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---- Chapter 17 ---- International Takeovers and Restructuring © 2001 Prentice Hall Takeovers, Restructuring, ---- Chapter 17 ---- International Takeovers and Restructuring © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1

Background • Significant proportion of total takeover activity has an international dimension © 2001 Background • Significant proportion of total takeover activity has an international dimension © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 2

 • Main reasons for large increase in foreign M&A activity – Europe is • Main reasons for large increase in foreign M&A activity – Europe is moving toward a common market – Globalization and increased intensity of international competition – Rapid technological change – Consolidation of major industries © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 3

Historical and Empirical Data • U. S. acquisitions of foreign businesses • Foreign acquisitions Historical and Empirical Data • U. S. acquisitions of foreign businesses • Foreign acquisitions of U. S. companies © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 4

 • Dollar values of foreign acquisitions of U. S. targets have exceeded U. • Dollar values of foreign acquisitions of U. S. targets have exceeded U. S. acquisitions of foreign targets • For 25 largest cross border transactions in history completed as of 12/31/99 – Transactions involving U. S. targets amounted to $305. 1 billion – Transactions involving U. S. acquirers amounted to $105. 4 billion – Transactions involving only foreign companies amounted to $229. 6 billion © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 5

 • Major reasons for cross border transactions – Combine complementary capabilities – Strengthen • Major reasons for cross border transactions – Combine complementary capabilities – Strengthen distribution networks – Achieve critical mass required for new approaches to R&D, production, etc. • Industry characteristics related to M&A pressures – Telecommunications • Technological change • Deregulation • Efforts to develop a global presence © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 6

– Media • Technological change in content and delivery • Overlap in content of – Media • Technological change in content and delivery • Overlap in content of different media outlets • Attractive and glamorous industry – Financial • Globalization • Serve clients globally – Chemicals, pharmaceuticals • • High amount of R&D Rapid imitation Rapid changes in technology High risks due to competitive pressures © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 7

– Autos, oil & gas, industrial machinery • Advantage of size — critical mass – Autos, oil & gas, industrial machinery • Advantage of size — critical mass • Global excess capacity • Oil price and supply instability – Utilities • Deregulation • Geographic expansion • Broadening of managerial capabilities – Food, retailing • Slower growth • Seek growth in new international markets – Natural resources, timber • Exhausting sources of supply • Match raw material supplies with manufacturing capacity © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 8

Forces Driving Cross Border Mergers • Growth – Most important motive – U. S. Forces Driving Cross Border Mergers • Growth – Most important motive – U. S. highly regarded by foreign markets – U. S. firms have looked abroad to countries in relatively earlier faster-growing stages of life cycle — especially U. S. food companies – Enable medium-sized firms to attain size necessary to improve their competitiveness – Achieve size necessary for economies of scale; for effective global competition © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 9

 • Technology – Impact on international mergers • Technologically superior firm may exploit • Technology – Impact on international mergers • Technologically superior firm may exploit its technological advantage worldwide • Technologically inferior firm may acquire technologically superior target to enhance competitive position – Technological superiority tends to be more portable • No cultural baggage • Acquirer may select technologically inferior target — improve target competitive position and profitability • Buy into foreign markets to exploit their technological knowledge advantage © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 10

 • Value increasing acquisitions – Acquiring firm may have an advantage in general • Value increasing acquisitions – Acquiring firm may have an advantage in general management functions such as planning and control or research and development – Specific management functions such as marketing or labor relations tend to be environment specific • Not readily transferable • May explain predominance of U. K. and Canada as international merger partners of U. S. © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 11

 • Extend advantages in differentiated products – Strong correlation between multinationalization and product • Extend advantages in differentiated products – Strong correlation between multinationalization and product differentiation – Firms that have developed a reputation for superior products in domestic market may also find acceptance for their products in foreign markets © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 12

 • Roll-ups — combine firms in fragmented industries • Consolidation — adjust to • Roll-ups — combine firms in fragmented industries • Consolidation — adjust to worldwide excess capacity • Government policy – Circumvent tariffs and quotas on imports or exports – Avoid restrictions that may protect a large lucrative market – Environmental and other regulations can increase cost of building de novo facilities – Response to changes in government policy and regulations © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 13

 • Exchange rates – Affect prices of foreign acquisitions, cost of doing business • Exchange rates – Affect prices of foreign acquisitions, cost of doing business abroad – Affect value of repatriated profits to the parent – Exchange rate risk management becomes important © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 14

 • Political/Economic stability – Can alleviate or exacerbate higher risks inherent in operating • Political/Economic stability – Can alleviate or exacerbate higher risks inherent in operating abroad – Political factors • • Changes in administrations in power Likelihood of government intervention Risk of expropriation War vs. peace © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 15

– Economic factors • • • Low or at least predictable inflation Labor relations – Economic factors • • • Low or at least predictable inflation Labor relations climate Stability of exchange rates Depth and breadth of financial markets Transportation and communications networks – U. S. market attractive to foreign investors in terms of political/economic factors © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 16

 • To follow clients – Importance of long-term client relationships – Example: Financial • To follow clients – Importance of long-term client relationships – Example: Financial firms expand abroad to retain clients who have expanded abroad • Diversification – Provide diversification • Product line • Geographically – Systematic risk reduction possible if world economies are not perfectly correlated © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 17

Premiums Paid • Foreign bidders pay higher premiums to acquire U. S. companies than Premiums Paid • Foreign bidders pay higher premiums to acquire U. S. companies than premiums paid in all acquisitions • Harris and Ravenscraft (1991) – Sample of companies between 1970 -1987 – Foreign bidder pays higher premia by 10 percentage points – High foreign currency values led to increased premia © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 18

– Foreign buyers concentrate on R&D intensive industries when they buy U. S. firms – Foreign buyers concentrate on R&D intensive industries when they buy U. S. firms — intensity is 50% higher than in purely domestic transactions – U. S. bidders earn only normal returns in both domestic and cross-border acquisitions • For period 1987 -1998, premiums in foreign acquisitions exceeded all acquisitions by about 5 percentage points © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 19

 • Possible reasons – Foreign buyers may offer higher premium to preempt potential • Possible reasons – Foreign buyers may offer higher premium to preempt potential domestic bidders – U. S. targets have less knowledge of foreign buyers and need higher premiums to resolve uncertainty – If foreign currencies are strong, can afford to pay more in dollars – If prospective future exchange rate movements favor the U. S. dollar, foreign firms must pay more in dollars © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 20

Event Returns • General results – Similar results as domestic transactions – Targets receive Event Returns • General results – Similar results as domestic transactions – Targets receive large abnormal returns – Buyers earn nonsignificant returns © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 21

 • Doukas and Travlos (1988) – Positive abnormal returns for U. S. multinational • Doukas and Travlos (1988) – Positive abnormal returns for U. S. multinational enterprises with no previous operation in target firm's country – Positive but not significant when U. S. firms expand internationally for first time – Negative but not significant for U. S. firms that have already been operating in target's home country – Greatest benefits from foreign acquisitions when there is simultaneous diversification across industry and geography © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 22

 • Harris and Ravenscraft (1991) – Sample of 1, 273 U. S. firms • Harris and Ravenscraft (1991) – Sample of 1, 273 U. S. firms acquired in 1970 -1987 – 75% of cross-border transactions, buyer and seller not in related industries – Takeovers more frequent in R&D intensive industries than are domestic transactions – Percentage gain to U. S. targets of foreign buyers significantly higher than targets of U. S. buyers – Cross-border effects positively related to weakness of U. S. dollar © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 23

 • Kang (1993) – Japanese takeovers of U. S. firms – Significant wealth • Kang (1993) – Japanese takeovers of U. S. firms – Significant wealth gains for both Japanese bidders and U. S. targets – Returns increase with • Leverage of bidder • Bidder's ties to financial institutions • Depreciation of dollar in relation to Japanese yen © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 24

 • Dewenter (1995) – Controls for relative corporate wealth and levels of investments • Dewenter (1995) – Controls for relative corporate wealth and levels of investments in different countries – Finds no significant relationship between exchange rate levels and foreign investment relative to domestic investments in U. S. chemical and retail industries © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 25

 • Eun, Kolodny, and Scheraga (1996) – 225 foreign acquisitions of U. S. • Eun, Kolodny, and Scheraga (1996) – 225 foreign acquisitions of U. S. firms during 1979 -1990 – For eleven-day window, [-5, +5], CAR was a positive 37. 02% and significant for whole sample of U. S. targets – Firms acquired by firms from other countries than Japan had CARs between 35% and 37% © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 26

 • Cakici, Hessel, and Tandon (1996) – 195 foreign acquisitions of U. S. • Cakici, Hessel, and Tandon (1996) – 195 foreign acquisitions of U. S. firms during 1983 -1992 – Sample compared to 112 U. S. acquisitions of foreign firms – Foreign acquiring firms experienced positive and significant CARs of 0. 63% for event period [0, +1] and 1. 96% for period [-10, +10] – U. S. acquirers had negative but not significant CARs of -0. 36% for event period [0, +1] and -0. 25% for period [-10, +10] © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 27

 • Doukas (1995) – 234 U. S. bidding firms involved in 463 international • Doukas (1995) – 234 U. S. bidding firms involved in 463 international acquisitions during 1975 -1989 – Study relationship between bidders' gains and its q ratios – Value maximizing firms (q ratios > 1), CAR was positive and significant 0. 41% for window [-1, 0] – Overinvested firms (q ratio < 1), CAR was negative and insignificant -0. 18% – Negative relationship between dollar exchange rate and level of foreign direct investment – Method of payment and industry relatedness not significant © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 28

 • Seth, Song, and Pettit (1999) – 100 cross-border acquisitions of U. S. • Seth, Song, and Pettit (1999) – 100 cross-border acquisitions of U. S. targets during 1981 -1990 – For event window [-10, +10], CAR for acquirers was an insignificant 0. 11%, CAR for targets was significant 38. 3% © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 29

International Joint Ventures • Advantages – May be only feasible method of obtaining raw International Joint Ventures • Advantages – May be only feasible method of obtaining raw materials – May involve different capabilities and link together complementary skills – Local partners may reduce risks involved in operating in foreign country – May be necessary to overcome foreign government restrictions © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 30

– May enhance advantages found in domestic joint ventures such as economies of scale – May enhance advantages found in domestic joint ventures such as economies of scale and may provide basis for faster growth rate – Knowledge acquisition potentials can be substantial • Disadvantages – Provide information which makes partner a future competitor – Different cultures may increase tensions normally found in joint ventures © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 31

 • Principles for management of successful collaborations – Should involve complementary capabilities – • Principles for management of successful collaborations – Should involve complementary capabilities – Contracts should make it easy to terminate relationship – Control and ultimate decision makers should be specified – Formulate terms under which one company can buy out other – Activities and information flows should be tied into normal communications structures © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 32

– Criteria for evaluation of performance should be defined – Allocation of rewards and – Criteria for evaluation of performance should be defined – Allocation of rewards and responsibilities under different types of outcomes should be considered © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 33

 • Chen, Hu, and Shieh (1991) – Sample of 88 international joint ventures • Chen, Hu, and Shieh (1991) – Sample of 88 international joint ventures – Significant positive portfolio excess returns when U. S. firms invest relatively small amounts in joint venture – Excess returns no longer significant when firms make relatively large investments © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 34

 • Mangum, Kim, and Tallman (1996) – Summary data on investments by 7 • Mangum, Kim, and Tallman (1996) – Summary data on investments by 7 foreign steel makers in U. S. joint ventures – In-depth case studies of 7 joint ventures • Foreign partners mainly form Japan • Initial motive was availability of foreign capital for modernizing U. S. steel industry • Another main objective was transfer superior process technologies of Asian partners to American plants • Tension from cross-cultural differences • Joint ventures generally successful • Only joint venture that experienced great difficulties — NKK of Japan and National Steel Corporation of the U. S. © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 35

Cost of Capital in Foreign Acquisitions and Investments • Main concepts – Fundamental international Cost of Capital in Foreign Acquisitions and Investments • Main concepts – Fundamental international parity or equilibrium relationships — related to cost of debt of domestic and foreign firm – Issues of whether global capital markets are integrated or segmented — related to cost of equity capital in different countries © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 36

 • Cost of Debt Relationships – International parity relationships assume perfect and efficient • Cost of Debt Relationships – International parity relationships assume perfect and efficient markets • • Financial markets are perfect Goods market are perfect Future is known with certainty Markets are in equilibrium © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 37

– Interest rate parity theorem (IRPT) • Ratio of forward and spot exchange rates – Interest rate parity theorem (IRPT) • Ratio of forward and spot exchange rates equal current ratio of foreign and domestic nominal interest rates where Xf = current forward exchange rate expressed as number of foreign currency units (FC) per dollar X 0 = current spot exchange rate expressed as FC per dollar Rf 0 = current foreign nominal interest rate Rd 0 = current domestic nominal interest rate Ef = current forward exchange rate expressed as dollars per FC E 0 = current spot exchange rate expressed Takeovers, Restructuring, and Corporate Governance, 3/e per FC as dollars © 2001 Prentice Hall Weston - 38

– Forward parity theorem (FPT) • Current forward foreign exchange rates should be unbiased – Forward parity theorem (FPT) • Current forward foreign exchange rates should be unbiased predictors of future spot rates • Current forward rate, Xf , should equal future spot rate, X 1 © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 39

– Purchasing power parity theorem (PPPT) • Expression of the law of one price – Purchasing power parity theorem (PPPT) • Expression of the law of one price • In competitive markets, exchange-adjusted prices of identical tradable goods and financial assets must be equal worldwide (taking account of information and transaction costs) © 2001 Prentice Hall = 1 + foreign country inflation Td rate where Tf = 1 + domestic inflation rate Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 40

– International Fisher relation (IFR) • Nominal interest rates reflect anticipated rate of inflation – International Fisher relation (IFR) • Nominal interest rates reflect anticipated rate of inflation where T r Rn = = = 1 + rate of inflation real rate of interest nominal rate of interest • If other parity relations hold, real rates will be the same across countries, but nominal rates will differ by the countries' inflation factors © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 41

 • Notes on parity relationships – In the shortrun, many real world frictions • Notes on parity relationships – In the shortrun, many real world frictions cause departures from parity conditions – In the longrun, international financial markets move toward parity relationships – Hedging foreign exchange risk • Futures markets • Borrowing in foreign markets foreign projects • Conducting manufacturing operations in multiple countries • Making sales in multiple countries © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 42

Cost of equity and cost of capital • Capital asset pricing model (CAPM) © Cost of equity and cost of capital • Capital asset pricing model (CAPM) © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 43

 • Market definition – Integrated global markets — investments are made globally and • Market definition – Integrated global markets — investments are made globally and systematic risk is measured relative to world market index – Segmented capital markets — investments are predominantly made in particular segment or country and systematic risk is measured relative to domestic index • World is moving toward a globally integrated capital market © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 44

 • There is still a home bias phenomenon — investors place only a • There is still a home bias phenomenon — investors place only a relatively small part of their funds abroad – Extra costs of obtaining and digesting information – Greater uncertainty associated with foreign investments © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 45

 • If capital markets are not fully integrated – Gains from international diversification • If capital markets are not fully integrated – Gains from international diversification – Multinational corporation (MNC) would apply to foreign investment a lower cost of capital than would a local (foreign) company – MNC will have a cost of equity capital related to beta measured with respect to markets in which it operates © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 46

 • Procedure – Cost of equity for a foreign investment in nominal foreign • Procedure – Cost of equity for a foreign investment in nominal foreign currency terms should reflect risk differential above cost of debt borrowing in that foreign country – Cost of capital calculated based on an estimated leverage ratio and tax rate – Cash flows expressed in foreign currency units (FC) discounted by the FC cost of capital gives present value expressed in FC – Present value in FC can be converted to dollars at the spot exchange rate to give net present value of investment in dollars © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 47

 • Similar alternate procedure – Begin with expected cash flows in FC – • Similar alternate procedure – Begin with expected cash flows in FC – Adjust expected cash flows by risk factors that reflect foreign country's risk – Convert risk-adjusted expected FC cash flows to dollars over time by using expected foreign exchange rates at time t based on interest rate parity and relative inflation rates – Discount dollar cash flows by WACC of U. S. firm © 2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 48