(23) Mergers & Other Forms of Corporate Restructuring

7/23/2019 (23) Mergers & Other Forms of Corporate Restructuring

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Chapter 23Chapter 23Mergers and OtherMergers and Other

Forms of CorporateForms of Corporate

RestructuringRestructuring 2001 Prentice-Hall, nc!

Fundamentals of Financial Management, 11"eCreated #$% &regor$ '! (uhleme$er, Ph!)!

Carroll College, *au+esha, *


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Mergers and Other Forms ofMergers and Other Forms of

Corporate RestructuringCorporate Restructuring

ources of alue

trategic 'c.uisitionsn/ol/ing Common toc+

'c.uisitions and Capital

udgeting Closing the )eal


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Mergers and Other Forms ofMergers and Other Forms of

Corporate RestructuringCorporate Restructuring

a+eo/ers, ender Offers, and

)efenses trategic 'lliances

)i/estiture

Onership Restructuring

3e/eraged u$outs


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Why Engage inWhy Engage in

Corporate Restructuring?Corporate Restructuring?

ales enhancement and operatingeconomies4

mpro/ed management nformation effect *ealth transfers a5 reasons

3e/erage gains Hu#ris h$pothesis Management6s personal agenda

4 *ill #e discussed in more detail in lides 27-8 and 27-9


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Sales EnhancementSales Enhancement

and Operating Economiesand Operating Economies

ales enhancementales enhancement can occur #ecause ofmar+et share gain, technological

ad/ancements to the product ta#le, and fillinga gap in the product line!

Operating economiesOperating economies can #e achie/ed#ecause of the elimination of duplicate

facilities or operations and personnel! $nerg$$nerg$-- :conomies reali;ed in a merger

here the performance of the com#ined firme5ceeds that of its pre/iousl$ separate parts!


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Sales EnhancementSales Enhancement

and Operating Economiesand Operating Economies

Hori;ontal mergerHori;ontal merger% #est chance for economies

ertical mergerertical merger% ma$ lead to economies

Conglomerate mergerConglomerate merger% fe operatingeconomies

)i/estiture)i/estiture% reverse synergy ma$ occur

:conomies of cale:conomies of cale-- he #enefits ofsi;e in hich the a/erage unit cost falls

as /olume increases!


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Strategic c!uisitionsStrategic c!uisitions

"nvolving Common Stoc#"nvolving Common Stoc#

*hen the ac.uisition is done for common stoc+, a


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:5ample:5ample -- Compan$ ' ill ac.uire Compan$ ith shares of common stoc+!

Present earnings @20,000,000 @8,000,000

hares outstanding 8,000,000 2,000,000

:arnings per share @A!00 @2!80Price per share @9A!00 @70!00

Price " earnings ratio 19 12

Compan$ ' Compan$


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:5ample:5ample -- Compan$ has agreed on an offerof @78 in common stoc+ of Compan$ '!

otal earnings @28,000,000

hares outstanding4 9,0B7,80

:arnings per share @A!10

ur/i/ing Compan$ '

:5change ratio D @78 " @9A D !8A9E8!8A9E8

4 e shares from e5changee shares from e5change D !8A9E8!8A9E85 2,000,000

D 1,0B7,801,0B7,80


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he shareholders of Compan$ ' ille5perience an increase in earnings pershare #ecause of the ac.uisition G@A!10 post-merger :P /ersus @A!00 pre-merger :P!

he shareholders of Compan$ ille5perience a decrease in earnings per share

#ecause of the ac.uisition G!8A9E8 5 @A!10 D@2!2A post-merger :P /ersus @2!80 pre-merger :P!


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ur/i/ing firm :P ill increase an$ time theP": ratio


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:5ample:5ample -- Compan$ has agreed on an offerof @A8 in common stoc+ of Compan$ '!


hares outstanding4 9,A09,280

:arnings per share @7!B0

ur/i/ing Compan$ '

:5change ratio D @A8 " @9A D !07128!07128

4 e shares from e5changee shares from e5change D !07128!071285 2,000,000

D 1,A09,2801,A09,280


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he shareholders of Compan$ ' ille5perience a decrease in earnings per share

#ecause of the ac.uisition G@7!B0 post-merger :P /ersus @A!00 pre-merger :P!

he shareholders of Compan$ ille5perience an increase in earnings per

share #ecause of the ac.uisition G!07128 5@A!10 D @2!EE post-merger :P /ersus @2!80pre-merger :P!


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ur/i/ing firm :P ill decrease an$ timethe P": ratio


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What $outWhat $out

Earnings %er Share &E%S'?Earnings %er Share &E%S'?

Merger decisionsshould not #e madeithout considering

the long-termconse.uences!

he possi#ilit$ offuture earnings groth

ma$ outeigh theimmediate dilution ofearnings!

*ith the*ith the

mergermerger

*ithout the*ithout the

mergermerger

ime in the Future >$ears?

:5pected:P

,>@?

nitiall$, :P is less ith the merger!

:/entuall$, :P is greater ith the merger!

:.ual


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Mar#et (alue "mpactMar#et (alue "mpact

he a#o/e formula is the ratio of e)change ofmar#et price!

f the ratio is less than or nearl$ e.ual to 1, theshareholders of the ac.uired firm are not li#ely toha/e a monetar$ incenti/e to accept the mergeroffer from the ac.uiring firm!

Mar+et price per shareMar+et price per share

of the ac.uiring compan$of the ac.uiring compan$

um#er of shares offered #$um#er of shares offered #$

the ac.uiring compan$ for eachthe ac.uiring compan$ for each

share of the ac.uired compan$share of the ac.uired compan$

Mar+et price per share of the ac.uired compan$Mar+et price per share of the ac.uired compan$

I


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:5ample:5ample -- 'c.uiring Compan$ offers toac.uire ought Compan$ ith shares of

common stoc+ at an e5change price of @A0!

Present earnings @20,000,000 @9,000,000

hares outstanding 9,000,000 2,000,000:arnings per share @7!77 @7!00

Price per share @90!00 @70!00

Price " earnings ratio 1E 10

'c.uiring oughtCompan$ Compan$


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:5change ratio:5change ratio D @A0 " @90 D !99

Mar+et price e5change ratioMar+et price e5change ratio D @90 5 !99 " @70 D 1!77


hares outstanding4 ,777,777

:arnings per share @7!88

Price " earnings ratio 1E

Mar+et price per share @97!B0

ur/i/ing Compan$

4 e shares from e5changee shares from e5change D !99999!999995 2,000,000

D 1,777,7771,777,777


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otice that #oth earnings per share and mar+etprice per share ha/e risen #ecause of theac.uisition! his is +non as P":? 5 >:arnings?! herefore, the increase in the mar+et price per share

is a function of an e5pected increase in earnings pershare andandthe P": ratio OOdeclining!

he apparent increase in the mar+et price is dri/en#$ the assumption that the P": ratio ill not changeand that each dollar of earnings from the ac.uiredfirm ill #e priced the same as the ac.uiring firm

#efore the ac.uisition >a P": ratio of 1E?!


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Empirical EvidenceEmpirical Evidence

on Mergerson Mergers

arget firms in ata+eo/er recei/e ana/erage premium of

70J! :/idence on #u$ing

firms is mi5ed! t isnot clear that

ac.uiring firmshareholders gain!ome mergers doha/e s$nergistic#enefits!

u$ingu$ing

companiescompanies

ellingelling

companiescompanies

M: 'ROK) 'OKC:M:

>da$s?

'nnouncement date

0

-

L

CKM

K3'1-:'-:R

'&:

'0FO

RM'3R:1KRF>J?


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*evelopments in Mergers*evelopments in Mergers

and c!uisitionsand c!uisitions

dea is to rapidl$ #uild a larger and more /alua#le firmith the ac.uisition of small- and medium-si;ed firms>economies of scale?!

Pro/ide sellers cash, stoc+, or cash and stoc+! Oners of small firms li+el$ sta$ on as managers!

f pri/atel$ oned, a a$ to more rapidl$ gro toardsgoing through an initial pu#lic offering >see lide 22?!

Roll-Kp ransactionsRoll-Kp ransactions he com#ining ofmultiple small companies in the same

industr$ to create one larger compan$!


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*evelopments in Mergers*evelopments in Mergers

and c!uisitionsand c!uisitions

PO funds are used to finance theac.uisitions!

PO Roll-KpPO Roll-Kp 'n PO of independentcompanies in the same industr$ that

merge into a single compan$ concurrentith the stoc+ offering!

'n "nitial %u$lic Offering &"%O'is acompany+s first offering of common stoc#

to the general pu$lic,


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c!uisitions andc!uisitions and

Capital -udgetingCapital -udgeting

'n ac.uisition can #e treated as a capital #udgetingproNect! his re.uires an anal$sis of the free cashfree cash

flo.sflo.s of the prospecti/e ac.uisition!

Free cash flo.sFree cash flo.s are the cash flos that remain aftere su#tract from e5pected re/enues an$ e5pectedoperating costs and the capital e5pendituresnecessar$ to sustain, and hopefull$ impro/e, the

cash flos! Free cash flo.sFree cash flo.s should consider an$ s$nergistic

effects #ut #e #efore an$ financial charges so thate5amination is made of marginal after-ta5 operating

cash flos and net in/estment effects!


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Cash c!uisition andCash c!uisition and

Capital -udgeting E)ampleCapital -udgeting E)ample

':R'&: FOR :'R >in thousands?

1 - 8 9 - 10 11 - 18

'nnual after-ta5 operating'nnual after-ta5 operating

cash flos from ac.uisitioncash flos from ac.uisition @2,000 @2,000 @1,E00@1,E00 @1,A00 @1,A00et in/estmentet in/estment 900 900 700 700 --- ---

Cash flo after ta5esCash flo after ta5es @1,A00 @1,A00 @1,800 @1,A00@1,800 @1,A00

19 - 20 21 - 28'nnual after-ta5 operating'nnual after-ta5 operating cash flos from ac.uisitioncash flos from ac.uisition @ E00 @ E00 @ 200@ 200

et in/estmentet in/estment --- --- --- ---

Cash flo after ta5esCash flo after ta5es @ E00 @ E00 @ 200@ 200


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Cash c!uisition andCash c!uisition and

Capital -udgeting E)ampleCapital -udgeting E)ample

he appropriate discount rate for our e5ample freefree

cash floscash flos is the cost of capital for the ac.uiredfirm! 'ssume that this rate is 18J after ta5es!

he resulting present /alue of free cash flofree cash flo is@E,2A,000@E,2A,000! his represents the ma5imumac.uisition price that the ac.uiring firm should #eilling to pa$, if e do not assume the ac.uired

firm6s lia#ilities! f the ac.uisition price is less than >e5ceeds? the

present /alue of @E,2A,000@E,2A,000, then the ac.uisition ise5pected to enhance >reduce? shareholder ealth

o/er the long run!


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Other c!uisition andOther c!uisition and

Capital -udgeting "ssuesCapital -udgeting "ssues

oncash pa$ments and assumptiononcash pa$ments and assumption

of lia#ilitiesof lia#ilities

:stimating cash flos:stimating cash flos

Cash-flo approach /ersus earningsCash-flo approach /ersus earnings

per share >:P? approachper share >:P? approach &enerall$, the :P approach e5amines the

ac.uisition on a short-run #asis, hile the cash-flo approach ta+es a more long-run /ie!


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Closing the *ealClosing the *eal

arget is e/aluated #$ the ac.uirer erms are agreed upon Ratified #$ the respecti/e #oards

'ppro/ed #$ a maNorit$ >usuall$ to-thirds? of

shareholders from #oth firms 'ppropriate filing of paperor+

Possi#le consideration #$ he 'ntitrust )i/ision ofthe )epartment of ustice or the Federal radeCommission

ConsolidationConsolidation -- he com#ination of to or more firmsinto an entirel$ ne firm! he old firms cease to e5ist!


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/a)a$le or/a)a$le or

/a)0Free /ransaction/a)0Free /ransaction

a5a#lea5a#le

-- if pa$ment is made #$ cash or ith a

de#t instrument!

a5-Freea5-Free-- if pa$ment made ith /otingpreferred or common stoc+ and the transaction

has a ote% to #e a ta5-free transaction a fe more technicalre.uirements must #e met that depend onhether the purchase is for assets or thecommon stoc+ of the ac.uired firm!?

't the time of ac.uisition, for the selling firmor its shareholders, the transaction is%


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lternativelternative

ccounting /reatmentsccounting /reatments

Pooling of nterests >method?Pooling of nterests >method? -- ' method ofaccounting treatment for a merger #ased on

thenet $oo# valuenet $oo# value of the ac.uiredcompan$6s assets! he #alance sheets ofthe to companies are simpl$ com#ined!

Purchase >method?Purchase >method? -- ' method of accountingtreatment for a merger #ased on themar#etmar#et

priceprice paid for the ac.uired compan$!


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FS- and lternativeFS- and lternative

ccounting /reatmentsccounting /reatments

Pooling of interests is largel$ a Knited tatesphenomenon!

n 1BBB, F' /oted unanimousl$ toeliminate pooling of interests!

3i+el$ to #ecome effecti/e in 2000 once afinal standard is issued >although still /ocalopposition to the accounting change?!

Pooling of nterestsPooling of nterests


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ccountingccounting

/reatment of 1ood.ill/reatment of 1ood.ill

&oodill cannot #e amorti;ed for more thanA0 $ears for


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/ender Offers/ender Offers

'llos the ac.uiring compan$ to #$passthe management of the compan$ it ishesto ac.uire!

ender Offerender Offer -- 'n offer to #u$ currentshareholders6 stoc+ at a specified price, often

ith the o#Necti/e of gaining control of the

compan$! he offer is often made #$ anothercompan$ and usuall$ for more than the present

mar+et price!


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/ender Offers/ender Offers

t is not possi#le to surprise anothercompan$ ith its ac.uisition #ecause the:C re.uires e5tensi/e disclosure!

he tender offer is usuall$ communicatedthrough financial nespapers and directmailings if shareholder lists can #e o#tained

in a timel$ manner! ' t.o0tier offer>lide 7A? ma$ #e made ith

the first tier recei/ing more fa/ora#le terms!his reduces the free0rider pro$lem!


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/.o0/ier /ender Offer/.o0/ier /ender Offer

ncreases the li+elihood of successin gaining control of the target firm!

enefits those ho tender e!g!,

higher amount or all cash? for a specifiedma5imum num#er >or percent? of shares andsimultaneousl$ offers to ac.uire the

remaining shares at a second-tier price!


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*efensive /actics*efensive /actics

he compan$ #eing #id for ma$ use a num#er ofhe compan$ #eing #id for ma$ use a num#er of

defensi/e tactics including%defensi/e tactics including% >1? persuasion #$ management that the offer is not in

their #est interests, >2? ta+ing legal actions, >7?increasing the cash di/idend or declaring a stoc+ splitto gain shareholder support, and >A? as a last resort,loo+ing for a i!e!, hite +night? topurchase them!

*hite (night*hite (night -- ' friendl$ ac.uirer ho, at the in/itationof a target compan$, purchases shares from the hostile#idder>s? or launches a friendl$ counter-#id in order to

frustrate the initial, unfriendl$ #idder>s?!


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ntita#eover mendmentsntita#eover mendments

and Other *evicesand Other *evices

hareholders6 nterest H$pothesishareholders6 nterest H$pothesis

his theor$ implies that contests for corporatecontrol are d$sfunctional and ta+e management

time aa$ from profit-ma+ing acti/ities!

Managerial :ntrenchment H$pothesisManagerial :ntrenchment H$pothesis

his theor$ suggests that #arriers are erected toprotect management No#s and that such actionsor+ to the detriment of shareholders!

Moti/ation heoriesMoti/ation heories%%


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ntita#eover mendmentsntita#eover mendments

and Other *evicesand Other *evices

tagger the terms of the #oard of directors Change the state of incorporation upermaNorit$ merger appro/al pro/ision Fair merger price pro/ision 3e/eraged recapitali;ation Poison pill tandstill agreement Premium #u$-#ac+ offer

har+ Repellenthar+ Repellent -- )efenses emplo$ed #$ acompan$ to ard off potential ta+eo/er

#idders -- the


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on ntita#eover *eviceson ntita#eover *evices

:mpirical results are mi5ed in determining ifantita+eo/er de/ices are in the #est interestsof shareholders!

tandstill agreements and stoc+ repurchases#$ a compan$ from the oner of a large #loc+of stoc+s >i!e!, greenmail? appears to ha/e anegati/e effect on shareholder ealth!

For the most part, empirical e/idence supportsthe management entrenchment h$pothesismanagement entrenchment h$pothesis#ecause of the negati/e share price effect!


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Strategic llianceStrategic lliance

trategic alliances usuall$ occur #eteen >1? suppliersand their customers, >2? competitors in the same#usiness, >7? non-competitors ith complementar$strengths!

'Noint /entureNoint /enture is a #usiness Nointl$ oned and controlled#$ to or more independent firms! :ach /enture partnercontinues to e5ist as a separate firm, and the Noint/enture represents a ne #usiness enterprise!

trategic 'lliancetrategic 'lliance -- 'n agreement #eteen toor more independent firms to cooperate in orderto achie/e some specific commercial o#Necti/e!


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*ivestiture*ivestiture

3i.uidation3i.uidation-- he sale of assets of a firm,either /oluntaril$ or in #an+ruptc$!

ell-offell-off-- he sale of a di/ision of a

compan$, +non as a partial sell-off, orthe compan$ as a hole, +non as a/oluntar$ li.uidation!

)i/estiture)i/estiture -- he di/estment of a portionof the enterprise or the firm as a hole!


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*ivestiture*ivestiture

pin-offpin-off-- ' form of di/estiture resulting ina su#sidiar$ or di/ision #ecoming anindependent compan$! Ordinaril$, sharesin the ne compan$ are distri#uted to theparent compan$6s shareholders on a prorata #asis!

:.uit$ Car/e-out:.uit$ Car/e-out-- he pu#lic sale of stoc+in a su#sidiar$ in hich the parent usuall$retains maNorit$ control!


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on *ivestitureson *ivestitures

For li.uidation of the entire compan$, shareholders ofthe li.uidating compan$ reali;e a L12 to L20J return!

For partial sell-offs, shareholders selling the compan$

reali;e a slight return >L2J?! hareholders #u$ingalso e5perience a slight gain!

hareholders gain around 8J for spin-offs!

hareholders recei/e a modest L2J return for e.uit$

car/e-outs! )i/estiture results are consistent ith the

informational effect as shon #$ the positi/e mar+etresponses to the di/estiture announcements!


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O.nership RestructuringO.nership Restructuring

he most common transaction is pa$ingshareholders cash and merging the compan$

into a shell corporation oned #$ a pri/atein/estor management group!

reated as an asset sale rather than a merger!

&oing Pri/ate&oing Pri/ate -- Ma+ing a pu#liccompan$ pri/ate through the repurchase

of stoc+ #$ current management and"oroutside pri/ate in/estors!


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Motivation and EmpiricalMotivation and Empirical

Evidence for 1oing %rivateEvidence for 1oing %rivate

:limination of costs associated ith #eing a pu#licl$held firm >e!g!, registration, ser/icing of shareholders,

and legal and administrati/e costs related to :Cregulations and reports?!

Reduces the focus of management on short-termnum#ers to long-term ealth #uilding!

'llos the realignment and impro/ement ofmanagement incenti/es to enhance ealth #uilding #$directl$ lin+ing compensation to performance ithoutha/ing to anser to the pu#lic!

Moti/ationsMoti/ations%%


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Motivation and EmpiricalMotivation and Empirical

Evidence for 1oing %rivateEvidence for 1oing %rivate

3arge transaction costs to in/estment

#an+ers! 3ittle li.uidit$ to its oners!

' large portion of management ealth istied up in a single in/estment!

:mpirical :/idence:mpirical :/idence%%

hareholders reali;e gains >L12 to L22J?for cash offers in these transactions!

Moti/ations >Offsetting 'rguments?Moti/ations>Offsetting 'rguments?%%


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O.nership RestructuringO.nership Restructuring

he de#t is secured #$ the assets of the enterprisein/ol/ed! hus, this method is generall$ used ith

capital-intensi/e #usinesses! ' management $uyoutmanagement $uyout is an 3O in hich the pre-

#u$out management ends up ith a su#stantial e.uit$position!

3e/erage u$out >3O?3e/erage u$out >3O? -- ' primaril$de#t financed purchase of all the stoc+

or assets of a compan$, su#sidiar$, ordi/ision #$ an in/estor group!


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Common Characteristics ForCommon Characteristics For

*esira$le -O Candidates*esira$le -O Candidates

he compan$ has gone through a program of hea/$capital e5penditures >i!e!, modern plant?!

here are su#sidiar$ assets that can #e sold ithoutad/ersel$ impacting the core #usiness, and theproceeds can #e used to ser/ice the de#t #urden!

ta#le and predicta#le cash flos! ' pro/en and esta#lished mar+et position!

3ess c$clical product sales!

:5perienced and .ualit$ management!

Common characteristics >not all necessar$?Common characteristics >not all necessar$?%%

Documents

(23) Mergers & Other Forms of Corporate Restructuring