REPORTING FOR CAPITAL MARKET

TOPIC: INVESTMENT SPECIAL SITUATION AND ANOMALIES

(BORANG PART)
INVESTMENT SPECIAL SITUATION - Investment in special situations is an event
turning business that impacts on the company’s value. This will include restructuring of
a company and corporate transactions such as spin-offs, share repurchase, asset sales
and mergers and acquisitions or any other catalyst-oriented situation.

EXPLANATION: Special situation investment is a subclass of alternative

investment. These investments are risky and challenging and they require
specialized expertise, to determine the best price for the investment as this can be
very difficult. The profits are not assured because the price might increase as
higher prices are offered. These makes special situation investments to be closely
monitored especially by hedge fund managers for they provide interesting
investment opportunities. Private equity funds and other institutional investors also
do special situation investment as part of their strategies.
MERGERS AND ACQUISITION - A merger is a transaction that combine two firms into
one new firm while an acquisition is a purchase of one firm by another firm. In some
instances, two organizations are combined into one and one less stock is publicly
traded.

EXPLANATION: Any merger or acquisition that has no effect on the after-tax cash
flows of either firm will not create or destroy value. The aspect of creation of value
for a merger and acquisition is achieved when the after-tax cash flows of the
combined firm, exceed the sum of the after-tax cash flows of the individual firms
before the merger.
Mergers can also be categorized as:
 Friendly-Offer made directly to the firm management or board of directors
 Hostile-where there is objection and the bidder firm applies hostile offer for the
target firm.
Types of mergers and their critical evaluation

1. Strategic acquisition - It is a horizontal merger. It was common during the

period leading up to the great depression. It involves operating synergies this
implies that two firms are more profitable combined than separate. Also, it
involves the merger of former competitors.
2. Financial acquisition - The bidder usually believes that the price of the
firm’s stock is less than the value of the firm’s assets. It’s motivated by the
tax gain associated with the acquisition. The acquirer believe that the target
firm is undervalued relative to its assets because it is badly managed. It is
also regarded as disciplinary takeover when the takeover is perceived as
hostile. Are often structured as leverage buyout - An individual or a group
often led by a firm own management arranges to buy a public company and
make it private. All the publicly traded shares are purchased and the firm
ceases to be a public company. These are called leveraged buyouts because
the transactions are financed mainly with debts
3. Conglomerate - Also called diversifying acquisition. It involves firms with
no apparent potential for operating synergies. Motivated by financial
strategies which lower a firm cost of capital.
BENEFITS OF ACQUISITIONS

1. Benefits to the Economy - Theoretically, the potential for acquisitions to

create an economy-wide gain does exist if, as a consequence of acquisitions,
assets are transferred from the control of inefficient managers to the control
of efficient managers. Unfortunately, the motives behind acquisitions often
owe more to managerial self-interest than to the more efficient use of assets.
Empirical evidence however suggests that gains from acquisition are neutral
and there are no extreme efficient gains.
2. Benefits to the shareholders involved - Empirical evidence show that, target
company shareholders tend to enjoy significant positive abnormal returns,
whereas acquiring company shareholders experience statistically
insignificant negative or positive abnormal returns.
3. Managers and employees of acquiring and target companies - Generally,
acquiring company managers benefit more from a successful takeover. This
is caused by the increased power and status, which is reflected by an
increased financial reward.
RISKS INVOLVED
Mergers and acquisitions may fail due to the following reasons.

1. Overpayment - According to Agrawal and Jaffe (1999), acquirers tend to

overpay for the ‘high growth’ companies based on past performance. By
overpaying for an acquisition, the acquirers condemn themselves to having
to improve profitability to earn the financial returns required by investors on
a higher net asset.
2. Acquirers overestimated synergies - The acquirers may overestimate the
estimated synergy and are therefore unable to realize those returns. In
overpayments, there is a higher likelihood of the acquiring firm to overstate
their synergies. The acquiring firm is then forced to write off the goodwill
associated with prior acquisition or a part of acquired assets.
3. Slow integration - The integration of the acquired firm with the acquiring
firm is usually more challenging than it is anticipated. Consequently, paying
less than the fair market value may enable the acquiring firm to realize
attractive financial returns even if they were unable to quickly realize the
forecast amount of cost and benefits.
 (AREDIDON PART)
SHARE REPURCHASE - These are cash offers for outstanding shares of common
stock. They change the book capital structure of the firm by reducing the amount of
common stock.
Effects of share repurchase on leverage ratio;
 Leverage ratio increases because the amount of common stock is reduced
 The leverage ratio is magnified if excess cash which is used to extinguish
common stock is no longer deducted from debt to measure leverage ratio
 If additional debt is used to buy common stock, similar magnification of leverage
is identified.
Factors that have led to the increased growth in share repurchase

1) Tax Savings - This is because cash dividends are liable to a tax, but return of
cash from share repurchase may qualify for long term capital gains in some
countries up to 20%.
2) Timing of Taxes - Shareholders can choose whether or not to participate in a
buyback program. Consequently, they can choose to defer tax payments.
3) Management Incentives - A share repurchase increase the percentage
ownership of the firm for non-participants such as officers and directors.
They are incentives of officers and directors making them think like the
owners. They also reduce agency problems in the firm.
4) Management Responsibility - By returning excess cash to the shareholders,
the directors may be perceived to act in the best interest of shareholders. The
shareholders trust their officers and directors because the excess funds were
not used for negative NPV investments.
5) Under-Valuation Signal - Non participation of officers and directors in
buyback programs may signal that stock price is undervalued. The cash
flows are likely to increase in the future.
6) Sharp Price Declines - After a sharp decline in the stock market in October
1987, many firms initiated substantial share repurchase programs. Share
repurchase represent a statement by management that overall market decline
did not justify the sharp drop in their firms’ share price.