Acquisition Wars Prof Ian Giddy New York University

Acquisition Wars Prof. Ian Giddy New York University

Mergers and Acquisitions Mergers & Acquisitions l Valuation l Divestitures l Concept: Is a division or firm worth more within the company, or outside it? Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 2

Valuation in a Bidding-War Context Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 3

Case Study: The Acquisition of Conrail Why merge Conrail and CSX? l How was the CSX offer structured? l How was Conrail’s resistance to an unfriendly bid structured? l How would you, as a Conrail shareholder, react to the offer? l What’s Conrail worth? l Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 4

Gains from Conrail Acquisition? Rationale: Firm A should merge with Firm B if [Value of AB > Value of A + Value of B + Cost of transaction] l Synergies (what kind? ) l Gain market power l Discipline l Taxes l Financing Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 5

The Network Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 6

The CSX Offer l Two-tier offer (why? ) u. Front-end cash offer, in two stages 40%*$92. 50 u. Back-end stock swap 60%*(1. 85619*$46. 75) Combined offer 40%*$92. 50+60%*(1. 85619*$46. 75) =$89. 07 l Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 7

Conrail: Obstacles to an Unfriendly Takeover l Pennsylvania u “Fair Value” statute: bids >20% all get same price u Bidder’s voting rights maxed at 20% unless management approves u “Constituency” statute: protect unions l Conrail u Break-up fee to CSX u CSX has “lock up” option to buy 16 m new shares u Poison pill (suspended for CSX): shareholders get new shares at half price if outsider buys 10% u 6 -month “no talk” clause Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 8

Takeover Defenses l Poison Pills Preferred flip-over stock u Flip-over rights u Flip-in rights u Poison put bonds u l Shark Repellants u u u u l Limitations on board changes Limitations on shareholder actions Supermajority rules Anti-greenmail limits on share repurchases Fair-price provisions Supervoting stock exchange offers Reincorporation Golden parachutes Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 9

Post-Takeover Bid Responses l l l l “Just Say No” Litigation White Knight Greenmail ESOP Pac-Man Restructuring, including u u u Copyright © 2002 Ian H. Giddy Leveraged Recapitalization Share Buybacks Using cash for acquisitions Divestitures Going private Liquidation Corporate Financial Restructuring 10

Should Shareholders Accept the CSX Offer? What is Conrail Worth? l Stand-alone value u. Market value u. Comparables u. Discounted present value Value to acquirer l Value in bidding-war context l Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 11

What is Conrail Worth? l Stand-alone value u. Market value: $71. 00 u. Comparables P/E ratio) q Conrail: $89/4. 91=18 x u. Discounted present value Value to acquirer l Value in bidding-war context l Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 12

Comparables Value Indicator n Earnings n Cash Flow n Revenues n Book Copyright © 2002 Ian H. Giddy Average Comparable n Industry n Firms n Deals Target Company Numbers or Projections Estimated Value of Target Corporate Financial Restructuring 13

What is Conrail Worth? Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 14

Estimating Future Cash Flows n n n Copyright © 2002 Ian H. Giddy Dividends? Free cash flows to equity? Free cash flows to firm? Corporate Financial Restructuring 15

What is Conrail Worth? l Stand-alone value u. Market value: $71. 00 u. Comparables u. Discounted present value Value to acquirer l Value in bidding-war context l Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 16

How Much Premium Can a Buyer Pay? Applying the discounted cash flow approach, we need to know: l The incremental cash flows to be generated from the acquisition, adjusted for debt servicing and taxes l The rate at which to discount the cash flows (required rate of return on equity) l The deadweight costs of making the acquisition (investment banks' fees, etc) l Cost of losing out! Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 17

Gains From an Acquisition of Conrail? Gains from merger Synergies Top line Copyright © 2002 Ian H. Giddy Bottom line Control Financial restructuring Business Restructuring (M&A) Corporate Financial Restructuring 18

Conrail: A Focus on the Value of the Synergies If CSX can produce the following net dollar synergies for the next four years and beyond, at a discount rate of 16. 15%, what is the present value of the cash flow stream? $0 $122 $257 $358 …. $1. xxx = Present Value of cash flow stream $1. xxx/90. 2 m shares =$? Per share …. add to $70 to get price could afford Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 19

What is Conrail Worth? Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 20

Conrail: Required Return kj = RF + bj (km - RF) kj = 16. 15% (required return on company) RF = 6. 83% (US Treasury bond) bj km = = Copyright © 2002 Ian H. Giddy 1. 30 (estimated Beta for company) 14% (average S&P return) Corporate Financial Restructuring 21

What is Conrail Worth? l Stand-alone value u. Market value: $71. 00 u. Comparables u. Discounted present value Value to acquirer l Value in bidding-war context l Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 22

A Higher Price for Conrail Could Norfolk Southern make a bid? l How? How much? l Does this change what CSX has to pay? l Answer: Yes! l Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 23

What is Conrail Worth? Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 24

Equity Valuation : Results l l l Estimating discount rate Estimating cash flows Application to CSX 1 & 2 Application to NS Decision? Result: Conrail shareholders opposed the CSX move and Conrail was split See spreadsheet: conrail. xls Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 25

What's It Worth? Market value l Comparable companies or deals l Acquisition value l u. Incremental value of synergies u. Break-up value u. Value to rival Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 26

What’s It Worth? Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 27

But Where Are the Profits? January 2001 http: //www. railwayage. com/jun 01/conrail_split. html Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 28

But Where Are the Profits? NSC S&P 500 CSX Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 29

Contact Info Ian H. Giddy NYU Stern School of Business Tel 212 -998 -0426; Fax 212 -995 -4233 Ian. giddy@nyu. edu http: //giddy. org Copyright © 2002 Ian H. Giddy Corporate Financial Restructuring 33