Fundamentals of corproate finance 3e chapter 22

Chapter Twenty-two Mergers, Acquisitions and Takeovers Copyright  2004 McGraw-Hill Australia Pty Ltd 22-1 Chapter Organisation 22.1 22.2 22.3 22.4 22.5 22.6 22.7 22.8 22.9 The Legal Forms of Acquisitions Regulation of Business Combination Taxes and Acquisitions Gains from Acquisition Some Financial Side-effects of Acquisitions The Cost of an Acquisition Defensive Tactics Some Evidence on Acquisitions Summary and Conclusions Copyright  2004 McGraw-Hill Australia Pty Ltd 22-2 Chapter Objectives • Discuss the legal forms of acquisitions • Understand the legal framework for mergers, acquisitions and takeovers • Discuss the gains from acquisition • Explain the financial side-effects of acquisitions • Calculate the costs and NPV of an acquisition • Identify and discuss possible defensive tactics to a takeover attempt Copyright  2004 McGraw-Hill Australia Pty Ltd 22-3 Legal Forms of Acquisitions • Merger → complete absorption of one company by another • Consolidation → creation of a new firm by combining two existing firms • Advantages of mergers and consolidations: simplicity (buyer assumes all assets and liabilities) – inexpensive – • Disadvantages of mergers and consolidations: shareholders of both firms must approve – difficulty in obtaining cooperation of management – Copyright  2004 McGraw-Hill Australia Pty Ltd target company’s 22-4 Legal Forms of Acquisitions • Acquisition of assets → transfer of assets and liabilities of the target company to the acquiring company • Acquisition of shares (tender offer) → acquire sufficient voting shares to gain management control via a direct public offer for the shares • Majority control versus effective control Copyright  2004 McGraw-Hill Australia Pty Ltd 22-5 Acquisition Classifications • Horizontal acquisition → between two firms in the same industry • Vertical acquisition → the buyer expands backwards by acquiring a firm with the source of raw materials or forwards by acquiring a firm that is closer in the direction of the ultimate consumer • Conglomerate acquisition → involves companies in unrelated industries Copyright  2004 McGraw-Hill Australia Pty Ltd 22-6 A Note on Takeovers Merger or consolidation Takeovers Acquisition Acquisition of stock Proxy contest Acquisition of assets Going private (leveraged buyouts) Copyright  2004 McGraw-Hill Australia Pty Ltd 22-7 Takeover Situations • Creeping takeover – • Off market bid – • Holdings in a target company can be increased by no more than per cent every six months A formal written offer is made to acquire the shares of a target company Market bid – An announcement by a stockbroker that a broking firm will stand in the market to purchase the target company’s shares for a specified price for a specified period Copyright  2004 McGraw-Hill Australia Pty Ltd 22-8 The Legal Framework Common law Contract law Enacted law (legislation) Stock Exchange Rules Law of tort Trade Practices Act 1974 Corporations Act 2001 Australian Securities Commission Act 1989 Corporations Regulations Copyright  2004 McGraw-Hill Australia Pty Ltd 22-9 Taxes and Acquisitions • Generally, assets purchased after 19 September 1985 are subject to capital gains tax (CGT) when sold • CGT can be deferred under rollover provisions • CGT still applies when the consideration is shares, and when more than 50 per cent of pre-19 September 1985 shareholders have changed (regardless of purchase date) Copyright  2004 McGraw-Hill Australia Pty Ltd 22- Acquisitions and EPS Growth Pizza Shack and Checkers Pizza are merging to form Stop ’n’ Go Pizza The merger is not expected to create any additional value Stop ‘n’ Go, valued at $1 875 000, is to have 125 000 shares outstanding at $15 per share Copyright  2004 McGraw-Hill Australia Pty Ltd 22- Acquisitions and EPS Growth Before and after merger financial positions 100 000 Stop ’n’ Go shares to Pizza Shack holders 25 000 Stop ’n’ Go shares to Checkers holders Copyright  2004 McGraw-Hill Australia Pty Ltd 22- Acquisitions and EPS Growth • EPS has increased (and the P/E ratio has decreased) because the total number of shares is less • The merger has not ‘created’ value Copyright  2004 McGraw-Hill Australia Pty Ltd 22- Diversification • Does not create value in a merger • Is not, in itself, a good reason for a merger • Reduces unsystematic risk BUT • Shareholders can this for themselves more easily and less expensively Copyright  2004 McGraw-Hill Australia Pty Ltd 22- The Cost of an Acquisition • The net incremental gain from a merger of Firms A and B is: ∆V = VAB – (VA + VB) • The total value of Firm B to Firm A is: VB* = VB + ∆V • The NPV of the merger is: NPV = VB* – Cost to Firm A of the acquisition • The cost of the acquisition to Firm A depends on the medium of exchange used to acquire Firm B—cash or shares Copyright  2004 McGraw-Hill Australia Pty Ltd 22- The Cost of an Acquisition • Whether cash or shares are used to finance the acquisition depends on the following factors: Sharing gains: If cash is used, the selling firm’s shareholders will not participate in the potential gains (or losses) from the merger – Control: Control of the acquiring firm is unaffected in a cash acquisition Acquisition with voting shares may have implications for control of the merged firm – Copyright  2004 McGraw-Hill Australia Pty Ltd 22- Example—Cash or Shares? Pre-merger information for Firm A and Firm B: Both firms are 100 per cent equity financed The estimated incremental value of the acquisition is $500 Copyright  2004 McGraw-Hill Australia Pty Ltd 22- Example—Cash or Shares? (Continued) • Firm B has agreed to a sale price of $675, payable in cash or shares • The value of Firm B to Firm A is: VB ∗ = ∆V + VB = $500 + $560 = $1060 • How much does Firm A have to give up? Copyright  2004 McGraw-Hill Australia Pty Ltd 22- Example—Cash Acquisition • Cost of acquiring Firm B is $675 • NPV of the cash acquisition is: NPV = VB * − Cost = $1060 − $675 = $385 • The value of Firm A after the merger is: VAB = VA + (VB ∗ − Cost ) = $1800 + ( $1060 − $675) = $2185 • Price per share after the merger is $18.20 Copyright  2004 McGraw-Hill Australia Pty Ltd 22- Example—Share Acquisition • The value of the merged firm: VAB = VA + VB + ∆V = $1800 + $560 + $500 = $2860 • Firm A must give up $675/$15 = 45 shares • After the merger there will be 165 shares outstanding, valued at $17.33 per share Copyright  2004 McGraw-Hill Australia Pty Ltd 22- Example—Share Acquisition • True cost of the acquisition: 45 shares × $17.33 = $779.85 • NPV of the merger to Firm A: NPV = VB * − Cost = $1060 − $779.85 = $280.15 • Cash acquisition preferred (higher NPV) Copyright  2004 McGraw-Hill Australia Pty Ltd 22- Defensive Tactics Managers who believe their firms are likely to become takeover targets and who wish to fend off unwanted acquirers often implement one or more takeover defences These defensive tactics take several forms: Friendly shareholders offer the best defence – Poison pills—designed to ‘repel’ takeover attempts – Share rights plans—allow existing shareholders to purchase shares at some fixed price in the event of a takeover bid – Going private and leveraged buyouts—the publicly owned shares in a firm are replaced with complete equity ownership by a private group (often financed by debt) – Copyright  2004 McGraw-Hill Australia Pty Ltd 22- Terminology of Defensive Tactics • Golden parachutes—compensation management • Poison puts—purchase securities back at a set price • Crown jewels—selling off of major assets • White knights—acquisition by a ‘friendly’ firm • Lockups—option for a ‘friendly’ firm to purchase shares or assets at a fixed price • Shark repellant—designed to discourage unwanted mergers Copyright  2004 McGraw-Hill Australia Pty Ltd to top-level 22- Evidence on Acquisitions • Shareholders of target companies involved in successful takeovers gain substantially • Abnormal gains of around 25 per cent reflect merger premium Copyright  2004 McGraw-Hill Australia Pty Ltd 22- Evidence on Acquisitions • Shareholders of bidding firms involved in successful takeovers only experience gains of per cent There are a variety of explanations for this: – – – – – Overestimated anticipated gains Scale effect (bidders usually larger than targets) Agency problem Competitive market for takeovers Gains already reflected in bidder’s price (no new information) Copyright  2004 McGraw-Hill Australia Pty Ltd 22- .. .Chapter Organisation 22. 1 22. 2 22. 3 22. 4 22. 5 22. 6 22. 7 22. 8 22. 9 The Legal Forms of Acquisitions Regulation of Business Combination Taxes and Acquisitions... 22- 4 Legal Forms of Acquisitions • Acquisition of assets → transfer of assets and liabilities of the target company to the acquiring company • Acquisition of shares (tender offer) → acquire sufficient... Economies of scale Economies of vertical integration Complementary resources Copyright  2004 McGraw-Hill Australia Pty Ltd 22- Incremental Cash Flows • C Tax gains Use of net operating losses Use of