26-1 mergers and acquisitions chapter 26 copyright © 2013 by the mcgraw-hill companies, inc. all...

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Mergers and Acquisitions

Chapter 26

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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Chapter Outline

•The Legal Forms of Acquisition•Taxes and Acquisitions•Gains from Acquisitions•Some Financial Side Effects of Acquisitions•The Cost of an Acquisition

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Chapter Outline(Continued)

•Defensive Tactics•Some Evidence on Acquisitions: Do M & A’s Pay?•Divestitures and Restructurings

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Chapter Outline

• The Legal Forms of Acquisition• Taxes and Acquisitions• Gains from Acquisitions• Some Financial Side Effects of Acquisitions• The Cost of an Acquisition

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Merger versus Consolidation

MergerOne firm is acquired by another

Acquiring firm retains name and acquired firm ceases to exist

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Merger versus Consolidation

MergerAdvantage – legally simple

Disadvantage – must be approved by stockholders of both firms

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Merger versus Consolidation

ConsolidationEntirely new firm is created from combination of existing firms

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AcquisitionsA firm can be acquired when another

firm or individual(s) purchases voting shares of the firm’s stock

Tender offer is a public offer to buy shares on the market.

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Acquisitions

Stock acquisitionNo stockholder vote requiredCan 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

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Acquisitions

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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TakeoversControl of a firm transfers from one group to another

Possible forms:Acquisition

Merger or consolidationAcquisition of stockAcquisition of assets

Proxy contestGoing private

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Chapter Outline

• The Legal Forms of Acquisition

• Taxes and Acquisitions• Gains from Acquisitions• Some Financial Side Effects of

Acquisitions• The Cost of an Acquisition

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Taxes

Taxable acquisitionFirm purchased with cash

Capital gains taxes – stockholders of target may require a higher price to cover the taxes

Assets are revalued – affects depreciation expense

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TaxesTax-free acquisitionBusiness purpose; not solely to avoid taxes

Continuity of equity interest – stockholders of target firm must be able to maintain an equity interest in the combined firm

Generally, stock for stock acquisition

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Chapter Outline

• The Legal Forms of Acquisition

• Taxes and Acquisitions• Gains from Acquisitions• Some Financial Side Effects of

Acquisitions• The Cost of an Acquisition

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Accounting for Acquisitions

Pooling of interests accounting isno longer allowed.

Purchase AccountingAssets of acquired firm must be reported at the fair market value.

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Accounting for Acquisitions

Purchase AccountingGoodwill is created – difference between purchase price and estimated fair market value of net assets

Goodwill no longer has to be amortized – assets are essentially marked-to-market annually and goodwill is adjusted and treated as an expense if the market value of the assets has decreased

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Chapter Outline

• The Legal Forms of Acquisition

• Taxes and Acquisitions• Gains from Acquisitions• Some Financial Side Effects of

Acquisitions• The Cost of an Acquisition

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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

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Synergy

This is generally a good reason for a merger

Examine whether the synergies create enough benefit to justify the cost

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Revenue Enhancement

Marketing gainsAdvertisingDistribution network

Product mixStrategic benefits

Market power

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Cost ReductionsEconomies 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 integrationCoordinate operations more effectivelyReduced search cost for suppliers or

customersComplimentary resources

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TaxesTake advantage of net operating lossesCarry-backs and carry-forwards

Merger may be prevented if the IRS believes the sole purpose is to avoid taxes

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Taxes

Unused debt capacity

Surplus fundsPay dividendsRepurchase shares

Buy another firm

Asset write-ups

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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 reducing human capital as well)

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General Rules1. Do not rely on book values

alone – the market provides information about the true worth of assets

2. Estimate only incremental cash flows

3. Use an appropriate discount rate

4. Consider transaction costs – these can add up quickly and become a substantial cash outflow

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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!

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DiversificationDiversification, in and of itself, is not a

good reason for a mergerStockholders can normally diversify their

own portfolio cheaper than a firm can diversify by acquisition

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Diversification

Stockholder wealth may actually decrease after the merger because the reduction in risk, in effect, transfers wealth from the stockholders to the bondholders

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Chapter Outline

• The Legal Forms of Acquisition

• Taxes and Acquisitions• Gains from Acquisitions• Some Financial Side Effects of

Acquisitions• The Cost of an Acquisition

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Cash AcquisitionThe NPV of a cash acquisition is

NPV = VB* – cash costValue 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 not undesirable

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Stock AcquisitionValue of combined firm:

VAB = VA + VB + VCost 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

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Stock vs. Cash Acquisition

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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Chapter Outline(Continued)

• Defensive Tactics• Some Evidence on

Acquisitions: Do M & A’s Pay?• Divestitures and

Restructurings

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Defensive TacticsCorporate charter

Establishes conditions that allow for a takeover

Supermajority voting requirementTargeted repurchase (a.k.a. greenmail)Standstill agreementsPoison pills (share rights plans)Leveraged buyouts

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More (Colorful) TermsGolden parachutePoison putCrown jewelWhite knightLockupShark repellentBear hugFair price provisionDual class capitalizationCounter-tender offer

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Chapter Outline(Continued)

• Defensive Tactics• Some Evidence on

Acquisitions: Do M & A’s Pay?• Divestitures and

Restructurings

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Evidence on Acquisitions I

Shareholders of target companies tend to earn excess returns in a mergerShareholders 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 II

Shareholders of bidding firms, on average, do not earn or lose a large amountAnticipated gains from mergers

may not be achievedBidding firms are generally

larger, so it takes a larger dollar gain to get the same percentage gain

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Evidence on Acquisitions III

Shareholders of bidding firms, on average, do not earn or lose a large amount 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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Chapter Outline(Continued)

• Defensive Tactics• Some Evidence on

Acquisitions: Do M & A’s Pay?• Divestitures and

Restructurings

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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

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Divestitures and Restructurings

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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Ethics Issues

In the case of takeover bids, insider trading is argued to be particularly endemic because of the large potential profits involved and because of the relatively large number of people “in on the secret.” What are the legal and ethical implications

of trading on such information?Does it depend on who knows the

information?

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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 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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Comprehensive Problem

Two identical firms have yearly after-tax cash flows of $20 million each, which are expected to continue into perpetuity. If the firms merged, the after-tax cash flow of the combined firm would be $42 million. Assume a cost of capital of 12%.Does the merger generate synergy?What is VB*?What is ΔV?

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Terminology

• Merger• Consolidation• Acquisition• Takeover• Synergy• Diversification• Defensive Tactics• Divestiture• Restructuring

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Formulas

NPV = VB* – cash cost

VAB = VA + (VB* - cash cost)

VAB = VA + VB + V

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Key Concepts and Skills• Define the terminology

used in mergers andacquisitions.

• Explain the reasons for mergers and critique their value to the shareholders.

• Describe the methods to pay for an acquisition.

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Key Concepts and Skills

• List and discuss the various defensive tactics firms can use to prevent a takeover.

• Compute the value of a merger or acquisition.

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1. The merging of two firms can be done in a friendly or unfriendly environment.

2. Mergers have tax, funding, accounting, and control implications for the shareholders of both companies.

What are the most important topics of this chapter?

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3. Synergy can be a valuable motivation for firms to merge.

4. Unfriendly merger attempts can be thwarted with numerous strategies.

5. Merger values can be computed and evaluated as a capital budgeting problem.

What are the most important topics of this chapter?

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Questions?