2. 25-2
Key Concepts and Skills
⢠Be able to define the various terms
associated with M&A activity
⢠Understand the various reasons for
mergers and whether or not those reasons
are in the best interest of shareholders
⢠Understand the various methods for a
paying for an acquisition
⢠Understand the various defensive tactics
that are available
3. 25-3
Chapter Outline
⢠The Legal Forms of Acquisitions
⢠Taxes and Acquisitions
⢠Accounting for Acquisitions
⢠Gains from Acquisition
⢠Some Financial Side Effects of Acquisitions
⢠The Cost of an Acquisition
⢠Defensive Tactics
⢠Some Evidence on Acquisitions: Does M&A
Pay?
⢠Divestitures and Restructurings
4. 25-4
Merger versus Consolidation
⢠Merger
⢠One firm is acquired by another
⢠Acquiring firm retains name and acquired firm
ceases to exist
⢠Advantage â legally simple
⢠Disadvantage â must be approved by
stockholders of both firms
⢠Consolidation
⢠Entirely new firm is created from combination
of existing firms
5. 25-5
Acquisitions
⢠A firm can be acquired by another firm or individual(s)
purchasing voting shares of the firmâs stock
⢠Tender offer â public offer to buy shares
⢠Stock acquisition
⢠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 â complete absorption requires a merger
⢠Classifications
⢠Horizontal â both firms are in the same industry
⢠Vertical â firms are in different stages of the production process
⢠Conglomerate â firms are unrelated
6. 25-6
Takeovers
⢠Control of a firm transfers from one group
to another
⢠Possible forms
⢠Acquisition
⢠Merger or consolidation
⢠Acquisition of stock
⢠Acquisition of assets
⢠Proxy contest
⢠Going private
7. 25-7
Taxes
⢠Tax-free acquisition
⢠Business purpose; not solely to avoid taxes
⢠Continuity of equity interest â stockholders of target
firm must be able to maintain an equity interest in the
combined firm
⢠Generally, stock for stock acquisition
⢠Taxable acquisition
⢠Firm purchased with cash
⢠Capital gains taxes â stockholders of target may
require a higher price to cover the taxes
⢠Assets are revalued â affects depreciation expense
8. 25-8
Accounting for Acquisitions
⢠Pooling of interests accounting no longer allowed
⢠Purchase Accounting
⢠Assets of acquired firm must be reported at
fair market value
⢠Goodwill is created â difference between
purchase price and estimated fair market
value of net assets
⢠Goodwill no longer has to be amortized â
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
9. 25-9
Synergy
⢠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
11. 25-11
Cost Reductions
⢠Economies of scale
⢠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
⢠Coordinate operations more effectively
⢠Reduced search cost for suppliers or
customers
⢠Complimentary resources
12. 25-12
Taxes
⢠Take advantages of net operating losses
⢠Carry-backs and carry-forwards
⢠Merger may be prevented if the IRS believes the sole
purpose is to avoid taxes
⢠Unused debt capacity
⢠Surplus funds
⢠Pay dividends
⢠Repurchase shares
⢠Buy another firm
⢠Asset write-ups
13. 25-13
Reducing Capital Needs
⢠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)
14. 25-14
General Rules
⢠Do not rely on book values alone â the
market provides information about the true
worth of assets
⢠Estimate only incremental cash flows
⢠Use an appropriate discount rate
⢠Consider transaction costs â these can
add up quickly and become a substantial
cash outflow
15. 25-15
EPS Growth
⢠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
16. 25-16
Diversification
⢠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
17. 25-17
Cash Acquisition
⢠The NPV of a cash acquisition is
⢠NPV = VB* â cash cost
⢠Value of the combined firm is
⢠VAB = VA + (VB* - cash cost)
⢠Often, the entire NPV goes to the target
firm
⢠Remember that a zero-NPV investment is
also desirable
18. 25-18
Stock Acquisition
⢠Value of combined firm
⢠VAB = VA + VB + âV
⢠Cost of acquisition
⢠Depends on the number of shares given to the target
stockholders
⢠Depends on the price of the combined firmâs stock
after the merger
⢠Considerations when choosing between cash
and stock
⢠Sharing gains â target stockholders donât participate in
stock price appreciation with a cash acquisition
⢠Taxes â cash acquisitions are generally taxable
⢠Control â cash acquisitions do not dilute control
19. 25-19
Defensive Tactics
⢠Corporate charter
⢠Establishes conditions that allow for a
takeover
⢠Supermajority voting requirement
⢠Targeted repurchase aka greenmail
⢠Standstill agreements
⢠Poison pills (share rights plans)
⢠Leveraged buyouts
20. 25-20
More (Colorful) Terms
⢠Golden parachute
⢠Poison put
⢠Crown jewel
⢠White knight
⢠Lockup
⢠Shark repellent
⢠Bear hug
⢠Fair price provision
⢠Dual class capitalization
⢠Countertender offer
21. 25-21
Evidence on Acquisitions
⢠Shareholders of target companies tend to earn excess
returns in a merger
⢠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
⢠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 stockholdersâ best interest
⢠Takeover market may be competitive
⢠Announcement may not contain new information about the
bidding firm
22. 25-22
Divestitures and Restructurings
⢠Divestiture â company sells a piece of itself to
another company
⢠Equity carve-out â company creates a new
company out of a subsidiary and then sells a
minority interest to the public through an IPO
⢠Spin-off â company creates a new company out
of a subsidiary and distributes the shares of the
new company to the parent companyâs
stockholders
⢠Split-up â company is split into two or more
companies and shares of all companies are
distributed to the original firmâs shareholders
23. 25-23
Quick Quiz
⢠What are the different methods for achieving a
takeover?
⢠How do we account for acquisitions?
⢠What are some of the reasons cited for mergers?
Which may be in stockholdersâ best interest and
which generally are not?
⢠What are some of the defensive tactics that firms
use to thwart takeovers?
⢠How can a firm restructure itself? How do these
methods differ in terms of ownership?