week 9

• Merger


  A transaction that combines two firms into one new firm. Both companies' stock are surrendered and new company stock is issued
• Acquisition


  The purchase of one firm by another. The buyer's stock continues to be traded
• Acquirer (or bidder)


  The buyer of the firm
• Target


  The seller of the firm
• Percentage of public companies taken over each quarter, 1926-2012

  
• Characteristics of M&A


  • Merger activities appear to come in waves
  • Positively related to share price indices
  • Exhibit industry clustering (maybe due to economic, regulatory or innovation shocks)
  • Acquisitions are initiated by higher performing firms in the recent past
• Types of M&A


  • Horizontal/Strategic merger
  • Vertical merger
  • Conglomerate/diversifying merger
• Horizontal/Strategic merger


  Target and acquirer are in the same industry, involves operating synergies, but makes acquirer undiversified and may create monopoly problems
• Vertical merger


  Two companies that produce different goods or services related to one specific finished product, increases efficiency and saves cost, but may create anti-competitiveness
• Conglomerate/diversifying merger


  Involves companies in unrelated lines of businesses, motivated by financial synergies, but difficult to manage
• What drives firms to merge?


  • Monopoly power
  • Economies of scale and scope
  • Transaction costs in markets
  • Costs of internalization
  • Complementary resources
  • Surplus funds
  • Eliminating inefficiencies
  • Conflicts of interest
  • Overconfident manager
• Economies of scale


  Increase profit by reducing costs or reducing competition, e.g. container ships, breweries, tobacco
• Economies of vertical integration


  Better coordination and administration, gain control over the production process
• Market power


  Upstream firm merging with downstream firm can exploit market power by raising prices, reducing consumer welfare
• Complementary resources


  Acquirers search for capabilities for innovation, product development and differentiation
• Surplus funds


  Firms with surplus cash and shortage of investment opportunities turn to mergers as a way to redeploy capital
• Eliminating inefficiencies


  A new better management team replaces the old one to compete more efficiently
• Conflicts of interest


  Managers pursue higher pay and prestige through mergers
• Overconfident manager


  Managers overestimate the benefits of mergers, e.g. AOL-Time Warner deal
• Cadbury case


  • Cadbury, a historic British company, was acquired by Kraft, a US food giant, in 2010
• Cadbury had announced closure of Somerdale in 2007, Bournville headcount had fallen from 2,000 in 2007 to 1,000 in 2009, operating costs 3x German comparable
• In 2017, Kraft completed a £75m modernisation of Cadbury, including a £18m new global research operation
• Kraft increased Cadbury's maternity pay from 4 to 9 months
• Who are the winners and losers from the Cadbury-Kraft M&A?


  • Shareholders of target (Cadbury)
  • Shareholders of acquirer (Kraft)
  • Workers of target (Cadbury)
  • UK local communities
  • Other stakeholders (investment bankers, lawyers, accountants, arbitrageurs)
• Target shareholders' gains


  US targets, 1980-2005: 7% runup, 15% announcement. Targets are typically undervalued and there is competition among potential bidders
• Bidder (acquirer) shareholders' gains


  Average gains of 0.5% (runup), 0.7% (announcement) mask huge variation, 49% of deals have negative announcement returns, some very large acquirers made bad deals
• 1998-2001: US acquirers lost $240bn through M&A
• US targets, 1980-2005: 7% runup, 15% announcement
• Why do sellers earn higher returns?


  • Buying firms are typically larger than selling firms
  • The competition among potential bidders
• CAR US targets, 1980-2005
• CAR US targets, long term performance
• Target gains may be because they are deeply undervalued
• After a failed merger, target returns to original price
• Most mergers targeted at firms and industries with little R&D for potential synergies
• Bidder (Acquirer)


  • Average gains of 0.5% (runup), 0.7% (announcement) mask huge variation
  • 49% of deals have negative announcement returns
• Since announcing the $182 billion AOL Time Warner merger on Jan. 10, 2000, Time Warner stock has plummeted almost 90% to $23
• The aim was to create a company that could offer consumers a comprehensive package of media and information products. But it didn't work.
• Time Warner (TWX) is officially spinning off AOL in 2009
• Monthly Buy-and-Hold Return (1998-2002)
• Why Might Acquirers Undertake Bad Deals?


  • Deliberate: Paid for deals
  • Deliberate: Paid for prestige, empire-building or size
  • Unintentional: Overconfidence