returns…very high rate of
merger failure…rampant merger failure…
~Grubb & Lamb (2000)
• On the contrary, M&As should constitute +ve NPV projects, improve
shareholder wealth

Practioner Studies and Their Key findings
Source &Date

Sample Size Sample
Period

Findings

McKinsey & Co., 1987
(cited in Lajoux and
Weston, 1998)

116 Firms

61% failed to earn back the
cost of equity.

McKinsey & Co. (cited in NA
Fisher, 1994)

A 10-year
period

David Mitchell of
Economists Intelligence
Unit, 1996 (cited in
Lajoux and Weston,
1998)

1992-1996 30%- successful
53%- satisfactory
11%- unsatisfactory
5%- disastrous

Survey of
executives in
150
companies

Ref. Bruner, R.F. Applied Mergers and Acquisitions. John Wiley and Sons, Inc.

23% transactions recovered
the cost incurred in the
deal

KPMG on Performance of Indian Companies

• KPMG study, 2013: Indian cos. that closed deals between 2005 & 2011
• Benchmark – Nifty & Sensex, > Index (by 10%) – exceed value, <Index by 10% Destroy value
• Synergies are more tangible with asset based deals (as compared to people
based deals – in case of Services sector)

Growth story vs. The sobering reality
• “In the 2007 and 2008 [economic] heyday they wanted to get [into]
global markets and I don’t think many of their strategies made sense.
• A number were looking at acquisitions as a paradigm shift, with
$100m-companies looking to acquire $200m- or $300m-companies.
• Some of these acquisition were more for the promoter [the
controlling entrepreneur] to make a name – an ego boost.
• Plus a number of Indian companies got carried away with the press
coverage on the India growth story and wanted to ride that wave.
~Prashant Mara, co-chair of the India Group at Osborne Clarke, a law firm

Ref. http://blogs.ft.com/beyond-brics/2013/04/09/india-ma/

POSSIBLE OUTCOMES
• Value Conserved:
• Investment return equals the required return.
• Investor earn “normal” return.

• Value Created:
• Return on investment exceed the returns required.

• Value Destroyed:
• Investment returns are less than required.

For buyer and seller of target company, and the combined entity

Measurement Of M&A Profitability: Better Than
What?
Test

Structure : M&A
Pays If:

Description And comments

Weak
Form

P_After >
P_Before

Price improve from before to after the deal?
Used by consultants & journalists
Confounding events & Market wide events

Semi
strong
Form

% R_M&A Firm >
% R_Benchmark

Return exceed that of a benchmark?
Used by Academic researchers.

Strong
Form

%R_Firm with
M&A > %R_Firm
without M&A

Does the return on the firm’s share exceed what it would have
been without the deal.

Ref. Applied Mergers and Acquisitions by ROBERT F. BRUNER, WILEY FINANCE.

Approaches:
1. Accounting Studies:

• Focuses on net income, return on equity, EPS, leverage and
liquidity of the firm.
• Best studies are structured as matched-sample comparisons
• Weaknesses



Backward looking data
Change in reporting practices can make data incomparable
Differences in accounting policies across firms adds noise
Cross border comparisons not possible (different accounting
principles)

2. Event Studies:

• Examine abnormal returns to shareholders.
• Compared to a Benchmark

Event Studies
• 𝐸(𝑅𝑖𝑡 ) = 𝛼 + 𝛽 𝑅𝑚𝑡
• 𝐴𝑅𝑖𝑡 = 𝑅𝑖𝑡 − 𝐸(𝑅𝑖𝑡 )
• 𝐶𝐴𝑅𝑖𝑇 = 𝑡

2 𝑡
=𝑡1 A 𝑅𝑖𝑡

• Event, event date, first time when the information is disseminated
• Normal returns: Returns generated from a return generating model
• Excess Returns – Statistical test to test their significance
• If the event window studied starts from t-7, then the estimation period for
the model starts prior to the t-7 day (if the estimation period is 200 days
then: t-207 to t-8 day)
• Ref. Brown and Warner (1980, 1985), Mackinlay (1997), and Kothari & Warner (2007).

Event Studies (contd.)
• Forward looking measure of value creation
• Weakness: Inferences drawn from it are always joint hypothesis
• That the event earns abnormal returns
• That the benchmark used proves the right measure of normal returns

• Weakness: Vulnerable to confounding events

Returns: Sell-side

Returns to the Target Firm Shareholders
Study

CARs (%)

N

Sample
Period

Event
Windows
(Days)

Notes

Lang Stulz Walkling
(1989)

+40.3%*

87

1968-1986

(-5,5)

Tender offers only

Servaes (1991)

+23.64%*

704

1972-1987

(-1,close)

Mergers & tender offers

Healy, Palepu,
Ruback(1992)

+45.6%*

50

1979-1984

(-5,5)

Largest U.S merger during
period

Eckbo, Thorburn (2000)

+7.45%*

332

1964-1983

(-40,0)

Canadian targets only

Renneboog,
Goergen(2003)

+9.01%*

136

1993-2000

(-1,0)

European transactions

Myth: Takeovers harm the shareholders of target companies.

Returns: Buy-side

Studies Reporting Negative Returns to Acquirers.
Study

CARs

Sample

Sample
Period

Event
Window
(Days)

Notes

Asquith, Bruner,
Mullins (1987)

-0.85%*

343

1973-1983

(-1,0)

Servaes(1991)

-1.07%*

384

1972-1987

(-1, close)

Merger and tender offer

Healy, Palepu,
Ruback (1992)

-2.2%

50

1979-1984

(-5,5)

50 largest U.S mergers during
period

Kaplan, Weisbach
(1992)

-1.49%*

271

1971-1982

(-5,5)

Mergers and tender offers

Mitchell,
Stafford(2000)

-0.14%*

366

1961-1993

(-1,0)

Fama and French 3 factor model

Kuipers, Miller,
Patel (2003)

-0.92%*

138

1982-1991

(-1,0)

Foreign acquirers of U.S targets

Studies Reporting Positive Returns to Acquirers
Study

CARs

Size

Period

Days

Bradley, Desai, Kim
(1982)

+2.35* successful

161

19621980

(-10, +10) Tender offers only

Asquith, Bruner, Mullins
(1983)

+3.48%* successful
+0.70%
unsuccessful

170

19631979

(-20, +1)

Mergers only

+0.70%*

142

19932000

(-1, 0)

European transactions

Renneboog, Goergen
(2003)

Notes

41

Summary of Studies of Financial Statement Data
Author, Sample Period
and Sample Size

Major Findings

Meeks (1977)
1964-1972
233 mergers

ROA for acquiring firms in the United Kingdom
consistently declined in post merger years

Healy, Palepu, Ruback (1997)
1979-1984
50 mergers

Based on the 50 largest U.S mergers, operating
cash flow returns as a result of merger met, but
did not exceed the premium paid for target.

Carline, Linn, Yadav (2001)
1985-1994
86 mergers

Buyers & targets, underperformed their industry
peers in 5 years before merger & outperformed
in 5 years after.

Concern
• If bidders are more likely to lose or not create value
• And Bidders are larger in size
• In a combined entity: Large gains by targets could be easily offset by small
loss to bidder
• And the merger as a whole could destroy value

Returns to the Combined Entity

Combined Returns
Study

CARs

N

Sample
Period

Event
Window

% Positive
Returns

Notes

Servaes (1991)

+3.66%*

384

1972-1987

(-1,close)

NA

Mergers &
tender offer

Kaplan,
Weisbach (1992)

+3.74%*

209

1971-1982

(-5,5)

66%

Merger and
tender offer

Mulherin,
Boone(2000)

+3.56%

281

1990-1999

(-1,+1)

NA

Returns to Rivals
• Rivals of acquisition targets earn significant positive abnormal returns
• Increased probability that they will become targets themselves
• In case of terminated deals, targets lose whereas rivals gain

New Evidence on Value Creation

Cumulative Abnormal Returns to Acquiring Firms
Transaction Region

Mean

Median

No.

1. All

-0.91***

-0.80***

4,577

2. US

-1.34***

-1.11***

3,171

3. UK

-1.58***

-1.24***

354

4. CAN

-1.54***

-1.42***

325

5. RofE

1.65***

1.11***

212

6. Japan

2.45***

1.80***

182

7. RofA

0.75

0.49

99

8. Oceania

1.04

0.64

181

9. S. Africa

0.64

0.75

36

10. S. America

2.32*

1.68

27

11.UUC

-1.38***

-1.15 ***

3,850

12. RoW

1.56***

1.10***

727

Cumulative Abnormal Returns to Target
Transaction Region

Mean

Median

No.

1. All

17.65***

15.39***

2,996

2. UUC

19.65***

17.42***

2,430

3. RoW

9.04***

7.81***

566

(3)- (2)

-10.61***

-9.61***

Cumulative Abnormal Returns to
Combined Firms
Transaction Region

Mean

Median

No.

1. All

1.45***

1.27***

2,995

2. UUC

1.19***

1.06***

2,429

3. RoW

2.57***

2.15***

566

(3)-(2)

1.38***

1.09***

Cumulative Abnormal returns – Indian
Acquirers
Event Study Analysis - Summary of Abnormal Returns

TYPE OF DEAL N

CASH

286 Mean
P-value

Deals with
Negative CARs
STOCK

%
49 Mean
P-value

Deals with
Negative CARs

%

Day 0

Day -1 to Day -3 to Day -5 to Day 0 to Day -1 to Day -2 to Day -2 to Day -3 to
0
0
0
1
1
0
+1
-1

CAR1

CAR2

CAR3

CAR4

CAR6

CAR10

CAR14

CAR15

CAR17

0.0079

0.0122

0.0106

0.0094

0.0098

0.0141

0.0088

0.0107

0.0026

0.0005

0.0001

0.007

0.0328

0.0018

0.0001

0.0111

0.0081

0.3846

45%

44%

46%

46%

42%

42%

43%

44%

52%

0.0047

0.0031

0.0201

0.0190

-0.0040

-0.0056

0.0140

0.0054

0.0154

0.2700

0.6721

0.0509

0.1483

0.5994

0.6023

0.0629

0.6249

0.0825

47%

51%

43%

49%

55%

61%

49%

51%

45%

The Performance Implications Of
Participating In An Acquisition Wave
• Acquisition performance is higher for early movers
• Lower for acquirers that participate at the height of the acquisition wave.
• Both industry and acquirer characteristics influence the degree to which firms
seize early mover advantages or fall pray to bandwagon pressures.

Value Creation/Destruction during Merger
Waves
Early Mover
Advantages
Bandwagon effect

Mcnamara, G.M., Haleblian, J., & Dykes, B.J. 2008. ‘The performance implications of participating in an acquisition wave: Early
mover advantages, bandwagon effects & moderating influence of industry characteristics and acquirer tactics’. The Academy of
Management Journal, 51(1), pp. 113-130.

Wealth Destruction on Massive Scale

Yearly Aggregate Dollar Return of Acquiring-firm shareholders (1980-2001)
Moeller, S.B., Schlingemann, F.P., and Stulz, R.M., 2005. ‘Wealth destruction on a Massive Scale? A study of Acquiring-firm
returns in the recent merger wave’. The Journal of Finance, 60(2), pp. 757-782

Value Creation during Indian Merger Waves
Early Movers versus Late Entrants in a Merger Wave -The Difference of Means test
Panel I: Year 2004 vs. 2011

Event
windows

Day 0

Day -1
to 0

Day 0 to Day 0 to Day 0 to Day 0 to Day -1
1
3
5
7
to 1

Day -5
to 5

Day -7
to 7

Day -2
to 0

Day -2 to
+1

Diff. of
Mean (N:
19,20 )

0.0097

0.0280

0.0278

0.0307

0.0460

0.0514

0.0461

0.0647

0.0773

0.0169

0.0349

p-value

0.3822

0.0559

0.0789

0.1991

0.0628

0.0698

0.0164

0.0840

0.0606

0.2751

0.0991

Panel II: Year 2004-5 vs. 2010-11
Diff. of
Mean (N:
43, 56)

0.0125

0.0203

0.0183

0.0267

0.0353

0.0442

0.0262

0.0424

0.0490

0.0142

0.0200

p-value

0.0659

0.0144

0.0406

0.0226

0.0046

0.0028

0.0111

0.0178

0.0164

0.1396

0.0828

Panel III: Year 2004-5-6 vs. 2009-10-11
Diff. of
Mean (N:
74, 90)

0.0055

0.0161

0.0094

0.0124

0.0192

0.0203

0.0200

0.0141

0.0119

0.0100

0.0139

p-value

0.3157

0.0288

0.2236

0.1746

0.0525

0.0822

0.0296

0.3297

0.4734

0.2253

0.1645

Wave vs. Non-Wave period
Cumulative Abnormal Returns for Wave period and Non-wave period Deals
Panel I: Aggregate Wave Period Deals (2004-2011)
Event
windows

Day 0 Day -1 to 0 Day -3 to 0 Day -5 to 0 Day -7 to 0 Day 0 to 1 Day -1 to 1 Day -2 to 0

Day -2 to
+1

Day -3 to
+1

Mean
(N=247)

0.0068

0.0097

0.0111

0.0091

0.0071

0.0057

0.0086

0.0084

0.0073

0.01

p-values

0.0027

0.0013

0.0043

0.0508

0.173

0.0749

0.0236

0.012

0.0696

0.0253

Panel II: Aggregate Non-Wave Period Deals (1995-2003)
Mean
(N=108)

0.0077

0.0117

0.0136

0.0137

0.0187

0.0107

0.0146

0.0109

0.0138

0.0165

p-values

0.0481

0.0369

0.0658

0.0865

0.0541

0.0601

0.0341

0.0846

0.0725

0.0578

Panel III: Difference of Means Test (Non-Wave vs. Wave Period Deals)
Diff. of
Means
(108, 247)

0.0009

0.002

0.0025

0.0046

0.0116

0.005

0.0061

0.0024

0.0065

0.0065

p-values

0.8257

0.7308

0.7445

0.6029

0.2525

0.4111

0.4058

0.7093

0.4121

0.4596

Viewing The Whole Mosaic: Some
Conclusions
• Does Pay: For targets, value is created.
• Doesn’t Pay: Buyers get at least what they deserve.
• It depends
• Managers can make choices that materially influence the profitability of
M&A.

Factors Affecting Gains in M&A

Factors Affecting Gains in M&A
• Acquisition method: Merger or Tender Offer
• Less scope for drastic restructuring and potential value creation after the
merger

• Method of Payment
• Information asymmetries & overvaluation
• Risk Sharing (Private targets)

• Country
• Developed countries have highly competitive market for corporate control
(high premium)

• Wave Period
• Position in the wave
• No diff in non-wave period

Factors (contd.)
• Attitude of the Transaction
• Hostile bidders lose

• Ownership: Toehold
• Target gains decrease with the size of the initial bidder’s toehold.
• Less bargaining power

• Financial Synergies
• When high growth and cash poor firm is acquired by a cash-rich bidder
• Bidder, target and total returns are highest for acquisitions that combine
slack poor & free cash flow firms
• Negative returns for deals where bidders & targets are similarly classified

Factors (contd.)
• Diversification
• Value destroying

• Managerial Holdings
• Greater money at stake – value creating
• LBOs are value creating

• Free Cash flow
• Deals by firms with excess cash are value destroying

• Hubris
• Glamour acquirers (w.r.t high M/B, past performance – stock price, earnings, &
cash flows) tend to fall prey to CEO hubris
• Value creating in the short run
• Reversal in the long run - destroys value

• Speed of Integration
• Fast track integration – achieve over 80% of objectives
• Go-slow integration – failure rate approaching 50%

Myths Surrounding M&A’s
• Takeovers harm the shareholders of target companies.
• Evidence to the contrary

• Takeover expenditures are wasted.
• Takeovers are solutions to the problems associated with free cash flows

• By merging competitors, takeovers create a monopoly that will raise
product prices, produce less, and thereby harm consumers.
• Consolidating facilities after a takeover leads to plant closings,
layoffs, and employee dismissals- all at great social cost.
• Managers act in their own interests and are in reality unanswerable
to shareholders.

References
• Applied Mergers and Acquisitions by ROBERT F. BRUNER, WILEY FINANCE.
• Gains from Mergers and Acquisitions Around the World: New Evidence by G.
Alexandridis, D. Petmezas, and N.G.Travlos, Financial Management.
• Takeovers: Folklore and Science by Michael C. Jensen.
• Mcnamara, G.M., Haleblian, J., & Dykes, B.J. 2008. ‘The performance implications of
participating in an acquisition wave: Early mover advantages, bandwagon effects &
moderating influence of industry characteristics and acquirer tactics’. The Academy of
Management Journal, 51(1), pp. 113-130.