Mergers and
Acquisitions
M&A Market
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Market for Corporate Control
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Competition for control of firm assets
Associated with Downsizing
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“It’s amazing that the basic cause of downsizing is so rarely
acknowledged: these companies have more workers than
they need or can afford to pay… If we must blame
somebody for the layoffs, it ought to be you and me…. I
haven’t met one person who would agree to pay AT&T twice
the going rate if AT&T would promise to stop laying people
off. These companies are responding to the constant pressure
from consumers and shareholders.”
- Peter Lynch, formerly of Fidelity’s Magellan fund
M&A Introduction
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Purchase & Sale of Firms or Divisions
Bidder
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Target
Consideration
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Company
Raiders
Cash or securities offered
Advisors
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I-Banks, Consultants, Attorneys, Accountants
M&A Types
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Friendly - Mgmt support
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Hostile - Without mgmt support
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Horizontal
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2 Competitors
Vertical
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Williams Act ’68 made more difficult
Target in same industry, but different production stage
Conglomerate
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2 Unrelated Firms
Taxes
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Tax-free acquisition
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Business purpose; not solely to avoid taxes
Continuity of equity interest
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Target stockholders have an equity interest in the combined firm
Taxable acquisition
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Firm purchased with cash
Capital gains
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Target stockholders require a higher price to cover the taxes
Merger versus Consolidation
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Merger
One firm is acquired by another
 Acquired firm ceases to exist
 Advantage: legally simple
 Disadvantage: approval of both stockholders
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Consolidation
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New firm is created by combining existing firms
Takeovers
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Control transfers from one group to another
Possible forms
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Acquisition
Merger or consolidation
 Acquisition of stock
 Acquisition of assets
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Proxy contest
 Going private
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M&A Motivation
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‘Synergy’
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Whole is worth more than the sum of the parts
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Break-up Value
Market Power
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Agency Issues, Hubris
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Diversification
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Avoid takeover attempts
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Synergy
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ΔV = VAB – (VA + VB)
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Synergy: ΔV > 0
Possible sources
Δ CF = Δ Rev. - Δ Costs - Δ Taxes - Δ Cap Req.
 Increase revenue
 Reduce costs
 Lower taxes or capital requirements
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Revenue Enhancement
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Marketing gains
Advertising
 Distribution network
 Product mix
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Strategic benefits
Market power
Cost Reductions
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Economies of scale
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Lower average cost by spreading overhead
Economies of scope (vertical integration)
Coordinate operations more effectively
 Reduced search cost for suppliers or customers
 Reduce contracting problems
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Lower Taxes or Capital Needs
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Taxes:
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Take advantages of net operating losses
Carry-backs and carry-forwards
 IRS can prevent merger if sole purpose is to avoid taxes
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Unused debt capacity
Capital Requirements:
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Reduce relative to the two firms operating separately
Acquisitions
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Cash Acquisition
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NPV = VB* – cash cost
Value of the combined firm
Stock Acquisition
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Value of combined firm
Cost of acquisition
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VAB = VA + (VB* - cash cost)
VAB = VA + VB + V
Depends on # shares given to target stockholders
Depends on post-merger stock price
Example
Cash vs. Stock
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Sharing gains
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Taxes
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Cash acquisitions are generally taxable
Control
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Target stockholders don’t participate in stock price
appreciation with a cash acquisition
Cash acquisitions do not dilute control
Signal
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Stock acquisitions indicate your stock is overvalued
M&A Valuation
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Market values
Only incremental cash flows
Appropriate discount rate
Consider transaction costs
After Valuation
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Friendly
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Work with management
Hostile
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Toe-hold or Bear-hug
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Open market purchase
Threaten target BOD with tender offer
Proxy Fight
Tender Offer
Defenses
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Poison pills/put, greenmail, golden parachute, etc.
Defensive Tactics
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Corporate charter
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Establishes conditions that allow for a takeover
Standstill agreements / Targeted repurchase
Poison pills (share rights plans)
Leveraged buyouts
Free-Rider Problem
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Purchase toe-hold
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Buy from large shareholders
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Two-tiered offer
Value to Acquirer
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Target - 10 million shares, $9/share
~ Target’s value to bidder
Target’s current market value
Merger premium
= $163.9 million
= $ 90.0 million
= $ 73.9 million
Change in Shareholders’
Wealth
Acquirer
Target
$9.00
0
5
$16.39
10
15
Bargaining Range =
Synergy
20
Price Paid
for Target
Market Reaction
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Target shares increase +20%
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Bidder shares are stagnant or decrease

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Stock offers: -1.5%
Cash offers: unclear
Effect on competitors varies
M&A Risk
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Overpayment
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Operating Risk
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Winner’s Curse
Integration issues, culture
Mgmt resources
Continued subsidization of sub-par groups
Financial Risk
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Leverage