Mergers And Acquisitions PDF

https://www.youtube.com/watch?v=Qf_Rpsce0S4 MERGERS AND ACQUISITIONS https://www.youtube.com/watch? v=S7DoKFPOhZk https://www.youtube.com/watch? v=9dFvhq2sKfM  SINERGY Lower cost Higher growth  If synergy is Valuation Inputs that will be affected are Economies o...

https://www.youtube.com/watch?v=Qf_Rpsce0S4 MERGERS AND ACQUISITIONS https://www.youtube.com/watch? v=S7DoKFPOhZk https://www.youtube.com/watch? v=9dFvhq2sKfM  SINERGY Lower cost Higher growth  If synergy is Valuation Inputs that will be affected are Economies of Scale Operating Margin of combined firm will be greater than the revenue-weighted operating margin of individual firms. Growth Synergy More projects:Higher Reinvestment Rate (Retention) Better projects: Higher Return on Capital (ROE) Longer Growth Period Again, these inputs will be estimated for the combined firm.  Acquisition Friendly Hostile the managers - the target firm’s of the target management does not want firm welcome to be acquired. the acquisition - The acquiring firm offers a and in some price higher than the target cases seek it firm’s market price prior to out the acquisition Acquisition premium= acquisition price - market price prior to the acquisition  Goodwill= acquisition price - adjusted book value of equity Acquisition premium= acquisition price - market price prior to the acquisition https://www.youtube.com/watch? v=qDeQYPj_WMY Classification of Acquisitions  Question https://www.youtube.com/watch? v=hIcHfneWEeU  STEPS IN AN ACQUISITION 1. development of a rationale and a strategy for doing acquisitions,and what this strategy requires in terms of resources 2. Choice the target for the acquisition and the valuation of the target firm, with premiums given the motive 3. determination of how much to pay on the acquisition, how best to raise funds to do it, and whether to use stock or cash to pay for the target. 4. make the acquisition work after the deal is complete  I. development of a rationale and a strategy 1. Acquire Undervalued Firms 1. A capacity to find firms that trade at less than their true value. 2. Access to the funds that will be needed to complete the acquisition 3. Skill in execution. Efficient markets? 2. Diversify to Reduce Risk Transaction costs vs private or family firms 3. Create Operating or Financial Synergy Synergy is the potential additional value from combining two firms. Sources of Operating Synergy: Operating income or growth -Economies of scale -Greater pricing power -Combination of different functional strengths -Higher growth in new or existing markets Sources of Financial Synergy: higher cash flows or lower cost of capital -firm with excess cash or cash slack (and limited project opportunities) and a firm with high-return projects (and constraints on raising capital) -Debt capacity can increase -Tax benefits  II. How to value a Sinergy? If synergy is perceived to exist in a takeover, the value of the combined firm should be greater than the sum of the values of the bidding and target firms, operating independently.  Some considerations 1. Take Over Poorly Managed Firms and Change Management The poor performance of the firm being acquired should be attributable to management, rather than to market or industry factors that are not under management control. The acquisition has to be followed by a change in management The market price of the acquisition should reflect the status quo—the cu management of the firm and their poor business practices Firms typically acquired in hostile takeovers It has underperformed other stocks in its industry and the overall market, in terms of returns to its stockholders in the years preceding the takeover. It has been less profitable than firms in its industry in the years preceding the takeover. It has a much lower stock holding by insiders than do firms in its peer groups. Cater to Managerial Self-Interest: Empire building. Managerial ego. Compensation and side benefits. https://www.youtube.com/watch? v=VVxYOQS6ggk Choosing a Target Firm and Valuing Control/Synergy 1. Choosing a Target Firm  Target firm valuation The valuation of an acquisition is not fundamentally different from the valuation of any firm, although the existence of control and synergy premiums introduces some complexity into the valuation process 1. status quo valuation of the firm 2. value for control and a value for synergy. Status quo valuation  Value of Corporate Control Determinants of the Value of Corporate Control If we can identify the changes that we would make to the target firm, we can value control. The value of control can then be written as: Value of control = Value of firm optimally managed - Value of firm with current management We said earlier that one of the reasons Digital was targeted by Compaq was that it was viewed as poorly managed. Assuming that Compaq was correct in its perceptions, we valued control at Digital by making the following assumptions: Digital will raise its debt ratio to its optimal of 20%. The beta will increase, but the cost of capital will decrease. New beta = 1.25 , New after-tax cost of debt = 5.25%; the firm Optimally managed value of firm is riskier, and its default risk will increase. Digital will raise its return on capital to 11.35%, which is its cost of capital. Pretax operating margin will go up to 4%, which is close to the industry average The reinvestment rate remains unchanged, but the increase in the return on capital will increase the expected growth rate in the next five years to 10%. After year 5, the beta will drop to 1, and the after-tax cost of debt will decline to 4%, as in the previous exercise.  Valuing Operating Synergy two fundamental questions 1. What form is the synergy expected to take? - reduce costs - Increase future growth cash flows from existing assets, higher expected growth rates (market power, higher growth potential), a longer growth period (from increased competitive advantages), or a lower cost of capital (higher debt capacity). 2. When will the synergy start affecting cash flows? Once we answer these questions, we can estimate the value of synergy using discounted cash flow techniques. 1. we value the firms involved in the merger independently, by discounting expected cash flows to each firm at the weighted average cost of capital for that firm. 2. we estimate the value of the combined firm, with no synergy,by adding the values obtained for each firm in the first step. 3. we build in the effects of synergy into expected growth rates and cash flows, and we value the combined firm with synergy. 4. The difference between the value of the combined firm with synergy and the value of the combined firm without synergy provides a value for synergy. Returning to the Compaq/Digital merger, note that synergy was one of the stated reasons for the acquisition. To value this synergy, we needed to first value Compaq as a standalone firm. To do this, the following assumptions were made: Compaq had earnings before interest and taxes of $2,987 million on revenues of $25,484 million. The tax rate for the firm is 36%. The firm had capital expenditures of $729 million and depreciation of $545 million in the most recent year; working capital is 15% of revenues. The firm had a debt-to-capital ratio of 10%, a beta of 1.25, and an after-tax cost of debt of 5%. The operating income, revenues, and net capital expenditures are all expected to grow 10% a year for the next five years. After year 5, operating income and revenues are expected to grow 5% a year forever, and capital expenditures are expected to be 110% of depreciation. In addition, the firm will raise its debt ratio to 20%, the after-  Valuing Financial Synergy Synergy can also be created from purely financial factors. 1. Diversification A takeover motivated only by diversification considerations has no effect on the combined value of the two firms involved in the takeover when the two firms are both publicly traded and when the investors in the firms can diversify on their own. 2. Tax Benefits Several possible tax benefits accrue from takeovers. If one of the firms has tax deductions that it cannot use because it is losing money, whereas the other firm has income on which it pays significant taxes, combining the two firms can result in tax benefits that can be shared by the two firms. The value of this synergy is the present value of the tax savings that result from this merger Methods to Forecast the Resulting Beta M&A: 1. Weighted Average Beta: A simple method is to calculate the weighted average beta of the two companies before the acquisition. The weight is proportional to the market capitalization (or enterprise value) of each company. The formula is: 2. Relevering Beta: You can adjust for differences in financial leverage. A company's beta is affected by its debt-to-equity ratio (D/E), and after an acquisition, this ratio may change. This involves calculating the unlevered beta (which removes the effect of debt) and then relevering the beta using the new capital structure post-acquisition. 3. Historical Regression Analysis: Another approach is to perform a regression analysis of the stock returns of the acquiring company on the market index, using historical data. Post-acquisition, the combined company’s returns can be used to calculate the beta. This involves: Using historical data to estimate the combined company's beta over a period before and after the acquisition. Re-running a regression analysis of stock returns relative to market returns to observe the beta change. 4. Montecarlo simulation (Python code) 1. Value of combined firm with Sinergy (100) To value the synergy, we made the following assumptions about the way in which synergy would affect cash flows and discount rates at the combined firm: The combined firm will have some economies of scale, allowing it to increase its current after-tax operating margin slightly. The annual dollar savings will be approximately $100 million. This will translate into a slightly higher pretax operating margin: The combined firm will also have a slightly higher growth rate of 10.50% in revenues, operating income, and net cap ex over the next five years because of operating synergies. The beta of the combined firm should be computed in three steps. 2. Unlevered betas for Digital and Compaq 3. weight these unlevered betas 4. Employ the debt-to-equity ratio for the combined firm to estimate a new levered beta and cost of capital for the firm. The debt-to-equity ratio for the combined firm, estimated by