External Growth through Mergers

ExternalGrowththroughMergers20ChapterOutlineMergersasameansofincreasingoperatingefficiencyandforfinancialmotivesAcquiringofcompaniesthroughcashortheexchangeofsharesPotentialimpactofmergersonearningspershareandassessmentofstockvalueDiversificationbenefitsUnfriendlybuyoutsLargestAcquisitionsEverMotivesforBusinessCombinationsMergerAcombinationoftwoormorecompaniesinwhichtheresultingfirmmaintainstheidentityoftheacquiringfirmConsolidationTwoormorecompaniescombinedtoformanewentityMightbeutilizedwhenthefirmsareofequalsizeandmarketpowerFinancialMotivesMergerallowsacquiringfirmstoenjoyapotentiallydesirableportfolioeffectAchieveriskreductionwhilemaintainingthefirm’srateofreturnVariabilityinperformancemaybereducedforthebusinessfirmswithoppositephasesofthebusinesscyclePortfoliodiversificationbecomescomplicatedwithrespecttopracticalitiesItimprovesthefinancingpostureasaresultofexpansionTaxLossCarryforward(cont’d)NonfinancialMotivesDesiretoexpandmanagementandmarketingcapabilities,andacquisitionofnewproductsMaybedirectedtowardverticalorhorizontalintegrationAntitrustpolicygenerallyprecludestheeliminationofcompetitionManagementmotivation-synergisticeffect:EliminatingoverlappingfunctionsinproductionandmarketingMeshingtogethervariousengineeringcapabilitiesMotivesofSellingStockholdersMotivationcanbefromtheprobabilityofreceivingtheacquiringcompany’sstockStockholderscandiversifytheirholdingsintonewinvestments-ifcashisofferedOfficersmayreceiveattractivepostmergermanagementcontractsalongwithdirectorshipoftheacquiringfirmBiasagainstsmallerbusinessesthathasdevelopedworldwidecanbeamotivationalfactorCashPurchasesInsteadofpurchasingnewplantormachinery,thepurchaserhasoptedtoacquireagoingconcernAssumethatFirmAisconsideringtheacquisitionofFirmBfor$1million.FirmBhasanexpectedcashflow(aftertaxearningsplusdepreciation)of$100,000peryearforthenext5yearsand$150,000peryearforthe6ththroughthe20thyearsThesynergisticbenefitswilladdupto$10,000peryeartocashflowFirmBhasa$50,000losscarryforwardforimmediateuse.Witha40%taxrate,thiswillshield$20,000ofprofitfromtaxesFirmAhasa10%costofcapital,andthisisassumedtoremainstablewiththemergerCashPurchases(cont’d)CashPurchases(cont’d)Thepresentvaluefactorforthefirstfiveyearsisbasedonn=5,i=10%.Forthe6ththroughthe20thyears,thepresentvaluefactoristakenforn=20,i=10%Totalpresentvalueofinflows……..$1,172,690Netcashoutflow…………………...980,000Netpresentvalue…………………..$192,690TheacquisitionseemslikeadesirableoptionStock-for-StockExchangeEmphasisislaidonearningspershareimpactofexchangingsecuritiesShareholdersoftheacquiredfirmareconcernedwith:TheinitialpricetheyarepaidfortheirsharesTheoutlookfortheacquiringfirmAnalysisishencemademainlyfromtheviewpointofthefirmFinancialDataonPotentialMergingFirmsPostmergerEarningsPerSharePossibilitiesofMergersbasedonStock-for-StockExchangesAcquiringfirmincreasesitsimmediateearningspershareasaresultofthemerger:ButmayslowitsfuturegrowthrateifisbuyingalessaggressivefirmAcquiringfirmmaydiluteimmediatepostmergerearningspershare:ButincreaseitspotentialgrowthrateforthefutureasaresultofacquiringarapidlygrowingfirmPortfolioEffectThereductionorincreaseinriskmayinfluencetheP/EratioasmuchasthechangeinthegrowthrateIftheoverallriskisreduced,thereisanincreaseinpostmergerP/EratioandmarketvaluemayincreaseBusinessriskreduction:acquireanotherfirmthatisinfluencedbyasetoffactorsoppositefromthosethatinfluencethefirmFinancialriskreduction:restructurethepostmergerfinancialarrangementstoincludelessdebtIfthereislessriskinafirm,theinvestormaybewillingtoassignahighervaluation,thusincreasingtheP/EratioRisk-ReductionPortfolioBenefitsAccountingConsiderationsinMergersandAcquisitionsPoolingofinterests:Acquiringfirmissuesonlycommonstockinexchangeformostlyalloftheotherfirm’svotingstockAcquiredfirm’sstockholdersmaintainanownershippositioninthesurvivingfirmCombinedentitydoesnotintendtodisposeofalargeportionoftheassetsofthemergedfirmswithintwoyearsCombinationiseffectedinasingletransactionPurchaseofAssetsGoodwillmaybecreatedwhenassetspurchaseisinvolvedNecessarywhenthetenderofferisincash,bonds,preferredstock,orcommonstockwithrestrictedrightsFASBputSFAS141andSFAS142inplacetoeliminatepoolingofinterestsaccountingPlacedonthebalancesheetoftheacquiringfirmatthetimeofacquisitionEvaluationofGoodwillFairvalueofgoodwillcanbedeterminedbytakingpresentvalueoffuturecashflows,andsubtractingliabilitiesIfthegoodwillisimpaired,partofitmustimmediatelybewrittendownagainstoperatingincomeTheFASBalsoallowscompaniestotakeaone-timewrite-downofallpastgoodwillimpairmentsatthetimeofadoptionbythefirmNegotiatedversusTenderedOffersTraditionally,productlines,qualityofassets,andfuturegrowthprospectshavebeendiscussedandanexchangeratioisagreeduponThetakeovertenderofferinvolvesanattemptbyacompanytoacquireatargetfirmagainstitswill(McGraw-Hill–AmericanExpress)NotallcompaniescanfendoffsuchunwantedadvancesNegotiatedversusTenderedOffers(cont’d)Saturdaynightspecial:asurpriseoffermadejustbeforethemarketclosesfortheweekendWhiteknight:athirdfirmthatthemanagementcallsontohelpitavoidtheinitialunwantedtenderofferMovingthecorporateofficestostatesthathavetoughprenotificationandprotectionprovisionsinregardtotakeoverbidsBuyingbacksomeoftheirownsharestorestricttheamountofstockavailableforthetakeoverProtectiveMeasuresagainstaTakeoverTenderOfferEncouragingemployeestobuystockunderthepensionplansIncreasingdividendsPossibletargetshavealsoboughtupothercompaniestoincreasetheirownsizePoisonpillisalsoaneffectivedeviceforprotectionPremiumOffersandStockPriceMovementsMostmergersarenotacquiredattheircurrentmarketvalueAmergerpremiumof40-60%(ormore)ispaidoverthepremergerpriceoftheacquiredcompanyDisadvantage:MuchoftheupsidemovementmayoccurbeforethepublicannouncementAdvantage:GoodprofitscanbemadeafterthemergerisaccomplishedPremiumOffersandStockPriceMovements(cont’d)Troublewithanymerger-relatedinvestmentstrategy:ThemergermaybecalledoffMergercandidate’sstockmayfallbacktotheoriginalvaluePricemayquicklyreboundifthereismergernegotiationwithanothercompanyStockMovementofPotentialAcquireesTwo-StepBuyoutTheacquiringcompanyattemptstogaincontrolbyofferingaveryhighpriceof51%ofthesharesoutstandingAnnouncesasecond,lowerpricethatwillbepaidofflate,eitherincash,stock,orbondsProvidesastronginducementtostockholderstoquicklyreacttotheofferAllowsacquiringfirmtopayalowertotalpricethanifasingleofferismadeTwo-StepBuyout(cont’d)TheSECkeepsacloseeyeonthismethodFearsthatsmallerstockholdersmaynotbeinformedenoughtokeepupwithinstitutionalinvestorsEmphasizestheneedforprorataprocessingofstockholderordersEachstockholderreceivesanequalpercentageofsharestenderedInternationalFinancialManagement21ChapterOutlineThemultinationalcorporationEffectofexchangeratesHedgingandreductionofforeignexchangeriskEvaluatingpoliticalriskinforeigninvestmentsWaysoffinancinginternationaloperationsGrowingInterdependencyIntegratednatureofcapitalmarketsPossibledeclinesbeyondtheexpectedeconomicimpactofaneventCurrencymarketsImpacttradebetweennationsaffectingsalesandearningsofinternationalcompaniesTheadventoftheeuroImpactonearningsofU.S.companiesdoingsignificantbusinessinEuropeOneU.S.DollartotheBritishPoundandEuroInternationalSalesofSelectedU.S.CompaniesTheMultinationalCorporation:NatureandEnvironmentAfirmdoingbusinessacrossitsnationalbordersCantakeonvariousformsExporterLicensingAgreementJointVentureFullyOwnedForeignSubsidiaryTheMultinationalCorporation:NatureandEnvironment(cont’d)ExporterLeastriskymethodReapbenefitsofforeigndemandNolong-terminvestmentcommitmentrequiredLicensingAgreementsLicensegrantedtoanindependent,localmanufacturerReturnsincludelicensingfeeorroyaltyEffectiveexportingtechnologyTheMultinationalCorporation:NatureandEnvironment(cont’d)JointVentureEstablishedwithalocalforeignfirmMostconduciveenvironment-legal,political,andeconomicFullyownedforeignsubsidiaryHigherrisksandcomplexitiesofoperationLowersportfolioriskoftheparentcorporationMoreprofitablethandomesticfirmsDecisivefactorinshapingthepatternoftrade,investment,andtheflowoftechnologyFactorsInfluencingExchangeRatesThecurrenciesofmajortradingpartnersoftheUnitedStatesaretradedinfreemarketsExchangerateisdeterminedbythesupplyof,anddemandfor,thosecurrenciesThisactivityissubjecttointerventionbymanycountries’centralbanksExchangeRatedtotheDollarOtherFactorsInfluencingExchangeRatesInflation:Purchasingpowerparitytheory:ExchangeratesvaryinverselywiththeirrespectivepurchasingpowersProvidesthesameorsimilarpurchasingpowerineachcountryInterestrates:Interestrateparitytheory:TheinterplaybetweeninterestratedifferentialsandexchangeratesOtherFactorsInfluencingExchangeRates(cont’d)Balanceofpayments:GovernmentaccountsthatcatalogflowofeconomictransactionsbetweencountriesTradesurplusandtradedeficitGovernmentpolicies:InterventionintheforeignexchangemarketMaintenanceofundervaluedcurrencyCurrencyvaluessetbygovernmentdecreeRestrictionoftheinflowandoutflowoffundsMonetaryandfiscalpoliciesOtherFactorsInfluencingExchangeRates(cont’d)Otherfactors:ExtendedstockmarketrallySignificantdropindemandforanation’sprincipalexportsgloballyPoliticalturmoilinacountryWidespreadlaborstrikesSpotRatesandForwardRatesSpotrateExchangerateatwhichthecurrencyistradedforimmediatedeliveryForwardratesTradingofcurrenciesforfuturedeliveryReflectstheexpectationsregardingthefuturevalueofacurrencyDiscountorpremium:ExpressedasanannualizedpercentagedeviationfromthespotrateCrossRates–KeyCurrencyCrossRatesasofFebruary21,2006ManagingForeignExchangeRiskForeignexchangeriskPossibilityofadropinrevenueoranincreaseincostinaninternationaltransactionduetochangesinforeignexchangeratesFreetrading-freelyfloatingratesystemIncreasedvolatilityforcedtheattentiontowardforeignexchangeriskmanagementExchangeriskofamultinationalcompany:AccountingortranslationexposureTransactionexposureTranslationExposureMNCs’foreignassetsandliabilitiesareexposedtolossesandgainsduetochangingexchangeratesTheSFAS52:Requiresallforeigncurrency-denominatedassetsandliabilitiestobeconvertedattherateofexchangePartiallyreducestheimpactofaccountingexposureTransactionExposureForeignexchangegainsorlossesresultingfrominternationaltransactionsVolatilityofreportedearningspershareincreasesDifferentstrategiescanbeusedtominimizetransactionexposure:ForwardexchangemarkethedgeMoneymarkethedgeCurrentfuturesmarkethedgeOtherFormsofProtectionagainstForeignExchangeRiskMNCshavedevelopedforeignassetmanagementprograms,involvingstrategies:SwitchingcashandotherassetsintostrongcurrenciesPilingupdebtandotherliabilitiesindepreciatingcurrenciesQuickcollectionofbillsinweakcurrenciesbyofferingsizablediscounts,whileextendingliberalcreditinstrongcurrenciesForeignInvestmentDecisionsFactorsencouragingforeignaffiliates:AvoidtheimpositionoftradebarriersLowerproductioncostsoverseasAmericantechnologyenabledexploitationofresourcesindevelopingcountriesAdvantagesrelatedtotaxesMotivatedbystrategicconsiderationsinanoligopolisticindustryInternationaldiversificationofrisksRiskReductionfromInternationalDiversificationForeignInvestmentDecisions(cont’d)Deterrents:GovernmentinterferencebyimpositionofunfriendlyforeignexchangerestrictionsLimitationofforeignownershiptoasmallpercentageRepatriationofasubsidiary’sprofittotheparentfirmmaybeblockedtemporarilyGovernmentmayexpropriatetheforeignsubsidiary’sassetsGuardingAgainstPoliticalRiskInvestigatethecountriespoliticalstability-methodsinclude:EstablishajointventurewithalocalentrepreneurEstablishajointventurewithfirmsfromothercountriesInsuranceagainstperceivedpolitical-risklevelcanbeobtainedOverseasPrivateInvestmentCorporation(OPIC)Insuranceorpolitical-riskumbrellaisnotcheapFinancingInternationalBusinessOperationsCreditsalesareinfluencedby:RelationshipofthepartiesinvolvedPoliticalstabilityofcountriesinvolvedRiskofnonpaymentinducesimporter’sbankstoissueletterofcreditCreditrisktoexporterisabsorbedbytheimporter’sbankExportersrequiringcashpaymentoraletterofcreditgenerallyloseoutonfurtherordersFinancingInternationalBusinessOperations(cont’d)Alternativestoavoidinglossofbusiness:ObtainingexportcreditinsuranceTheForeignCreditInsuranceAssociation(FCIA)providesthiskindofinsuranceFundingofTransactionsEximbank(Export-ImportBank)DirectloanprogramDiscountprogramLoansfromtheparentcompanyParallelloansFrontingloansEurodollarloansUSdollarsdepositedinforeignbanksLendingratesbasedonLondonInterbankOfferedRate(LIBOR)FundingofTransactions(cont’d)EurobondmarketIssuesaresoldinseveralnationalcapitalmarketsWidelyusedcurrency–U.S.dollarInternationalequitymarketsCompaniesarelistedonmajorstockexchangesIssueAmericanDepositoryReceipts(ADRs)TheInternationalFinanceCorporation(IFC)ApproachedbycompaniesfacingissueswithraisingequitycapitalinaforeigncountrySomeUnsettledIssuesinInternationalFinanceNatureoffinancialdecisionsforanMNCarecomplex:AccesstomoresourcesoffundsthanapurelydomesticcorporationInterestratesandmarketconditionsmaydifferCorporatefinancialfactorsmaydifferControloverfinancialdecisionsisafactorDividendpolicydecisionsmaybeinfluencedbyforeigngovernmentregulations