Audit Chap 029
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Transcript of Audit Chap 029
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Mergers and Acquisitions
Chapter 29
Copyri ght 2010 by the McGraw-Hi ll Companies, Inc. All ri ghts reserved.McGraw-Hill/Irwin
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Key Concepts and Skills Be able to define the various terms associated
with M&A activity
Understand the various reasons for mergersand whether or not those reasons are in the
best interest of shareholders
Understand the various methods for paying foran acquisition
Understand the various defensive tactics that
are available
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Chapter Outline29.1 The Basic Forms of Acquisitions29.2 Synergy29.3 Sources of Synergy
29.4 Two Financial Side Effects of Acquisitions29.5 A Cost to Stockholders from Reduction in Risk29.6 The NPV of a Merger29.7 Friendly versus Hostile Takeovers29.8 Defensive Tactics
29.9 Do Mergers Add Value?29.10 The Tax Forms of Acquisitions29.11 Accounting for Acquisitions29.12 Going Private and Leveraged Buyouts
29.13 Divestitures
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29.1 The Basic Forms of Acquisitions There are three basic legal procedures that
one firm can use to acquire another firm:
Merger or Consolidation Acquisition of Stock
Acquisition of Assets
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Merger versus Consolidation Merger
One firm is acquired by another
Acquiring firm retains name and acquired firmceases to exist
Advantagelegally simple
Disadvantagemust be approved by stockholders
of both firms Consolidation
Entirely new firm is created from combination ofexisting firms
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Acquisitions A firm can be acquired by another firm or individual(s)
purchasing voting shares of the firms stock
Tender offerpublic 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 moneycomplete absorption requires a merger
Classifications Horizontalboth firms are in the same industry
Verticalfirms are in different stages of the production process
Conglomeratefirms are unrelated
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Varieties of Takeovers
Takeovers
Acquisition
Proxy Contest
Going Private(LBO)
Merger
Acquisition of Stock
Acquisition of Assets
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Synergy Suppose firmAis contemplating acquiring
firmB.
The synergy from the acquisition isSynergy = VAB(VA+ VB)
The synergy of an acquisition can be
determined from the standard discounted cashflow model:
Synergy =
DCFt
(1 +R)tSt= 1
T
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29.3 Sources of Synergy Revenue Enhancement
Cost Reduction
Replacement of ineffective managers Economy of scale or scope
Tax Gains
Net operating losses
Unused debt capacity
Incremental new investment required inworking capital and fixed assets
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29.4 Two Financial Side Effects of
Acquisitions
Earnings Growth
If there 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 (i.e., an accounting
illusion).
Diversification
Shareholders who wish to diversify can accomplishthis at much lower cost with one phone call to their
broker than can management with a takeover.
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29.5 A Cost to Stockholders from
Reduction in Risk The Base Case
If two all-equity firms merge, there is no transfer
of synergies to bondholders, but if Both Firms Have Debt
The value of the levered shareholders call option
falls.
How Can Shareholders Reduce their Losses
from the Coinsurance Effect?
Retire debt pre-merger and/or increase post-merger
debt usage.
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29.6 The NPV of a Merger
Typically, a firm would use NPV analysis
when making acquisitions.
The analysis is straightforward with a cashoffer, but it gets complicated when the
consideration is stock.
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Cash Acquisition
The NPV of a cash acquisition is:
NPV = (VB+ V)cash cost = 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 mayalso be desirable.
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Stock Acquisition Value of combined firm
VAB= VA+ VB+ DV
Cost of acquisition
Depends on the number of shares given to the targetstockholders
Depends on the price of the combined firms stock after themerger
Considerations when choosing between cash and
stock Sharing gainstarget stockholders do not participate in
stock price appreciation with a cash acquisition
Taxescash acquisitions are generally taxable
Controlcash acquisitions do not dilute control
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29.7 Friendly vs. Hostile Takeovers
In a friendly merger, both companies
management are receptive.
In a hostile merger, the acquiring firmattempts to gain control of the target without
their approval. Tender offer
Proxy fight
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29.8 Defensive Tactics
Corporate charter
Classified board (i.e., staggered elections)
Supermajority voting requirement Golden parachutes
Targeted repurchase (a.k.a. greenmail)
Standstill agreements Poison pills (share rights plans)
Leveraged buyouts
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More (Colorful) Terms
Poison put
Crown jewel
White knight
Lockup
Shark repellent
Bear hug
Fair price provision Dual class capitalization
Countertender offer
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29.9 Do Mergers Add Value?
Shareholders of target companies tend to earn excessreturns in a merger:
Shareholders of target companies gain more in a tender
offer than in a straight merger. Target firm managers have a tendency to oppose mergers,
thus driving up the tender price.
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Do Mergers Add Value?
Shareholders of bidding firms earn a small excessreturn in a tender offer, but none in a straightmerger:
Anticipated gains from mergers may not be achieved. Bidding firms are generally larger, so it takes a larger
dollar gain to get the same percentage gain.
Management may not be acting in stockholders best
interest. Takeover market may be competitive.
Announcement may not contain new information aboutthe bidding firm.
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29.10 The Tax Forms of Acquisition
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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29.11 Accounting for Acquisitions
The Purchase Method
Assets of the acquired firm are reported at their
fair market value. Any excess payment above the fair market value
is reported as goodwill.
Historically, goodwill was amortized. Now it
remains on the books until it is deemed
impaired.
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29.12 Going Private and Leveraged
Buyouts 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 thepervious managers into owners.
This reduces the agency costs of equity.
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29.13 Divestitures
Divestiturecompany sells a piece of itself toanother company
Equity carve-outcompany creates a newcompany out of a subsidiary and then sells aminority interest to the public through an IPO
Spin-offcompany creates a new company
out of a subsidiary and distributes the shares ofthe new company to the parent companysstockholders
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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 of these may be in stockholders best interest
and which generally are not?
What are some of the defensive tactics that firms useto thwart takeovers?
How can a firm restructure itself? How do these
methods differ in terms of ownership?