Chapter 2

1. 1.  Mark L. Mitchell and Kenneth Lehn, “Do Bad Bidders Become Good Targets?,” Journal of Political Economy 98, no. 2 (1990): 372–398. See also Jeffrey W. Allen, Scott L. Lummer, John J. McConnell, and Debra K. Reed, “Can Takeover Losses Explain Spin-Off Gains?,” Journal of Financial and Quantitative Analysis 30, no. 4 (1995): 465–485.

2. 2.  For the more complete story of Amazon, see Brad Stone, The Everything Store: Jeff Bezos and the Age of Amazon (New York: Little, Brown, 2013). Data source for deals: AlphaSense search engine, as of August 2020. See also Zoe Henry, “Amazon Has Acquired or Invested in More Companies Than You Think,” Inc., May 2017, https://www.inc.com/magazine/201705/zoe-henry/will-amazon-buy-you.html; “Infographic: Amazon’s Biggest Acquisitions,” CBInsights, June 19, 2019, https://www.cbinsights.com/research/amazon-biggest-acquisitions-infographic/.

3. 3.  Laura Stevens and Annie Gasparro, “Amazon to Buy Whole Foods for 13.7 Billion,” Wall Street Journal, June 16, 2017, https://www.wsj.com/articles/amazon-to-buy-whole-foods-for-13-7-billion-1497618446; Amazon, “Amazon.com Announces Minority Investment in Homegrocer.com,” press release, May 18, 1999, https://press.aboutamazon.com/news-releases/news-release-details/amazoncom-announces-minority-investment-homegrocercom. The Piper Jaffray analyst comment appears in Robert D. Hof, “Jeff Bezos’ Risky Bet,” Bloomberg Businessweek, November 13, 2006.

4. 4.  On the Kindle figure, see Consumer Intelligence Research Partners, 2013, as cited in “Kindle Device Owners Spend 55% More Every Year with Amazon,” https://www.geekwire.com/2013/kindle-owners-spend-55-amazon-study/.

5. 5.  Steven Levy summarized Amazon’s acquisition of Evi in “Inside Amazon’s Artificial Intelligence Flywheel,” Wired, February 1, 2018, https://www.wired.com/story/amazon-artificial-intelligence-flywheel/.

6. 6.  Tara-Nicholle Nelson, “Obsess over Your Customers, Not Your Rivals,” hbr.org, May 11, 2017, https://hbr.org/2017/05/obsess-over-your-customers-not-your-rivals.

Chapter 3

1. 1.  For example, the seller might have disposed of a business through a purported tax-free spin-off that wasn’t executed properly, thus resulting in actual unpaid tax liabilities the buyer would be stepping into.

2. 2.  Subsequent adjustments might include such issues as allowance for doubtful accounts, obsolete inventory reserves, litigation, restructuring charges, severance, closing costs for facilities, or lease payments on closed stores.

3. 3.  In the past, if an acquirer discovered that one of the target’s representations or warranties was false, they would go after the seller for the claimed damages, which may or may not be recoverable through an escrow account. Today, acquirers purchase insurance policies so they can put in an insurance claim. As part of the insurance underwriting process, the underwriters will want to read all the diligence reports and exclude facts that were identified in diligence.

4. 4.  This quote comes from Charles Shoemate, former CEO of Bestfoods.

5. 5.  Net Promoter Scores are a popular metric for assessing customer sentiment—a dimension of stickiness—of brands or particular products. Typically executed through an online survey, respondents are asked to score, “How likely are you to recommend Product X to a friend or colleague?” on a scale of 1–10 (10 being the highest), and the Net Promoter Score is the percentage of promoters less the percentage of detractors.

Chapter 4

1. 1.  This chapter has been adapted from Mark Sirower and Stephen O’Byrne, “The Measurement of Post-Acquisition Performance: Toward a Value-Based Benchmarking Methodology,” Journal of Applied Corporate Finance 11, no. 2 (Summer 1998): 107–121.

2. 2.  Enterprise value is generally defined as market capitalization of the equity + net debt + preferred shares + minority interests.

3. 3.  Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985). This was a landmark judgment against Van Gorkom and the directors of the Trans Union Corporation. In a meeting lasting only two hours, the directors approved a leveraged buyout offer presented as fair by Van Gorkom, owner of 75,000 shares of the company. The court found the directors grossly negligent because they did not make an informed decision. Specifically, the directors did not seek to inform themselves as to Van Gorkom’s motives, they did not adequately inform themselves as to the intrinsic value of the company, and the decision was made in a two-hour meeting in the absence of an emergency situation. See M. R. Kaplan and J. R. Harrison, “Defusing the Director Liability Crisis: The Strategic Management of Legal Threats,” Organization Science 4, no. 3 (1994): 412–432.

4. 4.  Warren Buffett in the 1981 Berkshire Hathaway Annual Report.

5. 5.  On EVA, see G. Bennett Stewart, The Quest for Value: A Guide for Senior Managers (New York: HarperCollins, 1991); and S. David Young and Stephen F. O’Byrne, EVA and Value-Based Management: A Practical Guide for Implementation (New York: McGraw-Hill, 2000). For extensive discussion of EVA Math, see Stephen O’Byrne, “A Better Way to Measure Operating Performance (or Why EVA Math Really Matters),” Journal of Applied Corporate Finance 28, no. 3 (2016): 68–86.

6. 6.  Merton H. Miller and Franco Modigliani, “Dividend Policy, Growth, and the Valuation of Shares,” Journal of Business 34, no. 4 (1961): 411–433.

7. 7.  See Stephen F. O’Byrne, “EVA and Market Value,” Journal of Applied Corporate Finance 9, no. 1 (1996): 116–126.

8. 8.  In this example, we have held capital constant from the prior year. Where there is an increase in capital from the prior year, maintaining current EVA will require an increase in NOPAT to compensate for the additional capital charge and thus, maintaining current EVA (with the commensurate increase in NOPAT) will provide a cost-of-capital return on COV but no return on FGV. In our model, only maintaining current EVA implies that ΔEVA = 0.

9. 9.  Using EVA math, c × FGV = ΔEVA + ΔEVA/c + ΔFGV; thus, with constant FGV yields:

c × FGV = ((1 + c)/c) × ΔEVA, or ΔEVA = c × FGV/((1 + c)/c). (See appendix C for additional details.)

1. 10.  We use the weighted average WACC as a good approximation. There are more technical approaches where we would go through an exercise of unlevering the “betas” in the cost of equity of each company and then relevering to calculate a new beta, based on the new capital structure of the combined company, and arrive at the new WACC for the pro-forma merger. See Susan Chaplinsky, “Methods of Valuation for Mergers and Acquisition,” Darden Graduate School of Business, University of Virginia, 2000 (Case: UVA-F-1274).

2. 11.  This is a simplified example where the WACCs of both companies are the same and beginning capital is unchanged from the prior year for both companies. And, in all tables, we refer to capitalized present value of expected EVA improvements simply as “Capitalized PV of expected EVA improvements.”

3. 12.  This method is discussed in Sirower and O’Byrne, “Measurement of Post-Acquisition Performance.” Calculating new current EVA by taking a capital charge as if the combined acquirer and target had all the new capital on its balance sheet in the prior year—that is, including the market value of the target plus the premium along with the acquirer’s prior year beginning capital—effectively creates a “pro-forma base year.” That is, we create a level playing field for future EVA improvements such that the capital charge in future ΔEVAs is only impacted by the change in the acquirer’s capital from the prior year and additional capital growth following the acquisition. Otherwise, the first year ΔEVA would have a huge negative impact because of the large capital increase from the deal. The name of the game is improvements.

4. 13.  New COV = Homeland COV + Affurr COV = 3,900 + 1,200 = 5,100; New FGV = Homeland FGV + Affurr FGV = 1,100 + 800 = 1,900.

5. 14.  To be precise, the value is actually 24.545, which we rounded down for simplicity so that 17.27 + 7.27 = 24.54.

6. 15.  Please note that we are using prior year beginning capital to calculate current EVA (NOPAT less the capital charge). So, for Future, current EVA is (1,889.34 − (32,009.84 × 0.08)) = −671.45 and for Cabbãge, current EVA is (3,151.33 − (29,888.60 × 0.076)) = 879.80. We round each calculation to two decimal places.

7. 16.  We used market values for the weighted average WACC. For the denominator we used (40,924.41 + 45,799.24 + 10,000) = 96,723.65, which is Future’s total market value plus Cabbãge’s total market value plus the premium. The numerator for Future at its 8% WACC is 40,924.41 (its market value), and the numerator for Cabbãge at its 7.6% WACC is 55,799.24 (its market value plus the premium).

8. 17.  For those of you who are following through in Excel, we have rounded to two decimal places after each step. In either case we arrive at the same answers except for “Expectations of ΔEVA driven up using our method” value, which would round to 57.41 instead of 57.42.

9. 18.  The sum of the independent COVs is not equal to the new COV from our method because the former is calculated on the target’s prior beginning capital whereas the new COV effectively assumes the target, and ultimately the acquirer, had all the capital (market value and the premium) on its balance sheet in the prior year; the usefulness of creating this “pro-forma base year” is that the first year ΔEVA is only impacted by the change in the acquirer’s prior year capital and changes in NOPAT. The new COV is also impacted by the new (weighted average) WACC, which can create slight differences in the pro-forma COV and resulting FGV.

10. 19.  This is a simplification to make the point and put the spotlight on NOPAT. Of course, if there are meaningful planned additional capital investments, then NOPAT would need to be higher to cover the capital charge on that new invested capital to achieve the required ΔEVAs.

11. 20.  $10B = ((1 + 7.77%)/7.77%) × [$194.25/(1 + 7.77%) + $293.08/(1 + 7.77%)² + $360.97/(1 + 7.77%)³]

12. 21.  Another example to illustrate the point: If the new Future Industries realized 50% of required synergies in the second year and 50% in the third year, that would yield required EVA improvements of $419M and $451M, respectively, for a run rate of $870M of after-tax improvements after the third year onward—again not even close to announced $500M of pre-tax synergies.

13. 22.  In the case of all-stock and combo deals (a mix of cash and stock), the value to the seller can fluctuate pre-close based on the movements of the buyer’s shares because the seller will be joint owners in the new enterprise (more on this in chapter 9). In any case, the movement in the buyer’s shares is based largely on expectations of whether the buyer can realize the performance improvements embedded in the offer price and especially the premium.

Chapter 5

1. 1.  This chapter is adapted from Mark L. Sirower and Steve Lipin, “Investor Communications: New Rules for M&A Success,” Financial Executive 19 (January–February 2003). For more on the board’s evaluation of the deal, see chapter 9.

2. 2.  Acquirers must recognize that investor relations in M&A must contend with and help solve a classic asymmetric information problem: Management knows more about the transaction than investors, so investors can only go by what management signals to them through investor communications. Investors around the world will listen to management and then make the decision to hold their shares of the acquirer, buy, or sell. Target shareholders will want answers if the deal involves stock because their board has essentially recommended an investment decision that is presumably in the best interests of their shareholders.

3. 3.  The quotation comes from “University of Rochester Roundtable on Corporate M&A and Shareholder Value,” Journal of Applied Corporate Finance 17, no. 4 (Fall 2005): 70. Recognizing this, some CEOs attempt to surround announcements with unrelated good news, and recent evidence suggests those CEOs engage in this strategy when they perceive a deal as riskier, and subsequently exercised more options than those who did not offer unrelated news. Findings suggest that CEOs who issue unrelated positive news exercise 6.7% more options in the next quarter than CEOs who did not, suggesting a lower level of confidence in the outcomes of those deals. Daniel L. Gamache, Gerry McNamara, Scott D. Graffin, Jason T. Kiley, Jerayr Haleblian, and Cynthia E. Devers, “Why CEOs Surround M&A Announcements with Unrelated Good News,” hbr.org, August 30, 2019, https://hbr.org/2019/08/why-ceos-surround-ma-announcements-with-unrelated-good-news.

4. 4.  Not only will a negative market reaction jeopardize the success of the merger, but it can also distract managers and employees from ongoing business activities, threatening the growth value already built into the acquirer’s share price—potentially causing losses in the share price far beyond the amount of the premium.

5. 5.  On Conseco, see Leslie Eaton, “Conseco and Green Tree, an Improbable Merger,” New York Times, April 8, 1998.

6. 6.  Information drawn from Nexstar Media Group acquisition of Tribune Media investor presentation and conference call, December 3, 2018. Subsequent calls at closing raised the projected synergy number to $185M.

7. 7.  For a review of our evidence on the disappointing returns to stock deals, see appendix A. Presumably, the board of the seller would also have done that before recommending their investors take the acquirer’s stock, but that doesn’t appear to be the case, on average. For additional details, see chapter 9.

8. 8.  Information drawn from Avis Budget Group acquisition of Zipcar investor presentation and conference call, January 2, 2013.

9. 9.  David Harding and Sam Rovit, “Building Deals on Bedrock,” Harvard Business Review, September 2004, https://hbr.org/2004/09/building-deals-on-bedrock.

10. 10.  Information from PepsiCo press release at close on August 13, 2001, “PepsiCo Raises Estimate of Quaker Merger Synergies to $400 Million,” and cited in Chicago Tribune story, “Quaker Savings, Sales Growth Expectations Double for PepsiCo,” August 14, 2001.

Chapter 6

1. 1.  HSR filing goes to either DOJ or the Federal Trade Commission. All deals go through preliminary review, when regulating agencies make a determination of which agency does the investigation. As a consequence, the deal moves forward and can potentially close in less than 30 days. If the 30-day waiting period expires then the deal is deemed “approved without objection.” Within 30 days the agency can come back and ask for a meeting or additional data to satisfy their concern. They may have an anti-trust concern, which will trigger additional investigation through a second request. There can be many requests, responding to which can take many pages and many months. The waiting period can expire, or an agency can provide explicit approval, or it can come back and challenge the deal, requiring some divestment, or a governance review, or an injunction that the acquirer will have to contest.

2. 2.  On the distinction between “close” and “Day 1,” see chapter 1, note 12, above.

3. 3.  David Carney and Douglas Tuttle, “Seven Things Your Mother Never Told You about Leading as an Integration Manager,” Deloitte M&A Institute white paper from the Deloitte publication, “Making the Deal Work,” 2007.

Chapter 7

1. 1.  This section is drawn from Ami Louise Rich and Stephanie Dolan, “Please Excuse My Dear Aunt Sally: The Order of Operations for Organization Design during an M&A Event,” Deloitte M&A Institute working paper, July 2019, and from many helpful discussions.

2. 2.  The levels and reporting relations may appear different, depending on the size of the company, its divisions and constituent business units, and the CEO’s preference.

3. 3.  Exiting leaders may still have a significant positive impact. Retaining them for a period of time may make employees feel more comfortable, confident, and valued. Acquirers can also draw on their knowledge of the business, and they can advocate for the exciting new chapter. But toxic people have to go. Very large organizations have employment contracts, so acquirers should be careful that they don’t trigger change of control clauses sooner than desirable. Employees will also need to know the next layer of the organization that directly impacts them so they can discern the direction, broad policies, interaction models with customers those leaders will adopt. Absent that information there will be a power struggle between both organizations because people don’t know who will win.

4. 4.  Option 1 yields precise costs layer by layer. Option 2 allows “napkin math” for approximate costs because names aren’t yet in the boxes; it also gets us quicker to the fact that we may not hit our synergy targets.

5. 5.  For example, a $3M cost baseline would quickly reveal a $2M synergy target is not reasonable. Further, if legal has a baseline of $9M and a synergy target of $2M, the combined cost structure post synergy realization should be $7M. There are two ways to get there, either direct reduction from the baseline or reduction in the legal budget by the synergy target.

Chapter 8

1. 1.  On the difference between “close” and Day 1,” see chapter 1, note 12, above.

2. 2.  See, for example, Val Srinivas and Richa Wadhwani, “Recognizing the Value of Bank Branches in a Digital World,” Deloitte Insights, February 13, 2019, https://www2.deloitte.com/us/en/insights/industry/financial-services/bank-branch-transformation-digital-banking.html; Rob Morgan, “The Future of the Branch in a Digital World, ABA Banking Journal, June 15, 2020, https://bankingjournal.aba.com/2020/06/the-future-of-the-branch-in-a-digital-world/; and Kate Rooney, “Despite the Rise of Online Banks, Millennials Are Still Visiting Branches,” CNBC, December 5, 2019, https://www.cnbc.com/2019/12/05/despite-the-rise-of-online-banks-millennials-still-go-to-branches.html.

3. 3.  Jay W. Lorsch and Emily McTague, “Culture Is Not the Culprit,” Harvard Business Review, April 2016, https://hbr.org/2016/04/culture-is-not-the-culprit.

4. 4.  Todd D. Jick, “On the Recipients of Change,” in Organization Change: A Comprehensive Reader, ed. W. Warner Burke, Dale G. Lake, and Jill Waymire Paine (San Francisco: Jossey-Bass, 2009), 404–417.

5. 5.  For additional background, see the M&A classics, David M. Schweiger, John M. Invancevich, and Frank R. Power, “Executive Actions for Managing Human Resources before and after Acquisition,” Academy of Management Executive 1, no. 2 (1987): 127–138; and Mitchell L. Marks and Philip H. Mirvis, “The Merger Syndrome,” Psychology Today, October 1986, 35–42.

6. 6.  Joel Brockner, The Process Matters: Engaging and Equipping People for Success (Princeton, NJ: Princeton University Press, 2015).

7. 7.  For a review with implications for M&A, see Gary B. Gorton, Jill Grennan, and Alexander K. Zentefis, “Corporate Culture,” National Bureau of Economic Research, working paper 29322 (October 2021).

8. 8.  Robert Iger, The Ride of a Lifetime: Lessons Learned from 15 Years as CEO of the Walt Disney Company (New York: Random House, 2019).

9. 9.  John Kotter, “Leading Change: Why Transformation Efforts Fail,” Harvard Business Review, May–June 1995, https://hbr.org/1995/05/leading-change-why-transformation-efforts-fail-2.

10. 10.  Lorsch and McTague, “Culture Is Not the Culprit.”

Chapter 9

1. 1.  The business judgment rule is primarily a tool of judicial review and only indirectly a standard of conduct. The rule applies if directors have met specific conditions. See, for example, Donald G. Kempf Jr., “ ‘Can They Take My House?’: Defending Directors and Officers,” Illinois Bar Journal 81 (May 1993): 244–248.

2. 2.  Adapted from Alfred Rappaport and Mark L. Sirower, “Cash or Stock: The Trade-offs for Buyers and Sellers in Mergers and Acquisitions,” Harvard Business Review, November–December 1999, https://hbr.org/1999/11/stock-or-cash-the-trade-offs-for-buyers-and-sellers-in-mergers-and-acquisitions.

3. 3.  The prevalence of cash, stock, or combinations of the two have shifted dramatically over the decades of merger waves. For example, 1980s were dominated by all-cash deals representing nearly 70% of all deals by the end of the decade. That trend dramatically shifted to the rise of all-stock deals in the 1990s, particularly for large deals. From our data of 1,267 deals we have the following percentage breakdown of cash, stock, or combination for each eight-year period, respectively. 1995–2002: 10%, 52%, 38%; 2003–2010: 26%, 26%, 48%; 2011–2019: 25%, 30%, 45% (please excuse the rounding).

4. 4.  See appendix A and, for example, Tim Loughran and Anand M. Vijh, “Do Long-Term Shareholders Benefit from Corporate Acquisitions?,” Journal of Finance 52, no. 5 (December 1997): 1765–1790. See also Mark L. Sirower, The Synergy Trap: How Companies Lose the Acquisition Game (New York: Free Press, 1997); and Richard Tortoriello, Temi Oyeniyi, David Pope, Paul Fruin, and Ruben Falk, Mergers & Acquisitions: The Good, the Bad, and the Ugly (and How to Tell Them Apart), S&P Global Market Intelligence, August 2016, https://www.spglobal.com/marketintelligence/en/documents/mergers-and-acquisitions-the-good-the-bad-and-the-ugly-august-2016.pdf.

5. 5.  A board that has determined to proceed with a share offer still has to decide how to structure it. That decision depends on an assessment of the risk of a drop in the price of the acquiring company’s shares between the announcement of the deal and its closing.

6. Research has shown that the market responds more favorably when acquirers demonstrate their confidence in the value of their own shares through their willingness to bear greater preclosing market risk. See, for example, Joel Houston and Michael Ryngaert, “Equity Issuance and Adverse Selection: A Direct Test Using Conditional Stock Offers,” Journal of Finance 52, no. 1 (1997): 197–219.

7. A fixed-share offer is not a confident signal since the seller’s compensation drops if the value of the acquirer’s shares falls. Therefore, the fixed-share approach should be adopted only if the preclosing market risk is relatively low. But there are ways for an acquiring company to structure a fixed-share offer without sending signals to the market that its stock is overvalued. The acquirer, for example, can protect the seller against a fall in the acquirer’s share price below a specified floor level by guaranteeing a minimum price. (Acquirers that offer such a “floor” typically also insist on a “ceiling” on the total value of shares distributed to sellers.)

8. An even more confident signal is given by a fixed-value offer in which sellers are assured of a stipulated market value while acquirers bear the entire cost of any decline in their share price before closing. If the market believes in the merits of the offer, then the acquirer’s price may even rise, enabling it to issue fewer shares to the seller’s stockholders. The acquirer’s shareholders, in this event, would retain a greater proportion of the deal’s NPV. As with fixed-share offers, floors and ceilings can be attached to fixed-value offers, in the form of the number of shares to be issued. See Rappaport and Sirower, “Cash or Stock”; and Carliss Y. Baldwin, “Evaluating M&A Deals: Floors, Caps, and Collars,” Harvard Business School Background Note 209-138, March 2009.

9. 6.  Adapted from Mark L. Sirower and Richard Stark, “The PMI Board Pack: New Diligence in M&A,” Directors & Boards, Summer 2001, 34–39.

10. 7.  On the re-emergence of hostile deals, see Kai Liekefett, “The Comeback of Hostile Takeovers,” Harvard Law School Forum on Corporate Governance, November 8, 2020, https://corpgov.law.harvard.edu/2020/11/08/the-comeback-of-hostile-takeovers/.

11. 8.  Adapted from Mark L. Sirower and Sumit Sahni, “Avoiding the Synergy Trap: Practical Guidance on M&A Decisions for CEOs and Boards,” Journal of Applied Corporate Finance 18, no. 3 (Summer 2006): 83–95. See also G. Bennett Stewart, The Quest for Value: A Guide for Senior Managers (New York: HarperCollins, 1991), chap. 2; and Eric Lindenberg and Michael P. Ross, “To Purchase or to Pool: Does it Matter,” Journal of Applied Corporate Finance 12 (Summer 1999): 2–136.

12. 9.  We are not advocating an earnings accretion or multiples-based approach to valuing target companies. Rather, we use those perspectives by focusing on the target to highlight the relevant performance challenge regardless of whether a deal is accretive or dilutive to the short-term earnings of the acquirer.

13. 10.  A constant P/E implies the preservation of the base case expectations of the stand-alone business. Any downward change in the P/E of the acquirer at announcement can be translated into an implied reduction in the target’s P/E; it is an unfortunate reminder that synergies might be achieved but at the expense of the existing expectations of the forward plan. Alternatively, the drop could also be interpreted as an adjustment reflecting the expectations that synergies will not be awarded the growth value in the P/E of the target, or both.

14. 11.  This is a big assumption, but one that is made regularly by CEOs and security analysts. Applying the same P/E to synergies means that any accretion from synergies is capitalized in perpetuity along with any growth value component of the P/E. Awarding any synergies the full P/E multiple is potentially the largest factor in explaining why typical accretion analysis might not yield realistic valuations. For example, suppose the cost of capital (c) is 10% then the perpetuity value of current earnings without growth is 1/c or a multiple of 10. If the P/E is 20, then the additional multiple of 10 is the growth value based on expectations of future improvements. If the synergies have no growth value, applying the full P/E will lead to overvaluation of the target.

15. 12.  As in any simplifying finance model (including dividend growth models and the terminal value calculations used in DCFs), there are limitations at the extremes. The usefulness of the %SynC expression diminishes as the profit margin approaches extreme values. For example, as the profit margin approaches zero, %SynC tends to zero. This could lead to erroneous conclusions about the extent of profit improvements required to earn back the premium paid for a very low profitability target. Alternatively, as the profit margin approaches 50%, %SynC tends to 100%. This would suggest the elimination of all operating costs as a strategy to earn the acquisition premium.

16. 13.  Moving from concept to practice, if we were to use a “pure” earnings model then we would use the net income before tax margin in the numerator and denominator. But then we might base required synergies on an abnormally low pre-tax earnings number that includes extraordinary items and that would also yield an abnormally high P/E. On the other hand, modeling the equity market value on EBIT yields a lower effective P/E multiple and thus, a lower growth value assumption for synergies in the model. In practice, we generate MTP Lines for other pre-tax measures so we can discuss the different results and assumptions. For simplicity and practicality, here we use EBIT in both the numerator and denominator because it focuses on operations.

17. 14.  Over years of experience, we have found that the first estimate of cost reduction is from optimization of addressable overhead and SG&A costs, which are typically not more than one-third of the total cost base. A reduction of overhead costs by one-third is usually considered an upper bound, and the resulting third of a third gives us roughly 10% of the total cost base (what we called “the magic 10%” in chapter 3).

18. 15.  See Richard P. Rumelt, Strategy, Structure, and Economic Performance (Cambridge, MA: Harvard University Press, 1974); and Robert F. Bruner, Applied Mergers and Acquisitions (New York: Wiley, 2004).

19. 16.  Reviewed in Sirower, The Synergy Trap, chapters 5, 7, 8, and appendices A and B; and David J. Flanagan, “Announcements or Purely Related and Purely Unrelated Mergers and Shareholder Returns: Reconciling the Relatedness Paradox,” Journal of Management 22, no. 6 (1996): 823–835. See also Yasser Alhenawi and Martha L. Stilwell, “Toward a Complete Definition of Relatedness in Mergers and Acquisitions Transactions,” Review of Quantitative Finance and Accounting 53 (2019): 351–396.

20. 17.  See, for instance, Chris Zook and James Allen, Profit from the Core: Growth Strategy in an Era of Turbulence (Boston: Harvard Business School Press, 2001) and their subsequent works.

21. 18.  Joseph L. Bower, “Not All M&A’s Are Alike—And That Matters,” Harvard Business Review, March 2001, https://hbr.org/2001/03/not-all-mas-are-alike-and-that-matters.

22. 19.  Charles Calomiris and Jason Karceski, “Is the Bank Merger Wave of 1990s Efficient? Lessons from 9 Case Studies,” in Mergers and Productivity, ed. Steven N. Kaplan (Chicago: University of Chicago Press, 2000), 93–178. Banking analyst James Hanbury commented, “The reason to do the merger is to try to deal with the problems by developing a new income stream from savings, as you eliminate overlapping costs of two banks operating in the same marketplace.” See Paul Deckelman, “Chemical Bank, Manufacturers Hanover Officially Merge,” UPI, December 31, 1991, https://www.upi.com/Archives/1991/12/31/Chemical-Bank-Manufacturers-Hanover-officially-merge/3446694155600/.

23. 20.  Adapted from Mark L. Sirower and Steve Lipin, “Investor Communications: New Rules for M&A Success,” Financial Executive 19 (January–February 2003): 26–30.

24. 21.  Although not discussed, the Avis Budget acquisition of Zipcar (described in chapter 5), which received a very positive market reaction even at 49% premium, is another good illustration. The combination of Zipcar assets with Avis Budget gave a center of gravity close to the bottom left in figure 9.3a. Zipcar offered expansion into adjacent markets but as CEO Ron Nelson stated during the investor call, “They share exactly the same core, allowing people to use the vehicles they don’t own, when they want, where they want and how they want.” Zipcar offered Avis Budget better market access and Avis offered Zipcar better capabilities and scale in fleet management (buying, financing, maintaining), optimization, and utilization. Across the three sources of value described in the investor presentation, roughly $30M was from cost reductions and $30M from revenue increases, yielding a (%SynR, %SynC) point of roughly (11%, 11%). Zipcar had a low EBIT margin (3.4%) largely because of the high costs of its fleet of cars. Its MTP Line intersects the %SynC axis at roughly 2% and at 49% on the %SynR axis, a line of much lower slope than our other examples. The point management proposed in their investor presentation lies well above the MTP line and just at the edge of our hypothetical Plausibility Box.

25. 22.  Data used in calculations is taken from last 10Ks available before the announcement deals—that is, 1997 for BetzDearbon, 1999 for Time Warner, 2000 for Quaker Oats, and 2018 for Tribune Media (the latter two deals were announced in December of their respective year). Revenue synergies projected for the PepsiCo/Quaker deal were calculated by grossing up the projected additions to operating profit from revenue synergies ($79M) by the 16% EBIT margin of Quaker Oats. %SynC assumes an addressable cost base that includes COGS, SG&A, and D&A and these were the respective costs used to calculate the EBIT margin.

26. 23.  For BetzDearborn, %SynC of 9.2%; for Time Warner, %SynC of 4.2%; for Quaker Oats, a mix of %SynC of 3.6% and %SynR of 10.0%; for Tribune, a mix of %SynC of 5.1% and %SynR of 3.7%. Figures are calculated based on respective cost and revenue bases.

27. 24.  Mark L. Sirower, “When a Merger Becomes a Scandal,” Financial Times, August 14, 2003.

Appendix A

1. 1.  Scott D. Graffin, Jerayr (John) Haleblian, and Jason T. Kiley, “Ready, AIM, Acquire: Impression Offsetting and Acquisitions,” Academy of Management Journal 59, no. 1 (2016): 232–252.

2. 2.  All data and results significant at the p < 0.05 or better except for the overall one-year returns on combo deals (p < 0.1); and full sample 2003–2010 one-year returns, and full sample 2011–2018 announcement returns where we can’t reject the null.

3. 3.  These findings reaffirm the widely reported underperformance of stock deals. See, for example, Nicolas G. Travlos, “Corporate Takeover Bids, Methods of Payment, and Bidding Firms’ Stock Returns,” Journal of Finance 42, no. 4 (September 1987): 943–963; and Tim Loughran and Anand M. Vijh, “Do Long-Term Shareholders Benefit from Corporate Acquisitions?,” Journal of Finance 30, no. 5 (December 1997): 1765–1790.

4. 4.  Although much can happen to an acquirer over a two-year period of performance, it is interesting to note that for acquirers that had positive or negative one-year returns, regardless of the initial reaction, 72% and 82% were positive or negative for their two-year returns, respectively. Similarly, for persistently positive or persistently negative performers, 73% and 82% were persistent for their two-year returns, respectively.

5. 5.  Our findings of the absolute percentage point difference between the premiums paid for persistently negative and persistently positive portfolios are consistent with the findings of Sara B. Moeller, Frederik P. Schlingemann, and Rene M. Stulz, “Wealth Destruction on a Massive Scale? A Study of Acquiring-Firm Returns in the Recent Merger Wave,” Journal of Finance 60, no. 2 (April 2005): 757–782. These authors find that the premium paid in large loss acquirers is 8% to 10% higher on average.

6. 6.  George Alexandridis, Nikolaos Antypas, and Nickolaos Travlos, “Value Creation from M&As: New Evidence,” Journal of Corporate Finance 45 (2017): 632–650.

Appendix B

1. 1.  Merton H. Miller and Franco Modigliani, “Dividend Policy, Growth, and the Valuation of Shares,” Journal of Business 34, no. 4 (1961): 411–433.

2. 2.  See G. Bennett Stewart, The Quest for Value: A Guide for Senior Managers (New York: HarperCollins, 1991); Stephen F. O’Byrne, “EVA and Market Value,” Journal of Applied Corporate Finance 9, no. 1 (Spring 1996): 116–125 (where the author adapts M&M’s equation 12 for the mechanics of EVA); Stephen F. O’Byrne, “A Better Way to Measure Operating Performance (or Why the EVA Math Really Matters),” Journal of Applied Corporate Finance 28, no. 3 (2016): 68–86; and S. David Young and Stephen F. O’Byrne, EVA and Value-Based Management: A Practical Guide to Implementation (New York: McGraw-Hill, 2000).

Appendix C

1. 1.  In their equation 12, M&M assume a uniform perpetual stream of earnings on the current asset base, what we call Cap₀. They presume, in effect, that prior year’s NOPAT (NOPAT₀) will increase sufficiently to maintain what we call “current EVA” (EVA₀), which is based on prior year’s NOPAT and the prior year’s capital charge. Thus, maintaining current EVA in the EVA equation yields a cost-of-capital return on what we call COV, equivalent to a cost-of-capital return on the first term in M&M’s equation 12. M&M’s presumed “NOPAT₁” will equal NOPAT₀ when prior year’s beginning capital is equal to Cap₀. Further, because we incorporate beginning capital, we can include a perpetual change in EVA (ΔEVA) beginning in the first year, where M&M assume the return on an investment and the capital charge are realized in the year immediately following the investment, so their assumption of constant return on the current asset base would yield ΔEVA₁ = 0. Since the present value of a ΔEVA₁ perpetuity will be ΔEVA₁/c at time zero (today) and not ΔEVA₁/c(1 + c), as might be incorrectly inferred from the second term in equation 12, we need to multiply the adapted second term by (1 + c) to account for that distinct possibility (a positive ΔEVA₁, for example, year 1 expected synergies) as represented in the third term of the EVA equation. To clarify, the first period change in the second term of equation 12 is the second period change in the EVA equation, and so on—but FGV, the third term of the EVA equation, and the second term in equation 12 are the same value. An important feature of the EVA equation is that it allows us to relax important assumptions in equation 12—that the return on the current asset base is constant, that new investments are required to create additional value, and that the returns on those investments are constant in perpetuity. Because ΔEVA is defined as ΔNOPAT minus the Δcapital charge, the EVA equation allows varying returns on the current asset base (such as synergies) and future investments (e.g., a cost transformation that yields higher NOPAT without necessarily increasing the capital base).

2. 2.  We owe special thanks to Anurag Srivastava, a former student of Mark’s on the NYU Stern Executive MBA program, for his very helpful approach and comments on this alternative derivation of our EVA equation.