international investing prof. ian giddy new york university
TRANSCRIPT
International Investing
Prof. Ian Giddy
New York University
Copyright ©1996 Ian H. Giddy International Investing 2
International Capital Budgeting
Strategic FDI decision vs. project appraisal NPV, IRR, NTV, APV Analyzing the cash flows:
Tax and repatriationSubsidies, including low-cost financeInflation and exchange rate changesWhose cash flow?Blocked funds
Special risks & risk analysis in ICB
Copyright ©1996 Ian H. Giddy International Investing 3
Foreign Direct Investment
Why FDI? The theories Sources of competitive advantage Tactical choices
export vs. foreign productionlicensing vs. FDI
Ownership policywholly-owned vs jv
Modes of entryde novo vs. Acquisition
Copyright ©1996 Ian H. Giddy International Investing 4
Nature of FDI
Q: Why?A: Ownership-specific advantages of the firm
Q: How?A: Internationalization of markets implies FDI
Q: Where?A: Location-specific advantages of host
country
Copyright ©1996 Ian H. Giddy International Investing 5
Conditions for FDI
1. Expected returns exceed the next best alternative (relative return for risk)
2. Foreign investor has competitive advantage relative to host country rivals (monopolistic advantage)
3. FDI more profitable than exporting (location-specific advantage)
4. FDI more profitable than unaffiliated foreign production
5. Special advantage of foreign investor exceeds costs and risks of owning and managing a foreign operation
Copyright ©1996 Ian H. Giddy International Investing 6
FDI Theories
Economic/financial Expected return differential Currency premium Diversification benefits
Behavioral Defensive action in oligopolistic market
Monopolistic advantage Firm-specific advantage overcomes inherent disadvantage
of operating abroad Product life cycle
Internalization Markets vs heirarchies
Eclectic Mon. Adv., Internalization & location specific advantage
Copyright ©1996 Ian H. Giddy International Investing 7
A Case: Connor Vila Real
Connor Peripherals is a U.S. manufacturer of compact, resilient hard drives for laptop and desktop PC's. Connor sells drives to PC manufacturers worldwide. Because of certain incentives and low labor costs, Connor is considering shifting a substantial proportion of its production to Vila Real, Portugal.
1. What might be the advantages of
locating production in Portugal?
2. What risks might Connor face?
Base your answer on FDI theory.
Copyright ©1996 Ian H. Giddy International Investing 8
Connor Vila Real
A. Alternatives?
B. Advantages IncentivesLower costs of productionPortuguese market/EU market
C. RisksQuality controlOn time deliveryCustomer responsiveness & interaction suffer?Production disruptionsExchange riskPolitical risk
Copyright ©1996 Ian H. Giddy International Investing 9
Capital Budgeting Proposals
BOARD OF DIRECTORS
MANAGEMENTCOMMITTEE
INVESTMENTADVISORYCOMMITTEE
TREASURER'SDEPARTMENT
LOCAL AFFILIATE
GUIDELINES
PROJECTPROPOSAL
Copyright ©1996 Ian H. Giddy International Investing 10
International Capital Budgeting
The Capital Budgeting Decision Process The Relevant Cash Flows
Initial Operating Terminal
Exchange and Political Risk Factors Capital Budgeting Techniques
Payback NPV IRR
Approaches for Dealing with Risk
Copyright ©1996 Ian H. Giddy International Investing 11
International Capital Budgeting And Long-Term Investments
Direct Foreign Investment (FDI) involves the transfer of capital, managerial, and technical assets to a foreign country
Two additional factors must be considered:Exchange rate fluctuations Political/jurisdictional risks and barriers
Firms can protect themselves against exchange rate fluctuations using debt and/or derivativespricing.
Copyright ©1996 Ian H. Giddy International Investing 12
Hangzhou Power Project
INVESTORSINVESTORS
INTERMEDIARIESINTERMEDIARIES
SPONSORSSPONSORS
Key elements: Cash flow
analysis Understanding
risks and returns of the financing techniques
Valuation
Copyright ©1996 Ian H. Giddy International Investing 13
Hanel: Net Income
-5000
0
5000
10000
15000
20000
25000
30000
35000
40000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Net Revenues, 000 RMB
(Baseline assumptions)
Copyright ©1996 Ian H. Giddy International Investing 14
The Relevant Cash Flows
Relevant Cash Flows include:The incremental after-tax cash outflow
(investment) for the projectThe resulting subsequent cash inflows
associated with the project Incremental Cash Flows are the additional cash
flows directly attributable to the proposed project Can be expressed in host currency, then result
translated into home currency
Copyright ©1996 Ian H. Giddy International Investing 15
Cash Flow Components
$50,000
$4,000 $5,000 $6,000 $7,000 $7,000 $8,000 $8,000 $8,000 $9,000 $10,000
0 1 2 3 4 5 6 7 8 9 10
Operating Cash Flows
Terminal Cash Flow $25,000
Time (Years)
Initial Investment
Copyright ©1996 Ian H. Giddy International Investing 16
Finding the Initial Investment
The initial investment Initial investment is determined by
subtracting all cash inflows occurring at time zero from all the cash outflows occurring at time zero
Installed cost of new assetOutflows to be considered include:
Cost of the new assetInstallation costs
Copyright ©1996 Ian H. Giddy International Investing 17
The income statement format for calculating operating cash inflows is:
Revenue- Expenses (Excluding Depreciation)
= Profits Before Depreciation and Taxes- Depreciation
= Net Profits Before Taxes- Taxes
= Net Profits After Taxes+ Depreciation
= Operating Cash Inflows
Finding the Operating Cash Inflows
Copyright ©1996 Ian H. Giddy International Investing 18
The Terminal Cash Flow is an after-tax cash flow from the termination and liquidation of a project at the end of its expected useful life
To lend closure to the analysis, the firm must end up where it started, i.e. without the asset.
Finding the Terminal Cash Flow
Copyright ©1996 Ian H. Giddy International Investing 19
Hanel: Cash Flow from Operations
0
5000
10000
15000
20000
25000
30000
35000
40000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21
Net Operating Cash Flows, 000 RMB
(Baseline assumptions)
Copyright ©1996 Ian H. Giddy International Investing 20
Interpreting the Cash Flows: NPV
n
NPV = i=1
= Present Value of Cash Inflows - Initial Investment
CFt (1 + k)t - II
Copyright ©1996 Ian H. Giddy International Investing 22
IRR is calculated by solving:
n t = 1
PV of Cash Inflows = Initial Investment
CFt (1 + IRR)t = II
Copyright ©1996 Ian H. Giddy International Investing 23
Adjusted Present Value in International Capital Budgeting
APV =
- Initial costs
+ Present value of operating cash flows
+ Present value of tax shield
+ Present value of financing subsidies
What rate should be used to discount cash flows in APV?
Copyright ©1996 Ian H. Giddy International Investing 24
Inflation and Devaluation
Currency treatment of cash flows?
REAL NOMINAL
DOMESTIC
FOREIGN
Also: Evaluate local or only repatriated cash flows?
Copyright ©1996 Ian H. Giddy International Investing 25
Blocked Funds
Local cash flows
Repatriated cash flowsProjected cash flows,
reinvested at local
rate of return
Copyright ©1996 Ian H. Giddy International Investing 26
Imperial Power Spain
1. Domestic sales volume & foreign sales volume (from price changes & elasticities)
2. X projected prices = peseta revenues
3. From units sold get variable costs
4. Other costs; taxable income; income & withholding taxes
5. Project cash flows, incl. Depr., W.C., T.V., int. after tax
6. Dollars
7. Royalties
8. U.S. Taxes
9. Discount to present at 16%
10.Discuss assumptions
Copyright ©1996 Ian H. Giddy International Investing 27
Imperial Power SpainTABLE 1 TO TAL SALES VO LUM E AND REVENUE
1979 1980
Dom estic Sales 1. Units budgeted to be sold 50000 60000 2. Unit sales price (15% p.a. increase) x 1,300 x 1,495 3. Dom estic sales revenue (Ptas 000) 65000 89700
Export Sales 4. Pta. unit price in Spain (line 2) 1300 1495 5. Forecast Exchange rate, Pta./FF 16.67 17.5 6. Unit price in French francs 77.98 85.43 7. Change in franc price over prior year 9.55% 8. Less allowable 5% annual inflation -5.00% 9. Relative price change over prior year1 4.55%10. Resulting volum e change (tim es -1.5) -6.82%11. Prior year sales volum e 15000012. Increase for 10% growth 1500013. Volum e before price effect 16500014. Tim es elasticity factor (line 10)2 x 0.931815. Units budgeted to be sold 150000 15374716. Tim es unit price (in pesetas) x 1,300 x 1,49517. Export sales revenue (Ptas. 000) 195000 229852
Calculation of Sales Volum e18. Dom estic Volum e (line 1) 50000 6000019. Export Volum e (line 15) 150000 15374720. Total Unit Volum e 200000 213747
Copyright ©1996 Ian H. Giddy International Investing 28
Cost Calculations
EXHIBIT 2 CO ST CALCULATIO NS1979 1980
Calculation of per-unit cost of im ported m aterial (Note: 20% of Ptas. 840 = Ptas. 168
21. O riginal dollar unit cost (Ptas. 168/70) $2.40 $2.4022. Adjusted to U.S. inflation rate (tim es 1.05n) x 1.0000 x 1.050023. Inflated dollar unit cost 2.4 2.5224. Exchange rate (year begin) 70 7025. Peseta unit cost of im ported m aterial 168 176.4
Calculation of peseta interest expense
26. Dollar interest paid (10% x $600,000) $60,000 $60,00027. Exchange rate (year end) 70 8528. Peseta interest expense (000) 4200 5100
Calculation of peseta royalty expense
29. Dollar royalties paid $30,000 $30,00030. Exchange rate (year end) 70 8531. Peseta royalty expense (000) 2100 2550
Copyright ©1996 Ian H. Giddy International Investing 29
Pro-Forma Income StatementTABLE 3 PRO -FO RM A INCO M E STATEM ENTS (Pta 000)
1979 1980
Revenue from Sales32. Dom estic sales revenue (line 3) 65000 8970033. Export sales revenue (line 17) 195000 22985234. Total revenue 260000 319552
Expenses35. Im port m aterial/unit (line 25) 168 176.436. Dom estic m aterial/unit (840)(0.4)(1.15)n 336 386.437. Labor/unit (840)(0.4)(1.15)n 336 386.438. Total unit variable costs 840 949.239. Tim es unit sales volum e (line 20) x 200,000 x 213,747
40. Total variable costs (Ptas 000) 168000 20288941. M anufacturing overhead (x 1.15n) 75000 8625042. Depreciation (10% of cost) 7000 700043. Interest (line 28) 4200 510044. Royalties (line 31) 2100 255045. Total expenses 256300 303789
Profit & Dividend Calculation46. Net incom e before tax 3700 1576347. Less 30% incom e tax 1110 472948. Net incom e after tax 2590 1103449. Less 10% dividend tax 259 110350. Dividend paid to IPC (US) 2331 9931
Dollar equivalents on above51. Year-end exchange rate 70 8552. Net incom e before incom e tax ($) 52857 18544753. Incom e & Dividend taxes paid 19557 6861254. Dividend paid to IPC (US) 33300 116835
Copyright ©1996 Ian H. Giddy International Investing 30
Project Cash Flow Analysis
TABLE 4 PRO JECT CASH FLO W S (Pta 000)1978 1979 1980
Cash Inflows55. Net incom e after tax (line 48) -- 2590 1103456. Depreciation (line 42) -- 7000 700057. Interest after tax (line 28 x 0.7) -- 2940 357058. Recapture of working capital3 -- -- --59. Net term inal value4 -- -- --60. Total cash inflow 12530 21604
Cash O utflows61. Net working capital 77000 -- --62. Equipm ent 70000 -- --63. Total outflows 147000 -- --
Cash Flow Analysis64. Net cash flows -147000 12530 2160465. 16% present value factor 1 0.8621 0.743266. Present value of each cash flow -147000 10802 1605667. Cum ulative net present value -147000 -136198 -120142
68. Approxim ate internal rate of return = 46%
Copyright ©1996 Ian H. Giddy International Investing 31
Parent Cash Flow Analysis
TABLE 5 PARENT CASH FLO W ANALYSIS (US$)1978 1979 1980
Cash Inflows69. Dividends from IPC-Spain (line 54) -- 33300 11683570. Royalty receipts from IPC-Spain (line 29) -- 30000 3000071. Net term inal value5 -- -- --72. Total cash inflow -- 63300 146835
Cash O utflows73. Parent equity investm ent 1500000 -- --74. Pre-tax incom e, IPC-Spain (line 52) -- 52857 18544775. U.S. taxes at 50% -- 26428 9272376. Less credit for Spanish taxes (line 53) -- 19557 6861277. U.S. taxes payable on dividend incom e -- 6871 2411178. U.S. taxes payable on royalty incom e -- 15000 1500079. Total outflow 1500000 21871 39111
Cash Flow Analysis80. Net cash flow -1500000 41429 10772481. 16% value factor 1 0.8621 0.743282. Present value of each cash flow -1500000 35716 8006083. Cum ulative net present value -1500000 -1464284 -1384224
84. Approx. internal rate of return =27%
Copyright ©1996 Ian H. Giddy International Investing 34
Adjusting for Risk
Scenario, sensitivity and simulation Certainty equivalent Adjusting the discount rate Risk and the CAPM
Copyright ©1996 Ian H. Giddy International Investing 36
Sensitivity andScenario Analysis
An approach that attempts to capture the variability of cash inflows and NPV's
Sensitivity Analysis uses a number of possible values for a given variable to assess its impact on return, as measured by NPV
Scenario Analysis is similar to sensitivity analysis but allows for simultaneous changes in a number of variables
Copyright ©1996 Ian H. Giddy International Investing 37
Simulation
Simulation is a statistically-based approach using probability distributions and random numbers to estimate risky outcomes
Use computer to simulate virtually every inflow and outflow variable and determine the resulting NPV's
After a thousand or so simulations the decision maker has a good idea of not only the expected value of the return on a project, but also the dispersion: the probability of achieving a given return.
Copyright ©1996 Ian H. Giddy International Investing 39
Risk Adjustment Techniques
Certainty Equivalents (CE's) adjust cash inflows to determine the percentage of estimated inflows that investors would be satisfied to receive for certain in exchange for those that are possible each year
NPV when CE's are used is calculated as: n NPV = = - I I
t =1 (1 + RF)t t = Certainty Equivalent factor in year t (0 < t < 1)
CFt = Relevant cash inflow in year t
RF= Risk-free rate of return
t x CFt
Copyright ©1996 Ian H. Giddy International Investing 42
Risk-Adjustment Techniques
Risk-Adjusted Discount Rates (RADR's) adjust for risk by changing the discount rate -- raising it for higher risk and lowering it for lower risk
RADR's are calculated as n
NPV = t =1
The use of RADRs is closely linked to the capital asset pricing model (CAPM)
- II CFt
(1 + RADR)t
Copyright ©1996 Ian H. Giddy International Investing 43
RADR and CAPM
Recall that
total risk = nondiversifiable risk + diversifiable risk
Beta is a measure of nondiversifiable risk and
kj = RF + j (km-R F) (CAPM)If we assume that real corporate assets are traded in efficient
markets, CAPM can be modified as follows:
kProject j = RF + j Project (km-RF)
where:
j Project is the relationship between the project's expected return and the market's expected return
Copyright ©1996 Ian H. Giddy International Investing 44
RADR and CAPM
SML
AcceptReject
k
km
RF
0
1.0Beta
Copyright ©1996 Ian H. Giddy International Investing 47
Portfolio Effects
The value of the firm is generally not affected by diversification
The market for real corporate assets is inefficient, therefore total risk is most relevant
Copyright ©1996 Ian H. Giddy International Investing 50
Risk-Adjusted Investment Cutoff Rates
COUNTRY CUTOFF RATE
ARGENTINA 17%
AUSTRALIA 10
BELGIUM 10
BRAZIL 14
CANADA 10
FRANCE 12
GERMANY 10
GREECE 17
INDIA 20
INDONESIA 17
ITALY 14
JAPAN 14
MALAYSIA 12
MEXICO 17
COUNTRY CUTOFF RATE
NETHERLANDS 10
NEW ZEALAND 10
NIGERIA 20
PHILIPPINES17
PORTUGAL 14
PUERTO RICO 12
SINGAPORE 12
SOUTH AFRICA 12
SOUTH KOREA 20
SPAIN 14
TAIWAN 17
THAILAND 20
UNITED KINGDOM 12
UNITED STATES 10
VENEZUELA 17
Copyright ©1996 Ian H. Giddy International Investing 51
Government Subsidized Financing
i = normal cost of debt
i* = subsidized cost Then subsidy equals F(i-i*), where f is the
amount of debt subsidized. A. Adjusting project's cost of capital B. Adjusting project net cash flows
Which is correct? Depends on reinvestment assumption.
Copyright ©1996 Ian H. Giddy International Investing 52
Financing Decisions
Capital Structure Firm Financing Needs Short Term Debt Long Term Debt Equity Hybrid Securities
Copyright ©1996 Ian H. Giddy International Investing 53
THEFIRM
DEBT
EQUITY
SHORTTERM
LONGTERM
BANK LOANSREVOLVERS,
EUROCREDITS
COMMERCIALPAPER
TERM LOANS
PREFERRED STOCK
BONDS
LEASINGCOMMON
HYBRIDS
CONVERTS WARRANTSRIGHTS
BONDS
Financing Choices
Copyright ©1996 Ian H. Giddy International Investing 54
Bond Credit Risk
Moody’sStandard &Poor’s Interpretation
AaaAa
AAAAA
High-quality debt instruments
ABaa
ABBB
Strong to adequate ability topay principal and interest
BaBCaaCaC
BBBCCCCCC
Ability to pay interest andprincipal speculative
D In default
Copyright ©1996 Ian H. Giddy International Investing 55
Book Value Per Share Liquidation Value Per Share Price/Earnings (P/E) Multiples Capital Asset Pricing Model (expected
return and nondiversifiable risk) Risk-Adjusted Net Present Value
Valuation of Common Stock
Copyright ©1996 Ian H. Giddy International Investing 56
THEFIRM
DEBT
EQUITY
SHORTTERM
LONGTERM
BANK LOANSREVOLVERS,
EUROCREDITS
COMMERCIALPAPER
TERM LOANS
PREFERRED STOCK
BONDS
LEASINGCOMMON
HYBRIDS
CONVERTS WARRANTSRIGHTS
BONDS
Financing Choices
Copyright ©1996 Ian H. Giddy International Investing 62
Mergers and Acquisitions
Mergers Acquisitions Divestitures
Concept: Is a division or firm worth more within the company, or outside it?
Copyright ©1996 Ian H. Giddy International Investing 63
Corporate Finance
CORPORATE FINANCE
DECISONS
CORPORATE FINANCE
DECISONS
INVESTMENTINVESTMENT RISK MGTRISK MGTFINANCINGFINANCING
CAPITAL
PORTFOLIO
M&ADEBT EQUITY
TOOLS
MEASUREMENT
Copyright ©1996 Ian H. Giddy International Investing 64
The Market for Corporate Control
M&A&D situations often arise from conflicts: Owner vs manager ("agency problems" Build vs buy ("internalization") Agency problems arise when owners' interests and
managers' interests diverge. Resolving agency problems requires Monitoring & intervention, or Setting incentives, or Constraining, as in bond covenants
Resolving principal-agent conflicts is costly Hence market price may differ from potential value of a
corporation
Copyright ©1996 Ian H. Giddy International Investing 65
“Internalization”: Is an activity best done within the company, or outside it?
Issue: why are certain economic activities conducted within firms rather than between firms?
As a rule, it is more costly to build than to buy—markets make better decisions than bureaucrats
Hence there must be some good reason, some synergy, that makes an activity better if done within a firm
Eg: the production of proprietary information Often, these synergies are illusory
Copyright ©1996 Ian H. Giddy International Investing 66
Goals of Acquisitions
Rationale: Firm A should merge with Firm B if
[Value of AB > Value of A + Value of B + Cost of transaction]
Synergy Gain market power Discipline Taxes Financing
Copyright ©1996 Ian H. Giddy International Investing 67
Do Acquisitions Benefit Shareholders?Successful Bids
Technique Target Bidders
Tender offer 30% 4%
Merger 20% 0
Proxy contest 8% na
Note: Abnormal price changes are price changes adjusted to eliminate the effects of marketwide price changes
Copyright ©1996 Ian H. Giddy International Investing 68
Do Acquisitions Benefit Shareholders?Unsuccessful Bids
Technique Target Bidders
Tender offer -3% -1%
Merger -3% -5%
Proxy contest 8% na
Copyright ©1996 Ian H. Giddy International Investing 69
Goal of Acquisitions and Mergers
Increase size - easy! Increase market value - much
harder!
Copyright ©1996 Ian H. Giddy International Investing 70
Fallacies of Acquisitions
Size (shareholders would rather have their money back, eg Credit Lyonnais)
Downstream/upstream integration (internal transfer at nonmarket prices, eg Dow/Conoco, Aramco/Texaco)
Diversification into unrelated industries (Kodak/Sterling Drug)
Copyright ©1996 Ian H. Giddy International Investing 71
Success Rates For Cross-Border Mergers And Acquisitions
Success43%
Failure57%
100%=28
Copyright ©1996 Ian H. Giddy International Investing 72
Success Rates For Cross-Border Alliances
Success55%
Failure27%
Undecided18%
100%=45
Copyright ©1996 Ian H. Giddy International Investing 73
What's It Worth?
Valuation Methods Book value approach Market value approach Ratios (like P/E ratio) Break-up value Cash flow value
Copyright ©1996 Ian H. Giddy International Investing 74
How Much Should We Pay?
Applying the discounted cash flow approach, we need to know:
1.The incremental cash flows to be generated from the acquisition, adjusted for debt servicing and taxes
2.The rate at which to discount the cash flows (required rate of return)
3.The deadweight costs of making the acquisition (investment banks' fees, etc)
Copyright ©1996 Ian H. Giddy International Investing 75
Framework for evaluating the value of an Acquisition
Value ofacquirer ifit does not
acquiretarget
Value of target
to acquirer
Price paidincludingpremium
Net value
gainedfrom
acquisition
Adapted from: W. Pursche, “Building Better Bids: Synergies and Acquisition \prices”, Chief Financial Officcer USA (1988):63-64
Stand-alone
value ofacquirer
(pre-merger)
Stand-alone
value oftarget
(withoutany
takeoverpremium)
Value ofSynergies
TransactionCosts
CombinedValue
Copyright ©1996 Ian H. Giddy International Investing 76
Framework For Assessing Restructuring Opportunities
Restructuring Framework
1
2
CurrentMarketValue
3
Optimal restructuredvalue
Potential value withinternaland externalimprovements
Potentialvalue withinternalimprovements
Companyvalue as is
Maximum restructuringopportunity
Financialengineeringopportunities
4
Disposal/Acquisitionopportunities
Strategicand operatingopportunities
Currentperceptionsgap
5
Copyright ©1996 Ian H. Giddy International Investing 77
Using The Restructuring Framework$ Millions of Value
RestructuringFramework
1
2
CurrentMarketValue
3
Optimalrestructuredvalue
Potentialvalue withinternaland externalimprovements
Potentialvalue withinternalimprovements
Companyvalue as is
Maximumrestructuringopportunity
Financialengineeringopportunities
4
Disposal/Acquisitionopportunities
Strategicand operatingopportunities
Currentperceptionsgap
5
$ 25
$ 975
$ 350
$ 1,325
$ 300
$ 1,625
$ 100
$ 1,725
$ 725
$1,000
Increase D/E
Copyright ©1996 Ian H. Giddy International Investing 78
The Cost of Capital
Required rate of return on equity, RE, may be computed from the Capital Asset Pricing Model (CAPM):
RE = RF + Beta (RM - RF)
where RF = risk-free rate
Beta= nondiversifiable risk factor, and
RM = return on the market.
In short, the discount factor should reflect the riskiness of the acquisition.
Copyright ©1996 Ian H. Giddy International Investing 79
Application
Fakawi Navigation plans to acquire Feng-Shui Compass Co. This would result in $25 million of incremental operating revenues in each of the first 5 years, and in $15 million of additional debt servicing costs per annum, as well as $5 million in tax shields. Fakawi expects to divest the target in year 6 for $100 million. The Treasury note rate is 6%, and the S&P return is 16%. Fakawi's advisors estimate that Feng-Shui has a beta of 1.3. For this advice they are charging 2% of the acquisition price.
What is the maximum price that Fakawi should offer for Feng-Shui?
Copyright ©1996 Ian H. Giddy International Investing 80
Reasons Why Many Acquisitions Fail To Generate Value
Value
Destruction
Deal price not based on cash flow value
Copyright ©1996 Ian H. Giddy International Investing 81
Reasons Why Many Acquisitions Fail To Generate Value
Value
Destruction
Over optimisticmarketassessments
Deal price not based on cash flow value
Copyright ©1996 Ian H. Giddy International Investing 82
Reasons Why Many Acquisitions Fail To Generate Value
Value
Destruction
Over optimisticmarketassessments
Overestimatingsynergies
Deal price not based on cash flow value
Copyright ©1996 Ian H. Giddy International Investing 83
Reasons Why Many Acquisitions Fail To Generate Value
Value
Destruction
Over optimisticmarketassessments
Poorpost-mergerintegration
Overestimatingsynergies
Deal price not based on cash flow value
Copyright ©1996 Ian H. Giddy International Investing 84
Typical Losing Pattern For Mergers
Candidates are screened on basis of industry and company growth and returns
One or two candidates are rejected on basis of objective DCF analysis
Frustration sets in; pressures build to do a deal; DCF analysis is tainted by unrealistic expectations of synergies
Deal is consummated at large premium Postacquisition experience reveals
expected synergies are illusory Company’s returns are reduced and stock
price falls
Copyright ©1996 Ian H. Giddy International Investing 85
Divestitures
Divestiture: the sale of a segment of a company to a third party
Spin-offs—a pro-rata distribution by a company of all its shares in a subsidiary to all its own shareholders
Equity carve-outs—some of a subsidiary' shares are offered for sale to the general public
Split-offs—some, but not all, parent-company shareholders receive the subsidiary's shares in return for which they must relinquish their shares in the parent company
Split-ups—all of the parent company's subsidiaries are spun off and the parent company ceases to exist.
Copyright ©1996 Ian H. Giddy International Investing 86
Divestitures Add Value
Shareholders of the selling firm seem to gain, depending on the fraction sold:
Total value created by divestititures between 1981 and 1986 = $27.6 billion.
% of the firm sold Announcement effect
0-10%10-50%50%+
0+2.5%+8%
Copyright ©1996 Ian H. Giddy International Investing 87
Strategic Alliances:An Alternative to Acquisition "A strategic alliance is a collaborative agreement
between two or more companies, which contribute resources to a common endeavor of potentially important competitive consequences, while maintaining their individuality."
Example with internal emphasis: Sunkyong with GTE, Vodaphone & Hutchinson Whampoa for cellular system
Example with external emphasis: Santander with Royal Bank of Scotland for European market in financial services
Driving forces: Complementary resources - gain strategic resources Similar capabilities - gain economies or market power
Copyright ©1996 Ian H. Giddy International Investing 88
Forms of Strategic Alliance
Many linkages are options for future development of relationships
IRREVERSIBILITY OF COMMITMENT
POTENTIAL
FOR CONTROL
INFORMAL
ALLIANCE
JOINT
PROJECTS
JOINT
VENTURE
MERGER
WITH FULL
INTEGRATION
ACQUISITION
SPECIFIC
DISTRIBUTION
OR SUPPLY
AGREEMENT
Copyright ©1996 Ian H. Giddy International Investing 89
Pitfalls and Problems
Linkage may not offer access to partner's resources (JP Morgan-Espirito Santo)
Disagreement on contribution (Euroclear-Cedel) Partners competing in one another's market
(Credit Lyonnias-Commerzbank) Linkage may exclude other options for expansion
into a product or market Clash of cultures; cross-purpose marketing (Credit
Suisse-First Boston)
Key predictor of stability is asset specificity and irreversibility of commitment.
Copyright ©1996 Ian H. Giddy International Investing 90
Geographic Overlap Helps Mergers And Acquisitions...
8
9492
6
Minimalgeographic
overlap (sampleof 12)
Moderate orhigh geographicoverlap (sample
of 16)
Failure foracquirer
Success foracquirer
Copyright ©1996 Ian H. Giddy International Investing 91
...But It Hinders Alliances
62
25
14
38
2437
Minimalgeographic
overlap(sample of 37)
Moderate orhigh
geographicoverlap
Failure for both partners
Mixed Results
Success for both partners
Copyright ©1996 Ian H. Giddy International Investing 92
Mergers and Acquisitions: Summary
Mergers & Acquisitions Divestitures Strategic Alliances
Concept: Is a business worth more within our company, or outside it?