Metrics and Multiples M&A

8/7/2019 Metrics and Multiples M&A

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Mergers and Acquisitions

Arzac, Chapter 9


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Mergers many people including Warren Buffett have expressed skepticism of

the power of mergers: Many managements apparently were overexposed in

impressionable childhood years to the story in which theimprisoned handsome prince is released from a toads body by a

kiss from a beautiful princess. Consequently, they are certain theirmanagerial kiss will do wonders for the profitability of CompanyT(arget) Investors can always buy toads at the going price fortoads. If investors instead bankroll princesses who wish to paydouble for the right to kiss the toad, those kisses had better packsome real dynamite. Weve observed many kisses but very fewmiracles. Nevertheless, many managerial princesses remain

serenely confident about the future potency of their kisses evenafter their corporate backyards are knee-deep in unresponsivetoads We have tried occasionally to buy toads at bargain priceswith results that have been chronicled in past reports. Clearly ourkisses fell flat. We have done well with a couple of princes butthey were princes when purchased. At least our kisses didnt turnthem into toads. And, finally, we have occasionally been quitesuccessful in purchasing fractional interests in easily identifiable

princes at toadlike prices.


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M&As changing forces driving mergers:

technological change

globalization and freer trade deregulation

economies of scale, scope, and technological catch-up

change in industry organization

individual entrepreneurship

macroeconomic factors** Weston, Siu, and Johnson (2001)

mergers vs. tender offers

types


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Control of Decision Powers

compensation arrangements

proxy contest premium buy-backs (greenmail)

takeover defenses

stakeholder relationships ethics and reputation


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Theories of Mergers

efficiency increases (restructuring)

operating synergies financial synergy

information

hubris agency problems


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Pattern of Gains Related to Takeover Theories

(with value changes referring to movements in prices of securities of firms)

Motive Total Gains Gains to Target Gains to Acquirer

Efficiency and/or synergy + + +

Hubris 0 + -

Agency problems - + -


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Example 1 Assume the buyer acquires a debt-free target for

$100 cash, the targets tax basis in the assets is $40,

the target shareholders basis in the stock is $15, andthe fair MV of the stock was $70 prior to theacquisition. Let the corporate tax rate be 40%, thepersonal tax rate on capital gains be 20%, andassume that all the gain to the seller is classified as

capital gain and the buyers price in excess of thetargets basis is allocated to goodwill. Look at theproceeds to the target using both a stock purchaseand an asset purchase.

Review Example 2 and 3 in the text.


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Returns in M&As Kaplan and Weisbach (1992), Servaes (1991),

and Mulherin and Boone (2000)

mergers in banking industry

Becher (2000) looked at because of increasednumber of bank mergers that occurred aroundindustry deregulation

evidence that bank mergers created wealth

target returns

bidder returns


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Value of Mergers VC = VA + VT + Synergies Cash Premium = PT VT Premium = pc*m + cash Acquirers Gain = Synergies Premium Acquirers Gain + Sellers Gain = Synergies pC = VC/ (n + m)

or pC = (VA + VT + Synergies Cash)/(n + m)where n = # of old shares of acquirerand m = # of shares issued to target shareholders Break-Even Synergies = Premium = mpA + Cash VT GainA = Synergy - Premium


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Accretion/Dilution Analysis alternate way to look at the impact of the

merger to the shareholders of the acquirer

find pro-forma EPS for merged firm for yearprior to merger and then years after also

for share exchange, combine NI and divide by

new number of shares outstanding if new EPS is > EPS of acquirer, then there is

accretion if new EPS < EPS of acquirer, then thereis dilution


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Merger Analyses

terms of the merger

financing the merger break-even synergies

financial model of the merger

accretion-dilution analysis free cash-flow valuation

stress-testing and scenario analysis


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Balance Sheet XYZ Inc. as of 12/31/2004

Cost Fair Value

Current Assets

Cash and marketable securities 14,000 14,000

Accounts Receivable 86,702 81,523Inventories

Raw Materials 34,671 45,123

Works in Progress 18,790 19,342

Finished Goods 70,415 85,457

123,876 149,922

Other Current Assets 11,500 11,500

Total Current Assets 236,078 256,945

Investments 25,460 38,634Net PP&E 987,234 1,470,381

Intangible Assets 265,211 143,782

Total Assets 1,513,983 1,909,742

Current Liabilities

ST Debt and Current LTD 43,784 42,512

Accounts Payable 56,234 54,318

Accrued Expenses 2,840 2,840

Taxes Payable 8,128 8,128

LT Debt 335,578 310,456

Deferred Income Taxes 8,561 8,561

Total Liabilities 455,125 426,815

Preferred Stock 249,870 229,455

Common Stock and Retained Earnings 808,988 1,253,472

Total Net Worth 1,058,858 1,482,927

Total Liabilities and Equity 1,513,983 1,909,742


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Balance Sheet XYZ Inc. as of 12/31/2004

ABC XYZ Eliminations and Adjustments

Current Assets Debit Credit Consolidat

Cash and marketable securities 34,021 14,000 48,021Accounts Receivable 196,032 81,523 277,555

Inventories 298,723 149,922 448,645

Other Current Assets 30,044 11,500 41,544

Total Current Assets 558,820 256,945 815,765

Investments 1,554,230 38,634 1,500,000 92,864

Net PP&E 3,568,229 1,470,381 5,038,610

Intangible Assets

Goodwill 246,528 246,528Other 789,541 143,782 933,323

Total Assets 6,470,820 1,909,742 7,127,090

Current Liabilities

ST Debt and Current LTD 67,834 42,512 110,346

Accounts Payable 108,340 54,318 162,658

Accrued Expenses 4,567 2,840 7,407

Taxes Payable 12,690 8,128 20,818

LT Debt 1,890,450 310,456 2,200,906

Deferred Income Taxes 32,189 8,561 40,750

Total Liabilities 2,116,070 426,815 2,542,885

Preferred Stock 229,455 229,455

Common Stock and Retained Earnings 4,354,750 1,253,472 1,500,000 246,528 4,354,750

Total Net Worth 4,354,750 1,482,927 4,584,205

Total Liabilities and Equity 6,470,820 1,909,742 7,127,090


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Bs acquisition of T

B T

Pre-announcement stock price $ 30 $ 22

Net income (million) $ 80 $ 37.50

Shares outstanding (million) 40 15

EPS $ 2.00 $ 2.50

P/E 15 8.8

Market value (million) $1200 $330

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Metrics and Multiples M&A