Under the deal Cytopia shareholders will be offered 1 YM share for every 11.737 Cytopia shares.

The agreed offer represents a share price offer of 16.59 cents per Cytopia share (last traded 10.50 cents (October 5, 2009).

By 11:30am on October 6, price was 13.00 (23.81% increase)

It values the takeover offer at $14 million. (market cap of $9m on October 5, 2009)

Cytopia accepts takeover by Canadian biotech (October 6, 2009,11:29AM )

CYTOPIA share price at 1pm on October 6, 2009

Should the share price increase to 16.59 cents? (stock closed at 11 cents on Oct 6)

If yes by when (same day/ following day) If not then why not? Does market capitalisation have any implication?

◦ The market cap on October 5, 2009 was only $9m Does share ownership have any implication?

◦ Around 30% shares are owned by the management

CYTOPIA share price analysis using announcement

A merger is a combination of two or more businesses (companies)◦ Statutory merger: when the assets and/or

liabilities of the target company are acquired◦ Subsidiary merger: the target company becomes

a subsidiary of the acquirer company (parent)

Chapter 11 Mergers and Acquisitions

Mergers are performed for a variety of reasons, most of them involve an attempt to improve a firm’s competitive advantage in the market.

Focus on the use of financial statement analysis to evaluate whether a merger creates value for the acquiring firm’s shareholders

Mergers and Acquisitions

There are a number of reasons why a firm may choose to merge with or acquire another one, including:◦ Economies of scale◦ Improving target management◦ Combining complimentary resources◦ Capturing tax benefits from acquiring a loss

making company Cytopia has an accumulated loss of $63.52m

(never made a profit)

Motivations for Merger or Acquisition

Providing low-cost financing to target

Creating value through restructuring and breakups

Penetrating new markets Increasing product-market rents Diversification

Motivations for Merger or Acquisition, (Cont.)

Conglomerate merger – in booming economies◦ Middle of the 20th century

Horizontal merger – create monopolies◦ late 19th and early part of 20th century

Hostile takeover ◦ During 1980s

Vertical merger The M&A in the late 20th and early 21st century

about strategic benefits (mega mergers)

Types of merger will depend on motivation

• The Arcelor-Mittal merger (2006-07) serves as a great real-life example to examine some of the issues related to M&A.

• ArcelorMittal continued to explore growth opportunities in 2007, with 35 acquisition transactions.

• Refer to Zephyr database for information on Australian and global M&A

Motivation for the Arcelor-Mittal Merger

Unique geographical and product diversification,

Upstream and downstream integration Reduction in exposure to risk and cyclicality

Mergers and acquisitions have historically been a key pillar ofArcelorMittal’s strategy to which it brings unique experience, particularly in terms of integration. Instead of creating new capacity, mergers and acquisitions increase industry consolidation and create synergies.

ArcelorMittal growth philosophy

Viterra’s bid price represented around 30% premium to target shareholders.

Initial market reactions were significantly positive for ABB.

Viterra will now acquire 100 per cent of ABB for $1.6 billion as announced on 9 September 2009.

Shareholders were offered $4.35 a share in cash, plus a 41-cent-a-share ABB Grain special dividend, as well as 0.4531 Viterra shares for each ABB Grain share.

Viterra takeover of ABB

The form of payment is an important financing decision.◦ Capital structure effects

If debt financing is used, analysis should be conducted to see if the increase in financial leverage is excessive.

◦ Information problems Asymmetric information levels between

management and shareholders may cause investors to misinterpret the form of financing.

◦ Control and the form of payment Using stock to finance M&A dilutes the ownership

and control of the acquiring firm.

Acquisition Financing and Form of Payment

VALUE OF

SYNERGY

Synergy is the additional value that is

generated by combining two firms,

creating opportunities that would not

been available to these firms operating

independently.

What is Synergy

Operating synergies. Operating synergies are those synergies that allow firms to increase their operating income from existing assets, increase growth or both. We would categorize operating synergies into four types.•Economies of scale•Greater pricing power•Combination of different functional strengths,•Higher growth in new or existing markets,

Categories of Synergy

May arise from the merger, allowing the combined firm to become more cost-efficient and profitable.

In general economies of scales occur in mergers of firms in the same business (horizontal mergers)

E.g two banks coming together to create a larger bank or two steel companies combining to create a bigger steel company.

Economies of Scale

Greater Pricing Power that results from reduced competition and higher market share result in higher margins and operating income.

This synergy is also more likely to show up in mergers of firms in the same business and should be more likely to yield benefits when there are relatively few firms in the business to begin with.

Thus, combining two firms is far more likely to create an oligopoly with pricing power

Greater pricing power

Would be the case when a firm with strong marketing skills acquires a firm with a good product line.

This can apply to wide variety of mergers since functional strengths can be transferable across businesses.

Combination of different functional strengths

This would be case, for instance, when a US consumer products firm acquires an emerging market firm, with an established distribution network and brand name recognition, and uses these strengths to increase sales of its products.

Higher growth in new or existing markets, arising from

the combination of the twofirms

Financial synergies the payoff can take the form of either higher cash flows or a lower cost of capital (discount rate) or both.

Categories of Synergy

A combination of a firm with excess cash, or cash slack, (and limited project opportunities) and a firm with high-return projects (and limited cash) can yield a payoff in terms of higher value for the combined firm.

The increase in value comes from the projects that can be taken with the excess cash that otherwise would not have been taken.

This synergy is likely to show up most often when large firms acquire smaller firms, or when publicly traded firms acquire private businesses.

When two firms combine, their earnings and cash flows may become more stable and predictable. This, in turn, allows them to borrow more than they could have as individual entities, which creates a tax benefit for the combined firm. This tax benefit usually manifests itself as a lower cost of capital for the combined firm.

Increase in Debt capacity

Arise either from the acquisition taking advantage of tax laws to write up the target company’s assets or from the use of net operating losses to shelter income.

Thus, a profitable firm that acquires a money-losing firm may be able to use the net operating losses of the latter to reduce its tax burden.

Alternatively, a firm that is able to increase its depreciation charges after an acquisition will save in taxes and increase its value.

Tax benefits

Most Important Question is whether synergy can be valued and, if so, what that value should be.

Some argue synergy is too nebulous to be valued and that any systematic attempt to do so requires so many assumptions that it is pointless.

If this is true, a firm should not be willing to pay large premiums for synergy if it cannot attach a value to it. The other school of thought is that we have to make

our best estimate of how much value synergy will create in any acquisition before we decide how much to pay for it, even though it requires assumptions about an uncertain future.

Valuing Operating Synergy

What form is the synergy expected to take?◦ Will it reduce costs as a percentage of sales and increase

profit margins ? (Economies of Scale)◦ Will it increase future growth (e.g., when there is increased

market power) ◦ Or the length of the growth period?

When will the synergy start affecting cash flows?

◦ Synergies seldom show up instantaneously◦ Since the value of synergy is the present value of the cash

flows created by it, the longer it takes for it to show up, the lesser its value.

Synergy can be valued by answering two fundamental

Questions.

Synergy, to have an effect on value, has to influence one of the four inputs into the valuation process –

Higher cash flows from existing assets (cost savings and economies of scale),

Higher expected growth rates (market power, higher growth potential),

Longer growth period (from increased competitive advantages), or

A lower cost of capital (higher debt capacity).

First, 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.

Second, we estimate the value of the combined firm, with no synergy, by

adding the values obtained for each firm in the first step.

Third, we build in the effects of synergy into expected growth rates and

cash flows and we revalue the combined firm with synergy. 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.

Steps in Valuing Operating Synergy

Value of

Control

The value of a business is determined by decisions made by the managers of that business on where to invest its resources, how to fund these investments and how much cash to return to the owners of the business.

When we value a business, we make implicit or explicit assumptions about both who will run that business and how they will run it.

Value of Control

When valuing an existing company, private or public, where

there is already a management in place, we are faced with a

choice.

We can value the company run by the incumbent managers

and derive to a status quo value.

On the Contrary, we can also revalue the company with a

hypothetical “optimal” management team and estimate an

optimal value.

The difference between the optimal and the status quo

values can be considered the value of controlling the

business.