Lecture: 8 - Mergers and Restructuring
I.
Reasons for Merging
a. Increased Combined Value of Firms
synergy, economies of scale in management,
distribution, production or research.
b. “Dubious Reasons”
diversification, buy growth, and EPS Rise
II.
How to Decide to Merge - Like Any Investment, NPV
NPVMerger = ValueTarget + ValueMerged Firm - Price Paid
III.
Steps to Calculating NPVMerger
a. ValueTarget= Market Value of Securities = Shr x P
to get P, you can use P= D/(k - g) or P = P/E x EPS
b. Value =
CFt

t
t 1 (1  k )
n
c. CF = CFBT(1 - T) + Depr(T) - Additional
Outlays + Gain/Loss From Sale of Assets
Lecture: 8 - Mergers and Restructuring
III.
Steps to Calculating NPVMerger - Continued
d. Get k Commensurate with Risk
e. Get Costs Which are Clear for Cash Offers
f. Cost for Stock Offers - Calculate % of Bidding
Firm Owned by Target Shareholders After Merger
W
= Shares Held by Target in Merged Firm
Total Shares in Merged Firm
ValueMerged firm = ValueTarget + ValueAcquirer
+ ValueMerged Firm
Cost
= W x (Value of Merged Firm)
g. If DCF’s have Infinite Life Then Use
Constant Growth Model or Infinite Annuity
Lecture: 8 - Mergers and Restructuring
Example: Consider the following incremental cash flows,
depreciation and investments from a merger.
Year
CFBT
Depr
Investment
0
0
0
1
200,000
400,000
1,200,000
2
400,000
500,000
300,000
3
500,000
200,000
200,000
4- 
800,000
50,000
200,000
100,000
If the corporate tax rate is .35, the cost of capital is 20%, the
present market value of the target is $1,000,000 and the
bidder’s market value is $4,500,000, should the target be
acquired if the bidder will have to give the target
shareholders 25% of the combined firm’s shares as payment
to complete the acquisition?
Lecture: 8 - Mergers and Restructuring
Year CFBT
0
+ Depr
0
- Investment
0
CF
=
100,000
-100,000
1 200,000(.65)
400,000(.35)
1,200,000
-930,000
2 400,000(.65)
500,000(.35)
300,000
135,000
3 500,000(.65)
200,000(.35)
200,000
195,000
4 - 800,000(.65)
50,000(.35)
200,000
337,500
PV at time 3 of CF’s for year 4 and after = 337,500/.20
= 1,687,500
ValueMerged Firm = -100,000 - 930,000[PV.20,1] +
135,000 [PV.20,2] + 195,000 [PV.20,3] +
1,687,500 [PV.20,3]
= 308,159
ValueMerged Firm = 4,500,000 + 1,000,000 + 308,159
= 5,808,159
Cost of purchase = .25(5,808,159) = 1,452,040
NPV = 1,000,000 + 308,159 - 1,452,040 = -143,881
Lecture: 8 - Mergers and Restructuring
IV.
Market Value Exchange Ratio
Market Value of Cash and Securities Offered by
Acquiring Firm/Market Value of Target’s Stock
Guideline: Usually 125 - 150%
V.
EPS (Earnings Per Share) “Illusion” - Continued
c. For Cash Payment -> EPS = E/Nx
d. For Shares Payment -> Post Merger
EPS = E/[Nx + PyNy/Px]
where,
E
= Total Earnings of Combined Firm
Nx = # Old Shares of Acquiring Firm X
Ny = # of Shares of Target Firm Y
VI.
Px
= Share Price of Acquiring Company
Py
= Share Price Offered for Target
Who Benefits From Mergers
a. Target Usually Benefits
b. Acquirer Usually Loses or Gains Very Little
c. Investment Bankers Make a Fortune
Lecture: 8 - Mergers and Restructuring
VIII.
Tax Implications of a Merger - Tax Free if:
a. Consolidation - No Tax Motivations and
Continuity of Organization
b. Acquisition of Whole Firm - Uses Voting Stock
& Acquires at least 80% of Target’s Stock
c. Acquisition of Assets - Target Shareholders
Must be Shareholders in Combined Firm
IX.
Accounting Treatment of a Merger
X.
Balance Sheet Effects of a Merger
XI.
Income Sheet Effects of a Merger
XII.
Successful Mergers Focus on Fixed Assets
XIII.
Financing Alternatives of a Merger
a. Junk Bonds
b. Bonds Used for LBOs (Leveraged Buyouts)
c. Divestiture of Parts of Firm to Pay for LBO
d. Finance Through ESOP (Employee Stock
Ownership Plan)
Lecture: 8 - Mergers and Restructuring
XIV.
Terminology
a. Greenmail or Repurchase Standstill Agreements
b. Golden Parachutes
c. Golden Handcuffs
XV.
Defensive Tactics
a. Staggered Board of Directors
b. Super Majority
c. Super Common Stock
d. Poison Pills
e. Scorched Earth
f. Leverage
g. Restructure
h. White Squire
i. White Knight
j. Pac Man
k. Nancy Reagan - Just Say No!
l. Bear Hug
Lecture: 8 - Mergers and Restructuring
XVI.
Divestiture
a. Difficult Decision for Business Managers
b. Sell Off Assets Worth More to Others
c. Focus on Assets Best Managed by Present
Managers
XVII.Steps to Decide on Divestiture - getting Merger NPV
a. Estimate Operating CFs of the Division
b. Get the After Tax Discount Rate k for the Division
c. Calculate PV of CFs
d. Subtract Liabilities Associated with Division
NPV =
CFt
- Market Value of Liabilities

t
t 1 (1 + k)
n
This assumes that the acquirer assumes the target’s
liabilities (e.g., you own a $120,000 home with a
$100,000 mortgage - sell for $20,000 or more if
buyer assumes the mortgage.)
e. Compare NPV with Net After Tax Proceeds
if After Tax Proceeds > NPV then sell.
Lecture: 8 - Mergers and Restructuring
XVII.Steps to Decide on Divestiture - Continued
f. If Acquirer Does Not Accept Liabilities, Adjust
Offer Downward by Liabilities Value
Note: Process is exactly the reverse of the decision
to merge process.
XVIII. Abandonment
a. Check NPV Periodically
b. Salvage Value After Tax > PV of Remaining
CFs => Abandon Project, Else, Keep
Example: SIV Products can sell a product line for $50,000
after tax or it can keep the product line which will earn
$17,500 each year for the next 4 years. If its cost of capital
is 14 percent, should SIV divest the product line? How about
if the product line has $3000 in liabilities that will be
assumed by the purchaser?
a.NPVkeep = 17,500[PVA.14,4] - 50,000 = 990
Keep, do not divest.
b. NPVkeep = 17,500[PVA.14,4] - 50,000 - $3000 = -2010
Now you should divest.
Lecture: 8 - Mergers and Restructuring
XIX.
Financial Distress
a. Out of Court Options
1. Extensions
2. Composition
3. Assignment
b. In Court Options /Bankruptcy Reform Act 1978
1. Debtor Files - Voluntary
2. Creditor Files - Involuntary
3. Chapter 7 - Liquidation
XX.
Reorganization
a. Trustee can Reorganize or Run it Himself
b. Creditors Vote to Accept/Reject Trustee’s Plan
for Reorganization
XXI.
Decision to Liquidate or Reorganize
Calculation of:
NPVliq. > NPVreorg. => Liquidate
NPVreorg. > NPVliq. => Reorganize