Chapter 23
MERGERS AND
ACQUISITIONS
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Definition

The phrase mergers and acquisitions
(abbreviated M&A) refers to the aspect
of corporate strategy, corporate finance
and management dealing with the buying,
selling and combining of different
companies that can aid, finance, or help a
growing company in a given industry grow
rapidly without having to create another
business entity.
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Business valuation
The five most common ways to valuate a
business are
 asset valuation,
 historical earnings valuation,
 future maintainable earnings valuation,
 relative valuation (comparable company &
comparable transactions),
 discounted cash flow (DCF) valuation
232
Chapter Outline
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The Legal Forms of Acquisitions
Accounting for Acquisitions
Gains from Acquisition
The Cost of an Acquisition
Defensive Tactics
Some Evidence on Acquisitions
Divestitures and Restructurings
3
Legal Forms of Acquisitions

Merger or consolidation

Acquisition of stock

Acquisition of assets
4
Merger versus Consolidation

Merger
◦ One firm is acquired by another
◦ Acquiring firm retains name and acquired firm
ceases to exist

Consolidation
◦ Entirely new firm is created from combination
of existing firms
5
Stock Acquisition (1)
A firm can be acquired by purchasing
voting shares of the firm’s stock
 Tender offer – public offer to buy shares
 Circular bid – takeover bid communicated
to shareholders by direct mail
 Stock exchange bid – takeover bid
communicated to shareholders through a
stock exchange

6
Stock Acquisition (2)
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

7
Acquisition Classifications

Horizontal – both firms are in the same
industry

Vertical – firms are different stages of the
production process

Conglomerate – firms are unrelated
8
Takeovers
Control of a firm transfers from one
group to another
 Possible forms

◦ Acquisition
◦ Proxy contest
◦ Going private (LBO vs. MBO)
9
Alternatives to Merger

Strategic alliance = agreement between
firms to cooperate in pursuit of a joint
goal

Joint venture = an agreement between
firms to create a separate, co-owned
entity established to pursue a joint goal
10
Accounting for Acquisitions

The Purchase Method
◦ Assets of acquired firm are written up to fair
market value
◦ Goodwill is created – difference between
purchase price and estimated fair market
value of net assets
11
Gains from Acquisition
Synergy
 Revenue enhancement
 Cost reductions
 Tax gains

12
Synergy

The whole is worth more than the sum of
the parts
Synergies
should create enough benefit
to justify the cost
13
Revenue Enhancement

Marketing gains
◦ Advertising
◦ Distribution network
◦ Product mix

Strategic benefits

Market power
14
Cost Reductions

Economies of scale
◦ Ability to produce larger quantities while
reducing the average per unit cost

Economies of vertical integration
◦ Coordinate operations more effectively
◦ Reduced search cost for suppliers or customers

Complimentary resources
15
Taxes

Tax losses

Unused debt capacity

Surplus funds
Asset write-ups
 ∆FA = ∆EBIT + ∆Depreciation - ∆ Tax ∆Capital Requirements

16
Reducing Capital Needs

Firms may be able to manage existing
assets more effectively under one
umbrella

Some assets may be sold if they are not
needed in a combined firm
17
Diversification

Diversification, in and of itself, is not a
good reason for a merger

Stockholders can diversify their own
portfolio cheaper than a firm can diversify
by acquisition
18
EPS Growth

Mergers may create the appearance of growth
in earnings per share

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

In this case, the P/E ratio should fall because the
combined market value should not change
19
The Cost of Acquisition:
Cash Acquisition

The NPV of a cash acquisition is
◦ NPV = VB* – cash cost

Value of the combined firm is
◦ VAB = VA + (VB* - cash cost)
◦ VB* = VB + ∆V
20
Valuation Formulas

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1. VA* = VA + VT + S - C
2. Price per share = VA*/number of shares
3. PT = price per share*number of shares + C (for stock
and mixed offers)
4. Target shareholders’ gain from transaction = PT - VT
5. VA* - value of the new company
VA – value of the acquirer
VT – value of the target company
S – synergies
C – cash paid
PT – price paid for the target company
VT – pre-merger value of the target company
PT = price per share*number of shares
2321
The Cost of Acquisition:
Stock Acquisition

Value of combined firm

Cost of acquisition
◦ VAB = VA + VB + V
◦ Depends on the number of shares given to the target
stockholders
◦ Depends on the price of the combined firm’s stock
after the merger
◦
A
B
◦ Price
$20
$10
◦ # sh
25
10
◦ Market value
500
100
22
Cash vs. Common Stock
Cash price 150
VB* = VB + ∆V = 100 +100

NPV = 200 -150 =50
VAB = VA + (VB* - cost) = 500+ 200 – 150 =550
Share price = 550/25 = 22
Stock acquisition ($150 equiv. stock of A at $ 20)
VAB = VA + VB + V =700
$150 in stock A is 7.5 shares (25+7.5=32.5 sh)
700/32.5=21.54 a share
Cost of acquisition is 7.5*21.54=161.55
NPV = 38.45
2323
Cash vs. Common Stock

Sharing rights

Taxes

Control
24
Defensive Tactics(1)

Corporate charter
◦ Establishes conditions that allow for a
takeover
◦ Supermajority voting requirement
Targeted repurchase (Greenmail)
 Standstill agreements
 Exclusionary offers
 Poison pills
 Share rights plans

25
Defensive Tactics (2)
Leveraged buyouts (LBO)
 Other defensive tactics

◦ Golden parachutes
◦ Crown jewels
◦ White knight
26
Evidence on Acquisitions

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
27
More Evidence

Shareholders of bidding firms do not earn much
excess return in either a tender offer or 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
28
Divestitures and Restructurings
Divestiture = sale of assets, operations, or
divisions to a third party
 Equity carve-out


Spin-off

Split-up
29