Chapter 25


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Chapter 25

  1. 1. ChapterMcGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.25•Mergers and Acquisitions
  2. 2. 25-2Key Concepts and Skills• Be able to define the various termsassociated with M&A activity• Understand the various reasons formergers and whether or not those reasonsare in the best interest of shareholders• Understand the various methods for apaying for an acquisition• Understand the various defensive tacticsthat are available
  3. 3. 25-3Chapter 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&APay?• Divestitures and Restructurings
  4. 4. 25-4Merger versus Consolidation• Merger• One firm is acquired by another• Acquiring firm retains name and acquired firmceases to exist• Advantage – legally simple• Disadvantage – must be approved bystockholders of both firms• Consolidation• Entirely new firm is created from combinationof existing firms
  5. 5. 25-5Acquisitions• 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• No stockholder vote required• Can deal directly with stockholders, even if management isunfriendly• May be delayed if some target shareholders hold out for moremoney – complete absorption requires a merger• Classifications• Horizontal – both firms are in the same industry• Vertical – firms are in different stages of the production process• Conglomerate – firms are unrelated
  6. 6. 25-6Takeovers• Control of a firm transfers from one groupto another• Possible forms• Acquisition• Merger or consolidation• Acquisition of stock• Acquisition of assets• Proxy contest• Going private
  7. 7. 25-7Taxes• Tax-free acquisition• Business purpose; not solely to avoid taxes• Continuity of equity interest – stockholders of targetfirm must be able to maintain an equity interest in thecombined firm• Generally, stock for stock acquisition• Taxable acquisition• Firm purchased with cash• Capital gains taxes – stockholders of target mayrequire a higher price to cover the taxes• Assets are revalued – affects depreciation expense
  8. 8. 25-8Accounting for Acquisitions• Pooling of interests accounting no longer allowed• Purchase Accounting• Assets of acquired firm must be reported atfair market value• Goodwill is created – difference betweenpurchase price and estimated fair marketvalue of net assets• Goodwill no longer has to be amortized –assets are essentially marked-to-marketannually and goodwill is adjusted and treatedas an expense if the market value of theassets has decreased
  9. 9. 25-9Synergy• The whole is worth more than the sum ofthe parts• Some mergers create synergies becausethe firm can either cut costs or use thecombined assets more effectively• This is generally a good reason for amerger• Examine whether the synergies createenough benefit to justify the cost
  10. 10. 25-10Revenue Enhancement• Marketing gains• Advertising• Distribution network• Product mix• Strategic benefits• Market power
  11. 11. 25-11Cost Reductions• Economies of scale• Ability to produce larger quantities whilereducing the average per unit cost• Most common in industries that have highfixed costs• Economies of vertical integration• Coordinate operations more effectively• Reduced search cost for suppliers orcustomers• Complimentary resources
  12. 12. 25-12Taxes• Take advantages of net operating losses• Carry-backs and carry-forwards• Merger may be prevented if the IRS believes the solepurpose is to avoid taxes• Unused debt capacity• Surplus funds• Pay dividends• Repurchase shares• Buy another firm• Asset write-ups
  13. 13. 25-13Reducing Capital Needs• A merger may reduce the requiredinvestment in working capital and fixedassets relative to the two firms operatingseparately• Firms may be able to manage existingassets more effectively under one umbrella• Some assets may be sold if they areredundant in the combined firm (thisincludes human capital as well)
  14. 14. 25-14General Rules• Do not rely on book values alone – themarket provides information about the trueworth of assets• Estimate only incremental cash flows• Use an appropriate discount rate• Consider transaction costs – these canadd up quickly and become a substantialcash outflow
  15. 15. 25-15EPS Growth• Mergers may create the appearance ofgrowth in earnings per share• If there are no synergies or other benefitsto the merger, then the growth in EPS isjust an artifact of a larger firm and is nottrue growth• In this case, the P/E ratio should fallbecause the combined market valueshould not change• There is no free lunch
  16. 16. 25-16Diversification• Diversification, in and of itself, is not agood reason for a merger• Stockholders can normally diversify theirown portfolio cheaper than a firm candiversify by acquisition• Stockholder wealth may actually decreaseafter the merger because the reduction inrisk in effect transfers wealth from thestockholders to the bondholders
  17. 17. 25-17Cash Acquisition• The NPV of a cash acquisition is• NPV = VB* – cash cost• Value of the combined firm is• VAB = VA + (VB* - cash cost)• Often, the entire NPV goes to the targetfirm• Remember that a zero-NPV investment isalso desirable
  18. 18. 25-18Stock Acquisition• Value of combined firm• VAB = VA + VB + ∆V• Cost of acquisition• Depends on the number of shares given to the targetstockholders• Depends on the price of the combined firm’s stockafter the merger• Considerations when choosing between cashand stock• Sharing gains – target stockholders don’t participate instock price appreciation with a cash acquisition• Taxes – cash acquisitions are generally taxable• Control – cash acquisitions do not dilute control
  19. 19. 25-19Defensive Tactics• Corporate charter• Establishes conditions that allow for atakeover• Supermajority voting requirement• Targeted repurchase aka greenmail• Standstill agreements• Poison pills (share rights plans)• Leveraged buyouts
  20. 20. 25-20More (Colorful) Terms• Golden parachute• Poison put• Crown jewel• White knight• Lockup• Shark repellent• Bear hug• Fair price provision• Dual class capitalization• Countertender offer
  21. 21. 25-21Evidence on Acquisitions• Shareholders of target companies tend to earn excessreturns in a merger• Shareholders of target companies gain more in a tender offerthan in a straight merger• Target firm managers have a tendency to oppose mergers, thusdriving up the tender price• Shareholders of bidding firms earn a small excess returnin 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 gainto 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 thebidding firm
  22. 22. 25-22Divestitures and Restructurings• Divestiture – company sells a piece of itself toanother company• Equity carve-out – company creates a newcompany out of a subsidiary and then sells aminority interest to the public through an IPO• Spin-off – company creates a new company outof a subsidiary and distributes the shares of thenew company to the parent company’sstockholders• Split-up – company is split into two or morecompanies and shares of all companies aredistributed to the original firm’s shareholders
  23. 23. 25-23Quick Quiz• What are the different methods for achieving atakeover?• How do we account for acquisitions?• What are some of the reasons cited for mergers?Which may be in stockholders’ best interest andwhich generally are not?• What are some of the defensive tactics that firmsuse to thwart takeovers?• How can a firm restructure itself? How do thesemethods differ in terms of ownership?
  24. 24. ChapterMcGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.25•End of Chapter