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Excerpts from the Book > Chapter 10

Chapter 10 : Mergers and Acquisitions

Excerpt from Chapter 10

Mergers and acquisitions have become a prominent, and permanent, part of the corporate landscape. In these high-stakes games, companies often risk a substantial percentage of their market capitalization in an effort to improve their competitive positions. And unlike routine capital investments, merger and acquisition (M&A) deals often strike like lightning, literally changing a company's strategic and financial characteristics overnight.

Mergers and acquisitions are significant for investors for several reasons. First, M&A activity is so pervasive that sooner or later, it affects a sizeable portion of most stock portfolios. Second, no corporate announcement affects the stock price as quickly or as profoundly as a major acquisition. Finally, M&A deals often create buying and selling opportunities that acquiring and selling company shareholders, as well as other investors, can exploit.

This chapter explores the opportunities and risk that mergers and acquisitions offer investors. We first show how acquiring companies add value in mergers and acquisitions, including the key issues in evaluating synergies. Next, we lay out the appropriate analytical steps an expectations investor takes on the heels of a deal announcement. These steps include assessing the deal's potential value impact, reading management signals, anticipating the stock market's initial reaction, and updating the analysis after the market's initial reaction.

Questions Addressed in Chapter 10

To explore M&A issues, Chapter 10 answers the following questions:

  • Why is the most commonly used M&A metric—the estimated accretion or dilution in a company's earnings per share—provide no meaningful indication of the shareholder value created or destroyed by an M&A deal?
  • How can we calculate the value created or destroyed by an M&A deal?
  • How can we evaluate and quantify the value of synergies from an M&A deal?
  • How does the premium pledged over market prices affect the value created or destroyed by an M&A deal?
  • How does the currency used in an M&A deal—whether cash or stock—affect the risk of a deal, from both the point of view of acquiring and target shareholders?
  • How does an acquiring company's choice of currency in a deal send a powerful signal to investors?
  • How can we calculate the synergy risk for acquiring and selling shareholders?

Essential Ideas in Chapter 10

  • Earnings per share changes are a poor proxy for M&A success.
  • The shareholder value added by the acquiring company is equal to the present value of synergies minus the premium.
  • Shareholder value at risk (SVAR) shows acquiring shareholders what percentage of their stock price they are betting on the success of the acquisition.
  • Premium at risk shows selling shareholders what percentage of their premium they are betting on the success of the acquisition.
  • In cash acquisitions the acquiring shareholders assume the entire synergy risk, while in stock transactions the selling shareholders share it.
  • A stock deal sends two potential signals to expectations investors: that management lacks confidence in the acquisition and that the acquiring company's shares are overvalued.
  • Post-announcement price changes in the acquirer's stock require a recalculation of SVAR to identify possible buying and selling opportunities.

 

Chapter Errata

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