1 Other Acquisition and Capital Budgeting Issues u Noncash payments and assumption of liabilities u Estimating cash flows u Cash-flow approach versus earnings per share (EPS) approach u Generally, the EPS approach examines the acquisition on a short-run basis, while the cash- flow approach takes a more long-run view.

2 Closing the Deal u Target is evaluated by the acquirer u Terms are agreed upon u Ratified by the respective boards u Approved by a majority (usually two-thirds) of shareholders from both firms u Appropriate filing of paperwork u Possible consideration by The Antitrust Division of the Department of Justice or the Federal Trade Commission Consolidation Consolidation -- The combination of two or more firms into an entirely new firm. The old firms cease to exist.

3 Taxable or Tax-Free Transaction u Taxable u Taxable -- if payment is made by cash or with a debt instrument. u Tax-Free u Tax-Free -- if payment made with voting preferred or common stock and the transaction has a “business purpose.” (Note: to be a tax- free transaction a few more technical requirements must be met that depend on whether the purchase is for assets or the common stock of the acquired firm.) At the time of acquisition, for the selling firm or its shareholders, the transaction is:

4 Alternative Accounting Treatments Pooling of Interests (method) net book value Pooling of Interests (method) -- A method of accounting treatment for a merger based on the net book value of the acquired company’s assets. The balance sheets of the two companies are simply combined. Purchase (method) market price Purchase (method) -- A method of accounting treatment for a merger based on the market price paid for the acquired company.

5 Accounting Treatment of Goodwill u Goodwill cannot be amortized for more than 40 years for “financial accounting purposes.” u Goodwill charges are generally deductible for “tax purposes” over 15 years for acquisitions occurring after August 10, Goodwill Goodwill -- The intangible assets of the acquired firm arising from the acquiring firm paying more for them than their book value. Goodwill must be amortized.

6 Restricted Conditions for Pooling of Interests 1. Each of the combined companies must be autonomous for at least two years prior to the pooling, and independent of the others in the sense that none would have owned more than 10 percent of the stock of the other. 2. The combination must be consummated either in a single transaction or in accordance with a specific plan within one year after the plan is initiated. In this regard, no contingent payments are permitted.

7 Restricted Conditions for Pooling of Interests 3. The acquiring corporation can issue only common stock, with rights identical to those of the majority of outstanding voting stock, in exchange for substantially all of the voting common stock of another company. Here, “substantially” means 90% or more. 4. The surviving corporation must not later retire or reacquire common stock issued in connection with the combination, must not enter into an agreement for the benefit of former shareholders, and must not dispose of a significant portion of the assets of the combining companies for at least two years.

8 Tender Offers u Allows the acquiring company to bypass the management of the company it wishes to acquire. Tender Offer Tender Offer -- An offer to buy current shareholders’ stock at a specified price, often with the objective of gaining control of the company. The offer is often made by another company and usually for more than the present market price.

9 Tender Offers u It is not possible to surprise another company with its acquisition because the SEC requires extensive disclosure. u The tender offer is usually communicated through financial newspapers and direct mailings if shareholder lists can be obtained in a timely manner. u A two-tier offer may be made with the first tier receiving more favorable terms. This reduces the free-rider problem.

10 Defensive Tactics u The company being bid for may use a number of defensive tactics including: u (1) persuasion by management that the offer is not in their best interests, (2) taking legal actions, (3) increasing the cash dividend or declaring a stock split to gain shareholder support, and (4) as a last resort, looking for a “friendly” company (i.e., white knight) to purchase them. White Knight White Knight -- A friendly acquirer who, at the invitation of a target company, purchases shares from the hostile bidder(s) or launches a friendly counter-bid in order to frustrate the initial, unfriendly bidder(s).

11 Antitakeover Amendments and Other Devices Shareholders’ Interest Hypothesis This theory implies that contests for corporate control are dysfunctional and take management time away from profit-making activities. Managerial Entrenchment Hypothesis This theory suggests that barriers are erected to protect management jobs and that such actions work to the detriment of shareholders. Motivation Theories:

12 Antitakeover Amendments and Other Devices u Stagger the terms of the board of directors u Change the state of incorporation u Supermajority merger approval provision u Fair merger price provision u Leveraged recapitalization u Poison pill u Standstill agreement u Premium buy-back offer Shark Repellent Shark Repellent -- Defenses employed by a company to ward off potential takeover bidders -- the “sharks.”

13 Empirical Evidence on Antitakeover Devices u Empirical results are mixed in determining if antitakeover devices are in the best interests of shareholders. u Standstill agreements and stock repurchases by a company from the owner of a large block of stocks (i.e., greenmail) appears to have a negative effect on shareholder wealth. management entrenchment hypothesis u For the most part, empirical evidence supports the management entrenchment hypothesis because of the negative share price effect.

14 Strategic Alliance u Strategic alliances usually occur between (1) suppliers and their customers, (2) competitors in the same business, (3) non-competitors with complementary strengths. joint venture u A joint venture is a business jointly owned and controlled by two or more independent firms. Each venture partner continues to exist as a separate firm, and the joint venture represents a new business enterprise. Strategic Alliance Strategic Alliance -- An agreement between two or more independent firms to cooperate in order to achieve some specific commercial objective.

15 Divestiture u Liquidation u Liquidation -- the sale of assets of a firm, either voluntarily or in bankruptcy. u Sell-off u Sell-off -- the sale of a division of a company, known as a partial sell-off, or the company as a whole, known as a voluntary liquidation. Divestiture Divestiture -- The divestment of a portion of the enterprise or the firm as a whole.

16 Divestiture u Spin-off u Spin-off -- a form of divestiture resulting in a subsidiary or division becoming an independent company. Ordinarily, shares in the new company are distributed to the parent company’s shareholders on a pro rata basis. u Equity carve-out u Equity carve-out -- the public sale of stock in a subsidiary in which the parent usually retains majority control.

17 Empirical Evidence on Divestitures u For liquidation of the entire company, shareholders of the liquidating company realize a +12 to +20% return. u For partial sell-offs, shareholders selling the company realize a slight return (+2%). Shareholders buying also experience a slight gain. u Shareholders gain around 5% for spin-offs. u Shareholders receive a modest +2% return for equity carve-outs. u Divestiture results are consistent with the informational effect as shown by the positive market responses to the divestiture announcements.

18 Ownership Restructuring u The most common transaction is paying shareholders cash and merging the company into a shell corporation owned by a private investor management group. u Treated as an asset sale rather than a merger. Going Private Going Private -- Making a public company private through the repurchase of stock by current management and/or outside private investors.

19 Motivation and Empirical Evidence for Going Private u Elimination of costs associated with being a publicly held firm (e.g., registration, servicing of shareholders, and legal and administrative costs related to SEC regulations and reports). u Reduces the focus of management on short-term numbers to long-term wealth building. u Allows the realignment and improvement of management incentives to enhance wealth building by directly linking compensation to performance without having to answer to the public. Motivations:

20 Motivation and Empirical Evidence for Going Private u Large transaction costs to investment bankers u Little liquidity to its owners u A large portion of management wealth is tied up in a single investment Empirical Evidence: u Shareholders realize gains (+12 to +22%) for cash offers in these transactions. Motivations (Offsetting Arguments):

21 Ownership Restructuring u The debt is secured by the assets of the enterprise involved. Thus, this method is generally used with capital-intensive businesses. management buyout u A management buyout is an LBO in which the pre- buyout management ends up with a substantial equity position. Leverage Buyout (LBO) Leverage Buyout (LBO) -- A primarily debt financed purchase of all the stock or assets of a company, subsidiary, or division by an investor group.

22 Common Characteristics For Desirable LBO Candidates u The company has gone through a program of heavy capital expenditures (i.e., modern plant) u There are subsidiary assets that can be sold without adversely impacting the core business, and the proceeds can be used to service the debt burden. u Stable and predictable cash flows. u A proven and established market position. u Less cyclical product sales. u Experienced and quality management. Common characteristics (not all necessary):