P.V. Viswanath
Class Notes for FIN 648: Mergers and Acquisitions

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Taxation
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Risk Exposure
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Control
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Continuity
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Form of Payment
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 The structure of the acquisitive form can make the benefits from the deal immediately taxable to the target shareholders or not (tax-free or deferred).
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Tax deferral requires the ability to view the acquisition as one of the entire concern. This allows the “fiction” that there is no taxable event for target shareholders.
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One may compare it to an employee whose company has been acquired but nothing in his/her working conditions have changed.
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In a tax-free deal, since the purchase is of a “goingconcern,” Net Operating Loss Carryforwards can be used by the acquirer.
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 If only cash or debt is used, the deal is usually taxable.
 Conceptually, this is like target shareholders having “sold” their shares, which can be thought of as a taxable event, similar to a private sale of stock. Consequently, capital gains taxes have to be paid by target shareholders.
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For the buyer, in taxable deals,
 the tax basis of the acquired assets can be stepped up, thus allowing a larger depreciation shield.
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Hence there is an advantage for the buyer, but a disadvantage for a seller.
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Evidence suggests that tax considerations can actually cause merger activity. The motivations are:
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Exploitation of Net Operating Loss tax carryforwards and tax credits
Step-up in basis on which tax shields (depreciation expense) are computed
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Exploitation of debt tax shields through increased financial leverage.
 However, it is often possible to realize the tax benefits without resorting to an otherwise unnecessary merger.
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 Tax liability
 Exposure to target’s liabilities
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If the deal is structured as a purchase of assets only, exposure may be avoided.
 Need for shareholder vote
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Increase risk since shareholders may not approve deal.
 Survival of target company
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Sometimes key contracts, warranties and retail leaseholds may not be assignable to other entities, even if the other entity is the new owner.
 Flexibility can be affected by the form
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E.g., no taxfree deals are allowed within two years of a spin-off
(before or after) without incurring tax on the distribution of stock.
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 Wall Street Journal . New York, N.Y.: Nov 15, 2005. pg. C.6
 The New York Stock Exchange is expected to decide within two weeks whether to require Sovereign Bancorp Inc. to allow shareholders to vote on its controversial transaction with a
Spanish bank and a New York thrift.
 At issue is the Philadelphia bank's plan to sell a 19.8% stake in itself to Banco Santander Central Hispano SA and use the proceeds to help buy Independence Community Bank Corp.
Sovereign officials say the $2.4 billion deal doesn't need shareholder approval, citing an NYSE rule that requires votes only on sales of stakes of 20% or more.
 But shareholders, including Relational Investors LLC and Franklin
Mutual Advisers, argue the deal does require a shareholder vote under NYSE rules, in part because it would effectively change control at Sovereign.
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 Buyer exchanges cash for the target’s assets.
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Target liabilities are not transferred except by express agreement.
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After the transaction, the target may liquidate or remain as a holding company for other investments.
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The case of Marriott: the original company created a new subsidiary that was left holding a lot of liabilities – bondholders saw their value diminished.
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 The New York Times, March 12, 1993
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The Marriott Corporation … said yesterday that it had agreed to issue new bonds at higher interest rates and to shift some debt between the two new companies.
The original plan to split, announced in October, angered bondholders and brought lawsuits because virtually all of Marriott's nearly $3 billion in debt would have been left with the new real estate company, rather than the profitable management company.
News of the planned reorganization in October had sent the price of
Marriott's 20-year bonds plunging by 30 percent. Yesterday, the bonds were up slightly after the news of the revision. Marriott's stock, which rose 12 percent the day the proposed reorganization was announced, closed yesterday on the New York Stock Exchange at $26.50, up 75 cents.
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 Immediately taxable to target company. However, if target shareholders retain their shares, they do not realize capital gains or losses until target liquidates or shareholders dispose of their shares.
 Step-up of asset values for buyer
 Buyer has no exposure to target’s liabilities, except as agreed.
 No need for buyer shareholder vote; target may need to vote if there is substantial change in nature of target.
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No stock is purchased; hence no need to deal with minority holdouts.
 The target may or may not survive, since it may have no assets.
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 The buyer acquires target’s assets in a tax free exchange under Section 368 in exchange for the buyer’s stock.
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Target stockholders exchange their stock for acquirer’s stock. Target shareholders do not pay tax on the exchange.
The acquirer takes a carryover basis the in target’s assets
(i.e. tax basis to buyer is the same as for target)
The buyer will acquire target’s tax attributes
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Immediately taxable to seller.
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The buyer can treat this as a purchase of assets; if so, there is a step-up of asset values for the buyer, but the target’s tax attributes
(such as NOLs) are lost. However, the target can use NOLs to offset recapture and capital gains taxes.
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Else, there is no change in basis and target NOLs are kept.
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Purchase of stock means that both assets and liabilities are purchased – buyer exposed to target liabilities.
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The target company is not making any decisions – individual shareholders are; hence no shareholder vote is needed.
 There is no “merger;” hence acquiring shareholders don’t have to vote, either.
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The target will usually survive – it becomes majority-owned by the acquirer.
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In a reverse triangular merger, the target survives. Hence unassignable contracts where the target is a party will survive as well. The alternative of buying the target for cash will not ensure this. However, the buyer is exposed to target liabilities.
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In a forward triangular merger, the target does not survive, but the buyer is exposed to target liabilities. The alternative is buying the stock of the target for cash. However, this can leave minority shareholders.
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Yet another alternative is to directly buy the shares of the target or to merge the target directly into the buying company. This will not create a subsidiary.
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One advantage of creating a subsidiary is the ability to separate assets, so that, e.g., debt can be issued solely on the security of the subsidiary’s assets.
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 In a consolidation, two or more corporations combine into one new corporation. This creates a “merger of equals,” which may be necessary to accomplish the merger politically.
 In a merger, one company acquires the other. Target shareholders exchange their shares in return for the buyer’s stock plus other consideration, such as cash or notes, called
“boot.”
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The payment in stock is tax deferred to target stockholders, but boot is immediately taxable.
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The target company ceases to exist and the buyer acquires ownership of the assets of the target in an efficient manner
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 This form is advantageous over buying the stock of the target in that:
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The buyer need only pay partially with stock, but the seller wants cash.
Minority/Dissident shareholders are eliminated.
Unwanted assets can be sold prior to the merger without jeopardizing the tax-free status of the merger.
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The merger is not taxable to the target shareholders if boot < 50%.
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Can be structured as a two-tier transaction, where a controlling fraction of shares was first acquired with cash and the target was then merged forcibly into the buyer (or into a special subsidiary).
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This can be be coercive, if the first-tier sellers are given better terms. As a result, recent laws have discouraged this.
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 If P acquires T’s stock in a tax-free exchange under
S. 368
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T’s shareholders will not generally recognize gains on the exchange of their stock for stock of P.
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P is not permitted to step up the basis of T’s assets.
P generally retains T’s tax attributes, but it might be limited in its ability to use T’s NOLs, capital losses and tax credit carryforwards.
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 PR Newswire, March 13, 1988
 CINCINNATI, March 13 /PRN/ -- Federated Department Stores,
Inc. (NYSE:FDS) announced today that when its board met on Friday,
March 11, the directors present unanimously reaffirmed their conclusion that the Macy's tender offer and merger transaction is superior to Campeau's coercive two-tier offer for 70.5 million (or 80 percent of the) Federated common shares at $75 per share with a second-step merger for the remaining shares at $44 per share. The
Federated board noted that the Campeau offer is for a blended consideration $1.50 per share less than Campeau's advisors had indicated they would recommend to Campeau on March 1 for a negotiated transaction.
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 PR Newswire, TORONTO, March 22
 Campeau Corporation today announced that it has amended its tender offer for Federated
Department Stores, Inc. to provide for the purchase by Campeau of up to 70.5 million shares of Federated common stock (representing approximately 80 percent of the shares outstanding) for $82 per share in cash. The tender offer is to be followed by a merger in which Campeau will pay $37 per share in cash for all remaining shares. The tender offer and merger have a blended value of approximately $73 per share. Campeau will no longer increase the merger consideration if the "break-up" fees agreed upon by Macy's and Federated are invalidated or otherwise not paid (but nevertheless will contest their validity).
The tender offer, withdrawal rights and the proration period will now expire at midnight, New York City time, on April 4, 1988, unless extended. The tender offer remains conditioned upon, among other things, Campeau's receipt of a majority of the outstanding
Federated shares on a fully diluted basis
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 If a majority, but not all, of the stock of the target is purchased, the buyer has a subsidiary it controls, but it has to deal with minority shareholders.
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The same result occurs if a special subsidiary of the buyer buys the stock of the target.
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As long as they exist, this subsidiary has to submit annual reports to shareholders, hold shareholder meetings, elect a board of directors, etc.
 These are all opportunities for bothersome actions by the minority shareholders.
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However, if the buyer obtains shareholder approval, it can merger the target into itself or into the special subsidiary.
This will eliminate a minority interest in the target.
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If the target company is merged into the acquiring company or into a subsidiary, then the target company does not exist – hence there are no minority shareholders.
 Cash purchases of a target’s assets also have the same result; the buying company has no relationship with the target company or its shareholders.
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