Mergers and acquisitions

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  • 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. A good review of the effect of diversification would be to discuss equity as a call option on debt.
  • Mergers and acquisitions

    1. 1. Mergers andAcquisitions 29-1
    2. 2. 11.1 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 29-2
    3. 3. Merger versus Consolidation• Merger – 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 – Entirely new firm is created from combination of existing firms 29-3
    4. 4. Acquisitions• 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 is unfriendly – May be delayed if some target shareholders hold out for more money – 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 29-4
    5. 5. 11.2 Sources of Synergy • Revenue Enhancement • Cost Reduction – Replacement of ineffective managers – Economy of scale or scope • Tax Gains – Net operating losses – Unused debt capacity 29-5
    6. 6. 11.3 Two Financial Side Effects of Acquisitions• Earnings Growth – 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 (i.e., an accounting illusion).• Diversification – Shareholders who wish to diversify can accomplish this at much lower cost with one phone call to their broker than can management with a takeover. 29-6
    7. 7. Cash Acquisition• The NPV of a cash acquisition is: – NPV = (VB + ΔV) – cash cost = VB* – 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 may also be desirable. 29-7
    8. 8. Stock Acquisition• Value of combined firm – VAB = VA + VB + ∆V• Cost of acquisition – 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 – Sharing gains – target stockholders do not participate in stock price appreciation with a cash acquisition – Taxes – cash acquisitions are generally taxable – Control – cash acquisitions do not dilute control 29-8
    9. 9. 11.4 Friendly vs. Hostile Takeovers• In a friendly merger, both companies’ management are receptive.• In a hostile merger, the acquiring firm attempts to gain control of the target without their approval. • Tender offer • Proxy fight 29-9
    10. 10. 11.5 Defensive Tactics• Corporate charter – Classified board (i.e., staggered elections) – Supermajority voting requirement• Golden parachutes• Targeted repurchase (a.k.a. greenmail)• Standstill agreements• Poison pills (share rights plans)• Leveraged buyouts 29-10
    11. 11. More (Colorful) Terms• Poison put• Crown jewel• White knight• Lockup• Shark repellent• Bear hug• Fair price provision• Dual class capitalization• Countertender offer 29-11
    12. 12. 11.6 Do Mergers Add Value?• 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. 29-12
    13. 13. Do Mergers Add Value?• 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 stockholders’ best interest. – Takeover market may be competitive. – Announcement may not contain new information about the bidding firm. 29-13
    14. 14. 11.7 Going Private and Leveraged Buyouts• 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. 29-14
    15. 15. 11.8 Divestitures in merger and acquisition.• Divestiture – company sells a piece of itself to another company – Equity carve-out – Parent company creates a separate company of the division in question and then arranges an IPO where a small fraction of the company is sold to the public. The parent company retains enough shares to maintain control. 29-15
    16. 16. – Spin-off – Parent company distributes shares of the subsidiary to existing shareholders in the same proportion as their ownership in the parent company. Shareholders can keep the shares or sell them as they see fit.– Split-up – A company breaks into two or more companies, and shareholders have their shares in old company swapped for shares in the new companies. 29-16

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