chapter 25-mergers & acquisitions
Post on 29-Nov-2014
141 Views
Preview:
TRANSCRIPT
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 1
MERGERS & ACQUISITIONS
25MERGERS & ACQUISITIONS
Chapter
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 2
MERGERS & ACQUISITIONS
Mergers, Acquisitions, and Takeovers: What are the Differences?
Merger
A strategy through which two firms agree to integrate their operations on a
relatively co-equal basis
Acquisition
A strategy through which one firm buys a controlling, or 100% interest in
another firm with the intent of making the acquired firm a subsidiary business
within its portfolio
Takeover
A special type of acquisition when the target firm did not solicit the acquiring
firm’s bid for outright ownership
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 3
MERGERS & ACQUISITIONS
Increased diversification
Learning and developing new
capabilities
Acquisitions
Cost new product development/increased
speed to market
Increased market power Avoiding excessive
competition
Overcoming entry barriers
Lower risk compared to developing new
products
Adapted from Figure 7.1Adapted from Figure 7.1
Reasons for Acquisitions and Problems in Achieving Success
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 4
MERGERS & ACQUISITIONS
Market Power Acquisitions
Acquisition of a company in the same industry in
which the acquiring firm competes increases a
firm’s market power by exploiting:
Cost-based synergies
Revenue-based synergies
Acquisitions with similar characteristics result in
higher performance than those with dissimilar
characteristics
Horizontal Horizontal AcquisitionsAcquisitions
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 5
MERGERS & ACQUISITIONS
Market Power Acquisitions (cont’d)
Acquisition of a supplier or distributor of one or
more of the firm’s goods or services
Increases a firm’s market power by controlling
additional parts of the value chain
Horizontal Horizontal AcquisitionsAcquisitions
Vertical Vertical AcquisitionsAcquisitions
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 6
MERGERS & ACQUISITIONS
Market Power Acquisitions (cont’d)
Acquisition of a company in a highly related
industry
Because of the difficulty in implementing
synergy, related acquisitions are often
difficult to implement
Horizontal Horizontal AcquisitionsAcquisitions
Vertical Vertical AcquisitionsAcquisitions
Related Related AcquisitionsAcquisitions
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 7
MERGERS & ACQUISITIONS
Acquisitions
Reasons for Acquisitions and Problems in Achieving Success
Adapted from Figure 7.1Adapted from Figure 7.1
Integration difficulties
Inadequate evaluation of
target Large or extraordinary debt
Inability to achieve synergy
Too much diversification
Managers overly focused on acquisitions
Too large
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 8
MERGERS & ACQUISITIONS
Problems in Achieving Acquisition Success: Integration Difficulties
Integration challenges include:
Melding two disparate corporate cultures
Linking different financial and control systems
Building effective working relationships (particularly when management styles differ)
Resolving problems regarding the status of the newly acquired firm’s executives
Loss of key personnel weakens the acquired firm’s capabilities and reduces its value
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 9
MERGERS & ACQUISITIONS
Problems in Achieving Acquisition Success: Inadequate Evaluation of the Target
Due Diligence
The process of evaluating a target firm for acquisition
Ineffective due diligence may result in paying an excessive premium for
the target company
Evaluation requires examining:
Financing of the intended transaction
Differences in culture between the firms
Tax consequences of the transaction
Actions necessary to meld the two workforces
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 10
MERGERS & ACQUISITIONS
Problems in Achieving Acquisition Success: Large or Extraordinary Debt
High debt can:
Increase the likelihood of bankruptcy
Lead to a downgrade of the firm’s credit rating
Preclude investment in activities that contribute to the firm’s long-term success
such as:
Research and development
Human resource training
Marketing
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 11
MERGERS & ACQUISITIONS
Problems in Achieving Acquisition Success: Inability to Achieve Synergy
Synergy exists when assets are worth more when used in conjunction with
each other than when they are used separately
Firms experience transaction costs when they use acquisition strategies
to create synergy
Firms tend to underestimate indirect costs when evaluating a potential
acquisition
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 12
MERGERS & ACQUISITIONS
Problems in Achieving Acquisition Success: Too Much Diversification
Diversified firms must process more information of greater diversity
Scope created by diversification may cause managers to rely too much on
financial rather than strategic controls to evaluate business units’ performances
Acquisitions may become substitutes for innovation
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 13
MERGERS & ACQUISITIONS
Problems in Achieving Acquisition Success: Managers Overly Focused on Acquisitions
Managers invest substantial time and energy in acquisition strategies in:
Searching for viable acquisition candidates
Completing effective due-diligence processes
Preparing for negotiations
Managing the integration process after the acquisition is completed
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 14
MERGERS & ACQUISITIONS
Problems in Achieving Acquisition Success: Managers Overly Focused on Acquisitions
Managers in target firms operate in a state of virtual suspended animation during
an acquisition
Executives may become hesitant to make decisions with long-term
consequences until negotiations have been completed
The acquisition process can create a short-term perspective and a greater aversion
to risk among executives in the target firm
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 15
MERGERS & ACQUISITIONS
Problems in Achieving Acquisition Success: Too Large
Additional costs of controls may exceed the benefits of the economies of scale
and additional market power
Larger size may lead to more bureaucratic controls
Formalized controls often lead to relatively rigid and standardized managerial
behavior
Firm may produce less innovation
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 16
MERGERS & ACQUISITIONS
Attributes of Successful
Acquisitions
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 17
MERGERS & ACQUISITIONS
Restructuring and Outcomes
Adapted from Figure 7.2Adapted from Figure 7.2
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 18
MERGERS & ACQUISITIONS
Explain why a company might decide to engage in corporate restructuring.
Understand and calculate the impact on earnings and on market value of companies
involved in mergers.
Describe what benefits, if any, accrue to acquiring company shareholders and to
selling company shareholders.
Analyze a proposed merger as a capital budgeting problem.
Describe the merger process from its beginning to its conclusion.
Describe different ways to defend against an unwanted takeover.
Discuss strategic alliances and understand how outsourcing has contributed to the
formation of virtual corporations.
Explain what “divestiture” is and how it may be accomplished.
Understand what "going private" means and what factors may motivate
management to take a company private.
Explain what a leveraged buyout is and what risk it entails.
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 19
MERGERS & ACQUISITIONS
Sources of Value
Strategic Acquisitions Involving Common Stock
Acquisitions and Capital Budgeting
Closing the Deal
Mergers and Other Forms of Corporate Restructuring
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 20
MERGERS & ACQUISITIONS
Takeovers, Tender Offers, and Defenses
Strategic Alliances
Divestiture
Ownership Restructuring
Leveraged Buyouts
Mergers and Other Forms of Corporate Restructuring
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 21
MERGERS & ACQUISITIONS
Any change in a company’s:
Capital structure,
Operations, or
Ownership
that is outside its ordinary course of business.
So where is the value coming
from (why restructure)?
What is Corporate Restructuring?
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 22
MERGERS & ACQUISITIONS
Sales enhancement and operating economies*
Improved management
Information effect
Wealth transfers
Tax reasons
Leverage gains
Hubris hypothesis
Management’s personal agenda
* Will be discussed in more detail in the following two slides.
Why Engage in Corporate Restructuring?
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 23
MERGERS & ACQUISITIONS
Sales enhancement Sales enhancement can occur because of market share gain, technological
advancements to the product table, and filling a gap in the product line.
Operating economies Operating economies can be achieved because of the elimination of duplicate
facilities or operations and personnel.
SynergySynergy -- Economies realized in a merger where the performance of the combined
firm exceeds that of its previously separate parts.
Sales Enhancement and Operating Economies
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 24
MERGERS & ACQUISITIONS
Horizontal mergerHorizontal merger: best chance for economies
Vertical mergerVertical merger: may lead to economies
Conglomerate mergerConglomerate merger: few operating economies
DivestitureDivestiture: reverse synergy may occur
Economies of ScaleEconomies of Scale -- The benefits of size in which the average unit cost falls as
volume increases.
Sales Enhancement and Operating Economies
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 25
MERGERS & ACQUISITIONS
When the acquisition is done for common stock, a “ratio of exchange,” which
denotes the relative weighting of the two companies with regard to certain key
variables, results.
A financial acquisition financial acquisition occurs when a buyout firm is motivated to purchase the
company (usually to sell assets, cut costs, and manage the remainder more
efficiently), but keeps it as a stand-alone entity.
Strategic Acquisition Strategic Acquisition -- Occurs when one company acquires another as part of its
overall business strategy.
Strategic Acquisitions Involving Common Stock
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 26
MERGERS & ACQUISITIONS
Example Example -- Company A will acquire Company B with shares of common stock.
Present earnings $20,000,000 $5,000,000
Shares outstanding 5,000,000 2,000,000
Earnings per share $4.00 $2.50
Price per share $64.00 $30.00
Price / earnings ratio 16 12
Company A Company B
Strategic Acquisitions Involving Common Stock
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 27
MERGERS & ACQUISITIONS
Example Example -- Company B has agreed on an offer of $35 in common stock of Company A.
Total earnings $25,000,000Shares outstanding* 6,093,750Earnings per share $4.10
Surviving Company A
Exchange ratio = $35 / $64 = .546875.546875
* New shares from exchange New shares from exchange = .546875.546875 x 2,000,000= 1,093,7501,093,750
Strategic Acquisitions Involving Common Stock
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 28
MERGERS & ACQUISITIONS
The shareholders of Company A will experience an increase in earnings per share
because of the acquisition [$4.10 post-merger EPS versus $4.00 pre-merger EPS].
The shareholders of Company B will experience a decrease in earnings per share
because of the acquisition [.546875 x $4.10 = $2.24 post-merger EPS versus $2.50
pre-merger EPS].
Strategic Acquisitions Involving Common Stock
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 29
MERGERS & ACQUISITIONS
Surviving firm EPS will increase any time the P/E ratio “paid” for a firm is less than
the pre-merger P/E ratio of the firm doing the acquiring. [Note: P/E ratio “paid” for
Company B is $35/$2.50 = 14 versus pre-merger P/E ratio of 16 for Company A.]
Strategic Acquisitions Involving Common Stock
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 30
MERGERS & ACQUISITIONS
Example Example -- Company B has agreed on an offer of $45 in common stock of Company A.
Total earnings $25,000,000
Shares outstanding* 6,406,250
Earnings per share $3.90
Surviving Company A
Exchange ratio = $45 / $64 = .703125.703125
* New shares from exchange New shares from exchange = .703125.703125 x 2,000,000 = 1,406,2501,406,250
Strategic Acquisitions Involving Common Stock
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 31
MERGERS & ACQUISITIONS
The shareholders of Company A will experience a decrease in earnings per share
because of the acquisition [$3.90 post-merger EPS versus $4.00 pre-merger EPS].
The shareholders of Company B will experience an increase in earnings per share
because of the acquisition [.703125 x $4.10 = $2.88 post-merger EPS versus $2.50
pre-merger EPS].
Strategic Acquisitions Involving Common Stock
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 32
MERGERS & ACQUISITIONS
Surviving firm EPS will decrease any time the P/E ratio “paid” for a firm is greater
than the pre-merger P/E ratio of the firm doing the acquiring. [Note: P/E ratio “paid”
for Company B is $45/$2.50 = 18 versus pre-merger P/E ratio of 16 for Company A.]
Strategic Acquisitions Involving Common Stock
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 33
MERGERS & ACQUISITIONS
Merger decisions should not be
made without considering the
long-term consequences.
The possibility of future earnings
growth may outweigh the
immediate dilution of earnings.
Initially, EPS is less with the merger.
Eventually, EPS is greater with the merger.
With theWith themergermerger
Without theWithout themergermerger
Time in the Future (years)
Exp
ecte
d E
PS
($)
Equal
What About Earnings Per Share (EPS)?
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 34
MERGERS & ACQUISITIONS
The above formula is the ratio of exchange of market price.
If the ratio is less than or nearly equal to 1, the shareholders of the acquired firm are
not likely to have a monetary incentive to accept the merger offer from the acquiring
firm.
Market price per share of the acquiring company
Number of shares offered by the acquiring company for each share of the acquired company
Market price per share of the acquired company
X
Market Value Impact
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 35
MERGERS & ACQUISITIONS
Example Example -- Acquiring Company offers to acquire Bought Company with shares of common stock at an exchange price of $40.
Present earnings $20,000,000 $6,000,000Shares outstanding 6,000,000 2,000,000Earnings per share $3.33 $3.00Price per share $60.00 $30.00Price / earnings ratio 18 10
Acquiring BoughtCompany Company
Market Value Impact
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 36
MERGERS & ACQUISITIONS
Exchange ratio = $40 / $60 = .667Market price exchange ratio = $60 x .667 / $30 = 1.33
Total earnings $26,000,000
Shares outstanding* 7,333,333
Earnings per share $3.55
Price / earnings ratio 18
Market price per share $63.90
Surviving Company
* New shares from exchange = .666667 x 2,000,000 = 1,333,333
Market Value Impact
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 37
MERGERS & ACQUISITIONS
Notice that both earnings per share and market price per share have risen because
of the acquisition. This is known as “bootstrapping.”
The market price per share = (P/E) x (Earnings).
Therefore, the increase in the market price per share is a function of an expected
increase in earnings per share and the P/E ratio NOT declining.
The apparent increase in the market price is driven by the assumption that the P/E
ratio will not change and that each dollar of earnings from the acquired firm will be
priced the same as the acquiring firm before the acquisition (a P/E ratio of 18).
Market Value Impact
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 38
MERGERS & ACQUISITIONS
Target firms in a takeover
receive an average premium
of 30%.
Evidence on buying firms is
mixed. It is not clear that
acquiring firm shareholders
gain. Some mergers do have
synergistic benefits.
Buyingcompanies
Sellingcompanies
TIME AROUND ANNOUNCEMENT(days)
Announcement date
0
-
+
CU
MU
LA
TIV
E A
VE
RA
GE
AB
NO
RM
AL
RE
TU
RN
(%
)
Empirical Evidence on Mergers
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 39
MERGERS & ACQUISITIONS
Idea is to rapidly build a larger and more valuable firm with the acquisition of small- and
medium-sized firms (economies of scale).
Provide sellers cash, stock, or cash and stock.
Owners of small firms likely stay on as managers.
If privately owned, a way to more rapidly grow towards going through an initial public
offering (see Slide 22).
Roll-Up Transactions – The combining of multiple small companies in the same industry
to create one larger company.
Developments in Mergers and Acquisitions
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 40
MERGERS & ACQUISITIONS
IPO funds are used to finance the acquisitions.
IPO Roll-Up IPO Roll-Up – An IPO of independent companies in the same industry that merge into a
single company concurrent with the stock offering.
An Initial Public Offering (IPO) is a company’s first offering of common stock to the
general public.
Developments in Mergers and Acquisitions
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 41
MERGERS & ACQUISITIONS
An acquisition can be treated as a capital budgeting project. This requires an
analysis of the free cash flowsfree cash flows of the prospective acquisition.
Free cash flowsFree cash flows are the cash flows that remain after we subtract from expected
revenues any expected operating costs and the capital expenditures necessary to
sustain, and hopefully improve, the cash flows.
Free cash flowsFree cash flows should consider any synergistic effects but be before any financial
charges so that examination is made of marginal after-tax operating cash flows and
net investment effects.
Acquisitions and Capital Budgeting
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 42
MERGERS & ACQUISITIONS
AVERAGE FOR YEARS (in thousands) 1 - 5 6 - 10 11 - 15
Annual after-tax operating cash flows from acquisition $2,000 $1,800 $1,400
Net investment 600 300 ---
Cash flow after taxes $1,400 $1,500 $1,400
16 - 20 21 - 25Annual after-tax operating cash flows from acquisition $ 800 $ 200
Net investment --- ---
Cash flow after taxes $ 800 $ 200
Cash Acquisition and Capital Budgeting Example
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 43
MERGERS & ACQUISITIONS
The appropriate discount rate for our example free cash flows free cash flows is the cost of capital
for the acquired firm. Assume that this rate is 15% after taxes.
The resulting present value of free cash flow free cash flow is $8,724,000$8,724,000. This represents the
maximum acquisition price that the acquiring firm should be willing to pay, if we do
not assume the acquired firm’s liabilities.
If the acquisition price is less than (exceeds) the present value of $8,724,000$8,724,000, then
the acquisition is expected to enhance (reduce) shareholder wealth over the long
run.
Cash Acquisition and Capital Budgeting Example
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 44
MERGERS & ACQUISITIONS
Noncash payments and assumption of liabilitiesNoncash payments and assumption of liabilities
Estimating cash flowsEstimating cash flows
Cash-flow approach versus earnings per share (EPS) approachCash-flow approach versus earnings per share (EPS) approach
Generally, the EPS approach examines the acquisition on a short-run basis,
while the cash-flow approach takes a more long-run view.
Other Acquisition and Capital Budgeting Issues
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 45
MERGERS & ACQUISITIONS
Target is evaluated by the acquirer
Terms are agreed upon
Ratified by the respective boards
Approved by a majority (usually two-thirds) of shareholders from both firms
Appropriate filing of paperwork
Possible consideration by The Antitrust Division of the Department of Justice or the
Federal Trade Commission
Consolidation -- The combination of two or more firms into an entirely new firm. The old
firms cease to exist.
Closing the Deal
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 46
MERGERS & ACQUISITIONS
Taxable -- if payment is made by cash or with a debt instrument.
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:
Taxable or Tax-Free Transaction
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 47
MERGERS & ACQUISITIONS
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 were simply combined.
Purchase (method) -- A method of accounting treatment for a merger based on the
market price paid for the acquired company.
Accounting Treatments
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 48
MERGERS & ACQUISITIONS
AS eliminated mandatory periodic amortization of goodwill for financial accounting
purposes, but requires an impairment test (at least annually) to goodwill.
Goodwill charges are generally deductible for “tax purposes” over 15 years for
acquisitions occurring after August 10, 1993.
An impairment to earnings is recognized when the book value of goodwill exceeds
its market value by an amount that equals the difference.
Goodwill -- The intangible assets of the acquired firm arising from the acquiring firm
paying more for them than their book value.
Accounting Treatment of Goodwill
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 49
MERGERS & ACQUISITIONS
Allows the acquiring company to bypass the management of the company it wishes
to acquire.
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.
Tender Offers
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 50
MERGERS & ACQUISITIONS
It is not possible to surprise another company with its acquisition because the SEC
requires extensive disclosure.
The tender offer is usually communicated through financial newspapers and direct
mailings if shareholder lists can be obtained in a timely manner.
A two-tier offer (next slide) may be made with the first tier receiving more favorable
terms. This reduces the free-rider problem.
Tender Offers
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 51
MERGERS & ACQUISITIONS
Two-Tier Tender Offer
Increases the likelihood of success in gaining control of the target firm.
Benefits those who tender “early.”
Two-tier Tender Offer – Occurs when the bidder offers a superior first-tier price (e.g.,
higher amount or all cash) for a specified maximum number (or percent) of shares and
simultaneously offers to acquire the remaining shares at a second-tier price.
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 52
MERGERS & ACQUISITIONS
The company being bid for may use a number of defensive tactics including:
(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 -- 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).
Defensive Tactics
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 53
MERGERS & ACQUISITIONS
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 TheoriesMotivation Theories::
Antitakeover Amendments and Other Devices
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 54
MERGERS & ACQUISITIONS
Stagger the terms of the board of directors
Change the state of incorporation
Supermajority merger approval provision
Fair merger price provision
Leveraged recapitalization
Poison pill
Standstill agreement
Premium buy-back offer
Shark Repellent -- Defenses employed by a company to ward off potential takeover
bidders -- the “sharks.”
Antitakeover Amendments and Other Devices
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 55
MERGERS & ACQUISITIONS
Empirical results are mixed in determining if antitakeover devices are in the best
interests of shareholders.
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.
For the most part, empirical evidence supports the management entrenchment management entrenchment
hypothesishypothesis because of the negative share price effect.
Empirical Evidence on Antitakeover Devices
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 56
MERGERS & ACQUISITIONS
Strategic alliances usually occur between (1) suppliers and their customers, (2)
competitors in the same business, (3) non-competitors with complementary
strengths.
A joint venture 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 -- An agreement between two or more independent firms to cooperate
in order to achieve some specific commercial objective.
Strategic Alliance
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 57
MERGERS & ACQUISITIONS
Divestiture
Liquidation -- The sale of assets of a firm, either voluntarily or in bankruptcy.
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 -- The divestment of a portion of the enterprise or the firm as a whole.
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 58
MERGERS & ACQUISITIONS
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.
Equity Carve-out -- The public sale of stock in a subsidiary in which the parent
usually retains majority control.
Divestiture
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 59
MERGERS & ACQUISITIONS
• For liquidation of the entire company, shareholders of the liquidating company realize
a +12 to +20% return.
• For partial sell-offs, shareholders selling the company realize a slight return (+2%).
Shareholders buying also experience a slight gain.
• Shareholders gain around 5% for spin-offs.
• Shareholders receive a modest +2% return for equity carve-outs.
• Divestiture results are consistent with the informational effect as shown by the positive
market responses to the divestiture announcements.
Empirical Evidence on Divestitures
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 60
MERGERS & ACQUISITIONS
The most common transaction is paying shareholders cash and merging the company
into a shell corporation owned by a private investor management group.
Treated as an asset sale rather than a merger.
Going Private -- Making a public company private through the repurchase of stock by
current management and/or outside private investors.
Ownership Restructuring
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 61
MERGERS & ACQUISITIONS
Motivation and Empirical Evidence for Going Private
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).
Reduces the focus of management on short-term numbers to long-term wealth building.
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.
MotivationsMotivations::
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 62
MERGERS & ACQUISITIONS
Motivation and Empirical Evidence for Going Private
Large transaction costs to investment bankers.
Little liquidity to its owners.
A large portion of management wealth is tied up in a single investment.
Empirical Evidence:
Shareholders realize gains (+12 to +22%) for cash offers in these transactions.
Motivations (Offsetting Arguments):
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 63
MERGERS & ACQUISITIONS
The debt is secured by the assets of the enterprise involved. Thus, this method is
generally used with capital-intensive businesses.
A management buyout is an LBO in which the pre-buyout management ends up with
a substantial equity position.
Leverage Buyout (LBO) -- A primarily debt financed purchase of all the stock or assets
of a company, subsidiary, or division by an investor group.
Ownership Restructuring
Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat
Copyright © 2008, Dr Sudhindra Bhat
2 ND
25 – 64
MERGERS & ACQUISITIONS
The company has gone through a program of heavy capital expenditures (i.e.,
modern plant).
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.
Stable and predictable cash flows.
A proven and established market position.
Less cyclical product sales.
Experienced and quality management.
Common characteristics (not all necessary):
top related