Corporate Finance (2nd half) Flashcards
(12 cards)
Types of mergers
- mergers of equals
- buyout (a private investment firm will provide management with an opportunity t focus on their long-term plans rather than the pressure of short-term earnings expectations.
- acquisition
Alternatively:
- horizontal
- vertical
- conglomerate
Friendly vs hostile takeovers
Friendly: the board of directors of two firms agree to combine and seek shareholders’ approval (i.e. negotiated deal). => technically friendly offers can still be quite hostile.
Hostile: raider makers an offer directly to shareholders -> tender offer.
Who benefits from a takeover?
- target firms tend to benefit most in terms of abnormal returns.
- acquirer returns average out to a very limited abnormal return.
Sources of value creation in M&As
- Synergies:
- economies of scale (large fixed costs in production)
-> fixed costs spread over larger production volumes & eliminate overlapping functions.
=> firms can be too large to function efficiently
- economies of scope (valuable interactions between different parts of the combined firm e.g. knowledge transfer, cross-selling & access to new markets & (positive/negative image transfer) - Vertical integration (buying suppliers or customers):
- facilitates knowledge transfer and coordination & greater supply chain control. - Increased market power (buying competitors to reduce competition) => may be regulatory issues
- Improved management: taking out bad management
- Purchase undervalued assets: transfers value from target shareholders to acquirer shareholders (=> winner’s curse) - conversely; sell overvalued assets.
Dubious & negative sources of value
- risk reduction through diversification: does not make much sense because you can only eliminate idiosyncratic risk (and shareholders can manage this risk personally).
N.B. it may reduced expected costs of financial distress and increase borrowing capacity (and hence lower taxes) - managerial improvements (overconfidence): empirical evidence suggests that managers are often not able to create value for shareholders through M&A.
- empire building
Takeover defenses
- poison pill: allow existing shareholders (other than acquirer) to purchase additional shares at a deeply discounted price, thus diluting the share of the acquirer.
- supermajority requirement (e.g. 80%)
- staggered board (only a third of board of directors elected each year)
- dual class shares -> shares with superior voting rights that are held by insiders.
- placing shares in friendly bonds.
- white knight (different acquirer?)
- filing an anti-trust lawsuit.
Are takeover defences good for shareholders?
+ increased bargaining power
+ insulates managers from short-term pressures
- protects bad managers
- allows managers to maximise their own well-being ahead of the shareholders (e.g. if he/she knows he would lose his job)
***the elimination of poison pills and other anti-takeover provisions tends to increase stock price.
IPO definition
Register securities with the regulator (e.g. SEC) and satisfy information disclosure and other requirements.
Benefits & cons of IPOs
+ raise large amount of capital and make future access to capital easier
+ create liquidity and allow initial investors to sell.
+ establish a market value for shares
+ publicity and visibility.
- IPO process is costly
- significant information disclosure
- legal risks and regulatory scrutiny
- potential loss of control
IPO process
- select investment banker/underwriting team
- financial analysis & due diligence by underwriter
- file registration statement
- road show presentation
- book building & pricing
- IPO- *firm commitment vs. best effort
Underpricing IPO phenomenon
- average 15% underpricing in IPO markets means that the firm and original shareholders ‘lose’ in a way
- firms likely to want a ‘successful’ IPO in the eyes of the public
- allows underwriters to essentially pay their best clients to participate and provide useful information during the book building stage (perhaps investors ‘pay’ for underpriced offering with promise of future business for the underwriter).
- must be some underpricing to get uninformed investors to participate.
** after first day ‘pop’, most IPOs tend to underperform the market.
Types of real options & steps (and necessary conditions)
- option to delay (mimics American call option)
- option to expand/grow (same as call option + accounts for most value in some industries e.g. R&D)
- option to abandon/suspend (similar to put options, particularly important in capital-industries, new product industries and high variable cost industries).
STEP 1: identification (what are the real options embedded in the project & ignoring the options that are not relevant)
STEP 2: valuation
Conditions:
- news will arrive in the future
- this news will affect decisions when it arrives.
