0. Chapter 23
mergers and acquisitions

1. Definition
The phrase mergers and acquisitions (abbreviated M&A) refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling and combining of different companies that can aid, finance, or help a growing company in a given industry grow rapidly without having to create another business entity.

2. Business valuation The five most common ways to valuate a business are
asset valuation,
historical earnings valuation,
future maintainable earnings valuation,
relative valuation (comparable company & comparable transactions),
discounted cash flow (DCF) valuation

3. Chapter Outline The Legal Forms of Acquisitions
Accounting for Acquisitions
Gains from Acquisition
The Cost of an Acquisition
Defensive Tactics
Some Evidence on Acquisitions
Divestitures and Restructurings

4. Legal Forms of Acquisitions
Merger or consolidation
Acquisition of stock
Acquisition of assets

5. Merger versus Consolidation
One firm is acquired by another
Acquiring firm retains name and acquired firm ceases to exist
Consolidation
Entirely new firm is created from combination of existing firms

6. Stock Acquisition (1)
A firm can be acquired by purchasing voting shares of the firm’s stock
Tender offer – public offer to buy shares
Circular bid – takeover bid communicated to shareholders by direct mail
Stock exchange bid – takeover bid communicated to shareholders through a stock exchange

7. Stock Acquisition (2) 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

8. Acquisition Classifications
Horizontal – both firms are in the same industry
Vertical – firms are different stages of the production process
Conglomerate – firms are unrelated

9. Takeovers Control of a firm transfers from one group to another
Possible forms
Acquisition
Proxy contest
Going private (LBO vs. MBO)

10. Alternatives to Merger
Strategic alliance = agreement between firms to cooperate in pursuit of a joint goal
Joint venture = an agreement between firms to create a separate, co-owned entity established to pursue a joint goal

11. Accounting for Acquisitions
The Purchase Method
Assets of acquired firm are written up to fair market value
Goodwill is created – difference between purchase price and estimated fair market value of net assets

12. Gains from Acquisition
Synergy
Revenue enhancement
Cost reductions
Tax gains

13. Synergy The whole is worth more than the sum of the parts
Synergies should create enough benefit to justify the cost

14. Revenue Enhancement Marketing gains Strategic benefits Market power
Advertising
Distribution network
Product mix
Strategic benefits
Market power

15. Cost Reductions Economies of scale
Ability to produce larger quantities while reducing the average per unit cost
Economies of vertical integration
Coordinate operations more effectively
Reduced search cost for suppliers or customers
Complimentary resources

16. Taxes
Tax losses
Unused debt capacity
Surplus funds
Asset write-ups

17. Reducing Capital Needs
Firms may be able to manage existing assets more effectively under one umbrella
Some assets may be sold if they are not needed in a combined firm

18. Diversification
Diversification, in and of itself, is not a good reason for a merger
Stockholders can diversify their own portfolio cheaper than a firm can diversify by acquisition

19. 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

20. The Cost of Acquisition: Cash Acquisition
The NPV of a cash acquisition is
NPV = VB* – cash cost
Value of the combined firm is
VAB = VA + (VB* - cash cost)

21. The Cost of Acquisition: 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

22. Shares vs. Common Stock
Sharing rights
Taxes
Control

23. Defensive Tactics(1) Corporate charter Targeted repurchase (Greenmail)
Establishes conditions that allow for a takeover
Supermajority voting requirement
Targeted repurchase (Greenmail)
Standstill agreements
Exclusionary offers
Poison pills
Share rights plans

24. Defensive Tactics (2) Leveraged buyouts (LBO) Other defensive tactics
Golden parachutes
Crown jewels
White knight

25. 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

26. More Evidence
Shareholders of bidding firms do not earn much excess return in either a tender offer or 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

27. Divestitures and Restructurings
Divestiture = sale of assets, operations, or divisions to a third party
Equity carve-out
Spin-off
Split-up