Mergers & Acquisitions (and Divestitures) Prof. Ian GIDDY Stern School of Business New York University igiddy/dakar

Mergers & Acquisitions(and Divestitures)

Prof. Ian GIDDYStern School of Business

New York University

www.stern.nyu.edu/~igiddy/dakarwww.stern.nyu.edu/~igiddy/dakar

Copyright ©2003 Ian H. Giddy M&A 3

Mergers and Acquisitions

Mergers & Acquisitions Divestitures Valuation

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


The Gains From an Acquisition

Gains from merger

Synergies Control

Top line Financial

restructuring

Business

Restructuring

(M&A)

Bottom line


Goal of Acquisitions and Mergers

Increase size - easy! Increase market value - much

harder!


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


Fallacies of Acquisitions

Size (shareholders would rather have their money back, eg Vivendi Universal)

Downstream/upstream integration (internal transfer at nonmarket prices, eg DuPont/Conoco, AOL/Time Warner)

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.


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%

Equity Valuation:Application to M&A

Prof. Ian GiddyNew York University


How Much Should We Pay?

Applying the discounted cash flow approach, we need to know:

1.The incremental cash flows to be generated from the acquisition, adjusted for debt servicing and taxes

2.The rate at which to discount the cash flows (required rate of return)

3.The deadweight costs of making the acquisition (investment banks' fees, etc)


The Gains From an Acquisition

Gains from merger

Synergies Control

Top line Financial

restructuring

Business

Restructuring

(M&A)

Bottom line


Equity Valuation in Practice

Estimating discount rate Estimating cash flows Application to Optika Application in M&A: Schirnding-Optika


Optika OptikaGrowth 5%Tax rate 35%Initial Revenues 3125COGS 89%WC 10%Equity Market Value 1300Debt Market Value 250Beta 1Treasury bond rate 7%Debt spread 1.5%Market risk premium 5.50%

T+1Revenues 3281-COGS 2920-Depreciation 74=EBIT 287EBIT(1-Tax) 187-Change in WC 16=Free Cash Flow to Firm 171Cost of Equity (from CAPM) 12.50%Cost of Debt (after tax) 5.53%WACC 11.38%

Firm Value 2278

CAPM:

7%+1(5.50%)

Debt cost

(7%+1.5%)(1-.35)

WACC:

ReE/(D+E)+RdD/(D+E)

Value:

FCFF/(WACC-growth rate)

Equity Value:

Firm Value - Debt Value

= 2278-250 = 2028


Optika & SchirndingSchirnding-Optika

Optika Schirnding CombinedGrowth 5% 5% 5%Tax rate 35% 35% 35%Initial Revenues 3125 4400 7525COGS 89% 87.50%WC 10% 10% 10%Equity Market Value 1300 2000 3300Debt Market Value 250 160 410Beta 1 1 1Treasury bond rate 7% 7% 7%Debt spread 1.5% 1.5% 1.5%Market risk premium 5.50% 5.50% 5.50%

T+1 T+1Revenues 3281 4620 7901-COGS 2920 4043 6963-Depreciation 74 200 274=EBIT 287 378 664EBIT(1-Tax) 187 245 432-Change in WC 16 22 38=Free Cash Flow to Firm 171 223 394Cost of Equity (from CAPM) 12.50% 12.50% 12.50%Cost of Debt (after tax) 5.53% 5.53% 5.53%WACC 11.38% 11.98% 11.73%

Firm Value 2278 3199 5859


Optika-Schirnding with SynergySchirnding-Optika

Optika Schirnding Combined SynergyGrowth 5% 5% 5% 5%Tax rate 35% 35% 35% 35%Initial Revenues 3125 4400 7525 7525COGS 89% 87.50% 86.00%WC 10% 10% 10% 10%Equity Market Value 1300 2000 3300 3300Debt Market Value 250 160 410 410Beta 1 1 1 1Treasury bond rate 7% 7% 7% 7%Debt spread 1.5% 1.5% 1.5% 1.5%Market risk premium 5.50% 5.50% 5.50% 5.50%

T+1 T+1 T+1Revenues 3281 4620 7901 7901-COGS 2920 4043 6963 6795-Depreciation 74 200 274 274=EBIT 287 378 664 832EBIT(1-Tax) 187 245 432 541-Change in WC 16 22 38 38=Free Cash Flow to Firm 171 223 394 503Cost of Equity (from CAPM) 12.50% 12.50% 12.50% 12.50%Cost of Debt (after tax) 5.53% 5.53% 5.53% 5.53%WACC 11.38% 11.98% 11.73% 11.73%

Firm Value 2278 3199 5859 7479Increase 1620


Optika-Schirnding with SynergySchirnding-Optika

Optika Schirnding Combined SynergyGrowth 5% 5% 5% 5%Tax rate 35% 35% 35% 35%Initial Revenues 3125 4400 7525 7525COGS 89% 87.50% 86.00%WC 10% 10% 10% 10%Equity Market Value 1300 2000 3300 3300Debt Market Value 250 160 410 410Beta 1 1 1 1Treasury bond rate 7% 7% 7% 7%Debt spread 1.5% 1.5% 1.5% 1.5%Market risk premium 5.50% 5.50% 5.50% 5.50%

T+1 T+1 T+1Revenues 3281 4620 7901 7901-COGS 2920 4043 6963 6795-Depreciation 74 200 274 274=EBIT 287 378 664 832EBIT(1-Tax) 187 245 432 541-Change in WC 16 22 38 38=Free Cash Flow to Firm 171 223 394 503Cost of Equity (from CAPM) 12.50% 12.50% 12.50% 12.50%Cost of Debt (after tax) 5.53% 5.53% 5.53% 5.53%WACC 11.38% 11.98% 11.73% 11.73%

Firm Value 2278 3199 5859 7479Increase 1620

Case Study: Ashanti-Bogoso


Ipoh-KelantanIpoh-Kelantan Bank

Ipoh KelantanRevenues RM4,400.00 RM3,125.00Cost of Goods Sold (w/o Depreciation)as % of Revenue Depreciation RM200.00 RM74.00Tax Rate 35.00% 35.00%

10% of 10% of Revenue Revenue

Market Value of EquityOutstanding debt RM160.00 RM250.00

Now estimate the value of the merged bank, assuming synergies.

What is the value of the combined bank? Is Kelantan overpaying?

As part of the consolidation of banks in Malaysia, Bank of Ipoh and Kelantan Bank Holdings Bhd are planning a merger. The proposed merger will occur through an exchange of shares, with Kelantan paying 1.5 shares for each share of Ipoh. Ipoh shares are cur

The following are the details of the two potential merger candidates (RM figures in millions):

87.50% 89.00%

As a result of the merger, the combined firm is expected to have a cost of goods sold of only 86% of total revenues. earnings will grow faster, at 6%. The combined firm does not plan to borrow additional debt.

Estimate the value of Ipoh and of Kelantan, operating independently. Then estimate their combined value, assuming no synergies. If it does not increase debt, the combined firm's rating will be A+ (with an interest rate of 7.75%)

Finally, assume that, as a result of the merger, the Ipoh-Kelantan Bank's optimal debt ratio increases to 20% of total capital from current levels. (At that level of debt, the combined firm will have an A rating, with an interest rate on its debt of 8%.)

Working Capital

RM2,000.00 RM1,300.00

Both firms are in steady state and are expected to grow by 5% a year in the long term. Capital spending is expected to be 90% of depreciation. The beta for Ipoh is 1.7, and for Kelantan 1.5, and both firms are rated BBB, with an interest rate on their deb


1. Manage preacquisition phase Instruct staff on secrecy requirements Evaluate your own company Identify value-adding approach

Understand industry structure, and strengthen core businessCapitalize on economics of scaleExploit technology or skills transfer

2. Screen Candidates Identify knockout criteria Decide how to use investment banks Prioritize opportunities Look at public companies, divisions of companies, and

privately held companies

Steps in a Successful Merger and Acquisition Program - Step 1 and 2


Steps in a Successful Merger and Acquisition Program - Step 3 to 53. Value remaining candidates Know exactly how you will recoup the takeover premium Identify real synergies Decide on restructuring lan Decide on financial engineering opportunities

4. Negotiate Decide on maximum reservation price and stick to it Understand background and incentives of the other side Understand value that might be paid by a third party Establish negotiation strategy Conduct due diligence

5. Manage postmerger integration Move as quickly as possible Carefully manage the process

Conclusion



Contact Info

Ian H. Giddy

NYU Stern School of Business

Tel 212-998-0426; Fax 212-995-4233

[email protected]

http://giddy.org

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Mergers & Acquisitions (and Divestitures) Prof. Ian GIDDY Stern School of Business New York University igiddy/dakar