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 Key Concepts and Skills
£ Be able to define the various terms associated
with M&A activity
£ Understand the various reasons for mergers
and whether or not those reasons are in the
best interest of shareholders
£ Understand the various methods for paying for
an acquisition
£ Understand the various defensive tactics that
are available
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 Chapter Outline
19.1 The Legal Forms of Acquisitions
19.2 Taxes and Acquisitions
19.3 Accounting for Acquisitions
19.4 Gains from Acquisition
19.5 Some Financial Side Effects of Acquisitions
19.6 The Cost of an Acquisition
19.7 Defensive Tactics
19.8 Some Evidence on Acquisitions: Does M&A Pay?
19.9 Divestitures and Restructurings

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 19.1 The Legal Forms of Acquisitions
£ There are three basic legal procedures that
one firm can use to acquire another firm:
Merger or Consolidation
Acquisition of Stock
Acquisition of Assets

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 Merger versus Consolidation
£ Merger
One firm is acquired by another
Acquiring firm retains name and acquired firm
ceases to exist
Advantage ± legally simple
Disadvantage ± must be approved by stockholders
of both firms
£ Consolidation
Entirely new firm is created from combination of
existing firms
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 Acquisitions
£ A firm can be acquired by another firm or individual(s)
purchasing voting shares of the firm¶s stock
£ Tender offer ± public offer to buy shares
£ 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
£ Classifications
Horizontal ± both firms are in the same industry
Vertical ± firms are in different stages of the production process
Conglomerate ± firms are unrelated

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 Varieties of Takeovers
Merger

Acquisition Acquisition of Stock

Takeovers Proxy Contest Acquisition of Assets

Going Private
(LBO)

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 19.2 Taxes and Acquisitions
£ If it is a taxable acquisition, selling
shareholders need to figure their cost basis
and pay taxes on any capital gains.
£ If it is not a taxable event, shareholders are
deemed to have exchanged their old shares for
new ones of equivalent value.

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 19.3 Accounting for Acquisitions
£ The Purchase Method
The source of much ³goodwill´
£ Pooling of Interests
Pooling of interest is generally used when the
acquiring firm issues voting stock in exchange for
at least 90 percent of the outstanding voting stock
of the acquired firm.
£ Purchase accounting is generally used under
other financing arrangements.
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 19.4 Gains from Acquisition
£ Most acquisitions fail to create value for the
acquirer.
£ The main reason why they do not lies in failures
to integrate two companies after a merger.
Intellectual capital often walks out the door when
acquisitions aren't handled carefully.
Traditionally, acquisitions deliver value when they
allow for scale economies or market power, better
products and services in the market, or learning from
the new firms.
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 Synergy
£ Suppose firm  is contemplating acquiring
firm

£ The synergy from the acquisition is
Synergy =  ± ( +  )
£ The synergy of an acquisition can be
determined from the standard discounted cash
flow model: O
|
Synergy = 
=1
(1 + V)

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 Sources of Synergy
£ Revenue Enhancement
£ Cost Reduction
Replacement of ineffective managers
Economies of scale or scope
£ Tax Gains
Net operating losses
Unused debt capacity
£ Incremental new investment required in
working capital and fixed assets
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 Calculating Value
£ Avoiding Mistakes
Do not ignore market values
Estimate only 
V
 cash flows
Use the correct discount rate
Don¶t forget transactions costs

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 19.5 Some Financial Side Effects
£ Earnings Growth
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 (i.e., an accounting
illusion).
£ Diversification
Shareholders who wish to diversify can accomplish
this at much lower cost with one phone call to their
broker than can management with a takeover.

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 19.6 The Cost of an Acquisition
£ Typically, a firm would use NPV analysis
when making acquisitions.
£ The analysis is straightforward with a cash
offer, but gets complicated when the
consideration is stock.

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 Cash Acquisition
£ The NPV of a cash acquisition is:
NPV = (VB + ǻV) ± cash cost = 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 may
also be desirable.

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 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
£ 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
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 19.7 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

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 More (Colorful) Terms
£ Golden parachute
£ Poison put
£ Crown jewel
£ White knight
£ Lockup
£ Shark repellent
£ Bear hug
£ Fair price provision
£ Dual class capitalization
£ Countertender offer
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 19.8 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.

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 Evidence on Acquisitions
£ Shareholders of bidding firms earn a small excess
return in a tender offer, but none in 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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 19.9 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
£ 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

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 $uick $uiz
£ 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 of these 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?
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