week 13

Question 1

what does a takeover typically involve?

Answer 1

when an acquiring company acquires the controlling interest in the voting shares of a target company

Question 2

Takeovers are important transactions in the

Answer 2

market for corporate control

Question 3

After a takeover, the acquiring company obtains

Answer 3

After a takeover, the acquiring company obtains control of the target company’s assets, so a takeover is an indirect investment in assets

• so this investment should only proceed if it has a +NPV

Question 4

describe why takeovers may be more common when share prices increase rapidly

Answer 4

rapid increase in share price –> reflect increased demand in goods –> increase productive capacity –> internal investment (buy machinery etc) + external invesment (take control of existing assets esp those not being used efficiently –> takeover)

Question 5

Andrade and Stafford (2004) demonstrate that in

Answer 5

Andrade and Stafford (2004) demonstrate that in addition to takeovers providing an opportunity for companies operating in growth industries to expand productive capacity, they also provide the mechanism by which companies operating in industries that are contracting and have low growth prospects exit the industry and allow invested capital to be redeployed elsewhere

Question 6

horizontal takeover

give example

Answer 6

takeover of a target company operating in the same line of business as the acquiring company.

e.g. take over by Westpac Bank of St George bank in 2008.

Question 7

vertical takeover

Answer 7

takeover of a target company that is either a supplier of goods to, or a consumer of goods produced by, the acquiring company.

Question 8

conglomerate takeover

example

Answer 8

is the takeover of a target company in an unrelated type of business.

e.g. in the last 30 years Wesfarmers has acquired companies operating in industries as diverse as retail, mining etc.

Question 9

describe the market for corporate control

Answer 9

alternative management teams compete for the right to manage corporate assets

Question 10

where is there competition in the market for corporate control?

Answer 10

Competition in this market should ensure that asset control is acquired by those teams that are expected to be the most efficient in utilising those assets.

e.g.

Question 11

example of market for corporate control

Answer 11

Commpany is poorly managed, resulting in low profits and a low share price.

An opportunity then exists for a more efficient management team to take over this company, replace the inefficient managers and reverse the poor performance of the company.

Question 12

increased profitability through a change of management does not imply what?

Answer 12

Increased profitability through a change of management does not necessarily imply that the previous management was incompetent, only that a more efficient team was available (Dodd & Officer 1986).

Question 13

how can wealth be created by takeover?

Answer 13

When two companies are combined, wealth is created if the control of assets is transferred to managers who can recognise more valuable uses for those assets, either within the combined company or by redeployment of the assets elsewhere.

Question 14

what is synergy

Answer 14

he situation where the performance and therefore the value of a combined entity exceeds the sum of the previously separate components

Question 15

if there are synergistic benefits associated with combining two companies A and T, then

Answer 15

the combined company will be worth more than the sum of their values as independent entities:

V_AT > V _A + V _T

_{VAT = value of combined assets of the company}

_{VA = value of company A operating independtly VT = value of company T operating indenepdently}

Question 16

takeovers are what kind of transactions?

market for corporate control is influenced largely by what?

Answer 16

takeovers are value-increasing transactions

the market for corporate control is influenced largely by the existence of synergies.

Question 17

evaluation of the reasons for takeover

the target company is managed inefficiently

describe

Answer 17

the acquiring company’s managers may see an opportunity to use the target company’s assets more efficiently –> when assets are being used efficiently –> increase target company’s value

Question 18

evaluation of the reasons for takeover

the target company is managed inefficiently

can the acquiring company ALWAYS improve the efficiency of the target company’s operations.

Answer 18

Not always. Even if the acquiring company is efficiently managed, does not mean manager will improve the target company’s performance

Question 19

evaluation of the reasons for takeover

the target company is managed inefficiently

when is it less likely for the acquiring company to improve the performance of the target company?

Answer 19

two companies operate in different industries, so less likely for efficiency to be improved when conglomerate takeovers take place

Question 20

evaluation of the reasons for takeover

the target company is managed inefficiently

improvements in efficiency are more likely in what kind of takeovers?

Answer 20

improvements in efficiency are most likely to be achieved with a horizontal takeover, as the acquiring company’s managers are likely to have the expertise needed to manage the target company’s operations more efficiently.

Question 21

evaluation of the reasons for takeover

the target company is managed inefficiently

the target company’s market value may be low why? apart from being inefficient

Answer 21

managers are not necessarily inefficient, rather they pursue their interests instead of shareholders

Question 22

evaluation of the reasons for takeover

the target company is managed inefficiently

what if the reduction of the company’s market value is large?

Why?

Answer 22

it is likely that the company will eventually be identified as a takeover target, since an acquiring company will be able to eliminate, or at least reduce, the agency costs, thereby providing benefits for its own shareholders.

Question 23

reasons for takeover

complementary assets

describe

give an example

Answer 23

if either or both of the companies can provide the other with needed assets at relatively low cost

e.g. the target company’s managers are considered to have valuable skills. motive for the takeover is to acquire expertise. It may be cheaper to acquire this expertise via a takeover than to hire and train new staff.

Question 24

reasons for takeover

complementary assets

give an example in terms of small unlisted companies

Answer 24

engineers lack marketing skills –> low profit

large company with a strong marketing team takes over

target company benefits from acquiring company’s staff –> increase profitability, acquiring company benefits from skills of target company

Question 25

reasons for takeover

target company is undervalued

this may occur when

Answer 25

when the market value of the target company is less than the sum of the market values of its assets

Question 26

reasons for takeover

target company is undervalued

this may occur when

so?

Answer 26

when the market value of the target company is less than the sum of the market values of its assets

other managers see that there can be alternative and/or better uses of the copmany’s assets ==> takeover

Question 27

reasons for takeover

target company is undervalued

corporate raiders?

Answer 27

aggressive corporate or individual investors who takeover a company with the intention of achieving a controlling interest and replacing its current management

Question 28

reasons for takeover

target company is undervalued

why may the activites of corporate raiders be synergystic?

Answer 28

because acquiring company’s managers is identifying opportunities to create value by redeploying assets to alternative uses.

Question 29

reason for takeover

cost reductions

describe

Answer 29

the total cost of operating the combined company is expected to be less than the cost of operating the two companies separately.

Question 30

reason for takeover

cost reductions

these cost savings are due to

more likely to be achieved?

example

Answer 30

various economies of scale

horizontal takeover

e.g. two furniture manufacturers

Question 31

reason for takeover

cost reductions

describe how cost savings can be achieved by vertical takeovers

Answer 31

combining companies where one is a supplier –> costs of communication and various forms of bargaining can be reduced ==> more efficient coordination

Question 32

reason for takeover

increased market power

Answer 32

Taking over a company in the same industry may increase the market power of the combined company.

Question 33

reason for takeover

increased market power

the increased market power may?

Answer 33

. The increase in market power may enable the acquiring company to earn monopoly profits if there are significant barriers to entry into the industry

Question 34

reason for takeover

increased market power

government’s response?

Answer 34

Section 50 of the Competition and Consumer Act 2010 prohibits a company from acquiring the shares or assets of another company where the acquisition is likely to result in a substantial lessening of competition in a market.

Question 35

reason for takeover

increased market power

what are the merger guidelines?

Answer 35

ACCC has issued Merger Guidelines to explain the procedures and policies that it will follow in determining if a certain takeover is anti-competitive and should be opposed

Question 36

reason for takeover

increased market power

Give an example of a takeover ACCC opposed and reasons for the opposition

Answer 36

• October 2012. ACCC opposed joint venture partners behind the Masters chain of hardware stores from acquiring a small chain of three hardware stores around Ballarat in country Victoria
• Why? acquisition would result in a substantial lessening in competition in the hardware market in the Ballarat region.

Question 37

reasons for takeover

diversification

Answer 37

takeover enables a company to reduce risk via diversification.

Question 38

reasons for takeover

give an example of why risk may not be in fact reduced

Answer 38

• steel company diversifies its interest by acquiring an oil exploration company
• The steel manufacturer’s shareholders already had the opportunity to hold shares in oil exploration companies so the takeover does not provide any investment opportunity that did not previously exist

Question 39

reasons for takeover

diversification

when shareholders themselves hold diversified portfolios does diversifcation by a company increase their share value?

Answer 39

it will neither alter its market value nor benefit its shareholders

Question 40

reasons for takeover

diversification

takeovers motivated by diversification may benefit who?

what may arise

Answer 40

managers –> this creates agency problems

Question 41

Reasons for take-over

diversifcation

what is the co-insurance effect?

Answer 41

when two companies, each with debt securities outstanding, merge –> The default risk of each company’s debt will fall and the value of the debt securities will increase –> lenders to one company can now be paid out of the combined assets of both companies

Question 42

Reasons for take-over

diversifcation

another argument for reduction of risk is?

Answer 42

Co-insurance argument:

risk of default on debt is lowered when two companies whose earnings are less that perfectly correlated

debt capacity of the combination> than the sum of the debt capacities of the two companies operating separately.

Question 43

Reasons for take-over

diversifcation

while the

Answer 43

risk of default on debt is lowered when two companies whose earnings are less that perfectly correlated

debt capacity of the combination> than the sum of the debt capacities of the two companies operating separately.

Question 44

reasons for takeover

diversifcation

while the co-insurance argument is correct …..

Answer 44

While the co-insurance argument is essentially correct, the problem is that shareholders will not necessarily benefit from the reduction in default risk and interest cost of debt.

Question 45

Reasons for take-over

diversifcation

co-insurance effect

the gain to debtholders is?

Answer 45

This gain to debtholders is at the expense of shareholders, who now have to guarantee the debt of both companies

the loss to shareholders exactly offsets the gain to debtholders

Question 46

Reasons for take-over

diversifcation

co-insurance effect

If two companies combine and then borrow

Answer 46

shareholders will benefit from a lower interest rate, but they are providing the lenders with lower risk, so there is still no net gain.

Question 47

Reasons for take-over

diversifcation

co-insurance effect

how may shareholders benefit from the co-insurance effect

Answer 47

shareholders can benefit from the co-insurance effect to the extent that expected bankruptcy costs are reduced, or there are net tax savings.

Question 48

Reasons for take-over

excess liquidity or free cash flow

describe

Answer 48

1. companies seeking access to funds may takeover a company with excess liquidity
2. companies with excess liquidity acquire other companies rather than distribute cash to shareholders

Question 49

Reasons for take-over

excess liquidity or free cash flow

Contrary of this argument

Answer 49

capital market can provide funds at lower transaction costs rather than paying premium to acquire a company to access their free cash flow

Question 50

reasons for takeover

free cash flow

when a company with excess cash flow acquires another company instead of distributing it as cash to shareholders can be viewed as?

how come?

Answer 50

the managers are acting in their own interest rather than shareholders

• Managers may pursue greater market share in existing lines of business or diversification into additional industries because larger companies are often associated with higher salaries and benefits, and more promotion opportunities.

Question 51

reasons for takeover

free cash flow

what did Jensen Argue

Answer 51

Jensen argued that this conflict of interest can be severe in companies that generate substantial free cash flow and can lead to such companies engaging in takeovers that generate very small benefits, or even value reductions

Question 52

reasons for takeover

what does the free cash flow hypothesis show?

Answer 52

some takeovers are evidence of the conflicts of interest between shareholders and managers

Question 53

reasons for takeover

tax benefits

describe

Answer 53

Taking over a company with accumulated tax losses may reduce the total tax payable by the combined company.

Question 54

reasons for takeover

tax benefits

describe the law in australia regarding tax losses

Answer 54

In Australia, the Commissioner of Taxation restricts the use of past accumulated tax losses to situations where it can be shown that either the continuity-of-ownership-and-control test or the same-business test is satisfied

Question 55

reasons for takeover

tax benefits

describe the law in australia regarding tax losses

Answer 55

In Australia, the Commissioner of Taxation restricts the use of past accumulated tax losses to situations where it can be shown that either the continuity-of-ownership-and-control test or the same-business test is satisfied

Question 56

reasons for takeover

tax benefits

how do you pass the continuity-of-ownership-and-control test?

Answer 56

1. owners of at least 51 per cent of the company’s shares when it incurred losses 2. these owners must remain as owners when those accumulated losses are offset against taxable income and the effective control of the company has not changed between the generation and utilisation of the tax losses

Question 57

reasons for takeover

tax benefits

The same-business test provides that

Answer 57

where the continuity-of-ownership-and-control test is not satisfied, the past accumulated losses can still be offset against taxable income where the acquired company continues in the same business after the takeover.

Question 58

reasons for takeover

tax benefits

For companies with resident shareholders?

Answer 58

the incentive to reduce company tax payments by takeover is smaller under the imputation system compared to classical

BECAUSE

company tax is essentially a withholding tax against the personal tax liabilities of shareholders SO reduction of company tax –> shareholders have to pay more personal tax on dividends

Question 59

reasons for takeover

tax benefits

takeover for tax benefits is reduced under the imputation system b/c reduction in company tax means shareholders will have to pay more on their dividends

what does this mean?

Answer 59

any advantage associated with lowering company tax payments will be only a timing advantage

Question 60

reasons for takeover

tax benefits

what about in an international setting?

Answer 60

there are potentially substantial gains to be made by acquirers operating in high-tax jurisdictions taking over target companies which are located in countries with lower tax rates.

Question 61

reasons for takeover

Increased earnings per share and price–earnings ratio effects

what may an acquiring company do?

Answer 61

acquiring company may evaluate the effect of a proposed takeover on its EPS.

Question 62

reasons for takeover

Increased earnings per share and price–earnings ratio effects

why may evaluating the effect the proposed takeover has on EPS be unreliable?

Answer 62

a takeover that is economically viable _should lead to increased EPS f_or the acquiring company BUT it is easy to design a takeover that produces no economic benefits, but which nevertheless produces an immediate increase in EPS

Question 63

reasons for takeover

Increased earnings per share and price–earnings ratio effects

describe bootstrapping

Answer 63

it occurs in share-exchange takeovers whenever the acquiring company’s price–earnings ratio exceeds the target company’s price–earnings ratio.

e.g. A (with PE ratio of 10) was able to acquire a company (PE ratio of 5) with earnings of $100 000 per annum by issuing only 50 000 of its shares.

Question 64

reasons for takeover

Increased earnings per share and price–earnings ratio effects

Since EPS may be due to the bootstrap effect, what should we do

Answer 64

distinguish between true growth and the bootstrap effect, or ignore EPS b/c it can be misleading

Question 65

reasons for takeover

Increased earnings per share and price–earnings ratio effects

should the acquiring company’s pre-takeover P/E ratio apply to the combined company?

Answer 65

there is no basis for assuming that an acquiring company’s pre-takeover price–earnings ratio will continue to apply to a combined company.

Question 66

what is the most popular motive for takeover?

Answer 66

to take advantage of synergystic benefits

Question 67

in a survey about motives for takeover

what was a popular response for diversification benefits from takeover?

Answer 67

diversification ‘results in much less devastating effects on the firm during economic downturns’.

Question 68

how do shareholders benefit from the company diversifying?

Answer 68

reduced expected bankrupty costs –> reduced risk of bankrupty –> lower risk fo for shareholders

Question 69

benefit of diversification for managers?

how will this affect shareholders wealth?

Answer 69

management can protect the value of their own capital (both financial and human), which is largely tied up in the company.

This reduces shareholders’ wealth

Question 70

what are the 2 main roles for takeover?

Answer 70

1. threat or potential for akeover can discipline management of target companies
2. takeovers can take adv of synergies

Question 71

Role for takeover

threat or potential for takeovers can be used to discipline target companies

describe?

how will this be effective?

Answer 71

it is important in controlling managers’ behaviour

• threat needs to be carried out

Question 72

Role for takeover

threat or potential for takeovers can be used to discipline target companies

what if there is still significant efficiencies or agency problems even after the threat is made?

Answer 72

the managers of target companies can be replaced via takeovers e.g. there is evidence turnover of top executive managers increase significantly pursuant to a takeover (Martin and McConnell 1991)

Question 73

Role for takeover

can take adv of synergies

give examples

Answer 73

takeovers can take advantage of synergies such as economies of scale or complementarity between assets.

Question 74

Role for takeover

distinguish between using takeovers to discipline managers AND to take adv of synergies

Answer 74

discipline managers - gains related to changes of control

take adv of synergy - gains related to combining assets or companies

Question 75

For an acquiring company, takeovers are investments that should proceed if

Answer 75

NPV is +

Question 76

if the value of the target entity is not equal to its market value, what should management do

e.g. Board Ltd has been regarded by market participants as a likely takeover target and this speculation has increased its share price from $1.70 to $2.

Answer 76

1. management should check that the share price of a proposed target has not already been increased by takeover rumours
2. management should keep i_ts takeover intentions completely confidential_ until formally announcing the bid.

Question 77

if the value of the target entity is not equal to its market value, what should management do

if there are rumours that have increased the target’s share price,

Answer 77

if there are rumours that have increased the target’s share price, the market price no longer gives a measure of the target’s value as an independent entity.

Question 78

what is a share-exchange takeover?

Answer 78

acquiring company issues shares in exchange for the target’s shares.

Question 79

difference between cash and share-exchange offers

Answer 79

cash offer: net cost independent of takeover gain; if there is a valuation error e.g. board’s assets worth 5m, cash to board’s shareholders cannot be recovered –> acquring company’s shareholders bear the loss

Share-exchange offer: cost depends on the takeover gain, because the cost is a function of the acquiring company’s share price after the bid is announced.

• valuation error: part of the loss will be borne by target company’s shareholders

Question 80

role of ASIC

Answer 80

to administer activities covered under Corporations Act 2001

e.g. ASIC can apply to the Takeovers Panel for an acquisition of shares to be declared unacceptable or for a declaration of unacceptable circumstances.

Question 81

what can the takeovers panel do?

Answer 81

The panel can make a declaration that an acquisition is unacceptable even if the legislation has not been contravened

Question 82

what does s 659B provide

Answer 82

parties to a takeover cannot commence civil litigation relating to a current takeover

Question 83

when there is a current takeover, how can disputes be resolved?

what other power does this body have?

Answer 83

Takeovers Panel has the power to resolve these disputes

which also has the power to review decisions about parties to a takeover made by ASIC

Question 84

The takeovers legislation provides that, unless the procedures laid down in Chapter 6 of the Corporations Act are followed, the acquisition of additional shares in a company is virtually prohibited if this would:

Answer 84

result in a shareholder being entitled to more than 20 per cent of the voting shares; or

increase the voting shares held by a party that already holds between 20 per cent and 90 per cent of the voting shares of the company.

Question 85

If an investor wishes to exceed the 20 per cent threshold and obtain control of a target company

how can this be done?

Answer 85

this can generally be done only by following one of the two procedures that the legislation permits: an off-market bid or a market bid.

Question 86

once the holding exceeds 5 per cent?

Answer 86

a substantial shareholding notice must be issued within two business days, or by 9:30 am on the next business day if a takeover bid is currently underway

Question 87

An off-market bid can be used to acquire shares that are

Answer 87

An off-market bid can be used to acquire shares in the target company that are listed on a stock exchange or shares in an unlisted company.

Question 88

. A market bid is applicable only where

Answer 88

the target is listed on a stock exchange.

Question 89

how long must an off-market bid be open?

Answer 89

This offer must remain open for between 1 and 12 months

Question 90

an off-market bid may be for?

Answer 90

for 100 per cent or a specified proportion of each holder’s shares.

Question 91

A broad outline of the steps involved in an off-market bid is provided in

Answer 91

s. 632 of theCorporations Act

Question 92

Once an off-market bid has been made for a listed company, the offeror is allowed to

Answer 92

Once an off-market bid has been made for a listed company, the offeror is allowed to purchase target company shares on the stock exchange

Question 93

off-market bid

what happens when the offeror increases its offer price?

Answer 93

An offeror can increase its offer price but has to pay this increased amount to all shareholders who accept the offer, including any who have previously accepted a lower price.

Question 94

describe market-bid

Answer 94

1. the buyer must pay cash for the shares
2. offer cannot be conditional
3. shares of target company listed in stock exchange
4. procedure outlined under s 634
5. offer open for a period of 1-12 months

Question 95

market-bid

what happens if the offer price is increased

Answer 95

if the offer price is increased, there is no need to pay the higher price to target shareholders who sold prior to the increase.

Question 96

info required to be disclosed in the bidder’s statement include

Answer 96

1. bidder’s identify
2. details of bidder’s intentions (continuing target business, major changes)
3. details of how cash consideration will be obtained etc.

any other info that can assist target company’s shareholders in deciding whether to accept the offer.

Question 97

The target must respond to the takeover bid by

Answer 97

issuing a target’s statement, which is the same for both off-market and market bids.

Question 98

what must the target statement include?

Answer 98

1. all information that target shareholders would reasonably require to make an informed decision on whether to accept the bid
2. a statement by each director of the target recommending whether or not the bid should be accepted and giving reasons for the recommendation or not made
3. expert report if bidder’s voting power in the target is 30%+ , or if a director of the bidder is a director of the target.

Question 99

describe creeping takeover

Answer 99

permitted under s 611

cannot acquire up to 3% of target’s shares in 6 months, provided 19% threshold has been maintained for at least 6 months

no public statement needed

time to take control –> little commercial signifiance

Question 100

what is a partial takeover

Answer 100

where a bidder seeks to gain control by acquiring only 51 per cent, or perhaps less, of the target company’s shares

VERY RARE IN AUSTRALI

Question 101

The bidder in a partial takeover must specify

Answer 101

at the outset the proportion of each holder’s shares that the bidder will offer to buy.

Question 102

proportional bid

Answer 102

partial take over bid to acquire a proportion of shares held by each shareholder

Question 103

A company’s constitution may provide that a proportional takeover bid for the company can proceed only

what does the corporations act say about this

Answer 103

if shareholders vote to approve the bid.

The Corporations Act allows this restriction on proportional takeovers but also specifies that any shareholder approval requirements generally cease to apply after 3 years.

Question 104

a bidder engaged in an off-market bid needs to acquire the approval of

Answer 104

at least 75 per cent of shareholders holding at least 90 per cent of the shares in the target company before it can compulsorily acquire the remaining share

Question 105

describe scheme of arrangement

Answer 105

alternative to takeover bid when two companies want to merge operations

governed in chapter 5 of corporations

Question 106

scheme of arrangement

when will court grant approval

Answer 106

court will grant approval

• once ASIC had provided a written statement stating it does not object
• scheme not designed to avoid chapter 6

Question 107

scheme of arrangement

how many votes does the proposed scheme need to get?

Answer 107

Provided that more than 50 per cent of shareholders holding at least 75 per cent of shares in the company vote in favour of the scheme, the scheme will be passed, subject to the court’s approval, allowing all shares in the target company to be transferred to the bidder.

Question 108

. The Takeovers Panel has issued a guidance note relating to takeover defences in which it states

Answer 108

a decision about the ownership and control of a company should ultimately be made by shareholders and not by management

BUT if a target’s management believes resistance is in the best interests of the company’s shareholders, such action would be consistent ch 6’s purpose

Question 109

Outline defence strategies that can be used by target companies

poison pill

Answer 109

pre-emptive measure

• company that may become a target company makes its shares less attractive to the acquirer (potential bidder) by increasing the cost of a takeover

Question 110

Outline defence strategies that can be used by target companies

Acquisition by friendly parties

the management of a company seeks the assistance of a

Answer 110

• white knight

Question 111

Outline defence strategies that can be used by target companies

Acquisition by friendly parties

role of the white knight

Answer 111

purchases the target’s shares on the open market with the aim of either driving up the share price, or preventing the bidder from achieving its minimum acceptance level.

Question 112

Outline defence strategies that can be used by target companies

Acquisition by friendly parties

give an example

Answer 112

mid-1980s

• Bond Corporation preparing for a takeover bid of Arnott’s.
• US company Campbell Soup Company purchased shares as a friendly party and acquired a strategic parcel (or ‘blocking stake’) of Arnott’s shares
• thwarted Bond Corporation’s takeover ambitions

Question 113

Outline defence strategies that can be used by target companies

Disclosure of favourable information

Answer 113

Management of a target company may release information that it hopes will convince shareholders that the bid undervalues the company.

IT MUST BE ACCURATE

Question 114

Outline defence strategies that can be used by target companies

Disclosure of favourable information

what is the purpose?

Answer 114

to make the takeover prohibitively expensive for the bidder and/or deliver additional value to shareholders in the form of an increased offer price.

Question 115

Outline defence strategies that can be used by target companies

Disclosure of favourable information

the information disclosed must? example when information was witheld

Answer 115

the information disclosed must be accurate

three former directors of GIO (AMP target) have been targeted by ASIC for allegedly withholding information

Question 116

Outline defence strategies that can be used by target companies

Claims and appeals

Answer 116

The management of a target company often claims that the bid is inadequate and may also appeal to regulatory authorities such as the Foreign Investment Review Board, the Australian Competition and Consumer Commission and/or the Takeovers Panel

may cricitise bidding company

Question 117

Outline defence strategies that can be used by target companies

Claims and appeals

example of target company criticising bidding company

Answer 117

hostile takeover bid for Patrick Corporation by the Toll Holdings group. C

• hris Corrigan, the chief executive of Patrick Corporation, fiercely defended his company from acquisition
• placed ads in newspapers criticising Toll

Question 118

Outline defence strategies that can be used by target companies

Effects of takeover defences

, directors of a target company may oppose a bid b/c

Answer 118

may be unemployed if successful

they place their interests before their responsibilities to shareholders

Question 119

Outline defence strategies that can be used by target companies

Effects of takeover defences

esistance to a takeover bid can benefit shareholders if

Answer 119

if it forces the bidder to increase the offer, or attracts a higher offer from another bidder.

Question 120

Outline defence strategies that can be used by target companies

Effects of takeover defences

findings by Maheswaran and Pinder (2005)

Answer 120

• examined 133 bids for companies listed on the ASX
• resistance by a target company’s Board reduced the probability that a bid would be successful and increased the likelihood that the bidder would increase the offer price
• no impact on the chances that a competing bidder would launch an alternative bid for the target company’s shares.

Question 121

Outline defence strategies that can be used by target companies

The contention that managerial resistance to takeovers may not be in the best interests of shareholders is of concern since

Answer 121

the ‘market for corporate control’ concept sees takeovers as a mechanism for resolving shareholder–manager conflicts by replacing inefficient managers.

• The effectiveness of this market will be reduced if such managers use defensive tactics to entrench their positions

Question 122

Outline defence strategies that can be used by target companies

who will find it most difficult to maintain employment

Answer 122

poorly performing managers are likely to have the greatest difficulty in maintaining employment or obtaining other jobs after a takeove

Empirical evidence supports this - companies whose management resisted takeover are characterised by poorer performance prior to the takeover bid (Morck, Shleifer & Vishny 1988; Maheswaran & Pinder 2005).

Question 123

Outline defence strategies that can be used by target companies

. The problem of managers giving predominance to their own interests may be overcome by

Answer 123

structuring the compensation of top-level managers so that their own interests will be better aligned with those of shareholders.

Some companies approach this problem by offering top-level managers large termination payments (‘golden parachutes’) if they lose their jobs due to a takeover.

Question 124

Outline defence strategies that can be used by target companies

golden parachutes

Answer 124

large termination payments offered to top-managers if they lose their jobs from a takeover

Question 125

Outline defence strategies that can be used by target companies

golden parachutes may help reduce

Answer 125

be effective in preventing managers from resisting a takeover bid that is in the best interests of shareholders

Question 126

Identify the various types of corporate restructuring transactions

Divestitures?

Answer 126

involves assets, which may be a whole subsidiary, being sold for cash, and is therefore essentially a reverse takeover from the viewpoint of the seller

• also increases wealth of target shareholders (seller)

Question 127

Identify the various types of corporate restructuring transactions

spin offs

Answer 127

The operations of a subsidiary are separated from those of its parent by establishing the subsidiary as a separate listed company.

no change in ownership because shares in the former subsidiary are distributed to the shareholders of the parent company.

Question 128

Identify the various types of corporate restructuring transactions

Leveraged buyouts.

Answer 128

A company or division is purchased by a small group of (usually institutional) investors using a high proportion of debt finance.

after the buyout, it is privately owned

• almost always arranged by a buyout specialist who invests equity capital in the company, arranges the necessary debt finance and takes an active part in overseeing its performance

Question 129

Identify the various types of corporate restructuring transactions

management buyout.

Answer 129

senior managers of a company purchases all of a company’s issued shares

Question 130

Identify the various types of corporate restructuring transactions

Leveraged buyouts.

benefit of going private?

Answer 130

avoidance of listing fees and shareholder servicing costs,

Question 131

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

how does this benefit the target company? what evidence is there?

Answer 131

target company shareholders earn significant positive abnormal returns.

Brown and Da Silva Rosa (1997) found an average abnormal return of 25.5 per cent over the 7-month period around the takeover announcement. For the 1528 target companies in their sample, the total increase in shareholders’ wealth was approximately $15 billion

Question 132

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

Significant gains to target shareholders are to be expected because t

Answer 132

the acquiring company must offer more than the previous market price of the shares.

Question 133

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

target companies pre-bid?

Answer 133

on average, the shares in target companies performed poorly before the takeover bid. Brown and Da Silva Rosa (1997) found very poor pre-bid performance by target companier in their sample of 1371 targets shares on average was –23.3 per cent

Question 134

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

poor pre-bid performance of shares in target companies is consistent with?

Answer 134

the concept that takeovers transfer control of assets to companies with more efficient managers or more profitable uses for those assets.

Question 135

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

target companies

The initial increase in wealth of the target company’s shareholders….

Answer 135

The initial increase in wealth of the target company’s shareholders appears to be maintained, even where the takeover bid is unsuccessful

Question 136

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

target companies

The initial increase in wealth of the target company’s shareholders appears to be maintained. Why?

Answer 136

• the bid prompted a change in the target company’s investment strategy –> expected to improve performance
  2. info released during the bid caused the market to revalue the shares.
  3. market may expect a further bid for the target company.

Question 137

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

target companies

what evidence is there for the the maintenance of the initial increase in wealth in target companies ?

Answer 137

Bradley, Desai and Kim (1983) found that many companies that were the subject of an initial unsuccessful takeover bid received a subsequent successful bid within 5 years of the first.

• These subsequent bids resulted in further positive abnormal returns for target shareholders.

Question 138

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

target companies

Bradley, Desai and Kim (1983) found where no subsequent bid eventuated….

Answer 138

Where no subsequent bid eventuated, the shares of the unsuccessful targets declined, on average, to their (market-adjusted) pre-bid level.

Question 139

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

target companies

how much are bid prices?

Answer 139

Baker, Pan and Wurgler (2012) analysed over 7000 takeover bids in the US showed that the most common offer price set matched the highest price that the target company’s shares had reached over the 52 weeks before the announcement of the takeover bid.

the likelihood of the bid being accepted increases abnormally when the offer price exceeds a peak price

Question 140

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

acquiring companies

Answer 140

shareholders of acquiring companies earn positive abnormal returns in the years before the takeover bid is made.

Question 141

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

acquiring companies

Brown and Da Silva Rosa (1997) found that

Answer 141

Brown and Da Silva Rosa (1997) found that average abnormal returns accumulated to almost 32 per cent over the period from –36 to –6 months before the bid.

Question 142

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

acquiring companies

Brown and Da Silva Rosa (1997) found that average abnormal returns accumulated to almost 32 per cent over the period from –36 to –6 months before the bid.

what does this suggest

Answer 142

takeover bids are typically made by companies that have been doing well, and have demonstrated an ability to manage assets and growth.

Question 143

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

acquiring companies

describe the decline in abnormal returns

Answer 143

In the 7-month period around the announcement of the bid, the average abnormal return for successful bidders was 5.0 per cent.

other studies that have have found that the average abnormal return to shareholders of bidding companies is close to zero surrounding the announcement of takeover bids

Question 144

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

acquiring companies

negligible wealth effects of acquiring companies can be explained by?

Answer 144

takeovers are profitable, but the wealth effects are disguised

competition (multiple bidders) depresses returns to acquirer

takeovers are neutral or poor investments.

Question 145

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

acquiring companies

takeovers are neutral or poor investments. give evidence

Answer 145

Roll (1986)

• many managers of acquiring companies are affected by ‘hubris’ -over confident that their ability to value other companies is better than that of the market —> pay more for target company shares than they are worth
  
  • arge returns to target company shareholders represent wealth transfers from the shareholders of acquiring companies

Question 146

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

acquiring companies

Jarrell and Poulsen (1989) found

Answer 146

returns to acquirers were positively related to the size of the target relative to the bidder, which is consistent with the explanation that returns to acquirers can be disguised when target companies are small.

returns to acquirers were smaller when the bid was opposed by target management, and were lower after changes in regulation that favoured competing bidders.

Question 147

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

why may takeovers be poor investments?

Answer 147

the evidence on returns to acquiring company shareholders is much less conclusive.

Question 148

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

why may takeovers be poor investments?

Bradley, Desai and Kim (1988) found

Answer 148

They found an average gain of $117 million, or 7.4 per cent, in the combined wealth of shareholders.

takeovers yield real, synergistic gains and do not support Roll’s ‘wealth transfer’ hypothesis.

Question 149

Outline the main findings of empirical research on the effects of takeovers on shareholders’ wealth

distinguishing between poor and good takeovers

3 reasons why the managers of acquiring companies might pay more than targets are worth.

Answer 149

1. Roll’s hubris hypothesis suggests that managers pay too much for target companies because they overestimate their ability to run them.
2. acquiring companies do systematically pay too much in takeovers in which the benefits for managers are particularly large. –> free cash flow
3. Some managers may make unprofitable takeovers simply because they are poor managers,

Question 150

Da Silva Rosa and Walter (2004) drew the following conclusions after surveying vast evidence

Answer 150

1. Takeovers are initiated by companies that are high performers and are seeking to continue to perform well.
2. Target shareholders enjoy significant gains when their company is subject to a takeover bid, but these gains tend to dissipate where the bid is unsuccessful and no follow-up bid is launched.
3. Shares in acquiring companies tend to underperform in the market following acquisition. This is at least partly due to the relatively high costs incurred by acquirers as a consequence of the Australian regulatory environment in the market for corporate control
4. Following acquisition, the analysis of the long-run performance of combined entities indicates that the anticipated benefits from the acquisition often fail to materialise.

Question 151

While takeovers generate net benefits for shareholders on average, there is evidence that some types of takeover consistently harm the shareholders of acquiring companies.

how?

Answer 151

Such takeovers may serve the objectives of managers and are a ‘problem’ for investors, but the market for corporate control can also provide a ‘solution’ in that many unprofitable takeovers are later reversed.

Question 152

Comparing Gains and Costs

The amount of the cash consideration

Answer 152

nThe amount of the cash consideration determines how the total gain is divided between the two sets of shareholders.

• Every additional dollar paid to the target’s shareholders means a dollar less for the acquirer’s shareholders

Question 153

A stock-swap merger is a positive-NPV investment for the acquiring shareholders if

Answer 153

nthe share price of the merged firm exceeds the pre-merger price of the acquiring firm.

Question 154

Valuation Based on Earnings

this involves

Answer 154

nThe bidder values the target by first estimating the future earnings per share (EPS) of the target.

PV = EPS/ r = EPS x P/E = P

The EPS figure is then multiplied by an ‘appropriate’ price/earnings (P/E) ratio to obtain an implied price (valuation) of the target.

Question 155

Valuation Based on Assets

Answer 155

nA company’s equity can be valued by deducting its total liabilities from the sum of the market values of its assets.

Question 156

Valuation Based on Assets

may be appropriate when

Answer 156

nMay be appropriate where a bidder intends to sell many of the target’s assets, or where the company has been operating at a loss.

Question 157

what other legislations, apart from Corporations Act affect takeovers?

Answer 157

Trade Practices Act.

Foreign Acquisitions and Takeovers Act.

Industry-related legislation.

ASX listing rules — secrecy during takeover discussions, or apply for trading halt, shares cannot be placed (via a private placement) for 3 months after receiving a takeover offer.

Question 158

Tax Effects of Takeovers

what legislation governs this?

Answer 158

nThe New Business Tax System (Capital Gains Tax) Act 1999.

Question 159

Tax Effects of Takeovers

what kind of takeover offers are more favourable?

Answer 159

Scrip-based takeover offers are treated more favourably than cash offers.

Question 160

Tax Effects of Takeovers

difference between cash and share exchange takeover?

Answer 160

he shares received when a bid is accepted are not subject to capital gains tax (CGT) until they are sold.

Unlike cash received in a takeover.

Question 161

Tax Effects of Takeovers

what was historically argued?

Answer 161

Argued that, historically, bidders had to pay a CGT premium when making cash bids, inhibiting M & A activity

Question 162

Defence measures are of two basic types

Answer 162

¡Pre-emptive measures aimed at discouraging bids.

¡Strategies employed after a bid is received.

Question 163

takeover defences

example of poison pill

Answer 163

¡News Corp. provides a recent example.

November 2004, established a ‘shareholders rights plan’.

Offer of shares to existing shareholders (other than bidder) at half-price — effectively halve the bidders shareholding

Question 164

takeover defences

what are stagger boards? (classic boards)

Answer 164

In many public companies, a board of directors whose 3 year terms are staggered so that only 1/3 of the directors are up for election each year.

¡A bidder’s candidate would have to win a proxy fight two years in a row before the bidder had a majority presence on the target board.

Question 165

takeover defences

describe recapitalization

Answer 165

na company changes its capital structure to make itself less attractive as a target.

e.g. issue more debt and then use the proceeds to pay a dividend or repurchase stock.

Question 166

Other Defensive Strategies

Answer 166

nA firm can

• Require a supermajority (sometimes as much as 80%) of votes to approve a merger
• Restrict the voting rights of very large shareholders
• Require that a “fair” price be paid for the company, where the determination of what is “fair” is up to the board of directors or senior management

Question 167

nEffects of takeover defences

Answer 167

nDirectors are faced with a conflict of interest.

¡Resistance can extract additional value for shareholders but can be in interests of directors maintaining position.

¡¡Empirical evidence suggest worst managers are most likely to resist — hard to find a new job.

¡¡Golden parachutes

Question 168

The Free Rider Problem

Answer 168

Often times the target firm is poorly managed, resulting in a low share price

If the corporate raider can take control of the firm and replace management, the value of the firm (and the raider’s wealth) will increase.

Question 169

example of free rider problem

current price of the target firm is $45 per share and the potential price if the firm is taken over is $75 per share.

If the corporate raider makes a tender offer of $60 per share,

how much do tendering shareholders gain?

Answer 169

tendering shareholders gain $15 per share: $60 – $45 = $15

Question 170

example of free rider problem

current price of the target firm is $45 per share and the potential price if the firm is taken over is $75 per share.

If the corporate raider makes a tender offer of $60 per share,

what about non-tender shareholders?

Answer 170

non-tendering shareholders can “free ride.”

• By not tendering, these shareholders will receive the $75 per share or a gain of $30 per share. 75-45= 30
• However, if all the shareholders feel that the potential price is $75, they will not tender their shares and the deal will not go through

Question 171

example of free rider problem

non-tendering shareholders can “free ride.”

• By not tendering, these shareholders will receive the $75 per share or a gain of $30 per share. 75-45= 30

what if all shareholders feel that the potential price is 75? what shall we do?

Answer 171

they will not tender their shares and the deal will not go through

The only way to persuade shareholders to tender their shares is to offer them at least $75 per share, which removes any profit opportunity for the corporate raider.

Question 172

example of free rider problem

what is the problem?

Answer 172

existing shareholders do not have to invest time and effort, but still participate in all the gains from the takeover that the corporate raider generates, hence the term “free rider problem.”

• the corporate raider is forced to give up substantial profits and thus will likely choose not to bother at all.

Question 173

nSpin-offs

Answer 173

¡A single organisational structure is replaced by two separate units under essentially the same ownership.

Question 174

The Leveraged Buyout

give example

Answer 174

corporate raider announces a tender offer for half the outstanding shares of a firm.

¡Instead of using his own cash to pay for these shares, he borrows the money and pledges the shares themselves as collateral on the loan.

Because the only time he will need the money is if the tender offer succeeds, the banks lending the money can be certain that he will have control of the collateral.

Question 175

The Leveraged Buyout

If the tender offer succeeds?

Answer 175

, the corporate raider now has control of the company.

Question 176

The Leveraged Buyout

nIf the tender offer succeeds, the corporate raider now has control of the company.

The law allows the corporate raider to

Answer 176

attach the loans directly to the corporation

• At the end of this process the corporate raider still owns half the shares, but the corporation is responsible for repaying the loan.
• The corporate raider has effectively gotten half the shares without paying for them!