Presentation on

1

• Presentation on
• Mergers and Acquisitions
• By
• Prof. Sundeep Bedi
• Editor-In-Chief
• Equitycalls.com, Pune

2
DEFINITIONS

• Acquisition The purchase of a controlling
  interest in a firm, generally via a tender offer
  for the target shares.
• Anergy Negative synergy. Instead of a "22 5"
  effect, anergy implies "223". Business units
  actively interfere with each other and may have
  more value if separated.
• Arbitrage The Purchase of an asset for near term
  resale at a higher price in the context of M A
  risk arbitrage.

3
DEFINITIONS

• Backend Rights Plan A poison pill takeover
  defense in which target shareholders are issued a
  rights dividend exercisable if an acquirer
  obtains over a triggering amount of target stock.
  Shareholders (excluding the acquirer) may
  exchange each right-and-share-of-stock held for
  senior securities or cash equal in value to a
  back-end price set by the target board. This
  backend price is set higher than the market price
  and becomes a minimum takeover price below which
  no takeover can succeed.

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DEFINITIONS

• Beta In the capital asset pricing model, the
  systematic risk of the asset the variability of
  the asset's return in relation to the return on
  the market.
• Bottomup An approach to firm strategy
  formulation based on the aggregation of segment
  forecasts.
• Capital Budgeting The process of planning
  expenditures whose returns extend over period of
  time
• CAPM Calculates the required return on an asset
  as a function of the risk free rate plus the
  market premium times the asset Beta.

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DEFINITIONS

• Cleanup Merger Also called a take-out merger.
  The consolidation of the acquired firm into the
  acquiring firm after the acquirer has obtained
  control.
• Coercive Tender Offer Any tender offer, which
  puts pressure on target shareholders to tender by
  offering a higher price to those who tender
  early.
• Coinsurance Effect The combination of two firms
  whose cash flows of less variability for the
  merged firm, thus decreasing the risk to lenders
  to the firm, thus the risk to the firm, thus
  decreasing the risk to lenders to lenders to the
  firm and thereby increasing its debt capacity.

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DEFINITIONS

• Collateral Restraints Agreements between the
  parties to a joint venture to limit competition
  between themselves in certain areas.
• Concentric Merger A merger in which there is
  carry - over in specific management functions
  (e.g. marketing ) or complementary in relative
  strengths among specific management functions
  rather than carry over / complementary in only
  generic management functions (e.g. planning).

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DEFINITIONS

• Conjectural Variation The reaction of rival
  firms as one firm, Firm A, restricts o/p or
  raises prices. Ranges from -1 to 1 a negative
  conjectural variation indicates competitive
  behavior, i.e., Firm A's action is offset by the
  reactions of competing rival firms.
• Decision Management Decision functions related
  to day-to-day operations, which may be delegated
  to managers. Includes initiation and
  implementation of policies and procedures.

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DEFINITIONS

• Defensive Diversification Entering new product
  markets to offset the limitations of the firm's
  existing product - market areas
• Delphi Technique An information - gathering
  technique in which questionnaires are sent to
  informed individuals. The responses are
  summarized into a feedback report and used to
  generate subsequent questionnaires to probe more
  deeply into the issue under study.

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DEFINITIONS

• De Nova Entry Entry into an industry by forming
  a new company as opposed to combining with an
  existing firm in the industry.
• Dogs A Boston Consulting Group term for business
  segments characterized by low market share in
  product markets with low growth rates.
• Du Pot System A financial planning and control
  system focusing on return on investment by
  relating asset turnover (effective asset
  management) to profit margin on sales (effective
  cost control).

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DEFINITIONS

• Equity Carve Out A transaction in which a parent
  firm offers some of a subsidiary's common stock
  to the general public, to bring in a cash
  infusion to the parent without loss of control.
• ERAS- type ESOP Employee stock ownership plans
  other than tax credit ESOP's i.e. includes
  leveraged, leverageable, and non-leveraged ESOPs
  recognized under ERISA rather than under the tax
  reduction act of 1975.

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DEFINITIONS

• Fallen Angel A bond issued at investment grade
  whose rating is subsequently dropped to below
  investment grade, below BBB.
• Financial Synergy A theory, which suggests a
  financial motive for mergers, especially between
  firms with high internal cash flows (but poor
  investment opportunities) and firms low internal
  cash flows (but high investment opportunities
  which, absent merger, would require costly
  external financing). Also includes increased debt
  capacity or coinsurance effect, and economics of
  scale in floatation and transaction costs of
  securities.

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DEFINITIONS

• Front-End Loading A tender offer in which the
  offer price is greater than the value of any
  un-purchased shares. Resolves the free-rider
  problems by providing an incentive to tender
  early,
• Gambler's Ruin An adverse string of losses,
  which could lead to bankruptcy, although the long
  run cash flows could be positive.
• General Utilities Doctrine An IRS rule which
  allowed firms to not recognize gains on the
  distribution of appreciated property in
  redemption of, its shares (e.g. in a 'legal
  liquidation). Repealed by the Tax Reform Act of
  1986.

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DEFINITIONS

• Going-Concern Value The value of the firm as a
  whole over and above the sum of the values of
  each of its parts the value of organization
  learning and reputation.
• Growth / Share Matrix A guide to strategy
  formulation which emphasizes attainment of high
  market share in industries with favorable growth
  rates
• Hidden Equity Undervalued assets whose market
  value exceeds their depreciated book value, but
  is not reflected in stock price.

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DEFINITIONS

• Hold Up Whenever a resource is dependent on
  (specialized to) the rest of the firm there may
  be a temptation for others to try to expropriate
  the quasi rent of the dependent resource by
  withholding their complementary resources this
  is holdup.
• Internal Rate of Return (IRR) A Capital
  Budgeting method, which finds the discount rate
  (the IRR), which equates the present value of
  cash inflows and investment outlays.

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DEFINITIONS

• Learning Curve An approach to strategy
  formulation which hypothesize that costs decline
  with cumulative volume experience resulting in
  competitive advantage for the first entrants into
  the industry.
• Leveraged Buy Out (LBO) The purchase of a
  company by a small group of investors, financed
  largely by debt.
• Leveraged Cash Out (LCO) A defensive
  reorganization of the firm's capital structure in
  which outside share-holders receive a large one
  time cash dividend and inside shareholders
  receive new shares of stock instead The cash
  dividend is largely financed with newly borrowed
  funds, leaving the firm highly leveraged and with
  a greater proportional ownership share in the
  hands of management.

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DEFINITIONS

• Lock-up Option An option to buy a large block of
  newly issued shares which target may grant to a
  favored bidder, thus virtually guarantying that
  the favored bidder will succeed.
• Management Buy Out A going private transaction
  led by the incumbent managers of the formally
  public firm.
• Market Model In event studies, the most widely
  used method of calculating the return predicted
  if no event took place. In this method, a clean
  period (with no events) is chosen, and a
  regression is run of firm returns against the
  market index return over the clean period.

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DEFINITIONS

• Market Value Rule The principle that all
  decisions of a corporation should be judged
  solely by their contribution to the market value
  of the firm stock.
• Master Limited Partnership (MNP) An
  organizational firm in which limited partnership
  interests are publicly traded (like shares of
  corporate stock) while retaining the tax
  attributes of the partnership.
• Mezzanine Financing Subordinated debt issued in
  connection with leveraged buyout Sometimes
  carries payment in time (PIT) provisions, in
  which debt holders receive more of the same kind
  of debt securities in lieu of cash payments under
  specified conditions.

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DEFINITIONS

• Money Purchase Plan Defined contribution pension
  plan in which the firm contributes a specified
  annual amount of cash as approached to stock
  bonus plans in which the firm contributes stock
  and profit sharing plans in which the amount of
  the annual cash contribution depends on
  profitability.
• NASDAQ Stock Quotation system of the National
  Association of Security Dealers for stocks which
  trade over the counter as opposed to organized
  exchange.
• Oligopoly A small number of sellers.

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DEFINITIONS

• Open Corporations Fama and Jensen's term for
  large corporations whose residual claims (common
  stock) are least restricted. They identify the
  following characteristics
• They have property rights in net cash flows for
  an indefinite cash flows
• Stockholders are not allowed to hold any other
  role in the organization.
• Common stock is alienable (transferable,
  saleable) without restriction.

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DEFINITIONS

• Open Market Share Repurchase Refers to a
  corporation's buying its own shares in the open
  market at the going price just as any other
  investor might buy the corporation shares as
  opposed to a tender offer for share repurchase or
  a negotiated repurchase
• Organization Capital Firm specific informational
  assets, which accumulate over time to enhance
  productivity, includes information used in
  assigning employees to appropriate tasks and
  forming teams of employees and the information
  each employee acquires about other employees in
  the organization.

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DEFINITIONS

• Original Plan Poison Pill An early poison pill
  anti-takeover defense in which the firm issues a
  dividend of convertible preferred stock to its
  common stock holders. If an acquiring firm passes
  a triggering point of share ownership, preferred
  stockholders (other than the large block holder)
  can put the preferred stock to the target firm
  (force the firm to redeem it) at the highest
  price paid by the acquiring firm for the targets
  common or preferred stock during the past year.
• Parking A securities law violation in which
  traders attempt to hide the extent of their share
  ownership (to avoid the 5 trigger requiring
  disclosure of takeover intentions and keep down
  the price of target stock) by depositing or
  parking shares with an accomplice broker until a
  latter date e.g. when the takeover attempt is out
  in the open.

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DEFINITIONS

• Perfect Competition Set of assumptions for an
  idealized economic model
• Large numbers of buyers and sellers so none can
  influence market prices or output
• Economies of scale exhausted at relatively small
  size and cost efficiencies are the same for all
  companies
• No significant barriers of entry
• Constant innovation, new product development
• Complete knowledge of all aspects of input/output
  markets is costlessly available.

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DEFINITIONS

• Poison Put A provision in some new bond issues
  designed to protect bondholders against takeover
  related credit deterioration of the issuer.
  Following a triggering event, bondholders may put
  their bonds to the corporation at an exercise
  price of 100-101 of the bond amount.
• Predatory Behavior A theory, which holds that a
  dominant firm may price below cost or build
  excess capacity to inflict economic harm on
  existing firms and deter potential entrants.

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DEFINITIONS

• Poison Pill Any takeover defense, which creates
  securities, that provides their holders with
  special rights (e.g., to buy target or acquiring
  firm shares) excersible only after a triggering
  event (e.g. a tender offer for or the
  accumulation of a specified percentage of target
  shares). Exercise of the rights will make it more
  difficult and / or costly for an acquirer to take
  over the target against the will of its board of
  directors.
• Product Breadth Carry - over of organizational
  capabilities to new products.

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DEFINITIONS

• Price Pressure A theory that the demand curve
  for the securities of an individual company is
  sloping downwards and that this causes negative
  stock price effects of large supply increases
  such as large block offerings.
• Production Knowledge A form of organization
  learning managerial ability to organize and
  maintain complex production process economically.
• Profit Sharing Plan A defined contribution
  pension plan in which the firm's annual
  contributions to the plan are based on the firm's
  profitability.

26
DEFINITIONS

• q-ratio (Tobin's q ratio) The ratio of the
  market value of a firm's securities to the
  replacement costs of its physical assets.
• Quasi -rent The excess return to an asset above
  the return necessary to maintain its current
  service flow.
• Residual Analysis The examination of asset
  returns to determine if a particular event has
  caused the return to deviate from a normal or
  predicted return which would have resulted if the
  event had not taken place. The difference between
  the actual return and the predicted return is the
  residual.

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DEFINITIONS

• Residual Claims The right of owners of an
  organization to cash flows not otherwise
  committed.
• Roll Out MLP Also called spin off MLP a
  corporation transfers some of its assets to an
  MLP to avoid double taxation, for example. MLP
  units are initially distributed to corporate.
  Shareholders and corporate management serves as a
  general partner. 
• Roll-Up MLP The combination of several ordinary
  limited partnerships into a master limited
  partnership.
• Sell off General term for divestiture of part or
  all of a firm by any one of a number of means,
  e.g, liquidation, spin- off and so on.

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DEFINITIONS

• Shark Repurchase A public corporation buys its
  own shares, by tender offer on the open market,
  or on a negotiated buy back from a large block
  holder.
• Shark Repellent Any number of takeover defenses
  designed to make a firm less attractive and less
  vulnerable to unwanted acquirers.
• Shark Watcher A firm (usually a proxy
  solicitation firm) which monitors trading
  activity in its client's stock to detect early
  accumulations by an unwanted acquirer before the
  5 disclosure threshold.

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DEFINITIONS

• Spin-off A transaction in which a company
  distributes on a prorata basis all of the shares
  it owns in a subsidiary to its own shareholders.
  Create a new public company with (initially) the
  same proportional equity ownership as the parent
  company.
• Split-off A transaction in which some but not
  all parent company shareholders receive shares in
  a subsidiary in return for relinquishing their
  parent company shares. 
• Split-up A transaction in which a company spins
  off all of its subsidiaries to its shareholders
  and ceases to exist.

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DEFINITIONS

• Staggered Board Also called a classified board.
  An anti-takeover measure which divides a firm's
  board of the directors into several classes only
  one of which is up for election in any given
  year, thus delaying effective transfer of control
  to a new owner in a takeover. 
• Stakeholder Any individual or group who has an
  interest in a firm in addition to shareholders
  and bondholders, includes labors, consumers,
  suppliers, the local community and so on. 
• Stake-Out Investment Preliminary investment for
  a foothold in anticipation of the future
  possibility of a larger investment.

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DEFINITIONS

• Standstill Agreement A voluntary contract by a
  large block shareholder (or former large block
  holder bought out in a negotiated repurchase) not
  to make further investments in the target company
  for a specified period of time.
• Stock Appreciation Right (SAR) Part of executive
  compensation program to align managers' interests
  with those of shareholders. SARs are issued to
  managers giving them the right to purchase stock
  on favorable terms the exercise price can be as
  low as 50 percent of the stock price at issuance
  maximum life is ten years.

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DEFINITIONS

• Stock Bonus Plan A defined contribution pension
  plan in which the firm contributes a specified
  number of shares to the plan annually. The
  benefits to plan beneficiaries depend on the
  stock performance.
• Strip Financing A type of financing, often used
  in leveraged buy-outs in which all claimants hold
  approximately the same proportion of each
  security (except for management incentive shares
  and the most senior bank debt).

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DEFINITIONS

• Subchapter S Corporation A form of business
  organization, which provides the minimum
  liability feature of the corporate form while
  allowing business income to be taxed at the
  personal tax rates of the business owners.
• Supermajority A requirement in many
  anti-takeover charter amendments that a change of
  control (for example) must be approved by more
  than a simple majority of shareholders, at
  least 67 to 90 percent approval way be required.

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DEFINITIONS

• Swaps Exchange of one class of securities with
  another.
• Synergy The " 2 2 5 effect. The output of a
  combination of two entities is greater than the
  sum of their individual outputs. 
• Take-out Merger The second step transaction
  which merges the acquired firm into the acquirer
  and thus takes out the remaining target shares
  which were not purchased in the initial ( partial
  ) tender offer.

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DEFINITIONS

• Underwritten Offerings Public securities issues,
  which are sold by a firm to an investment banker
  at a negotiated price, the investment banker then
  bears the risk of price fluctuations before the
  securities are sold to the general public.
• Value Additivity Principle (VAP) A quality of
  the NPV method of capital budgeting which enables
  managers to consider each project independently.
  The sum of project NPVs represents the value
  added to the corporation by taking them on.

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DEFINITIONS

• Value Chain An approach to strategy which
  analyses the steps or chain of activities in the
  firm to find opportunities for reducing cost
  outlays while adding product characteristics
  valued by customers.
• Vertical Merger A combination of firms, which
  operate in different levels, or stages of the
  same industry, e.g. a toy manufacturer merges
  with a chain of toy stores (forward integration)
  an auto manufacturer merges with a tyre company
  (backward integration).

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DEFINITIONS

• White Knight A more acceptable merger partner
  sought out by the target of a hostile bidder.
• Winner's Curse The tendency that in a bidding
  contest or in some types of auctions, the winner
  is the bidder with the highest (overoptimistic)
  estimate of value. This explains the high
  frequency of negative returns to acquiring firms
  in takeovers with multiple bidders.

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DEFINITIONS

• White Squire A third party friendly to
  management who helps a company avoid an unwanted
  takeover without taking over the company on its
  own.
• WOTS UP Acronym for Weaknesses, Opportunities,
  Threats and Strengths a technique to identify
  these key elements as put of the iterative
  process used to develop strategy.

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VALUATION

• A companies future potential is identical to its
• historical profit rate.
• E r (NW) (In the perfect market Scenario)
• Where E Long run average profits
• r Rate of Return
• NW Net Worth

40
VALUATION

• Net Asset Value
• Historical Profit
• Market Value of Shares
• Average Price
• Market Capitalization

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VALUATION

• The Correct Discounting Rate
• r
• where E is the long-run average earnings
• NW is the Net Worth at the time of merger
  

E
NW
42
VALUATION

• FACTORS AFFECTING MERGERS
• Financial Synergies
• Tax Considerations
• Scenario 1(contd)
• If two corporations A B are considering a
  merger option and their respective profit
  statements read as
• EcA(1-t)PBTA PBTA-TA
• EcB(1-t)PBTB PBTB-TB
• Where T in general is total tax outflow.

43
VALUATION

• FACTORS AFFECTING MERGERS
• Financial Synergies
• Tax Considerations
• Scenario 1(contd)
• If tAtB both corporations have a positive PBT,
  on merger all happens is both corporations
  jointly pay a tax that is identical to what they
  were otherwise considering paying individually.
• That is TAB TATB

44
VALUATION

• FACTORS AFFECTING MERGERS
• Financial Synergies
• Tax Considerations
• Scenario 1(contd)
• There is no financial gain as
• EcAB EcAEcB
• Where there are no uniform taxes therefore merger
  can be based on tax gains. Let us assume the
  following values

45
VALUATION

• FACTORS AFFECTING MERGERS
• Financial Synergies
• Tax Considerations
• CORPORATION A CORPORATION B
• PBTA100 PBTB150
• tA0.40 tB0.40
• PATA60 PATB90
• On merger
• EcAEcB PATAPATB 6090 150

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VALUATION

• FACTORS AFFECTING MERGERS
• Financial Synergies
• Tax Considerations
• Uniform Tax rates do not by themselves create
  synergestic effects.
• Progressive Tax rates do not by themselves
  create synergestic effects, where EcA EcB are
  positive
• Progressive Tax rate create an effect that is
  exactly the reverse
• Under Regressive Tax rate mergers are greatly
  encouraged.

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VALUATION

• FACTORS AFFECTING MERGERS
• Financial Synergies
• Tax Considerations
• Let us consider
• tA 0.4, tB0.5, PBTA 100, PBTB150
• EcA (1-0.4)100 60
• EcB (1-0.5)150 75
• On merger let us consider a tax rate t, which is
  at equal to
• tB i.e. 50. The combined income before tax
  PBTAB250
• and EcAB (1-0.5)250 125

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SICK UNIT MERGERS

• Merger of profit making loss making companies
• PBT PAT must be negative resulting in merger
  gains

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