Question 2.

In a surprise announcement, ABC plc makes a stock-and-cash offer to acquire a product market competitor XYZ plc: ABC plc offers 0.75 shares in the merged entity for each XYZ plc share, plus $2.75 per XYZ plc share in cash. ABC plc has earnings per share of $5 and 8 million shares outstanding, each of which has price of $25. XYZ plc has earnings per share of $8 and 3 million shares outstanding, which are traded at $16 per share. Both firms have no debt. In questions (a)-(d), assume that, once the acquisition is announced, the acquisition will be completed with certainty: all market participants are informed of this on the announcement day.

a) Assume there are no synergies. Is the acquisition a positive NPV investment for the acquirer? Explain in two lines. (4 marks)

b) Assume there are no synergies. What is the premium received by XYZ plc shareholders at current prices? What is the actual premium they will be getting? Does the acquisition benefit the target shareholders? (6 marks)

c) Assume there are no synergies. Calculate earnings per share (EPS) of the combined entity after the merger. Explain why it is wrong to focus only on expected EPS in your valuation of mergers and acquisitions. (6 marks)

d) Assume now synergies are equal to > 0. What is the minimum level of synergies such that target shareholders benefit from the acquisition? What is the minimum level of synergies such that the acquirer shareholders benefit from the acquisition? (10 marks)

e) Assume now that merger is subject to the EU merger control regulations. After the deal is announced the market assigns a probability 54% to the deal being cleared by the EU and completed. Prices react to the offer announcement in the following way: the stock price of ABC plc jumps to $25.8 and the stock price of XYZ plc jumps to $18.1. From the stock market price reaction infer what synergies are expected by the market in case the merger is completed. Then establish whether the merger is a positive NPV investment. (10 marks)