Download Gains From Acquisitions

Mergers
&
Acquisitions
Introduction
Another firm should be acquired only if doing
so generates a positive NPV.
However, the NPV of an acquisition candidate
can be difficult to determine.
As such, acquisitions are an investment made
under uncertainty.
Introduction
Historically, there are distinct, systematic
patterns to the returns various security-holder
classes earn during corporate control
transactions (mergers and acquisitions).
The strongest and most consistent regularity
is that the target firm shareholders earn
large, positive abnormal returns in virtually all
transactions, while bidder shareholder results
are mixed.
Introduction
Target shareholder returns are larger:
1. For leveraged buyouts (by incumbent
management) than external takeovers.
2. In contested bids than single bidder
transactions.
3. In recent years than during the 1960s.
Introduction
Bidder shareholder returns are more mixed, in that:
1. Bidder shareholders earned significantly
positive abnormal returns during the 1960s,
but these have decreased over time.
2. Bidding firm shareholders on average break
even in those takeovers where cash is used,
but lose when stock is the form of payment.
3. Bidder shareholders lose when their firm
acts as a white knight.
Legal Forms Of Acquisitions
1. Acquisitions through Merger or Consolidation
Merger - the complete absorption of one firm by
another; after the merger, the acquired firm ceases
to exist as a separate business entity.
Consolidation - is the same as a merger except a
new firm is created; after the merger, both the
acquiring firm and the acquired firm terminate their
previous legal existence and became part of a new
firm.
Legal Forms Of Acquisitions
2. Acquisition of Stock
A second way to acquire another firm is to simply
purchase the firm’s voting stock in exchange for cash,
shares of stock, or other securities.
A tender offer (ie. public offer to buy shares) is made by
one firm directly to the shareholders of another firm.
If the shareholders choose to accept the offer, they
tender their shares by exchanging them for cash or
securities (or both), depending on the offer.
A tender offer is usually contingent on the bidder’s
obtaining some percentage of the total voting shares.
Legal Forms Of Acquisitions
3. Acquisition of Assets
A firm can effectively acquire another firm by
buying most or all of the assets.
However, the target firm does not necessarily cease
to exist unless its shareholders choose to dissolve it.
This type of acquisition requires a formal vote of the
shareholders of the selling firm.
The acquisition may involve transferring titles to
individual assets, a legal process that can be costly.
Legal Forms Of Acquisitions
A Note on Takeovers
A takeover occurs when one group takes control
from another. Three forms include:
1. Acquisitions (merger or consolidation) – occurs
when the bidding firm makes a tender offer or
acquires the assets of the target firm.
2. Proxy contest – occurs when a group attempts to
gain controlling seats on the B of D by voting in
new directors.
3. Going private – all the equity shares of a public firm
are purchased by a small group of investors through
a leveraged buyout (LBO). The shares are then
delisted from stock exchanges.
Legal Forms Of Acquisitions
A Note on Takeovers
Merger or
consolidation
Acquisition
Takeovers
Proxy contest
Going private
Acquisition of stock
Acquisition of assets
Taxes And Acquisitions
If one firm buys another firm, the transaction may be
taxable or tax-free.
In a taxable acquisition, the shareholders of the target
firm are considered to have sold their shares and they
have capital gains or losses that are taxed; it is a taxable
acquisition if the buying firm offers the selling firm cash
for its equity.
In a tax-free acquisition, since the acquisition is
considered an exchange rather than a sale, no capital
gain or loss occurs at that time; the general
requirements for tax-free status are that the acquisition
involves 2 corporations from same country, subject to
same corporate tax and that there be a continuity of
equity interest.
Taxes And Acquisitions
In addition, there are two tax-related factors to
consider when comparing acquisition alternatives:
1. The capital gains effect – in a taxable acquisition,
shareholders may demand a higher price as
compensation, thereby increasing the cost of the
merger.
2. The write-up effect – in a taxable acquisition, the
assets of the selling firm are revalued or “writtenup” from their historic book value to their estimated
current market value.
Gains From Acquisitions
Acquiring another firm makes sense only if there is
some concrete reason to believe the target firm is
somehow worth more in our hands than it is worth
now. Some reasons include:
1. Synergy
“The whole is worth more than the parts.”
Synergy is measured as the difference between
the value of the combined firm and the sum of
the values of the firms as separate entities – it is
the incremental net gain from the acquisition.
Gains From Acquisitions
2. Revenue Enhancement
Marketing gains: improved promotion, distribution
and/or product mix; cross-marketing.
Strategic benefits: enhances management flexibility
with regard to the company’s future operations –
the process of entering a new industry to exploit
perceived opportunities.
Market power: increased market share and market
power – profits can be enhanced through higher
prices and reduced competition.
Gains From Acquisitions
3. Cost Reductions
Economics of scale: the sharing of central facilities
spreads fixed overhead more thinly.
Economics of vertical integration: makes
coordinating closely related activities easier.
Complementary resources: to make better use of
existing resources or to provide the missing
ingredient for success.
Gains From Acquisitions
4. Tax Gains
Net operating losses: the combined firm would
have a lower tax bill than the two firms considered
separately.
Unused debt capacity: adding debt can provide
important tax savings and many acquisitions are
financed using debt.
Surplus funds: the tax problem associated with
paying dividends is avoided.
Asset write-ups: in a taxable acquisition, the assets
of the acquired firm can be revalued.
Gains From Acquisitions
5. Changing Capital Requirements
All firms must make investments in working capital
and fixed assets to sustain an efficient level of
operating activity.
A merger may reduce the combined investments
needed by the two firms.
For example, a firm that is producing at capacity
can either build new or merge with a firm that has
excess capacity.
Gains From Acquisitions
6. Inefficient Management
There are firms whose value could be increased
with a change in management.
These firms are poorly run or otherwise do not
efficiently use their assets to create shareholder
wealth.
Gains From Acquisitions
7. Going Global
Entering new markets may be more viable buying
existing operations and infrastructure in the foreign
country.
Government restrictions, consumer confidence in
foreigners, and entry barriers play key roles in
foreign market expansion decision-making.
Gains From Acquisitions
Some general rules in evaluating an
acquisition are:
1.
2.
3.
4.
5.
Do not ignore market values.
Estimate only incremental cash flows to your
firm.
Use the correct risk-adjusted cost of capital.
Be aware of transaction costs including merger
implementation costs.
Understand corporate culture and the impacts
this will have on the “marriage”.
Myths of Acquisitions
Diversification
Diversification is commonly mentioned as a benefit to
a merger – it reduces unsystematic risk.
However, given the value of an asset depends on
only its systematic risk, shareholders will not pay a
premium for a merged company just for the benefit
of diversification.
Stockholders can get all the diversification they want
simply by buying stock in different companies.
Myths of Acquisitions
EPS Growth
An acquisition can create the appearance of growth
in EPS.
This may fool investors into thinking the firm is doing
better than it really is.
Astute financial managers will look beyond the
accounting numbers in valuing the net impacts of an
acquisition.
The Cost of an Acquisition (Cash or Common Stock)
All other things being the same, if common
stock is used, the acquisition cost may be
higher because the target firm’s shareholders
must share the acquisition gains with the
shareholders of the bidding firm.
If cash is used, the cost of an acquisition may
not depend on the acquisition gains.
The Cost of an Acquisition (Cash or Common Stock)
Whether to finance an acquisition by
cash or by shares of stock depends on
several factors, including:
1.
2.
3.
sharing gains
taxes
control
Corporate Raiders
While most would agree that corporate raiders can
deliver benefits to shareholders and society, there is
increasing concern over whether the cost is too high.
That is, when plants close or move, workers and
equipment can be turned to other uses only at a cost
to society – usually paid for by taxpayers.
In addition, critics argue that they reduce trust
between management and labor thus reducing
efficiency and increasing costs.
Corporate raider – usually refers to the person or firm
that specializes in the hostile takeover of other firms.
Defensive Tactics
Target firms frequently resist takeover attempts;
resistance usually starts with press releases and mailings
to shareholders presenting management’s viewpoint.
It can eventually lead to legal action and solicitation of
competing bids.
Managerial action to defeat a takeover attempt may make
target shareholders better off if it elicits a higher offer
premium from the bidding firm or another firm.
However, management resistance may simply reflect
pursuit of self-interest at the expense of shareholders.
Defensive Tactics
The Control Block and the Corporate Charter
If an individual or group owns 51% of a company’s
common stock, this control block makes a hostile
takeover virtually impossible.
The corporate charter refers to the articles of
incorporation and corporate by-laws that establish
the governance rules of the firm.
Firms can amend their charter to make acquisitions
more difficult by, for example, requiring a merger to
be approved by 80% of the shareholders of record.
Defensive Tactics
Repurchase/Standstill Agreements
Standstill agreements are contracts where the bidding
firm (or individual) agrees to limit its holdings in the
target firm; these agreements usually lead to the end of
the takeover attempt.
Standstill agreements often occur at the same time that
a targeted repurchase is arranged.
In a targeted repurchase, a firm buys a certain amount
of its own stock from unwanted investor(s), usually at a
substantial premium (known as greenmail).
These premiums can be thought of as payments to
potential bidders to eliminate unfriendly takeover
attempts.
Defensive Tactics
Greenmail – refers to the practice of paying
unwanted suitors who hold an equity stake in
the firm a premium for their shares over the
market value, to eliminate the potential
takeover threat.
Defensive Tactics
Poison Pills and Share Rights Plans
A poison pill is a financial device designed to make
unfriendly takeover attempts unappealing if not
impossible.
A share rights plan, a type of poison pill, are provisions
allowing existing stockholders to purchase stock at
some fixed price should an outside takeover bid take
place, discouraging hostile takeover attempts.
Defensive Tactics
Poison Pill – is an amendment to the
corporate charter granting the shareholders
the right to purchase shares at little or no
cost in the event of a hostile takeover, thus
making the acquisition prohibitively expensive
for the hostile bidder.
Defensive Tactics
Going Private and Leveraged Buyouts
In a sense, a LBO can be a takeover defense.
However, it is only a defense for management.
From the stockholder’s point of view, a LBO is a
takeover because they are bought out.
In a LBO, the selling shareholders are paid a premium
on the market price of their stock, just as they are in a
acquisition.
Defensive Tactics
Does a LBO create value?
There are generally two reasons given for the
ability of a LBO to create value:
1. The extra debt creates a tax deduction which
(may) lead to an increase in firm value.
2. The LBO usually turns the previous managers
into owners, thereby increasing their incentive
to work hard.
Defensive Tactics
Since the mid-1980s, ongoing experience
with LBOs has revealed some weaknesses
both in the concept and the financing vehicle
– high-yield junk bonds.
Further, LBOs sometimes lead to spinoffs of
assets to pay down debt.
Defensive Tactics
Other Defensive Tactics
a. Golden Parachutes
Some target firms provide compensation to toplevel management if a takeover occurs.
This can be viewed as a payment to
management to make it less concerned for its
own welfare and more interested in the
shareholders who are considering the bid.
Defensive Tactics
b. Crown jewels
Firms sometimes sell major assets when faced
with a takeover threat.
c. White knight
Target firms sometimes seek a competing bid
from a friendly bidder who promises to maintain
the jobs of existing management and to refrain
from selling the target firm’s assets.
In-Conclusion
Shareholders of successful target firms
achieve substantial gains as a result of a
takeover.
Shareholders of bidding firms earn
significantly less from takeovers.
In fact, studies have found that the
acquiring firms actually lose value in
many mergers.
In-Conclusion
Rules of thumb for merger success?
Don’t rush the wedding - do your homework carefully
to prevent morning-after surprises.
Know what you’re buying - not just the financials, but
the corporate culture.
Adopt each partner’s best practices - don’t assume
the bigger company or the acquirer has all the
answers.
Be honest with employees about how a merger will
affect them - start early and communicate honestly
with them.
Take the time to do internal recruiting - make sure
the managers you want to keep don’t go wandering
off to a competitor.