This PhD thesis investigates sources of value in mergers and acquisitions, using a discounted cash-flow valuation method to develop a model that explains sources of economic gains. The model identifies three major sources of value in mergers, each of which can reduce or contribute to the combined wealth effect of a takeover deal. The overall value of the acquisition deal is a sum of the impacts of these factors on the combined value.
The research significantly contributes to new knowledge regarding the sources of economic benefit in a merger. There are implications for researchers, practitioners and teachers. This research significantly contributes new knowledge on sources of value in mergers. Future research about mechanisms through which mergers create or destroy value flows from analysis and findings of this thesis. Moreover, using the model developed in this study, shareholders, investors, and analysts can make a more accurate estimation of value effects of mergers. This also helps investors and shareholders of the merging firms to make better investment decisions.
Policy makers will also find the results of this study helpful. Although findings of the study suggest an actual value creation in mergers, it seems that a significant amount of value transfers from acquirer bondholders to target bondholders. This observation has implications for policy makers to regulate the market for corporate control in a way that minimises expropriation of wealth. The formulas and empirical findings of this thesis will also enrich the teaching agenda of corporate finance.
The model developed in this thesis suggests that the combined value effect of mergers can be broken down into three parts: (1) earnings synergies discounted at the rate of the WACC of the combined firm; (2) value effect of the difference between the WACCs of the combined firm and the acquirer; and (3) the difference between the WACCs of the combined firm and the target.
In any given merger, each of these components may add to or deduct from the total value of the merger. Moreover, the combined value of an acquisition estimated using this model might be negative, suggesting that the acquisition destroys value, or positive, suggesting that the acquisition creates value. The explanation of how mergers can be value creating, or value destroying, observes that the difference between the combined firm’s weighted average cost of capital and that of the acquirer and the target, along with the operating synergies, can account for total value effects of mergers.
In the second stage, a sample of 68 US acquisitions during the period 1998 to 2011 is employed to empirically decompose the total value effect of acquisitions (TVA) as suggested by the model. This study uses the mean I/B/E/S forecasts for stand-alone acquirer and target firms prior to the acquisition and forecasts for the combined firm in the month subsequent to the acquisition’ month in order to estimate changes in forecasted earnings that occur following an acquisition. These forecasts are also used to estimate implied cost of equity of the firms prior and subsequent to acquisitions. Since I/B/E/S forecasts are typically one month apart, any change in the forecasts can be attributed to the impact of the acquisition.
The empirical analysis provides important findings regarding the relative importance of the three components of the model suggested by this study. Specifically, the evidence provided in this study show that earnings synergies and the difference between the WACCs of the combined firm and the acquirer have a more significant role in value creation through mergers compared to the value effect of the difference between the WACCs of the combined firm and the target. Empirical evidence provided in this research shows that the combined value effect of acquisitions is positive, around 4%, on average. Aside from that, the results suggest that the two first components of the model account for more than 90% of value effect of acquisitions.
While much emphasis is put on synergy gains from acquisitions by managers, analysts and researchers, the evidence provided in this study shows that the WACC of the combined firm and the merging firms may have a significant role on the value effect of mergers. These findings suggest that changes in the capital structure of the combined firm, compared to capital structures of the acquirer and the target, play a key role in determining the value of an acquisition. For example, all the value created because of synergies between the operations of the acquirer and the target can be counterbalanced by raising too much debt for financing the acquisition, which in turn increases the risk of default and cost of capital of the combined firm. Moreover, reducing the cost of capital of the combined firm compared to the merging firms, is value creating even in the absence of operating synergies.
The empirical evidence provided in this study shows that the component of value associated with the difference between the WACCs of the combined firm and the acquirer is mainly determined by leverage of the acquiring firm and the method of payment. While cash payment is value creating, high leverage of the acquirer prior to an acquisition can destroy value by raising the cost of capital of the firm too much. This is especially important to managers when they are planning an acquisition.
Although an acquisition might potentially create significant synergies in earnings, it may also increase the WACC of the combined firm. As a result, total value created or destroyed in that merger will depend on the extent to which value creating components and value-destroying components of an acquisition counteract and neutralise each other. In other words, the value created because of synergies in earnings might be countervailed, for example, by raising too much debt for financing the acquisition which in turn increases cost of capital to a value-destroying level.
Finally, univariate and regression analyses are used to further investigate the relationship between components of the TVA and a number of acquirer and deal characteristics that are suggested to affect value of acquisitions. The results suggest that diversifying mergers create negative synergies in earnings and destroy value this way. However, diversification does not reduce the WACC of the combined firm compared to the WACC of the acquirer. Moreover, cash payments and lower levels of debt in the capital structure of the acquirer reduce the WACC of the combined firm and create value.
By developing a model that creates a novel framework for decomposing value effects of merges, by documenting the relative importance of the components of the model, and by documenting how acquirer and deal characteristics affect value of acquisitions, this dissertation opens up opportunities for future investigations.