Chapter 26 Mergers and Acquisitions McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Key Concepts and Skills • Be able to define the various terms associated with M&A activity • Understand the various reasons for mergers and acquisitions and whether or not these reasons are in the best interest of shareholders • Understand the various methods for paying for an acquisition and how to account for it • Understand the various defensive tactics that are available • Understand how to value the transaction and estimate the gains from the merger or acquisition 26-2 Chapter Outline • The Legal Forms of Acquisitions • Taxes and Acquisitions • Accounting for Acquisitions • Gains from Acquisition • Some Financial Side Effects of Acquisitions • The Cost of an Acquisition • Defensive Tactics • Some Evidence on Acquisitions: Do M&A Pay? • Divestitures and Restructurings 26-3 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 26-4 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 26-5 Takeovers • Control of a firm transfers from one group to another • Possible forms – Acquisition • Merger or consolidation • Acquisition of stock • Acquisition of assets – Proxy contest – Going private 26-6 Taxes • Tax-free acquisition – Business 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 • Taxable acquisition – Firm purchased with cash – Capital gains taxes – stockholders of target may require a higher price to cover the taxes – Assets are revalued – affects depreciation expense 26-7 Accounting for Acquisitions • Pooling of interests accounting no longer allowed • Purchase Accounting – Assets of acquired firm must be reported at fair market value – Goodwill 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 26-8 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 • This is generally a good reason for a merger • Examine whether the synergies create enough benefit to justify the cost 26-9 Revenue Enhancement • Marketing gains – Advertising – Distribution network – Product mix • Strategic benefits • Market power 26-10 [...]... 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 26- 18 Defensive Tactics • Corporate charter – Establishes conditions that allow for a takeover – Supermajority voting requirement • • • • Targeted repurchase (a.k.a greenmail) Standstill... Split-up – company is split into two or more companies, and shares of all companies are distributed to the original firm’s shareholders 26- 22 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... Complimentary resources 26- 11 Taxes • Take advantage of net operating losses – Carry-backs and carry-forwards – Merger may be prevented if the IRS believes the sole purpose is to avoid taxes • Unused debt capacity • Surplus funds – Pay dividends – Repurchase shares – Buy another firm • Asset write-ups 26- 12 Reducing Capital Needs • A merger may reduce the required investment in working capital and fixed assets... not contain new information about the bidding firm 26- 21 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 • Spin-off – company creates a new company out of a subsidiary and distributes the shares of the new company to... (this includes reducing human capital as well) 26- 13 General Rules • Do not rely on book values alone – the market provides information about the true worth of assets • Estimate only incremental cash flows • Use an appropriate discount rate • Consider transaction costs – these can add up quickly and become a substantial cash outflow 26- 14 EPS Growth • Mergers may create the appearance of growth in... differ in terms of ownership? 26- 23 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? 26- 24 Comprehensive Problem... 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? 26- 25 End of Chapter 26- 26 ... 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 26- 15 Diversification • Diversification, in and of itself, is not a good reason for a merger • Stockholders can normally diversify their own portfolio cheaper... (a.k.a greenmail) Standstill agreements Poison pills (share rights plans) Leveraged buyouts 26- 19 More (Colorful) Terms • • • • • • • • • • Golden parachute Poison put Crown jewel White knight Lockup Shark repellent Bear hug Fair price provision Dual class capitalization Countertender offer 26- 20 Evidence on Acquisitions • Shareholders of target companies tend to earn excess returns in a merger – Shareholders... risk, in effect, transfers wealth from the stockholders to the bondholders 26- 16 Cash Acquisition • The NPV of a cash acquisition is – NPV = 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 is not undesirable 26- 17 Stock Acquisition • Value of combined firm – VAB = VA + VB + ∆V • Cost . Chapter 26 Mergers and Acquisitions McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Key Concepts and Skills • Be able to. M&A activity • Understand the various reasons for mergers and acquisitions and whether or not these reasons are in the best interest of shareholders • Understand the various methods for. acquisition 26- 2 Chapter Outline • The Legal Forms of Acquisitions • Taxes and Acquisitions • Accounting for Acquisitions • Gains from Acquisition • Some Financial Side Effects of Acquisitions • The