Page 61 - FINAL CFA II SLIDES JUNE 2019 DAY 6

LOS 25.l: Explain how price and payment method affect the
distribution of risks and benefits in M&A transactions. READING 25: MERGERS AND ACQUISITIONS

Effect of Price
Acquirer will want to pay the lowest possible price (the pre-merger value of the target, V ), while MODULE 25.4: BID EVALUATION
T
the target wants to receive the highest possible price (the pre-merger value of the target plus the
expected synergies, V + S).
T
Effect of Payment Method

Cash offer. Acquirer assumes the risk and receives the potential reward from the merger, while the gain for the target shareholders is limited to the takeover
premium. If an acquirer makes a cash offer in a deal, but the synergies realized are greater than expected, the takeover premium for the target would remain
unchanged while the acquirer reaps the additional reward. Likewise, if synergies were less than expected, the target would still receive the same takeover
premium, but the acquirer’s gain may evaporate.

Stock offer. Some of the risks and potential rewards from the merger shift to the target firm. When the target receives stock as payment, the target’s
shareholders become a part owner of the acquiring company. This means that if estimates of the potential synergies are wrong, the target will share in the
upside if the actual synergies exceed expectations, but will also share in the downside if the actual synergies are below expectations.
The main factor that affects the method of payment decision is confidence in the estimate of merger synergies. The more confident both parties are that
synergies will be realized, the more the acquirer will prefer to pay cash and the more the target will prefer to receive stock. Conversely, if estimates of synergies
are uncertain, the acquirer may be willing to shift some of the risk (and potential reward) to the target by paying for the merger with stock, but the target may
prefer the guaranteed gain that comes from a cash deal.
LOS 25.m: Describe characteristics of M&A transactions that create value.

Acquirers are likely to earn positive returns on a deal characterized by:

• Strong buyer: Acquirers that have exhibited strong performance (in terms of earnings and stock price growth) in the prior three years.
• Low premium: The acquirer pays a low takeover premium.
• Few bidders: The lower the number of bidders, the greater the acquirer’s future returns.
• Favorable market reaction: Positive market price reaction to the acquisition announcement is a favorable indicator for the acquirer.