FIN 572 MOOC 1 Module 4 Word Transcript

Finance of Mergers and Acquisitions: Valuation and Pricing
Professor Heitor Almeida
Module 4: Synergies and Hostile Takeovers
Table of Contents
Module 4: Synergies and Hostile Takeovers ..................................................................................... 1
Lesson 4-1: Module 4 Introduction ................................................................................................... 2
Module 4 Objectives and Overview .................................................................................................................... 2
Lesson 4-2 ...................................................................................................................................... 13

Synergy Valuation: Management Perspective .................................................................................................. 13
Synergy Valuation: The Market's View ............................................................................................................. 30
The Chance of Deal Failure and Merger Arbitrage............................................................................................ 48
Additional Examples: When Markets and Managers Disagree ......................................................................... 60
Lesson 4-3 ...................................................................................................................................... 80

Bidder Strategies ............................................................................................................................................... 80
Target Strategies ............................................................................................................................................... 97
Do Takeover Defenses Create or Destroy Value? ........................................................................................... 119
Examples of Hostile Deals ............................................................................................................................... 131
Module 4 Review ......................................................................................................................... 157

Module 4 Review ............................................................................................................................................ 157
Couse Conclusion ......................................................................................................................... 162

Course Conclusion........................................................................................................................................... 162
1
Lesson 4-1: Module 4 Introduction
Module 4 Objectives and Overview
In this module, we're going to learn how to value synergies. A very interesting topic that
we're going to talk about is that there are two views about synergies. There is the
management view, which is financial managers, the managers of the acquiring the
target use to design the M&A deal. But then there's also the market view. We can
calculate. We can figure out what is the markets valuation of synergies.
2
As you might imagine very frequently, managements and markets have different views.
The management will, typically, in a strategic M&A, disclose estimates that we can use
to place a value on synergies, where we can calculate the net present value of
synergies using the techniques we're going to learn in this module. But the stock market
has its own views. If the acquirer is a public company, we can actually look at stock
market data to figure out what the market thinks about the M&A deal. Then as we're
going to see, there is often disagreement and we're going to learn why do managers
and markets often disagree with each other.
3
In order to figure out the market valuation of the deal, what we're going to do is, we're
going to use the market's reaction to the deal announcement. There is news about an
M&A deal we can use this news in order to figure out the market value of the deal. Also,
it's important to point out that the market reaction is not going to depend only on
synergies. It's going to depend on other variables as well and we need to know that in
order to properly interpret the reaction of the market and try to figure out what's the
market's view about the deal.
4
A very important concept that we're going to learn in this module is that synergies and
M&A premia are related. We're going to learn how to relate synergies to the premium
paid for target, what is the relationship between those two concepts and how to use
these calculations to figure out what is the net present value of a deal both for acquire
and target.
In the second part of this module, we're going to talk about a very interesting part of the
5
M&A world, which I like to call rare and fine because it's not the most common type of
M&A deal, but it really consists of some of the most interesting M&A deals that we have
out there, which is what we call a hostile takeover.
This is a situation in which the target does not want to be acquired, but then the acquire
tries to force the acquisition and there of course raises a lot of interesting issues. For
example, about governance and legal issues around M&A that we're going to highlight
in this module.
6
You can think of a hostile takeover as a battle for control.
You have acquirers, targets, boards, shareholders, judges. There are lots of players. In
my view is that not only is important, of course, to cover hostile takeovers, but it's also a
great way to learn more about M&A to think about this deals in which the target does
not want to be acquired.
7
The other reason why hostile takeovers is important is because the hostile takeover can
be the next step following a friendly negotiation, which also means that a friendly deal is
frequently framed by the prospect of a hostile battle. Even if hostile takeovers in practice
are rare, the threat of hostility may be framing the M&A market. It may be framing the
deals that appear to be friendly, but really are affected by the prospect of a hostile
battle, as we're going to learn in this module.
8
Specifically, in Module 4, you're going to learn how to value synergies. Of course, that's
a very important part of M&A. We're going to learn the difference between the
management and the market's perspective when value synergies.
Then we're going to learn how to calculate the NPV of a deal, both for the acquiring and
the target and how to relate synergies to M&A premia. Those two topics are very related
as you're going to learn. Then we're going to talk about the market's reaction. How can
9
we use the stock market reaction to figure out the value of those synergies? For that,
we need to discuss the idea that the stock market reaction depends on factors other
than synergies.
We're going to learn about merger arbitrage spreads, which is an important figure in the
M&A world and how to infer the chances of deal failure from this arbitrage spread.
10
Then we're going to move to hostile takeovers. We're going to talk about strategies, the
battle for control. We're going to talk about strategies that acquirers and targets have
during this hostile takeover battle. This battle is framed by very important regulations
that we need to talk about. Acquirers and targets are not free to do whatever they want.
There is certain rules and laws that need to be obeyed and that you have to learn about.
Specifically, we're going to learn about poison pills, which is a very important takeover
11
defense strategy and the role of other governance provisions, in particular, poison pills
and staggered boards, are the most important takeover defense that targets have. We
need to learn what these are and why they are important for the M&A market. We're
also going to talk about evaluation questions. This takeover defenses, for example,
poison pills, we're going to learn that they can benefit or they can hurt the shareholders
of the target and we're going to talk about this trade-off and we're going to talk about the
empirical evidence that we have on poison pills.
We're also going to talk about why poison pills are legal. We're going to have a lot of
discussion to figure out why poison pills are actually legal. I'm going to show some
evidence that poison pills destroy shareholder value on average, but they are legal.
We're going to learn why. However, it is true, as we are going to learn in this module as
well, that poison pills in order takeover defenses have become less common over time.
We're going to learn why. Finally, we're going to talk about the fact that even if a target
board does not have a poison pill available, a board can still have defenses sealed.
There are ways that companies can defend against hostile acquisition, even if you
cannot deploy poison pills.
12
Lesson 4-2
Synergy Valuation: Management Perspective
Most value creation in M&A deals comes from synergies. Which, as we already learned,
reflect changes such as cost reductions, increases in market power, other increases in
revenue, etc. We talked about these already in the course. What we're going to do in
these notes is to learn how to value synergies, and how to use this valuation in your
M&A deal analysis.
13
We already discussed what synergies are and where they come from, like cost
reduction for example. We also learned that so synergies are the main source of value
creation in M&A. Now what we need to know is we need to be able to place a value on
these synergies. I'll talk more about the details of how to do this valuation. It's very
similar to other valuations you have worked on already, but it's important to go over
some of the details here.
14
What we're going to use is the synergy cash flow. You can think about we always use
cash flows to do valuations. When an M&A deal is announced the management will
often almost always announce an expected increase in future cash flows coming from
these cost or revenue effect. These are the future cash flows that we're going to use to
discount and place a net present value on the synergy.
15
We're going to go back to an example we already discussed. It's the acquisition of
Bucyrus by Caterpillar.
In that case, we have the data on the synergies that we were talking about. This deal
was announced in November 2010. Caterpillar estimated $400 million in annual
synergies beginning in 2015 and the synergies, in that case, come from as it's explained
here they come combined financial strength and complementary product offerings of the
mining equipment business that both companies have.
16
Before we do the valuation, I want to point out here that there is this lag. Typically what
will happen is when a deal is announced the acquiring and the target have to take into
account the fact that the deal is going to take time to complete. It could be one year, two
years before the deal completes, and then there is the integration process. These
positive effects of M&A will take time to come. Typically at least two years, you're going
to see at least two years as a lag between the time that the deal is announced and the
time that the synergies are expected to kick in. This is something that we need to take
into account in the valuation.
17
In this specific example, the management of Caterpillar and Bucyrus does not discuss
integration costs. Integration costs come from issues like reduction in revenue from
similar products. For example, if two competitors merge, for example, if a company that
produces personal computers acquires another company that also produces personal
computers, a laptop for example, so some of the products are going to become
redundant and are going to be discontinued. There's going to be a reduction in revenue.
Then there can be legal costs, of course, so M&A costs money, you have to pay the
lawyers, the finance specialists, investment banks. These integration costs are always
going to be front-loaded, so they don't happen in the future, they are happening soon.
This happens immediately as soon as the M&A deal takes into things, for example, legal
costs are definitely going to be front-loaded. Typically, these integration costs when we
have the mini analysis are going to be frontloaded. In this first example, we're not going
to have integration cost, but we're going to do other examples later.
18
We need tax rates. Typically synergies are going to be disclosed on a pre-tax basis
because people have different ways of estimating taxes as we already discussed in the
course where we named we're going to need a discount rate to discount the synergies
and the growth rate because the synergies are going to be ongoing. They're not going
to be one time. The synergies are going to grow into the future.
Discounting synergies is tricky. We learned already that the discount rate is a function of
19
the risk of the project. For example, when you are valuing a company, you can get data
on the stock price of the company in order to estimate the risk of the company by
calculating betas. In the case of synergies though, it's tricky because we don't have a
market price on the synergy. Think about it, the synergy is a new thing, it's a new object,
a new product, etcetera, that the M&A do create. You don't really have market data to
do that. We also used multiples to do comparisons, to comparable analysis. Similarly,
you're not going to have comparable for synergies. It's a bit tricky to estimate the
discount rate for synergies. But here is an approach that is fairly standard in the
industry, is the one that we're going to be using.
If you think about it, there is an acquirer and the target. The synergy is different, it's
new, but it should be related to the acquirer and the target. The industries, for example,
industry risks. One way that you can accommodate that is by using a weighted average.
You have an acquirer and a target if they have similar size, for example, you can do an
average of the cost of capital of the acquirer and the target. Or in many cases, the
acquirer is larger than the target, so to simplify the estimation many practitioners, and
academics, they just use the cost of capital of the acquirer. If for example, in the case of
the Caterpillar Bucyrus merger, Caterpillar was almost 10 times the size of Bucyrus, so
it's reasonable to start from Caterpillar's cost of capital, which I'm not going to re-
estimate here. We learned how to estimate cost of capital already. I'm just going to give
you the numbers. In the case of Caterpillar, it's 8 percent in 2010. That's the number
we're going to use.
20
But then there is what we call the fudge factor, which is very typical in synergy
evaluation. Remember that synergy is this new thing, and new doesn't mean risky.
Maybe the new thing is going to reduce risk.
But typically what people do is to have this additional premium to the synergy discount
rate that takes into account the fact that the synergy is new and usually people have risk
aversion towards new things. The analysts who typically add this premium, so 2
21
percent, for example, is common, so you start from the acquirer discount rate or the
weighted average and then you add this fudge factor. In this case, I'm going to use 10
percent as the discount rate. The fudge factor, it's more of a practitioner thing. It's not
really based on finance theory, but it's typically, and typically I'm going to be using this 2
percent premium here.
In terms of the long-term growth rate, it's not different than any other evaluation that
we've done before. What we do typically is to be on the conservative side. We assume
that the long-term growth rate should be close to the expected inflation. In this example,
I'm going to use 3 percent.
22
Here's the evaluation, it should be fairly straightforward for you. You've done several
evaluations already in the course. You have the synergy that is starting five years from
now in 2015, the $400 million. We take the tax out, that's 30 percent, you get 280, and
then the synergy is going to grow 3 percent. That's why in 2016 you see that there is a 3
percent growth rate, and this is going to keep going. Similarly, to what we've done, the
relevant horizon is always infinite. What you need to do is you need to apply the
growing perpetuity formula, the most important formula in finance, to the synergy of 280,
and that brings the value one year before. Your synergy value in 2014 is 280 divided by
the discount rate minus the growth rate. That comes up to $4 billion, or 4,000 million. As
we've written here. Then what you do is you discount the $4 billion back to year 2010.
That gives us an NPV of the synergy of 2.73 billion at the end of 2010, which is the
announcement date that's when this merger was being evaluated. What this means is,
according, to the management of Caterpillar, and Bucyrus, this deal is going to create
$2.7 billion in value according to our estimates.
23
Of course, there is uncertainty here. We're not that confident. For example, we talked
about the synergy discount rate, we had this fudge factor. The cash flow is an estimate.
We talked about this already. Even when you do company valuation, there is a lot of
uncertainty about what the true value is. Here, the issue is, it's very difficult to do
comparable analysis for synergies that we discussed already because there really isn't
anything similar to the synergy and we can think about sensitivity analysis, but as we
discussed at already, sensitivity analysis basically going to tell you that the synergy can
be anything.
24
What I like to do when I value synergies is to focus on a specific calibration. It's a

specific type of sensitivity analysis which I think is useful when we think about an M&A
deal. This is the question, how large do the annual synergies have to be in order to
justify the premium paid for the target? In this case you're starting from the premium,
and then you're backing out how large the synergies have to be in order to justify that
premium.
25
In this case, the premium was $1.8 billion, just 32 percent of the targets value, as we
discussed already.
What you can do in your Excel spreadsheet, in your analysis is you can do the same
calculation we've done, but now the spreadsheet we back out for you, what this annual
synergy need to be in order for the net present value of the synergy to be exactly equal
to the premium. In this case, as the calculation shows you, as long as the annual
26
synergy is greater than $264 million, then the synergy NPV is greater than the premium.
So $264 million is the synergy cash flow that the management needs to focus on.
This is useful, because if you think about public targets, as we discussed already in the
course, the M&A premium can be estimated fairly well, it's typically around 30 percent.
This deal is another example. Starting from this 30 percent premium, the calculation
we've just done tells the acquired how large the increase in profits have to be in order to
justify the deal. The acquirer can have a very good way to tell, can I produce $264
million or not? If the answer is no, then maybe this is a bad deal. If the answer is yes,
then the deal becomes positive NPV.
27
I think this is a very useful calculation, and I recommend, for example, if you have to do
an M&A analysis for a course like our course, starting from the premium and backing
out the synergy can be a valuable and useful thing to do. This actually gets us to this
notion of net present value of the deal. It's really simple what the idea is, but I think it's
good to focus on this, and make sure everybody gets it. For a target, clearly, the net
present value of the deal is equal to the premium. Whatever premium is being paid for
the target is going to be the NPV for the target. For the acquirer, the net present value
of the deal clearly is the difference between the net present value of the synergy and
the premium. That's the part that is going for the acquirer.
28
To practice this idea, what I would like you to do is to stop a bit, and try to compute the
net present value of the deal. In this case, using our example, and using our evaluation
of synergies, compute the NPV of the deal for both CAT and Bucyrus.?
Here's the answer. The NPV of the deal for Bucyrus is the premium, so the premium in
this case is $1.8 million. For caterpillar, the NPV is the difference between the synergy
NPV, which we estimated as 2.73, then that comes up to a bit less than $1 billion, 0.93.
29
Essentially, what the premium is doing is dividing the synergy value between the
acquire the targets. Some of it goes to the target, some of it goes to the acquirer.
Synergy Valuation: The Market's View
We just talked about the management view. Now let's focus on the market. In the case
of public companies. If a company's private, you're not going to have a market reaction.
The markets is going to have a view, but you're not going to be able to measure it. But if
we're talking about public companies we can use the changes in stock prices around
the merger to estimate synergies. When you think about it, the synergy, as we
discussed that already in the course is the new thing, 2 plus 2 equal 5. The value of the
synergy of an M&A deal is going to be equal to the value of the target and the acquirer
combined after the merger minus the value of the target plus the value of the acquired
before the merger. It's this change in value of both firms around the merger is going to
be the market valuation of this synergy.
30
That's a very important idea in M&A. What we're going to do is we're going to do some
examples here, several examples for you to learn how to get it. The first thing that we
need to discuss is this notion of what do we mean by before and after? You're going to
have to get your dates right and the crucial thing here is to use what we call an
undisturbed stock price. It's a funny word, but it's going to be clear what we mean by an
undisturbed stock price is essentially a price that is not disturb by news about the M&A
deal. Then after what we're going to talk about is that we might have to consider
different time windows after the announcement of the deal to take into account the fact
that the market may take some time to react and to fully adjust to the M&A deal.
31
Let's talk about this notion of undisturbed stock price first. CAT-Bucyrus was announced
on the morning of November 15th. That was a Monday. In fact, this is actually pretty
common in M&A deals. Companies like to announce them in a weekend or early in
Monday so in a new week. If you're announcing in the weekend the market the analysts
have time to process the merger during the weekend. Some mergers are even
announced like Labor Day weekend in the US. Here Monday is a holiday and there are
several famous mergers that were announced on Labor Day weekend. This merger was
completed a few months later, July 8th, 2018. Ask yourself which date are we going to
use?
32
If you think about it, you really need to use the announcement date because of market
efficiency. The moment that the market learns about the deal, the market is already
going to incorporate the estimated effects of the deal on the value of the acquiring and
the targets. The completion date is too late. By then, the merger is not news anymore,
the stock prices have already adjusted, everything is already priced in, as we like to say
in finance. In some cases it's even trickier because the news about the merger may leak
prior to the official announcement date. Even before the merger is announced the
market may already know about this deal and one thing we need to figure out is how to
verify whether there is a leak. What is the date we're going to use to estimate this
changing values.
33
Let me do this by showing you data on stock price and volume for Caterpillar. It's the
acquire in the case of the deal that we were talking about and that the blue arrow that
you see here is an arrow that shows you the date of the announcement. This is
November 15th, 2010 as we discuss it, that is the date of the announcement. You can
see that on the date of the announcement, clearly there is an increase in volume. There
is a jump in volume that is this orange bars are clearly higher on the announcement
date. The jumping volume is a way that you can; When you look at the volume data, it's
a way that you can measure whether there is news about a merger or any other
cooperativeness being released in the market. There is a lot of trading also November
16th. But if you look at this graph there are other days before November 15th that have
high volume. Going back here, if you look at this graph for example, there is a date
there in October that has even more volume than the day of merger announcements. Is
it the case that do we have leakage in this case? There is another day here in the
beginning of November. It's a little bit tricky to fully answer this but there is a way you
can do that.
34
One thing that is valuable, I have hear in this slide with the stock prices and volume are
some. Capital IQ for example, has this data that tells you whether there are major
corporate events. For that date in October where you see that big increase in volume.
What's happening there is the release of earnings for example. But this is not going to
be the end of the story. The best way that you can solve this problem is to complement
the quantitative analysis with some qualitative analysis.
35
For example, you can go to Google or any other search device or you can go to Capital
IQ. Try to figure it out, what is the first date when the merger was mentioned in the
financial news? You're typically going to be able to do that. There's going to be a news
article. If a merger like Caterpillar Bucyrus's has announced that, that's typically going to
be a news article, in this case, you're going to find that despite these events prior to the
merger, November 15, 2010, does seem to be the first date that the market learns about
these deals. In this case, it is the announcement date is the first day that the market is
incorporating information about these deals. The companies were able to keep this fairly
private prior to the announcement.
That means we can get data on prices around the announcement. You have the closing
prices on Friday, November 12th listed here and then we have the opening prices on
Monday, November 15th. We also have the shares outstanding, so we can compute the
market values. Notice the Bucyrus price. Bucyrus is jumping significantly from Friday to
Monday. That is another piece of evidence that suggests that November 15th is in fact
the right date for us to look at here.
36
Using these values, we can compute the market values of equity. If you sum the market
value of Caterpillar and Bucyrus before the merger, you get $57.1 billion. After the
merger you get 58, so the market value of the synergy as we learned is the difference,
in this case it's $900 million. The stock market is telling us that the merger is creating
$900 million in value. Looking at the valuation of the two companies. As we discussed it
already, if markets are perfectly efficient, the opening price on the first day should
capture the effects of the merger. The moment the market opens on the first day that
they know about the merger immediately, everything adjusts. But, I mean, given the
complexity of M&A deals, that may be asking too much. Even market efficient diehards
are going to agree that the market may need some time to figure out what's going on.
37
I got some other prices here for you for Caterpillar. We have the closing price on
October 15. You can see that there was a significant change during that day. Then you
have closing prices on the next three days as well. Typically in M&A, a three-day
window, we use a three days, sometimes a week after the M&A deal. We don't go too
far, but we tend to use at least three days to look at synergy values and market
reaction.
38
We've done the calculation already using the opening price. You can check these
numbers, very simple algebra. Redo the calculation using the closing prices for the next
three days. Clearly, during the trading day of November 15, what might have gone on,
we don't know for sure, but what might have happened during that day is that the
market may have become more positive about this deal. If you look at the closing price,
to do the analogy are going to get a higher value of synergies. Then the price is
fluctuating the next three days we get a different estimate. Now we have four numbers.
What do we do? We don't really know which value is right.
Like I always like to say, finance is not physics. You don't have a formula. You don't
have a precise way of doing things. If markets were perfectly efficient like I said, the
right price to use is the opening price. It's cleaner. But the trade-off is the market may
not have had time. In the case of Caterpillar, the merger was actually announced in the
morning, it was not announced on the weekend. The analyst did not have time to do the
analysis yet. That pushes us towards using longer windows. On the other hand, the
problem of using longer windows is that it increases the risk that other factors affect
stock prices. For example, we saw on Caterpillar when the earnings was announced,
there was a significant change in volume. There was a change in stock prices. There
are things other than M&A affect stock prices as well. There is this trade-off.
39
Here's a possible solution that's typically what I do and I analyze them in ADUs is to
focus on the immediate reaction which is cleaner, but also look at an average from Day
1 to Day 3. The immediate reaction in this case is $900 million. But if you look at the
average from Day 1 to Day 3, you get 1.7 billion. What we're learning here is that in the
days after the merger, it's possible that the stock market is becoming a bit more
optimistic about the Caterpillar Bucyrus deal. The market reaction, the caterpillar stock
pricing particularly increases in the next few days after the deal is announced, so that
gives us some evidence that perhaps the market is becoming more positive.
40
That may not necessarily change the analysis. As we've done before, we've done the
calculation already, the management estimate is 2.7. The premium that Caterpillar paid
for the target is 1.8. Ask yourself, what do we learn from the market reaction? It could
be 0.9, it could be something around two billion. What do the numbers mean? Think
about that for a second.
Clearly, there are actually a few robust conclusions we are drawing from this.
41
The first one is that the management estimate of the synergy is greater than the
market's, and that's pretty common. Then the second point is that the market estimate
of the synergies is actually not much higher than the premium, it might even be lower.
The market does not believe that the synergies are large enough to justify the premium
that Caterpillar paid for the target. Therefore, what we expect is that Caterpillar stock
price is going to remain flat, or maybe even decrease a bit when the deal is announced.
As as we learned in Module 1, that's actually consistent with the empirical evidence, that
if you look at many M&A deals over the years, what you see is that, while the target
stock price reacts significantly to a deal, the acquirer is typically flat, even negative
sometimes, and this is what's happening here. That really is the robust conclusion, no
matter if you use the opening price, three days later you're going to, I believe, draw a
similar conclusion.
42
There is important limitations that we're going to go into a bit more detail later in this
module. It's related to this observation that the market reaction to an M&A deal is going
to depend on factors other than synergies. For example, we're going to talk about the
chance that the deal may not go through. That for sure is going to affect stock prices. If
you announce an impossible deal, for example, stock prices shouldn't change at all. It
also reflects the chances that the offer may go up. As we're going to see later in some
cases, the M&A announcement is going to prompt the market to believe that the offer
may not be large enough. Then there is other non-M&A related factors that we talked
about, for example, earnings announcements, other news about profits, etc.
43
Let's talk about the deal completion. The offer for Bucyrus is a cash offer. This is going
to be important. We're not going to talk much about cash versus stock in this module,
but the reason why cash is important here is that it's a fixed offer. The offer is not going
to change with the acquirer's stock price. It's $92 a share. But if you look at the Bucyrus
stock price reaction, it goes up to about $90, and it stays there in the first few days after
the deal is announced. Why is there this difference of two dollars? It's not a big
difference, but it's a difference.
44
The difference is due to the fact that the deal is not completed yet. If this deal is
completed immediately, then the stock price of Bucyrus has to be equal to $92. Later on
we're going to talk more about this difference. That is what we call an arbitrage spread,
which is a very important number in finance. But that's the first one. Then in other
cases, the market, like we said, may believe that the existing offer is not high enough.
The market will observe a deal and it's okay that this price is not good enough, the price
is going to go up. The stock price of the target is going to reflect that. Or maybe the
market expects that other bidders may come into the fray and place higher offers. That
may be something that affects prices as well as we're going to see in other examples
later. What are the biases due to these factors?
45
Typically, if there is a big chance that the deal is not completed, this is going to lead to a
lower market value of synergies, so the stock price is not going to react as much. For
example, the target price is not going to go up as much, so the estimated synergies
using market values are going to look lower. On the other hand, the chance of new
bidders is going to increase the market value of synergy, because it's basically reflecting
synergies from another deal. These are just two examples of factors that you need to
take into account when you look at market reactions.
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Then there is the non-M&A related factors that we talked about. Here, the important
thing to point out is, that is the main reason why we don't look at long-term stock price
reactions. You might be asking yourself, why are we looking at two days? We want to
maximize the long-term value. But the problem is, looking at long-term stock price
reactions is very complicated. Two, three years ahead, many things will happen. For
example, in the case of the mining industry, we know that following the Cat-Bucyrus
merger, there was a downward trend. The profits for mining companies decreased a lot
because the commodity boom was over, and that had a large effect on the stock prices
of Caterpillar and Bucyrus. It might be hard to look at two, three years, five, four, five
years ahead, and figure out what is the long-term stock market reaction to an M&A deal.
That's why we focus on the short-term, which is imperfect but definitely cleaner. Don't
look at, you're going beyond a month, it's going to make it very difficult for you to infer
anything from stock prices.
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The Chance of Deal Failure and Merger Arbitrage
The arbitrage spread is the difference between the offer and the target's current price.
As we discussed it already, this is a very important variable in financial markets. In
these notes, we're going to learn why. For example, in the example we were talking
about, Bucyrus price went up to $90 but the offer was 92. This difference is what in
financial markets we call the arb spread, arb is a short for arbitrage, which is typically
how we say it, so arb and merge arb etc. The arb spread is $2 a share. It's usually
expressed in percentage, of course, because the nominal stock price doesn't mean
much. In order to gauge how large the arbitrage spread is, it's good to have to express it
in percentages. In this case, 2 over 92 is 2.2 percent.
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What does the arb spread tells us? Think about it. If markets are efficient, the reason
why the target price is not equal to the offer is because the deal may not be completed.
The arb spread is giving us information about the chances that the deal will go through.
If you see a deal that has a high arb spread, what this is telling us is that basically there
is a high chance that the deal will fail according to the stock market. The stock market
could be right or wrong, we're going to see some examples. Of course, as we discussed
it already, the reason why deals fail is typically because of regulatory, also the
government may block the deal, or because of governance reasons. The acquirer may
give up, the target shareholders may vote against the deal, etc.
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Let's look at a couple of examples. First one, Kraft and Cadbury, and these are
examples that we're going to go back to later on in this course. Kraft and Cadbury was a
very talked-about merger. It's actually an example of a hostile takeover, which is
another topic we're going to talk about later. But in terms of the arb spread, Cadbury is a
company that trades in the [inaudible] the UK, so the prices are expressed in pences
here. The last day before the announcement was September 4th. That's an example of
a deal there was announced on Labor Day weekend as I was talking about before. Then
on Tuesday after Labor Day, Cadbury opened at 745 pence. The closing price was 791
pence. I apologize for this, the offer price was 745 pence. That's how much Kraft was
paying for Cadbury. Cadbury closed on September 8th at 791 pence. The point here is
that the closing price for Cadbury on the first day of trading was greater than the offer
price. What do we infer from these prices? think about that for a second.
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Clearly, this is a case where we have a negative arb spread, the price on the first day
actually is greater than the offer. In this case, the market definitely expects this deal to
go through, but it also expects more. It expects that the target may actually even get a
higher offer. There is an expectation that the price is going to go up. If you look at the
history of this case as we're going to do later in the course, we're going to learn that this
is in fact what happened, the offer for Cadbury went up. This is a hostile deal. In hostile
deals, it's fairly common that the prices will go up, the market is reflecting that.
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Another example is Microsoft and Yahoo. That's a deal that was supposed to happen in
2008. In this case, Yahoo was the target. A pre-announcement price was $19.18 on
January 31st. The deal was announced on January 31st, and then the market opened
on February 1st. In this case, the price that Microsoft was paying for Yahoo is $31 a
share but Yahoo close it the trading day of February 1st at $28.38. In this case, the
closing price of the target is lower than the bid price. What do we infer in this case?
Think about it for a second.
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The arb spread is close to 10 percent, so 2.6 is the difference between the offer and the
current price of the target. You divide that by the offer, you get 8.4 percent. What this
means is the market has significant doubts about whether this deal will close or not, and
it never did. Microsoft never acquired Yahoo. The companies basically gave up and
they didn't execute, this deal never closed. The market was already doubting that when
the deal was announced and that's actually what happened.
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Cato, is the market always right? You might be asking yourself now right then, the
answer is usually yes. There is actually very good research that looks at arb spreads,
comparing arb spreads for failed deals and for completed deals. It's a paper by Michel
and Pulvino that was written a few years ago. If you look at failed deals, the arb spread
is typically above 15 percent. If you look at deals that were ultimately completed, the arb
spread goes down. It's already at the announcement date or many months before the
deal is completed, the arb spread is already lower, indicating the fact that the market
anticipates that this deal we'll close.
Here's what the data looks like in a chart. You here you have on the y-axis the arb
spread, and on the x-axis what you have is trading days until resolution. Resolution
here, the dates zero, it means for a completed deal it means the day in which the deal
was finalized. For a failed deals, it means the day that you failed so that the regulators
block that the company is basically gave up on the deal. Starting here with completed
deals, as we said, what we see is that a 125 days before resolution, the arb spread is
already around 10 percent, and then it goes down to the day in which this deal is
completed. Date zero here, as we discussed already, the stock price of the target has to
be equal to the offer. In that case, the arb spread goes to zero. It's a very different
picture for a failed deals. Deals that ultimately failed, they always have a significantly
higher arb spread. They tend to be above 15 percent. There is some fluctuations here
and then of course, when the deal fails, the arb spread is going to go up, reflecting the
fact that the stock price of the target is typically going to decrease a lot. The difference
between the offer and the stock price of the target increases. Very clear evidence that
the stock market has good forecasting ability.
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If you want a more recent example, there was a very recent article in the very
interesting article in the Wall Street Journal, November 18th, 2015, talking about the fact
that there were very large arb spreads in the recent M&A wave, that pre-COVID, as we
discussed already in the course, there was a significant M&A wave that was
characterized by large same industry deals. These deals have a very significant chance
of failure because regulators will look at anti-trust issues if two companies are merging
in the same industry.
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Here are some examples from the Wall Street Journal article, four different deals.
Halliburton Baker Hughes, Aetna Humana, Anthem Cigna, Staples Office Depot, they all
have very large arbitrage spreads on November 2015. They were ongoing deals. The
companies were trying to merge, trying to convince regulators that these were good
deals and they were going to benefit society, but then what happened if you look at the
data 24 months later, from November 15th to November 2017, each and every one of
these deals was blocking. The market really knew. The market was already
incorporating these and these information many months before the regulators actually
block this deal. All of these deals were blocked.
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There is a lot of evidence that the market is relatively efficient in its ability to forecast
whether deals go through or not, but this does not stop hedge funds that Trump trying to
make money on this. That's what we call merger arb strategy. This is more on the
investment side. It's not really corporate finance, but I think it's good to just give a few
words about the merger arb. The typical strategy in this case involves buying the target
stock. If there is an arbitrage spread and the deal is eventually completed, the target
stock price is going to go up and the hedge fund is going to make money. This is a
hedge fund strategies, so it typically involves a short position as well as a hedge. What
funds typically do is too short the market or a similar form, a similar portfolio in order to
hedge other risks. Let me give you an example.
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Suppose we have a 20 percent merger arb spread. Very large one. If hedge funds
believes that the market is overreacting and that there is a good chance this deal will go
through, what the hedge fund can do is to buy the target stock in short the market or a
similar form as we discussed. Then what happens is if the deal is completed, the arb
spread goes to zero. There's a 20 percent return immediately. The merge arb front is
going to make a large return and if you think about it because of the short position, the
merger arb fund is not really expose it to other risks, like market risk because you're
shorting the market. If there is a decline in the market as a whole or if you're shorting a
similar form, if there is a decline in the industry, this is not going to affect the strategies
return.
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But if the deal is completed, the hedge fund makes a lot of money. That's the idea.
These arbitrage activity is an explanation. We saw that data there is this large jumps in
trading volume that we see during M&A deals. Merger arb is one explanation for these
large jumps. When an M&A deal is announced that there is a lot of activity from hedge
funds that are betting, not necessarily that the deal will be completed. It's also possible
to make money on the failure. If a hedge fund believes that a deal is going to fail, it
might be better to short the target. If the market has not reacted significantly, if the arb
spread is not large enough, then the hedge fund may decide to short the target and
make money on the deal failure, or the hedge fund can try to make money on the
acquirer's stock as well, so you can buy or sell. The difficulty here is that it's harder to
predict the direction. In the case of the target is very clear that if a deal is completed, the
target price goes up. That simplifies the strategy. For the acquirer, it might be harder to
tell, as we saw already in the course. In some cases, the acquirer's stock price goes up.
In other cases it goes now. Making money on the acquirer's stock can be a bit more
challenging but strategies that bet on the target are very common on financial markets
and they do help explain why there are large jumps in volume around M&A deals.
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Additional Examples: When Markets and Managers Disagree
It's always a good idea to practice right. So more is more when it comes to learning
finance one of my goals here is just to give additional examples of synergy evaluation.
But also it's important to give other examples because while the cat be a serious
example that we talked about is pretty standard, right? In the sense that managers are
more optimistic than the market etc. Right the markets were a bit more, more
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pessimistic but fairly close. So most games go to targets the acquirer is flat, right?
Those were the robust conclusions we drew from Quetta vi Rose iris. In other cases,
there is going to be bigger differences between markets and managers which we need
to think about.
Okay, so let's talk about one of these examples. This is the acquisition of NXP by
Qualcomm in the semiconductor industry. It's a friendly offer that was announced on
October 27, 2016.
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So in that case you can get data on the synergies again, as we discuss it. Management
announces expected synergies. It's $500 million dollars a year. Starting two years from
the closing date. Qualcomm's cost of capital was around 9% of the time we're using a
tax rate of 20 a growth rate of 2% as we discussed it already.
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So if you do the valuation of the synergies which should be fairly straightforward
discounting this $500 million 200-2016. You get approximately $4 billion dollars in the
NPV of synergy.
So let's compare that to the premium and the market valuation of the deal right? So in
this case it's the cash offer of $110 a share that comes up to $37.4 billion. So that's the
offer. It's pretty clear. But to figure out the premium as we discussed it already, we have
to think about the undisclosed stock price. Right, what is the right stock price to use?
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The way we do this is by looking at stock price and volume data. So in the case of NXP
and XP is the target. The arrow again shows you the announcement date. So clearly
when the deal was officially announced that there was a lot of training, right? This
orange bar jumps up. But if you look at this graph right there is this very suspicious
increase in volume. And a big jump in stock prices of an XP a few weeks before that
right? So there is this date here at the end of September, if you look at the graph where
there is a large jump in stock prices. And if you look at the stock price of NXP on the
announcement date. It's not changing that much, it's actually going down. So this graph
is telling us that there may be some anticipation right?
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So what is the undisturbed price in this case?
So, ask yourself look at the graph again and if you want to do some qualitative analysis,
I'm going to show you in a second. So, but think about what is the undisturbed price in
this case? Clearly, what's going on? Is that the undisturbed price has to be taken at a
date prior to that first movement right? So it has to be before the stock price of the
target jumped. So this blue arrow again is showing you what is my estimate for the
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undisturbed price right? It has to be taken here at the end of September. And in fact, if
you do the qualitative analysis, this is what you're going to find out.
If you search on google, what you see is that the financial media with the first reported
on this merger at the end of September. So the price jumped when the market opened
on September 30th, the price jumped from 82 to 102. That suggests that we should take
$82 as our undisturbed price for NXB. So, if you go back to the offer, right you compute
the difference between the offer. And the unstructured price, you're going to get a
premium of $9.5 billion, that's how much Qualcomm was paying in premiums for an XP
in this case.
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And following the analysis we've done before right? So if the synergy NPD is four billion
and the premium is 9.5, the NPV for the acquire should be negative right? So the
acquirer is paying a lot more than the synergy. So what should have happened to the
stock price of you would expect that the stock price would have decreased, but we can
look at the data right.
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So again, I'm pointing out here, the blue arrow is highlighting the date in which the
market learned about the deal. And interestingly enough, what's happening is the stock
price of Qualcomm is actually going up on that day. So the the acquired stock prices
increasing, which seems interesting, right? Because the synergy doesn't seem to justify
this.
So the stock price on September 30 for Qualcomm is going up from 63 to $69. Right so
the market is telling us that the deal is positive NPV for the acquire and that synergies
are much bigger than four billion right? So what can be going on?
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This is a case in which the market is more optimistic than the management in some way
right. So this is a strange case where everything is reversed. That's part of the reason
why I wanted to present it because it happens sometimes right? What this means is that
it must be the case in the Qualcomm and XP merger that there are other benefits, right?
The management's forecast is not completely disclosing all the benefits of these deals.
So, there may be synergies that are not reported. So that's $500 million cost reduction.
May not represent all the synergies of this deal. And there may be some financing
advantages that we're going to talk about later.
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So, it's very typical on MNA deals. And I believe we talked about this already. When
management announces an MNA deal, they usually talk about cost synergies only.
That's the case in Qualcomm and NXP as well. 500 million represent cost synergies.
So, it's a reduction in costs that can be achieved by merging the true company. But in
many deals, there are revenue synergies. In fact, as we discussed it, the merger wave
that was going on at the time of Qualcomm and experience, it's all about revenue
synergies. It's merging companies in the same industry in order to increase market
power right? And this is a good reason for a merger, but it's also a good reason for
regulators to stop deals right? So, regulators don't like the fact that mergers like
Qualcomm. And XP maybe increasing the combined market power of the merged firm.
So, these deals are very likely to be blocked by regulators. And that may be a potential
explanation for why these are unreported, in a sense, they are strategically non reported
right? So, the acquiring the target may choose not to about to talk about revenue
synergies. Because that's is going to give easy material for regulators to block the deal.
And in fact, if you look at the history of Qualcomm and NXP, this deal was actually
blocked by regulators, not in the US, it was blocked by the Chinese antitrust authority.
There is some debate about whether this is really due to antitrust or whether it's due to
politics, but this deal wasn't naturally blocked.
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The other potential benefit of this dealing specifically is that has to do with tax rules in
the US. So it turns out that Qualcomm held a significant amount of cash outside of the
US. And this cash could not be brought back to the us prior to 2018 without incurring a
large tax bill. But since N XP was incorporated in the Netherlands, Qualcomm could use
this foreign cash to acquire NXP. And according to analysts that we're now talking about
this deal at the time that that was one of the benefits of the of the deal structure is to
allow Qualcomm to use this for in cash. So it's important to note that the tax plan of
2018 eliminated this bias towards foreign M and A this is something we're going to talk
about later in the course. In fact we're going to go back to this. But at that time 2016,
there was this benefit acquiring foreign targets. It was a way of deploying foreign cash in
an effective way.
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Let's talk about another example. This is a more recent, it's the acquisition of Sprint by T
Mobile. We talked about sprinting the course already with the evaluation of sprint right?
So this deal was officially announced on April 29 2018.
Synergies in this case are reported to be $6 billion dollars a year within four years.
Again, there is a lag here, there is an integration cost as well. In fact, I'm pointing out to
a very interesting Forbes article which I believe is available for free online. You can read
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about, there is a very detailed analysis of the potential synergies of this merger which is
recommended reading if you have the time.
Other data, we need the whack, right? We are using T Mobile's whack in this case plus
the fudge factor right? The tax rate and the growth rate.
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Okay, so here's the valuation that we've done already another example right? The more
examples, the more you do, the more you learn right? So the synergy starts in 2022 in
this case. If you tax the synergies $4.8 billion discounting, taking out the integration
costs, the integration costs here is like an initial investment right? So it's the one time
negative $15 billion you get an MP view of the of the synergy is $43.8 billion. So very
large right? So in fact the Forbes article was talking about the fact that the net present in
this case the synergies associated with this deal seems to be huge right?
So let's think about the premium now. Right first we need the offer. So this offer was in
stock. It makes it a little bit more complicated as we're going to discuss more later, but
we can still gauge what the premium is. If I mean what the offer is and then the premium
if we get the undisturbed price. So in this case the offer at that time was $6.15 a share.
So multiplying by shares outstanding of sprint, you get 24.7 billion.
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Okay, so again, what we need now is to figure out the undisturbed price right? So we
start from the announcement date as we've done already. This deal was announced on
that day at the end of April, right. There was the blue arrow is highlighting here the
announcement, there clearly is a jump in the stock price of sprint. However, if you look
at the chart, there is a suspicious date to the left, right in the beginning of April. There is
already a jump in the stock price of sprint and and a significant increase in volume. So
we need to do some research to figure out what happened on that date. It turns out that
the news about the merger were actually first released on that first date. So April 10th
was the date when the market learned that T Mobile and Sprint, we're going to merge
before the deal was officially announced.
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So that's why in this case I'm taking $5 a share as the undisturbed price. It has to be the
price before April 10. Okay, so if we take $5 as the undisturbed price, we're going to get
a premium of $4.6 billion. So that's that's the premium that T mobile is paying for for
spring.
So putting the data together, right? The synergy is huge. The premium is 4.6 billion.
What would you predict? What do you conclude that this is a great deal right.
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This acquisition is a great deal for T mobile. The NPV for 40, mobile should be 40, close
to $40 billion. And then if we look at the stock prices of T Mobile, we should see the
stock price is going up right? So NPV and stock prices are related since this is a great
deal. The market should have reacted by increasing the stock price of T Mobile.
All right, let's look at what happened. It's interesting again because we cannot look at
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the announcement date, right? The announcement date here is highlighted with the
arrow. But as we learned already the first date that the market learned about this deal is
prior to April 10 right? So it's that first jump in volume of T mobile. That's when the
market is incorporating the information about this deal.
So if we take the data in this way, then the undisturbed price is $60 a share on day zero
April 10th. The stock price of T mobile is in fact going up, right? But then on April 30 is
going back down when the market actually learns the details about the deal right? On
April 10, the market learned gender information that Zimbabwean sprint, we're going to
merge. And then the details about the announcement came up on April 30. The stock
price was basically back down to 60.
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Okay, so what do we make of this if we use the April 10 data there is a 5% increase on
T mobile equity. So that comes up to $10 billion right? Consistent with the fact that the
NPV is greater than the premium right? But it's reversed at the announcement date.
Okay, so comparing it to the management NPV of the synergy right? Even if we ignore
the reversal using April 30, right? The market in this case is being much the managers
are a lot more optimistic than the market is right? So the synergy MPV according to
managers is $39 billion 14.6 or even lower because as we discussed it already. It's
important to look at future data and the the announcement date, there seems to be a
reversal.
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Lesson 4-3
Bidder Strategies
Suppose a company decides to pursue an acquisition, so you become an acquirer.
What is the strategy the acquirer should follow? In fact, we talked about this already. It
makes sense to always try a friendly approach first.
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Why? Because you are very likely to get better pricing, right?
The hostile barrow is going to, as we're going to learn in this module, in many cases,
results in a higher premium for the target. You will have access to better data. The
target will be able to give you proprietary data about the company, etc, because it's a
friendly to you. The integration process is also easier. We're not talking much about
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management strategy issues but if you think about it, in a friendly deal it's probably
going to be much easier to integrate management employees, etc. That's like more than
95 percent of all deals end up being friendly so everybody tries a friendly approach first.
The hostile takeovers that we're going to talk about in this module are really a
secondary but very important option. Hostile takeovers happen when basically, the
target board says no. Right? So the target does not want to negotiate an offer. In that
case, the acquirer has to consider other options. It's important in this section to
understand which options the acquirer has.
There are regulations that frame the hostile takeover market and that effects what the
acquirer can do. Once the deal becomes hostile, essentially it's going to become even
more subject to regulatory scrutiny. Because it becomes very important for securities
laws and law in general to ensure that managers are acting in the interest of
shareholders and that shareholders are getting a fair deal. They're getting the best
possible price out of a merger.
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One passion that I always get from students is I don't understand all this takeover stuff.
Why can't the acquirer simply buy their shares in the market? Every time students ask
that, so it's good to talk about it. The answer is simple. It's illegal. The acquirer cannot
just go in the market and buy shares. In fact, there is a very specific regulation by the
SEC that requires any party that acquires more than 5% of the shares to file a form.
This form has to disclose the purpose of the transaction and it has to be done within 10
days of acquiring that stake.
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Essentially, what this means is, no one can acquire more than 5 percent of the shares
of a company without explicitly disclosing the purpose of the acquisition and if the
ultimate purpose is to acquire the target, then this has to become clear. What this will do
is, it will make it impossible for an acquirer to just go into market and buy the company.
The moment that an acquirer crosses the 5 percent threshold, this is going to trigger
market reactions, it's going to trigger a reaction from the board of the target effectively,
the takeover is becoming hostile at this point.
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That's very important to understand the effect of schedule 13D. This equity stake that an
acquirer can buy before the deal is announced is called toehold in M and a language.
So this 5 percent maximum stake, the terminology that we use for its total.
It's important to remember, as I just discussed, that, the maximum toehold is 5 percent,
so no one can buy more than that without disclosing the intentions of acquiring the
company. But the evidence suggests that in many cases, the acquirer does not even
buy that much. In fact, in only 10 percent or less of all existing tender offers, we actually
observe toeholds so in many cases, the acquirer doesn't buy anything. So the Acquirer
acquires zero.
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And, there is a debate about why this is the case. One reasonable argument is that
acquiring a toehold might make the target even less friendly, right? Ultimately, the
acquirer is going to have tried to convince the board of directors of the target, and
having this toehold is going to make the deal more hostile. In fact, that's exactly the
acquirer's next move. If the board says no, what the acquirer should do is try to directly
persuade the shareholders that they should sell their shares. The acquirer has some
mechanisms to achieve that.
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One of them is the bear hug that we already mentioned in the course. The idea of the
bear hug is that the acquirer discloses an offer with a price. So it's important to make
the price available so that creates that monetary incentive for shareholders to sell.
Usually, this includes both a public announcement to the financial press and a letter to
the board of the target. In fact, in many cases, the bear hug is one of the first times that
the financial press learns about the deal. We talked about the announcement date
before in the course. The date of the bear hug is typically the first day that the financial
press learns about the deal if there is a bear. The idea, of course, is to put pressure to
the shareholders. Why don't you sell your shares at XXX premium, 30% or more? The
board of the target, of course, is going to become pressured to do something about it.
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That's an example of a bear hug. There's actually a failed deal that happened back in
2008. Microsoft tried to acquire Yahoo. Here you have an excerpt from The New York
Times that basically explains what a bear hug is. Explaining what the sources of
synergies maybe, new levels of innovation, etc. Mr. Ballmer, the CEO of Microsoft at the
time, wrote to the CEO of Yahoo and the board in the hope that the CEO of Yahoo and
the board share our enthusiasm. Of course, as I said, this is both a letter in a public
announcement. Twenty-four hours later, this letter was made public to the financial
press with a price tag.
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This deal, in this case, it failed. But this is as a good example as any of a bear hug.
One other two that the acquirer has is what we call proxy campaign. The opposition to a
takeover typically comes from the board of directors, as we're going to see in some
cases at the end of this module. What the acquirer can do is try to change the board
and elect new directors who are more friendly to the deal. The board of directors is not
set in stone and the acquirer can try to change the board. Here's where the idea of a
staggered board is going to come into place. This strategy of changing the board means
is going to become more effective or less effective or in some cases not effective at all if
the target has what we call a staggered board, which we're going to talk about later.
We're also going to give an example of a deal where this proxy campaign played a role
and the staggered board played a role as well.
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It's the Air Products-Airgas deal that we'll talk about later. If the board keeps saying no,
the acquirer has one final option in some cases, as we're going to learn later. If the
target has a poison pill, then this option is basically not worth anything. It's useless. But
if the target does not have a poison pill, then the acquirer has the option to take the
M&A offer directly to shareholders. You can offer to buy the shares directly from the
shareholders through a formal tender offer. It's an offer to buy shares at a certain price.
As you might imagine, tender offers are subject to very strict regulations.
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In fact, since 1968 in the US, as an example, the US market is the most important M&A
market around. There is a law called the Williams Act, which regulates standard offers
since '68. There are several provisions. You can read about the Williams act anywhere.
For example, the offer must be opened for at least 20 days. It cannot be made on a first-
come-first-served basis. You cannot privilege some shareholders in the detriment of
others. Shareholders always have withdrawal rights during the life of the offer. So if you
decide to tender and then you change your mind, you can do that. The offer cannot
discriminate against shareholders, so everybody has to get the same deal, and once the
tender offer is formally announced, then the bidder cannot purchase more share or
other than through the tender offer.
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Even if you haven't purchased that at a toehold, that five percent that we mentioned
earlier. After you formalize a tender offer, that's the only mechanism through which the
acquirer can buy shares. Of course, the goal of this regulation, as we mentioned earlier,
is to make sure that the target shareholders get a fair deal, get the best possible price.
Here are some examples of outcomes of different hostile takeover battles that
happened in recent years. Kraft and Cadbury is a deal we talked about already in the
course. It ended up with board capitulation. In the end, the board of Cadbury decided to
allow the acquisition to happen at a higher price. That happened in 2010. Then there
are other deals that come to a shareholder votes. There will be a tender offer and
shareholders will vote whether they want to tender the shares are not. One example is
Mylan-Perigo in 2015. In that case, the shareholders of the target voted not. They did
not tender their shares to the acquirer. Shareholders in some cases can be persuaded
not to sell shares as we're going to argue later. Then of course, it's always possible that
the acquirer will give up.
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One example we're going to talk about later is the Xerox-HP deal that happened during
2020, right before the COVID-19 crisis hit, and in fact, what happened is COVID-19
actually stopped this deal as we're going to discuss later. We're going to learn that in
most hostile deals, the acquirer ends up increasing the bid price. It's a typical strategy.
It's a typical outcome as the deal progresses and the Board of Directors try to keep the
acquirer away, it's very common to see the price going up. For example, Kraft-Cadbury,
Air Products. We talked about Kraft and Cadbury already. We're going to see the Air
Products example later. Of course, the goal here is to convince shareholders. The
higher the premium, the tougher it is for the Board of Directors to keep the acquirer
away.
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Here's just a question for you to think about, how this pricing thing works? Suppose that
you have a target that's priced to $5 per share, and suppose the target is fairly valued,
so there is no undervaluation gain here as we discussed already, that's the fair
evaluation. The synergy that the acquirer estimates is $2 a share. You have 5 plus 2,
that's what you can make out of this acquisition. Suppose the acquire expects the deal
to be hostile, think about the following. How much should the acquirer bid in that case if
you expect this deal to become hostile.
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As we learned already, the acquire should never go beyond seven. On the other hand,
as we also learned in the course, the target is unlikely to sell for less than the usual
M&A premium. The point here is that you really don't have a lot of room for negotiation if
you are an acquirer. You can try to bid less than 6.5, knowing that the target will
probably say no, and then you can come to a better offer. The point is that in many
cases, the acquirer is not going to have a lot of room for further negotiation, and as we
talked about already in the course, in many cases, acquires end up paying too much.
When you enter these takeover battles, the price goes up and maybe the acquirer
become, "The synergy is not true, maybe we can produce synergy off $3 a share, etc"
and in the end, the acquirer ends up overpaying for the deal.
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It's important to remember the evidence and this hostility that we're talking about now
may actually be another reason why acquires may end up overpaying and destroying
value for their own shareholders. Of course, this is because hostile deals tend to
happen at higher price. If there is hostility, the target we want to get up the price. In fact,
we know from empirical evidence that there are lower returns to the acquire when the
deal is hostile, and that's another reason why there are so few of them, as we
mentioned in the beginning. You should always try to do a friendly deal first because
one of the benefits would be to negotiate a better price for you.
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Target Strategies
The target, of course, we also have strategies that the target can deploy in a hostile
takeover battle. It's about defense, right? So the target, might want to defend against
the deal. But really, the first question that we need to ask ourselves is why would a
target want to do that? Takeover offers happen at a premium so shareholders are
making money. What's the point of having takeover defenses?
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And as we're going to discuss in this, part of the course, there are good, bad and ugly
reasons for takeover defenses from the target.
The good reason is to increase the offer. There is significant evidence that at least
anecdotal evidence that takeover defenses allow targets to get a higher price. Even
though, as we're going to discuss later, this evidence has been challenged by recent
empirical research. But there are many cases that we're going to see in which
deployment takeover defense results in a higher price. And that's always the stated
reason why targets employed defenses is to, because the offer undervalues the target.
So I'm using my takeover defense in order to get a higher price.
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The bad is just say no okay. So in some cases it appears that the target does not want
to sell. Perhaps because of agency reasons, it may be the case that the management of
the target does not want to lose control. You want to keep control of the company and
the board may be siding with management instead of maximizing shareholder value. In
fact, the hostile takeover barrels is one of the most common examples of poor
governance, decisions that we have in the history of corporate finance. So, this may
actually be a very good example of an agency problem situations in which the board
does not maximize shareholder value.
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And then the ugly because it's difficult is what we were, it's becoming increasingly
important in finance is what we call the stakeholder view right? So the management of
the target may decide to decline an offer, not because of management's own interest
necessarily, but in order to protect other stakeholders such as the labor force. We have
evidence that in many deals, and the labor force of the target ends up losing, people are
fired, people lose jobs, the positions become unnecessary, right? And management in
some cases argues that the reason why I'm keeping an acquirer ways to protect
stakeholders. And, the reason I'm calling this ugly is because it's very difficult to tell
what managers really mean in these cases. So of course, it's a value no protecting labor
is a valuable go. But the problem is the board of of the shareholders may be using that
as an excuse in order to protect the management. And it's difficult to tell sometimes.
And it's also important to note that in the US where the role of the board of directors
really is to maximize shareholder value. It's not clearly it's not clear that this is legal
right? That the board of directors is supposed to think about shareholders not
necessarily stakeholders. So you could get in trouble by trying to protect stakeholders at
least in the US of course in other countries the situation might be difficult. So this is
really ugly. It's hard to really tell what's going on and I think this is an interesting topic for
future research in M$A. The existing researchers we're going to talk about later
basically tries to disentangle the good from the from the bad, the ugliest kind of left
behind the bad.
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So but how how can a target defend right. So these are the reasons, what do you
actually do? The little strategy that targets can can deploy is a combination of a poison
pill and a staggered board.
And this this strategy is not necessarily legal. It is legal in the US there are countries
such as Ireland that do not allow companies to issue poison pills okay? Since the US
market is a very important and then the market is a good example as any in the US this
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is a legal strategy and it has been deployed many many times in hostile battle. So what
is a poison pill? Right so I'm sure at this point students are curious, I mentioned this a
few times. So a poison pill is a security like a stock or option okay. But it's a very special
security. It's a security that gives its holders the right to buy more stock conditional on
an event, for example, a merger. And in this case the poison pill is going to be
conditional on the acquired buying a certain steak okay. So the pill can be adopted by
the target board without shareholder approval. This is important in case the board
disagreed with the shareholders, the board is free to deploy a poison pill. And before the
rights become exercisable, they can be redeemed by the board for a trivial amount. So
the board can always eliminate the poison pill by paying, what is usually set at a very
small amount, such as when when one cent per right? So the board, so the company
doesn't spend money to redeem the poison pill. So essentially what happens is that if
the transaction is friendly, the target board will first redeem the pill to allow the merger to
happen. And of course, the you can also be redeemed if the board is forced by the
shareholders to agree to a hostile offer.
So let me give an example to make it more clear how a poison pill works. So suppose
we have a company that has a stock price of $30 a share and has one million shares
outstanding. And what the poison pill can do in this case, I suppose this company has a
poison pill in place and the poison pill is triggered after the acquisition of a 20% stake by
anybody. So 20% is the threshold. What the poison pill is going to do is to allow shares
to be issued to non raider stakeholders, shareholders only. Not stakeholders apologize
shareholders only. So non raider, the person, the company who is buying 20% is not
included. These other shareholders can buy at a 90% discount. So suppose, if the price
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is still $30 you are allowed to buy shares at $3 a piece and say you issue 800,000, so
you issue one for one. Okay, so each non raider share is entitled to participate, but the
raider is not.
So ask yourself, how does the pew affect the acquisition attempt? If the acquire crosses
the 20% threshold, if you decide to buy 200,000 shares, let's say through a tender offer
or through any other means you can't do it directly in the market as we learned already.
What will happen is this poison pill is exercise so the poison pill becomes in the money
shareholders will be entitled to buy a share at $3 a piece. If you are a non-raider
shareholder, it's an obvious deal, right? The shares are worth a lot more Should they
take it? You know, obviously, yes, right.
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And what will happen is the non-raider shareholder will now own 1.6 million shares.
That is going to lower the share price. Right? But remember the important thing is the
raider still owns 200,000. So you have diluted the stake of the raider a lot. Right? What
can the raider you should you keep buying? All right. The answer is no, because if you
keep buying, you trigger 20% again. You know the price of the pill is going to be
triggered again and the shareholders are going to get more shares.
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So, the bottom line is that with a poison pill in place, it is impossible foreign acquired to
achieve an acquisition. So poison pill is 100% effective. There is no way around the
poison pill. In fact, we have evidence that no target has ever been acquired if a poison
pill is in place. So, it's that's what I meant by a little strategy. It's a strategy that always
works. Okay, so far due to happen. The conclusion is, the board has to redeem the pill,
as we learned pills can be redeemed for it very small price. So if the board redeems the
pill, then the pill becomes non existent and then the acquisition can happen effectively.
What's happening is that the decision making power is resting with the board of director.
Here's the other important observation. So we already learned that there are no
examples of deals happening when a poison pill is in place. We also do not have any
examples of a poison pill actually being exercised. There has never been a poison pill
that was actually exercised. And at this point just stop and think about that for a second.
Why would it be? Right that we can give examples of poison pills, but we actually have
no examples of poison pill exercise.
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The obvious answer is that no reasonable acquire would ever cross that threshold. So if
a company has a poison period basically means that it's negative NPV to buy shares of
that company. If so, any anyone who triggers that threshold will be immediately diluted.
And this is real dilution. The other shareholders are getting shares, you're not. So very
bad decision and no one is that stupid right to actually do that. So, what we know from
evidence is the poison pills have never been exercised. Its just a threat.
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And that transfers decision making powers to the board of directors of the target. So
essentially for it due to happen when a poison pill in place is in place, the deal has to
become friendly. And friendly here is between quotation marks, because it might also be
that the board is forced right to agree. The shareholders put pressure, but in the end,
the board has to say yes, that's what I mean by friendly.
It has to be the deal has to be negotiated between the board of directors because the
board has all the power. As we mentioned already, the board of directors is not set in
stone. And there is something called the proxy fight by which an acquired can try to
change the board. And if you elect members who are in favor of the deal, then the deal
is becoming more likely and the new board perhaps can redeem the pew.
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And that's where the staggered board comes into place. So this is also called classified
board. Those are synonyms, it's called classified board because the way it's structured
legally is the directors are placed in different classes and these different classes are up
for reelection in different years. So, and the reason it's called staggered is because what
will happen is only a fraction are going to be up for reelection every period.
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So let me give an example again, to make it clear, Suppose you have a board with nine
members, which is a pretty common board size. The way that you stagger the board is
to have only three of them up for reelection every year. So let's say that this is 2020,
three members are going to be up for reelection 2020, then the next three will be up for
reelection in 21 and the next three will be up for reelection in 22. So even if the acquire
wins every election for every board seat, it would take at least one year. Right? So
suppose the election is today, you have to wait a year in order to gain majority and to
elect three more board members 0r up to two years. Right. Suppose you are thinking
about acquiring a company now, but the board meeting is only in December, right? It's
supposed this is January, right? And the board meeting is in December, it happened, it
just happened. It might take two years. So the point is with a staggered board it takes a
long time for the acquired two in a proxy fight. And if there is a pill in place, then it's
guaranteed right that the current board is going to have the decision making power.
Right? So the pill will remain in place unless the current board decides to redeem it.
So that's why, this is, I like to think of this as the lethal cocktail. The combination of a
poison pill and a staggered board means that there is no chance of a hostile deal. The
board has to agree first. The existing board, you cannot change the board either.
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Besides these, there are other defenses. There are in particular, there are other
provisions in the corporate charter that are less important than the poison pill and the
staggered board and then they're operational defenses that turned out to be very
important.
So for example, other contractual defenses, the most common ones are what we call
the supermajority. So this is fairly common. It's rather than having 51% of votes needed
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to approve a merger, many corporate charters require, for example, 2/3 or 66%. So of
course, what this means is a higher fraction of the shareholders has to be in favor of a
merger in order to approve it. And then there are also limitations to shareholder rights.
So, shareholders in some cases have the right to call meetings by themselves or to act
by written consent, for example, trying to replace board director, the corporate charter
can limit shareholder rights in some cases, and again, to give more power to the board.
And then finally, there is the separation between ownership and control, which is a very
important mechanism to take power away from shareholders in many different parts of
the world. It's less important in the US but still exists. So it's the, basically, these are
deviations from the one share, one vote principle or the situation in which not all shares
have the same voting powers. So as well as I mentioned already in many countries,
there are complex ownership structures that involve pyramids, et cetera that can
achieve the separation. In the US, the case is that, that we observe have to do with
special voting rights. So let me give you an example.
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Google, for example, has three classes of shares. There is a class A, which basically
gives one vote for each share and that has a certain ticker. And then there is a class C
that has no votes. So some people own just cash flows. They don't, these shares do not
allow shareholders to vote. And then you have class B, which gives the owner stand
votes per share. So I guess who owns the class B shares? Obviously the founders,
Right? The founders of google are the owners of the class B shares. And effectively
they have greater voting rights. So, to change anything at Google, for example, to agree
to an acquisition or to make a major decision, that the deviation from one share, one
vote, will give more power to the founders.
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Okay, so, can Google ever be acquired? Only if the founders agree. Okay, or if at some
point they decided to change the company's ownership structure. So with a special
voting rights, it becomes much more difficult for a company to be acquired. That's why
this is an important M&A tool.
So, however, you know, if you think about Google, it seems like a silly question, right?
Because Google is not a reasonable M&A target, even if you didn't have this specific
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structure. Okay, so I think in the case of Google, the special voting rights matter and
more because they give the company more day to day control over decisions, right? So,
the founders have more day to day control, even if the shareholders change the board
etc., than this extra voting power will give control to the founders.
It's a very common structure in Silicon Valley companies like Amazon and Facebook or
we also have that. Then, this actually gets us into operation of defenses, right? So, the
reason why Google is not very likely to be acquired, is because it's very successful. So
the company is very large, it has grown a lot, and that's the reason why it's hard to
imagine a situation in which Google will be acquired. As we like to say, having a high
stock price, having a high equity value is one of the best takeover defenses. All right, so
if you're successful, you're much less likely to become a target, simple, right? And then
there are other operational changes that targets can make that make a takeover less
likely. That's what we characterize in operational defenses.
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So, for example, a target can increase leverage. When you have very high leverage, as
we learned already, debt holders will end up capturing some of the gains from M&A
deal. Right, so debt holders are getting a premium when leverage is high. If your equity
holders insist on a high premium as well, then this may make the deal not feasible,
right? You have to convince both equity holders and debt holders by paying a premium.
The debt holders get a premium by design, right? If the company has high leverage. So
having very high leverage is a way to keep acquires away as well. And then stock
repurchase, which is related but slightly different, right? If a target, conducts a lot of
stock repurchase, essentially what you're doing is, you're getting rid of excess cash that
the acquirer can use to finance an M&A deal. Later on, we're going to talk about M&A
financing, and obviously having cash in the target is one way that the acquirer can
finance the deal. A stock repurchase will get rid of this excess cash. It's another
financial tool, that the target can use.
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Then the M&A moves that are also operational in nature, essentially the target can look
for alternative acquires, right? And these have like fancy names in M&A language as
well. Although you can look for a White knight or you can even execute what we call a
Pac-Man defense.
So, a White knight is essentially another bidder. So, if a target is faced with the hostile
bidder, what you do is, you look for another bidder who agrees to a more friendly
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negotiated deal. Typically, with better terms for management and the board as well. All
right, so you're doing this partly because of the management. And what we see is,
White Knight do stand to have better terms for the management and the existing board.
This is not very common. It's hard to find examples of White knight deals in recent
years. In the Kraft and Cadbury case, Cadbury did explore a merger with the White
knight. It was her, she's in that case, but her, she's ended up walking away. So it didn't
work.
And then there is a Pac-Man defense, which is a situation in which the target becomes
the acquire.
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So, you're object of a hostile deal, and then your defense is to actually go after the
acquire. It's not very common and in recent years I don't recall any example of a direct
Pac-Man defense. There was an example that was related to this idea, which is The
Mylan-Perrigo-Teva Battle that happened in 2015. Teva was trying to acquire Mylan. It
was a hostile deal, and at the same time, Mylan launched a bid for another company.
So it's not for the same company, it's not exactly a Pac-Man, but, it's one way to make
the deal as likely because you're swallowing another company, you're becoming bigger,
right? And maybe, Teva did not want to acquire Perrigo, they wanted to acquire Milan.
So, then that's kind of the idea you make yourself less attractive by acquiring another
company. In this case, both hostile bids ended up failing. Teva actually gave up. So,
perhaps the strategy worked. In that sense Teva did not want to acquire Perrigo, they
ended up walking away. And Mylan launched sealed the offer, but the Perrigo
shareholders ended up voting against the deal, as we mentioned before
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Do Takeover Defenses Create or Destroy Value?
Some targeted strategies as we learned are designed to prevent takeovers with no

change in operations, with no other offers. So in principle, with no gains to
shareholders, and as we learned the combination of the poison pill and the staggered
ward is the most common defense that has this characteristic, to stop a takeover
without any other change. So this also what we think of as a preventive takeover
defense in M and A.
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And you might be wondering why is this legal? Right? So isn't the board's supposed to
maximize shareholder value? So how come the board can deploy a poison pill that
essentially stops takeovers, right? The takeover is going to increase the stock price.
What we know from history is that every time a poison pill has been challenged in court
and it has happened, acquirer have challenged poison pills in court claiming that they
were not legal. Every time the poison pill was upheld by the court. So the judges ruled
that poison pills were legal. We're going to see the Airgas-Air Products case later.
Okay?
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And the reason is that, the target board is never going to say that the goal is to stop the
takeover. It's not the stated goal of the poison pill. Even when this is the real intention,
the stated goal of the poison pill is to increase the offer price. Alright, so the potential
benefit of a poison pill is to force the acquirer to raise the offer. And we know from
history that there is significant evidence, there is a lot of anecdotal evidence at least
suggesting that poison pills actually increased takeover premia. So there are many
cases in which the board there is a poison pill in place, the board says no, the acquirer
increases the offer and the judge will look at that and say, look, the evidence I have
suggests that poison pills increased premia. So, you know, it's good for shareholders.
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So far so good, the problem is the dog that didn't bark, right? As in the famous Sherlock
Holmes stories where the important evidence in that story is that the dog did nothing in
the night-time, it's written here, Gregory said, right, the dog did nothing the night-time,
and Sherlock Holmes concludes that that's the evidence, right? Very similar here. The
problem with poison pills is the dog that doesn't bark is the fact that the offer never
happened. The poison pill prevents an offer from happening and the judge does not
observe that, right?
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The M and A judges are not going to know that an acquirer was thinking about buying a
target and then he gave up because there was a poison pill there. So this is really
where the key clues are coming from for the cost that might point out to a negative
effect of poison pills, but judges will never know about.
And, it turns out that even though you can't use this evidence in court, we can use the
evidence in the academic research, right? Not all firms have poison pills in place. And
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what researchers can do is to compare firms that have poison pills in place with firms
that don't. And what we see is that firms that have pills in place are less likely to become
targets in the first place.
So there is a trade off, right. On one hand, it's true that poison pills increased premia,
there is an offer in place that we can observe, then premia might go up. In fact, there
are many cases where it happens, but on the other hand, the poison pill reduces the
probability of an offer. Some deals never happened. The dog doesn't bark, right. And
the the it's the key question here is, which effect dominates? Is there a way we can tell?
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It turns out that there is some recent research that actually provides this evidence, the
Alters our Queen Miettinen Guadalupe, that have written two recent papers suggesting
that poison pills do destroy shareholder value. What they exploit in this research are
what we call shareholders sponsored proposals. So there are many cases in the US
between 1994 and 2013, there are 2820 proposals through which shareholders are
proposing the elimination of either a poison pill or another takeover provisions. So, it's a
change to the laws of the cooperation in 931 different SP 1500 firms in the US. So it's a
very large wide sample what the authors are doing is exploiting the close election.
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So in some cases, the outcome of the vote is known. So shareholders propose, let's get
rid of the poison pill and 95% vote in favor. So it's likely that the stock market already
knew about it. Okay. But then there are close elections. So there are elections in which
51% of the shareholders vote in favor, 49% vote against. And in this case the
implementation of the poison pill is a surprise, right? Very similar to when we look at the
announcement of an M and A deal, right? What happens to stock prices when the
market learns about an M and A deal? What Cunat, Gine and Guadalupe do, is they
look at how the stock market interprets a surprise about the poison pill.
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So now the company does not have a poison pill anymore, what happens to stock
prices? or the poison pill has been kept in place? Right? What happens to stock prices?
What the altars find is that, if a poison pill is in fact eliminated as the shareholders were
proposing, the probability of a takeover in the next five years goes up by 9%. So not
surprising, right? This is the dog that didn't bark. If the poison pill is not there, then the
dog starts barking, right? There is this, and then this is the the more the more recent
paper finds very interesting evidence that if you look at all deals, if you actually look at a
wide sample, there isn't a lot of evidence that takeover premia decrease. Right? So the
tradeoff we mentioned before is that deploying the poison pill in some cases increases
premia. But if you look at the sample of close deals, the evidence is not there. And more
most importantly this is really the most important piece of evidence The Altar finds that if
a poison pill is eliminated, if the shareholders vote against keeping the poison pill in
place, then stock prices jumped by 1.3% on the same day. Right? So this is an
announcement return, there is a close election, the market learns about it. There is no
poison pill. Stock prices jumped by 1.3%. As we discussed already. When we do
announcements studies in finance, we look at the one day return that is the cleanest,
but we also look at longer periods, to allow the market to better digest the information,
and what we find is that there is a 2.4% positive return. If we look at a seven day period.
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So this is evidence, right? That poison pills do seem to destroy shareholder value and
average, eliminating these preventive defense like poison pills and staggered boards as
well should be good for shareholders at least on average right. There are cases in
which, we cannot eliminate the possibility that in individual cases the poison pill may
benefit shareholders. And as other research in finance has suggested this eliminating
poison pill may also have the indirect effect. Remember there are operational changes
right that companies can implement in order to avoid takeovers. The most important of
them is to perform well. Right? So we have evidence that when companies don't have
access to takeover defenses managers work harder and companies increase the
productivity etc. So there are several benefits. It's not only through the direct possibility
that you get acquired, there are also indirect effects through better performance.
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So of course then we have the Ugly right that we mentioned before. There is the good,
the bad, the bad seems to dominate the good in this case for the takeover defense
seems to be bad for shareholders. What about stakeholders? It is important to point out
that if you consider stakeholders as well, you might be able to make the case that
poison pills have a more positive side. Right? So labor for example can lose with
takeovers. The the labor force of the target can essentially, people can can be fired.
Right? There is evidence that M and A destroyed jobs in some cases. And you might be
able to make the case that the poison pill has a more positive side there. It's important
to point out though, that we don't have clear evidence. So this is a topic for for future
research, as well as I mentioned. But that's why I call it the ugly right? It's a topic that is
difficult and we're learning about it now. The existing evidence suggests that the poison
pills are on average bad, but maybe the stakeholder concerns can actually change
some of these conclusions in the future.
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We also have related the evidence, looking simply at what has happened to poison pills
over time. Right? So if poison pills were in fact good for shareholders, we would expect
that poison pills were essentially kept in place and companies were maintaining pills
and staggered boards. In fact, what we do observe is that, the prevalence of defenses
such as poison pills and staggered boards are declining over time. This used to be a lot
more important in the 1990s than what they are now, for example, if we look at the data
in 2002, 60% of S and P 500 firms had pills in place, 61% had a staggered board
structure. So all of these, essentially as we learned, these companies cannot be
acquired without the board agreeing to the to the deal. These fractions are down to 7%
and 11% in 2013. So the academic research, I think, is going hand in hand with the real
world, in the sense that takeover defenses are being eliminated, we also have evidence
that this is probably good for shareholder value.
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Examples of Hostile Deals
We've been talking a lot about theory, legal definitions, empirical evidence, but it turns
out that to learn about hostile takeovers. One of the best methods is the old storytelling,
so just getting a couple of cases reading about it. It's a good way to learn how hostile
battles actually happen in the real world, so we're going to tell two stories here.
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The first one is air products and airgas, which is a very interesting story in the gas
industry, on February 6, air products and chemicals.
2010 sorry, this was way back on February 6, 2010, air products and chemicals
announced $5.1 bid for rival airgas after having been rebuffed for months. So remember
what we learned, friendly approach is always the first approach. And in this case the
acquired disclosed that they was trying to acquire air gas for a few months, but has
been rebuffed the offer, was at a 38% premium. So $60 a share in that case was a 38%
premium relative to the, what we call the undisturbed stock price, right?
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We already learned what this is in the course as well, hostel offering place, right, what
should the target do? One option is to accept right 38% premium, but and then we
would probably wouldn't be talking about.
We wouldn't be telling this story, it wouldn't have been that interesting, what happened
is the usual, right? In the case of a hostile battle, the board of directors of their guests
rejected the offer on February 22 of the same year, a few weeks later. With the usual
133
argument that the offer is too low, and it undervalues the company, all right, so we
would be willing to sell at a higher price. This is not about the management, it's about
the shareholders, right? We want to increase the price, and it turns out that air gas had
a poison pill and the staggered boarding place. So you might wonder, why did the dog
bark, right? What we learned already, is in this case you are less likely to become a
target. But the some of the most interesting stories come from situations in which,
companies with these defenses actually become a target.
So the dog didn't bark in this case, what did air products do? The usual response is to
increase the offer, and as we learned already that is the reason why poison pills are
considered to be legal. Because there is these anecdotes showing that poison pills
increased price, right? So if that's the case,in this specific story, air products raised the
offer to $63.5 in July 2010, and then it raised it again, in September 2010 to 65.5. That
was one of the the of the tools that he acquired right, but they acquire on the side, was
also trying to change the board of directors. So this, airgas had a staggered board
structure as we learned. So, there were nine total directors, but only three were up for re
election in that year.
134
So air products nominated three directors for the first election, and guess what
happened on September 15 of 2010, the shareholders of their guests elected all of
them, right? So the three nominees that were selected by our products, were elected,
so shareholders voted in favor of them. Right, so if you think about it, this is evidence
that shareholders were in favor of the merger, right? They essentially voted for
nominees of the acquire, and 60% of that, there was another shareholder proposal.
Whose goal was to anticipate the annual meeting to January 2011, 60% of the
shareholders of airgas also voted in favour.
135
Okay, however, airgas had an additional trick, which is the super majority rule that we
talked about before 60% was not enough. In order to anticipate the meeting, it turns out
that 67% had to vote in favor because the bylaws had a super majority rule. So the
meeting was not anticipated, anticipating the meeting would require changing the
bylaws right?
136
And then air products was facing a real dilemma here, because it was clear that the
shareholders of the target would support the merger right? They were voting in favor of,
of directors, right? It was really the board of the target that was stopping it, but the board
had the power to do so as we learned. It's the little cocktail, there's nothing the acquired
cannot take the offer directly to shareholders, because the poison pill would kick in and
we would basically destroy the deal right? What they can do is to keep raising the price,
should they do it, now, you face the dilemma, right? The synergies are not infinite as we
discussed it before, there is a maximum that you should pay right?
So this is what airgas tried to do, they actually tried to sue. They try to go to the court in
this case the acquire air products, they believed that they had enough evidence that the
board was not acting in the interest of the shareholders. Maybe because of the outcome
of the vote right? The air products believed that they were going to be able to convince
a judge, to invalidate the poison pill or maybe, to anticipate the annual meeting to
January, so they could electorate more directors.
137
This is how the court reacted in October 2010, the first, Delaware court denied the
request to anticipate the meeting. So the court concluded that the bylaws were fine,
there was nothing wrong with it, supermajorities allowed. So it is essentially denied the
request to anticipate the annual meeting to generate 2011. So that didn't work, and
then, guess what, air products decided to raise the offer again, right? So that's the
problem, this is why courts like takeover defenses. There are all these cases in which
air products, a cyanotic products, right, in which acquires end up, acquirers including air
products, end up increasing price. So now we are the premiums above 50%, what does
the target say no.
138
Okay, air gas rejected the offer again, in December 22, and the argument is again, the
offer is inadequate. So they re evaluated the offer and with the help of investment
bankers right? They, came to the conclusion that the minimum price that they would
take was $78 per share, so notice, they are not just saying no right? They hired
investment bankers should do evaluation to think about how much they should get. And
the conclusion was that $70, even though it's a 50% premium is still not enough.
139
What does, air products do? So, the next move right, is to try to convince the Try to
convince shareholders, right? So the CEO of Air Products issued this statement, right?
Claiming that the that the shelter should understand that these forecasts that, that the
board used and that financial advisors used were provided only by Airgas management.
They were not verified, they were not independently developed. So who knows? Maybe
they were coming up with super optimistic forecasts, right? So the opinion of the
investment bankers is conditional on the data that is provided by the target. So that was
the reaction of the CEO. And then the CEO of their products, the company decided to
go after the poison pill.
They thought they had enough evidence to actually challenge the poison pill itself. And
this is a case that went for the Delaware Court in the beginning of 2011. I remember I
was already teaching and a back then and at that time it was super exciting because the
Wall Street Journal, the Financial Press, everybody was looking at this case. Because
there was a chance, there was a significant chance given the nature of this case that
the court was actually going to invalidate the poison pill, right? And this would be a
momentous fighting because it might actually become, it might actually mean that
poison pills become illegal going forward. However, what happened is that the
Chancellor, in that case of the Delaware Court, William B Chandler the third ruled
against Air Products. So the poison pill was upheld. And the legal opinion is very
interesting. So this next thing, I told you this story is very, very cool.
140
So the Chancellor asserted that he actually wanted to redeem the poison pill. He
thought that the innate sense to redeem the poison pill, because the context had the
contest had lasted more than 16 months including the friendly time. The offer was
noncoercive, shareholders could decide whether they were going to take the offer or
not. And to him it didn't make sense that the board had to be so, so protective.
However, the problem is what we call jurisprudence, which means past decisions. In the
past, poison pills have always been upheld by the Delaware Supreme Court and the
judge had to take this jurisprudence into account. And he concluded that he did not
have sufficient evidence to overturn the former Supreme Court decisions that basically
upheld poison pills. So the judge wanted to eliminate the poison pill, but decided that he
didn't have enough power to do so. Okay, poison pill is legal.
141
And Air Products had this argument that seems totally reasonable to me, right? So if the
Airgas board is so confident that the company is worth $78 per share, why don't you let
shareholders decide? We'll make the tender offer at 70, if shareholders think that the
company is worth more, they don't sell the share. And that's it, right, that's shareholder
democracy, but but the board didn't allow it. Okay, and in the end, as you might
imagine, Air Products walked away, right?
142
What are the key takeaways of this case? This is a great example of the little cocktail in
place, right? I mentioned this is the, if you have this cocktail in place, there is no no
deal. And this is what happens, right? The poison pill plus the staggered board. And
that's true. Even if shareholders disagree in this case, we had evidence that
shareholders wanted the merger to happen. But the board has the power, right? And
the 3rd important point here is this case was crucial to a certain the legality of the
poison pill, even in this extreme which you can consider an extreme situation in which
the board, it's questionable whether the board is acting in the interests of the
shareholders. The Delaware Court still maintained the legality of the poison pill.
Okay, the outcome, as I mentioned already is no, no deal. Air Products decided not to
raise the offer about $70 a share, which if you go back to what we learn in the course is
sensible. Synergies are limited, right? There is a maximum price you should be willing
to pay once you reach that price you shouldn't go over that. And perhaps $70 was the
maximum offer that they were willing to entertain.
143
But the story's not over what happened to Airgas, right? I mean, this has been many
years in the past. We can look we can get stock price data to see what happened to
Airgas, what happened to Air Products. The interesting thing is that Airgas has done
very well since that deal was since the board stopped this deal. This is you can see
here the blue line with the stock price of Airgas. And you can see that the Airgas has
done better than Air Products. It has also done better than both the market as a whole
and also the S&P 500 Chemicals Index, right? So you can look at the industry specific
return and you see that Airgas has done better.
144
So who knows? Right, maybe the board was right. And in fact there was a new deal in
November 19th, 2015, Airgas was actually sold to a French firm called Air Liquide and
the offer was much higher, was $142 a share. So, I mean, maybe the board was right in
this case. That is the difficulty with invalidating poison pills, right? You have these cases
that smart corporate lawyer, a competent corporate lawyer can get a case like this and
just make a living out of it, right? So if you want to show evidence that poison pills
increase shareholder value, all you need to do is to come up with cases like that, it
becomes very difficult for the acquired to argue otherwise.
145
Okay, interesting story.
Right, so let's pass the page and talk about the next one much more recent, it's Xerox-
HP.
146
Another hostile battle. In November 5, 2019, Xerox offered to acquire HP for $33.3
billion. That is a combination of cash and shares. The price was $22 per share. Then
this was the bear hug already. So as usual, there was a friendly stage in which Xerox
was trying to convince the board of HP, but nothing happened. So on November 5, they
disclosed the offer at a certain price with the intention to put pressure on shareholders.
And then of course, what happens is the target response, right?
147
On November 17th of 2019, the board of directors of HP unanimously rejected the offer
with the usual argument that it significantly undervalues HP. So the no, no board is
going to say no, right? The argument is, the offer is too low.
Which takeover defenses could they deploy? Here is the interesting thing, that's
probably the main reason why I have this more modern case. What you see is evidence
148
that companies have fewer takeover defenses in modern times. So if you go to Hewlett
Packard, this data comes from capital like you, by the way, which is a source you might
be using already for other purposes. You can actually get data on which takeover
defenses the company has.
In the case of Hewlett Packard, If you check here, for example, at the bottom, you can
see whether a company has an active poison pill or not. Hewlett Packard does not have
a poison pill. It did not have a poison pill at that time, okay?
149
And there are other things here, but essentially consistent with this evidence that poison
pills are becoming less and less common. Then there's more governance data we can
get from capital like you specifically here. We can look at whether the company has a
staggered board.
150
And you can see here, it's called capital. Like you calls it classified board as you can
see here, it's not staggered or classified or synonyms. And yet as you can see HP does
not have a classified board.
So all the directors are up for reelection at the same time. You could change the board,
the acquirer could change the board of directors in this case.
151
So what can the target do? You have no poison pill, you have no staggered board, you
do not have that little cocktail. But you think that this deal is bad. What can the target
do? Just think about that for a second.
This is a situation in which the power is with the shareholders. So the board, it needs to
convince shareholders that the offer is too low, there is no other option. Shareholders
have the power to sell, because the board does not have the benefit of the little cocktail.
So shareholders have to be convinced, they have to be persuaded. And the evidence in
this case suggests that persuasion can't work.
152
The board said no and of course, the board was, tried to convince shareholders, giving
evidence that the offer was low, that Xerox could in fact increase the offer. This is what
happened on February 10, 2020, Xerox increase the offer to $24 a share. So 10%
increase, both the cash and the stock components increased, right?
So, that's the stated goal of takeover defense is to increase the price, right? And again,
we have evidence that when the board says no, price goes up, what's the acquirers next
153
move? What should Xerox do? In this case, the tender offer is possible, right? Because
there is no poison pill, right? As we learned, the offer can be taken directly to
shareholders. So you could take the $24 a share offer to just ask shareholders to vote
with their pockets, right? If you tendered a share, you think that this deal is good. If you
don't then you think that, that the deal is bad. And this is exactly what the Xerox did on
March second of 2020, it launched the Tender offer at those same terms, $24 a share.
HP told its shareholders to not do anything because it needed time to review and
evaluate the offer. So that was HP is response on March second and then at some
point, of course it was expected that shareholders would start tendering shares right?
They would start voting with their pockets.
154
The problem is that Covid-19 hit. So HP in this case was, the the board at least right?
Was lucky because in the beginning of March, that exactly the time when the Covid-19
financial crisis hit the market. If you look at Xerox stock price, for example, it dropped
from $33 a share to $16 a share in a few weeks. And of course, this makes the offer
much more difficult,right? Because the offer is going down as well. Part of the offer is in
stock, as we're going to discuss later, when offers are in stock, then the offer price
depends on the stock price of the acquirer and that is going to make the deal less likely
to happen. So, Xerox looked at the data, it looked at the crisis and decided that it was
better to drop the offer, okay? So for exogenous reasons perhaps, right? Even though
the tender offer was going to happen in this case, under normal conditions, because of
COVID-19 it did not.
155
So what are the key takeaways from this case? It's an example of the fact that US
companies now have fewer takeover defenses than than they did back then, right? So
the HP had to defend itself by persuading shareholders. But this case also shows that
the persuasion strategy can work, right? The board might still be able to persuade
shareholders that the offer is bad for them. And that's what happened, Xerox will have
to increase the offer because the HP board was successful in forcing the acquirer to do
so. So, shareholder power does not mean bad deals. Going back to the empirical
evidence, we talked about, the paper really doesn't find much evidence that poison pills
increase takeover premium. On average, the Xerox-HP case is a case consistent with
that. It's a case in which there is no poison pill, shareholders have power, but the
acquirer has to increase the price because the board is able to persuade the
shareholders that the original offer is too low.
156
Module 4 Review
Module 4 Review
In module four, we learned how to value synergy. That's a key aspect of a financial
analysis of an emanated. And in particular, we learned that there is a difference
between the management and the market's perspective when valuing synergies and it's
really important to use both as an analyst in order to learn more about specific deals
that you're interested in.
157
We learned how to calculate the NPV of a deal from the perspective of both the
acquiring the target, and how to relate synergies to M&A premia. Synergies and premia
are directly related, and they actually determine the NPV of a deal. And in this model,
we learned how to do that. Then we talked about the market reaction to a deal, which
reflects the markets, the stock market's view of a deal, but it also reflects other factors.
158
For example, right? We talked about the merger arbitrage spread, which, as we learned
can reflect the chances that the deal will fail, that deal that has been announced, that is
not going to go through, which is one of the factors that affect how the market reacts to
the deal. And we learned how to calculate an arbitrage spread and how to interpret that
in this market.
We also talk about strategies that acquires and targets have during a hostile takeover.
The second part of the of the module is focused on hostile takeovers. This is a battle,
right is a battle for control that is framed by important regulations that we're discussing
in this module. There are key laws, regulations that acquires and targets have to follow
in a hostile takeover battle.
159
We also talked about takeover defenses, right? Poison pills are the probably the most
important takeover defense that targets have available. We talked about what they are
and they're rolling hostile takeovers. We also talked about other takeover defenses,
other governance provisions, in particular staggered boards that targets can use to
defend against the hostile acquisition. And then we talked about the empirical evidence
of whether takeover defenses benefit or hurt shareholders of the target. What we have
learned with finance research is that poison pills are likely to destroy shareholder value
on average.
160
However, poison pills are legal and in this model, we also discussed why is it that
poison pills are legal? If you know, most people believe that on average poison pills are
not good for shareholder value. It is true though, as we learned in this module, that
poison pills, another takeover defenses have become less common over time, probably
as a reflection of this value destruction. And it's also true that boards still have defenses
available. If there is a hostile battle, that is not in the interest of the target, then there are
other things that the boards can do. We illustrated deals with some real world examples,
even if they cannot deploy poison pills.
161
Couse Conclusion
Course Conclusion
In this course, we focused on what I like to call the finance of mergers and acquisitions.
M&A is a very rich field that has other aspects such as strategic aspects etc, but our
course focuses on the finance of M&A.
162
In particular, in this course we focused a lot on valuation. We learned how to value and
price an M&A deal. We talked about valuing targets, acquirer, valuing synergies, and
how to use these valuations in the design of an M&A during the real-world. Then we
also talked about the relationship between valuation and pricing. Of course, the
valuation of an M&A deal is directly related to the pricing of the deal and vice versa.
These two objects interact with each other and now you know how to deal with that.
In terms of the modules, we actually started this course with a broad overview of M&A
topics, which covers the history of M&A, and the key terminology that we use to talk
about M&A deals, and then we went more specifically into valuation. In Module 2, we
talked about company valuation, the main techniques to place a value on companies
including multiples and discounted cash-flow. Then in Module 3, we learned how to use
these valuations in M&A, so what is the role of target and acquirer valuation as drivers
of M&A deals? Then finally in Module 4, we talked about synergies. The synergies are
the new value that is created by an M&A deal, and you also learned how to place a
value on synergies. Then as a bonus, we also talked about hostile takeovers in Module
4, which is a very important interesting part of the takeover market. That's when the
target does not want to be acquired and offers resistance to the bidder, and then there
is this interesting battle that we talked about, that have some valuation implications as
well.
163
I really emphasize the fact that in this course there is no compromise, so in some cases
it may have been harder than what I could have done, but I really tried to bring state of
the art methods to my courses. So the methods and theories in this course, they try to
reflect the most up-to-date research in the finance of M&A. Even when that might make
it harder in some cases, we have to go over more details, more complicated financial
models, but as I see it, my goal is to really try to bring the up-to-date research, the state
of the art techniques to the classroom, to our virtual classroom, so you can learn about
those and start applying these in the real world as well.
164
Just around the corner there is a new MOOC, MOOC 2, which is the follow-up to this
course, where we're going to talk about how to fully design the finance of a successful
M&A deal. So valuation is not the end of the story; beyond the corner there are other
things that we need to learn for example, creating financial statements, talking about the
means of payment, so are you going to pay stock or cash, and very importantly, talking
about financing. M&A deals are very large, and they have very important implications for
financing, so it's actually turns out to be an excellent laboratory to study corporate
financial decision. If you like this MOOC, I highly recommend that you also take MOOC
2, the two MOOC's actually go very well together.
165
Then finally, just a big thank you, hearing many languages including my own
Portuguese. Just I want to thank you for taking your time to watch these videos, work on
the quizzes. I hope you have learned something about M&A, as I just said I tried to
make this very state of the art and as helpful as I can, as up-to-date as I can, so you
learn as much as possible about M&A during this course. Thank you.
166

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Finance of Mergers and Acquisitions: Valuation and Pricing

Professor Heitor Almeida

Module 4: Synergies and Hostile Takeovers

Lesson 4-2 ...................................................................................................................................... 13

Lesson 4-3 ...................................................................................................................................... 80

Module 4 Review ......................................................................................................................... 157

Couse Conclusion ......................................................................................................................... 162

Lesson 4-1: Module 4 Introduction

Module 4 Objectives and Overview

You can think of a hostile takeover as a battle for control.

Synergy Valuation: Management Perspective

What I like to do when I value synergies is to focus on a specific calibration. It's a

Synergy Valuation: The Market's View

So what is the undisturbed price in this case?

Suppose a company decides to pursue an acquisition, so you become an acquirer.

Some targeted strategies as we learned are designed to prevent takeovers with no

Okay, interesting story.

And then of course, what happens is the target response, right?

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