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Finance 7311Finance 7311

Market for Corporate Control

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TerminologyTerminology

Target– Potential takeover candidate

Acquirer (Bidder)– Firm doing the ‘taking over’

Merger– Friendly combination of two firms

Tender Offer (Hostile Takeover)– Opposed by target management

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Terminology, cont.Terminology, cont.

Leveraged Buyout– Takeover in a highly leveraged transaction– Advantages

Concentrates ownership in fewer hands Takes cash out of management hands Tax advantage of debt

– Disadvantages Effect of economic downturn

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Terminology, cont.Terminology, cont.

Management Buyout– Same as LBO, except existing management is major

shareholder

Proxy Contest– Voting by S/H on major corporate transactions

Restructuring– Significant change in allocation of corporate

resources– Current management stays on

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Defensive TacticsDefensive Tactics

Methods used by management to avoid being taken over

Poison Pill White Knight Greenmail Just Say No Supermajority Voting Courts: OK if only one ‘bidder’

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Selecting and Valuing a TargetSelecting and Valuing a TargetBusiness Plan or Objective

– Vertical Integration– Excess Capacity

Product ==> Distribution Distribution ==> Product

– (Time Warner; Paramount, previously)

– (AOL, Time Warner)

– Strategic: Enter a new market for example– Diversification (Later)

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ValuationValuation

PVt = PV of target (stand alone)

PVa = PV of acquiring firm (stand alone)

PVc = PV of combined firm

TP = tender price

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Synergy ==> Value CreatedSynergy ==> Value Created

PVc - (PVa - PVt) = Total Synergy

NPV of acquisition to acquiring firm:

PVc - (Pva + PVt) - (TP - PVt)

= total synergy - synergy to target

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SynergySynergy

Sources of Synergy?

– Economies of Scale in Production Distribution Management/Administration

– Strategic– Management: better allocation of resources

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Calculation of SynergyCalculation of Synergy

Estimate ‘combined’ cash flows and subtract sum of the parts

Estimate the change in cash flows

Must identify the source of value

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AcquisitionAcquisition

What is reflected in Target’s current price?– Value ‘as is’– Value with expected changes (current mgmt)– Value ‘in play’

How much of a ‘change in control’ premium is already reflected in price?

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AcquisitionAcquisition

Acquirer must offer a Premium to induce S/H to tender

Must bid less than total value; (Neg NPV)Do other Bidders exist? Is source of value

generic or specific?– Provision of ‘information’ to market– If value highest to you, you can win

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Acquisition, cont.Acquisition, cont.

Strategy: Bid high enough to deter potential bidders, but low enough to retain value

Avoid Winner’s Curse

Target:– Defensive Tactics

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Motives or ReasonsMotives or Reasons

Corporate Raiding– Raider buying company for less than value– Premiums average 30%

Creation of Monopoly Power– Hard to test; others should benefit

Wealth Transfer from other parties– Not much evidence

Taxes: May support economics

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Motives, cont.Motives, cont.

Market Inefficiency– Firm is Undervalued by Market– Information to market

Unsuccessful takeovers– Target value goes back to preoffer price– No perm. Reevaluation of firm– Value created in combination

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DiversificationDiversification

Reduce Risk - may obtain better terms and/or better relationships from:– Employees– Suppliers– Customers– Analagous to ‘too much debt’ before

Management - much human risk and human capital tied up in firm; S/H?

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Diversification EvidenceDiversification Evidence

Comment & Jarrell (‘95 JFE)– Firm performance is increasing in firm focus

Lang & Stulz (‘94 JPE)– Firms diversify when growth opportunities

within industry exhausted– Such diversification does not benefit S/H

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Diversification EvidenceDiversification Evidence

Berger & Ofek (‘95 JFE)– Compare stand-alone value of diversified

firm segments to specialized firms– Diversified firm worth 13% - 15% less than

sum of stand alone components

Day (‘95 JFE)– Examines motives for risk reduction

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Day, cont.Day, cont.

Firms pursue equity variance reducing activities:

– Higher levels of personal wealth in firm– More years invested w/ firm– The poorer previous performance– CEO specialists invest in similar specialties

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Performance ChangesPerformance Changes

Dennis & Denis (‘95 JFE)– Turnover

Forced Normal

– Forced: Operating Income/Assets decreases in 3 years prior & increases following

– Normal: Little difference prior; small improvement afterward

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Dennis & Dennis, cont.Dennis & Dennis, cont.

Forced resignations are rare– 68% preceded by active monitoring by large

s/h, b/h or potential acquirers– 56% are the target of some form of control

activity

Boards not so effective in isolationModern Trend: Outside Directors