L18 - Mergers Flashcards
What are the different types of mergers?
Horizontal Merger
•One that takes place between two firms in the same line of business
Vertical merger
•Involves companies at different stages of production
Conglomerate merger
•Involves companies in unrelated lines of business
What are the six motives for mergers?
- Economies of Scale
- Economies of Vertical Integration
- Complimentary Resources
- Surplus Funds
- Eliminating Inefficiencies
- Industry Consolidation
Why are Economies of Scale a reason for mergers?
•A larger firm may be able to reduce its per-unit cost by using excess capacity or spreading fixed costs across more units
Why are Economies of Vertical Integration a reason for mergers?
- Control over suppliers “may” reduce costs.
- Over-integration can cause the opposite effect
Why is Complementary Resources a reason for mergers?
•Merging may result in each firm filling in the “missing pieces” of its firm with pieces from the other firm.
Why is Surplus fund a reason for mergers?
•If your firm is in a mature industry with few, if any, positive-NPV projects available, acquisition may be the best use of your funds
Why is eliminating inefficiencies a reason for mergers?
•Poor management may waste money, make poor decisions, conduct improper risk/return investments, and harm the value of the company. Sometimes, the only way to remedy the situation is to change management.
Why is Industry Consolidation a reason for mergers?
- The biggest opportunities to improve efficiency seem to come in industries with too many firms and too much capacity.
- These conditions often trigger a wave of mergers and acquisitions, which then force companies to cut capacity and employment and release capital for reinvestment elsewhere in the economy.
What are some Dubious reasons for Mergers?
Diversification
- Diversification is easier and cheaper for the stockholder than for the corporation. There is little evidence that investors pay a premium for diversified firms.
Increasing Earnings per Share: The Bootstrap Game
- The acquiring firm has a high P/E ratio
- The selling firm has a low P/E ratio (due to the low number of shares)
- After the merger, acquiring firm has short-term EPS rise
- Long term, the acquirer will have slower than normal EPS growth due to share dilution
How do you calculate if there is an economic gain to a merger?
Do the terms of the merger make the company and its shareholders better off?
Firm A is the acquiring firm and Firm B is selling firm
PV(AB) > PV(A) + PV(B)
Gain = PVAB - (PVA + PVB) = ΔPVAB
Cost = cash paid - PVB
NPV = gain - cost = ΔPVAB - (cash paid - PVB)
What a problematic way of estimating net gain?
- Estimated Net gain = DCF valuation of all future cash flows including merger benefits - cash required for the acquisition
- while this seems sound you can generate a positive net gain but this could be because your forecast was overall optimistic
- Before you conduct this analysis you should first ask:
- Why the firms should be worth more together than apart
- You add value only if you can generate additional economic rents –> any competitive edge that you have that the manager of the selling firm cannot achieve on their own –> or is the firm worth more to you than a competing firm trying to acquire it
How does a purchase of one firm appear in the balance sheet of the other firm?
- This is called merger accounting - this particular method is called purchase method:
- A buy B for $18m
- On the left-hand side,
- we sum Net Working Capital (NWC) Net book value of Fixed assets (FA)
- Add any goodwill
- On the right hand side:
- WE sum Debt and the value of Equity (this rises by an equal amount to goodwill)
Goodwill is where the company is brought a premium due to brand name, patents etc = Purchase Price - Equity of Firm B
What are some possible tax consequences of mergers?
- if cash is involved in a merger it is consider taxable, if its mostly in the form of shares its said to be tax free - exchanging old shares for similar new ones
- After a tax-free acquisition, the merger firms are taxed as if they had always been together
- In a taxable acquisition, the assets of the selling firm are revalued, the resulting write up or write down is treated as a taxable gain or loss, and tax depreciation is recalculated on the basis of the restated asset value
- For example In 1995 Captain B forms SeaCorp and purchases a boat for $300,000 - which for tax purposes has depreciated over 20 years on a straight line basis (300,000/20) = 15,000
- In 2005 it has the net book value of 150,000
- But after careful maintenance, inflation and good times in the fishing industry the boat is really worth $280,000 and Seacorp has $50,000 in marketable securities
- If Captain B sells the firm to Baycorp for $330,00, The possible tax consequence of the acquisition is shown below, In this case Captain B may ask for a tax-free deal to defer capital gains tax.
- But Baycorp can afford to pay more in a taxable deal because depreciation tax shields are larger
How can you change the manager in another firm?
Proxy Contests
- A proxy is the right to vote another shareholder’s shares
- Dissident shareholders attempt to obtain enough proxies to elect their own slate to the BOD
- these are usually difficult to win and expensive
Takeovers
- Alternative to a proxy fight
- Tender offer directly to the shareholders
- If successful, new owner is free to make any management changes
What are some example of Takeover Defences?
White knight: Friendly potential acquirer sought by a target company threatened by an unwelcome suitor.
Shark repellent: Amendments to a company charter made to forestall takeover attempts. –> amended to require than any merger requires a supermajority of 80%
Poison pill: Measure taken by a target firm to avoid acquisition; for example, the right for existing shareholders to buy additional shares at an attractive (bargain) price if a bidder acquires a large holding.
