INTRODUCTION TO MERGERS AND ACQUISITIONS: FIRM DIVERSIFICATION

Transcription

1 XV. INTODUCTION TO MEGES AND ACQUISITIONS: FIM DIVESIFICATION In the ntroducton to Secton VII, t was noted that frs can acqure assets by ether undertakng nternally-generated new projects or by acqurng exstng assets of other frs. Havng exaned the forer there and agan n Secton XIV, we now turn to the latter. Under the operatonal crteron for good anageent of axzng current shareholders' wealth, there are essentally three reasons for consderng the acquston of another copany: 1. Synergy: By cobnng the two copanes, the value of the operatng assets of the cobned fr wll exceed the su of the values of the operatng assets of the two copanes taken separately. Such synergy wll occur f there are econoes of scale n arketng, purchasng of aterals, plant sze, and dstrbuton syste. It can also occur through the elnaton of duplcate efforts n anageent or research and developent. Such econocs are ost lkely to occur wth ether horzontal or vertcal ergers. In essence, the value goes up because the factors of producton are ore effcently organzed n the cobned fr.. Taxes: The arket value of the fr reflects ts value to the prvate sector. Of course, snce the fr pays taxes (or ay pay taxes n the future), there s an addtonal "shadow" value of the fr to the publc sector n the for of the present value of ts tax payents. The su of the arket value and ths "shadow" value s the value of the fr to socety. In the case of synergy, the value of the fr to socety s ncreased wth a correspondng ncrease n both the arket and shadow values of the fr. However, f a cobnaton of two frs can reduce the cobned present values of these frs' tax payents taken separately, then the arket value of the cobned fr can exceed the su of the values of the two frs taken separately even f the value of the cobned fr to socety s just equal to the su of the values to socety of the two frs. I.e., ths cobnaton does not ncrease the total value to socety, but t does redstrbute the total between the 87

2 obert C. Merton shareholders of the frs and the publc sector. Two exaples are: (a) a ore-effectve use of a tax-loss carryover; (b) ncreased debt capacty for the cobned fr whch ay reduce taxes f there s a "tax-sheld" value to the deductblty of nterest [see Secton IX for further dscusson]. 3. The Fr to be Acqured s a "Bargan": If the fr to be acqured has a arket value whch s less than ts "far" value, then by acqurng the fr, the anageent of the acqurng fr can ncrease ts stockholders' wealth. There are two dstnct reasons why a fr could be sellng for less than "far" value. The frst s that relatve to the acqurng fr's nforaton set, the stock arket s not effcent n the sense to be dscussed n Secton XVII. That s, the anageent of the acqurng fr beleves that t has nforaton such that f ths nforaton were wdely-known, the arket value of the fr to be acqured would be hgher than ts acquston cost. If ths s the prncpal reason for the acquston, then the anageent's behavor s dentcal to that of a securty analyst whose job t s to dentfy sprced securtes. In ters of the CAM and Secton XIII, the anageent beleves t s purchasng a securty wth a postve "alpha" (α). Hence, all the warnngs about beng able to "beat the arket" gven n that secton apply equally well here. A second reason why a fr could be sellng for less than ts "far value" s that the fr to be acqured s currently beng sanaged. That s, through ether ncopetence or alevolence, the current anageent s not anagng the fr's resources so as to axze the arket value of the fr. Unlke the frst reason, ths reason s copletely consstent wth an effcent captal arket. Indeed, as dscussed at length n Secton III, fro socety's pont of vew, ths reason s probably the ost portant one for perttng ergers and takeovers. 88

3 Fnance Theory Fr Dversfcaton Notable by ts absence aong the three reasons for acqustons s dversfcaton: That s, the acquston of another fr for the sole purpose of reducng the volatlty (varance or "total" rskness) of the fr's operatons. Although "dversfcaton" s a frequently cted reason for an acquston, t s often not the "real" reason. More often than not, t wll be for one of the three reasons already gven. However, f dversfcaton s the real reason, then the acquston route wll n general be an neffcent way to acheve t. The arguent for fr dversfcaton s often presented by analogy wth an ndvdual nvestor where we have seen that dversfcaton s qute portant. However, ths type of arguent sply llustrates the ptfalls of treatng the fr "as f" t were an ndvdual household wth exogenous preferences rather than as an econoc organzaton desgned to serve specfc econoc functons. To show why fr dversfcaton s not an portant actvty for anageent and f t s undertaken, why the acquston route s neffcent, we begn wth an explct analyss of the value of the fr under the captal asset prcng odel. Let there be two frs where each fr has a sngle project as descrbed n the begnnng of Secton XIV. Fro forula (XIV.), the value of fr ( 1,) s gven by I (XV.1) V [x - λe ν ρm], 1,. Suppose that frs #1 and # erge to for fr #3. In an analogous fashon to frs #1 and #, defne I3 as the nvestent n fr #3 and ~ x 3 as the rando varable end-of-perod cash flow of fr #3 per dollar of nvestent. If no changes n the nvestent plans of the frs occur as a result of the cobnaton, then I + I and ~ x δ ~ x + (1- δ) ~ x where I δ I. ν3 VA( x% 3 ) δ ν1+ (1 - δ ) ν + δ(1 - δ ) Cov( x% 1, x% ). I + I 1 89

4 obert C. Merton (XV.) Cov[ ~ x3, ZM] ρ3m V ν3 σm δcov[x ~ δ)cov[x ~ 1, ZM] + (1- ν3σm δ ν1 σm ρ1m + (1- δ) ν σm ρ ν3 σm δ ν1ρ1m + (1- δ) ν ρm ν 3 M, Z M ] Fro Secton XIV, (XIV.), the value of fr #3 wll satsfy I3 (XV.3) V3 [x3 - λe ν3ρ3m] Substtutng nto (XV.3) for ρ3m fro (XV.), we have that I3 (XV.4) V3 { x3 - λe[δ ν1ρ1m + (1- δ) ν ρm]} Notng that E[x ~ 3] δ x + (1- δ) x, we have that x 1 I 3 (XV.5) V 3 { [ x1- e 1 1M ] + (1- )[ x- e M ]} δ λν ρ δ λν ρ But I3δ I1 and I3(1 δ) I. Hence, fro (XV.5), we have that (XV.6) V 3 I1 [x1 - λ V + V. 1 e ν ρ 1 1M I ] + [x - λ e ν ρ ] Thus, the value of the cobned fr wll just equal the su of the values of the two frs pror to the erger. In connecton wth both ergers and frs possbly undertakng any (ndependent) captal budgetng projects, we generalze the above deonstraton to a fr wth projects. 90

5 Fnance Theory Let fr take on dfferent projects where physcal nvestent n project s I and the rando varable end-of-perod cash flow s I I, and total fr end-of-perod cash flow per dollar of physcal nvestent, x can be wrtten as 1 (XV.7) x [ 1 1 I x ]/ I δ x where δ I/ I and δ 1. 1 It follows fro (XV.7) that (XV.8) x δ x 1 and j j 1 j1 (XV.9) Var( x ) ν δ δ Cov( x, x ). It follows also that (XV.10) Cov(x, Z 1 M δ ρ ) ρ M ν σ M M ν. σ M 91

6 obert C. Merton Fro (XIV.), (XV.8), and (XV.10), we have that (XV.11) V I [x I [ I [ V δ x - λe δ - λ ( e x ν - ρ 1 ] δ ν ρ λ ν ρ e M M )] M ] where V I (x - λe ν ρ )/ s the "stand-alone" value of project. M Hence, dversfcaton does nothng to the arket values of the frs and hence, accordng to the value-axzaton crteron, t s not portant. The result shown n (XV.6) and (XV.10) s called value addtvty and can be shown to obtan n qute general structures (provded that there exsts a well-functonng captal arket). An ntutve explanaton of why the arket values are unaffected even though the cobned fr ay have a saller total rsk (varance) than the ndvdual frs s as follows: In order for nvestors to be wllng to pay a hgher prce for the cobned fr than they were wllng to pay for the two frs separately, the act of cobnng the two frs ust provde a "servce" to the nvestors whch they were prevously unable to obtan. However, pror to the cobnaton, any nvestor could purchase shares of ether or both frs n any x he wants. And, n partcular, n the case of the erger, the nvestor could purchase the shares of fr #1 to fr # n the rato 1 / V whch s exactly the rato plct n the cobned fr. Hence, each V nvestor could acheve for hself (pror to the erger) the sae aount of dversfcaton (of the rsks of the frs #1 and #) as s provded by the cobned fr, and therefore, the erger provdes no new dversfcaton opportuntes to nvestors. For that reason, nvestors would not pay a preu for the cobned fr. Although t wll not be the case for the captal asset prcng odel, t s possble that the cobned fr could sell for less than the su of the values of the two separate frs,.e., that fr dversfcaton could "hurt" arket value. The reason s that post-consoldaton, nvestors have fewer choces for portfolo constructon than they dd pre-consoldaton. For exaple, pror 9

7 Fnance Theory to the erger, an nvestor could hold postve aounts of fr #1 and none of fr # or vce versa. ost the erger, the only way that an nvestor can hold fr #1 s to nvest n the cobned fr #3 whch eans he ust also nvest n fr #. Indeed, he can only nvest n fr #1 f he s wllng to nvest n fr # n the relatve proporton V1 / V. The reason that ths "loss of freedo" does not have a negatve effect on the cobned fr's value s the CAM s that n that odel, t s optal for all nvestors to hold fr #1 and fr # n the relatve proportons fr #3. 1 / V whch s exactly the proporton provded by the cobned V Note that ths "negatve" aspect of fr dversfcaton apples even n a "frctonless" world of no transactons costs and where the erger takes place on ters where no preu above arket value s pad for the acqured fr by the acqurng fr. In the real world, the acqurng fr ust usually pay a preu above the arket value to acqure a fr. The preu can range fro 5 to ore than 100 percent wth an average soewhere around 0 percent. A natural queston to ask s "Why do the owners of the fr to be acqured deand a preu for ther shares?" Whle there are several possble explanatons, one that s consstent wth our prevous analyses s as follows: If the acqurng fr's anageent s behavng optally, then the reason for ther akng a takeover attept ust be one of the three reasons dscussed at the outset of ths secton. Snce anyone of these three reasons wll ncrease the value of the acqurng fr's shares, the acqured fr's shareholders are deandng copensaton for provdng the eans for ths ncrease n value. How ths potental ncrease n value s shared between the acqurng and acqured frs' shareholders cannot be deterned n general (as s the usual case for blateral barganng), but alost certanly, the acqured fr's shareholders wll deand soe postve share. Of course, the acqured fr's shareholders do not know what the acqurng fr's anageent beleves the value of the acqured fr s. Hence, t ght appear that no consoldaton could be consuated because whatever prce s offered, clearly, the acqurng fr's anageent beleves t s worth ore, and therefore, the acqured fr's shareholders should deand ore. However, the fact that the acqurng fr beleves t s worth ore does not ean that t s, ndeed, worth ore. I.e., ther belefs ay be wrong. Hence, at a 93

8 obert C. Merton hgh enough prce above arket, the acqured fr's shareholders wll take the "sure" preu, and let the acqurng fr take the rsk (and earn the possble reward) that ts nforaton s suffcently superor to the arket's that the acqured fr s stll a "bargan." Whether or not the acqured fr's shareholders or the acqurng fr's shareholders coe out ahead on these takeovers s stll an open eprcal queston. However, t s clear that acqurng another fr for the sole purpose of dversfcaton s a losng proposton for the acqurng fr because t ust pay a preu for a fr whose acquston proses no ncrease n arket value even f t s purchased at arket. Whle the preu pad over arket for the acqurng fr s usually the prncpal cost of an acquston, there are other costs as well whch can frequently be substantal. In an uncontested erger, there are legal costs and anageent's te whch could be spent on other actvtes. There are uncertantes created for the acqured fr's anageent, supplers, and custoers whch could affect the operatons of that fr durng the negotatons and subsequent transton. Of course, f the erger s contested, then ltgaton costs wll be substantal. Even f t s decded that fr dversfcaton s warranted, then achevng ths dversfcaton through acquston s very costly. If, because of anageent rsk averson or debt capacty or suppler concerns, t s decded that the volatlty or total rsk of the fr should be reduced, then ths can be acheved uch ore effcently (.e., at lower cost) by sply purchasng a portfolo of equtes and fxed-ncoe securtes where no preu ust be pad over arket and no sgnfcant transactons costs ust be pad. If dversfcaton s desred to provde "cash flow" fro these operatons to fund growth nvestents n current operatons, then t s alost certanly less costly to ssue securtes and rase the funds n the captal arkets. Don't pay $1 to $0 to acqure $10 n cash! If t s costly for your shareholders to dversfy ther portfolos by drect purchase of ndvdual frs' shares, then ths servce can be provded at less cost by utual funds, nvestent copanes, and other fnancal nteredares. In suary, there are three types of reasons for a fr to consder the acquston of another fr: 94

9 Fnance Theory 1) Synergy ) Taxes 3) The fr to be acqured s a "Bargan" They all have n coon that the acquston should ncrease the value of the acqurng fr's current stockholders' wealth. The possblty of a takeover of one fr by another s an portant "check" whch serves to force anageents to pursue polces whch are (at least approxately) value-axzng. Dversfcaton by the fr s, n general, not an portant objectve for the anageent of the fr. Hence, f pursued, then a nu of resources should be used to acheve t. Specfcally, the acquston of another fr s a costly way to acheve dversfcaton. Warnng: "dversfcaton" s frequently gven as the reason for acqurng a fr by the acqurng fr's anageent. If carefully nvestgated, (ost of the te) the eanng of "dversfcaton" as used s not the one descrbed here, and the real reasons wll be one or ore of the three (proper) reasons for akng an acquston. 95