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Mergers and Acquisition

RWJ Chp 30

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The Basic Forms of Acquisitions

There are three basic legal procedures

that one firm can use to acquire another

firm: Merger

Acquisition of Shares

Acquisition of Assets

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Varieties ofTakeovers

Takeovers

Acquisition

Proxy Contest

Going Private

(LBO)

Merger

Acquisition of Shares

Acquisition of Assets

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The Tax Forms of Acquisitions

If it is a taxable acquisition, selling

shareholders need to figure their cost

basis and pay taxes on any capital gains. If it is not a taxable event, shareholders

are deemed to have exchanged their old

shares for new ones of equivalent value.

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Accounting for Acquisitions

The Purchase Method

The source of much goodwill

Pooling of Interests

Pooling of interest is generally used when the

acquiring firm issues voting shares in exchange

for at least 90 percent of the outstanding voting

shares of the acquired firm. Purchase accounting is generally used under

other financing arrangements.

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Determining the Synergy from 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 aren't handled carefully.

Traditionally, acquisitions deliver value when they

allow for scale economies or market power, betterproducts and services in the market, or learning from

the new firms.

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Source of Synergy from Acquisitions

Revenue Enhancement

Cost Reduction

Including replacing ineffective managers. Tax Gains

Net Operating Losses

UnusedD

ebt Capacity The Cost of Capital

Economies of Scale in Underwriting.

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Calculating the Value of the Firm after

an Acquisition

Avoiding Mistakes

Do not Ignore Market Values

Estimate only IncrementalCash Flows Use the Correct Discount Rate

Dont Forget Transactions Costs

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A Cost to Shareholders from Reduction

in Risk

The Base Case

If two all-equity firms merge, there is no

transfer of synergies to bondholders, but if

One Firm has Debt

The value of the levered shareholders call

option falls.

How Can Shareholders Reduce their

Losses from the Coinsurance Effect?

Retire debt pre-merger.

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Two "Bad" Reasons for Mergers

Earnings Growth

Only 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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The NPV of a Merger

Typically, a firm would use NPV analysis

when making acquisitions.

The analysis is straightforward with a cashoffer, but gets complicated when the

consideration is shares.

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The NPV of a Merger: Cash

NPV of merger to acquirer =Synergy Premium

SynergyBAABVVV !

Premium = Price paid forB - VB

NPV of merger to acquirer = Synergy - Premium

]forpaidPrice[BBAABVBVVV !

BBAABVBVVV ! forpaidPrice

BVV AAB forpaidPrice!

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The NPV of a Merger: Ordinary Shares

The analysis gets muddied up because we

need to consider the post-mergervalue of

those shares were giving away.valuefirmNewpayoutfirmTarget vuE

issuedsharesNewsharesOld

issuedsharesNew

!E

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Cash versus Ordinary Shares

Overvaluation

If the target firm shares are too pricey to buy

with cash, then go with shares.

Taxes

Cash acquisitions usually trigger taxes.

shares acquisitions are usually tax-free.

Sharing Gains from the Merger

With a cash transaction, the target firm

shareholders are not entitled to any

downstream synergies.

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Defensive Tactics

Target-firm managers frequently resist takeoverattempts.

It can start with press releases and mailings to

shareholders that present managementsviewpoint and escalate to legal action.

Management resistance may represent the

pursuit of self interest at the expense of

shareholders. Resistance may benefit shareholders in the end

if it results in a higher offer premium from the

bidding firm or another bidder.

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Divestitures

The basic idea is to reduce the potential diversification

discount associated with commingled operations and to

increase corporate focus,

Divestiture can take three forms:

Sale of assets: usually for cash

Spinoff: parent company distributes shares of a

subsidiary to shareholders. Shareholders wind up

owning shares in two firms. Sometimes this is done

with a public IPO. Issuance if tracking shares: a class of common

shares whose value is connected to the performance

of a particular segment of the parent company.

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The Corporate Charter

The corporate charter establishes the

conditions that allow a takeover.

T

arget firms frequently amend corporatecharters to make acquisitions more

difficult.

Examples

Staggering the terms of the board of directors.

Requiring a supermajority shareholder

approval of an acquisition

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Repurchase Standstill Agreements

In a targeted repurchase the firm buys back its

own shares from a potential acquirer, often at a

premium.

Critics of such payments label them greenmail.

Standstill agreements are contracts where the

bidding firm agrees to limit its holdings of

another firm.

These usually leads to cessation of takeover

attempts.

When the market decides that the target is out of play,

the shares price falls.

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Exclusionary Self-Tenders

The opposite of a targeted repurchase.

The target firm makes a tender offer for its

own shares while excluding targetedshareholders.

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Going Private and LBOs

If the existing management buys the firm

from the shareholders and takes it private.

If it is financed with a lot of debt, it is aleveraged 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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OtherDevices and the Jargon of

Corporate Takeovers

Golden parachutes are compensation to outgoingtarget firm management.

Crown jewels are the major assets of the target. If

the target firm management is desperate enough,they will sell off the crown jewels.

Poison pills are measures of true desperation tomake the firm unattractive to bidders. They reduce

shareholder wealth. One example of a poison pill is giving the shareholders in

a target firm the right to buy shares in the merged firm at abargain price, contingent on another firm acquiring control.

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Example 1

Lams share is trading for RM50 a share while Yeohs sharegoes for RM25 a share. Lams EPS is RM1 while YeohsEPS is RM2.50. Both are 100% equity financed. Bothcompanies have one million shares of stock outstanding.

a. What is the post-merger EPS, If Lam can acquire Yeohs inan exchange based on market value, what should be thepost-merger EPS?

b. Suppose Lam pays a premium of 20% in excess of Yeoh's

current market value. How many shares of Lam must begiven to Yeohs shareholders for each of their shares?

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c. Based on your results in b, what will

Lams EPS be after it acquires Yeoh?

d. If Yeoh were to acquire Lam by

offering a 20% premium in excess of

Lams current market price, how

many shares of stock would Yeoh

have to offer, and what would be the

effect on Yeohs EPS?

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