The Economics of mergers & acquisitions

Estimating the Benefits of Mergers

The procedure starts with the target company’s stand-alone market value and focuses on the changes in cash flow that would result from the merger. Ask why the two companies should be worth more together than apart (whether you are acquiring or selling the target company); otherwise, there is no additional (merger) value created that would accrue to the buyer or the seller.

Estimating the Cost of a Merger

The rule is that one should go ahead with a merger if the gain exceeds the cost. The gain is the difference between the value of the merged company and the value of the separate companies. The cost of the merger is the premium that the buyer pays for the target company over the value as a separate, standalone entity.

Therefore, incremental change in cash flow value must be greater than the take-over premium for the merger to make economic sense.

The attachments provides backgrounders on the following:

a) pertinent points to consider in a merger and acquisition process;

b) approach to valuing mergers and acquistions

The last attachment "To Whom are Boards Accountable" touches on the fiduciary duties of directors. A director of a company owes a duty of loyalty to act in the best interests of the company and its shareholders, for which he or she is a fiduciary. This is based on the private property concept of a company and its principles as ruled in the 1919 Michigan Supreme Court decision, Dodge v Ford Motor Co. In the last two decades, legislative acts in the US have authorised boards to weigh the interests of all stakeholders in their decision making; these actions implicitly recognising the social entity concept of a company. The alternative social entity concept treats the company as an institution with multiple constituencies. It is no longer a private entity responsible solely to its owners, but "tinged with a public purpose". Under the social entity concept, the duties of directors goes beyond "assuring investors a fair return, to include a duty of loyalty to all those interested in or affected by the company".