Mergers & Acquisitions

  1. Give two reasons why leverage increasing exchange offer announcements are associated with positive share price revaluations. 

Why don’t all firms increase their leverage to gain from the announcement date price effects of leverage increasing exchange offers? 

What sort of signals do leverage decreasing exchange offers send to financial markets? 

  • Conglomerates tend to trade at a discount to the sum of their stand-alone division values.  Describe two things you can do to correct this valuation discount, while keeping control of the various divisions.
  • Behemoth Inc is a firm with two large divisions operating in the aerospace and fast food industries.  The current CEO has defended such diversification as a move to lower its cost of debt capital since cash flow from each division tends to offset the other division’s shortfalls.  This makes Behemoth’s debt less risky than a pure-play firm’s debt.  Unfortunately, the current CEO is about to retire, and in her place is coming a new CEO who believes that spinning off the fast food division will create a more focused firm and add value for shareholders.  The new CEO believes that the common stock of the fast food spunoff unit will trade at a P-E multiple of 15, while the remaining aerospace shares will continue to trade at a multiple of 10.  The current P-E multiple for the firm is 10. 

Assuming that the two units currently contribute equal earnings to the firm, calculate the percent gain in equity value from the spinoff. 

  • In a recent editorial titled “How Mergers Damage the Economy”, The New York Times (Nov-1-2015) noted that M&A activity has greatly increased the market power of firms in many industries. Exhibit 1 for this conclusion is based on a study documenting increasing concentration in these industries. Exhibit 2 is based on another study showing a handful of firms capturing an increasingly greater share of earnings in its industry. The NYT editorial cites lax anti-trust scrutiny for M&A activity as chiefly responsible for the above.

Present arguments against the NYT editorial stance.