Topic 7 - Mergers and Acquisitions Flashcards
What are two characteristics of a merger?
- One firm is acquired by another
- Acquiring firm retains name and acquired firm ceases to exist
What are the advantages and disadvantages of a merger?
- Advantage – legally simple
- Disadvantage – must be approved by stockholders of both firms
What is the process of consolidation?
Entirely new firm is created from combination of existing firms
How is a firm acquired?
By another firm or individual(s) purchasing voting shares of the firm’s stock.
What is a Tender offer?
Public offer by acquirer to buy shares
What are the characteristics of a Stock acquisition? (3)
- 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 money – complete absorption requires a merger
What are three acquisition classifications?
- Horizontal: both firms are in the same industry
- Vertical: firms are in different stages of the production process
- Conglomerate: firms are unrelated
Why do most acquisitions fail to create value for the acquirer? (2)
- Failure to successfully integrate two companies after a merger
- Intellectual capital often walks out the door when acquisitions aren’t handled carefully
When do Acquisitions deliver value? (3)
- Scale economies or market power,
- Better products and services in the market, or
- Learning from the acquired firm
What are four sources of synergy?
- Revenue Enhancement
- Cost Reduction (replacing mgmt)
- Tax Gains (Net Operating Losses,Unused Debt Capacity)
- Incremental new investment required in working capital and fixed assets
What are considered “bad” reasons for merger?
- Earnings growth (if not synergies then increased EPS is just due to larger firm, not true growth)
- Diversification (can be achieved through stock purchases)
What happens to bondholders and equity holders value when two firms with debt merge? how could shareholders increase their value in the merger?
- value of shareholders call option (equity) falls
- value of debt rises because standard deviation (risk) falls
- if there is no debt no synergies are transferred to the bondholders, i.e. retire debt pre merger or increase debt post merger.
What is the typical analysis a firm would do when considering a merger?
NPV
What are the 3 NPV formula for a merger?
NPV of acquirer = synergy - premium
NPV of acquirer = Vab - Va - Price paid for B
NPV of acquirer = (Vb + delta V) - cash cost
How is synergy calculated?
synergy = Vab - (Va + Vb)
How is the premium calculated?
Premium = price paid for b - Value of b
What is the formula for the value of the combined firm with only cash consideration paid?
Vab = Va + ((Vb + delta V) - cash cost)
Why may a zero-NPV investment be attractive?
If the firm is looking for risk reduction.
What is the formula for the value of the combined firm when stock consideration is paid?
VAB = VA + VB + ∆V
What does the cost of acquisition depend on with stock consideration?
- Depends on the number of shares offered to the target stockholders
- Depends on the price of the combined firm’s stock after the merger
What are 3 considerations when choosing between cash and stock forms of merger consideration?
- Sharing gains: target stockholders do not participate in stock price appreciation with a cash acquisition
- Taxes: cash acquisitions are generally taxable
- Control: cash acquisitions do not dilute control
How do we value post-merger shares being offered to target firm shareholders?
Target firm payout = α × New firm value
Where alpha:
α = New shares issued / (Old shares + New shares issued)
How is the ownership proportion of the target firm in the new firm expressed?
Ownership = New shares issued / (New shares issued + Current shares of acquiring firm)
How do we find the exchange ratio?
Exchange ratio = New shares / Existing shares in target firm
In which what way can overvaluation issues of target firms stock be overcome when merging two companies?
If the target firm shares are considered over-priced, or firm A offers ‘too much’ for firm B, A’s shareholders are better off if firm A makes a stock offer, and not a cash offer. The forthcoming bad news about B’s value will then be partly borne by B’s shareholders
What are the benefits of cash mergers to the acquiring firms shareholders?
Target firms shareholders receive no money from the share of gains/ downstream synergies resulting from the merger.
What’s the difference between a friendly and a hostile takeover?
- Friendly merger, both companies’ management are receptive
- Hostile merger, the acquiring firm attempts to gain control of the target without their approval
(Tender offer/Proxy fight)
What are a negative and a positive to defensive tactics by mgmt to resist takeovers?
- Management resistance may represent the pursuit of self-interest at the expense of shareholders.
- Paradox: Resistance may benefit shareholders in the end if it results in a higher offer premium from the bidding firm or another bidder.
Do mergers add value to shareholders? target and acquirer shareholders
- Shareholders of target companies gain more in a tender offer than in a straight merger, price often driven up by resistance from managers
- Shareholders of acquirer firms are found to earn a small excess return in a tender offer, but none in a straight merger.
Why do Shareholders of acquirer firms tend to earn a small excess return in a tender offer? (4)
- Anticipated gains from mergers may not be achieved
- Acquirer 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.
- Announcement may not contain new information about the acquirer firm
Why would stock returns of hostile cash acquirers outperform those of friendly cash acquirers?
Unfriendly cash bidders are more likely to replace poor management
How is good will accounted for in the acquiring firms books?
It use to be amortised, it now remains on books and is tested for impairment.
What does “going private” refer to?
The existing management buys the firm from the shareholders and takes it private
What does a leveraged buyout refer to? what are some advantages of a LBO?
- The existing management buys the firm from the shareholders and takes it private and it is financed with a lot of 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
What are Golden parachutes, Crown Jewels and Poison Pills
- 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.
