Mergers & Acquisitions – Slide Set Session 1

Introduction. Does M&A create value?

Michael H. Grote

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overview and some figures

 Worldwide M&A activity totaled US$5.9 trillion during full year 2021
 increase of 64% in value compared to 2020

source: Refinitiv 2022

 strongest year since records began in 1980

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headline-making transactions

source: Refinitiv 2022

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2021: technology most active

source: Refinitiv 2022

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big tickets drive volume

source: Refinitiv 2022

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Private Equity all-time high, too

 Private Equity (PE) hit all-time high, accounting for 20% of M&A
activity during full year 2021
 PE value reached US$1.2 trillion, more than doubling year ago levels
 more than 14,500 PE backed deals announced, +56% 2020

 Private Equity-backed buyouts Special Purpose Acquisition

Companies (SPACs) announced 335 initial business combinations
during full year 2021, totaling US$598.8 billion, or 10% of overall

source: Refinitiv 2022

value

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ca. 1/3 of transaction volume cross-border

source: Refinitiv 2022

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Europe‘s activity driven by GDP
and capital market size

source: Refinitiv 2022

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2020: Covid-19 infected global M&A activity

source: Bloomberg Law 2021

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Covid-19 uncertainty in spring – Germany

source: Oaklins 2021

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M&A - a truly puzzling field

stra- organi- capital

tegic zation market economics
mana- theory
gement theory

Mergers
tax and legal
accounting &
& Acquisitions
auditing
antitrust psychology

contract

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complex setup – lead has important role

Transaction Lead

Investment Bank or
Consultancy Client
M&A advisory

source: Lo 2001
Tax advisor Lawyer Auditor

Specialists Specialists

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complex setup – mirrored

Buyer Seller
main communication

 in large transactions often several investment banks are involved on

either side, mainly for capital market / investor access

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M&A – it’s about coordination

Mergers and Acquisitions cut through a lot of theories and easily

cross diverse subject areas
M&A consists to a large extent of co-ordination of and trust in
specialists (tax accountants, lawyers, auditors, environmental
experts, real estate agents, etc.)
experience, therefore, is essential in m&a business

bottom line:
even after attending this m&a-course, in your next job you will
presumably not talk to Christian Sewing about what global bank
to buy next or how much to pay for it ...

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M&A – what to expect from the course

BUT ... you will have

a good overview of the process,
command of a sound theoretical base about m&a, including
common valuation techniques,
some knowledge on m&a in Germany, with special regard to the
„Mittelstand“,

and you will be

able to follow and comment on most of the issues in m&a,
prepared to start in an investment bank or m&a advisory,
able to advise your company on how m&a works and where the
pitfalls are.

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Investment banking is a profitable business

London stock exchange acquiring Refinitiv in 2020

“bankers, lawyers and other advisers working on London Stock

Exchange Group’s takeover of data provider Refinitiv are set to earn
$1.1bn in fees, one of the biggest paydays for a UK acquisition. […]
The LSE said that £358m of the deal costs would be for services
including financial advisory, legal work and accounting. […] A further
£477m will go to financing costs related to the deal, which will see the
issuance of new shares and debt to pay Refinitiv’s owners, it added.”

source: ft.com 2020

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Investment banking can be fun, sometimes

 This will, however, come with some work to be done...

...and some fun, hopefully.

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 schedule

 introduction
 competition and league tables
 vocabulary: types of mergers and acquisitions
 task
 success of m&a – methods and measurement challenges
 short-term studies

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 winning mandates by trust

especially for sme, m&a often is a once-in-a-lifetime decision

choosing an m&a advisor is like choosing an brain surgeon - it is not
exactly the price that matters most
trust, trust and trust are the essentials of the business

how to create trust:

be recommended by someone else the potential client knows

(very powerful tool!)
be serious and knowledgeable: this is the reason for many reports on
M&A-related topics from practitioners
be recommended by some „neutral institution“
 league table!

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 reputation and league tables

investment banks, and especially m&a-advisors are obsessed with

league tables
not only because of their vanity
high league table rank is itself business-creating:

Self-reinforcing mechanism „reputation“

advisor gains
advisor gets high rank
experience and
in league table
reputation

clients choose
experienced advisor (as
proven by league table
rank)
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 league table reporting

in virtually every presentation of m&a advisors, you will find at least
one or two league tables
usually proving that the respective advisor is no. 1 in the market
advisors are very creative in finding out how to put themselves in the
first ranks

oh, yes - of course, every advisor claims the whole deal volume for
the own books

deal volume in league tables dwarfs volume reported by transactions

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 some leading M&A data providers

Refinitiv SDC Platinum

(market leader, formerly Thomson ONE Banker)

Bureau van Dijk / Moody‘s (Zephyr database)

Bloomberg Terminal > Type: MA and press [GO]

dealogic

mergermarket

Standard & Poors‘ Capital IQ

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 league tables sorting

 league tables could be differentiated e.g. by

 completed vs. announced deals,

 time,
pssst ...
 no. of deals vs. volume / mix, sometimes, it is
 geographical area, not entirely clear
who will /
 domestic and international,
is able to check
 incoming and outgoing m&a, the numbers ...
 sectors,
 type of buyer (financial/industrial),
 type of deal, ...

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 league table: global announced deals 2021

source: Thomson Financial

source: Refinitiv 2022

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 LT: any European involvement 2021

source: Thomson Financial

source: Refinitiv 2022

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 LT: any German involvement 2021

source: Thomson Financial

source: Refinitiv 2022

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©Frankfurt–School.de
LT: German mid-market 2021

source: Thomson Financial

27

source: Refinitiv 2022; transactions up to USD 500m

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LT: German small caps 2021

source: Thomson Financial

28

source: Refinitiv 2022; transactions up to USD 50m

 observations from league tables

international business dominated by „bulge bracket“ investment

banks, almost evenly around the globe

„global local“ presence is decisive factor in attracting clients

less important for SME (small and medium sized enterprises)-deals,
though many advisors build international networks

remember: a large part of transactions are cross-border

which deals are counted?

„all deals … of which Refinitiv was made aware“.
many deals have no disclosed value, these are still rank eligible

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 league tables, jobs and FIPEMA

many students interested in M&A use league tables to find a job in

M&A, notably at a bulge bracket investment bank
not all may accept the „M&A lifestyle“ for themselves (see Goldman
Sachs junior analyst slides; document 01g)

less visible players may offer great opportunities in M&A, too, but
receive considerable less attention

luckily, the Frankfurt Institute for Private Equity and M&A is here to
help:

https://www.frankfurt-school.de/home/research/centres/fipema

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 observations from Goldman Sachs juniors

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 schedule

 introduction
 competition and league tables
 vocabulary: types of mergers and acquisitions
 task
 success of m&a – methods and measurement challenges
 short-term studies

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 mergers vs. acquisitions

„M&A“ or „mergers and acquisitions” are mostly used as a pair,

describing the joining of two firms

in an acquisition, one company (the buyer) purchases another

company (the target) outright
in a merger, two firms form a new legal entity, most likely with a new
corporate name; the two firms being roughly of the same size
in former times a “merger of equals” allowed a peculiar accounting
for the transaction (no longer possible)

a transaction is often called a merger to signal the equal contribution

of both firms – for most mergers, however, there is still a de facto
acquirer and a de facto target
(in fact, for accounting reasons this distinction has to be made)

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 acquisition: asset vs. share deal

purchase and sale of a company can be structured in one of two

basic formats:
(1) purchase of the assets of the selling corporation or
(2) purchase of the stock (share) of the selling corporation

asset deal
the assets to be acquired are specified in the contract
in a complete deal, the buyer purchases all of the company's
equipment, furniture, fixtures, inventory, trademarks, trade names,
goodwill and other intangible assets
usually, no liabilities - except perhaps accounts payable - convey
the selling corporation uses the proceeds from the sale to liquidate
short-term and long-term liabilities

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 asset deal

an asset transaction is generally advantageous to the buyer

buyer may acquire a new cost basis in the assets which allows a
larger depreciation deduction
buyer may prefer an asset transaction for liability reasons (income
taxes, payroll withholding taxes and legal actions against the
company that are contemplated but as yet uninitiated)

seller must pay taxes on the difference between the basis in the
assets and the price paid for the company

asset deals allow for partial sales (e.g., carve outs)

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 share deal (sometimes stock deal)

all of the shares of the selling corporation transfer to the buyer

therefore, all of the assets and liabilities also convey
in some cases, the buyer and seller may choose to exclude certain
assets or liabilities from being conveyed
seller must pay taxes on the difference between the seller's basis in
the stock and the price paid by the buyer

stock deals could be more expedient for both parties

provide for continuity in relationships with suppliers
less complex contracts
risk of inheriting undisclosed debts can be minimized by providing for
the buyer's indemnification or guarantees

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 share vs. asset deal in practice

differentiation in practice often not that relevant: different legal

structure, but economic logic remains the same

example: diversified construction company

wants to sell - in a spin off - its concrete drain-tube building parts
conrete drain-tubes are easy to produce but heavy to transport
there are four building sites in Germany to save on transport costs
(not much economies of scale to loose)

site A
headquarters | production site

production site B production site C production site D

other production lines
GmbH GmbH GmbH

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 share vs. asset deal in practice

example: diversified construction company (continued)

three of the building sites are run as independent businesses (limited

liability - GmbH)
one of it is directly located at the headquarters and is part of the
holding company

to sell the whole business line, the deal will be structured as three
share deals
and one asset deal (building site at headquarters)

again: legal contracts are different, economic logic remains the same

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 sell-offs, spin-offs and carve-outs

a sell-off means selling a part (usually a division) of the company to

someone else

a spin-off is a new, independent company, also created by detaching

part of a parent company

„anti-synergy“, diseconomies of scale and scope

focus on core business

value and performance can be traced easier
internal cross-subsidies drop out
spin-offs can improve incentives for managers

generally greeted as good news by investors

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 spin-offs

widen investors‘ choice by allowing them to invest in just one part of

the business

important distinction to carve-outs:

spin-off shares in the new company are distributed to the parent
company‘s stockholders

spin-offs are in general not taxed as long as shareholders in the

parent company are given at least 80 percent of the shares in the new
company
otherwise the value of the distribution is taxed as a dividend to the
investors

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 carve-outs

a carve out is similar to a spin-off

shares in the company are not given to existing shareholders
but are sold in an initial public offering (IPO)

in general, carve-outs leave parents with majority control of the

subsidiary, at least from the start
usually around 80 percent (to consolidate the subsidiary with the
parent‘s tax accounts)

may not convince investors who worry about strategic fit

is enough to set managers‘ compensation based on subsidiary‘s
stock price, and install control from capital markets

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 tracking stock

„carve out light“

tracking stocks are tied to the performance of particular divisions
does not require a spin-off or carve-out
only creation of new stock

sometimes used in negotiations to give the seller a share in the future

development of the acquired division

incentives again managerial incentives and compensation

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 LBOs - Leveraged Buyouts

leveraged buyouts (LBOs) are the base of the private equity

business model
the purchase of a company, by a (or a small group of) investor/s,
using a high percentage of debt financing

if lead by the managers or executives of the company, this is called a

management buyout (MBO),
if lead by new managers coming in, this is called a management buy
in (MBI)

LBOs can include whole companies, segments, divisions or

subsidiaries

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 reverse mergers

a "reverse merger" is a method by which a private company goes

public (= becomes a listed company)

a private company merges with a public company with no assets or

liabilities,
a so-called "public shell" since all that exists is its corporate structure
the private company obtains the majority of the shell’s stock (usually
90%)
normally will change the name of the public corporation (often to its
own name)

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 advantages of reverse mergers

in an IPO, the process of going public and raising capital is combined
in a reverse merger, these two functions are unbundled - a company
can go public without raising additional capital
through this unbundling operation, the process of going public is
simplified:
the costs are signifigantly less than the costs required for an IPO
the time is considerably less than that for an IPO

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SPAC - Special Purpose Acquisition Company

 SPACs are somewhat similar to reverse mergers:

 listed shell corporations with the purpose of acquiring a yet-to-be-
specified private company at a later stage (different to reverse
mergers)
 thus making it public without going through the traditional initial
public offering process (similar to reverse mergers)

 SPACs work similar to private equity, but focus on one firm, and
listing it
 SPAC shares can be bought at the stock exchange before and after
the acquisition (“blank check companies” before)

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 schedule

 introduction
 competition and league tables
 vocabulary: types of mergers and acquisitions
 task
 success of m&a – methods and measurement challenges
 short-term studies

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 task

see document

00 project_ma_2022.pdf

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 schedule

 introduction
 competition and league tables
 vocabulary: types of mergers and acquisitions
 task
 success of m&a – methods and measurement challenges
 short-term studies

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 success of m&a

„success” is relative
a lot of different parties may have different thoughts about
the success of an m&a transaction
 investment banks & other advisors
(any deal done is a success)
 shareholders of
 bidder
 target
 combined entity after merger
 management
 employees

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 success of m&a

 „success” is relative (cont’d)

 clients
 competitors
 suppliers
 society

 short term vs. long term effects

dynamic vs. static effects

(innovative activity? new strategy as result of m&a?)

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 success of m&a

measuring of the success of an m&a transaction is notoriously

problematic
there is always the issue of comparing what has happened with what
could have happened, if ...

with merger without merger

A ?
A+B 
B ?

time time

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 success of m&a

in principle, several methods - none fully satisfactory, as always - to

look at success or failure

short-term stock price reaction of acquirer and target (event studies)

long-term development of stock prices of combined company
long-term development of growth of firm financials
development of market share relative to
market... and
divestiture rate own history
subjective satisfaction of management (studies almost exclusively
conducted by consultancies)

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 success of m&a

the problem of comparing one observable state with a counter-factual

one remains with most methods

solution is to compare the observed development of the combined

companies with a reference development
as reference development usually the expected development is
chosen: how would the two firms have developed separately?

the difference between the expected development and the observed

development is the so-called abnormal return

abnormal return = observed return – expected return

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 success of m&a

abnormal return = observed return – expected return

 abnormal return > 0
means that the deal has created value

 if we calculate the abnormal returns of more than one period

(e.g., the abnormal return of stock prices on several
consecutive days), then the concept is extended to the
T
 cumulative abnormal return
car   art
t 1
 sums up the considered abnormal returns (ar) for each
period t up to T (only when daily abnormal returns are
calculated with logarithms!)

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 success of m&a

 what is the „return“?

 can be taken from financial statements:

 earnings
 cash-flow
 ebitda
 return on assets
(= operating income / book value of assets)
 what financial figure?

 or from stock market:

 share price movements (and dividends)

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success of m&a

 how to calculate the „expected return“?

 from development of stock market index

 stock market index rose 2%

 expected return is 2% (assumption: beta = 1)

 combined share prices of company A and B rose 12%

 abnormal return of 10% for company AB – success!

 which index?

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 success of m&a

 how to calculate the „expected return“?

 from development of stock market index and firms‘ relative

historical share price development (beta)

 stock market index rose 3%

 with a β=0.5 expected return is 1.5%

 combined share prices of company A and B rose 9%

 abnormal return of 7.5% for company AB – success!

 how to calculate beta? changing beta after transaction?

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 calculation of “beta“
announcement day

| share price of firm

| DAX

-255 -6 -5 -4 -3 -2 -1 0 +1 +2 +3 +4 +5

estimation window for β event window

here: [-255;-6] often max [-5;5]
 β shows sensitivity of firm‘s returns to market  β from estimation window used
returns to forecast hypothetical share
 β >1  share price reacts more than index price without transaction
(high risk firm) (expected return)
 β <1  share price reacts less than index
(low risk firm)

 here: estimation of β by „market model“: daily returnfirm = α + β*daily returnDAX

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 success of m&a

 divestiture rate as a measure of success

 acquisitions that are later divested again could be termed

unsuccessful (Porter 1987)
 the larger the percentage of acquisitions that are divested,
the less successful the firm
 the faster divestitures occur, the worse the decision

 highly controversial measurement:

 many good reasons to divest
 any private equity firm would be considered extremely
unsuccessful

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 success of m&a

 market shares as a measure of success

 since a higher market share is associated with higher pricing

power and thus higher profits
 the development of market shares is (rarely) used to
determine if a merger could be considered a success

 if market shares of AB > market shares of A + B

 the merger might be considered a success

 might also be considered in terms of market share growth

 problems: generally the relation between market share and

profits is weak;
“extra”market share not necessary to reap benefits
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 success of m&a

 opinion of management as a measure of success

 most informed people are asked (via interviews)

 could reveal success in “soft facts” like post-merger
spreading of best practice, use of technology, customer
satisfaction, etc.

 could be expected to yield the most optimistic view of merger

success
 management unlikely to admit failure

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 Schedule

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 schedule

 introduction
 competition and league tables
 vocabulary: types of mergers and acquisitions
 task
 success of m&a – methods and measurement challenges
 short-term studies

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 success of m&a

 most statistically reliable evidence on whether mergers create value

for shareholders comes from short-window event studies
 where the average abnormal stock market reaction at mergers
announcement is used as a gauge of value creation or destruction
 in a capital market that is efficient with respect to public information,
stock prices quickly adjust following a merger announcement -
incorporating any expected value changes
 moreover, the entire wealth effect of the merger should be
incorporated into stock prices by the time uncertainty is resolved -
namely, by merger completion

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 success of m&a

 two commonly used event windows are the three days immediately
surrounding the merger announcement
 that is, from one day before to one day after the announcement

 and a longer window beginning several days prior to the

announcement and ending at the close of the merger

 next slide, data is displayed from roughly 3,500 mergers‚ main

propositions do not change much over time

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 success of m&a

 cumulative abnormal returns in m&a processes

period
(days around merger announcement)

[-1;+1] [-20; close]

combined 1,8% 1,9%

target 16,0% 23,8%

acquirer -0,7% -3,8%

frame denotes statistical significance at 1 percent level
source: andrade/mitchell/stafford 2001 jep

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 success of m&a

 over time, the sizes of the effects change, but the pattern remains the
same:

 Alexandridis et al. (2017) obtain US target CARs of 29% for the 2010s

 announcement returns to acquirer shareholders are either close to

zero or indistinguishable from zero; Alexandridis et al. (2017) report
slightly positive acquirer CARs

 combined (weighted) acquirer and target announcement returns are

significantly positive and slightly increase over time
but remain small: 1.5% in the 1970s, 2.6% in the 1980s, 1.06% in the
1990s, 1.69% in the 1990s and 2000s, and 4.51% for the 2010s

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success of m&a

 statistical precision is considerably reduced as the event window is

lenghtened to an average of 142 days (-20 to closing), and this
estimate cannot be reliably distinguished from zero

 target firm shareholders are clearly winners in merger transactions

 the average three-day abnormal return for target firms is 16%, which
rises to 24 percent over the longer window

 in other words, over a three-day period, target firm shareholders

realize a return equivalent to what a shareholder would normally
expect to receive over a 16-month period (i.e. 12%)

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 success of m&a

 statistically, it is difficult to claim that acquiring firm shareholders are

losers in merger transactions,
 but they clearly are not big winners like the target shareholders
 in fact, acquiring firm shareholders appear to come dangerously close
to subsidizing these transactions
 the reasons for the unequal reactions of acquirer and target share
prices remain not fully understood

 there are some characteristics hidden in the overall picture, especially

concerning financing structure of deals,
 i.e. cash vs. share deals

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 success of m&a

problems in relating short-term share price reactions to merger

success

at announcement date, new information is revealed and created about

stand-alone value of bidder
stand-alone value of target
expected synergies
division of synergies between target and bidder shareholders
likelihood that merger will be closed
price pressure due to merger arbitrage especially in share deals
(downward on acquirers‘ shares, upward on targets‘ shares)

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 success of m&a

problems in relating short-term share price reactions to merger

success

usual – but not necessarily correct – simplifying assumptions are:

∆ stand-alone value of bidder = 0
∆ stand-alone value of target = 0
likelihood that merger will be closed = 1
price pressure due to merger arbitrage especially in
share deals = 0

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 Mergers & Acquisitions – Slide Set Session 1

-- END OF SESSION 1 --

Michael H. Grote

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