Tài chính doanh nghiệp - Chapter 20: Analysis of takeovers

Chapter 20Analysis of TakeoversLearning ObjectivesEvaluate suggested reasons for takeovers.Explain how to estimate the gains and costs of takeovers.Explain the main differences between cash and share-exchange takeovers.Outline the regulation and tax effects of takeovers in Australia.Learning Objectives (cont.)Outline defence strategies that can be used by target companies.Identify the various types of corporate restructuring transactions.Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth.Fundamental ConceptsTakeovers typically involve one company purchasing another by acquiring a controlling interest in its voting shares.Also called ‘acquisitions’ and ‘mergers’.Market for corporate controlA market in which alternative teams of managers compete for the right to control corporate assets.Such a market enables the quick redeployment of assets in ways expected to bring economic benefits to shareholders.Importance of Takeovers in AustraliaImportant because they involve changes in the ownership and/or control of valuable assets.Table shows Ernst & Young survey results on acquisitions by Australian listed industrial companies with a total market capitalisation of more than $45m.Table 20.1Fluctuations in Takeover ActivityNo generally accepted explanation for the existence of takeover ‘waves’:Evidence that takeover activity is positively related to the behaviour of share prices.Periods when share prices are increasing are also periods of optimism for investment.While companies will increase internal investment (new plant and equipment) they will also look for external investment (opportunities to take control of existing assets).Changes in legislation controlling takeovers may also influence the level of takeover activity.Fluctuations in Takeover Activity (cont.)Recent results from the US suggest:Takeovers triggered by industry-level economic shocks — force industry rationalisation.Acquisition followed by shutdown of marginal production capacity.Deregulation is another important source, which forces industry-wide rationalisation and thus is a catalyst for mergers and acquisitions activity.Types of TakeoversHorizontal takeover: takeover of a target company operating in the same line of business as the acquiring company.Vertical takeover: takeover of a target company that is either a supplier of goods to, or a consumer of goods produced by, the acquiring company.Conglomerate takeover: takeover of a target company in an unrelated type of business.Reasons for TakeoversSynergy in takeovers is the situation where the performance, and therefore the value, of a combined entity exceeds those of the previously separate components: Reasons for Takeovers (cont.)The target company is managed inefficiently.The acquiring and target companies have assets that are complementary.The target company is undervalued.Cost reductions result.Increased market power.Reasons for Takeovers (cont.)Diversification benefits.The target company or the acquiring company has excess liquidity or free cash flow.Tax benefits result.There are increased earnings per share and price–earnings ratio effects.Evaluation of the Reasons for TakeoversThe target company is managed inefficiently:The acquiring company’s managers may see an opportunity to use the target company’s resources more efficiently.Improvements in efficiency are most likely in horizontal takeovers, as the acquiring company’s managers are likely to have the necessary expertise.Managers may not be inefficient, they may be making decisions in their own interest rather than shareholders, thereby reducing market value and inducing takeover offers.Evaluation of the Reasons for Takeovers (cont.)Complementary assets:Sometimes either or both of the companies can provide the other with needed resources at relatively low cost.For example, the target’s managers may be considered to have valuable skills, motivating a takeover based on acquiring expertise. It may be cheaper to acquire this expertise via a takeover than to hire and train new staff.Evaluation of the Reasons for Takeovers (cont.)Target company is undervalued:Market efficiency suggests that most managers will find it very difficult to identify undervalued companies.However, if share markets are not efficient in the strong-form sense, managers may be able to use private information to identify ‘bargains’.A takeover may also occur when the market value of the target company is less than the sum of the market values of its assets. Other managers may recognise the existence of alternative and better uses for the assets.Evaluation of the Reasons for Takeovers (cont.)Cost reductions:The total cost of operating the combined company may be expected to be less than the cost of operating the two companies separately.Cost savings may be due to economies of scale.Horizontal takeovers may reduce production costs.Vertical takeovers may reduce the costs of communication and of various forms of bargaining.Evaluation of the Reasons for Takeovers (cont.)Increased market power:Taking over a company in the same industry may increase the market power of the combined company.This increase in market power may enable the acquiring company to earn monopoly profits if there are significant barriers to entry into the industry.However, various legislative measures are in place to prevent anti-competitive takeovers.For example, ACCC opposed Boral’s attempted takeover of Adelaide Brighton due to reduced competition in cement industry.Evaluation of the Reasons for Takeovers (cont.)Diversification benefits:The takeover, it is suggested, enables a company to reduce risk via diversification.However, when shareholders themselves hold diversified portfolios, diversification by a company is a neutral factor that will neither alter its market value nor benefit its shareholders.Combining two companies whose earnings streams are less than perfectly correlated will lower the risk of default on debt, so that the debt capacity of the combination is greater than the two separate companies.Evaluation of the Reasons for Takeovers (cont.)Excess liquidity and free cash flow:A company with excess liquidity may be identified as a takeover target by companies seeking access to funds.On the other hand, companies with excess liquidity may turn to the acquisition of other companies rather than return more cash to shareholders.Such takeovers may result from managers pursuing their own interests ahead of the interests of shareholders.Jensen argues that companies engaging in takeovers of this kind are likely to become targets themselves.Evaluation of the Reasons for Takeovers (cont.)Tax benefits:Taking over a company with accumulated tax losses may reduce the total tax payable by the combined company.The use of past accumulated tax losses is restricted to situations where it can be shown that either the continuity-of-ownership test or the same-business test is satisfied.Other things being equal, reduction of company tax will mean that resident shareholders have to pay more personal tax on dividends. Therefore, any advantage associated with lowering company tax payments will be only a timing advantage.Evaluation of the Reasons for Takeovers (cont.)Increased earnings per share (EPS) and price–earnings ratio effects:While acquiring companies may wish to evaluate the effect of a proposed takeover on their EPS, this is an unreliable approach.It is quite possible that a takeover that produces no economic benefits will nevertheless produce an immediate increase in EPS (bootstrapping).The Roles of TakeoversThe threat of takeover can discipline the management of target companies:To be effective, threats must sometimes be carried out, and where significant inefficiencies or agency problems remain, the managers of target companies can be replaced by takeovers.Takeovers can take advantage of synergies such as economies of scale or complementarity between assets.Economic Evaluation of TakeoversThe gain from the takeover can be defined as the difference between the value of the combined company and the sum of their values as independent entities: Economic Evaluation of Takeovers (cont.)Assuming that cash is used to buy Company T, the net cost is defined as: Cost is considered in terms of the premium paid over T’s value as an independent entity.The takeover will have a positive NPV for Company A’s shareholders only if the gain exceeds the net cost: Economic Evaluation of Takeovers (cont.)If NPVA is equal to zero, then the above equation can be used to find the value of Company T to Company A, VT(A), which is the maximum price A should pay for the target: Economic Evaluation of Takeovers (cont.)It is necessary to focus on the incremental cash flow effects of the takeover:Incremental inflowssales revenueproceeds from disposal of surplus assetsIncremental outflowsoperating costscapital investments to upgrade existing assets or acquire new assetsComparing Gains and CostsThe amount of the cash consideration determines how the total gain is divided between the two sets of shareholders.Every additional dollar paid to the target’s shareholders means a dollar less for the acquirer’s shareholders.Comparing Gains and Costs(cont.) Note that the possible gains from a takeover may already be impounded into the target’s market price.Management should therefore check that the share price of a proposed target has not already been increased by takeover rumours.Management should also keep its takeover intentions completely confidential until formally announcing the bid.Estimating Cost for a Share-Exchange TakeoverShare-exchange takeover: the acquiring company issues shares in exchange for the target’s shares.The cost will depend on the post-takeover price of the acquiring company’s shares.Estimating Cost for a Share-Exchange Takeover (cont.)In general, the estimated cost of a share-exchange takeover is as follows: For a cash offer, the net cost is independent of the takeover gain, whereas for a share-exchange offer, the cost depends on the takeover gain.Valuation Based on EarningsThe bidder values the target by first estimating the future earnings per share (EPS) of the target.The EPS figure is then multiplied by an ‘appropriate’ price/earnings (P/E) ratio to obtain an implied price (valuation) of the target.Valuation Based on AssetsA company’s equity can be valued by deducting its total liabilities from the sum of the market values of its assets.May be appropriate where a bidder intends to sell many of the target’s assets, or where the company has been operating at a loss.Valuation Based on Assets (cont.) Criticisms of asset based valuationBalance-sheet figures based on historical cost are unlikely to provide a reliable guide to market values.Intangible assets may not be included in the balance sheet.There may be complementarity between assets so that the total market value of the assets may be greater than the sum of their individual values.Regulation of TakeoversThe main legislation is Chapter 6 of the Corporations Act 2001.Australian Securities and Investments Commission (ASIC) administers the Corporations Act.ASIC has some discretion and can apply to the Takeovers Panel if an acquisition is believed to be inappropriate.Regulation of Takeovers (cont.)The most important aspect of the Corporations Act is that unless the procedures laid down in Chapter 6 are followed, the acquisition of additional shares in a company is virtually prohibited if this would:Result in a shareholder being entitled to more than 20% of the voting shares, orIncrease the voting shares held by a party that already holds 20–90% of the voting shares of the company.Regulation of Takeovers: Off-Market BidThis type of offer must remain open for between 1 and 12 months and may be for 100%, or a specified proportion, of each holder’s shares.Steps of an off-market bid:Bidder’s statement must be lodged with ASIC. Bidder’s statement sent to holders of bid class securities.Target informed of bid.The target must respond with target’s statement, recommending whether the offer should be accepted.Regulation of Takeovers: Market Bids‘Market bid’: offer to acquire shares of listed target company, up to a specified bid price.Bid cannot be conditional, must be in cash and for a period between 1 and 12 months.The offerer must supply ASIC, the ASX and the target company and its shareholders with bid statement.The target replies to all parties with a target statement.Regulation of Takeovers: Disclosure RequirementsCorporations Act has provisions for disclosure by bidders and targets.Some examples of bidder information include: bidder’s identity, bidder’s intentions for target, sources of funding, a prospectus where securities are issued as consideration.Target statement must include information that would help shareholders decide whether to accept or not, including directors’ recommendation.If bidder is related, expert’s report.Regulation of Takeovers: Creeping TakeoverThis approach allows the acquisition of no more than 3% of the target company’s shares every 6 months, provided that the threshold level of 19% has been maintained for at least 6 months.No public statement is necessary.Because of the time required, such an approach is of little commercial significance.Regulation of Takeovers: Partial TakeoversIn a partial takeover, a bidder seeks to gain control by acquiring only 51%.The bidder must specify at the outset the proportion of each holder’s shares that the bidder will offer to buy.Reasons for a partial takeoverThe premium for control may be paid to only a favoured group of shareholders.There is potential for target shareholders to be coerced into accepting an offer not in their best interests.Other Controls on TakeoversLegislation other than the Corporations Act may affect takeovers:Trade Practices Act — competition.Foreign Acquisitions and Takeovers Act — Federal Treasurer has the power to prohibit takeovers by foreign companies — for example Shell and Woodside (2001).Industry-related legislation — media ownership laws, four pillars banking policy.ASX listing rules — secrecy during takeover discussions, or apply for trading halt, shares cannot be placed (via a private placement) for 3 months after receiving a takeover offer.Tax Effects of TakeoversThe New Business Tax System (Capital Gains Tax) Act 1999.Scrip-based takeover offers are treated more favourably than cash offers.The shares received when a bid is accepted are not subject to capital gains tax (CGT) until they are sold. Unlike cash received in a takeover.Argued that, historically, bidders had to pay a CGT premium when making cash bids, inhibiting M & A activity. Takeover Defences Takeovers Panel — decisions on takeovers should be made by shareholders.Takeover defence should be in interests of shareholders.Defence measures are of two basic types:Pre-emptive measures aimed as discouraging bids.Strategies employed after a bid is received.Takeover Defences (cont.) Poison pillsPre-emptive measure to make target less attractive to potential bidder.News Corp. provides a recent example.November 2004, established a ‘shareholders rights plan’.Offer of shares to existing shareholders (other than bidder) at half-price — effectively halve the bidders shareholding.Takeover Defences (cont.)Acquisition by friendly partiesThe management of a target company seeks the assistance of a ‘white knight’, which generally purchases the target’s shares with the aim of driving up the share price or preventing the bidder from achieving its minimum acceptance level.Example: in mid 1980s speculation that Bond Corp. was planning takeover of Arnott’s.Campbell Soup Company took a strategic/blocking stake in Arnott’s.Initially a ‘White Knight’, Campbell’s eventually took over Arnott’s in 1992.Takeover Defences (cont.)Disclosure of favourable informationManagement may release information that it hopes will convince shareholders that the bid undervalues the company.Make takeover more expensive for bidder and attempt to extract more value for target shareholders.Such information must be accurate — three former directors of GIO (AMP target) have been targeted by ASIC for allegedly withholding information.Takeover Defences (cont.) Claims and appealsManagement of the target company may:Claim that the bid is inadequate. Appeal to regulatory authorities — FIRB, ACCC and Takeovers Panel.Criticise the bidding company.Appeal to shareholders for loyalty.Takeover Defences (cont.)Effects of takeover defencesDirectors are faced with a conflict of interest.It is also important that management ensures that their recommendation is consistent with their responsibilities to shareholders.Resistance can extract additional value for shareholders but can be in interests of directors maintaining position.Empirical evidence suggest worst managers are most likely to resist — hard to find a new job.Even pay packages with termination packages in the event of takeover may not work — directors may recommend a low takeover to get payout.Corporate RestructuringDivestituresInvolves assets, which may be a whole subsidiary, being sold for cash.It is essentially a reverse merger, from the viewpoint of the seller.It has been found that divestitures create value for the shareholders of selling companies.The assets transferred must be more valuable to the buyer than the seller.The selling company may also benefit by the removal of a unit that was managed poorly, or that had created diseconomies of scale.Corporate Restructuring (cont.)Spin-offsA single organisational structure is replaced by two separate units under essentially the same ownership.US research has found significant positive market reaction to spin-offs.Likely explanations are gains from:Simplifying a complex conglomerate structure.Decentralising decision making.Motivating management more effectively.Corporate Restructuring (cont.)BuyoutsInvolve a transfer from public to private ownership of a company through the purchase of its shares by a small group of investors.A buyout or going private transaction can take several forms:Management buyout: purchase of all of a company’s issued shares by a group led by the company’s management.Leveraged buyout: takeover of a company that is largely financed using borrowed funds; the remaining equity is privately held by a small group of investors.Corporate Restructuring (cont.)Gains from going privateAvoidance of listing fees and shareholder servicing costs.Increased managerial incentives. Managers who own their company stand to benefit more than salaried employees from their efforts.Empirical Evidence on Takeovers: Target CompanyTarget company shareholders earn significant positive abnormal returns.Brown and da Silva Rosa (1997): average abnormal return of 25.5% over the 7-month period around the takeover announcement.Casey, Dodd and Dolan (1987) reported significant abnormal returns on target company shares around the time that significant shareholding notices were filed.Empirical Evidence on Takeovers: Target Company The initial increase in wealth of the target company’s shareholders appears to be maintained, even where the bid is unsuccessful.The bid may have prompted a change in the target company’s investment strategy, which is expected to improve performance.Information released during the bid caused the market to revalue the shares.The market may expect a further bid for the target company.Empirical Evidence on Takeovers: Acquiring CompanyOn average, the shareholders of acquiring companies earn positive abnormal returns in the years before the takeover bid is made.This suggests that takeover bids are typically made by companies that have been doing well, and have demonstrated an ability to manage assets and growth.Many studies have found that around the time of the announcement, the average abnormal returns to shareholders of bidding companies is close to zero and, in some cases, negative.Empirical Evidence on Takeovers: Acquiring Company (cont.) Jarrell and Poulsen (1989) identified three general explanations for the negligible wealth effects for acquiring company shareholders:Takeovers are profitable, but the wealth effects are disguised.Competition depresses returns to acquirers.Takeovers are neutral or poor investments.Empirical Evidence on Takeovers: Acquiring Company (cont.) The wealth effects of takeovers are disguised:An acquiring company is typically much larger than a target company, so while there may be a worthwhile dollar gain to shareholders, the gain is small relative to the total value of the company.When a company has a known strategy of growth by acquisition, the expected gains from this strategy may already be reflected in the company’s share price.Announcement effects that are small or negative may also reflect market reaction to the financing of the takeover.Empirical Evidence on Takeovers: Acquiring Company (cont.) CompetitionReturns to successful bidders are likely to be lower if a takeover is resisted by target management, or contested by multiple bidders.Returns to acquiring companies when there are multiple bidders are insignificantly different from zero.Returns to acquiring companies when there is only one bidder are significantly positive. Empirical Evidence on Takeovers: Acquiring Company (cont.) Takeovers are neutral or poor investmentsRoll’s hubris hypothesis — managers of acquiring companies are supremely confident that their ability to value other companies is better than that of the market. Consequently, they pay more for companies than they are worth.The large returns to target shareholders represent wealth transfers from the shareholders of acquiring companies.Empirical Evidence on Takeovers: Are Takeovers Poor Investments?Bradley, Desai and Kim (1988)Found an average gain of $117m, or 7.4%, in the combined wealth of shareholders.Their results support the hypothesis that takeovers yield real, synergistic gains and do not support Roll’s ‘wealth transfer’ hypothesis.However, they found for some types of acquisitions there were consistent losses to acquiring company shareholders.Empirical Evidence on Takeovers: Are Takeovers Poor Investments? (cont.)Andrade, Mitchell and Stafford (2001)US event study, found large abnormal returns to target company shareholders.No significant effect to bidder company shareholders.Overall shareholder wealth effect is positive and significant.Also found that method of payment was important.Gains are larger when paid in cash, no overall effect when paid in acquirer’s shares.Empirical Evidence on Takeovers: Are Takeovers Poor Investments? (cont.)Long-term abnormal returnsLoughran and Vijh (1997) — US study finds differences between announcement period (short-term) returns and long-term returns to takeovers.5-year abnormal returns differed depending on form of payment.Share offers had returns of –24%, cash offers had returns of +18.5%.Related to hostility of takeover.Brown and da Silva Rosa (1998) — Australian study finds no long-term abnormal returns.Distinguishing between Good and Bad TakeoversRoll’s hubris hypothesisManagers pay too much for target companies because they overestimate their ability to run them.Managers may pursue their own objectives rather than those of their shareholders:Often the result of free cash flow problems.Some managers may make unprofitable takeovers simply because they are poor managers:Such managers are possibly seeking other fields in which they hope to perform better.Distinguishing between Good and Bad Takeovers (cont.)EvidenceLang, Stulz and Walking (1989) using Tobin’s q ratio as a measure of managerial performance:Found takeovers involving an acquirer with high q and a target with a low q produced large gains; andTakeovers involving an acquirer with a low q and a target with a high q produced losses to shareholders.Distinguishing between Good and Bad Takeovers (cont.)Mitchell and Lehn (1990)Results suggest the stock market is able to distinguish between ‘good’ and ‘bad’ bidders.Results consistent with the argument that one role of takeovers is to discipline managers who fail to maximise profits, including those that make value-reducing takeovers.Morck, Shleifer and Vishny (1990)Found that acquiring companies do systematically pay too much in takeovers in which the benefits for managers are particularly large.The Net Effects of TakeoversThe above evidence was obtained from market-based studies.Some researchers have preferred to use accounting data to assess the effects of takeovers on company performance by examining measures of profitability, risk and growth.Recent Australian evidence on takeovers in various industries finds little accounting evidence of improved post-acquisition performance.The Net Effects of Takeovers (cont.)McDougall and Round (1986)Found no evidence of benefits such as improved profitability or reduction of risk.However, this study was criticised due to various problems in using accounting data.Healy, Palepu and Ruback (1992)Used both accounting data and share price data and focused on operating cash flows before interest and tax to minimise the problems with accounting data.Their results provided further evidence that mergers do result in improved performance.The Sources of Gains from TakeoversMarket myopiaInvestors are preoccupied with short-term earnings performance and will undervalue companies that undertake long-term developments, making them prime targets for takeovers.Empirical evidence soundly rejects this hypothesis.The Sources of Gains from Takeovers (cont.)Tax benefitsAppear to have at least a minor role in motivating takeover activity.Healy, Palepu and Ruback (1992)Gains are primarily from increased asset productivity.Some evidence of lower labour costs. The Sources of Gains from Takeovers (cont.)Da Silva Rosa and Walter (2004) survey of Australian evidenceTakeovers initiated by high performing companies who are seeking to continue high performance.Target shareholders enjoy significant gains that dissipate if takeover is unsuccessful with no follow-up bid.Shares in acquiring firm tend to under-perform following acquisition. Related to high costs associated with Australian regulatory environment.The Sources of Gains from Takeovers (cont.)Da Silva Rosa and Walter (2004) survey of Australian evidence (cont.)Long run performance of combined entities suggest anticipated benefits often fail to materialise.Qualify their results stating that methodological problems make it difficult to arrive at strong conclusions.Summary Takeovers are an important part of the market for corporate control.Like any investment, a takeover should proceed only if it has a positive NPV.Takeover activity in Australia can be erratic; industry shocks, including deregulation, play an important role.Three main types of takeover: horizontal, vertical and conglomerate.Summary (cont.) Reasons for takeovers include:Assets can be used more efficiently under new management.Synergistic gains.Diversification and EPS benefits dubious.Takeovers regulated by Corporations Act, intends that all parties are treated fairly and have enough information to make a fully informed decision.Value-enhancing corporate restructures include divestitures, spin-offs and buyouts.Summary (cont.)Evidence shows that target company shareholders gain, bidding company shareholders do not gain as much, if at all.Takeovers paid for in shares tend to be less successful for the acquiring company, seeming to benefit managers interests, indicating problems with agency costs.Recent Australian evidence shows that while acquirers are well motivated, main gainers from takeovers are target shareholders, anticipated benefits for acquirers failing to materialise.