Transcript Mergers and Acquisitions

Merger versus Consolidation
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Merger
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One firm is acquired by another
Acquiring firm retains name and acquired firm ceases
to exist
Advantage – legally simple
Disadvantage – must be approved by stockholders of
both firms
Consolidation
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Entirely new firm is created from combination of
existing firms
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Acquisitions
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A firm can be acquired by another firm or individual(s) purchasing
voting shares of the firm’s stock
Tender offer – public offer to buy shares
Stock acquisition
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No stockholder vote required
Can deal directly with stockholders, even if management is unfriendly
May be delayed if some target shareholders hold out for more money
– complete absorption requires a merger
Classifications
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Horizontal – both firms are in the same industry
Vertical – firms are in different stages of the production process
Conglomerate – firms are unrelated
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Takeovers
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Control of a firm transfers from one group to
another
 Possible forms
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Acquisition
• Merger or consolidation
• Acquisition of stock
• Acquisition of assets
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Proxy contest
Going private
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Taxes
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Tax-free acquisition
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Business purpose; not solely to avoid taxes
Continuity of equity interest – stockholders of target firm must be
able to maintain an equity interest in the combined firm
Generally, stock for stock acquisition
Taxable acquisition
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Firm purchased with cash
Capital gains taxes – stockholders of target may require a higher
price to cover the taxes
Assets are revalued – affects depreciation expense
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Accounting for Acquisitions
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Pooling of interests accounting no longer allowed
Purchase Accounting
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Assets of acquired firm must be reported at fair market value
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Goodwill is created – difference between purchase price and
estimated fair market value of net assets
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Goodwill no longer has to be amortized – assets are essentially
marked-to-market annually and goodwill is adjusted and treated
as an expense if the market value of the assets has decreased
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Synergy
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The whole is worth more than the sum of the
parts
 Some mergers create synergies because the
firm can either cut costs or use the combined
assets more effectively
 This is generally a good reason for a merger
 Examine whether the synergies create enough
benefit to justify the cost
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Revenue Enhancement
 Marketing
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gains
Advertising
Distribution network
Product mix
 Strategic
benefits
 Market power
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Cost Reductions
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Economies of scale
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Ability to produce larger quantities while reducing the average
per unit cost
Most common in industries that have high fixed costs
Economies of vertical integration
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Coordinate operations more effectively
Reduced search cost for suppliers or customers
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Taxes
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Take advantage of net operating losses
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Unused debt capacity
Surplus funds
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Carry-backs and carry-forwards
Merger may be prevented if the IRS believes the sole purpose is
to avoid taxes
Pay dividends
Repurchase shares
Buy another firm
Asset write-ups
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Reducing Capital Needs
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A merger may reduce the required investment in working
capital and fixed assets relative to the two firms
operating separately
Firms may be able to manage existing assets more
effectively under one umbrella
Some assets may be sold if they are redundant in the
combined firm (this includes human capital as well)
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General Rules
Do not rely on book values alone – the market
provides information about the true worth of
assets
 Estimate only incremental cash flows
 Use an appropriate discount rate
 Consider transaction costs – these can add up
quickly and become a substantial cash outflow
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EPS Growth
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Mergers may create the appearance of growth in
earnings per share
If there are no synergies or other benefits to the merger,
then the growth in EPS is just an artifact of a larger firm
and is not true growth
In this case, the P/E ratio should fall because the
combined market value should not change
There is no free lunch
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Diversification
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Diversification, in and of itself, is not a good
reason for a merger
 Stockholders can normally diversify their own
portfolio cheaper than a firm can diversify by
acquisition
 Stockholder wealth may actually decrease after
the merger because the reduction in risk, in
effect transfers wealth from the stockholders to
the bondholders
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Cash Acquisition
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The NPV of a cash acquisition is
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NPV = VB* – cash cost
Value of the combined firm is
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VAB = VA + (VB* - cash cost)
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Often, the entire NPV goes to the target firm
 Remember that a zero-NPV investment may
also desirable
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Stock Acquisition
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Value of combined firm
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Cost of acquisition
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VAB = VA + VB + V
Depends on the number of shares given to the target
stockholders
Depends on the price of the combined firm’s stock after the
merger
Considerations when choosing between cash and stock
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Sharing gains – target stockholders don’t participate in stock
price appreciation with a cash acquisition
Taxes – cash acquisitions are generally taxable
Control – cash acquisitions do not dilute control
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Defensive Tactics
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Corporate charter
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Establishes conditions that allow for a takeover
Supermajority voting requirement
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Targeted repurchase A.K.A. greenmail
 Standstill agreements
 Poison pills (share rights plans)
 Leveraged buyouts
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More (Colorful) Terms
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Golden parachute
Poison put
Crown jewel
White knight
Lockup
Shark repellent
Bear hug
Fair price provision
Dual class capitalization
Countertender offer
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Evidence on Acquisitions
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Shareholders of target companies tend to earn excess returns in a
merger
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Shareholders of target companies gain more in a tender offer than in
a straight merger
Target firm managers have a tendency to oppose mergers, thus
driving up the tender price
Shareholders of bidding firms earn a small excess return in a
tender offer, but none in a straight merger
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Anticipated gains from mergers may not be achieved
Bidding firms are generally larger, so it takes a larger dollar gain to
get the same percentage gain
Management may not be acting in stockholders’ best interest
Takeover market may be competitive
Announcement may not contain new information about the bidding
firm
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Divestitures and Restructurings
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Divestiture – company sells a piece of itself to another
company
Equity carve-out – company creates a new company out
of a subsidiary and then sells a minority interest to the
public through an IPO
Spin-off – company creates a new company out of a
subsidiary and distributes the shares of the new
company to the parent company’s stockholders
Split-up – company is split into two or more companies
and shares of all companies are distributed to the
original firm’s shareholders
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