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Mergers & Acquisitions

IntroductionAnother firm should be acquired only if doing so generates a positive NPV. However, the NPV of an acquisition candidate can be difficult to determine. As such, acquisitions are an investment made under uncertainty.

IntroductionHistorically, there are distinct, systematic patterns to the returns various security-holder classes earn during corporate control transactions (mergers and acquisitions). The strongest and most consistent regularity is that the target firm shareholders earn large, positive abnormal returns in virtually all transactions, while bidder shareholder results are mixed.

IntroductionTarget shareholder returns are larger: 2. For leveraged buyouts (by incumbent management) than external takeovers. 3. In contested bids than single bidder transactions. 4. In recent years than during the 1960s.

IntroductionBidder shareholder returns are more mixed, in that:

2. Bidder shareholders earned significantly positive abnormal returns during the 1960s, but these have decreased over time. 3. Bidding firm shareholders on average break even in those takeovers where cash is used, but lose when stock is the form of payment. 4. Bidder shareholders lose when their

Legal Forms Of Acquisitions1. Acquisitions through Merger or ConsolidationMerger - the complete absorption of one firm by another; after the merger, the acquired firm ceases to exist as a separate business entity. Consolidation - is the same as a merger except a new firm is created; after the merger, both the acquiring firm and the acquired firm terminate their previous legal existence and became part of a new firm.

Legal Forms Of Acquisitions1. Acquisition of StockA second way to acquire another firm is to simply purchase the firms voting stock in exchange for cash, shares of stock, or other securities. A tender offer (ie. public offer to buy shares) is made by one firm directly to the shareholders of another firm. If the shareholders choose to accept the offer, they tender their shares by exchanging them for cash or securities (or both), depending on the offer. A tender offer is usually contingent on the bidders obtaining some percentage of the total

Legal Forms Of Acquisitions1. Acquisition of AssetsA firm can effectively acquire another firm by buying most or all of the assets. However, the target firm does not necessarily cease to exist unless its shareholders choose to dissolve it. This type of acquisition requires a formal vote of the shareholders of the selling firm. The acquisition may involve transferring titles to individual assets, a legal process that can be costly.

Legal Forms Of AcquisitionsA Note on TakeoversA takeover occurs when one group takes control from another. Three forms include: 3. Acquisitions (merger or consolidation) occurs when the bidding firm makes a tender offer or acquires the assets of the target firm. 4. Proxy contest occurs when a group attempts to gain controlling seats on the B of D by voting in new directors. 5. Going private all the equity shares of a public firm are purchased by a small group of investors through a leveraged buyout (LBO). The shares are then delisted from stock exchanges.

Legal Forms Of AcquisitionsA Note on TakeoversMerger or consolidation


Acquisition of stock

Proxy contest

Acquisition of assets

Going private

Taxes And AcquisitionsIf one firm buys another firm, the transaction may be taxable or tax-free. In a taxable acquisition, the shareholders of the target firm are considered to have sold their shares and they have capital gains or losses that are taxed; it is a taxable acquisition if the buying firm offers the selling firm cash for its equity. In a tax-free acquisition, since the acquisition is considered an exchange rather than a sale, no capital gain or loss occurs at that time; the general requirements for tax-free status are that the acquisition involves 2 corporations from same country, subject to same corporate tax and that there be a continuity of equity interest.

Taxes And AcquisitionsIn addition, there are two tax-related factors to consider when comparing acquisition alternatives: 2. The capital gains effect in a taxable acquisition, shareholders may demand a higher price as compensation, thereby increasing the cost of the merger. 3. The write-up effect in a taxable acquisition, the assets of the selling firm are revalued or written-up from their historic book value to their estimated current market value.

Gains From AcquisitionsAcquiring another firm makes sense only if there is some concrete reason to believe the target firm is somehow worth more in our hands than it is worth now. Some reasons include:

3. SynergyThe whole is worth more than the parts. Synergy is measured as the difference between the value of the combined firm and the sum of the values of the firms as separate entities it is the incremental net gain from the acquisition.

Gains From Acquisitions1. Revenue EnhancementMarketing gains: improved promotion, distribution and/or product mix; crossmarketing. Strategic benefits: enhances management flexibility with regard to the companys future operations the process of entering a new industry to exploit perceived opportunities. Market power: increased market share and market power profits can be enhanced through higher prices and reduced competition.

Gains From Acquisitions1. Cost ReductionsEconomics of scale: the sharing of central facilities spreads fixed overhead more thinly. Economics of vertical integration: makes coordinating closely related activities easier. Complementary resources: to make better use of existing resources or to provide the missing ingredient for success.

Gains From Acquisitions1. Tax GainsNet operating losses: the combined firm would have a lower tax bill than the two firms considered separately. Unused debt capacity: adding debt can provide important tax savings and many acquisitions are financed using debt. Surplus funds: the tax problem associated with paying dividends is avoided. Asset write-ups: in a taxable acquisition, the assets of the acquired firm can be revalued.

Gains From Acquisitions1. Changing Capital RequirementsAll firms must make investments in working capital and fixed assets to sustain an efficient level of operating activity. A merger may reduce the combined investments needed by the two firms. For example, a firm that is producing at capacity can either build new or merge with a firm that has excess capacity.

Gains From Acquisitions1. Inefficient ManagementThere are firms whose value could be increased with a change in management. These firms are poorly run or otherwise do not efficiently use their assets to create shareholder wealth.

Gains From Acquisitions1. Going GlobalEntering new markets may be more viable buying existing operations and infrastructure in the foreign country. Government restrictions, consumer confidence in foreigners, and entry barriers play key roles in foreign market expansion decision-making.

Gains From AcquisitionsSome general rules in evaluating an acquisition are:1. 2. 3. 4. 5.

Do not ignore market values. Estimate only incremental cash flows to your firm. Use the correct risk-adjusted cost of capital. Be aware of transaction costs including merger implementation costs. Understand corporate culture and the impacts this will have on the marriage.

Myths of AcquisitionsDiversificationDiversification is commonly mentioned as a benefit to a merger it reduces unsystematic risk. However, given the value of an asset depends on only its systematic risk, shareholders will not pay a premium for a merged company just for the benefit of diversification. Stockholders can get all the diversification they want simply by buying stock in different companies.

Myths of AcquisitionsEPS GrowthAn acquisition can create the appearance of growth in EPS. This may fool investors into thinking the firm is doing better than it really is. Astute financial managers will look beyond the accounting numbers in valuing the net impacts of an acquisition.

The Cost of an Acquisition (Cash or Common Stock) All other things being the same, if common stock is used, the acquisition cost may be higher because the target firms shareholders must share the acquisition gains with the shareholders of the bidding firm. If cash is used, the cost of an acquisition may not depend on the acquisition gains.

The Cost of an Acquisition (Cash or Common Stock)

Whether to finance an acquisition by cash or by shares of stock depends on several factors, including:1. 2. 3.

sharing gains taxes control

Corporate RaidersWhile most would agree that corporate raiders can deliver benefits to shareholders and society, there is increasing concern over whether the cost is too high. That is, when plants close or move, workers and equipment can be turned to other uses only at a cost to society usually paid for by taxpayers. In addition, critics argue that they reduce trust between management and labor thus reducing efficiency and increasing costs. Corporate raider usually refers to the person or firm that specializes in the hostile takeover

Defensive TacticsTarget firms frequently resist takeover attempts; resistance usually starts with press releases and mailings to shareholders presenting managements viewpoint. It can eventually lead to legal action and solicitation of competing bids. Managerial action to defeat a takeover attempt may make target shareholders better off if it elicits a higher offer premium from the bidding firm or another firm. However, management resistance may simply reflect pursuit of self-interest at the expense of shareholders.

Defensive TacticsThe Control Block and the Corporate CharterIf