CHAPTER

31 31-1

MERGERS

Brealey, Myers, and Allen

Principles of Corporate Finance
12th Edition
Slides by Matthew Will
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 Topics Covered
31-2

• Sensible Motives for Mergers

• Some Dubious Reasons for Mergers
• Estimating Merger Gains and Costs
• The Mechanics of a Merger
• Proxy Fights, Takeovers, and the Market for
Corporate Control
• Mergers and the Economy

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 Recent Mergers
31-3

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 Mergers (1962-2013)
31-4

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 Sensible Reasons for Mergers
31-5

Economies of Scale
A larger firm may be able to reduce its per unit cost by
using excess capacity or spreading fixed costs across
more units.

Reduces costs

$ $ $

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 Sensible Reasons for Mergers
31-6

Economies of Vertical Integration

o Control over suppliers “may” reduce costs.
o Over integration can cause the opposite effect.

Pre-integration Post-integration
(less efficient) (more efficient)
Company Company
S
S S S
S
S S S

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 Sensible Reasons for Mergers
31-7

Combining Complementary Resources

Merging may results in each firm filling in the
“missing pieces” of their firm with pieces from
the other firm.

Firm A

Firm B

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 Sensible Reasons for Mergers
31-8

Mergers as a Use for Surplus Funds

If your firm is in a mature industry with few, if
any, positive NPV projects available,
acquisition may be the best use of your funds.

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 Sensible Reasons for Mergers
31-9

Elimination of Inefficiencies
Poor management may waste money, make
poor decisions, conduct improper risk/return
investments and harm the value of the
company. Sometimes, the only way to remedy
the situation is to change management.

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 Sensible Reasons for Mergers
31-10

Industry Consolidation
The biggest opportunities to improve efficiency
seem to come in industries with too many firms
and too much capacity. These conditions often
trigger a wave of mergers and acquisitions, which
then force companies to cut capacity and
employment and release capital for reinvestment
elsewhere in the economy.

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 Bank of America Family Tree
31-11

Note: Ironically, MBNA was once owned by a previous version of

Bank of America, which sold it in an IPO.

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 Dubious Reasons for Mergers
31-12

• Diversification
oInvestors should not pay a premium for
diversification since they can do it
themselves.

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 Dubious Reasons for Mergers
31-13

The Bootstrap Game

Acquiring firm has high P/E ratio

Selling firm has low P/E ratio (due to low

number of shares)

After merger, acquiring firm has short-

term EPS rise

Long term, acquirer will have slower than

normal EPS growth due to share dilution

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 Dubious Reasons for Mergers
31-14

The Bootstrap Game

World Enterprises
World Enterprises (after buying Muck
(before merger) Muck and Slurry and Slurry)
EPS $ 2.00 $ 2.00 $ 2.67
Price per share $ 40.00 $ 20.00 $ 40.00
P/E Ratio 20 10 15
Number of shares 100,000 100,000 150,000
Total earnings $ 200,000 $ 200,000 $ 400,000
Total market value $ 4,000,000 $ 2,000,000 $ 6,000,000
Current earnings
per dollar invested
in stock $ 0.05 $ 0.10 $ 0.067

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 Dubious Reasons for Mergers
31-15

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 Estimating Merger Gains
31-16

• Questions
 Is there an overall economic gain to the merger?
 Do the terms of the merger make the company and
its shareholders better off?
 ????

PV(AB) > PV(A) + PV(B)

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 Estimating Merger Gains
31-17

Gain  PVAB  (PVA  PVB )  PVAB

Cost  cash paid  PVB

NPV  gain  lost

 PVAB  (cash  PVB )

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 Estimating Merger Gains
31-18

Example – Two firms merge creating $25 million in

synergies. If A buys B for $65 million, the cost is $15
million.
PVA  $200
PVB  $50
Gain  PVAB  $25
PVAB  $275 million

Cost  cash paid  PVB

 65  50  $15 million
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 Estimating Merger Gains
31-19

Example – The NPV to A will be the

difference between the gain and the cost.

NPVA  25  15  $10 million

NPVA  wealth with merger - wealth without merger

 (PVAB  cash )  PVA
 (275  65)  200
 $10 million

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 Estimating Merger Gains
31-20

• Economic gain

Economic gain = PV(increased earnings)

new cash flows from synergies

=
discount rate

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 Accounting for a Merger
31-21

Accounting for the merger of A Corp and B Corp

assuming that A Corp pays $18 million for B Corp.

Initial Balance Sheets

A Corporation B Corporation
NWC 20 30 D NWC 1 0 D
FA 80 70 E FA 9 10 E
100 100 10 10

Balance Sheet of AB corporation

NWC 21 30 D
FA 89 88 E
Goodwill 8
118 118

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 The Mechanics of a Merger
31-22

Taxable Merger Tax-free Merger

Capital gain can be deferred

Impact on Captain Captain B must recognize a
until Captain B sells the
B $30000 capital gain.
Baycorp shares.

Boat is revalued at $280000.

Tax depreciation increases to Boat's value remains at
Impact on Baycorp $280000/10=$28000 per year $150000, and tax depreciation
(assuming 10 years of continues at $15000 per year.
remaining life)

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 Oracle / PeopleSoft
31-23

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 Takeover Methods
31-24

Tools Used To Acquire Companies

Proxy Tender Offer

Contest

Acquisition Merger

Leveraged Management
Buy-Out Buy-Out

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 Takeover Defenses
31-25

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 Takeover Defenses
31-26

• White knight - Friendly potential acquirer sought by a

target company threatened by an unwelcome suitor.

• Shark repellent - Amendments to a company charter

made to forestall takeover attempts.

• Poison pill - Measure taken by a target firm to avoid

acquisition; for example, the right for existing
shareholders to buy additional shares at an attractive
price if a bidder acquires a large holding.

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 Benefits and Cost of Mergers
31-27

• Who usually benefits from the merger?

o Shareholders of the target
o Lawyers & Brokers
o The executives of the acquiring firm

• Who usually loses in a merger?

o Shareholders of the acquirer due to overpayment
o Executives on the target
o All employees due to restructuring

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