M&A

introduction
Sessions 1

Antonio Salvi

1
Agenda
M&A DEFINITIONS

M&A RATIONALE

M&A WAVES

M&A RETURNS
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M&A DEFINITIONS

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Key definitions of M&A
 Merger: two firms are combined into a new
legal entity
➢ Horizontal merger: combination of firms in the
same industry
➢ Vertical merger: combination of firms involved
at different stages of the same business
➢ Conglomerate merger: combination of firms in
different industries (unrelated)

 Acquisition: one firm buys another one (its

assets or shares)
➢ Friendly acquisitions
➢ Hostile acquisitions

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Hostile vs. friendly takeovers
 A friendly (hostile) takeover occurs when one acquiring
corporation attempts to take over another corporation, the
target corporation, with (without) the agreement of the
target corporation’s board of directors.
 Most takeovers are friendly, but hostile takeovers and
activist campaigns have become more popular since 2000
with the risk of activist hedge funds.
 A hostile takeover is usually accomplished by:
 tender offer: the corporation seeks to purchase shares
from outstanding shareholders of the target corporation
at a premium to the current market price.
 proxy fight: the acquiring corporation tries to persuade
shareholders to use their proxy votes to install new
management or take other types of corporate action.
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Asset sale vs. stock sale
 Asset sale: the purchase of a group of assets
(a specific business) and liabilities.
 Stock sale: the purchase of the owner's
shares of a corporation.
 Generally, buyers prefer asset sales,
whereas sellers prefer stock sales.
 Approximately 30% of all transactions are
historically stock sales. However, this figure
varies significantly by company size, with larger
transactions having a greater likelihood of being
stock sales.
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Asset vs. stock sale: buyers’ viewpoint
1. By allocating a higher value for assets that depreciate quickly
(like equipment, which has a 3-7 year life) and by allocating
lower values on assets that amortize slowly (like goodwill, which
has a 15 year life), the buyer can gain additional tax benefits.
This reduces taxes sooner and improves the company's cash flow
during the first years.
2. In addition, buyers prefer asset sales because they more easily
avoid inheriting potential liabilities, especially contingent
liabilities in the form of product liability, contract disputes,
product warranty issues, or employee lawsuits.
 However, asset sales may also present problems for buyers.
Certain assets are more difficult to transfer due to issues of
assignability, legal ownership, and third-party consents. Examples
of more difficult to transfer assets include certain intellectual
property, contracts, leases, and permits. Obtaining consents and
refiling permit applications can slow down the transaction process.
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Asset vs. stock sale: sellers’ viewpoint
 For sellers, asset sales generate higher taxes because while
intangible assets, such as goodwill, are taxed at capital gains
rates, other "hard" assets can be subject to higher ordinary
income tax rates.
 Furthermore, the seller faces double taxation. The corporation
is first taxed upon selling the assets to the buyer. The
corporation's owners are then taxed again when the proceeds
transfer outside the corporation.

https://www.youtube.com/watch?v=Kw4cTum_fVohttps://
www.youtube.com/watch?v=Kw4cTum_fVo

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Key definitions of M&A
 Spinoff/demerger: separation of a division
or subsidiary from its parent company to
create a new independent company by
issuing new shares
➢ The parent firm distributes shares of the
subsidiary to its shareholders through a stock
dividend.

 Carve out: partial spinoff, selling a minority

stake in a subsidiary for an IPO.
➢ A new publicly-listed company is created, but
the parent keeps a controlling stake in the
newly traded subsidiary.

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M&A RATIONALE

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M&A: motivations
1. Strategic realignment
1. Technological change
2. Deregulation
3. Market power
2. Synergy
1. Economies of scale/scope
2. Cross-selling
3. Financial considerations
1. Acquirer believes target is undervalued
2. Booming stock market
3. Falling interest rates
4. Tax considerations
5. Ego/Hubris
6. Diversification (Related/Unrelated)
(Video – 3 kinds of opportunities)
Diversification: a word of caution
 Diversification might pay if:
1. There is high relatedness in terms of industry
focus between the target and the buyer;
2. Promotes knowledge transfer across divisions
3. Creates critical mass for facing the
competition;
4. Exploits better transparency and monitoring
through internal capital markets;
5. Managers are properly motivated and
rewarded.

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Generic models on the diversification/performance
link (Nippa, Pidun, Rubner)

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Diversification: available evidence
 There is prevailing evidence that the U-
shaped curve best fits reality.
 Over a certain degree of diversification there is a
significant increase of the associated costs:
1. Information-processing constraints: difficulties in
monitoring the simultaneous performance of
businesses;
2. Internal politics: conflicts between various business
units;
3. Incentive problem: increasing difficulties of setting
common incentive schemes;
4. Lack of responsiveness: difficult time to the market
of the controlled businesses due to the lower decisional
process. 14
M&A WAVES

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Merger waves and their drivers
 M&A activity appears in waves, which follow a
random walk and show no regularity in terms of (1)
period length or (2) amplitude.

Macro hypotheses
1. Monopoly, competitive positioning and legal framework
2. Industry shocks

Financial hypotheses
1. Overvaluation of stocks, rising stock markets or
2. Low interest rates: M&A waves are procyclical!

Other hypotheses
1. Pride (or Hubris): my deal will be different!
(Video “Discipline and hubrys”)
2. Market manias: I don’t want to be left out!
3. Agency costs: hostile takeovers and LBOs
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Significance of M&A Waves
 Why it is important to anticipate M&A waves?
1. Financial markets reward firms pursuing promising
opportunities early on and penalize those that follow
later in the cycle.
2. Acquisitions made early in the wave often earn
substantially higher financial returns than those
made later in the cycle.
Merger waves
Wave 1 (1897-1903)  Merger for monopoly
Horizontal consolidation Horizontal integration mergers

Wave 2 (1916-1929)  Merger for oligopoly

Increasing concentration Vertical integration mergers

Wave 3 (1965-1973)  Conglomerates

Conglomerate era

Wave 4 (1981-1989)  Hostile takeovers

Retrenchment era Cost-cutting post-deal strategies

 Deregulation
Wave 5 (1996-2000)
Specific industries: banking; health
Strategic megamerger care; defense; technology
 Globalization
Wave 6 (2003-2008) 18
Specific industries: banking; health
Cross-border & Horizontal megamerg. care; defense; high technology

Wave 7 (2014-)
 ?
?
A recent wave?

12/09/2021 M&A 1 19
 Summary of waves
1st 2nd 3rd 4th 5th 6th 7th
Time period 1897-1903 1916-1929 1965-1973 1980s 1996-2000 2003-2008 2014?

Geographic US, UK, US, UK,

US US US, UK, EU Global Global
scope EU, Asia EU, Asia

Value (bn$) 6.9 7.3 46 608 4500 12000

# of deals 3012 4828 7545 9617 31152 46287

Elimination
Diversificatio Internationa Industry Industry
Rationale Monopolies Oligopolies conglomera
n l expansion consolidat. consolidat.
tes

•Lack •Antitrust • Increasing • Reduced • Deregulat •Low • Low rates

antitrust law; antitrust; antitrust ion interest • Technolo
Drivers of •Stock •post war • internal deregulat • Privatizati rates; gy
wave exchange boom capital ion; on •Excess • Gvt.
•Economic mkts • junk capacity Incentive
expansion bonds s

Acquisition
Friendly Friendly Friendly Hostile Hostile Friendly Friendly
types

Financing Cash Stock Stock Cash Stock Cash Cash

Positive for Positive for

Performance Positive Mixed Positive Positive ?
targets targets
Similarities and differences
among merger waves
 Similarities
1. Occurred during periods of sustained
economic growth
2. Rising stock markets
3. Low or declining interest rates
 Differences
◼ Emergence of new technology (e.g., railroads,
Internet, Fintech)
◼ Industry focus
◼ Type of transaction (e.g., horizontal, vertical,
conglomerate, strategic, or financial)
1. Horizontal Consolidation (1897-1903)
 Spurred by
◼ Lax enforcement of antitrust laws
◼ Westward migration, and
◼ Technological change
 Resulted in concentration in metals,
transportation, and mining industry
 M&A boom ended by 1903 stock market
crash and fraudulent financing.
2. Increasing concentration (1916-1929)
 Spurred by post-war boom
 Boom ended with
◼ 1929 stock market crash
◼ Passage of Clayton Act which more clearly
defined monopolistic practices
3. Conglomerate Era (1965-1973)
 Conglomerates buy earnings to boost their
share price
◼ Overvalued firms acquired undervalued high
growth firms
◼ Number of high-growth undervalued firms
declined as conglomerates bid up their prices
◼ Higher purchase price for target firms and
increasing leverage of conglomerates brought
era to a close. Oil crisis.
4. Retrenchment Era (1981-1989)
 Strategic U.S. buyers and foreign multinationals
dominated first half of the decade
 Second half dominated by financial buyers
◼ Buyouts often financed by junk bonds
◼ Drexel Burnham provided market liquidity
 Era ended with bankruptcy of several large LBOs
and demise of Drexel Burnham
5. Strategic Megamergers (1996-2000)
 Dollar volume of transactions reached record in
each year between 1996 and 2000.
 Purchase prices reached record levels due to:
◼ Soaring stock market
◼ Consolidation in many industries
◼ Technological innovation
◼ Benign antitrust policies
 Period ended with the collapse in global stock
markets, worldwide recession and Sep 11.
6. Cross Border and
Horizontal Megamergers (2003 – 2008)
 Average merger larger than in 1980s and
1990s, mostly horizontal, and cross border.
 Concentrated in banking, telecom, utilities,
healthcare and commodities (e.g., oil, gas, and
metals)
 Spurred by:
◼ Continued globalization to achieve economies
of scale and scope;
◼ Ongoing deregulation;
◼ Low interest rates;
◼ Increasing equity prices
◼ Expectations of high commodity prices
 Period ended with global credit market meltdown
and 2008-2009 recession.
M&A RETURNS

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When does M&A pay?
 The best measurable benchmark for evaluating
any investment is the investors’ required
return, i.e. the return that investors could have
earned on other investment opportunities of
similar risk:
1. Value is created when the returns on the
investment exceed the required rate of
return;
2. Value is destroyed when the investment
returns fall short of the return rate required
by investors;
3. Value is conserved when investors earn the
required rate of return.
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M&A and EPS fallacy
 The acquisition of an attractive business will
generally lead to earnings dilution, if the
multiple paid for the target tends to be relatively
high.
 Rule: when the target P/EPS ratio > buyer’s
P/EPS ratio, the buyer will experience a
dilution of its EPS.
 However, one should consider that:
EPS x P/EPS = P

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Does M&A pay?
 There are basically 3 ways for
estimating the value creation:
1. Event studies
2. Accounting studies
3. Surveys of executives

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Does M&A pay?
Major results from event studies
1. Shareholders of target firms receive
abnormal positive returns
2. Returns to buyer shareholders
essentially break even and value is
conserved
3. Shareholders who invest in the
combined entity formed by an M&A
transaction receive positive returns.

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Does M&A pay?
Major results from accounting studies
 4 studies report significantly negative
performance post acquisition
 6 report significantly positive performance
 Other studies are in the middle, with no
significant performance.

 To summarize: “if a generalization is to be

drawn, it would have to be that mergers have
modest effects, up or down, on the profitability
of merging firms in the 3 to 5 years following
mergers”.
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Key evidence from accounting studies
1. Expected synergies are important drivers of
wealth creation.
2. Increased market share does not create
value. Sources of gains from M&A do not derive
from anticompetitive combination of firms.
3. Paying with stock is costly; paying with cash
is neutral. The market believes the stocks are
overvalued.
4. Hostile deals create more value for buyers
than do friendly deals.
5. When managers have a greater economic
interest, more value is created.
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Findings from surveys of executives
 8 of the 16 studies suggest negative results.
 The remainder seem neutral or positive.

 The strength of the respondents view about all

M&A was inversely related to their view of their
own deals: the better they felt about their own
deals, the more they condemned M&A results in
general.
 For reasons of ego executives tell the world nicer
things about their own deals of others.

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Literature analysis: a conclusion
 Although most of all M&A transactions are
associated with financial performance that
compensates investors for their opportunity
cost, too many failures have been witnessed.

 Video: M&A - successes and failures

http://www.youtube.com/watch?v=VyqsLoMcKM0

 Video: Top 10 Disastrous Mergers &

Acquisitions (M&A):
http://www.youtube.com/watch?v=9dFvhq2sKfM

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Cross border M&A: a profile
1. More related to the buyer’s core industry
2. Paid for mainly in cash (distrust…)
3. Targets are mainly manufacturing firms
with low intangible assets

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Cross border M&A: drivers
1. Market imperfections (cheap labor or raw
materials,…)
2. Extending the reach of intangible assets (broaden
the scale of their use and preempt others who might
be tempted to imitate or appropriate them)
3. Reducing tax expense through arbitrage across
different tax jurisdictions
4. Improve governance
5. Exploit differences in capital markets and currency
conditions
6. Reducing risk through diversification across countries
(see next slide)

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Cross-Market Return Correlations
US JPN UK GER SWZ FRA NED DEN SWE NOR FIN World
US 1
JPN 0.119 1
UK 0.402 0.249 1
GER 0.455 0.229 0.663 1
SWZ 0.377 0.245 0.682 0.713 1
FRA 0.406 0.235 0.748 0.749 0.717 1
NED 0.405 0.255 0.760 0.779 0.764 0.803 1
DEN 0.246 0.225 0.489 0.528 0.512 0.523 0.556 1
SWE 0.349 0.274 0.609 0.642 0.608 0.663 0.664 0.536 1
NOR 0.250 0.266 0.514 0.532 0.554 0.524 0.567 0.514 0.588 1
FIN 0.288 0.199 0.508 0.528 0.458 0.551 0.563 0.438 0.639 0.460 1
World 0.782 0.472 0.603 0.625 0.565 0.598 0.604 0.419 0.549 0.438 0.442 1

Average 0.360 0.224 0.549 0.568 0.545 0.575 0.593 0.441 0.543 0.462 0.454 0.561

Daily index returns in the sample period December 31, 1999 to January 31, 2009.

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Drivers of international M&A
 This table shows the Investments Investments
extent to which in emerging in developed
markets markets
choices about country,
industry and specific Stock-
firm explained cross specific 16% 22%
factors
sectional variation
in global equity Industry
returns 38% 48%
factors
 Industry factors are
dominant in Country
46% 30%
developed countries factors
and country factors
are dominant in
TOTAL 100% 100%
emerging markets.
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Does cross border M&A pay?
 Cross border M&A does pay.
◼ Returns to target shareholders are
significantly positive.
◼ Returns to buyers are essentially zero.
◼ Positive joint wealth changes to buyers and
targets.

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An alternative analysis of performance
 The distribution of results is extremely wide.
 There is a prevalence of big wins and losses.
 Many deals create tremendous value.

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Key success factors : evidence
Factor Rationale
A higher degree of strategic fit leads to more successful
Strategic fit
transactions. Based on SIC codes, 8-digit similar SIC
(growth vs. cost
are 50% more successful than unrelated
saving strategies)
acquisitions.
Higher target profitability and growth is associated with
Profitability and
greater success, albeit these cases are associated with
growth
greater EPS dilution.
Higher multiple targets tend to outperform lower multiple
Valuation
targets.
The critical post-merger integration is easier for smaller
Deal size deals. Smaller deals tend to outperform larger
deals.
Private targets tend to outperform public targets.
Ownership Private targets tend to share all the pros of smaller
targets.
Market rewards serial acquirers (more than 5
Serial acquisitions transactions). There is evidence of learning-by-
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doing.
And now?....
 Video: Outlook 2021
https://www.youtube.com/watch?v=e0K3S-Q8JvE

Lessons to be learned:
 Video: Mergers and Acquisitions: The world's
best lecture tutorial in a nutshell
https://www.youtube.com/watch?v=sQ6xACl8hJk