In the previous episode we saw, that when the bidder employs a two

tier offer, there is a destruction of welfare for titled shareholders.

And that is the result of the so-called prisoner's dilemma.

If Phil knew how the other party would act, then they would

together act in a way that the welfare would not have been destroyed.

However, the reality is such that

people cannot communicate with each other in this case.

We talk about only five shareholders, but that's only for illustrative reasons.

Now, there is a market solution to prisoner's dilemma that allows

to remove this fraction.

That's called shared repurchase.

Now that goes like this.

If the bidder makes a two tier method, then the target management makes another,

let's say counter offer.

In which the terms are better than those of the bidder offer.

Let's take an example.

So that will be the, like I would say

this is free rider problem continued.

And we mentioned prisms dilemma first.

Just to keep this in mind.

And now we go to Solution

two, which is share repurchase.

Now, it goes like this, the target management does the following,

Pays, in our example, 80 bucks.

Up to five shares.

And then for those remaining, pays a smaller amount.

But still, that'll be higher than 20.

And that can be calculated as follows.

So this is the back-end price.

So before the welfare was $60 and 10 shares.

We subtract the amount we pay, 80 times 5.

And then we divide by 5.

Remaining, that gives us $40 per any share in excess of 5.

Now the important thing is that the share we purchase is an unconditional offer.

So it cannot be withdrawn if there is no majority.

That will be used for us in the next table, so this is unconditional.

Let me remind you that the bidder's offer is conditional.

If the bidder does not get majority, then the offer is withdrawn.

Now, let's see what's the welfare of target shareholders is.

So, this is shareholders target, shareholders payoffs,

and this is the big table now.

So I will draw all this table here.

This way.

And first of all we have the response.

And now there are more responses.

One response is I will put it in blue.

It's tender, To repurchase.

The other is tender to bidder.

And clearly, then, as also, the whole strategy.

Now here, there are three possible outcomes.

Well, the easiest to analyze is that both offers fail.

So in this case, nothing changes.

We had $60 per two shares, so we have 120 here, 120 here, and then 120 there.

However, There are two other options.

So this is if repurchase succeeds.

Well, it's unconditional but it does succeed when you have a majority.

Now, again, there are two options.

One, 50% of a stock is tendered and then all other.

Or we can see that the bidder succeeds.

Also 50%, which is enough and then all other.

Some of the answers we already know.

But let's go, again I will put These two lines.

So we have quite a few options here.

First of all, if you tended to repurchase, and repurchase succeeds,

then you get $80 per eight shares here, which is 160.

However, if all The shares are tendered

because obviously the inventory purchase is also in te pro rate of basis.

So we have 80 for our first share plus 40 for the second share.

So the total 120.

This is sort of the easy part.

By the same token we know what happens if tend to binder and binder succeeds.

Here you have 70 by 2, which is 140.

And then here is proration, 70 plus 20, which is 90.

So all this we know.

Well, what happens if you repurchase, but the bidder succeeds?

That means that you're one of the few Who

were happy enough to sell the purchase at 80.

So in both cases you have 80 times two which is 160.

And here this is the same.

Now let me remind you, that even if a bidder succeeds, and

it is sold to repurchase The repurchase offer cannot be withdrawn.

So, you sit with your 160.

Now what happens if you tender to bidder but repurchase is successful?

Well here it goes like this, let's say you are the first one.

You sold to bidder and you got 70 or

even so bold shares you got one 40.

However, if the repurchase succeeds, that means that bidder fails.

And the bidder withdraws and then you stay only

with the remaining shares of the successful repurchase.

So here you have 40 times 2 which is 80.

And here have the same 40 times 2 which is the 80.

So basically If repurchase succeeds.

But you tend to do the better, you are sort of the final,

the last one in this line intending to repurchase.

Now the hold, it's even easier because here if you held,

then you have 40 times 2, the same, 80.

40 times 2, the same 80.

It's worse when you sold to a bidder, because a bidder pays only 20.

So here, this is 40, 20 times 2, 40.

So this is kind of a cumbersome table, but it's important to think the way we did.

Now see what happens, clearly tempered repurchase is the dominant strategy.

So everyone does that, so we arrive at this point.

If we arrive at this point, see what happened.

The welfare of target shareholders is the same as it was before any tender.

So here, we effectively Conquered the prisoner's dilemma.

And at the same time you can see that in all these cells they dominate

the both the strategy to the bidder and the strategy to hold.

So this is a market solution to the prisoner's dilemma that is widely used.

By the target management.

Now, one final thing that I would like to add here is

that there is another solution that sometimes is available but not very often.

And this is, I will put it as solution.

Three, which I would put a special shareholder.

You can ask a question, what does that mean a special?

Well there are two options.

Option 3a, which is a large shareholder.

By large, normally People think we'll be holding of, let's say,

more than 25% but less than control.

Because if this is a controlling shareholder clearly you just go to this

shareholder and negotiate with him or her or this institution, and

then you're all set.

Now, If this is the large with minority share holder

the fact that you negotiate with the shareholder sends a signal to others small

shareholders that these guys might have agreed on anything.

And then that induces the other smaller people to sort

of act In the same way that the large shareholder does.

Now, so we can see here, negotiations and

we can see a signal as important things to observe.

The bad news is that this is very rare in the US Because there

are few large shareholders in American corporations.

Well, that means a solution three B which is sort of at crucial shareholder.

So a crucial shareholder is the on who does not have that many Shares of stock.

But still is influential.

The best example to that would be, they are doing the famous American

transaction that was under brink of a centuries.

In the statement that is prepared for voting and was mailed to all

share holders There was a special section in which it specifically said that Mr..

Edward Turner, who at that time was a crucial shareholder of Time Warner.

He held about 8% of he voting stock.

He sort of agreed in principle To vote in favor of the transaction.

So it was all done in a very specific legal, delicate way.

Not to abuse some of his rights.

But Was a big signal and

everyone who would open this small book would read that, and

that would influence, or might have influenced the voting of all other people.

So, here, I'd like to draw a line we are wrapping up this week,

and basically what did we do?

We studied various motives For transactions.

And, also, certain obstacles and how they can be overcome.

So basically, now, I put this will be we know,

Why and what, To do.

Now there's only one small question, well small, I am openly kidding.

And this is how much to pay.

And this huge question will be our discussion in the next week.

That is, as you might imagine, a vital valuation.

We talked valuation in corporate finance course,

we hinted at that in capital markets course.

We mentioned that many a time in our accounting course,

we are now wrapping that up together.

And in the next week, we start valuation and

it's various faces In the hope of finding the right number

that will if not, allow us to fully succeed.

But at least will enhance the probability of success.

I wish you all good luck with the assignments of this week and

I'll see you next week.

2.8. Free-rider problem – solutions (2)

Mergers and Acquisitions – The Relentless Pursuit of Synergy

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