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OKAN BAYRAK
Definitions
A merger is a combination of two or more
corporations in which only one corporation
survives and the merged corporations go out
of business.
Statutory merger is a merger where the
acquiring company assumes the assets and
the liabilities of the merged companies
A subsidiary merger is a merger of two
companies where the target company
becomes a subsidiary or part of a subsidiary
of the parent company
Types of Mergers
Horizontal Mergers
- between competing companies
Vertical Mergers
- Between buyer-seller relation-ship companies
Conglomerate Mergers
- Neither competitors nor buyer-seller relationship
History of Mergers and
Acquisitions Activity in United
States
The First Wave 1897-1904
- After 1883 depression
- Horizontal mergers
- Create monopolies
The Second Wave 1916-1929
- Oligopolies
- The Clayton Act of 1914
The Third Wave 1965-1969
- Conglomerate Mergers
- Booming Economy
The Fourth Wave 1981-1989
- Hostile Takeovers
- Mega-mergers
Mergers of 1990’s
- Strategic mega-mergers
Motives and Determinants of
Mergers
Synergy Effect
NAV= Vab –(Va+Vb) – P – E
Where Vab = combined value of the 2 firms
Vb = market value of the shares of firm B.
Va = A’s measure of its own value
P = premium paid for B
E = expenses of the operation
- Operating Synergy
- Financial Synergy
Diversification
Economic Motives
- Horizontal Integration
- Vertical Integration
- Tax Motives
FIRM VALUATION IN
MERGERS AND ACQUISITIONS
Equity Valuation Models
- Balance Sheet Valuation Models
• Book Value: the net worth of a company as shown on the
balance sheet.
• Liquidation Value: the value that would be derived if the firm’s
assets were liquidated.
• Replacement Cost: the replacement cost of its assets less
its liabilities.
FIRM VALUATION IN MERGERS
AND ACQUISITIONS-2
D1 D2 D3
V0 = + .......
1+ k 2
(1 k ) (1 3+k )
Where Vo = value of the firm
Di = dividend in year I
k = discount rate
FIRM VALUATION IN MERGERS
AND ACQUISITIONS-3
The Constant Growth DDM
D (1 +g ) D0 (1
+ g) 2
V0 = 0 + + ......
1 +k + k) 2
(1
P0 E (1 −b )
= 1
E1 k −ROExb
P0 1 −b
=
E1 k −ROExb
where ROE = Return On Equity
FIRM VALUATION IN MERGERS
AND ACQUISITIONS-5
Cash Flow Valuation Models
- The Entity DCF Model : The entity DCF model values the value of a company as
the value of a company’s operations less the value of debt and other investor claims,
such as preferred stock, that are superior to common equity
. Value of Operations: The value of operations equals the discounted value of
expected future free cash flow.
. Value of Debt
. Value of Equity
FIRM VALUATION IN MERGERS
AND ACQUISITIONS-6
What Drives Cash Flow and Value?
- Fundamentally to increase its value a company must do
one or more of the following:
. Increase the level of profits it earns on its existing
capital in place (earn a higher return on invested
capital).
. Increase the return on new capital investment.
. Increase its growth rate but only as long as the return
on new capital exceeds WACC.
. Reduce its cost of capital.
FIRM VALUATION IN MERGERS
AND ACQUISITIONS-7
=
Econom icPr ofit −
NOPLAT ( Invested Capital x W ACC)
where N O P LAT = N et O perating P rofit Less Adjusted Taxes
NOPLAT
Return on Investment Capital =
Invested Capital
B P S
W A C C= b (1
k - c T
) pk sk
V V V
where
kb = the pretax market expected yield to maturity on non -callable, non convertible debt
Tc = the marginal taxe rate for the entity being valued
B = the market value of interest -bearing debt
kp = the after -tax cost of capital for preferred stock
P = market value of the preferred stock
ks = the market determined opportunity cost of equity capital
S = the market value of equity
ks = rf (E )rm β+r f
ks = rf ( E1 +)F β rf 1 ( E2 )F − rf 2 ....
where E(Fk ) = the expected rate of return on a portfolio that mimics the k th factor and is
independent of all others.
Beta k = the sentivity of the stock return to the k th factor.
STEPS IN VALUATION-6
Estimating The Continuing Value
- Selecting an Appropriate Technique
. Long explicit forecast approach
. Growing free cash flow perpetuity formula
. Economic profit technique
Economic ProfitT+1 (NOPLATT+1 )(g /ROIC )(ROIC − WACC )
CV = +
WACC WACC( WACC− g)
STEPS IN VALUATION-7
Calculating and Interpreting Results
- Calculating And Testing The Results
- Interpreting The Results Within The
Decision Context
HP-COMPAQ MERGER CASE
The HP/Com
HIGH -END
HP-COMPAQ MERGER CASE-2
Arguments About The Merger
- Supporters
. HP-COMPAQ will become the leader in most of the
sub-sectors
. Ability to offer better solutions to customer’s demands
. New strategic position will make it possible to increase
R&D efforts and customer research
. Decrease in costs and increase in profitability
. Financial strength to provide chances to invest in new
profitable areas
HP-COMPAQ MERGER CASE-3
Arguments About The Merger
- Opponents
. Acquiring market share will not mean the leadership
. No new significant technology capabilities added to HP
. Large stocks will increase the riskiness of the company
(Credit rating of the HP is lowered after the merger
announcement)
. Diminishing economies of scale sector which both
companies have already a great scale.
HP-COMPAQ MERGER CASE-4
Valuation Process
- Relative Historical Stock Price Performance
Historical Exchange Ratios
Period ending August 31, Average Exchange Ratio Implied Premium (%)
2001
August 31 2001 0.532 18.9
10-Day Average 0.544 16.3
20-Day Average 0.568 11.3
30 Day Average 0.573 10.3
3 Months Average 0.557 13.7
6 Months Average 0.584 8.2
9 Months Average 0.591 7.1
12 Months Average 0.596 6.1
HP-COMPAQ MERGER CASE-5
Comparable Public Market Valuation Analysis
Accretion/Dilution Analysis
EPS EPS
Accretion/Dilution 2002 2003
Compaq stand-alone 0.67 0.88
HP stand-alone 1.21 1.86
Combined entity pro-forma, excluding proj. synergies 0.74 1.09
Combined entity pro-forma, including proj. synergies 1.05 1.51
Accretion/(Dilution) to Compaq, excluding proj. synergies 11% 24%
Accretion/(Dilution) to Compaq, including proj. synergies 57% 71%