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- 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 Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 33- 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 ©The McGraw-Hill Companies, Inc., 200 33- 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 $ Irwin/McGraw Hill Reduces costs $ $ ©The McGraw-Hill Companies, Inc., 200 33- Sensible Reasons for Mergers Economies of Vertical Integration Control over suppliers “may” reduce costs Over integration can cause the opposite effect Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 33- 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 S Irwin/McGraw Hill S S S ©The McGraw-Hill Companies, Inc., 200 33- 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 Irwin/McGraw Hill S S S S Company S S S ©The McGraw-Hill Companies, Inc., 200 33- 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- 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 Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 33- 11 Dubious Reasons for Mergers Diversification Investors should not pay a premium for diversification since they can it themselves Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 33- 12 Dubious Reasons for Mergers The Bootstrap Game Acquiring Firm has high P/E ratio Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 33- 13 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 33- 16 Dubious Reasons for Mergers Earnings per dollar invested (log scale) World Enterprises (after merger) World Enterprises (before merger) Muck & Slurry 10 067 05 Now Irwin/McGraw Hill Time ©The McGraw-Hill Companies, Inc., 200 33- 17 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) Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 200 33- 18 Estimating Merger Gains Economic Gain Economic Gain = PV(increased earnings) = Irwin/McGraw Hill New cash flows from synergies discount rate ©The McGraw-Hill Companies, Inc., 200 33- 19 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 ... Companies, Inc., 200 33- 17 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)... 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... 11.0 48.2 18.0 61.6 38.3 9.7 4.2 83.0 ©The McGraw-Hill Companies, Inc., 200 33- Sensible Reasons for Mergers Economies of Scale A larger firm may be able to reduce its per unit cost by using excess