Chapter 12.4 Flashcards
Motivations for Mergers and Acquisitions (140 cards)
1
Q
Why do firms pursue acquisitions?
A
Because the acquirer believes the target company will enhance the firm’s long-term value.
2
Q
What does the value of an acquisition depend on?
A
The type of acquisition and the structural changes occurring in the economy at the time.
3
Q
What were the main factors threatening Canadian M&A activity in early 2019?
A
Trade uncertainty, weak oil and gas prices, rising interest rates, and falling stock indexes.
4
Q
Why is uncertainty considered a major threat to M&A activity?
A
Because M&A is driven by confidence, and uncertainty discourages firms from pursuing large deals.
5
Q
How did Canadian markets perform in 2018, and how did that affect M&A?
A
The S&P/TSX fell 12%, leading to concerns about investor support for major transactions.
6
Q
How did political tensions with China affect Canadian M&A?
A
They created headwinds, including reduced Chinese investment and increased regulatory scrutiny.
7
Q
Despite headwinds, what trend was seen in Canadian deal volume in 2018?
A
A record number of deals, especially in domestic mid-market transactions.
8
Q
What factors influenced Canadian M&A activity in early 2019, and how did the market respond?
A
Trade tensions, weak commodity prices, rising interest rates, and political uncertainty (especially with China) dampened confidence and posed risks to large deals. Despite these challenges, Canadian M&A remained active in 2018—especially in mid-market transactions—driven by private equity interest, U.S. buyers, and well-performing companies in stable sectors.
9
Q
What are the 3 broad classifications of mergers and acquisitions?
A
- Horizontal merger
- Vertical merger
- Conglomerate merger
10
Q
What is a horizontal merger?
A
A merger in which 2 firms in the same industry combine
11
Q
What is a vertical merger?
A
A merger in which one firm acquired a supplier or another firm that is closer to its existing customers
12
Q
What is a conglomerate merger?
A
A merger in which 2 firms in unrelated businesses combine
13
Q
What is an example of an horizontal merger?
A
April 2019, Chevron announced a $33-billion cash and stock takeover of Andarko Petroleum Corp., which is in the same business.
Chevron CEO Mike Wirth said that “the deal offers ‘a compelling and unique fit’ because the two operate in similar areas.”
14
Q
How can a firm be expanded through a vertical merger?
A
Firm acquires another company at a different stage of its supply chain.
- Firm can expand by acquiring a company closer to its customers (“going forward”) or
- By acquiring a supplier that provides inputs into its production process (“going backward”).
15
Q
What is an example of a vertical merger where a firm went forward in the supply chain?
A
Bell Globemedia’s acquisition of CHUM Ltd., which allowed it to create an integrated media company by adding CHUM’s radio stations to its existing television, print, and media assets.
16
Q
What is an example of a vertical merger where a firm went backward in the supply chain?
A
AOL’s acquisition of Time-Warner, an attempt to go backward by acquiring media content and cable distribution to create an integrated media platform—although it became one of the most-storied failed mergers in history.
17
Q
What vertical merger involved a commodities trading company acquiring a key supplier in 2012?
A
Glencore International’s $6.1-billion bid for Canadian grain company Viterra Inc., approved by 99.8% of Viterra shareholders.
18
Q
Why was Glencore’s acquisition of Viterra considered a strategic backward vertical merger?
A
Because as a trading company, Glencore needed to secure access to raw materials, and owning a major grain supplier like Viterra helped ensure sourcing continuity in a global demand environment.
19
Q
What is a conglomerate merger’s primary motivation?
A
The motivation to create a conglomerate is that the different businesses face different risks, which tend to cancel each other out, lowering the overall risk of the combined company
20
Q
What is a classic example of a conglomerate merger in the United States?
A
In November 1981, U.S. Steel Corp. acquired control of Marathon Oil Corp., acting as a white knight in response to a hostile bid from Mobil Corp.
21
Q
Why was the U.S. Steel–Marathon Oil merger considered a conglomerate merger with limited economic rationale?
A
Because the merger combined two unrelated industries—oil and steel—with few synergies or strategic reasons for integration.
22
Q
What Canadian conglomerate merger is considered a classic example of failed expansion into unrelated business lines?
A
Seagram’s 1995 acquisition of Universal Studios, which marked a misaligned effort to branch from whisky production into the entertainment industry.
23
Q
What was the ultimate outcome of Seagram’s conglomerate merger with Universal Studios?
A
The business faced numerous challenges, and Seagram’s ceased to exist after both its entertainment and beverage divisions were sold off in 2000, ending a legacy dating back to 1857.
24
Q
How can acquisitions be classified in terms of geography?
A
- Domestic
or - Cross-border (international) M&As
25
What is a cross-border (international) M&A?
A merger or acquisition involving a Canadian and a foreign firm as either the acquiring or target company
26
What are two examples of Canadian involvement in cross-border M&As mentioned in the text?
A:
Canadian company Viterra as the target in a cross-border acquisition.
Canadian firm Fortis Inc. acting as the acquirer, seeking expansion into the U.S.
27
What trend is shown regarding Canadian M&A activity from 1985 to April 2019?
Canadian M&A activity follows cyclical patterns, with notable drops after market downturns in 2001 and 2008, and a strong recovery that peaked in 2017.
28
What caused the sharp decline in Canadian M&A activity in 2008?
A combination of limited access to capital and rapid declines in corporate earnings during the financial crisis.
29
What drove the high value of M&A activity in 2006–2007?
Booming energy and commodity sectors, high prices, a strong Canadian dollar, and a robust economy.
30
How has M&A activity historically behaved over time, according to the text?
M&A activity has occurred in periodic waves of intense activity, especially during strong economic conditions.
31
What is the theoretical motivation for a merger or acquisition?
The creation of synergy—when the combined firm's value exceeds the sum of the individual pre-merger firm values.
32
What is synergy?
Value created from economies of integrating a target and acquiring company; the amount by which the value of the combined firm exceeds the sum value of the 2 individual firms
33
What is the equation for synergy?
ΔV = Vᴬ⁻ᵀ − (Vᴬ + Vᵀ)
Where
Vᴬ= pre-merger value of the acquiring firm
Vᵀ= pre-merger value of the target firm
Vᴬ⁻ᵀ= value of the post-merger firm
We can say that synergy occurs whenever Vᴬ⁻ᵀ>Vᴬ + Vᵀ
Synergy is the additional value created ΔV
34
How is synergy created?
Due to economies of integration that are expected to occur for one reason or another
35
What characterized M&A activity during the 1895–1904 period?
- Driven by economic expansion, U.S. transcontinental railroad, and the development of national U.S. capital markets
- Characterized by horizontal M&As
36
What characterized M&A activity during the 1922–29 period?
- 60% occurred in fragmented markets (chemical, food processing, mining)
- Driven by growth in transportation and merchandising, as well as by communications developments
37
What characterized M&A activity during the 1940-47 period?
- Characterized by vertical integration
- Driven by evasion of price and quota controls
38
What characterized M&A activity during the 1960s period?
- Characterized by conglomerate M&As
- Driven by aerospace industry
- Some firms merged to play the earnings-per-share “growth game” (discussed in section 12.5 under “The Effect of an Acquisition on Earnings per Share”)
39
What characterized M&A activity during the 1980s period?
Characterized by leveraged buyouts and hostile takeovers
40
What characterized M&A activity during the 1990s period?
- Many international M&As (e.g., Chrysler and
- Daimler-Benz, Seagram and Martell)
Strategic motives were advanced (although the jury is still out on whether this was truly achieved)
41
What characterized M&A activity during the 1999-20001 period?
- High technology/Internet M&As
- Many stock-financed takeovers, fuelled by inflated stock prices
- Many were unsuccessful and/or fell through as the Internet “bubble” burst
42
What characterized M&A activity during the 2005-8 period?
- Resource-based/international M&A activity
- Fuelled by strong industry fundamentals, low financing costs, strong economic conditions
43
If the target and acquirer have initial values of $50 million (VT) and $100 million (VA), respectively, and the combined firm is worth $200 million (VA−T), then is the synergy value?
The synergy is $50 million, calculated as:
$200 million − ($100 million + $50 million) = $50 million
44
In the example where the acquirer pays $100 million for a $50 million target, who receives all the synergy value?
The target shareholders—since they are paid more than their firm’s standalone value, they receive the entire $50 million in synergy gains.
45
How is the $50 million synergy divided if the acquirer pays less than $100 million for the $50 million target?
The synergy gains are shared between the acquiring and target firm shareholders, since the acquirer pays less than the full synergy-inclusive value.
46
In the example where the target is valued at $50 million and the acquirer at $100 million, what does the $50 million in synergy represent?
The additional value created by the merger, showing that the combined firm ($200 million) is worth more than the sum of the two standalone firms ($150 million).
47
How do M&A announcements typically present the benefits of a proposed transaction?
They emphasize synergies, or total positive gains, often detailing expected cost savings and efficiency improvements.
48
What synergy projections were made in the proposed takeover of Flint Energy by URS?
URS projected cost savings of $10 million to $15 million in the first year, with continued annual savings beyond that.
49
Do synergy gains from M&A always materialize as expected?
No—sometimes the projected gains occur, and sometimes they don’t, depending on post-merger execution and integration success.
50
What does the upcoming section introduce regarding merger or acquisition decisions?
A list of commonly cited “value creation” motives used to justify M&A activity, some of which are more valid than others.
51
What are 3 operating synergies?
1. Economies of scale
2. Economies of scope
3. Complementary strengths
52
When do economies of scale arise?
Whenever bigger is indeed better
53
What 3 economies do potential benefits of economies of scale arise from?
1. Reducing capacity
2. Spreading Fixed costs
3. Geographic synergies
54
How is economies of scale beneficial when reducing capacity?
If an industry has grown too big and there are too many firms operating in it. A merger or acquisition in this situation often called an over capacity M&A
55
What type of M&A occurs when the industry has too much capacity and consolidation reduces excess supply?
An over-capacity M&A, where the goal is to reduce redundancy and improve efficiency in industries with too many competing firms.
56
What is an over-capacity M&A?
A merger or acquisition that occurs when an industry has too many firms operating in it
57
What is an example of an over-capacity M&A in the aluminum industry?
The 2003 acquisition of French aluminum producer Pechiney by Canadian firm Alcan to consolidate production capacity.
58
What example from the banking sector illustrates an M&A aimed at achieving economies of scale?
The merger of JPMorgan and Chase in the United States, which allowed for consolidation of services and infrastructure.
59
How are economies of scales beneficial when spreading fixed costs?
Often, significant costs in a business are fixed, independent of scale. By increasing the company’s size, these costs are spread over greater volumes, and the firm is more efficient
60
What are some examples of fixed costs that firms may aim to spread through an M&A?
Information technology (IT) infrastructure and research and development (R&D) costs, both of which are often duplicated across firms.
61
What proposed merger in 1998 was motivated by the desire to spread fixed costs, particularly in IT?
The Royal Bank–Bank of Montreal merger, which was ultimately blocked by the Canadian government
62
What justification did the Royal Bank and BMO offer for their proposed merger?
That merging would reduce overlapping IT development costs, as both banks were independently building similar technologies.
63
What are geographic synergies in the context of mergers and acquisitions?
Benefits that arise when a fragmented industry is consolidated across regions, creating a national firm with efficiencies in marketing, management, and distribution.
64
What is a geographic roll up?
The creation of a national firm from a series of regional ones
65
What historical example illustrates geographic synergy through industry consolidation?
Standard Oil, formed by John D. Rockefeller, consolidated the fragmented U.S. oil industry to streamline marketing and managerial overhead.
66
How has the retail sector demonstrated geographic synergies?
Through the creation of national chains from regional retailers, allowing gains in purchasing power and more efficient distribution channels.
67
What is an economy of scope in the context of mergers and acquisitions?
An economy of scope occurs when the combination of two activities reduces costs, typically by leveraging similarities in production or distribution processes.
68
What is a classic example of economies of scope in product distribution?
Seagram’s 1988 acquisition of Martell, where Seagram planned to distribute Martell’s cognac through the same U.S. distribution system it used for its whisky.
69
How did regulatory changes in the early 1980s support economies of scope in Canadian banking?
The Ontario Securities Commission (OSC) allowed investment dealers to incorporate and be acquired by commercial banks, arguing that combining commercial and investment banking would improve efficiency.
70
What limitation did regulators maintain despite recognizing economies of scope in banking?
Regulators resisted allowing banks to use their distribution systems to sell insurance, despite potential scope-related efficiencies.
71
What are two examples of M&As aimed at achieving economies of scope in the beverage industry?
1. Coca-Cola’s purchase of Gatorade to enter the sports drink market.
2. Quaker Oats’ acquisition of Snapple Beverage Corporation to expand its product portfolio.
72
What are complementary strengths in the context of mergers and acquisitions?
They occur when one firm is more efficient in a specific operational area than another, and combining the two allows both to benefit from their respective capabilities.
73
What is an example of a marketing-oriented acquisition that leveraged complementary strengths?
Victor Kiam’s acquisition of Remington, where he focused on aggressive marketing and reduced product development to revitalize the razor company.
74
How did the 2008 acquisition of Amex by NYSE Euronext illustrate complementary strengths?
While Amex was smaller, it offered a broader array of ETFs and options than NYSE, complementing NYSE’s strengths and also allowing cost savings by eliminating overlap—e.g., shutting down the Amex trading floor.
75
What is an extension M&A?
A merger or acquisition that extends a firm's expertise
76
How does an extension M&A relate to complementary strengths?
It occurs when firms with different but complementary organizational cultures and competencies merge—e.g., creative R&D firms joining with managerially strong development firms to bring products to market.
77
How do large pharmaceutical firms like Merck and Pfizer use extension M&As?
They acquire small biotech firms that develop new drugs, since large firms have the infrastructure and resources to navigate regulatory trials and scale production.
78
What Canadian mineral discovery illustrates the role of complementary strengths in the resource sector?
he 1994 Voisey’s Bay nickel discovery by Diamond Fields Resources Inc., which was eventually acquired by Inco Ltd., a major firm capable of developing the deposit.
79
Why did Inco Ltd. acquire Diamond Fields Resources?
Because Diamond Fields specialized in exploration, but Inco possessed the resources and operational expertise needed to develop the Voisey’s Bay deposit—demonstrating complementary strengths in action.
80
What are efficiency increases in the context of M&A, and when do they arise?
Efficiency gains occur when one or both firms involved have excess capacity—resources that are underutilized—leading to cost savings and improved operations post-merger.
81
Why do efficiency gains sometimes result in job losses after a merger?
Because some synergy is achieved by eliminating redundant roles or departments, especially when both firms have overlapping operations or workforce excess.
82
What are examples of non-labour-related excess capacity that can lead to efficiency gains?
Shipping, storage, and information technology systems that are underused and can be consolidated to improve cost efficiency.
83
How can management play a role in post-merger efficiency gains?
Acquiring firm believes that its management team will operate more efficiently than the target firm's management team
84
How does the concept of the “market for corporate control” relate to efficiency?
It refers to the idea that inefficiently managed firms become takeover targets, and that acquisitions function as a governance mechanism to discipline poor management by replacing it.
85
What are the 4 reasons financing synergies may arise?
1. Reduced cash flow variability
2. Increase in debt capacity
3. Reduction in average issuing costs
4. Fewer information problems
86
What kinds of entities have lower cash flow volatility?
Tends to be lower for larger entities, especially if the cash flows from the 2 underlying businesses aren't highly correlated
87
Why is reduced cash flow variability beneficial for a merged company?
May enable the company to reduce its need for external financing, since future financing needs can be forecast with greater certainty
88
Why may debt capacity rise in a synergetic merger?
Due to increase in size and/or reduction in cash flow volatility of the new company
89
What types of firms can't carry as much debt?
Smaller, riskier firms generally can't carry as much debt as larger firms
90
What financial advantage does increased debt capacity offer a merged firm?
Greater tax savings, since interest payments on debt are tax-deductible, lowering the firm’s overall tax burden.
91
How does a merger reduce the average cost of issuing new securities?
Since most security issues occur in large increments, the average cost of floating new debt or equity will decrease as the firm issues larger amount
92
Why do larger firms typically face lower issuing costs than smaller firms?
Larger firms can access a broader range of capital sources
93
How do larger firms have fewer information problems?
Usually attract more external security analysts and have greater exposure in the media
94
What is the result of larger firms attracting more external security analysts and having greater exposure in media?
They attract big institutional investors, which may lower their financing costs
95
When do tax benefits occur in an M&A?
When one firm has substantial operating loss credits it cannot take advantage of because it's not operating profitably.
96
Why are operating loss credits valuable?
They can be carried forward and used against future profits to reduce taxes.
97
What happens to operating loss credits if a firm stays unprofitable?
The losses may expire worthless
98
How can operating losses be used if a firm merges with a profitable one in the same line of business?
The losses can offset the profitable firm’s income and reduce taxes.
99
What 2004 merger is an example of using tax-loss carryovers?
The Kmart–Sears merger.
100
Why were tax-loss carryovers important in the Kmart–Sears merger?
Kmart had $509 million in tax-loss carryovers due to expire between 2021–2023, which could be used only by combining with a profitable firm.
101
How did the merger between Kmart and Sears help Kmart’s tax position?
Kmart had little chance of using their losses unless it combined w/ a profitable company. By combining, the net operating loss carryover could then be used as offsets against future taxable income, hence reducing taxes of the combined company
102
What other tax benefit can arise from a merger involving capital assets?
Depreciation of capital assets (i.e., current cost accounting tax shields) that can be claimed by the combined entity and the increased use of debt financing with more interest tax shields
103
What can provide a an incentive for M&A activity across different tax jurisdictions?
Tax benefits
104
What cross jursdiction M&A was partly motivated by tax benefits?
Burger King’s acquisition of Tim Hortons in 2014.
105
Why did Burger King benefit from moving its headquarters to Canada?
Canada had a lower corporate tax rate and allowed the company to avoid double taxation on foreign income.
106
What can strategic realignments through M&A allow the new entity to pursue?
The acquisition of new managerial skills and new product/service line growth opportunities may allow strategies that were previously not feasible.
107
What are the 2 common managerial motives for M&As?
1. Increased firm size
2. Reduced firm risk through diversification
108
Why might managerial motivations for M&As differ from shareholder motivations?
Because managers control the company, their motives for M&As can be distinct from the basic shareholder goal of creating value.
109
Why might increased firm size not always be a good thing in M&A?
It depends on whether any economic synergies are created.
110
What managerial motives have sometimes influenced M&As related to firm size?
Some managers have supported M&As to gain personal compensation and power.
111
What 1998 merger failed due to managerial conflict, and what was the consequence?
The proposed merger between Glaxo Wellcome and Smith Klein was cancelled because the two CEOs couldn’t agree on the management team, resulting in a £13 billion (C$30 billion) loss in market value.
112
How did managerial egos affect value in the Glaxo Wellcome–Smith Klein case?
They destroyed value by cancelling a potentially good merger, rather than by making a bad acquisition.
113
How can M&As be used to reduce firm risk through diversification?
By diversifying geographically, across industries, or in product mix—often through conglomerate mergers.
114
Why is diversification generally considered a poor motive for a merger?
It often leads to managerial complications and a lack of focus in running disparate businesses.
115
How do markets typically respond to diversification as a motive for M&A?
Not willing to pay a premium for diversification since it's easy to diversify a portfolio across the same industries and geographic borders
116
What do investors tend to prefer over diversified firms?
“Pure play” companies that are focused on one strategic plan tend to receive a premium.
117
Who tends to gain the most from mergers according to empirical studies?
Target firm shareholders.
118
What are the typical gains for target firm shareholders in stock- and cash-financed takeovers?
15–20% for stock-financed takeovers, and 25–30% for cash-financed takeovers.
119
How are the gains to target firm shareholders typically split around the announcement of a merger?
About one-third of the gain occurs before the announcement, and two-thirds after.
120
What are the two explanations for the pre-announcement run-up in the target's stock price?
1. Leaked information leading to insider trading (illegal).
2. Informed industry specialists predicting M&A activity based on related transactions.
121
What event illustrates the impact of merger speculation on stock prices?
On February 12, 2007, Alcan’s stock jumped $4 after The Times of London reported that BHP and Rio Tinto were planning a bid for Alcoa, prompting speculation about Alcan’s role.
122
Why does it "always pay" for shareholders of the target firm to be taken over?
Because they often receive short-term gains of 20–40%.
123
How does the empirical evidence on short-term takeover gains for target shareholders relate to the Sears Canada example?
The arbs refused to sell cheaply because Sears, Roebuck was preventing them from making their expected profit from the takeover premium.
124
When can takeover gains to the target be even higher?
When bidding wars occur or when deals are 100% cash, especially because target shareholders must pay capital gains tax.
125
What typically happens to the acquiring firm’s stock price after announcing a merger?
It usually shows no change or even dips marginally.
126
What does the acquiring firm's stock price usually dipping marginally imply?
Acquiring firms may overpay, pursue mergers for the wrong reasons, or overestimate the benefits of the transaction.
127
What do studies say about post-merger value for acquiring firms?
There is little or no increase in value; there are no synergistic gains to the acquirer, which are the supposed rationale for mergers.
128
What did a global study of over 13,000 mergers in 89 countries reveal about gains to acquirers and targets in competitive markets?
Gains to acquirers and targets were different in very competitive markets (e.g., the United States and United Kingdom) compared to other markets around the world
129
How did acquirers in competitive markets perform relative to those in less competitive markets?
Acquirers in competitive markets tended to underperform.
130
What did researchers observe in "value created" in acquisitions involving cash as a medium of exchange?
Acquisition resulted in a shift of wealth from the acquiring shareholders to the target shareholders; in other words value wasn't created, merely shifted
131
When did researchers observe synergistic gains in share-based acquisitions?
Only in non-competitive markets.
132
In the example of a $2-billion firm acquiring a $1-billion firm for $1.5 billion in cash with no synergies, what is the acquiring firm’s loss?
It loses the $0.5-billion premium, which equals 25% of its market value ($0.5/$2).
133
In an acquisition where a $2-billion firm acquires a $1-billion firm for $1.5 billion using a share swap, how is the $0.5-billion loss distributed if no synergies occur?
Original shareholders own only 57.14 percent of the new company ($2/$3.5) and will lose only this fraction of the lost $0.5 billion, or $286 million
134
Who bears the loss in a share swap when synergies fail to materialize?
The loss is shared between the acquiring and target firm shareholders.
135
What is the term for this analysis of risk borne by shareholders in M&A deals?
Shareholder Value at Risk (SVAR).
136
What basic point does SVAR illustrate about the use of cash versus shares in acquisitions?
When using cash, the acquirer bears all the risk; when using shares, the risk is shared.
137
How did Nortel illustrate the implications of using shares for acquisitions?
Nortel used its own shares as acquisition currency during the Internet bubble, and target shareholders who didn’t sell immediately lost value during the crash—just like Nortel shareholders.
138
How did Nortel benefit from using shares instead of cash for its acquisitions?
It survived the crash, which it likely couldn’t have done if it had taken on debt to finance the acquisitions.
139
What does SVAR suggest about managerial discipline when using cash for acquisitions?
Firms are usually more careful with pricing when paying in cash, because the risk is fully theirs.
140
Why might managers be less disciplined when using shares to make acquisitions?
Because they are more focused on completing the deal than on the financing structure.
