Effect of M&A on Stock Returns and Acquirer's Performance: A Case Study of BC Iron and Iron Ore Holdings Limited

This article discusses the effect of M&A on stock returns and acquirer's performance through a case study of BC Iron and Iron Ore Holdings Limited. It explains the calculation of offer premium, three-year holding period return, and abnormal returns. It also explores the role of operating flow, funding, and cost of capital in the corporate financial policy of BC Iron.

FINANCE

Table of Contents
PART A...........................................................................................................................................3
Question 1....................................................................................................................................3
Question 2....................................................................................................................................5
PART B...........................................................................................................................................7
REFERENCES..............................................................................................................................10

PART A
Question 1
Effect on stock returns of acquirer and target company post M&A announcement
Here, the chosen M&A case is taken of BC Iron and Iron Ore holdings limited which is an off
market offer for takeover placed BC Iron limited in an attempt to strengthen its own iron ore
portfolio by acquiring Iron Ore Holding limited. Therefore, in this case BC Iron is an acquirer
while Iron Ore holding limited is a target company.
1. The ticker of acquirer that is, BC Iron on ASX is “BCI” and that of target company that is,
Iron Ore holding is “IOH”.
2. The exact date on which the announcement pertaining to this acquisition made was 11th
August 2014.
3. Offer price for this particular M&A proposal was 0.44 new share of BC iron and Australian
dollar 0.10 in cash consideration for each of the share held of Iron Ore holding limited offered by
BC Iron whose is an acquirer. This lead to $1.59 per share value of IOH shares (Kim, Verdi, and
Yost, 2020).
4. Offer Price refers to the over and above payment made by acquirer of the assessed market
value of the target company while acquiring it (Leucci, 2020). Therefore, offer premium is
actually the difference between price paid per share during acquisition and actual market value
per share of the target company. Also, it can be defined as the excess amount paid to target over
the fair value of its identifiable assets.
Offer premium can be calculated with the help of following formula:
Offer premium = Acquirer’s offer price – Target’s price one day before announcement / Target’s
price one day before announcement
In the present case, it has been identified that the acquirer that is, BC Iron has offered 0.44 new
share in its own company and $0.10 cash consideration for each of the share held in IOH.
Accordingly, one share of IOH has been valued at $1.59 which includes both cash and share
consideration per share (Loyeung, 2019). Therefore, the identified offer price offered by BC Iron

to target that is, Iron Ore holding is $1.59 which is calculated on the basis of 60 days Value
Weighted Average Price of BC Iron that is, $3.39.
So, if VWAP of BC Iron for 60 days = $3.39
Proportionate share consideration in BC Iron IOH shareholders = 0.44
Then, Value of BC Iron share offered = 0.44 * 3.39 = $1.49
Cash consideration given = $0.10
Offer price = $0.10 + $1.49 = $1.59.
The offer premium for the given acquisition can be calculated as follows:
Acquirer’s Offer price = $1.59
Target’s price one day before announcement = $0.95
Offer premium = $1.59 - $0.95 / $0.95 = 0.6736 or 67.36%.
Acquirer’s stock return
Acquirer Target
T – 30 to T
- 1
T – 30 to T
+ 1
T, T + 1,
T + 2
T to T +
30
T – 30 to
T - 1
T – 30
to T + 1
T, T + 1,
T + 2
T to T +
30
0.00% 0.00% -9.70% -9.70% 1.10% 1.10% 39.50% 39.50%
3.70% 3.70% -0.70% -0.70% -3.40% -3.40% -1.10% -1.10%
3.00% 3.00% 5.10% 5.10% 1.20% 1.20% 1.50% 1.50%
-2.30% -2.30% -0.60% 0.00% 0.00% 0.80%
-0.90% -0.90% 1.30% 0.00% 0.00% -0.70%
-1.20% -1.20% -0.60% 2.90% 2.90% -0.40%
0.60% 0.60% 1.90% 0.00% 0.00% 1.50%
-0.60% -0.60% -0.90% -4.50% -4.50% -1.10%
-1.80% -1.80% -4.80% 1.20% 1.20% -3.00%
0.60% 0.60% 0.00% -0.60% -0.60% 0.40%
4.00% 4.00% -1.00% 0.00% 0.00% -1.50%
1.80% 1.80% -2.70% 7.10% 7.10% -2.70%
-2.30% -2.30% 0.30% 0.00% 0.00% 1.20%
-1.80% -1.80% -2.80% 1.10% 1.10% -3.60%
2.40% 2.40% -1.10% -1.10% -1.10% -1.20%
0.30% 0.30% -3.90% 2.20% 2.20% -1.70%

-0.60% -0.60% -3.50% -1.10% -1.10% -2.60%
-1.20% -1.20% -6.10% -2.20% -2.20% -5.70%
-1.20% -1.20% 1.30% 5.60% 5.60% -5.10%
-9.70% -3.90% 39.50% -1.00%
-0.70% -1.80% -1.10% -1.50%
-1.80% 0.00%
-0.90% -0.50%
-2.30% -1.50%
Sum of daily returns
2.50% -7.90% -5.30% -39.20% 9.50% 47.90% 39.90% 10.00%
From these results, it has been learnt that before announcement of acquisition, there are positive
returns from the stock of the acquirer whereas after announcement of the deal there are negative
returns resulting from the acquirer’s stock. The judgement is quite intuitive in nature because it
can be easily seen through the above acquirer’s return trends that before acquisition there were
positive returns, however post acquisition announcement there were negative returns which
indicates that market is not supporting the deal and investors are selling their BC Iron stake after
getting information about acquisition deal. Therefore, there are trends of falling returns to
acquirer as evidenced from above workings. On the other hand, there are rising trends of returns
for target just after the announcement of its acquisition where there is 67.36% offer premium are
offered to its shareholders because of which there are higher demands for its shares in the market
leading to rise in prices. Offer premium indicates that acquirer is offering higher than what is
being assessment by market.
Question 2
Examination of Acquirer’s performance after 3 years of takeover announcement
In the above case it has been identified that the BC Iron has acquired Iron Ore Holdings, so it is
necessary to determine what returns did the company’s (BC Iron) has enjoyed with respect to the
acquisition deal. For this, long term abnormal stock returns must be identified post acquisition
which has been done for the given scenario of acquisition in the following section through
calculating holding period returns. HPR refers to the return in total received by the acquirer by
holding a target company during the specified time period which is generally expressed in terms
of percentage (Lafontaine and Slade, 2021). It is calculated on the basis total returns obtained

from target which includes both income and changes occurred in value of share. Therefore, for
the given case, three year holding period return can be calculated with the help of the formula as
follows:
3 year holding period return = [(P3 – Pt) / Pt] * 100
P3 = $0.1550 (Adjusted closing price on 3rd anniversary of takeover announcement that is, on 11th
August 2017)
Pt = $2.4390 (Adjusted closing price on the day of takeover announcement that is, on 11th August
2014)
Three – year holding period return = [(0.1550 – 2.4390) / 2.4390] * 100
= -2.284 / 2.4390 * 100
= -93.64%.
Calculation of three year holding period return for All Ordinaries Index
P3 = $5743.50 (adjusted closing value of index on 3rd anniversary that is, on 11th August 2017)
Pt = $5449.40 (adjusted closing value of index on the day of takeover announcement that is, on
11th August 2017)
Three – year holding period return = [(5743.50 – 5449.40) / 5449.40] * 100
= 294.1 / 5449.40 * 100
= 5.4%
Abnormal three year returns can be calculated by obtaining the difference between acquirer’s
three-year holding period return and three year holding period returns calculated for All
Ordinaries Index.
Abnormal three years return = -93.64% - 5.4% = - 99.04%
Both long term returns and short term returns obtained has been negative for the acquirer
because stock returns continuously falling right from the announcement of acquisition. First,
before the announcement there were positive stock returns, but when announcement took place

the stock price of the acquirer falls continuously and after three years, the price falls by 93.64%
as compared to what it was before acquisition.
The acquisition has destroyed the acquirer’s value in the present case because stock price of the
acquirer has been declined by 94% approximately within the duration of three years. This
indicates investors are not taking the deal as profitable and started selling their stake in the
acquirer which leads to lower stock price in the market (Dranev, Frolova and Ochirova, 2019).
There are many other reasons due to which acquirer’s value get destroyed such as over price paid
towards acquisition like in the present case 0.44 has been exchanged on the basis of $3.39
VWAP as against actual share price of the company is falling from 2.4 to 1.3 during the time lag
involved in the deal of acquisition. This means higher price paid to target and accordingly, there
are abnormal losses for the acquirer which is 99.04% approximately.
CFO’s role in deciding offer price for the target are as follows:
 Conducting due diligence to understand risk element involved in the proposal, so that
lower offer price could be set for highly risky proposal and vice versa (Jory, Ngo and
Susnjara, 2020).
 Understanding IRR, EPS and funding requirement associated with the target company
before setting offer price.
PART B
The corporate financial policy of the BC Iron Company is to evaluate the investment decision
with the proper methods and investment appraisal techniques. The management of the BC Iron
Company evaluate the operating flow of the company. This involves analysing the flow of funds
in the business. Every acquisition in the business require the huge amount of funds and financial
resources that needed to evaluate by the company in order to make the investment decision.
Operating flow indicate and drive the business to know about the individual capability of the
organisation to invest in the business and acquire funds in the business (Albuquerqu and et.al.,
2019). The role of the operating flow of funds is significant as it empowers and drive the
business to make investment or acquisition related decision. Funding is one of the core aspect
that is a part of the policy making use by the BC Iron Company whole incorporating the
acquisition decision in the Ore Holding Limited (Schweizer, Walker and Zhang, 2019). This is

important that the organisation evaluate its finding option as the acquisition decision will require
the huge funds that can support the business to incorporate the acquisition decision successfully.
Analysing the financial need of the business and based on that this is about to identify the
suitable sources of funds in business. This will play a significant role for the organisation to
collect the funds and further channelize the same into taking the acquisition related decision. The
policy of the BC Iron Company is to analysis the total funding requires and further to evaluate
critically all the available funding sources that can bring finances to the organisation. Funding
choices are numerous in the current time and this become important for the organisation to
evaluate each funding source so that the acquisition can be done successfully.
Cost of capital related assessment is also a part of the policy adopted by the BC Iron
Company while incorporating the acquisition related decision in business. Analysing cost of
capital before approaching towards any funding source is a part of the policy adopt by the BC
Iron Company. Cost of capital is a term that is used to demonstrate the total cost that is incurred
by the company in order to practice the funding require in business. Cost of capital is the total
value company need to pay in against to arrange funds by accessing a particular funding source
in business (Malhotra and et.al., 2018). This method supports the business to efficiently generate
funds in order to acquire the business. The management need to analysis the cost of capital must
be lower than the total expected return over investment is made by the organisation. The another
key aspect of the policy is to identify the total expected return company may generate against the
investment is made in the project. This involve assessing about the total expected level; or
amount of return business may generate against the investment decision is taken by the company.
This is a suitable practice which business need to incorporate in against to make the investment
decision.
Pros
The above stated policies allow the BC Iron Company to assess the acquisition related
decision and its fruitfulness in favour of the business. This is important that the company
analysis the whole decision and its significance in term of profits and net outcome that may offer
in against to the investment take place (Kadim, Sunardi and Husain, 2020). The policy allow the
company to effectively value the possible outcome that may generate against the investment is
made in the project and further to potential cost of capital that company may bear in against to

channelise and adopt the investment decision in the business. The policy cover all areas that may
play a vital role in providing the investment decision to be right for the business.
Cons
The above stated method is very general in nature it is not a very professional approach to
analysis the acquisition decision taken by the company. The method must be professional enough
to identify the profitability involve once the acquisition take place by the company. The method
or policy is very general and not any expert mode of practice followed to practice the business
acquisition related practice in business. Hence, the policy do not strategically offer a clear
understanding over the significance of the acquisition decision that is taken by the company.
There are certain reason identified which disclose why acquirer on average pay a sizeable
offer premium to target company is because of certain factors. These factors involve synergy,
growth, stronger market power, unlocking hidden value, diversification, unique capabilities,
management personal motives and tax considerations are the core reasons. The target company
hold the better position which could allow the acquirer to pay the extra value in the form of
goodwill, growth and such other aspect. The acquirer hold better position which allow the
respective organisation to charge and ask such extra value against the acquisition decision has
been taken by the enterprise (Bebchuk and Tallarita, 2020). The average acquirer stock return are
much more lower and sometimes even the negative in number. This is because the investor
believe that the premium paid is too high many time which could imposed the acquire to drag the
price. There are further a problem associated with acquisition of the different workplace cultures.
Regularity issues are also associated. The market fluctuation also create an impact over the
return generated by the average acquirer. The fluctuation and changes occur in the market put a
direct impact over the possibility of the acquirer to gain healthy return. Many time the entire
market face crisis situation that certainly result into the lower or even the negative return over the
acquisition is taken place. This is important for the acquirer to make any decision with proper
analysis and evaluation about the market fluctuation and the possible future actions. Any
fluctuation in market will certainly influence the performance of the venture that certainly
influence the possible return over the acquisition is made.

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