Corporate Finance

MERGER, ACQUISITION AND

DIVESTITURE

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Outline
1. The Basic Forms of Acquisitions
2. Synergy and Source of Synergy
3. The NPV of a Merger
4. Going Private and Leverage Buyout
5. Divestiture

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The Basic Forms of Acquisitions
Three basic forms:
◦ Merger or Consolidation
◦ Acquisition of stock
◦ Acquisition of assets

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Merger or Consolidation
A Merger refers to the absorption of one firm by
another. (A + B = Bigger A)
◦ The acquiring firm retains its name and identity. It
acquires all of the assets and liabilities of the acquired
firm
◦ After the merger, the acquired firm ceases to exist as a
separate entity
A Consolidation is the same as a merger except that an
entirely new firm is created. (A + B = C)
◦ Both acquiring and acquired firm terminate their previous
legal existence and become part of the new firm
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Merger or Consolidation
A Merger: A + B = Bigger A
◦ Firm B’s shareholders are given share of Firm A’s
stock in exchange for share of firm B’s stock.
(Firm A issue new shares)
A Consolidation: A + B = C
◦ Shareholders of Firm A and B exchange their
shares for shares of Firm C (new firm)
Note: The stockholders of each firm must approve a
merger (typically, two-thirds of share owners must
vote in favor for it to be approved).
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Acquisition of Stock
Acquirer purchase the firm’s voting stock in exchange for cash,
shares of stock, or other securities.
Factors are involved in choosing between an acquisition of stock
and a merger:
◦ In an acquisition of stock:
◦ Shareholder meetings need not be held and a vote is not required.
◦ The bidding firm can deal directly with the shareholders of a target
firm via tender offer. (bypassed the target firm’s management and
BOD)
◦ Target managers often resist acquisition
◦ Frequently, a minority of shareholders will hold out in a tender
offer, thus the target firm cannot be completely absorbed.

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Acquisition of Assets
One firm acquire another by buying all of its assets.
A formal vote of the target stockholder is required.

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Classification
Horizontal acquisition: Both the acquirer and acquired are in the
same industry (AT&T’s proposed acquisition of T-Mobile)
Vertical acquisition: Involves firms at different steps of the
production process (Cable operator Comcast’s acquisition of
television network NBC Universal in 2010; Oracle purchase Sun
Microsystems- move from its primarily software business into
hardware)
Conglomerate acquisition: The acquiring firm and the acquired
firm are not related to each other (diversification)

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Synergy
The difference between the value of the combined firm
(VAB) and the sum of the values of the firms as separate
entities (VA and VB) is the synergy from the acquisition.
Synergy = VAB - (VA + VB)
Synergy will be shared between the acquiring and
acquired firm

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Source of Synergy
◦ Revenue enhancement
◦ Cost reduction
◦ Lower taxes
◦ Lower capital requirements

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Source of Synergy
◦ Revenue enhancement
◦ Strategic benefits (strategic merger)
◦ Market or Monopoly power (reduce competition)
◦ Cost reduction
◦ Economy of scale
◦ Elimination of Inefficient Management
◦ Technology Transfer
◦ Complementary Resources (improve usage of existing
resources: office, warehouse, machine…)

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Source of Synergy
◦ Tax gains
◦ The use of tax losses (a profitable division + an
unprofitable one)
◦ The use of unused debt capacity
◦ The use of surplus fund
◦ Reduced capital requirements
◦ Duplicate facilities, consolidate the R&D…

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The NPV of a Merger
Cash Offer
◦ A acquire B by cash
◦ Premium = Cash – VB
◦ NPVA = Synergy – Premium
◦ Example:
VA = $1,000; VB = $500. A acquire B for $600, Synergy =
$300. Premium?, NPVA?

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The NPV of a Merger
Stock Offer
◦ A acquire B by exchange stock (A+B=C)
◦ A issue x shares for 1 share of B
◦ Proportion of B’s shareholder in C: 𝜶 = xNB/(NA+xNB)
◦ Premium = 𝛼×VC – VB
◦ NPVA = Synergy – Premium
◦ Example:
VA = $1,000; VB = $500. NA = 1,000; NB = 250, x = 1.6,
Synergy = $300.
Premium?, NPVA? How much is x to make it indifferent
between cash and stock offer?
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The NPV of a Merger
Cash versus Stock Offer
◦ When to use Cash?
◦ When to use Stock?
◦ è Signal?

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 Accounting and Acquisition
Example: ($ in millions). Below is the Balance sheet before
the acquisition
Firm A Firm B
Cash $4 Equity $20 Cash $2 Equity $10
Land 16 Land 0
Buildings 0 Buildings 8
Total 20 20 Total 10 10

A issue $19 mil. bond to acquires B by cash. Fair market

value of buildings of Firm B is $14 mil.

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Accounting and Acquisition
Balance sheet after the acquisition
Firm AB
Cash Debt
Land Equity
Buildings
Goodwill
Total

◦ Goodwill is the portion of the purchase price that is higher

than the sum of the net fair value of all of the assets purchased
in the acquisition and the liabilities assumed in the process
◦ Each year the firm must access the value of its goodwill (if the
value goes down, the goodwill must be decrease accordingly
◦ Financial analyst often ignore the goodwill because it has no
cash flow consequences
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Going private and Leveraged Buyouts
◦ A publicly traded firm goes private when a private group
purchases its stock
◦ The firm’s stock is taken off the market (delisted)
◦ Going-private are frequently Leverage buyouts (LBOs)
◦ LBOs is financed with large amounts of debt (a little
equity capital)
◦ Equity capital is supplied by a small group of investors
(likely to be managers of the firm)

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Going private and Leveraged Buyouts
◦ Reasons for Synergy of Going private:
◦ Extra debt provides a tax deduction (LBO may simple increase the
firm’s debt to its optimum level)
◦ Going private increase efficiency
◦ Managers become owners under an LBOè incentive to work
hard
◦ High level of debt force the management to make changes è
revenue increases or cost reduction

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Divestitures
◦ SALE
◦ Sale a division, business unit, segment or set of assets to
another company
◦ The buyer generally pays in cash
◦ Reasons for sales:
◦ Improve corporate focus
◦ Provide cash for liquidity-poor firms
◦ Firms may simply want to sell unprofitable divisions

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Divestitures
◦ SPIN-OFF
◦ Turns a division into a separate entity and distributes
shares in this entity to the parent’s stockholders
◦ Parent firm receives no cash
◦ Initial stockholders of the spun-off division are the same as
the parent’s stockholders
◦ Reason for Spin-off
◦ Increase corporate focus
◦ Better information transparency of the spun-off division
◦ Tax consequences from a spin-off are generally better than
from a sale because the parent receives no cash
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Divestitures
◦ CARVE-OUT
◦ Turns a division into a separate entity and sell shares in the
division to the public
◦ Generally the parent retains a large interest in the division
◦ The reason for carve-out is the same with spin-off except
the parent will receive cash from a carve-out.
◦ Empirical evidence show: good signal if the cash from a
carve-out is used to reduce debt; bad signal if it is used for
investment projects.

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A note about Takeovers
Merger or consolidation
Acquisition
Acquisition of stock

Takeover Proxy contest

Acquisition of assets

Going private

Proxy contest: occurs when a group of shareholders attempts to gain

seats on the BOD. (Proxy is a written authorization for one
shareholder to vote the stock of another shareholder)

Going private: a small group of investor purchases all the equity

shares of a public firm. The shares of the firm are delisted form stock
exchanges.
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Question and Problems
Chapter 29:
◦ Q&Ps: 7, 14, 15, 17

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