BAF.

608E

Mergers and Acquisitions

Professor Martin Dierker
Lecture Notes Part 4
M&A and Corporate Strategy
 M&A and
Corporate Strategy
Introduction
Mergers and Acquisitions
… are puzzling.
 How can there be $2.4 trillion deal volu

me in first half of 2021 if

◦ Buyers pay large acquisition premia and
◦ We know that in the long run, merged firms
underperform?
 No clear answer
◦ BUT: Some players win consistently
M&A and Corporate Strategy
 One answer is that M&A is a crucial tool of
corporate strategy
 Esp. tech firms like Google (youtube),

Facebook (Instagram)
 Integration between internet service provider

and content:
◦ AOL – Time Warner 2001
 Conglomerates such as GE, Berkshire-
Hathaway and Tyco acquire many, sometimes
unrelated businesses
Example: Beer industry
 Traditionally, very local
 Each country, and even different regions of

each country, have their own beers

 Visit to 7-11 or C U:

◦ Korean beer
◦ American beer
◦ German beer
◦ Belgian beer
 These distinctions are now only in the realm
of marketing, because of …
The Emergence of Global Beer compa
nies through M&A
 If you guess where the maker of these brands
at the convenience store is located, you may
be mistaken
 Budweiser, Cass, Spaten, Corona, Foster’s are

now all Belgian beers by M&A:

 2004: Belgian Interbrew acquired Brazilian

Ambev to become InBev for 9 bn Euro

◦ Largest brewer in the world with 14% market share
 What happened next?
InBev
 2008: InBev acquired Anheuser-Busch for US$
52 bn
 Huge public shock to Americans
 $1.5 bn per year in synergies
 One of the biggest consumer brands in world
 2016: AB InBev acquired #2 beer maker, SAB Mill
er, for over US$ 100 bn
◦ Now over 30% global market-share, more than 3 tim
es that of current #2 Heineken
 Actually needed to sell MillerCoors to Molson
 Cost synergies of $1.4 bn per year
◦ Merger company actually struggles to pay off M&A debt
 M&A and
Corporate Strategy
Strategic vs. Financial Acquirer
s
Distinguish two kinds of buyers
 To understand this better, we distinguish
 Strategic buyers

◦ Who buy for their interest in target operations

◦ Often looking for operational synergies
 Often revenue increases or cost savings
◦ Strategic acquirers are often public firms
◦ They may use their stock for acquisitions
 Also use cash or debt financing
◦ Maximizing NPV or focus on strategic view?
 What was InBev’s goal? Synergy or global dominance?
Distinguish two kinds of buyers
 Financial buyers
 Often Private Equity firms

◦ Create new company for each acquisition

◦ Company usually remains stand-alone
◦ May change management a lot, BUT
◦ Usually less interested in synergies with existing busi
nesses
 Usually pay cash (buyout)
◦ Or large debt financing for cash acquisition (levera
ged buyout), leverage can be high
 Usually good relations with debt providers
◦ Limited horizon (~ 3-5 years), then IPO or sell on
Which are more common?
 Until 1980s, almost all deal volume was
strategic bidders
 Recent years, financial bidders (usually private)

are much more important

◦ Can be 30% or more of all deal volume
 Reasons: More availability of low-rated debt
 Since 2008: Extremely low interest rates make

financing very cheap.

 Private non-financial bidders are few
 Interesting: Financial bidders pay lower premia
Mergers and Acquisitions
 Can be of the following types.
◦ Horizontal: Between two direct competitors in the
same industry.
 Example: US Steel (Carnegie)
◦ Vertical: Between companies which have a buyer /
seller relationship
 Standard Oil Company (Rockefeller)
◦ Conglomerate: Between companies that are not in
the same industry or having a close relationship.
 Good Example: Berkshire-Hathaway (Warren Buffett)
 Bad Example: Tyco (Dennis Kozlowski)
Sources of synergies
 Horizontal mergers:
◦ More market power against consumers
◦ Take advantage of efficient scale (US Steel)
 Vertical mergers:
◦ Efficient stream-lined production
◦ Take advantage of market power against competitors
 Standard oil
 Horizontal mergers
◦ Financial acquirers: Buy cheaply, improve operational effi
ciency
◦ Berkshire-Hathaway: Buy cheaply, improve capital alloc
ation
 M&A and
Corporate Strategy
Market Power and Anti-Trust
Regulatory Approval
Market Power
 Has been controversial
 Consider Standard Oil:

◦ Started as a refining business

◦ Became to dominate local market in Cleveland
◦ Could get influence on oil transportation
 First: negotiate lower rail rates
 Then: control pipelines
 Abuse its power so competitors had to pay
much more to move their product
Market Power
 Standard Oil Co:
 Abuse this power to threaten competitors:

“If you refuse to sell, it will end in your being

crushed”
 Competitors often did not merge formally,

but exchanged stock secretly

 Finally, refineries merged in form of a trust
 Could then use power to negotiate contracts

with oil drillers

 Start of the vertically integrated oil company
Market Power
 This led to higher profits
 Owner (Rockefeller) became first billionaire
 But many complaints about abuses
◦ Similar in railroads
 President Theodore Roosevelt broke up St
andard Oil in 1911 using 1890 Sherman Anti
-trust Act
◦ Exxon, Mobile, Chevron, etc. were the spin-offs
 Today: Strong regulatory oversight in US, EU
◦ Natural monopolies like landline telephone, railroads,
electricity became regulated.
 M&A and
Corporate Strategy
Synergies: When is the whole
worth more than the sum of it
s parts?
Determining the Synergy from an Acq
uisition
 Most acquisitions fail to create value for the a
cquirer.
 The main reason why they do not lies in failur

es to integrate two companies after a merger.

◦ Intellectual capital often walks out the door when ac
quisitions aren't handled carefully.
 Traditionally, acquisitions deliver value when
they allow for scale economies or market pow
er, better products and services in the marke
t, or learning from the acquired firm.
 Synergy
 Example: Firm A is acquires firm B.
 The synergy from the acquisition is

Synergy = VAB – (VA + VB)

 The synergy of an acquisition can be determ
ined from the usual discounted cash flow m
odel: T

S
DCFt
Synergy = (1 + r)t
t=1
where
DCFt = DRevt – DCostst – DTaxest – DCapital Requirementst
 Source of Synergy from Acquisitions
DCFt = DRevt – DCostst – DTaxest – DCapital Requirementst
 Revenue Enhancement
 Cost Reduction

◦ Including replacement of ineffective managers.

 Tax Gains
◦ Net Operating Losses
◦ Unused Debt Capacity
 Incremental new investment required in wor
king capital and fixed assets
Calculating the Value of the Firm afte
r an Acquisition
 Avoiding Mistakes
◦ Use Market Values, not Book Values
◦ Estimate only Incremental Cash Flows
◦ Discount at the correct rate
◦ Don’t forget transactions costs
 Substantial in case of M&A
A Cost to Stockholders from Reductio
n in Risk
 The Base Case
◦ If two all-equity firms merge, there is no transfer of
synergies to bondholders, but if…
 One Firm has Debt
◦ The value of the levered shareholder’s call option fa
lls.
 How Can Shareholders Reduce their Losses fr
om the Coinsurance Effect?
◦ Retire debt pre-merger.
Two "Bad" Reasons for Mergers
 Earnings Growth
◦ Only an accounting illusion.
◦ Bad-faith managers can play tricks to deceive invest
ors by using legal tricks to confuse investors more
 Diversification
◦ Shareholders who wish to diversify can accomplish t
his at much lower cost with one phone call to their
broker than can management with a takeover.
Mergers and Acquisitions:
Introduction
Merger NPV and Cash Vs. Stoc
k Deals
The NPV of a Merger
 Typically, a firm would use NPV analysis
when making acquisitions.

 The analysis is straightforward with a cas

h offer, but gets complicated when the c
onsideration is stock.
The NPV of a Merger: Cash

NPV of merger to acquirer = Synergy – Premium

Synergy = VAB – (VA + VB)

Premium = Price paid for B – VB

NPV of merger to acquirer = Synergy – Premium

= [VAB – (VA + VB)] – [Price paid for B – VB]

= VAB – (VA + VB) – Price paid for B + VB

= VAB – VA– Price paid for B

The NPV of a Merger: Common Stock
 The analysis gets muddied up because we ne
ed to consider the post-merger value of thos
e shares we’re giving away.

Target firm payout    New firm value

New shares issued


Old shares  New shares issued
Cash versus Common Stock
 Overvaluation
◦ If the target firm shares are too pricey to buy with c
ash, then go with stock.
 Taxes
◦ Cash acquisitions usually trigger taxes.
◦ Stock acquisitions are usually tax-free.
 Sharing Gains from the Merger
◦ With a cash transaction, the target firm shareholder
s are not entitled to any downstream synergies.
Common Stock Offers
 Typically, analysis focuses on undervaluation of t
arget firm.
 Often ignored:
◦ Under/Over-Valuation of bidder
 Examples:
◦ America OnLine (AOL) acquired Time Warner in 1990s t
ech bubble
 AOL acquired valuable firm using overpriced shares as curr
ency
◦ Kraft acquiring Cadbury:
◦ Warren Buffett: “I feel poorer”
 Reason: Kraft shares undervalued more than Cadbury