Mergers and Acquisition RWJ Chp 30

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Mergers and Acquisition RWJ Chp 30
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The Basic Forms of Acquisitions

• There are three basic legal procedures that one
  firm can use to acquire another firm
• Merger
• Acquisition of Shares
• Acquisition of Assets

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Varieties of Takeovers
Takeovers
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The Tax Forms of Acquisitions

• 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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Accounting for Acquisitions

• The Purchase Method
• The source of much goodwill
• Pooling of Interests
• Pooling of interest is generally used when the
  acquiring firm issues voting shares in exchange
  for at least 90 percent of the outstanding voting
  shares of the acquired firm.
• Purchase accounting is generally used under other
  financing arrangements.

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Determining the Synergy from an Acquisition

• Most acquisitions fail to create value for the
  acquirer.
• The main reason why they do not lies in failures
  to integrate two companies after a merger.
• Intellectual capital often walks out the door
  when acquisitions aren't handled carefully.
• Traditionally, acquisitions deliver value when
  they allow for scale economies or market power,
  better products and services in the market, or
  learning from the new firms.

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Source of Synergy from Acquisitions

• Revenue Enhancement
• Cost Reduction
• Including replacing ineffective managers.
• Tax Gains
• Net Operating Losses
• Unused Debt Capacity
• The Cost of Capital
• Economies of Scale in Underwriting.

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Calculating the Value of the Firm after an
Acquisition

• Avoiding Mistakes
• Do not Ignore Market Values
• Estimate only Incremental Cash Flows
• Use the Correct Discount Rate
• Dont Forget Transactions Costs

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A Cost to Shareholders from Reduction in Risk

• The Base Case
• If two all-equity firms merge, there is no
  transfer of synergies to bondholders, but if
• One Firm has Debt
• The value of the levered shareholders call
  option falls.
• How Can Shareholders Reduce their Losses from the
  Coinsurance Effect?
• Retire debt pre-merger.

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Two "Bad" Reasons for Mergers

• Earnings Growth
• Only an accounting illusion.
• Diversification
• Shareholders who wish to diversify can accomplish
  this at much lower cost with one phone call to
  their broker than can management with a takeover.

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The NPV of a Merger

• Typically, a firm would use NPV analysis when
  making acquisitions.
• The analysis is straightforward with a cash
  offer, but gets complicated when the
  consideration is shares.

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The NPV of a Merger Cash
Synergy Premium

• NPV of merger to acquirer

Premium Price paid for B - VB
NPV of merger to acquirer Synergy - Premium
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The NPV of a Merger Ordinary Shares

• The analysis gets muddied up because we need to
  consider the post-merger value of those shares
  were giving away.

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Cash versus Ordinary Shares

• Overvaluation
• If the target firm shares are too pricey to buy
  with cash, then go with shares.
• Taxes
• Cash acquisitions usually trigger taxes.
• shares acquisitions are usually tax-free.
• Sharing Gains from the Merger
• With a cash transaction, the target firm
  shareholders are not entitled to any downstream
  synergies.

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Defensive Tactics

• Target-firm managers frequently resist takeover
  attempts.
• It can start with press releases and mailings to
  shareholders that present managements viewpoint
  and escalate to legal action.
• Management resistance may represent the pursuit
  of self interest at the expense of shareholders.
• Resistance may benefit shareholders in the end if
  it results in a higher offer premium from the
  bidding firm or another bidder.

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Divestitures

• The basic idea is to reduce the potential
  diversification discount associated with
  commingled operations and to increase corporate
  focus,
• Divestiture can take three forms
• Sale of assets usually for cash
• Spinoff parent company distributes shares of a
  subsidiary to shareholders. Shareholders wind up
  owning shares in two firms. Sometimes this is
  done with a public IPO.
• Issuance if tracking shares a class of common
  shares whose value is connected to the
  performance of a particular segment of the parent
  company.

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The Corporate Charter

• The corporate charter establishes the conditions
  that allow a takeover.
• Target firms frequently amend corporate charters
  to make acquisitions more difficult.
• Examples
• Staggering the terms of the board of directors.
• Requiring a supermajority shareholder approval of
  an acquisition

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Repurchase Standstill Agreements

• In a targeted repurchase the firm buys back its
  own shares from a potential acquirer, often at a
  premium.
• Critics of such payments label them greenmail.
• Standstill agreements are contracts where the
  bidding firm agrees to limit its holdings of
  another firm.
• These usually leads to cessation of takeover
  attempts.
• When the market decides that the target is out of
  play, the shares price falls.

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Exclusionary Self-Tenders

• The opposite of a targeted repurchase.
• The target firm makes a tender offer for its own
  shares while excluding targeted shareholders.

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Going Private and LBOs

• If the existing management buys the firm from the
  shareholders and takes it private.
• If it is financed with a lot of debt, it is a
  leveraged buyout (LBO).
• The extra debt provides a tax deduction for the
  new owners, while at the same time turning the
  pervious managers into owners.
• This reduces the agency costs of equity

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Other Devices and the Jargon of Corporate
Takeovers

• Golden parachutes are compensation to outgoing
  target firm management.
• Crown jewels are the major assets of the target.
  If the target firm management is desperate
  enough, they will sell off the crown jewels.
• Poison pills are measures of true desperation to
  make the firm unattractive to bidders. They
  reduce shareholder wealth.
• One example of a poison pill is giving the
  shareholders in a target firm the right to buy
  shares in the merged firm at a bargain price,
  contingent on another firm acquiring control.

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Example 1

• Lams share is trading for RM50 a share while
  Yeohs share goes for RM25 a share. Lams EPS is
  RM1 while Yeohs EPS is RM2.50. Both are 100
  equity financed. Both companies have one million
  shares of stock outstanding.
• What is the post-merger EPS, If Lam can acquire
  Yeohs in an exchange based on market value, what
  should be the post-merger EPS?

b. Suppose Lam pays a premium of 20 in excess
of Yeoh's current market value. How many shares
of Lam must be given to Yeohs shareholders for
each of their shares?
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• c. Based on your results in b, what will Lams
  EPS be after it acquires Yeoh?

• d. If Yeoh were to acquire Lam by offering a 20
  premium in excess of Lams current market price,
  how many shares of stock would Yeoh have to
  offer, and what would be the effect on Yeohs
  EPS?

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Example 2

• Susie's Pizza is analyzing the possible
  acquisition of Janet's Electric. The projected
  cash flows to debt and equity expected from the
  merger are as follows
• Year(s) CF
• 1 RM150,000
• 2 170,000
• 3 200,000
• 4 200,000
• 5, 6, 6 growth per year
• The current market price of Janet's debt is
  RM800,000, the risk-free rate is 8, the required
  return on the market is 12, and the beta of the
  firm being acquired is 1.5.
• a. Determine the maximum price (NPV) Susie can
  afford to pay.
• b. If Janet's current equity value is RM1,100,000
  and she demands a 30 premium, will the merger
  take place?