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Principles of Corporate Finance

Brealey and Myers

Sixth Edition

Mergers

Slides by
Matthew Will
Irwin/McGraw Hill

Chapter 33

The McGraw-Hill Companies, Inc., 200

33- 2

Topics Covered
Sensible Motives for Mergers
Some Dubious Reasons for Mergers
Estimating Merger Gains and Costs
The Mechanics of a Merger
Takeover Battles
Mergers and the Economy

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The McGraw-Hill Companies, Inc., 200

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1997 and 1998 Mergers


Selling Company
NYNEX
McDonnell Douglas
Digital Equipment
Schweizerischer
Energy Group PCC
Amoco Corp.
Sun America
BankAmerica Corp.
Chrysler
Bankers Trust Corp.
Netscape
Citicorp

Irwin/McGraw Hill

Acquiring Company
Bell Atlantic
Boeing
Compaq Computer
Union Bank of Swiz.
Texas Utilities
British Petroleum
American Intl.
Nationsbank Corp.
Daimler-Benz
Deutsche Bank AG
America Online
Travelers Group Inc.

Payment, billions of dollars


21.0
13.4
9.1
23.0
11.0
48.2
18.0
61.6
38.3
9.7
4.2
83.0

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Sensible Reasons for Mergers


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

$
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Reduces costs

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Sensible Reasons for Mergers


Economies of Vertical Integration
Control over suppliers may reduce costs.
Over integration can cause the opposite effect.

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The McGraw-Hill Companies, Inc., 200

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Sensible Reasons for Mergers


Economies of Vertical Integration
Control over suppliers may reduce costs.
Over integration can cause the opposite effect.
Pre-integration
(less efficient)
Company
S

S
S
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The McGraw-Hill Companies, Inc., 200

33- 7

Sensible Reasons for Mergers


Economies of Vertical Integration
Control over suppliers may reduce costs.
Over integration can cause the opposite effect.
Pre-integration
(less efficient)

Post-integration
(more efficient)

Company
S

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S
S

Company

S
S

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Sensible Reasons for Mergers


Combining Complementary Resources
Merging may result in each firm filling in the
missing pieces of their firm with pieces from the
other firm.
Firm A

Firm B

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The McGraw-Hill Companies, Inc., 200

33- 9

Sensible Reasons for Mergers


Combining Complementary Resources
Merging may result in each firm filling in the
missing pieces of their firm with pieces from the
other firm.
Firm A

Firm B
Irwin/McGraw Hill

The McGraw-Hill Companies, Inc., 200

33- 10

Sensible Reasons for Mergers


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

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Dubious Reasons for Mergers


Diversification

Investors should not pay a premium for


diversification since they can do it themselves.

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Dubious Reasons for Mergers


The Bootstrap Game
Acquiring Firm has high P/E ratio

Irwin/McGraw Hill

The McGraw-Hill Companies, Inc., 200

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Dubious Reasons for Mergers


The Bootstrap Game
Acquiring Firm has high P/E ratio
Selling firm has low P/E ratio (due to low
number of shares)

Irwin/McGraw Hill

The McGraw-Hill Companies, Inc., 200

33- 14

Dubious Reasons for Mergers


The Bootstrap Game
Acquiring Firm has high P/E ratio
Selling firm has low P/E ratio (due to low
number of shares)
After merger, acquiring firm has short term
EPS rise

Irwin/McGraw Hill

The McGraw-Hill Companies, Inc., 200

33- 15

Dubious Reasons for Mergers


The Bootstrap Game
Acquiring Firm has high P/E ratio
Selling firm has low P/E ratio (due to low
number of shares)
After merger, acquiring firm has short term
EPS rise
Long term, acquirer will have slower than
normal EPS growth due to share dilution.

Irwin/McGraw Hill

The McGraw-Hill Companies, Inc., 200

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Dubious Reasons for Mergers

Earnings per
dollar invested
(log scale)

World Enterprises (after merger)


World Enterprises (before merger)
Muck & Slurry

.10
.067
.05
Now
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Time

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Estimating Merger Gains


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

????

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

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Estimating Merger Gains


Economic Gain
Economic Gain = PV(increased earnings)

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New cash flows from synergies


discount rate

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Takeover Defenses
White Knight - Friendly potential acquirer sought by
a target company threatened by an unwelcome
suitor.
Shark Repellent - Amendments to a company charter
made to forestall takeover attempts.
Poison Pill - Measure taken by a target firm to avoid
acquisition; for example, the right for existing
shareholders to buy additional shares at an attractive
price if a bidder acquires a large holding.

Irwin/McGraw Hill

The McGraw-Hill Companies, Inc., 200