Mergers andAcquisitions

The Basic Formsof Acquisitions

Modes of acquiring a firm Acquisition of Stock Acquisition of Assets

Payment for acquisition Cash Stock of acquiring firm

Determining the Synergyfrom an 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 are not 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.

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 usual discounted cash flow model:

CFt = Revt – Costst – Taxest – Capital Requirementst

Synergy =CFt

(1 + r)tt = 1

T

where

Source of Synergy from Acquisitions

Revenue Enhancement Cost Reduction

Economies of scale from horizontal mergers Economies of vertical integration Elimination of inefficient management

Lower taxes Net Operating Losses Unused Debt Capacity

Lower cost of capital

Calculating the Value of the Firm after an Acquisition

Avoiding Mistakes Estimate only Incremental Cash Flows Use the Correct Discount Rate Do not Forget Transactions Costs

• Fees to investment bankers, legal fees, etc.

Paying for the Acquisition Cash or stock VA = 500 VB = 100 VAB = 700

Synergy = 100 Premium to acquire B = 50

(Acquisition cost of B) - VB

NA = 25 PA = 20 NB = 10 PB = 10

Pay by Cash

A pays 150 cash to shareholders of B Number of outstanding shares of A does

not change Shareholders of B do not own any stock

Pay by Stock

A issues new stock to buy stock of B Number of outstanding shares of A

increases Shareholders of B own stock of A How much new stock of A should be

issued? Stock exchange ratio “x : 1”

x shares of A for every 1 share of B

Pay by Stock (contd.)

The acquisition through stock should be equivalent to acquisition by cash in terms of value

valuefirm Newpayout firmTarget

issued shares Newshares Old

issued shares New

Pay by Stock (contd.)

α × VAB = 150

α = 0.2143 New shares issued by A = 6.819

To acquire 10 shares of B Stock exchange ratio = 0.6819 : 1