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US TARGETS
UK TARGETS
Bidder Premium
• Why are premiums smaller for bidders in
mergers?
– Could be that bidders know that tender offers are
more expensive, higher premia required.
– Greater chance of competition.
– Higher legal/investment banking fees.
• So they only pursue deals that are likely to have large
potential gains.
• There are some deals that remain profitable as mergers that
would not be as hostile tender offers, so the samples are not
comparable
Gains: Improved Managerial
Efficiency
• Market for corporate control assumes that
managers act in the interest of the
shareholders. Firms that do not maximize
shareholder value are targets for takeover.
• Prediction:
– Target share prices experience significant
declines prior to the merger or tender offer.
– Managers of target firms are fired after the
takeover.
Synergy Gains: Horizontal Mergers
• Firms producing similar products in similar
markets (i.e., the same industry).
• Monopolistic pricing: could be gains from
reducing competition:
• Reduce output, and increase profits
• Demand curve facing the firm becomes less elastic
• Antitrust Division of the Justice Department &
the Federal Trade Commission worry about
horizontal mergers.
– Monopoly pricing makes consumers worse off
– Efficiency increasing mergers make consumers better
off: more output at lower prices.
Synergy Gains: Vertical Mergers
• Upstream firm buys a downstream firm (or visa
versa)
• If one firm has a monopoly, can the merged firm
increase profits by charging monopoly prices at
both levels?
– NO.
• Are there efficiency gains from internal rather
than external contracting?
– It depends there is still an important transfer pricing
problem.
Synergy Gains: Conglomerate
Mergers
• Firms in totally different industries
• Perhaps there are efficiencies in
management or some centralized service,
but is doubtful today.
• May have been more important when
centralized information systems first came
into being (1960’s)
Conglomerate Mergers
Diversification
• At first sight diversification may create
value.
• Who benefits from diversification?
– Not stockholders (at least directly). They
could do it on their own account by buying the
stock of the two companies, avoiding paying a
premium. Better yet, their holdings wouldn’t
have to be in fixed proportions.
– May benefit indirectly.
Diversification: Employees
• Other stakeholders
– They are forced to hold undiversified
portfolios of the stock of the bidder/target firm.
– It is hard for them to diversify on their own
accounts.
• Employees cannot diversify their human capital.
• They may be willing to accept a lower salary
and/or have a larger commitment to the company if
they take less risk.
• May ultimately benefit shareholders.
Diversification: Bondholders
• Maybe the combined firm becomes safer.
• But bondholders do not have any decision
power!
– The firm’s debt capacity will be increased if the firm is
more diversified.
– Lenders care about total risk, not just systematic beta
risk.
• To the extent that there are advantages with
debt financing, shareholders will benefit.
Diversification: Executives
• Managers in small firms may be undiversified for
control purposes, and become too risk averse.
• Hence, both inside and outside shareholders
may benefit through diversification.
• A merger always changes control in at least one
of the firms.
– Good or bad depending on who is losing out and why.
• Fired: Bad if you are the one being dismissed.
• Retired: Good if you are the one being bought out.
Diversification Benefits the
Evidence
• Acquirers in diversifying mergers have negative
abnormal returns (-2%) in the 80’s.
• Not in the 90’s, instead earn about 0%.
• Acquirers in related businesses experience
positive returns of 2%, on average.
• Targets of hostile bids in late 80’s are often
broken up and sold to companies in related
businesses
• No evidence that there exists a large advantage
from diversification.
Conglomerate Mergers: Hubris
Hypothesis
• Managers commit errors of over-optimism
in evaluating merger opportunities due to
excessive pride, animal spirits or hubris.
Summary
• From a policy perspective, gains come from either
efficiency gains (good), or from monopolization (bad).
• Management shouldn’t care, except that the probability
of antitrust problems increase if the gains come from
monopoly pricing.
• Always ask yourself whether it is necessary to merge to
capture the efficiency/pricing gains. Are other
contracting methods better than paying a premium to
buy control?
• Diversification by itself should not increase firm value.
• Since corporate control always changes, this may be the
common factor explaining the gains
– Managers of target firms are often fired after the takeover.
Takeover Defenses
• Successful takeovers:
– Target Stockholders gain 20-35% or more
• Unsuccessful takeover:
– Target stockholders gain little if not eventually
taken over.
• Why defend a firm from a takeover?
Defense: Entrenchment or What?
• Why it might not be entrenchment.
– Target management may try to get a higher
bid from bidder.
• Sometimes such negotiations cause a deal to fail.
– Target management may defend the firm
while searching for another bidder willing to
pay more.
• The delay may inadvertently cause the deal to fail.
– Why it might be entrenchment.
• You know what they say about ducks!
Takeover Defenses: Charter
Amendments
• Supermajority Rules.
– 67% or more of votes necessary to approve
control change can be avoided by board.
– However, it can be avoided by board ("board
out")
– Fair-Price: supermajority clause can be
avoided if price is high enough (P/E or P/B).
• Staggered Board.
– Only 1/K of board is elected each year, so it
takes K years to turnover board completely.
Charter Amendments: Poison Pills
• Securities that provide shareholder (except acquirer) with special
rights, following the occurrence of a triggering event such as a
tender offer.
– They 'poison' the acquirer if it swallows the pill.
• Poison pills do not have to be approved by shareholders.
– Flip over plans:
• Shareholders have the right to buy the shares of the target at a premium
above the market.
• In case of a merger they flip-over: the shareholders have then the right to
buy the shares of the bidder at a substantial discount below market.
– Ownership flip-in plans:
• If the bidder acquires a threshold, shareholders (except the bidder) have the
right to purchase shares of the target firm at a discount.
– Back-end right plans:
• If the bidder acquires a threshold, shareholders (excluding bidder) can
exchange a right plus a share for cash equal to a back-end price set by the
board of directors of the issuing firm.
• Thus, back-end price will then becomes the minimum effective bid price.
Defenses: Voting Plans
• If a party acquires a substantial block of
the firm's stock, the other shareholders
receive more voting rights.
Legal/Regulatory Defenses
• State corporation/anti-takeover laws
impose rules that are similar to stringent
charter amendments for all corporations
chartered in that state.
• Inter-firm litigation can be effective.
– Target charges that bidder failed to disclose
something material in SEC filings.
Asset Restructuring Defense
• Crown Jewel defense
– Contract to sell attractive assets to a third
bidder contingent on hostile bid
• Pac Man defense
– Make competing tender offer for shares of
bidder.
Other Defenses
• Leverage Recapitalization.
– Partial LBO leaving equity holders with much riskier claims.
• ESOPs
– Employees get equity claim in the firm, but management votes
the shares of the stock in the ESOP.
• Golden Parachutes
– Lump sum payments to target management if fired due to
takeover.
– Usually small relative to size of deal, so probably not much
deterrence effect.
– Aligns the interests of target management with shareholders.
Other Defenses Continued
• Greenmail
– Buy back stock (at a premium above the
market price) from large stockholders who
may pose a threat.
– Often liked with “standstill agreements.”
• Shareholders bought out (through greenmail)
agree not to make further investments in the target
company.
– Should greenmail be outlawed?
Valuing Acquisitions
• Evaluating a potential acquisition is similar in
most respects to analyzing the NPV of any other
investment project a firm may be considering.
• Some subtle differences:
– The value of potential synergies must be added to
the value of the target firm's cash flows.
– The target firm's stock price will exceed the present
value of the firm's future cash flows, if it reflects the
possibility that the firm may eventually be taken over
at a premium.