Chapter 19

Mergers and Acquisitions

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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 “goodwill”
 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 A is contemplating acquiring firm B.
 The synergy from the acquisition is
Synergy = VAB – (VA + VB)
 The synergy of an acquisition can be determined
from the standard discounted cash flow model:


T
CFt
Synergy = (1 + r)t
t=1
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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 Incremental 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 + ΔV) – 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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 Quick Quiz
 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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