Chapter 31

MERGERS

Brealey, Myers, and Allen

Principles of Corporate Finance
11th Global Edition
McGraw-Hill Education Copyright 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
1MDB ran into problems due to failure to issue
IPO, says Najib
Published 10 May 2016, 11:49 pm

Prime Minister Najib Razak said a failed initial

public offering (IPO) exercise, as a result of being
"attacked", was the main reason why 1Malaysia
Development Bhd (1MDB) encountered
problems.
He said 1MDB used the debt funding approach to
operate its business, which required an IPO to be
undertaken in the shortest possible time.
31-2
 "At the time, we tried different approaches as we
did not want to utilise government funds.
Government funds can be used for other projects
or programmes.
"For 1MDB, we utilised 'debt funding' on condition
that we will undertake an IPO very soon. Yet, we
did not foresee that 1MDB would come under
relentless "attacks".
"When the 'attacks' were mounted, the IPO
exercise could not be carried out, hence the cash
flow problems," Najib said in an exclusive
interview telecast live over TV1 tonight in
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CHAPTER OUTLINE

Merger motives
Dubious reasons for mergers
Estimating merger gains and costs
Merger tactics
Economics of merger

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FIGURE 31.1 NUMBER OF MERGERS
IN UNITED STATES, 1962-2011

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TABLE 31.1 RECENT MERGERS

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 Name some of the recent mergers you
know.
Sime darby + guthrie + golden hope, 2007
Ekran + federal cables, 1900s
SapuraCrest Petroleum Bhd (SapuraCrest) +
Kencana Petroleum Bhd (Kencana), 2011
Zurich + MAA Takaful, 2016
FGV >> Eagle High?

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MALAYSIA'S FGV TO BUY INTO INDONESIA'S EAGLE HIGH PLANTATIONS

Friday, 12 June 2015

BY HANIM ADNAN

PETALING JAYA: Felda Global Ventures Holdings Bhd (FGV) is set to acquire a stake
in an Indonesian oil palm company, expanding the groups plantation assets in the
republic, even as it seeks to exit refining business in North America.
Sources told StarBiz that FGV was proposing to purchase a substantial stake in
Jakarta Stock Exchange-listed Eagle High Plantations Tbk at 800 rupiah a share.
The transaction values the Indonesian planter nearly twice as much as its current
market capitalisation of 13.9 trillion rupiah (US$1.04bil or RM3.89bil).
The deal is likely to be sealed in Jakarta anytime soon, a source said.

FGV has suspended its trading of its shares today pending a material announcement.
Its shares were was last traded six sen lower at RM1.86.
Shares in Eagle High, which is 65.5%-owned by billionaire Peter Sondakhs Rajawali
Group, rose to 440 rupiah yesterday its highest level since November last year.

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31-9
FGV SHARES HIT RECORD LOW ON EAGLE HIGH BID

June 16, 2015, Tuesday Sharon Kong, sharonkong@theborneopost.com

KUCHING: Shares of Felda Global Ventures Holdings Bhds (FGV) fell to a record low
on Monday following its proposed acquisition of a 37 per cent non-controlling stake in
PT Eagle High Plantations Tbk (Eagle High).
Felda shares fell by 11.29 per cent on Monday when trading in the stock resumed after
a suspension was imposed pending an announcement.
It closed at RM1.65 with 25.97 million shares traded during the day. The worlds third-
largest palm plantation operator plans to buy 37 per cent of Eagle High from Rajawali
Group, paying cash for 30 per cent and issuing shares to buy the other seven per cent.
It also plans to buy 95 per cent of a sugar project from Rajawali for around US$67
million.
The Eagle High deal would combine Feldas downstream capabilities with Eagle Highs
land bank, and reduce operating costs, the two companies said in a joint presentation
on Friday.
Meanwhile, the Eagle High deal has puzzled analysts as they peg the deal to be
expensive at about US$17,400 per hectare (ha).
According to Maybank Investment Bank Bhd (Maybank IB Research), the transaction
price for Eagle High is estimated at approximately 770 rupiah per share, a 71 per cent 31-10
31-1 SENSIBLE MOTIVES FOR MERGERS

1. Economies of Scale
Larger firms can reduce per-unit cost by
using excess capacity or spreading fixed
costs across more units.
This is an important source of synergy.
Mainly relevant for horizontal mergers.
Example: bank mergers in Malaysia in the
aftermath of the AFC 1997-98.

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31-1 SENSIBLE MOTIVES FOR MERGERS
2. Economies of Vertical Integration
An important source of synergy. Mainly
relevant for vertical mergers, up (with
supplier) or down (with distributor).
Control over suppliers and control over
downstream activities can reduce costs.
Example: A construction company merge
with a cable company, such as Ekran
taking over Federal Cables in 1992.
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31-1 SENSIBLE MOTIVES FOR MERGERS
3. Complementary Resources: Merging may
result in firms complementing each others
strengths. Example: combining one with
good production technology and another
with good marketing strategy.
4. Surplus Funds: Mature firm with surplus
cash can acquire growth firms with abundant
positive NPV projects but lack of funds to
invest.

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31-1 SENSIBLE MOTIVES FOR MERGERS

5. Eliminating inefficiencies: Inefficiently

managed firm may become targets of
takeover because there are great value
added potentials. Usually the inefficient
management will be replaced. Example?
6. Industry consolidation: A good example of
this type of merger is the consolidation of
the banking sector in Malaysia orchestrated
by the central bank in the aftermath the
1997-98 financial crisis.
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FIGURE 31.2 BANK OF AMERICA FAMILY TREE

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31-2 SOME DUBIOUS REASONS FOR
MERGERS
Diversification
In theory diversification reduces risk, but at
company level diversification may not be a thing
of value.
This is because investors can diversify
themselves and therefore should not pay a
premium for a firms diversification.
In fact, diversification is easier and cheaper for
stockholders than for corporations
Example: Sime Darby

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31-2 SOME DUBIOUS REASONS FOR
MERGERS
Increasing Earnings per Share: Bootstrap
Game
Acquiring firm has high P/E ratio

Target firm has low P/E ratio (due to low

number of shares)

After merger, acquiring firm has short-

term EPS rise

In the long term, acquirer will have slower than

normal EPS growth due to share dilution.

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TABLE 31.2 MARKET VALUE AND EARNINGS PER
SHARE, WORLD ENTERPRISES

The target firm has a low P/E ratio due to slower growth. After the merger, the
acquiring firm has a short-term increase in EPS. This is called the bootstrap game.

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FIGURE 31.3 EFFECTS OF MERGER
ON EARNINGS GROWTH

In the long run, the

acquirer will have slower
growth due to dilution.

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31-3 ESTIMATING MERGER GAINS AND
COSTS
Questions
Is there overall economic gain to merger?
Do terms of merger make company and
shareholders better off?
To create value, the value of the combined
firms should be greater than the sum of the
values of the two separate firms, i.e.

PVAB > PVA + PVB

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31-3 ESTIMATING MERGER GAINS AND
COSTS

Gain PVAB (PVA PVB ) PVAB

Cost cash paid PVB
NPV gain cost
PVAB (cash PVB )

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31-3 ESTIMATING MERGER GAINS AND
COSTS
Example: Firms A and B are valued at $200 and
$50 respectively. Firm A buys Firm B for $65
million, creating $25 million in synergies.
PVA $200
PVB $50
Gain PVAB $25
PVAB $275 million

Cost cash paid PVB

65 50 $15 million
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31-3 ESTIMATING MERGER GAINS AND
COSTS
Example: NPV to Firm A will be the
difference between gain and cost:
NPVA 25 15 $10 million
OR
NPVA wealth wit h merger wealth wit hout merger
(PVAB cash ) PVA
(275 65) 200
$10 million

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VALUING A TARGET

Method A: estimate cash flows of the target

as a merged entity, and evaluate the
present value of the cash flows.
Method B: estimate target as a stand alone
company, then estimate incremental cash
flows resulting from the merger.
It is suggested that method A often leads to
mistakes compared to method B.

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TABLE 31.3 ACCOUNTING FOR MERGER OF
A CORPORATION AND B CORPORATION
Assume A Corporation pays $18 million for
B Corporation

Why did A pay $8m above Bs

value?
The excess amount is for intangible
asset of B and treated as goodwill
in the merged balance sheet.

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31.5 PROXY FIGHTS, TAKEOVERS, MARKET FOR
CORPORATE CONTROL
Tools Used to Acquire
Companies

Proxy Contest Tender Offer

Acquisition Merger

Leveraged Buy- Management

Out Buy-Out

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 THESE ARE DIFFERENT METHODS USED TO
ACQUIRE COMPANIES
Proxy contest: Attempt to gain control of a firm by soliciting a
sufficient number of stockholder votes to replace the existing
management.
Acquisition: Occurs when one corporation buys the stock or
assets of another corporation
Leveraged buyout: Where an acquiring companys capital
structure is substantially higher debt than equity.
Management buyout: Occurs when managers of a firm form a
new corporation and, with funds provided by a lender, acquire
the firm.
Merger: When two or more corporations combine to form one
corporation.
Tender offer: A publicly announced offer by the buyer to acquire
shares of a single class of stock at a specified price.
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TABLE 31.5 KEY DATES IN ORACLE/PEOPLESOFT
TAKEOVER BATTLE

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TABLE 31.6 SUMMARY OF TAKEOVER
DEFENSES

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TABLE 31.6 SUMMARY OF TAKEOVER
DEFENSES
White Knight
Friendly potential acquirer sought by target
company who was threatened by unwelcome
acquirer
Shark Repellent
Amendments to company charter made to forestall
takeover takeover attempts
Poison Pill
Action taken by target firm to prevent acquisition,
e.g., right for existing shareholders to buy additional
shares at attractive price, should bidder acquire
large holding
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WHO GAINS IN MERGERS?
In general, most mergers create value, but
target shareholders usually gain more than
acquiring shareholders.
Takeover announcement usually results in
targets share price increase significantly,
while acquiring share price increase a little
or remained unchanged.
Sometimes acquiring firm pays too much,
resulting in a decline in its share price

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WHO GAINS IN MERGERS?
Targets gains are greater and acquirers gains
because:
1. Targets are in general much smaller in size
than acquirers, hence their percentage gain is
larger even if the absolute gains are equal.
2. Competitive bidding may also results in
acquiring firm paying too much, hence shifting
most or all of the gains to target shareholders.
3. Targets usually has a greater bargaining power
to demand higher price.
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RESEARCH IMPLICATION

Topic 1: Study synergistic versus

information gains of M&A announcement
Synergistic gains share price increases on the
announcement but declines if merger is
unsuccessful
Information gains - share price increases on the
announcement but does not decline if merger is
unsuccessful

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 Topic 2: Synergistic Gains in M&A: The
Case of Malaysia
Objective: To study the extent of synergistic
gains from M&A activities in Malaysia.
Topic 3: Synergistic Gains in M&A in
Malaysia: Economies of Scale or
Economies of Operation?
Compare horizontal vs. vertical mergers

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Topic 4: To study the small versus large
acquirers/target performance around
announcement returns.
Previous study find that small targets are
less attractive to overpriced stock acquirers
due to their size differences or that small
targets are more resistant to overpriced
stock offers.

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