Chapter 23
MERGERS AND
ACQUISITIONS
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
1
Legal Forms of Acquisitions

Merger or consolidation

Acquisition of stock

Acquisition of assets
2
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
3
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
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4
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
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5
Acquisition Classifications
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Horizontal – both firms are in the same
industry
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Vertical – firms are different stages of the
production process
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Conglomerate – firms are unrelated
6
Takeovers
Control of a firm transfers from one
group to another
 Possible forms

◦ Acquisition
◦ Proxy contest
◦ Going private (LBO vs. MBO)
7
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
8
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
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Gains from Acquisition
Synergy
 Revenue enhancement
 Cost reductions
 Tax gains
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Synergy

The whole is worth more than the sum of
the parts
Synergies
should create enough benefit
to justify the cost
11
Revenue Enhancement

Marketing gains
◦ Advertising
◦ Distribution network
◦ Product mix

Strategic benefits

Market power
12
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
13
Taxes
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Tax losses
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Unused debt capacity
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Surplus funds
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Asset write-ups
14
Reducing Capital Needs

Firms may be able to manage existing
assets more effectively under one
umbrella
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Some assets may be sold if they are not
needed in a combined firm
15
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
16
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
17
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)
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The Cost of Acquisition:
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
19
Shares vs. Common Stock

Sharing rights
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Taxes

Control
20
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
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21
Defensive Tactics (2)
Leveraged buyouts (LBO)
 Other defensive tactics
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◦ Golden parachutes
◦ Crown jewels
◦ White knight
22
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
23
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
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Divestitures and Restructurings
Divestiture = sale of assets, operations, or
divisions to a third party
 Equity carve-out


Spin-off

Split-up
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