Mergers and AcquisitionsCHAPTER
29
Chapter Outline
29.3 Accounting for Acquisitions
29.5 Source of Synergy from Acquisitions
29.6 Calculating the Value of the Firm after an Acquisition
29.8 Two "Bad" Reasons for Mergers
29.9 The NPV of a Merger
29.10 Defensive Tactics
29.1 The Basic Forms
of Acquisitions
There are three basic legal procedures that one firm can use to acquire another firm:
Merger or Consolidation
Acquisition of Stock
Acquisition of Assets
29.1 The Basic Forms
Merger or Consolidation
A merger refers to the absorption of one firm by another firm.
Acquiring firm retains its own name and identity.
Acquires all of assets and liabilities of the acquired firm.
The acquired firm ceases to exist as separate entity.
A consolidation is the same as a merger except that an entirely new firm is created.
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29.1 The Basic Forms
A merger is straight forward
Does not cost much like other forms
Avoid transferring the title of assets and liabilities.
A merger must be approved by a vote of the stockholder.
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29.1 The Basic Forms
Acquisition of Stock
Acquire another firm’s voting stock in exchange for cash, shares of stock or other securities.
A private offer is taken directly to the selling firm’s stockholders by another firm..
This can be accomplished by use of tender offer.
A tender offer is a public offer to buy shares of target firm.
It is made by one firm directly to the shareholder’s of another firm.
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29.1 The Basic Forms
Acquisition of Assets
One firm can acquire another firm by buying all of its assets.
A formal vote of the shareholders of selling firm is required.
Transfers title to assets which is costly.
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Classification of acquisitions
Vertical Acquisition
Acquisition involves firms at different steps of the productions process.
Conglomerate Acquisition
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Varieties of Takeovers
Varieties of Takeovers
Acquisition
If takeover is achieved by acquisition, it will be by merger, tender offer for shares of stock or purchase of assets.
Proxy contest
A group of shareholders gain control on the board of directors by voting in new directors
Going –private transactions
All equity shares of a public firm are purchased by a small group of investors.
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29.2 The Tax Forms of Acquisitions
If it is a taxable acquisition, selling shareholders need to figure their cost basis and pay taxes on any capital gains.
If it is tax free event, shareholders are deemed to have exchanged their old shares for new ones of equivalent value.
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29.3 Accounting for Acquisitions
The Purchase Method
The assets of acquired firm be reported at their fair market value on the books of the acquiring firm.
In a purchase, an accounting term called is created .
Goodwill is the excess of the purchase price over the sum of the fair market values of the individual assets required.
Purchase accounting is generally used under other financing arrangements.
FASB has announced its intent to eliminate the pooling of interest accounting method in early 2001.
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29.4 Determining the Synergy
The synergy from the acquisition is
Synergy = VAB – (VA + VB)
The synergy of an acquisition can be determined from the usual discounted cash flow model:
DCFt = DRevt – DCostst – DTaxest – DCapital Requirementst
where
Synergy =
DCFt
29.5 Source of Synergy
Increased revenue may come from
Marketing gains
Strategic benefits
29.5 Source of Synergy
Combined firm my operate more efficiently and lower the cost.
Economies of scale
Average cost of production falls while level of production increases.
Economies of vertical integration
29.5 Source of Synergy
Unused Debt Capacity
Financial distress cost is likely to be less for combined firm than that of two separate.
Increase debt-equity ratio which creates tax benefits
Surplus fund
29.8 Two "Bad" Reasons
for Mergers
Earnings Growth
An acquisition can create the appearance of earnings growth which may fool investors.
The merger may not create additional value
If the market is smart, it will realize that the combined firm is worth the sum of the value of separate firm before merger
If the market is fooled it might mistake the increase of earnings growth.
Only an accounting illusion.
A good question to ask students:
If you were a shareholder with a diversified portfolio, would you want the managers of individual firms to carry fire insurance?
Surprisingly, the answer is “no”—while the risk of fire may be nontrivial, the shareholders have already diversified that risk away.
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29.8 Two "Bad" Reasons
Diversification can produce gain s to the acquiring firm only
Diversification decrease the unsystematic variability
Diversification reduce the risk and increase debt capacity
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29.9 The NPV of a Merger
Typically, a firm would use NPV analysis when making acquisitions.
The analysis is straightforward with a cash offer, but gets complicated when the consideration is stock.
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The NPV of a Merger: Cash
NPV of merger to acquirer =
Synergy – Premium
NPV of merger to acquirer = Synergy – Premium
Synergy = VAB – (VA + VB)
= VAB – VA– Price paid for B
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The NPV of a Merger: Common Stock
The analysis gets muddied up because we need to consider the post-merger value of those shares we’re giving away.
value
firm
New
payout
firm
Target
Cash versus Common Stock
Overvaluation
If the target firm shares are too pricey to buy with cash, then go with stock.
Taxes
Cash acquisitions usually trigger taxes.
Stock acquisitions are usually tax-free.
Sharing Gains from the Merger
With a cash transaction, the target firm shareholders are not entitled to any downstream synergies.
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29.10 Defensive Tactics
Target-firm managers frequently resist takeover attempts.
It can start with press releases and mailings to shareholders that present management’s viewpoint and escalate to legal action.
Management resistance may represent the pursuit of self interest at the expense of shareholders.
Resistance may benefit shareholders in the end if it results in a higher offer premium from the bidding firm or another bidder.
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Divestitures
The basic idea is to reduce the potential diversification discount associated with commingled operations and to increase corporate focus,
Divestiture can take three forms:
Sale of assets: usually for cash
Spinoff: parent company distributes shares of a subsidiary to shareholders. Shareholders wind up owning shares in two firms. Sometimes this is done with a public IPO.
Issuance if tracking stock: a class of common stock whose value is connected to the performance of a particular segment of the parent company.
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The Corporate Charter
The corporate charter establishes the conditions that allow a takeover.
Target firms frequently amend corporate charters to make acquisitions more difficult.
Examples
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Repurchase Standstill Agreements
In a targeted repurchase the firm buys back its own stock from a potential acquirer, often at a premium.
Critics of such payments label them greenmail.
Standstill agreements are contracts where the bidding firm agrees to limit its holdings of another firm.
These usually leads to cessation of takeover attempts.
When the market decides that the target is out of play, the stock price falls.
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Exclusionary Self-Tenders
The opposite of a targeted repurchase.
The target firm makes a tender offer for its own stock while excluding targeted shareholders.
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Going Private and LBOs
If the existing management buys the firm from the shareholders and takes it private.
If it is financed with a lot of debt, it is a leveraged buyout (LBO).
The extra debt provides a tax deduction for the new owners, while at the same time turning the pervious managers into owners.
This reduces the agency costs of equity
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Other Devices and the Jargon
of Corporate Takeovers
Golden parachutes are compensation to outgoing target firm management.
Crown jewels are the major assets of the target. If the target firm management is desperate enough, they will sell off the crown jewels.
Poison pills are measures of true desperation to make the firm unattractive to bidders. They reduce shareholder wealth.