Advanced Corporate Finance
Summary of Lecture Slides
MSc Finance – Block 1 2019/2020
Vera Scholten
Lecture 1 M&A
What is Corporate Finance?
Corporate finance is the area of finance that deals with sources of funding, the capital structure of
corporations, the actions that managers take to increase the value of the firm to the shareholders,
and the tools and analysis used to allocate financial resources. The primary goal of corporate
finance is to maximize or increase shareholder value.
1.0 Introduction M&A's
1.1 How to acquire assets: either through cash (investors) or equity (shares)
The takeover market is highly active - on average 1 trillion dollars per year in transaction value
DANGER: the quickest and most decisive way to impoverish stockholders is to overpay on a takeover.
M&A Cycles:
60's = conglomerate wave. Conglomerate = very large company in a specific sector
80's = hostile takeovers - destroyed the conglomerates. Managers at conglomerates
destroyed shareholder value, making it easy to acquire the company through shares
90's = strategic/global deals - faith in future synergies.
Since 2000's = marked by consolidation in many industries and the larger role played by
private equity
Merged companies also regularly split up again - 31% at the moment
From Shleifer & Vishny:
Year Name Medium of Type of Period of high/low stock
payment acquisitions market valuation
1960’s Conglomerate stock Different industry High
wave
1980’s Hostile takeovers cash Same industry Low
1990’s M&A stock Same industry High
Synergy = the interaction or cooperation of two or more organizations, substances, or other agents
to produce a combined effect greater than the sum of their separate effects.
1.2 Reasons to acquire a company = achieving value through vertical integration
1. Large synergies are by far the most common justification that bidders give for the premium
they pay for the target. This can be realized through:
− Cost reduction synergies are more common and easier to achieve because they
generally translate into layoffs of overlapping employees and elimination of redundant
resources. e.g. better integrate your supply chain (profit margins) or = firing people.
− Revenue-enhancement synergies, however, are much harder to predict and achieve.
2. Economies of Scale/Scope
− Economies of scale = The savings a large company can enjoy from producing goods in
high volume, that are not available to a small company
− Economies of scope = Savings large companies can realize that come from combining
the marketing and distribution of different types of related products - e.g. Volkswagen has
, a lot of brands and has streamlined the production throughout all their brands and models. Can
use building blocks from all brands to design a new car
3. Other reasons to acquire
Vertical Integration / Complementary Assets = merger of two companies in the same
industry that make products required at different stages of the production cycle. Integration of
supply chain. e.g. Apple – makes both hardware and computer, whereas Microsoft only builds
hardware.
Buy and Built strategies = build a company by merging smaller companies. Works
especially in fragmented markets where companies do not have a big market power
Expertise = patents, a way to protect yourself. Buying a company because it has patents/
knowledge. Happens a lot in pharma and tech industry. e.g. google bought android because of its
patents + it bought Motorola, took the patents (one of the first players so lot of patents) and sold the
rest of the shell to Lenovo.
Monopolistic gains = one competitor less. In large M&A deals some parts of the target
have to be sold again so the market power is not centred around one company
Efficiency Gains = achieved through an elimination of duplication. Acquirers argue they
can run the target more efficiently than its existing management.
Earning Growth
Diversification: in liquidity, debt capacity and borrowing cost in order to create risk
reduction (especially for cyclical products, buying something anti-cyclical is good)
Most important aspects of M&A strategy
− Acquire technology = 15%
− Expand/diversify products or services = 19%
− Expand customer base in existing geographic markets = 20%
1.3 Market Reaction to a Takeover = Acquirer share price goes down, target goes up.
How to split up the synergy?
As a target you want to get the synergies for yourself - maximize through consulting firms. Therefore,
they create a competition/ bid war to identify potential buyers. They offer prices per shares that the
acquirer will pay for all company shares. Result: target stock price goes up →The target will get most
of the synergies.
In most U.S. states, the law requires that when existing shareholders of a target firm are forced to
sell their shares, they receive a fair value for their shares. As a consequence, a bidder is unlikely to
acquire a target company for less than its current market value. In practice, most acquirers pay a
premium to the current market value. But:
- Why do acquirers pay a premium over the market value for a target company?
- Although the price of the target company rises on average upon the announcement of the
takeover, why does it rise less than the premium offered by the acquirer?
- Why does the acquirer not experience a price increase?
1.4 Offer premia
Large-sample evidence on offer premiums are only starting to emerge. This evidence indicates that
both the initial and final offer premiums are
− greater after the 1980s − lower for toehold bidders;
− greater for public bidders − increasing in the target runup (mark-up
− greater in all-cash offers; pricing);
Do mergers add value? Overall value is negative. Thus, for the acquirer it does not add value.
However, sometimes the aggregate added value is positive. The big firm always loses and small firm
always wins. Usually when the aggregate is positive, it means the acquirer is small.
, Long term returns = buy-and-hold stock returns
Potential reason for deal success
1. Deal integration
2. Economic certainty
3. Accurately valuing a target
4. Strategic legislative environment
5. Proper target identification
6. Sound due diligence process
2.0 Stock market driven acquisitions - Shleifer and Vishny 2003
The basic idea: stock-for-stock mergers are done by acquirers who are overvalued and want to sell
stock. See article summary for more.
Key assumption: when you’re overvalued, you can’t just sell stock and park proceeds in T-bills (as in
BSW). You need a story.
Example: Tech bubble - e.g. increase in value if you only had .com behind your name. After the bubble burst it
was better to not have .com after your name which again increased the value. Indicates that markets are not
always rational.
3.0 Merger arbitrage
Once a tender offer (= 'I want to buy a company') is announced, the uncertainty about whether the
takeover will succeed adds to the volatility of the stock price. Probability of success/terms =
opportunity for investors to speculate on the outcome of the deal = go long or go short.
Risk arbitrageurs = traders who speculate on the outcome of the deal. Is not real arbitrage since it is
not risk-free (unless you are an informed insider).
Example = not all M&A's succeed. Heinz wants to buy Unilever. Failed because they underestimated how hard
it would be to push the deal through regulators and shareholders. Even with very professional bidders.
Afterwards Unilever tried to protect itself from takeovers through certain measures.
How does merger arbitrage work? You short/sell the expensive shares ( Heinz) and you long/buy the
cheaper shares (Unilever).
Merger-Arbitrage Spread – The difference between a target stock’s price and the implied offer price
Note: It is not a true arbitrage opportunity because there is a risk that the deal will not go through.
When the probability that the deal goes through is higher, the spread will be lower.
3.1 Board and Shareholder Approval
For a merger to proceed, both the target and the acquiring board of directors must approve the deal
and put the question to a vote of the shareholders of the target.
Friendly Takeover – When a target’s board of directors supports a merger, negotiates with potential
acquirers, and agrees on a price that is ultimately put to a shareholder vote
Hostile Takeover – A situation in which an individual or organization purchases a large fraction of a
target corporation’s stock and in doing so gets enough votes to replace the target’s board of
directors and CEO. A Corporate Raider is the acquirer in a hostile takeover.
3.2 Defensive Tactics
Before an initial attempt of a hostile takeover After an initial attempt
− Corporate charters − Greenmail and standstill agreements
Staggered boards − White knight and white squire
Supermajority provisions − Recapitalizations and repurchases
− Golden parachutes − Exclusionary self-tenders
− Poison pills − Asset restructurings
Summary of Lecture Slides
MSc Finance – Block 1 2019/2020
Vera Scholten
Lecture 1 M&A
What is Corporate Finance?
Corporate finance is the area of finance that deals with sources of funding, the capital structure of
corporations, the actions that managers take to increase the value of the firm to the shareholders,
and the tools and analysis used to allocate financial resources. The primary goal of corporate
finance is to maximize or increase shareholder value.
1.0 Introduction M&A's
1.1 How to acquire assets: either through cash (investors) or equity (shares)
The takeover market is highly active - on average 1 trillion dollars per year in transaction value
DANGER: the quickest and most decisive way to impoverish stockholders is to overpay on a takeover.
M&A Cycles:
60's = conglomerate wave. Conglomerate = very large company in a specific sector
80's = hostile takeovers - destroyed the conglomerates. Managers at conglomerates
destroyed shareholder value, making it easy to acquire the company through shares
90's = strategic/global deals - faith in future synergies.
Since 2000's = marked by consolidation in many industries and the larger role played by
private equity
Merged companies also regularly split up again - 31% at the moment
From Shleifer & Vishny:
Year Name Medium of Type of Period of high/low stock
payment acquisitions market valuation
1960’s Conglomerate stock Different industry High
wave
1980’s Hostile takeovers cash Same industry Low
1990’s M&A stock Same industry High
Synergy = the interaction or cooperation of two or more organizations, substances, or other agents
to produce a combined effect greater than the sum of their separate effects.
1.2 Reasons to acquire a company = achieving value through vertical integration
1. Large synergies are by far the most common justification that bidders give for the premium
they pay for the target. This can be realized through:
− Cost reduction synergies are more common and easier to achieve because they
generally translate into layoffs of overlapping employees and elimination of redundant
resources. e.g. better integrate your supply chain (profit margins) or = firing people.
− Revenue-enhancement synergies, however, are much harder to predict and achieve.
2. Economies of Scale/Scope
− Economies of scale = The savings a large company can enjoy from producing goods in
high volume, that are not available to a small company
− Economies of scope = Savings large companies can realize that come from combining
the marketing and distribution of different types of related products - e.g. Volkswagen has
, a lot of brands and has streamlined the production throughout all their brands and models. Can
use building blocks from all brands to design a new car
3. Other reasons to acquire
Vertical Integration / Complementary Assets = merger of two companies in the same
industry that make products required at different stages of the production cycle. Integration of
supply chain. e.g. Apple – makes both hardware and computer, whereas Microsoft only builds
hardware.
Buy and Built strategies = build a company by merging smaller companies. Works
especially in fragmented markets where companies do not have a big market power
Expertise = patents, a way to protect yourself. Buying a company because it has patents/
knowledge. Happens a lot in pharma and tech industry. e.g. google bought android because of its
patents + it bought Motorola, took the patents (one of the first players so lot of patents) and sold the
rest of the shell to Lenovo.
Monopolistic gains = one competitor less. In large M&A deals some parts of the target
have to be sold again so the market power is not centred around one company
Efficiency Gains = achieved through an elimination of duplication. Acquirers argue they
can run the target more efficiently than its existing management.
Earning Growth
Diversification: in liquidity, debt capacity and borrowing cost in order to create risk
reduction (especially for cyclical products, buying something anti-cyclical is good)
Most important aspects of M&A strategy
− Acquire technology = 15%
− Expand/diversify products or services = 19%
− Expand customer base in existing geographic markets = 20%
1.3 Market Reaction to a Takeover = Acquirer share price goes down, target goes up.
How to split up the synergy?
As a target you want to get the synergies for yourself - maximize through consulting firms. Therefore,
they create a competition/ bid war to identify potential buyers. They offer prices per shares that the
acquirer will pay for all company shares. Result: target stock price goes up →The target will get most
of the synergies.
In most U.S. states, the law requires that when existing shareholders of a target firm are forced to
sell their shares, they receive a fair value for their shares. As a consequence, a bidder is unlikely to
acquire a target company for less than its current market value. In practice, most acquirers pay a
premium to the current market value. But:
- Why do acquirers pay a premium over the market value for a target company?
- Although the price of the target company rises on average upon the announcement of the
takeover, why does it rise less than the premium offered by the acquirer?
- Why does the acquirer not experience a price increase?
1.4 Offer premia
Large-sample evidence on offer premiums are only starting to emerge. This evidence indicates that
both the initial and final offer premiums are
− greater after the 1980s − lower for toehold bidders;
− greater for public bidders − increasing in the target runup (mark-up
− greater in all-cash offers; pricing);
Do mergers add value? Overall value is negative. Thus, for the acquirer it does not add value.
However, sometimes the aggregate added value is positive. The big firm always loses and small firm
always wins. Usually when the aggregate is positive, it means the acquirer is small.
, Long term returns = buy-and-hold stock returns
Potential reason for deal success
1. Deal integration
2. Economic certainty
3. Accurately valuing a target
4. Strategic legislative environment
5. Proper target identification
6. Sound due diligence process
2.0 Stock market driven acquisitions - Shleifer and Vishny 2003
The basic idea: stock-for-stock mergers are done by acquirers who are overvalued and want to sell
stock. See article summary for more.
Key assumption: when you’re overvalued, you can’t just sell stock and park proceeds in T-bills (as in
BSW). You need a story.
Example: Tech bubble - e.g. increase in value if you only had .com behind your name. After the bubble burst it
was better to not have .com after your name which again increased the value. Indicates that markets are not
always rational.
3.0 Merger arbitrage
Once a tender offer (= 'I want to buy a company') is announced, the uncertainty about whether the
takeover will succeed adds to the volatility of the stock price. Probability of success/terms =
opportunity for investors to speculate on the outcome of the deal = go long or go short.
Risk arbitrageurs = traders who speculate on the outcome of the deal. Is not real arbitrage since it is
not risk-free (unless you are an informed insider).
Example = not all M&A's succeed. Heinz wants to buy Unilever. Failed because they underestimated how hard
it would be to push the deal through regulators and shareholders. Even with very professional bidders.
Afterwards Unilever tried to protect itself from takeovers through certain measures.
How does merger arbitrage work? You short/sell the expensive shares ( Heinz) and you long/buy the
cheaper shares (Unilever).
Merger-Arbitrage Spread – The difference between a target stock’s price and the implied offer price
Note: It is not a true arbitrage opportunity because there is a risk that the deal will not go through.
When the probability that the deal goes through is higher, the spread will be lower.
3.1 Board and Shareholder Approval
For a merger to proceed, both the target and the acquiring board of directors must approve the deal
and put the question to a vote of the shareholders of the target.
Friendly Takeover – When a target’s board of directors supports a merger, negotiates with potential
acquirers, and agrees on a price that is ultimately put to a shareholder vote
Hostile Takeover – A situation in which an individual or organization purchases a large fraction of a
target corporation’s stock and in doing so gets enough votes to replace the target’s board of
directors and CEO. A Corporate Raider is the acquirer in a hostile takeover.
3.2 Defensive Tactics
Before an initial attempt of a hostile takeover After an initial attempt
− Corporate charters − Greenmail and standstill agreements
Staggered boards − White knight and white squire
Supermajority provisions − Recapitalizations and repurchases
− Golden parachutes − Exclusionary self-tenders
− Poison pills − Asset restructurings
