Chapter
26
Mergers and Acquisitions
26-1
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Outline
•The Legal Forms of Acquisition
•Taxes and Acquisitions
•Gains from Acquisitions
•Some Financial Side Effects of
Acquisitions
•The Cost of an Acquisition
26-2
Chapter Outline
(Continued)
•Defensive Tactics
•Some Evidence on Acquisitions: Do M &
A’s Pay?
•Divestitures and Restructurings
26-3
Chapter Outline
• The Legal Forms of Acquisition
• Taxes and Acquisitions
• Gains from Acquisitions
• Some Financial Side Effects of
Acquisitions
• The Cost of an Acquisition
26-4
Merger versus Consolidation
Merger
One firm is acquired by another
Acquiring firm retains name and
acquired firm ceases to exist
26-5
Merger versus Consolidation
Merger
Advantage – legally simple
Disadvantage – must be approved
by stockholders of both firms
26-6
Merger versus Consolidation
Consolidation
 Entirely new firm is created from
combination of existing firms
26-7
Acquisitions
 A firm can be acquired when another firm or
individual(s) purchases voting shares of the firm’s
stock
Tender offer
is a public
offer to buy
shares on the
market.
26-8
Acquisitions
Stock acquisition
 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
26-9
Acquisitions
Classifications:
 Horizontal – both firms are in the
same industry
 Vertical – firms are in different stages
of the production process
 Conglomerate – firms are unrelated
26-10
Takeovers
Control of a firm
transfers
from one group
to another
 Possible forms:
 Acquisition
 Merger or consolidation
 Acquisition of stock
 Acquisition of assets
 Proxy contest
26-11
 Going private
Chapter Outline
•
•
•
•
The Legal Forms of Acquisition
Taxes and Acquisitions
Gains from Acquisitions
Some Financial Side Effects of
Acquisitions
• The Cost of an Acquisition
26-12
Taxes
Taxable acquisition
 Firm purchased with cash
 Capital gains taxes –
stockholders of target may
require a higher price to
cover the taxes
 Assets are revalued –
affects depreciation
expense
26-13
Taxes
Tax-free acquisition
 Business purpose; not solely to avoid taxes
 Continuity of equity interest – stockholders
of target firm must be able to maintain an
equity interest in the combined firm
 Generally, stock for stock acquisition
26-14
Chapter Outline
•
•
•
•
The Legal Forms of Acquisition
Taxes and Acquisitions
Gains from Acquisitions
Some Financial Side Effects of
Acquisitions
• The Cost of an Acquisition
26-15
Accounting for Acquisitions
 Pooling of interests accounting is
no longer allowed.
 Purchase Accounting
Assets of acquired firm must be
reported at the fair market value.
26-16
Accounting for Acquisitions
Purchase Accounting
 Goodwill is created – difference between
purchase price and estimated fair market
value of net assets
 Goodwill no longer has to be amortized –
assets are essentially marked-to-market
annually and goodwill is adjusted and
treated as an expense if the market value of
the assets has decreased
26-17
Chapter Outline
•
•
•
•
The Legal Forms of Acquisition
Taxes and Acquisitions
Gains from Acquisitions
Some Financial Side Effects of
Acquisitions
• The Cost of an Acquisition
26-18
Synergy
 The whole is worth more than
the sum of the parts
 Some mergers create synergies
because the firm can either cut
costs or use the combined assets
more effectively
26-19
Synergy
 This is generally a good
reason for a merger
 Examine whether the
synergies create
enough benefit to
justify the cost
26-20
Revenue Enhancement
 Marketing gains
 Advertising
 Distribution network
 Product mix
 Strategic benefits
 Market power
26-21
Cost Reductions
 Economies of scale
 Ability to produce larger quantities while reducing the
average per unit cost
 Most common in industries that have high fixed costs
 Economies of vertical integration
 Coordinate operations more effectively
 Reduced search cost for suppliers or customers
 Complimentary resources
26-22
Taxes
Take advantage of net
operating losses
 Carry-backs and carry-
forwards
 Merger may be
prevented if the IRS
believes the sole
purpose is to avoid taxes
26-23
Taxes
 Unused debt
capacity
 Surplus funds
 Pay dividends
 Repurchase shares
 Buy another firm
 Asset write-ups
26-24
Reducing Capital Needs
 A merger may reduce the required investment in
working capital and fixed assets relative to the two firms
operating separately
 Firms may be able to manage existing assets more
effectively under one umbrella
 Some assets may be sold if they are redundant in the
combined firm (this includes reducing human capital as
well)
26-25
General Rules
1. Do not rely on book values alone – the
market provides information about the
true worth of assets
2. Estimate only incremental cash flows
3. Use an appropriate discount rate
4. Consider transaction costs – these can
add up quickly and become a
substantial cash outflow
26-26
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
There is no free lunch!
26-27
Diversification
 Diversification, in and of itself, is not a good reason for
a merger
 Stockholders can normally diversify their own
portfolio cheaper than a firm can diversify by
acquisition
26-28
Diversification
Stockholder wealth may
actually decrease after the
merger because the
reduction in risk, in
effect, transfers wealth
from the stockholders to
the bondholders
26-29
Chapter Outline
•
•
•
•
The Legal Forms of Acquisition
Taxes and Acquisitions
Gains from Acquisitions
Some Financial Side Effects of
Acquisitions
• The Cost of an Acquisition
26-30
Cash Acquisition
 The NPV of a cash acquisition is
NPV = VB* – cash cost
 Value of the combined firm is
VAB = VA + (VB* - cash cost)
 Often, the entire NPV goes to the target firm
 Remember that a zero-NPV investment is not
undesirable
26-31
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
26-32
Stock vs. Cash Acquisition
Considerations when choosing between
cash and stock:
 Sharing gains – target stockholders don’t
participate in stock price appreciation
with a cash acquisition
 Taxes – cash acquisitions are generally
taxable
 Control – cash acquisitions do not dilute
control
26-33
Chapter Outline
(Continued)
• Defensive Tactics
• Some Evidence on Acquisitions: Do M &
A’s Pay?
• Divestitures and Restructurings
26-34
Defensive Tactics
 Corporate charter
 Establishes conditions that allow for a takeover
 Supermajority voting requirement
 Targeted repurchase (a.k.a. greenmail)
 Standstill agreements
 Poison pills (share rights plans)
 Leveraged buyouts
26-35
More (Colorful) Terms
 Golden parachute
 Poison put
 Crown jewel
 White knight
 Lockup
 Shark repellent
 Bear hug
 Fair price provision
 Dual class capitalization
 Counter-tender offer
26-36
Chapter Outline
(Continued)
• Defensive Tactics
• Some Evidence on Acquisitions: Do M &
A’s Pay?
• Divestitures and Restructurings
26-37
Evidence on Acquisitions I
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
26-38
Evidence on Acquisitions II
Shareholders of bidding firms, on
average, do not earn or lose a large
amount
 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
26-39
Evidence on Acquisitions III
Shareholders of bidding firms, on
average, do not earn or lose a large
amount
 Management may not be acting in
stockholders’ best interest
 Takeover market may be competitive
 Announcement may not contain new
information about the bidding firm
26-40
Chapter Outline
(Continued)
• Defensive Tactics
• Some Evidence on Acquisitions: Do M &
A’s Pay?
• Divestitures and Restructurings
26-41
Divestitures and
Restructurings
 Divestiture – company sells a piece of
itself to another company
 Equity carve-out – company creates a
new company out of a subsidiary and
then sells a minority interest to the
public through an IPO
26-42
Divestitures and
Restructurings
 Spin-off – company creates a new
company out of a subsidiary and
distributes the shares of the new
company to the parent company’s
stockholders
 Split-up – company is split into two
or more companies, and shares of all
companies are distributed to the
original firm’s shareholders
26-43
Ethics Issues
 In the case of takeover bids, insider trading is argued to
be particularly endemic because of the large potential
profits involved and because of the relatively large
number of people “in on the secret.”
 What are the legal and ethical implications of trading on
such information?
 Does it depend on who knows the information?
26-44
Quick Quiz
 What are the different methods for achieving a
takeover?
 How do we account for acquisitions?
 What are some of the reasons cited for mergers?
Which may be in stockholders’ best interest, and
which generally are not?
 What are some of the defensive tactics that firms
use to thwart takeovers?
 How can a firm restructure itself? How do these
methods differ in terms of ownership?
26-45
Comprehensive Problem
Two identical firms have yearly after-tax cash flows of
$20 million each, which are expected to continue into
perpetuity. If the firms merged, the after-tax cash flow
of the combined firm would be $42 million. Assume a
cost of capital of 12%.
 Does the merger generate synergy?
 What is VB*?
 What is ΔV?
26-46
Terminology
•
•
•
•
•
•
•
•
•
26-47
Merger
Consolidation
Acquisition
Takeover
Synergy
Diversification
Defensive Tactics
Divestiture
Restructuring
Formulas
NPV = VB* – cash cost
VAB = VA + (VB* - cash cost)
VAB = VA + VB + V
26-48
Key Concepts and Skills
• Define the terminology
used in mergers and
acquisitions.
• Explain the reasons for mergers and
critique their value to the
shareholders.
• Describe the methods to pay for an
acquisition.
26-49
Key Concepts and Skills
• List and discuss the
various defensive
tactics firms can use to
prevent a takeover.
• Compute the value of a
merger or acquisition.
26-50
What are the most important
topics of this chapter?
1. The merging of two firms can be done
in a friendly or unfriendly
environment.
2. Mergers have tax, funding,
accounting, and control implications
for the shareholders of both
companies.
26-51
What are the most
important topics of this
chapter?
3. Synergy can be a valuable motivation
for firms to merge.
4. Unfriendly merger attempts can be
thwarted with numerous strategies.
5. Merger values can be computed and
evaluated as a capital budgeting
problem.
26-52
26-53