You are on page 1of 6

FI-561 MERGERS & ACQUISITIONS

WEEK 1 -

HOMEWORK ANSWER KEY

1.5
An arbitrage firm (A) notes that a bidder (B) whose stock is selling at $30 makes an offer for a
target (T) selling at $40 to exchange 1.5 shares of B for 1 share of T. Shares to T rise to $44; B stays at
$30. A sells 1.5 B short for $45 and goes long on T at $44. One month later the deal is completed with B
at $30 and T at $45. What is As dollar and percentage annualized gain, assuming a required 50% margin
and 8% cost of funds on both transactions?
(Weston 16-17)

Question 1.5 (Chapter 1 p. 16)


A sells 1.5 B for $45 and buys T at $44. Assuming 50% margin, the investment is .5 ($45 + $44)
= $44.5. In one month, A uses T to cover 1.5 B. The dollar gain is $1. The percentage gain is
[($1/$44.5)] * 12 = 26.97% less the interest on the $44.5 borrowed on margin. If A invested the
full $89, the gain would be ($1/$89) * 12 = 13.48%.

Case 2.8 (Chapter 2 pp. 57-58)

Case 2.8 UNITED AIRLINES AND US AIRWAYS


On July 27, 2001, the U.S. Department of Justice blocked the merger of United Airlines and US Airways.
According to Attorney General John Ashcroft, if this acquisition were allowed to proceed, millions of
customers would have little choice but to pay higher fares and accept lower-quality air service.
Legislators on Capitol Hill applauded the decision of the DOJ to block the merger. The view was that
competition along the East Coast would be greatly reduced because United Airlines and US Airways are
the only two airlines in many markets offering connecting services between cities up and down the coast.
When the merger was announced in May 2000, the stock price of US Airways increased from $26.31 to
$49.00, nearly doubling in price. The bid by United Airlines was for $60 in cash. As investors expected
the deal to take a considerably long time to complete, and because there was a good chance that the deal
might be rejected by the regulations, the stock price of US Airways traded at a fairly large spread relative
to the agreed-upon price. When the DOJ blocked the merger, the stock price of US Airways immediately
dropped into the teens, and in August 2002, the company filed for federal bankruptcy protection.
Interestingly, before the year 2002 had ended, United Airlines had also filed for federal bankruptcy
protection. As of early 2003, the surviv-ability of both firms is questionable.
QUESTIONS
C2.8.1
The DOJs blocking of the merger rested on the case that it would greatly reduce
competition along the East Coast because the merging parties were often the only two major
airlines in some markets. Should potential competition, for example, arising from Southwest
Airlines, a mover into the East Coast market, factor into the DOJs decision?

C2.8.2
US Airways is a failing firm and has a substantial probability of bankruptcy.
Should the antitrust authorities consider a failing firm defense from the merging parties?
That is, should mergers be allowed to occur if otherwise the target firm faces bankruptcy?
(Weston 57-58)

C2.8.1 UAL & US Airways


Yes, potential competition is relevant and is often factored into DOJs decisions regarding merger
approval. Apparently in this case, DOJ held the view that United Airlines and US Airways
would have such a strong lock on the East Coast market that another airline such as Southwest
Airlines would be dissuaded from entering the market.
C2.8.2 UAL & US Airways
The antitrust authorities should, and often does, consider a failing firm defense from the merging
parties. In many cases, a merger is the only outcome that will save the target firm from outright
failure. The issue is not that the target firm should not be permitted from failing, rather that if the
merger creates value that otherwise would be destroyed in case of the target being forced to go it
alone, then there is economic value to allowing the merger to proceed. There are numerous cases
of negative shocks to industries whereby many of the firms are negatively impacted such that
mergers are an efficient reallocation of assets. Such appears to be the case in the airline industry
which has been undergoing immense pressure due to high union wage rates and reduction in air
travel demand due to the tragic events of September 2001. Indeed, since the time that DOJ
disqualified the merger of US Airways and United Airlines, both firms have filed for bankruptcy.

WEEK 2 HOMEWORK ANSWER KEY


Case 3.3 AOL Time Warner Case (Chapter 3, pp. 87-88)

C3.31 :Merger announcement date: January 7, 2000. What was the premium paid by AOL for
TWX?

Price per share paid to TWX = exchange ratio AOL price per share = 1.5 $72.88
= $109.32
Premium to TWX shareholders = ($109.32 $64.75) / $64.75 = $44.57 / $64.75 = 68.8%
= $109.32/$64.75 1 = 1.69 1 = 68.8%
C3.3.2: The value of AOL on September 10, 2002, was $13.36, and the number of shares
outstanding was 4.45 billion. What was the decline in value of AOL from its immediate
postmerger market capitalization?
Value of AOL on 9/10/02 = share price number of shares = $13.36 4.45 billion
= $59.5 billion
Dollar Decline = $342.6 billion $59.5 billion = $283.1 billion
Percent Decline = $283.1 billion / $342.6 billion = 82.6%
C3.3.3:
Explain the pro forma accounting adjustments (except for the miscellaneous
items) as an example of purchase accounting.

AOL paid $153.1 billion in stock value for TWX. So this is the total adjustment to be accounted
for. The basic entries for purchase accounting are:

Eliminate TWX book equity by a debit of $10 billion. Next, miscellaneous adjustments reflected
in a debit of $30.9 billion were made. The total increase in goodwill is $174 billion. So the sum
of the pro forma debit adjustments equals the market value of AOL stock paid for TWX.
We next consider the credits. The AOL common stock at par issued to pay for the purchase of
TWX is a credit of $0.1 billion (rounded). This is deducted from the amount paid for TWX to
obtain $153.0 billion which becomes the addition to AOL paid in capital.
.
C3.3.4:

Calculate the percent of goodwill and other intangibles to total assets for AOL
Asset Structure Changes in AOL and TWX ($ millions)
Pro Forma
Post Merger

Pre Merger
AOL
Amount
Total Assets
Goodwill+other intangibles
Tangible assets

TWX
%

Amount

Combined
%

Amount

$10,789

100.0%

$50,213

100.0%

$235,388

100.0%

$432

4.0%

$24,507

48.8%

$199,325

84.7%

$10,357

96.0%

$25,706

51.2%

$36,063

15.3%

The total assets of AOL pre-merger were about $11 billion. Total assets of TWX were $50
billion. Their sum is $61 billion. But as a result of purchase accounting total assets became
$235 billion much greater than the $61 billion. The reason is the great increase in goodwill
plus other intangibles. Tangible assets were $10 billion plus $26 billion to total $36 billion.
C.3.3.5:
Calculate the percent of total liabilities and of shareholders equity to total assets for AOL and for
TWX premerger and for the pro forma combined company postmerger. Discuss.
Leverage Changes in the AOL and TWX Merger
Pro Forma
Post Merger

Pre Merger
AOL
Total Liabilities
Shareholders' Equity
Total Claims
Liabilities/Equity

Amount
$4,370
$6,419
$10,789

%
40.5%
59.5%
100.0%

TWX
Amount
%
$39,949
79.6%
$10,264
20.4%
$50,213
100.0%

Combined
Amount
%
$79,095
33.6%
$156,293
66.4%
$235,388
100.0%

68.1%

389.2%

50.6%

Leverage changes reduced the combined firms liabilities-to-shareholders equity to 50.6%. This
reflected the large increase in paid in capital because of the large premium paid by AOL to TWX.

On 3/21/02, AOL-TWX had a market value of equity of $110 billion, 29.5% below the book
equity of $156 billion; liabilities-to-market equity were $79 billion/$110 billion equals 72%.
On 3/26/02, AOL announced a $54 billion write down to reflect the impairment of goodwill.
FASBs Statement of Financial Standards No. 142 on Goodwill and Other Intangible Assets
issued June 2001 states in 43 p. 16: The aggregate amount of goodwill impairment losses shall
be presented as a separate line in the income statement before the subtotal income from
continuing operations (or similar caption)

Question 4.2 (Chapter 4, p. 99)


Stock-for-stock transactions: Generally a nontaxable transaction. Acquired firm shareholders
deferred gains; still retain ownership in combined firm. Acquiring firm shareholders no
cash outlay or borrowing required; carryover of NOLs, tax credits, asset basis.
Cash-for-stock transactions: Acquired firm shareholders immediate gain recognition; no
longer have ownership interest. Acquiring firm shareholders potential benefits of stepped-up
asset basis for future depreciation.

Questions 5.1, 5.2, 5.3, 5.4 - (Chapter 5, p.123)


5.1
Strategy represents a long-range approach to dealing with the most fundamental aspects of a
firm's performance, present and future, in relation to its changing environment. Strategic
planning provides an approach to dealing with large-scale uncertainty and ill-structured
problems. Although it is mainly concerned with long-term issues, it must also consider the
effects of short-term and mid-term decisions and actions on the long-run goals and performance
of the firm.
5.2
Porter identifies attractive industries as those with the following characteristics:
a. High entry barriers.
b. Suppliers and/or buyers have weak bargaining power.
c. Few available substitute products/services.
d. Stable rivalry among competitors.
5.3
Cost leadership versus product differentiation.
a. Competitive advantage through cost leadership is based on a wide-ranging checklist which
includes the Boston Consulting Group Experience Curve theory.
b. Competitive advantage through product differentiation relates to formulating a strategy based
on product qualities not easily imitated by other firms.
5.4

a. Possible entry barriers:


1. Lower costs due to greater efficiencies.
2. Lower costs due to economies of scale.
3. Lower costs due to position on learning curve.
4. Advertising advantages.
5. Product differentiation advantages.
6. Large capital requirements for minimum required investment.
b. Significance. If they exist, they would confer market power to the holder; the ability to
restrict output and raise prices without the competition of supply increases by other firms. As
a result, firms within the industry need only concern themselves with a finite group of rivals
and have a greater ability to achieve above normal rates of return. But it is difficult to
separate entry barriers from superior efficiency of incumbent firms.

You might also like