CHAPTER 6

MERGER & ACQUISITION

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
 Chapter Outline
 The Legal Forms of Acquisitions
 Taxes and Acquisitions
 Accounting for Acquisitions
 Gains from Acquisition
 Some Financial Side Effects of Acquisitions
 The Cost of an Acquisition
 Defensive Tactics
 Some Evidence on Acquisitions: Does M&A Pay?
 Divestitures and Restructurings
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
 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
Takeovers
 Control of a firm transfers from one group to
another
 Possible forms
 Acquisition
 Merger or consolidation
 Acquisition of stock
 Acquisition of assets

 Proxy contest
 Going private
 Synergy
 The whole is worth more than the sum of the parts
 Some mergers create synergies because the firm
can either cut costs or use the combined assets
more effectively
 This is generally a good reason for a merger
 Examine whether the synergies create enough
benefit to justify the cost
Revenue Enhancement
 Marketing gains
 Advertising
 Distribution network
 Product mix
 Strategic benefits
 Market power
Cost Reductions
 Economies of scale
 Ability to produce larger quantities while reducing the average
per unit cost
 Most common in industries that have high fixed costs
 Economies of vertical integration
 Coordinate operations more effectively
 Reduced search cost for suppliers or customers
 Complimentary resources
Reducing Capital Needs
 A merger may reduce the required investment in
working capital and fixed assets relative to the two firms
operating separately
 Firms may be able to manage existing assets more
effectively under one umbrella
 Some assets may be sold if they are redundant in the
combined firm (this includes human capital as well)
EPS Growth
 Mergers may create the appearance of growth in
earnings per share
 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
 In this case, the P/E ratio should fall because the
combined market value should not change
 There is no free lunch
Diversification
 Diversification, in and of itself, is not a good
reason for a merger
 Stockholders can normally diversify their own
portfolio cheaper than a firm can diversify by
acquisition
 Stockholder wealth may actually decrease after
the merger because the reduction in risk, in effect
transfers wealth from the stockholders to the
bondholders
Cash Acquisition
 The NPV of a cash acquisition is
 NPV = 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 is also
desirable
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
NPV OF A MERGER
• Consideration (payment) from bidder firm to target firm can be ;
• (i) in cash
• (ii) in shares of bidder firm
• Whether to acquire or not, it depends on the NPV of the merger and the
market price of bidder shares after the merger
• Example: Suppose firm A (bidder) and firm B (target) has a pre (before)
merger market value of RM500 and RM100 respectively. Firm A has 25
shares outstanding and firm B has 10 shares. When they are merged, the
combined firm AB will have a market value of RM700 resulting in a
synergies of RM100. BOD of firm B requires payment of RM150. Would
firm A acquires firm B if the payments is in:
• a) cash b) shares

15 chapter 11 mergers and acquistions

 CASH ACQUISITION SHARES ACQUISITION

Value of Co. B to V*B = ∆V + VB V*B = ∆V + VB

Co. A = RM100 + RM100 = RM200 = RM100 + RM100 = RM200
Value of Co. AB VAB = VA + (V*B – Cost of Acquisition) VAB = VA + VB + ∆V
after merger = 500 + (200 – 150) = 500 + 100 + 100
= RM550 = RM700
Market Price per MP = Value of Co. AB after merger MP = Value of Co. AB after merger
share after merger No. of C/Stocks Total no. of C/Stocks (New + Old)
(Co. A) = RM550 / 25 = RM700 / 32.5 = RM21.54
= RM22 No. of new C/Stocks = Cost of Acquisition
MP of Co. A
= 150 / 20
= 7.5 units
Total no. of c/stocks = New + Old
= 7.5 + 25
= 32.5 units

NPV of the merger NPV = V*B – Cost of Acquisition NPV = V*B – Actual Cost of Acquisition
(Co. A) = 200 – 150 = 200 – (7.5units x RM21.54)
= RM 50 = RM38.45
Premium Pm = cash payment – Value of Co. B Pm = (New MP – Old MP) x No. of C/S of
= 150 – 100 Co. A
= RM50 = (22 – 20) x 25 = RM50
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
More (Colorful) Terms
 Golden parachute
 Poison put
 Crown jewel
 White knight
 Lockup
 Shark repellent
 Bear hug
 Fair price provision
 Dual class capitalization
 Countertender offer
 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
 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
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
Additional formula
 Market value

 Price earning ratio

 Earning per share (EPS)

 VAB

 VAB

 VA

 VB