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VALUATION OF COMPANIES FOR
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– MERGERS AND ACQUISITIONS
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- MODULE: CORPORATE FINANCE
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Lecturer: Dr. Jumanne Basesa
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 Lecture Overview
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 What are Mergers and Acquisitions (M&A)

 Classification of M&A
 Motives for M&A
 Examples
 Mergers
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 Merger involves the mutual decision of two companies to

combine and become one entity; it can be seen as a
decision made by two "equals.
 Merger may be defined as the combination of two or more
independent business corporations into a single
enterprise, usually involving the absorption of one or
more firms by a dominant firm.
 A corporate merger is the combination of the assets and
liabilities of two firms to form a single business entity. And
the combination is portrayed to be between equals.
 Acquisition
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 Acquisition describes a situation when a larger

corporation purchases the assets or stock of a smaller
corporation, while control remained exclusively with
the larger corporation.
❖ This is a combination of "unequal's"

 In Acquisition both companies may continue to exist.

 In everyday language, the term "acquisition" tends to
be used when a larger firm absorbs a smaller firm.
 Takeovers
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 A larger company can initiate a hostile takeover of

a smaller firm, which essentially amounts
to buying the company in the face of resistance
from the smaller company's management.
 A special type of acquisition strategy wherein the
target firm did not solicit (request) the acquiring
firm’s bid.
 Takeover occurs when one company acquires a
sufficient proportion of the shares of another
company to gain control of its board of directors.
 Major Negotiations
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 Friendly Acquisition:
The acquisition of a target company that is willing
to be taken over.
 Hostile Takeover:
A takeover in which the target has no desire to be
acquired and actively rebuffs the acquirer and
refuses to provide any confidential information.
 Terminologies
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Target: the corporation being purchased, when

there is a clear buyer and seller.
Bidder: The corporation that makes the purchase,
when there is a clear buyer and seller. Also is
known as the acquiring firm.
Friendly: The transaction takes place with the
approval of each firm’s management
Hostile: The transaction is not approved by the
management of the target firm.
 Categories of Mergers & Acquisitions
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 Horizontal: a merger occurring between two firms

in the same industry, firms producing similar and
possibly, competitive products for the same markets.
 Example of Horizontal merger include a merger
between two machine tool manufacturers.
 Motives:
◼ the reduction of competition,
◼ creation of companies capable of exercising some
market power.
◼ to exploit economies of scale
 Categories of Mergers & Acquisitions
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 Vertical: a merger occurring between firms that

are involved in different stages of production or
marketing of some product, and result in the
integration of activities.
 Example:
◼ A takeover of a food processing firm by a supermarket
chain.
◼ A car manufacture purchasing tire company.
 Motive:

◼ Vertical mergers are often used as a way to gain a

competitive advantage within the marketplace.
 Categories (cont…)
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 Conglomerate: a merger between firms that are

involved in totally interrelated business activity.
 In general, conglomerate merger involves companies in
unrelated lines of business i.e. companies have no
common activities.
 Example: a gas pipeline company merging with a high
technology company.
 Motive:
 Such mergers are often undertaken to obtain the
perceived advantages of diversification and risk
reduction.
 Sensible Motives for Merger
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 A merger makes sense only if it adds value.

 Value may be added by better management, or by
synergies, and other changes, which make the two firms
worth more together than they were apart:
 The underlying principle behind mergers and
acquisitions ( M&A ) is simple: 2 + 2 = 5. The value of
Company A is $ 2 billion and the value of Company B is
$ 2 billion, but when we merge the two companies
together, we have a total value of $ 5 billion.
 The joining or merging of the two companies creates
additional value which we call "synergy" value.
 Sensible Motives for Mergers …
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 Synergy value can take three forms:-

 Revenues: By combining the two companies, we will realize
higher revenues than if the two companies operate separately.
 Economies of scale, i.e., the opportunity to reduce per unit
costs by spreading fixed costs over a larger number of
units. Is done by removing duplicate departments or
operations, lowering the costs of the company relative to
the same revenue stream, thus increasing profit margins.
 Economies of scope or vertical integration, i.e.,
improvements in co-ordination and control of production. For
example, the merger of a company engaged in oil exploration
and production with a company engaged in refining and
marketing may improve coordination and control.
 Sensible Motives for Mergers (cont…)
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 Managerial effectiveness-One of the potential gains

of merger is an increase in managerial effectiveness.
 This may occur if the existing management team, which
is performing poorly, is replaced by a more effective
management team.
 Often a firm, plagued with managerial inadequacies, can
gain immensely from the superior management that is
likely to emerge as a sequel to the merger.
 A common argument for creating a favorable environment
for mergers is that it imposes a certain discipline on the
management
 Dubious reasons for mergers
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 Diversification:
 Diversification reduces risk
◼ This is beneficial.
 However, diversification is easier and cheaper for
shareholders to accomplish than it is for companies
to do by combining their operations.
 HOW?
◼ Shareholders just have to buy shares of company A
and company B to diversify their portfolio.
 Thus, they will not pay a premium for managers to
combine company A and company B merely for the
sake of diversification.
 Evaluating merger
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 How the Deal is Financed

i) Cash Transaction
◼ The receipt of cash for shares by shareholders in
the target company.
◼ Such transactions are usually termed acquisitions
rather than mergers because the shareholders of
the target company are removed from the
picture and the target comes under the (indirect)
control of the bidder's shareholders.
 Evaluating merger
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 How the Deal is Financed

ii) Share Transaction
◼ The offer by an acquiring company of shares or a
combination of cash and shares to the target
company’s shareholders.
◼ Payment in the acquiring company's stock, issued
to the shareholders of the acquired company at a
given ratio proportional to the valuation of the
latter.
 Evaluating merger (cont…)
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PVAB > PVA + PVB

PV( AB ) = PVA + PVB + Synergy
Synergy = PV (CostSavings )
Synergy is sometimes referred to as Gain
 Share issue
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NetGain = PV (Costsavings ) − NetCost

NetCost = GrossCost − PVT arg et

N
GrossCost =  V( AB )
N + N 0
 Cash offer
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NetGain = PV (Costsavings ) − NetCost

NetCost = Cashoutlay − PVT arg et

Conclusion:
For the merger to proceed the net gain for a
proposal should be positive i.e. NPV should be
positive for the merger to be on interest of
acquiring company.
 Example 1.1
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 There has been a considerable speculation in the

financial press about the possibility of a takeover
occurring for ABC Plc. The share price has increased
over the last few weeks from TZS1500 to TZS1700
when the overall market index has remained
unchanged. The market has identified a number of
possible bidders but there has been no mention in the
press of any interest of XYZ Plc. in mounting a
takeover. XYZ plc. produces a similar range of
products to those of ABC Plc., and its management
believes it would be feasible to produce cost savings
in ABC’s operations with a present value of TZS120M.
 Example 1.1 ...
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 XYZ is considering a bid in the form of its own shares.

Its current share price is TZS400 and is confident that
an offer of two in XYZ Plc for every four in ABC will be
successful. XYZ has 200 million shares outstanding
whereas ABC has issued 100 million shares.
i) Calculate the value of the group
ii) If XYZ plc makes a bid on the terms suggested, is the
takeover likely to be in the interest of its shareholders?
iii) If instead of a share offer, XYZ plc proposes a cash offer
of TZS1300 per share; will this be preferable to its
shareholders?
22

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