Merger

Question 1

What is a horizontal merger?

Answer 1

• when two firms in the same line of business merge

Question 2

What is a vertical merger?

Answer 2

• when firms at different stages of production merge
• I.e. supplier merged with company

Question 3

What is a conglomerate merger?

Answer 3

• when firms in unrelated lines of business merge

Question 4

What are sensible motives for mergers?

Answer 4

1. Economies of scale
   - larger firm has greater bargaining power reducing costs
2. Economies of vertical integration
   - facilitates coordination and admin
3. Filling in missing ingredients
4. Surplus funds
   - mature firms tend to have excess cash which they deploy to mergers
5. Merging can eliminate inefficiencies in management
6. Industry consolidation
   - improve efficiency in industries with too many firms and too much capacity

Question 5

What are dubious reasons for mergers?

Answer 5

1. Diversification
2. Management motives
   - overconfident managers believe they can do better
3. Inc. EPS (Bootstrap Game)
4. Lower borrowing costs

Question 6

Describe Bootstrap Game

Answer 6

• firms pursue merger as they say it will increase. EPS
• although EPS may increase there are no economic gains to the merger
• because of merger P/E falls and long term growth prospects also fall

Question 7

What is the gain from merger?

Answer 7

Gain = PV(AB) -(PV(A)+PV(B)

Question 8

What is the cost of a merger if it is financed by cash?

Answer 8

Cost=cash paid - PV(B)

• assuming A acquires B

Question 9

What is the NPV of a merger?

Answer 9

NPV = Gain - Cost

Question 10

What is the cost when merger is financed by equity?

Answer 10

Cost = XPV(AB) - PV(B)

If B’a shareholders are given N shares of combined firm what is the cost:

Cost = (N X P(AB) ) - PV(B)

N= no. Of shares offered to B
P(AB) = stock price of merged firm

Question 11

Describe the difference between stock and cash financing

Answer 11

Cash financing - cost of merger is unaffected my merger gains

Stock financing - cost depends on gains

Question 12

What does it mean if merger is cash financed?

Answer 12

• managers of acquiring firm are optimistic about merger

Question 13

What does it mean if merger is stock financed?

Answer 13

• acquiring firm more pessimistic

Investors know these signals and will mark down share price when firm uses stock financing

Question 14

What are takeover defences?

Answer 14

1. White knight
2. Shark repellent
3. Poison pill

Question 15

Describe merger waves

Answer 15

• peaks or merger activity surrounded by troughs
• activity frequently increases during upswings

Question 16

Who gains most in meters?

Answer 16

1. Shareholders of target
2. Lawyers and brokers
3. Executives of acquiring firm (may be rewarded)

Question 17

Deceive the effect of mergers on society?

Answer 17

1. Existing bond holders
   - lose if firm issues more debt to acquire firm (inc. risk)
2. Employees lose as large numbers are normally laid off
3. Suppliers and customers lose as merged firm has greater bargaining power altering prices to benefit them

Question 18

What does the evidence suggests about mergers?

Answer 18

• evidence suggests acquisitions destroy value

Question 19

What are some forms of acquisition?

Answer 19

1. Merge two companies
   - need approval of 50% of stockholders of each firm
2. Buy sellers stock in exchange for cash
   - buyer deals individuals with shareholders ( will seek approval but not required)
3. Buy some or all of the sellers assets