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1. Mergers and
Acquisitions
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2. 11.1 The Basic Forms of Acquisitions
• There are three basic legal procedures that
one firm can use to acquire another firm:
– Merger or Consolidation
– Acquisition of Stock
– Acquisition of Assets
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3. Merger versus Consolidation
• Merger
– One firm is acquired by another
– Acquiring firm retains name and acquired firm
ceases to exist
– Advantage – legally simple
– Disadvantage – must be approved by stockholders
of both firms
• Consolidation
– Entirely new firm is created from combination of
existing firms
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4. Acquisitions
• A firm can be acquired by another firm or individual(s)
purchasing voting shares of the firm’s stock
• Tender offer – public offer to buy shares
• Stock acquisition
– 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
• 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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5. 11.2 Sources of Synergy
• Revenue Enhancement
• Cost Reduction
– Replacement of ineffective managers
– Economy of scale or scope
• Tax Gains
– Net operating losses
– Unused debt capacity
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6. 11.3 Two Financial Side Effects of
Acquisitions
• Earnings Growth
– 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 (i.e., an accounting
illusion).
• Diversification
– Shareholders who wish to diversify can accomplish
this at much lower cost with one phone call to their
broker than can management with a takeover.
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7. Cash Acquisition
• The NPV of a cash acquisition is:
– NPV = (VB + ΔV) – cash cost = VB* – cash cost
• Value 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 may
also be desirable.
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8. 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
• Considerations when choosing between cash and
stock
– Sharing gains – target stockholders do not 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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9. 11.4 Friendly vs. Hostile Takeovers
• In a friendly merger, both companies’
management are receptive.
• In a hostile merger, the acquiring firm
attempts to gain control of the target without
their approval.
• Tender offer
• Proxy fight
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10. 11.5 Defensive Tactics
• Corporate charter
– Classified board (i.e., staggered elections)
– Supermajority voting requirement
• Golden parachutes
• Targeted repurchase (a.k.a. greenmail)
• Standstill agreements
• Poison pills (share rights plans)
• Leveraged buyouts
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11. More (Colorful) Terms
• Poison put
• Crown jewel
• White knight
• Lockup
• Shark repellent
• Bear hug
• Fair price provision
• Dual class capitalization
• Countertender offer
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12. 11.6 Do Mergers Add Value?
• 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.
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13. Do Mergers Add Value?
• Shareholders of bidding firms earn a small excess
return in a tender offer, but none in 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.
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14. 11.7 Going Private and Leveraged Buyouts
• The existing management buys the firm from
the shareholders and takes it private.
• If it is financed with a lot of debt, it is a
leveraged buyout (LBO).
• The extra debt provides a tax deduction for
the new owners, while at the same time
turning the pervious managers into owners.
• This reduces the agency costs of equity.
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15. 11.8 Divestitures in merger and
acquisition.
• Divestiture – company sells a piece of itself to
another company
– Equity carve-out – Parent company creates a
separate company of the division in question and
then arranges an IPO where a small fraction of the
company is sold to the public. The parent
company retains enough shares to maintain
control.
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16. – Spin-off – Parent company distributes shares of
the subsidiary to existing shareholders in the
same proportion as their ownership in the parent
company. Shareholders can keep the shares or
sell them as they see fit.
– Split-up – A company breaks into two or more
companies, and shareholders have their shares in
old company swapped for shares in the new
companies.
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