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Mergers and Acquisition
RWJ Chp 30
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The Basic Forms of Acquisitions
There are three basic legal procedures
that one firm can use to acquire another
firm: Merger
Acquisition of Shares
Acquisition of Assets
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Varieties ofTakeovers
Takeovers
Acquisition
Proxy Contest
Going Private
(LBO)
Merger
Acquisition of Shares
Acquisition of Assets
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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 not a taxable event, shareholders
are deemed to have exchanged their old
shares for new ones of equivalent value.
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Accounting for Acquisitions
The Purchase Method
The source of much goodwill
Pooling of Interests
Pooling of interest is generally used when the
acquiring firm issues voting shares in exchange
for at least 90 percent of the outstanding voting
shares of the acquired firm. Purchase accounting is generally used under
other financing arrangements.
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Determining the Synergy from an Acquisition
Most acquisitions fail to create value for the
acquirer.
The main reason why they do not lies in failures
to integrate two companies after a merger.
Intellectual capital often walks out the door when
acquisitions aren't handled carefully.
Traditionally, acquisitions deliver value when they
allow for scale economies or market power, betterproducts and services in the market, or learning from
the new firms.
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Source of Synergy from Acquisitions
Revenue Enhancement
Cost Reduction
Including replacing ineffective managers. Tax Gains
Net Operating Losses
UnusedD
ebt Capacity The Cost of Capital
Economies of Scale in Underwriting.
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Calculating the Value of the Firm after
an Acquisition
Avoiding Mistakes
Do not Ignore Market Values
Estimate only IncrementalCash Flows Use the Correct Discount Rate
Dont Forget Transactions Costs
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A Cost to Shareholders from Reduction
in Risk
The Base Case
If two all-equity firms merge, there is no
transfer of synergies to bondholders, but if
One Firm has Debt
The value of the levered shareholders call
option falls.
How Can Shareholders Reduce their
Losses from the Coinsurance Effect?
Retire debt pre-merger.
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Two "Bad" Reasons for Mergers
Earnings Growth
Only 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.
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The NPV of a Merger
Typically, a firm would use NPV analysis
when making acquisitions.
The analysis is straightforward with a cashoffer, but gets complicated when the
consideration is shares.
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The NPV of a Merger: Cash
NPV of merger to acquirer =Synergy Premium
SynergyBAABVVV !
Premium = Price paid forB - VB
NPV of merger to acquirer = Synergy - Premium
]forpaidPrice[BBAABVBVVV !
BBAABVBVVV ! forpaidPrice
BVV AAB forpaidPrice!
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The NPV of a Merger: Ordinary Shares
The analysis gets muddied up because we
need to consider the post-mergervalue of
those shares were giving away.valuefirmNewpayoutfirmTarget vuE
issuedsharesNewsharesOld
issuedsharesNew
!E
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Cash versus Ordinary Shares
Overvaluation
If the target firm shares are too pricey to buy
with cash, then go with shares.
Taxes
Cash acquisitions usually trigger taxes.
shares 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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Defensive Tactics
Target-firm managers frequently resist takeoverattempts.
It can start with press releases and mailings to
shareholders that present managementsviewpoint 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 shares: a class of common
shares 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.
T
arget firms frequently amend corporatecharters to make acquisitions more
difficult.
Examples
Staggering the terms of the board of directors.
Requiring a supermajority shareholder
approval of an acquisition
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Repurchase Standstill Agreements
In a targeted repurchase the firm buys back its
own shares 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 shares 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 shares while excluding targetedshareholders.
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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 aleveraged 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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OtherDevices and the Jargon of
Corporate Takeovers
Golden parachutes are compensation to outgoingtarget 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 tomake the firm unattractive to bidders. They reduce
shareholder wealth. One example of a poison pill is giving the shareholders in
a target firm the right to buy shares in the merged firm at abargain price, contingent on another firm acquiring control.
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Example 1
Lams share is trading for RM50 a share while Yeohs sharegoes for RM25 a share. Lams EPS is RM1 while YeohsEPS is RM2.50. Both are 100% equity financed. Bothcompanies have one million shares of stock outstanding.
a. What is the post-merger EPS, If Lam can acquire Yeohs inan exchange based on market value, what should be thepost-merger EPS?
b. Suppose Lam pays a premium of 20% in excess of Yeoh's
current market value. How many shares of Lam must begiven to Yeohs shareholders for each of their shares?
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c. Based on your results in b, what will
Lams EPS be after it acquires Yeoh?
d. If Yeoh were to acquire Lam by
offering a 20% premium in excess of
Lams current market price, how
many shares of stock would Yeoh
have to offer, and what would be the
effect on Yeohs EPS?
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