Prof. Ian Giddy New York University Mergers & Acquisitions When Do They Work?

Prof. Ian GiddyNew York University

Mergers & AcquisitionsWhen Do They Work?

Copyright ©1999 Ian H. Giddy M&A 2

Mergers and Acquisitions

Mergers & Acquisitions Divestitures Valuation Implementation

Concept: Is a division or firm worth more within the company, or outside it?


A Case Study: Kodak - Sterling Drugs

Eastman Kodak’s Great Victory


Earnings and Revenues at Sterling Drugs

Sterling Drug under Eastman Kodak: Where is the synergy?

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Kodak Says Drug Unit Is Not for Sale (NYTimes, 8/93)

Eastman Kodak officials say they have no plans to sell Kodak’s Sterling Winthrop drug unit.

Louis Mattis, Chairman of Sterling Winthrop, dismissed the rumors as “massive speculation, which flies in the face of the stated intent of Kodak that it is committed to be in the health business.”


Sanofi to Get Part of Kodak Drug Unit (6/94)

Taking a long stride on its way out of the drug business, Eastman Kodak said yesterday that the Sanofi Group, a French pharmaceutical company, had agreed to buy the prescription drug business of Sterling Winthrop, a Kodak subsidiary, for $1.68 billion. Shares of Eastman Kodak rose 75 cents yesterday, closing

at $47.50 on the New York Stock Exchange. Samuel D. Isaly an analyst , said the announcement was

“very good for Sanofi and very good for Kodak.” “When the divestitures are complete, Kodak will be entirely

focused on imaging,” said George M. C. Fisher, the company's chairman and chief executive.


Smithkline to Buy Kodak’s Drug Business for $2.9 Billion

Smithkline Beecham agreed to buy Eastman Kodak’s Sterling Winthrop Inc. for $2.9 billion.

For Kodak, the sale almost completes a restructuring intended to refocus the company on its photography business.

Kodak’s stock price rose $1.25 to $50.625, the highest price since December.


Fallacies of Acquisitions

Size (shareholders would rather have their money back, eg Credit Lyonnais)

Downstream/upstream integration (internal transfer at nonmarket prices, eg Dow/Conoco, Aramco/Texaco)

Diversification into unrelated industries (Kodak/Sterling Drug)


Who Gains What?

Target firm shareholders? Bidding firm shareholders? Lawyers and bankers? Are there overall gains?

Changes in corporate control increase the combined market value of assets of the bidding and target firms. The average is a 10.5% increase in total value.


Cumulative Abnormal Returns Before Takeover Attempts: Target Companies

Days relative to announcement date A

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Methods of Acquiring Corporate Control Mergers

Bidder typically negotiates a friendly agreement with target management and submits this for approval to both sets of shareholders

Usually entails an exchange of securities

Tender Offers Often hostile, often opposed, often generates competing bids Usually a direct cash offer to stockholders of an above-market

price

Proxy Fights A method of gaining control without acquisition: dissident

shareholders seek to change management by soliciting proxies from other shareholders.


Types of Mergers and Acquisitions

M&A

Acquisition

Proxy contest

Going private

Merger

Stock acquisition

Asset acquisition


Types of Takeover Activity

See Table 7.2: A Taxonomy of Types of Takeover ActivityMergers: Friendly, negotiatedTender offers, friendlyTender offers, hostile

What are the key differences between these?


Gains to Target Firm Shareholders

Targets of successful tender offers and mergers earn significantly positive abnormal returns from announcement to completion of merger. Gains range from 16.9% to 34.1%.

Targets of unsuccessful tender offers also gain. But those with no new offers in 2 years lose all previous gains, while those with new offers make further gains.

Targets of unsuccessful mergers appear to lose all positive returns earned after announcement by the time failure becomes known.


Gains to Bidding Firm Shareholders

There are positive returns to successful bidders in tender offers

For successful bidders in mergers, evidence is mixed. It seems that returns are around zero.

For unsuccessful bidders in both tender offers and mergers, returns are negative.


Do Acquisitions Benefit Shareholders?Successful Bids

Technique Target Bidders

Tender offer 30% 4%

Merger 20% 0

Proxy contest 8% na

Note: Abnormal price changes are price changes adjusted to eliminate the effects of marketwide price changes


Do Acquisitions Benefit Shareholders?Unsuccessful Bids

Technique Target Bidders

Tender offer -3% -1%

Merger -3% -5%

Proxy contest 8% na


The Price: Who Gets What?

Daimler Chrysler Combined

Market value before dealleaked

$52.8 $29.4 $82.2

Value added by merger $18.0

Merged Value $100.2

Shareholders get 57.2% 42.8% 100%

Which is now worth $57.3 $42.9 $100.2

Shareholders' shares ofthe gain

$4.5 $13.5 $18

Premium, as % 9% 46%


Reasons Why Many Acquisitions Fail To Generate Value

Value

Destruction

Deal price not based on cash flow value



Value

Destruction

Over optimisticmarketassessments




Value

Destruction


Overestimatingsynergies




Value

Destruction


Poorpost-mergerintegration

Overestimatingsynergies



Company’s returns are reduced and stock price falls

Postacquisitions experience reveals expected synergies are illusory

Deal is consummated at large premium

Frustration sets in; pressures build to do a deal; DCF analysis is tainted by unrealistic expectations of

synergies

One or two candidates are rejected in basis of objective DCF analysis

Candidates are screenedon basis of industry and company growth and returns

Typical Losing Pattern For Mergers


Overpaying on Takeovers

The quickest and perhaps the most decisive way to impoverish stockholders is to overpay on a takeover.

The stockholders in acquiring firms do not seem to share the enthusiasm of the managers in these firms. Stock prices of bidding firms decline on the takeover announcements a significant proportion of the time.

Many mergers do not work, as evidenced by a number of measures. The profitability of merged firms relative to their peer groups,

does not increase significantly after mergers. An even more damning indictment is that a large number of

mergers are reversed within a few years, which is a clear admission that the acquisitions did not work.


BETHESDA, Maryland, September 20, 1998 -- The boards of directors of Lockheed Martin Corporation and COMSAT jointly announced today their two companies have entered into a definitive merger agreement providing for the combination of COMSAT with Lockheed Martin in a two-phase transaction valued at approximately $2.7 billion.

Vance Coffman, Lockheed Martin chairman and CEO, said, "This initiative will unite two advanced-technology companies with complementary capabilities in the commercial, space-based telecommunications industry. The new subsidiary will benefit communications users in the United States and around the world by creating a dynamic new global competitor.”


Oops!

Market value of Lockheed Martin falls by about $930 million following announcement!

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Lockheed Shares Fall 4.9%.

Shares of the Lockheed Martin Corporation fell 4.9 percent amid concern that the world's largest defense company is putting earnings at risk with its $2.7 billion bid for Comsat Corp., a provider of satellite services.

Lockheed's revenue is generated primarily by the sale of military equipment to the Federal Government. While the business of selling time on satellites is growing far faster than defense spending, investors are concerned that Lockheed, which makes satellites, is now moving away from a defense

business that provides steady earnings. Lockheed's investors tend to own the stock because of the steady earnings, an

analyst said. They would rather see the money used to pay down debt or buy back stock, he said. Issuing shares to buy Comsat also raises concern that Lockheed's per-share earnings would be diluted.

www.nytimes.com


How Core Businesses Performed Prior to Acquisition Programs

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100% = 56 Acquisition Programs

52%

92%

48%

8%

Failure70%

Success23%

Unknown 7%

Weak Core Business

Strong Core Business

Source:

McKinsey


To Succeed,Analyse the Industry Structure

COMPETITIVEADVANTAGE

SUBSTITUTES

CUSTOMERS

BARRIERS TO ENTRY

SUPPLIERS


Using Industry Structure Analysis

COMPETITIVE

ADVANTAGE

SUBSTITUTESQuestions: Do substitutes exist? What is their price/

performance?

Potential Action: Fund venture capital and

joint venture to obtain key skills

Acquire position in new segment

CUSTOMERSQuestions: Is the customer base

concentrating? Is value added to

customer end product high,changing?

Potential Actions: Create differentiated

product Forward - integrate

BARRIERS TO ENTRYQuestions: Do barriers to entry exist? How large are the barriers? Are they sustainable?

Potential Actions: Acquire to achieve scale in

final product or critical component

Lock up supply of critical industry input

SUPPLIERSQuestions: Is supplier industry

concentrating? Is supplier value/cost

added to end product high, changing?

Potential Actions: Backward - integrate


Most Value is Created on the Asset Side (Operational Restructuring)

Discounted Cash Flow (DCF) analysis for project evaluation

Value-Based Management for performance evaluation

?

Wärtsilä NSD

(from Wärtsilä Diesel & New Sulzer Diesel


Wärtsilä NSD now has the world’s most extensive portfolio of heavy duty engines. Its 4-stroke engines are mainly Wärtsilä design, while the 2-stroke engines are based on Sulzer design. The engine range consists of lean burn gas engines, dual fuel engines and gas diesels. Market share is strong and production is being consolidated or out-sourced, particularly for low-speed engine technologies.

Wärtsilä NSD: Consolidating Production and Distribution


Wärtsilä NSD: Gains Market Power


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BBV ACQUISITION

SANTANDER ACQUISITION

Peruvian Banks: Market Share by Deposits, %

Sometimes, Too Late is Too Little


Goals of Acquisitions

Rationale: Firm A should merge with Firm B if

[Value of AB > Value of A + Value of B + Cost of transaction]

Synergy Gain market power Discipline Taxes Financing

Example:

Ciba-Geigy/

Sandoz


Case Study: Ciba-Geigy-Sandoz

Questions: What kind of merger was this? What was the motivation for the merger? What were the potential sources of

synergy? Where do you think value added woul

come from in this merger? What might go wrong?


www.giddy.org

Ian Giddy

NYU Stern School of Business

Tel 212-998-0332; Fax 212-995-4233

[email protected]

http://www.giddy.org

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Prof. Ian Giddy New York University Mergers & Acquisitions When Do They Work?