Question

(A) Marriott International is buying rival hotel chain Starwood in a deal that will secure its position as the world's largest hotelier. What type of merger is this deal? What are some possible sources of synergy for this type of deal? The Marriott-Starwood deal is friendly. If it were a hostile takeover, what defensive tactics would Starwood have taken to defend itself?

(B) Martin Manufacturing has earnings per share (EPS) of \$3.00, 5 million shares outstanding, and a share price of $32. Martin is considering buying Luther Industries, which has EPS of $2.50,2 million shares outstanding, and a share price of $20. Martin will pay for Luther by issuing new shares. Answer the following questions:
(1) Assuming no synergy expected from the transaction and no premium paid to Luther, what is the exchange ratio? How many new shares will Martin issue? How much of the combined company will Martin shareholders own? What will be the percentage of ownership for Luther shareholders? What will be EPS after the merger? Calculate Martin's price-earnings ( P/E) ratio both pre- and post-merger.
(2) If the projected synergies are $50 million and no premium is paid, what will be Martin's share price after the merger?
(3) If the projected synergies are $50 million and 50% premium is paid, how many new shares will Martin issue? What is the percentage of ownership of the combined company to Martin shareholders? To Luther shareholders? Is any wealth transfer between two companies' shareholders? What will be Martin's share price after the merger?
(2) If the projected synergies are $50 million and no premium is paid, what will be Martin's share price after the merger?
(3) If the projected synergies are $50 million and 50% premium is paid, how many new shares will Martin issue? What is the percentage of ownership of the combined company to Martin shareholders? To Luther shareholders? Is any wealth transfer between two companies' shareholders? What will be Martin's share price after the merger?
(C) Firm Target's one million shares of stock currently sell for $20 each. Firm Acquirer estimates that the merger will save the merged firm $1 million per year in production costs for ever. The opportunity cost of capital is 10%. Acquirer is prepared to offer $22 cash for each share of Target. Answer the following questions (ignoring taxes):
(1) How much is the economic gain from this merger? What percent of the merger gain will be captured by Target's shareholders? What's the NPV of this deal for Acquirer?
(2) If Acquirer's two million shares sell for $40 each before the merger, what will these shares sell for after the merger?
(3) Instead of paying cash, Acquirer issues 0.55 of its shares for every Target share acquired. What will be the price of the merged firm? What is the NPV of the merger to Acquirer when it uses an exchange of share?
(4) What fraction of the economic gain do Acquirer shareholders receive? What fraction do Target shareholders receive? Why does your answer differ from part (1)?

Answer 1

(A) The Marriott-Starwood deal is an example of an acquisition or a horizontal merger. In this type of merger, two companies in the same industry and at the same stage of production combine to form a larger company.

Some possible sources of synergy for this type of deal include:
- Increased market power: The combined company can have a stronger position in the market, which may lead to higher pricing power and increased market share.
- Cost savings: By combining operations, the company can eliminate duplicate functions and achieve economies of scale, resulting in cost savings.
(B) (1) To calculate the exchange ratio, we need to compare the EPS of Martin Manufacturing and Luther Industries. The exchange ratio is determined by dividing the EPS of Martin by the EPS of Luther: \$3.00 / \$2.50 = 1.2.

The number of new shares Martin will issue is determined by multiplying the exchange ratio by the number of shares outstanding for Luther Industries: 1.2 x 2 million = 2.4 million new shares.

To calculate the ownership percentage for Martin shareholders, divide the number of shares Martin will have after the merger by the total number of shares outstanding: (5 million + 2.4 million) / (5 million + 2 million) = 0.692 or 69.2%.

The ownership percentage for Luther shareholders is calculated by dividing the number of shares Luther will have after the merger by the total number of shares outstanding: 2 million / (5 million + 2 million) = 0.308 or 30.8%.

The pre-merger P/E ratio for Martin is calculated by dividing the share price by the EPS: \$32 / \$3.00 = 10.67.

The post-merger P/E ratio for Martin is calculated by dividing the share price by the EPS after the merger: \$32 / \$2.79 = 11.47.

(2) To calculate Martin's share price after the merger, we need to consider the projected synergies of \$50 million. Assuming no premium is paid, we can divide the total synergies by the number of shares outstanding for Martin: \$50 million / 5 million = \$10 per share. Thus, Martin's share price after the merger would increase to \$32 + \$10 = \$42.

(3) If a 50% premium is paid and the projected synergies are \$50 million, we need to calculate the number of new shares Martin will issue. The premium is calculated by multiplying the share price of Luther by the premium percentage: \$20 x 50% = \$10. The new share price for Luther would be \$20 + \$10 = \$30.

The number of new shares Martin will issue is determined by dividing the premium amount by the share price of Martin: \$10 / \$32 = 0.3125.

The ownership percentage for Martin shareholders is calculated by dividing the number of shares Martin will have after the merger by the total number of shares outstanding: (5 million + 0.3125 million) / (5 million + 2 million) = 0.722 or 72.2%.

The ownership percentage for Luther shareholders is calculated by dividing the number of shares Luther will have after the merger by the total number of shares outstanding: 2 million / (5 million + 2 million) = 0.278 or 27.8%.

Wealth transfer between the two companies' shareholders occurs because the premium paid by Martin results in Luther shareholders receiving a higher value for their shares

(C) (1) To calculate the economic gain from this merger, we need to subtract the cost of the acquisition from the savings generated by the merger. The economic gain is \$1 million - \$22 million = \$-21 million (negative value indicates a loss).

To determine the percent of the merger gain captured by Target's shareholders, we divide the economic gain by the cost of the acquisition: \$21 million / \$22 million = 0.955 or 95.5%.

To calculate the NPV of this deal for Acquirer, we need to discount the savings generated by the merger using the opportunity cost of capital. The NPV is calculated as follows: \$1 million / (1 + 0.10) = \$0.909 million.

(2) If Acquirer's two million shares sell for $40 each before the merger, we need to determine the share price after the merger. Since the merger is expected to save $1 million per year in production costs, the additional value per share is calculated as follows: \$1 million / 2 million shares = \$0.50. The share price after the merger would be \$40 + \$0.50 = \$40.50.

(3) If Acquirer issues 0.55 of its shares for every Target share acquired, we need to determine the price of the merged firm. The price is calculated by multiplying the number of Acquirer shares issued by the share price of Acquirer: 0.55 x 2 million shares x \$40 = \$44 million.

(4) The fraction of the economic gain received by Acquirer shareholders is determined by dividing the economic gain by the cost of the acquisition: \$21 million / \$22 million = 0.955 or 95.5%.

The answer differs from part (1) because in part (1), we calculated the percentage captured by Target's shareholders based on the cost of the acquisition, while in part (4), we calculated the fraction of the economic gain received by Target shareholders based on the economic gain.