Corporate Valuation and Financing M&As H. Pirotte.

Corporate Valuation and FinancingM&AsH. Pirotte

Introduction

Some history Great M&A wave in the 80’s

» 3’336 M&As (1986) in US

Colder in the first mid 90’s

Hot again in second mid 90’s to 2000» 9’566 M&As (2000) in US with 1’097 valued at > $100 mns

Typology» Majority: negotiated acquisitions» Minority: tender-offers» Even less: hostile takeovers

T. Boone Pickens, Ron Perelman, Jimmy Goldsmith, Carl Icahn,…

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Introduction

Some numbers

1998 1999 2000 2001 2002

US $1’373.3 $1’433.7 $1’792.2 $1’148.4 $612.6

Rest of the world $659.3 $917.3 $1’652.2 $821.8 $623.7

World $2’032.6 $2’351.0 $3’444.4 $1’970.2 $1’236.3

US % of world 67.6% 61.0% 52.0% 58.3% 49.6%

Source: Mergers & Acquisitions, 2003 Almanac, February 2003

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Introduction

Alternative Ownership Strategies Growth strategies

1. Mergers – one unit from two (or more) previous unitsa) Tender offers – method of making takeover via direct offer to target firm shareholdersb) Pooling of interest – combination of fin’l statements of two (or more) firms

2. Joint ventures – combination of subsets of assets for a specific purpose and duration3. Other forms

» Supplier networks» Alliances» Investments – stake, but not control in another organisation» Franchising

Shrinkage strategies1. Divestitures – sale of a segment to 3rd party for cash or securities2. Equity carveouts – parent firm offers some of a subsidiary’s common stock to the general public, to bring in

a cash infusion without loss of control3. Spin-offs – creation of new public cy out of subsidiary with share distribution on pro-rata

a) Splitoffs – some shareholders receive subs.’shares in exchange of the interest in parent firmb) Splitups – spinoff of all subsidiaries and no more parent firm

4. Tracking stock – a separate class of common stock of a company that tracks the perf of a particular segment or division

The market for restructuring H. Pirotte 4

Introduction

Changes in Ownership Structure

1. Exchange offers» Right or option to exchange one class of security for another

2. Share repurchases» A public corporation buys its own shares (a) by tender offer, (b) on the open market,

or (c) in negotiated buybacks

3. Leveraged buyouts (LBOs,MBOs)» The purchase of the company by a small group of investors, financed largely by debt

4. Leveraged recapitalizations» A large increase in the leverage ratio to finance the return of cash to shareholders

5. Employee stock ownership plans (ESOPs)» A defined contribution pension plan designed to invest primarily in the stock of the

employer firm

6. Dual-class recapitalization» Creation of two classes of common stock, with the superior-vote stock concentrated

in the hands of management

7. Reverse Takeovers (RTOs)


Introduction

Governance – Corporate control

1. Compensation arrangements» Payment forms to align interests of managers, owners and employees

2. Proxy contest» An attempt by a dissident group of shareholders to gain representation on a firm’s

board of directors

3. Premium buy-backs (greenmail)» The repurchase of specified shares, usually from a party seeking to take over a firm

4. Takeover defenses» Methods employed by targets to prevent success of bidder’s efforts

5. Stakeholder relationships

6. Ethics and reputation


Introduction

Motivation

Source: “Mergers and Acquisitions: Swiss Companies, their Motivations and Activities”, KPMG, 2002


Introduction

Motivation



Introduction

M&As basic forms Mergers

» Absorption of a firm by another, combination of assets and liabilities» Acquired firm cease to exist» Specificity: consolidation (an entirely new firm is created)

Acquisitions» Of Stock

Purchase of voting stock in exchange for cash, shares, or other securities May start as a private offer but then is offered to all selling shareholders (tender offer

by public announcement) Differences with mergers?

- No shareholder’s meeting, nor vote is required- Target’s firm management and board can be bypassed- Often unfriendly- A minority of shareholder may hold out and target cannot be completely absorbed- Complete absorption required a merger. Many acquisitions end up with formal merger

» Of Assets Formal vote is necessary Avoid potential problem of having minority shareholders Legal process of transferring assets can be costly

Value H. Pirotte 9

Introduction

M&As basic forms (2) Classification

» Horizontal acquisition» Vertical acquisition» Conglomerate acquisition

Note on takeovers» general and imprecise term referring to the transfer of control of a firm from one

group of shareholders to another.» Bidder: firm that has decided to take over another firm» Payment: cash or stock» The right to control the operating activities of the target firm is transferred to a

newly elected board of directors of the acquiring firm. This is a takeover by acquisition.

» Going private all the equity shares of a public firm are purchased by a small group of investors. The

group usually includes members of incumbent management and some outside investors. The shares of the firm are delisted from stock exchanges and can no longer be purchased in the open market.

From Ross, Westerfield and Jaffe, 7e.

Value H. Pirotte 10

Introduction

Valuation As for any other investment project: DCF analysis

But difficulties…» Synergies,» Legal effects,» Tax impacts,» Accounting impacts,» Agency costs,…

Problems» Allocation of the NPV (V=D + E) » Value impacts of using takeover defenses

Advices» Do not ignore market values» Estimate only incremental cash flows» Use the correct discount rate» Do not ignore transaction costs

Value H. Pirotte 11

Introduction

Valuation

0%

10%

20%

30%

40%

50%

60%

70%

DiscountedCash Flow

PractitionerMethod

Multiples Comparabletransactions

EconomicValue Added

Valuation methods


Value H. Pirotte 12

Introduction

Valuation


0%

10%

20%

30%

40%

50%

60%

70%

80%

Synergies Taxation effects Integration costs

Pricing aspects

Value H. Pirotte 13

Introduction

Debate Big debate on costs and benefits of takeovers

» Pros

» Cons

The classical explanation: synergies

AB A BSynergy V V V

1 1

Ttt

t

CFSynergy

k

Revenues Costs Taxes Capital Requirementst t t t tCF

Value H. Pirotte 14

Introduction

Example (case 1) A buys B and pays in cash

» VA = 1000, VB = 200» A has 20 shares, value of 50» B has 10 shares, value of 20» Synergy = 200» VAB = 1400» A pays 300 to buy back B

Gain for A shareholders:= VA ap. fusion – VA av. fusion

= 1100 – 1000 = 100

B shareholders receive 300 for their firm that has a value of 200» VAN = Synergy – Premium

» The merger’s synergy can be expressed through : VAB – (VA + VB)

» Synergie = 1400 – 1200 = 200

» Premium = 300 – 200 = 100

» VAN = 200 – 100 = 100

Value H. Pirotte 15

Introduction

Example (case 1) How are share values modified ?

» For A shareholders : PA before the merger = 1000/20 = 50 PA after the merger = 1100/20 = 55

» For B shareholders : Before the merger : 200/10 = 20 After the merger : 300/10 = 30

Value H. Pirotte 16

Introduction

Example (case 2) A pays B with shares : exchange ratio of 0.6 ?

» 6 A shares mean 6 50 = 300

» Value of AB share: PAB = 1400/ 26 = 53.85

» B shareholders have: 1400 6/26 = 323.08

The calculation is not correct because it is based on prices before the merger.

B shareholders will own in AB

must correspond to the proportion of new shares issued

Shares to issue = 5.46

2143.01400

300

new shares new shares

total old shares new shares

0.214320

new shares

new shares

Value H. Pirotte 17

Introduction

Example (case 2) Total number = 20 + 5.46 = 25.46

Exchange ratio = 0.546

PAB = 1400/25.46 = 55

Price paid by B shareholders : 5.46 55 = 300

Value H. Pirotte 18

Introduction

Sources of Synergies Revenue enhancement

» Marketing gains» Strategic benefits» Market or Monopoly Power

Cost reduction» Economies of scale» Economies of vertical integration» Complementary resources» Elimination of inefficient management

Tax gains» Net operating losses» Unused debt capacity» Surplus funds

The Cost of Capital» Why????

Value H. Pirotte 19

Introduction

Tobin’s Q Tobin’s Q = Market value / Book value

Indicator of under- or over-valuation» A buys back B» Tobin’s Q of B = 0.6» Premium of 50%» B is under-valued» Tobin’s Q main information engine

Value H. Pirotte 20

Introduction

Introduction - ListA. Total value increased

1) Efficiency increases2) Operating synergy3) Financial synergy4) Strategic realignements5) The q-ratio6) Information7) Signaling

B. Hubris: acquirer overpays for target

C. Agency: managers make value-decreasing mergers to increase size of firm

D. Redistribution1) Taxes – redistribution from government2) Market power – redistribution from customers3) Redistribution from bondholders4) Labor – wage renegotiation5) Pension reversions

E. Conglomerate mergers

Theories of mergers H. Pirotte 21

Introduction

Information theories Upward revaluation of shares of target firm

(Bradley [1980], Dodd & Ruback [1977])» Upon announcement? Yes, but also permanent new information has been gen!» Even if offer turns out to be unsuccessful

Two hypothesis» “Sitting on a gold mine” (Bradley, Desai & Kim [1983])

Tender offer disseminates information that firm is undervalued only» “Kick in the pants”

Tender offer inspires target firm management to implement a more efficient business


Introduction

Hubris and winner’s curse Winner’s curse

» The successful bidder is the one paying too high a price» Capen, Clapp & Campbell [1971] : analysis of sealed-bid competitive lease sales

Ratio of high estimate to true value as a function of uncertainty and the number of bidders

Hubris (Roll[1986])» If EMH verified, then target market price should reflect true value.» Higher valuation of bidders results from hubris.» Potential cause of winner’s curse: even if synergies, competition of other bidders

could cause the winning one to pay too much.


Introduction

Agency problems Theories following the paper of Jensen & Meckling [1976]

» Partial ownership may cause managers to work less vigorously.» In large corporations with dispersed shareholdings, not enough incentive to

monitor managers.» Agency problems arise because contracts between managers and owners cannot

be enforced at no cost.

Ideas» Changes in ownership & control as a solution to agency problems» Managerialism (e.g. for conglomerates (Mueller[1969]))» The free cash flow hypothesis


Introduction

Gains to target firm’s shareholdersTheories of mergers H. Pirotte 25

Introduction

Takeover defensesThe end of the game

Types» Poison pills (ex: in the incorporation status)

Merger approval with 90% of votes» Golden parachutes» Voting rights and proxy fights» Assets sale (ex: vente de la division recherchée)» « burned land » policy» ...

Is it good for the shareholder?» Entrenchment versus firm protection

From Wikipedia En 1812 Napoléon, stupéfait de voir Moscou en feu aurait dit : Cela dépasse tout : c'est une guerre d'extermination, c'est une tactique horrible, sans précédent dans l'histoire de la civilisation. Brûler ses propres villes ! Le démon inspire ces gens.Des barbares. Quelle résolution farouche, quelle audace.

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Introduction H. Pirotte |27

References Copeland, Weston & Shastri (2003), Financial Theory and Corporate Policy,

4e, Addison Wesley.

Ross, Westerfield and Jaffe (2005), Corporate Finance, 7e, McGraw-Hill.

Corporate Valuation and Financing M&As H. Pirotte.

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