Mergers and Acquisitions


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A general term used to refer to the consolidation of companies. A merger is a combination of two companies to form a new company, while an acquisition is the purchase of one company by another in which no new company is formed.

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Mergers and Acquisitions

  1. 1. Mergers and Acquisitions
  2. 2. Introduction When one company buys another. It is making an investment.  Acquisition of one firm by another is, of course, an investment made under uncertainty.  Go ahead with the purchase, if it makes a net contribution to shareholders wealth.  When a firm is taken over, its management is usually replaced. 
  3. 3.  Merger A transaction where two firms agree to integrate their operations on a relatively coequal basis because they have resources and capabilities that together may create a stronger competitive advantage  Acquisition A transaction where one firm buys another firm with the intent of more effectively using a core competence by making the acquired firm a subsidiary within its portfolio of businesses  Takeover If management of one firm believes that another company’s management is not acting in interest of investors, it can go over heads of that firm’s management and make tender offer directly to its stockholders.
  4. 4. The Merger Market Tools Used To Acquire Companies Proxy Contest Tender Offer Acquisition Leveraged BuyOut Merger Management Buy-Out
  5. 5. Proxy contest Takeover attempt in which outsiders compete with management for shareholders votes (so called proxy fight)  A proxy is the right to vote another shareholder’s share  In a proxy contest, outsiders would like to take control with electing new board members 
  6. 6. Mergers and Acquisitions  Three ways one firm to acquire another firm: ◦ Merger ◦ Tender offer ◦ Acquisition
  7. 7. Merger  Combination of two firms into one, with the acquirer assuming assets and liabilities of the target firm.  Merger must have approval of more than 50% of shareholders  Horizontal merger-take place between two firms in the same line of business (two banks)  Vertical merger-involves firms at different stages of production (raw materials and consumer products)
  8. 8. Sensible Reasons for Mergers Economies of Scale A larger firm may be able to reduce its per unit cost by using excess capacity or spreading fixed costs across more units. Opportunity to spread fixed costs across a larger volume of output. $ $ Reduces costs $
  9. 9. Sensible Reasons for Mergers Combining Complementary Resources Usually small firms are acquired by large firms can be part of success too. Merging may results in each firm filling in the “missing pieces” of their firm with pieces from the other firm. Firm A Firm B
  10. 10. Dubious Reasons for Mergers Diversification reduces risk,  Diversification is easier and cheaper for shareholders than for the company  Investors should not pay a premium for diversification since they can do it themselves 
  11. 11. Evaluating Mergers  Questions ◦ Is there an overall economic gain to the merger? (Value enhancing, worth two firms than apart) ◦ Do the terms of the merger make the company and its shareholders better off? P V (A B ) > P V (A ) + P V (B )
  12. 12. Evaluating Mergers  Economic Gain E co n o m ic G ain = P V (in creased earn in g s) = N ew cash flo w s fro m syn ergies d isco u n t rate
  13. 13. Evaluating Mergers Example - Given a 20% cost of funds, what is the economic gain, if any, of the merger listed below? ABC Foods Revenues Operating Costs Earnings Economic Targetco Combined 150 20 172 118 16 132 32 4 40 Gain = 40 $ 200 .20 Additional value is the basic motivation for the merger.
  14. 14. Operating costs reduced as combining companies marketing, administration and distribution departments.  Projected revenues will be increased  Increased earnings are the only synergy to be generated by the merger. 
  15. 15. Tender offer It is a takeover attempt in which outsiders directly offer to buy the stock of the firm’s shareholders  With this method acquiring firm (investors) can bypass the target firm’s management 
  16. 16. Leveraged Buy-Outs LBO-Acquisition of a firm by private group of investors using borrowed debt. Unique Features of LBOs:Large portion of buy-out financed by debt Shares of the LBO no longer trade on the open market