Download M&A

Accounting, Taxes, and M&A
Valuation
What Every Investment Banker
Needs to Know
M&A Accounting
• Depending on the characteristics of a
merger or acquisition transaction will be
accounted for as a:
– purchase combination or a
– pooling-of-interest (pooling) combination.
Purchase Method Accounting
• Purchase accounting requires the acquirer to
record in its financial statements the fair market
value of all assets acquired.
– Both tangible and intangible, and liabilities assumed.
– The fair value of an asset is generally its market or
appraised value, and liabilities are generally valued
on a present value basis.
• Any excess or residual purchase price over the
fair value of the net identifiable assets is
considered goodwill that must be recorded as an
asset and amortized over its useful life or a
maximum of 40 years.
Pooling Method Accounting
• The pooling method accounts for a combination of two
firms as a union of the ownership interests of the two
previously separated groups of stockholders.
• No sale or purchase is considered to have occurred.
• The assets and liabilities of the combining firms continue
to be carried at their book values, that is, on the basis of
their historical costs.
• Any goodwill carried on the target’s books prior to the
merger continues to be carried on the merged firm’s
books at its historical cost, but no new goodwill is
recognized as a result of the pooling.
• The stockholders’ equity of the merged firm is recorded
at the sum of the book values of the two firms.
Pooling-of-Interest Treatment
•
Twelve Criteria For A Pooling of Interests Merger
– Attributes of the Combining Companies
1. Autonomous (two-year rule)
2. Independent (10% rule)
– Manner of Combining Interests
3.
4.
5.
6.
7.
8.
9.
Single transaction (completed in one year following the initiation)
Exchange of common stock (90% "substantially all" rule)
No equity changes in contemplation of combination (two-year rule)
Shares reacquired only for purposes other than combination
No change in proportionate equity interests
Voting rights immediately exercisable
Combination resolved at consummation (no pending provisions)
– Absence of Planned Transactions
10. Issuing company does not agree to reacquire shares
11. Issuing company does not make deals to benefit former stockholders
12. Issuing company does not plan to dispose of assets within two years
(Source: http://acct.tamu.edu/smith/purpool/apb16_17.htm)
Controversy Over Pooling
•
On September 7, 1999, the FASB issued a draft with
four significant changes to existing accounting practice:
1. Use of the pooling-of-interest method would be prohibited.
2. The current 40 year maximum amortization period for goodwill
would be reduced to 20 years.
3. Companies would be required to present separate line items in
the income statement for income before taxes and goodwill
amortization , and for goodwill amortization net-of-tax basis.
4. The current 40-year maximum amortization period for acquired
intangible assets (other than goodwill) would be replaced with a
presumption that their useful lives are 20 years or less.
Example: Purchase of Assets
• Assume that Acquiror Co. buys Target Co. for
$200,000 in stock.
• Acquiror Co. must then revalue the assets and
liabilities of Target Co. to their fair values at the
date of the acquisition and record any
identifiable intangible assets that were not
carried on Target’s books.
• Any difference between the purchase price and
the fair value of the net assets would be shown
as goodwill arising from the acquisition.
Acquirer
Target’s
Balance Sheet
Prior to
Acquisition
Revalued
Target’s
Balance
Sheet
Merged
Firm
$185,000
$6,000
$6,000
$191,000
Accounts Receivables
$90,000
$8,000
$8,000
$98,000
Notes Receivable
$55,000
Assets
Cash
$55,000
Inventory
$140,000
$10,000
$9,000
$149,000
PPE (net)
$250,000
$35,000
$50,000
$300,000
$12,000
$113,000
$113,000
Trademark
$15,000
$15,000
Patent
$25,000
$25,000
Goodwill
Total Assets
$720,000
$71,000
$226,000
$946,000
Accounts Payable
$90,000
$14,000
$14,000
$104,000
LT Notes Payable
$170,000
$15,000
$12,000
$182,000
Shareholders' Equity
$460,000
$42,000
$200,000
$660,000
Total Liabilities & Equity
$720,000
$71,000
$226,000
$946,000
Liabilities and Equity
Example Pooling of Assets
• Now the merged firm only recognizes the
goodwill that existed prior to the
acquisition.
Assets
Cash
Target’s
Balance Sheet
Prior to
Acquirer
Acquisition
Revalued
Target’s
Balance
Sheet
Merged
Firm
$185,000
$6,000
$6,000
$191,000
Accounts Receivables
$90,000
$8,000
$8,000
$98,000
Notes Receivable
$55,000
$55,000
Inventory
$140,000
$10,000
$9,000
$150,000
PPE (net)
$250,000
$35,000
$50,000
$285,000
$12,000
$113,000
$12,000
Trademark
$15,000
$0
Patent
$25,000
$0
Goodwill
Total Assets
$720,000
$71,000
$226,000
$791,000
Accounts Payable
$90,000
$14,000
$14,000
$104,000
LT Notes Payable
$170,000
$15,000
$12,000
$185,000
Shareholders' Equity
$460,000
$42,000
$200,000
$502,000
Total Liabilities & Equity
$720,000
$71,000
$226,000
$791,000
Liabilities and Equity
Value from Nothing
• Under pooling, the earnings of the merged
firm “look better” than under purchase!
Purchase
Pooling
Revenues
$500,000
$500,000
COGS
$340,000
$340,000
Gross Margin
$160,000
$160,000
Depreciation
$75,000
$75,000
Amortization
$6,825
$300
SGAE
$70,000
$70,000
Other
$10,000
$10,000
Total Expenses
$161,825
$151,550
Net Income
-$1,825
$8,450
Expenses
Total Amortization uses the straight-line
method with zero residual value and a
10-year useful life for patents and
trademarks, and goodwill amortized over
40 years. Amortization: $6,825 =
($250,000+$15,000)/10 + $113,000/40
Total Amortization
uses the straightline method with
zero residual value.
Goodwill amortized
over 40 years.
Amortization is $300
= $12,000/40.
Straight-Line method of
depreciation with zero residual
value and a useful life of 4
years. Depreciation: $75,000 =
$300,000/4.
Tax Considerations
• In general, the target’s shareholders pay taxes
on the gains or losses immediately when the
transaction is concluded, while the acquirer
restates the acquired assets at fair market value.
• The asset write-up increases the amount of
depreciation which is valuable for an acquirer in
a tax paying status.
• M&As can be tax-free, whereby the target’s
shareholders recognize a loss or gain only if
they sell the assets they receive in payment from
the acquirer.
Qualifying for Tax Free Treatment:
Mergers
1. The shareholders of the target have to
retain a continuing equity interest in the
acquirer.
2. The interest must be substantial in
relation to the net assets of the target.
• These two rules have been interpreted to
mean that the target shareholders have
to receive at least 50 percent of their
payment in stock of the acquirer.
Qualifying for Tax Free Treatment:
Acquisitions
1. All payment to the shareholders of the
target has to be in the form of voting
stock.
2. The acquirer must obtain at least 80
percent of the voting stock of the target.
Valuing Acquisitions
• Despite 30 years of evidence
demonstrating that most acquisitions do
not create value for the acquiring
company, both the number and the
volume of deals have been increasing
from year to year.
• You need to understand however the
several meanings of the word “value.”
It Depends on What You Mean by
Value
• Intrinsic value.
– NPV of the future cash flows of the target irrespective of any acquisition.
– Conrail’s intrinsic value was around $71 per share when it was
acquired.
• Market value.
– The market adds a premium that incorporates the probability that the
target firm be acquired.
– Conrail stock price jumped to $85.13 the day the first bid by CSX was
announced.
• Purchase price.
– A.k.a. :anticipated takeout value.” How much the acquiror must pay to
get the target.
• Synergy value.
– The NPV of the future cash flows that result from integration.
• Value gap.
– The difference between the intrinsic value and the purchase price.
Valuing Synergies
• Types of synergies:
– Cost savings
– Revenue enhancements
– Process improvements
– Financial engineering
– Tax benefits
Valuation Assumptions
• Capital structure assumption.
– The capital structure assumption should not
be reflective of the financing used to buy the
target per se, but should reflect the degree to
which owning the target incrementally affects
your debt capacity.
Valuation Assumptions Continued
• Pre-Tender Offer Strategy
– The target firm’s stock price will exceed the
present value of the firm’s future cash flows if
it reflects the possibility that the firm may
eventually be taken over at a premium.
– Toeholds: Bidder buys shares in the open
market prior to making the tender offer.
• Can buy up to 5% and then have a window in
which to notify the markets that a tender offer will
be forthcoming. At that point open market
purchases must cease.
Target Firm Stock Prices Around a
Tender Offer
Total value
about 27%.
0.4
0.35
0.3
Information
leakage: about
10% out of 27%.
0.25
0.2
0.15
0.1
0.05
-0.05
US TARGETS
UK TARGETS
97
90
83
76
69
62
55
48
41
34
27
20
13
6
-1
-8
-15
-22
-29
-36
-43
-50
-57
-64
-71
-78
-85
-92
-99
-106
-113
-120
0