Financial Management subject For undergraduate students (semester 4)

1. Mergers and acquisitions
Meeting 10

2. • 1. Understanding takeovers, mergers, and acquisitions
• 2. Explain the analysis of merger and acquisition decisions with NPV.
• 3. Understand the implementation and management of mergers and
acquisitions.
• 4. Explain good and bad mergers and acquisitions.
• 5. Understanding valuations in mergers and acquisitions, merger &
acquisition strategies and tactics.

5. Types of M&A
Horizontal
the combination of
two companies
operating in the same
industry and at a
similar stage of
production
Vertical
the combination of two
companies operating at
different stages of
production within the
same industry
Conglomerate
the combination of
two companies
operating in different
areas of business

6. Examples of M&A
Horizontal
Facebook's acquisition
of Instagram
Exxon's acquisition of
Mobil
Vertical
Ebay acquisition of
PayPal
Disney's acquisition of
Pixar Studios
Conglomerate
Walt Disney Company
acquisition of the
American Broadcasting
Company
Proctor & Gamble Co
acquisition of Gillette Co

7. Merger types
Are the following hypothetical mergers horizontal,
vertical, or conglomerate?
•
a. IBM acquires Dell Computer.
b. Dell Computer acquires Walmart.
c. Walmart acquires H. J. Heinz.
d. H. J. Heinz acquires IBM.
•
(a) Horizontal; (b) conglomerate; (c) vertical;
(d) conglomerate.

8. Reasons to Acquire
• Economies of scale
• A large company can enjoy economies of scale, or savings from
producing goods in high volume, that are not available to a small
company.
• Larger firms can also benefit from economies of scope, which are
savings that come from combining the marketing and distribution of
different types of related products

9. Reasons to Acquire
• Expertise
• Firms often need expertise in particular areas to compete more
effectively. Faced with this situation, a firm can enter the labor market
and attempt to hire personnel with the required skills.
• However, hiring experienced workers with the appropriate talent
might be difficult with an unfamiliar, new technology. A more efficient
solution may be to purchase the talent as an already functioning unit
by acquiring an existing firm.

10. Reasons to Acquire
• Monopoly Gains
• Monopoly power could be very valuable, and we would expect that in
the absence of strong antitrust laws, many companies would merge.
• However, while all companies in an industry benefit when
competition is reduced, only the merging company pays the
associated costs (from, for instance, integrating the target and
managing a larger corporation).

11. Reasons to Acquire
• Tax Savings from Operating Losses
• When a firm makes a profit, it must pay taxes on the profit. However,
when it incurs a loss, the government does not pay back taxes.
• Thus, it might appear that a conglomerate has a tax advantage over a
single-product firm simply because losses in one division can be offset
by profits in another division.

12. Reasons to Acquire
• Diversification
• The justification for these benefits comes in three forms: direct risk
reduction, lower cost of debt or increased debt capacity, and liquidity
enhancement

13. Reasons to Acquire
• Earnings Growth
• It is possible to combine two companies with the result that the
earnings per share of the merged company exceed the premerger
earnings per share of either company, even when the merger itself
creates no economic value.

14. Reasons to Acquire
• Managerial Motives to Merge
• Managers may prefer to run a larger company due to the additional
pay and prestige it brings.

15. Reasons to Acquire
• Elimination of inefficient management
A company may be poorly run by its current managers, perhaps
because they are pursuing their own objectives rather than those of
their shareholders. The company’s declining share price will attract
potential bidders who believe they can manage the company more
efficiently.

16. Reasons to Acquire
• Entry to new markets
• Companies may want to expand into new geographical and business
areas in order to meet their strategic objectives. Organic or internal
growth may be deemed to be too slow or too costly and so
acquisition may be chosen as a more efficient route to expansion.

17. Reasons to Acquire
• Market power and share
Horizontal acquisitions increase market share and hence increase a
company’s ability to earn monopoly profits, whereas vertical
acquisitions increase a company’s power in raw material or
distribution markets.

18. The Takeover Process
• Valuation
• The Offer
• Merger “Arbitrage”
• Tax and Accounting Issues
• Board and Shareholder Approval

19. The Takeover Process
• Valuation
• the takeover is a positive-NPV project only if the premium it pays
does not exceed the synergies created
• Although the premium that is offered is a concrete number, the
synergies are not—investors might well be skeptical of the acquirer’s
estimate of their magnitude. The bidder’s stock price reaction to the
announcement of the merger is one way to measure investors’
assessments of whether the bidder overpaid or underpaid for the
target.
• Thus, the market, on average, believes that the premium is
approximately equal to the synergies.

20. The Takeover Process
• The offer
• Once the acquirer has completed the valuation process, it is in the
position to make a tender offer—that is, a public announcement of its
intention to purchase a large block of shares for a specified price. A
bidder can use either of two methods to pay for a target: cash or
stock.
• In a cash transaction, the bidder simply pays for the target, including
any premium, in cash.
• In a stock-swap transaction, the bidder pays for the target by issuing
new stock and giving it to the target shareholders.

21. The Takeover Process
• Merger “Arbitrage”
• Often acquirers have to raise the price to complete the deal.
Alternatively, the offer may fail. When an acquirer bids for a target, the
target firm’s board may not accept the bid.
• Because of this uncertainty about whether a takeover will succeed, the
market price generally does not rise by the amount of the premium when
the takeover is announced.
• This uncertainty creates an opportunity for investors to speculate on the
outcome of the deal. Traders known as risk arbitrageurs, who believe that
they can predict the outcome of a deal, take positions based on their
beliefs.

22. The Takeover Process
• Tax and Accounting Issues
• Once the terms of trade have been decided, the tax and accounting
implications of a merger can be determined. How the acquirer pays
for the target affects the taxes of both the target shareholders and
the combined firm.

23. The Takeover Process
• Board and Shareholder Approval
• For a merger to proceed, both the target and the acquiring board of directors must
approve the deal and put the question to a vote of the shareholders of the target (and, in
some cases, the shareholders of the acquiring firm as well).
• In a friendly takeover, the target board of directors supports the merger, negotiates with
potential acquirers, and agrees on a price that is ultimately put to a shareholder vote.
• Although it is rare for acquiring boards to oppose a merger, target boards sometimes do
not support the deal even when the acquirer offers a large premium.
• In a hostile takeover, the board of directors (together with upper-level management)
fights the takeover attempt. To succeed, the acquirer must garner enough shares to take
control of the target and replace the board of directors.
• When a takeover is hostile, the acquirer is often called a raider.

29. ADIDAS-REEBOK CASE STUDY
• 1. In 2005 Adidas announced its plan to acquire Reebok North
America in 2005 at an estimated value $ 3.78 billion.
• 2. Adidas offered to pay over 34% premium over last closing price for
Reebok.
• 3. The footwear market in North America was mainly dominated by
Nike with a 36% share. Increased market share and cost cutting
through synergies were clear-cut strategies for both Adidas and
Reebok.

30. ADIDAS-REEBOK CASE STUDY
• 3. Nike had 36% market share in August 2005. Post the acquisition of
Reebok, the market share of Adidas-Reebok in the US increased to
21% from 8.9%

31. WHAT LED TO THE SUCCESSFUL MERGER OF
ADIDAS REEBOK?
• #1 – CULTURAL BLEND
• The culture of Adidas and Reebok effortlessly merged and gave a new
identity to the organization
• Adidas is originally a German company and Reebok an American
entity
• Adidas was all about sports, while Reebok redefined lifestyle
• However, proper communication, clear strategies and effective
implementation did the job

32. WHAT LED TO THE SUCCESSFUL MERGER OF
ADIDAS REEBOK?
• #2 – A PERFECT BLEND OF INDIVIDUALITY AND UNION
• Maintaining both brands (keeping established market share).
• Adidas-Reebok is one such merger where both the companies
managed to create a portfolio of new offerings while keeping their
individuality intact.
• Adidas Chairman and CEO Herbert Hainer clearly stated “it is
important that each of these brands must retain their own identity.”
• While Reebok capitalised on its strong presence with the youth,
Adidas focused on its international presence and high-end technology

33. WHAT LED TO THE SUCCESSFUL MERGER OF
ADIDAS REEBOK?
• Adidas benefitted from enhanced distribution in North America,
where Reebok already has a strong position.
• Increased operations naturally translated into reduced cost across
each front of the value chain such as manufacturing, supply,
distribution and marketing.

34. MICROSOFT-NOKIA MERGER CASE STUDY
• 1. When Microsoft was getting weakened by Apple and Android
devices, it decided to merger with Nokia as a last attempt in 2013.
• 2. However, the deal failed. Microsoft has shifted much of its $7.5
billion acquisition into other divisions of the company, announced
mass layoff for Nokia employees, cut down its output of smartphones
per year, and eventually wrote off the entire acquisition price in a
$7.6 billion impairment charge.
• 3. Meanwhile, Nokia’s market share declined from a peak of 41% to
its current level of 3% despite Microsoft support.

35. WHAT ACTUALLY LED TO THE FAILURE OF
MICROSOFT NOKIA MERGER?
• FAILURE TO UNDERSTAND MARKET TRENDS AND DYNAMICS
• Even after two years of Windows Phone-powered Nokia handsets,
Microsoft’s operating system captured a mere 3.5% of the smartphone
market.
• This was a strong indication that developers are unwilling to invest
resources into creating applications for Windows-based phone.
• The mobile phone industry is not just about hardware and software.
• Applications, e-commerce, advertising, social media applications, location-
based services, and many other things matter today.
• The software on the phone wasn’t compatible or appealing enough for the
entire ecosystem.

36. Famous M&As
• In 2006 Google bought YouTube for $1.65 billion
• In 2012 Facebook bought Instagram for $1 billion
• In 2014 Facebook bought WhatsApp for $19 billion