Giddy/SIM M&A-1 SIM/NYU The Job of the CFO Mergers & Acquisitions (and Divestitures) Prof. Ian Giddy New York University Mergers and Acquisitions l Mergers & Acquisitions l Divestitures l Valuation Concept: Is a division or firm worth more within the company, or outside it? Copyright ©2000 Ian H. Giddy M&A 2 Giddy/SIM M&A-2 The Market for Corporate Control When you buy shares, you get dividends; and potential control rights There is a market for corporate control— that is, control over the extent to which a business is run in the right way by the right people. This market is constrained by uGovernment Example: Allied Signal’s attempts uManagement to acquire AMP, which is uSome shareholders located in Pennsylvania Copyright ©2000 Ian H. Giddy M&A 3 The Market for Corporate Control l M&A&D situations often arise from conflicts: l Owner vs manager ("agency problems" l Build vs buy ("internalization") l Agency problems arise when owners' interests and managers' interests diverge. Resolving agency problems requires u Monitoring & intervention, or u Setting incentives, or u Constraining, as in bond covenants l Resolving principal-agent conflicts is costly l Hence market price may differ from potential value of a corporation Copyright ©2000 Ian H. Giddy M&A 4 Giddy/SIM M&A-3 “Internalization”: Is an activity best done within the company, or outside it? Issue: why are certain economic activities conducted within firms rather than between firms? l As a rule, it is more costly to build than to buy—markets make better decisions than bureaucrats l Hence there must be some good reason, some synergy, that makes an activity better if done within a firm l Eg: the production of proprietary information l Often, these synergies are illusory Copyright ©2000 Ian H. Giddy M&A 5 Takeovers as a Solution to “Agency Problems” l There is a conflict of interest between shareholders and managers of a target company—Eg poison pill defenses l Individual owners do not have suffcient incentive to monitor managers l Corporate takeover specialists, Eg KKR, monitor the firm's environment and keep themselves aware of the potential value of the firm under efficient management l The threat of a takeover helps to keep managers on their toes—often precipitates restructuring. Copyright ©2000 Ian H. Giddy M&A 6 Giddy/SIM M&A-4 Goal of Acquisitions and Mergers lIncrease size - easy! lIncrease market value - much harder! Copyright ©2000 Ian H. Giddy M&A 7 Goal: Market Value Addition Definition It is a measure of shareholder value creation Methodology It is the change in the market value of invested capital ( debt and equity) minus the change in the book value of invested capital Copyright ©2000 Ian H. Giddy M&A 8 Giddy/SIM M&A-5 Value Changes In An Acquisition 10 Taxes on sale of assets Profit on sale 40 of assets 30 Takeover premium 50 Gain in Synergies and/ or operating 50 shareholder improvements value 75 Value of acquired company as a separate entity 250 Value of acquiring company 175 without acquisition Initial value Final value of plus gains combined company Copyright ©2000 Ian H. Giddy M&A 9 Goals of Acquisitions Rationale: Firm A should merge with Firm B if [Value of AB > Value of A + Value of B + Cost of transaction] l Synergy l Gain market power l Discipline l Taxes l Financing Copyright ©2000 Ian H. Giddy M&A 10 Giddy/SIM M&A-6 Goals of Acquisitions Rationale: Firm A should merge with Firm B if [Value of AB > Value of A + Value of B + Cost of transaction] l Synergy u Eg Martell takeover by Seagrams to match name and inventory with marketing capabilities l Gain market power u Eg Atlas merger with Varity. (Less important with open borders) l Discipline u Eg Telmex takeover by France Telecom & Southwestern Bell (Privatization) u Eg RJR/Nabisco takeover by KKR (Hostile LBO) l Taxes u Eg income smoothing, use accumulated tax losses, amortize goodwill l Financing u Eg Korean groups acquire firms to give them better access to within-group financing than they might get in Korea's undeveloped capital market Copyright ©2000 Ian H. Giddy M&A 11 Fallacies of Acquisitions l Size (shareholders would rather have their money back, eg Credit Lyonnais) l Downstream/upstream integration (internal transfer at nonmarket prices, eg Dow/Conoco, Aramco/Texaco) l Diversification into unrelated industries (Kodak/Sterling Drug) Copyright ©2000 Ian H. Giddy M&A 12 Giddy/SIM M&A-7 Methods of Acquiring Corporate Control l Mergers u Bidder typically negotiates a friendly agreement with target management and submits this for approval to both sets of shareholders u Usually entails an exchange of securities l Tender Offers u Often hostile, often opposed, often generates competing bids u Usually a direct cash offer to stockholders of an above-market price l Proxy Fights u A method of gaining control without acquisition: dissident shareholders seek to change management by soliciting proxies from other shareholders. Copyright ©2000 Ian H. Giddy M&A 13 Who Gains What? l Target firm shareholders? l Bidding firm shareholders? l Lawyers and bankers? l 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. Copyright ©2000 Ian H. Giddy M&A 14 Giddy/SIM M&A-8 The Price: Who Gets What? Daimler Chrysler Combined Market value before deal $52.8 $29.4 $82.2 leaked 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 of $4.5 $13.5 $18 the gain Premium, as % 9% 46% Copyright ©2000 Ian H. Giddy M&A 15 A Case Study: Kodak - Sterling Drugs l Eastman Kodak’s Great Victory Copyright ©2000 Ian H. Giddy M&A 16 Giddy/SIM M&A-9 Earnings and Revenues at Sterling Drugs Sterling Drug under Eastman Kodak: Where is the synergy? 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 1988 1989 1990 1991 1992 Revenue Operating Earnings Copyright ©2000 Ian H. Giddy M&A 17 Kodak Says Drug Unit Is Not for Sale (NYTimes, 8/93) l Eastman Kodak officials say they have no plans to sell Kodak’s Sterling Winthrop drug unit. l Louis Mattis, Chairman of Sterling Winthrop, dismissed the rumors as “massive speculation, which flies in the face of the stated intent of Kodak that it is committed to be in the health business.” Copyright ©2000 Ian H. Giddy M&A 18 Giddy/SIM M&A-10 Sanofi to Get Part of Kodak Drug Unit (6/94) l Taking a long stride on its way out of the drug business, Eastman Kodak said yesterday that the Sanofi Group, a French pharmaceutical company, had agreed to buy the prescription drug business of Sterling Winthrop, a Kodak subsidiary, for $1.68 billion. u Shares of Eastman Kodak rose 75 cents yesterday, closing at $47.50 on the New York Stock Exchange. u Samuel D. Isaly an analyst , said the announcement was “very good for Sanofi and very good for Kodak.” u “When the divestitures are complete, Kodak will be entirely focused on imaging,” said George M. C. Fisher, the company's chairman and chief executive. Copyright ©2000 Ian H. Giddy M&A 19 Smithkline to Buy Kodak’s Drug Business for $2.9 Billion l Smithkline Beecham agreed to buy Eastman Kodak’s Sterling Winthrop Inc. for $2.9 billion. l For Kodak, the sale almost completes a restructuring intended to refocus the company on its photography business. l Kodak’s stock price rose $1.25 to $50.625, the highest price since December. Copyright ©2000 Ian H. Giddy M&A 20 Giddy/SIM M&A-11 Reasons Why Many Acquisitions Fail To Generate Value Overestimating synergies Over Poor optimistic Value post-merger market Destruction assessments integration Deal price not based on cash flow value Copyright ©2000 Ian H. Giddy M&A 24 Using Industry Structure Analysis SUBSTITUTES Questions: l Do substitutes exist? l What is their price/ performance? Potential Action: l Fund venture capital and joint venture to obtain key skills l Acquire position in new segment SUPPLIERS CUSTOMERS Questions: Questions: l Is supplier industry l Is the customer base concentrating? concentrating? l Is supplier value/cost l Is value added to added to end product high, COMPETITIVE customer end product changing? high,changing? ADVANTAGE Potential Actions: Potential Actions: l Backward - integrate l Create differentiated product l Forward - integrate BARRIERS TO ENTRY Questions: l Do barriers to entry exist? l How large are the barriers? l Are they sustainable? Potential Actions: l Acquire to achieve scale in final product or critical component l Lock up supply of critical industry input Copyright ©2000 Ian H. Giddy M&A 27 Giddy/SIM M&A-12 Goals of Acquisitions Rationale: Firm A should merge with Firm B if [Value of AB > Value of A + Value of B + Cost of transaction] l Synergy l Gain market power l Discipline Example: l Taxes Ciba-Geigy/ l Financing Sandoz Copyright ©2000 Ian H. Giddy M&A 28 Most Value is Created on the Asset Side (Operational Restructuring) l Discounted Cash Flow (DCF) analysis for project evaluation l Value-Based Management for performance evaluation Wärtsilä NSD (from Wärtsilä Diesel & New Sulzer Diesel ? Copyright ©2000 Ian H. Giddy M&A 29 Giddy/SIM M&A-13 Wärtsilä NSD: Consolidating Production and Distribution Wärtsilä NSD now has the world’s most extensive portfolio of heavy duty engines.