26. Mergers and Acquisitions

When should one firm acquire another?

Only if doing so generates a positive net present value (NPV) for the shareholders of the acquiring firm.

What are some special problems that arise in mergers and acquisitions?

Valuing strategic fits, complex accounting/tax/legal effects, control issues between managers and shareholders, and unfriendly takeovers.

What are strategic fits in the context of acquisitions?

Benefits from acquisitions that depend on how well the acquiring and target firms align strategically.

Why are strategic fits difficult to value?

Because they are hard to define precisely and difficult to estimate using discounted cash flow techniques.

How can acquisitions act as a control device for shareholders?

Acquisitions can be used to remove existing managers when there is a conflict between managers and shareholders.

What are “unfriendly” transactions in mergers and acquisitions?

When one firm attempts to acquire another without mutual agreement and the target resists the takeover.

What is the acquiring firm often called in an acquisition?

The bidder.

What is the firm being acquired called?

The target firm.

What is meant by “consideration” in an acquisition?

The cash or securities offered to the target firm.

Define a merger.

The complete absorption of one firm by another, in which the acquiring firm retains its name and identity and the acquired firm ceases to exist as a separate business entity.

Define a consolidation.

A merger in which an entirely new firm is created and both the acquired and acquiring firms cease to exist.

What is the main difference between a merger and a consolidation?

In a consolidation, a new firm is created; in a merger, the acquiring firm keeps its identity.

What happens to the assets and liabilities in a merger or consolidation?

They are combined between the acquired and acquiring firms.

What is one primary advantage of using a merger to acquire a firm?

It is legally simple and less costly because firms agree to combine their entire operations without transferring individual asset titles.

What is one primary disadvantage of using a merger to acquire a firm?

It must be approved by a vote of each firm’s stockholders, often requiring two-thirds or more of the votes.

Why can obtaining stockholder approval for a merger be difficult?

Because it is time-consuming and requires cooperation from the target firm’s management, which may not be easy or cheap to obtain.

What is an acquisition of stock?

The purchase of another firm’s voting stock using cash, shares of stock, or other securities.

Define a tender offer.

A public offer by one firm to directly buy the shares of another firm.

How does a tender offer work?

It is made directly to shareholders, who may tender their shares in exchange for cash or securities, depending on the offer.

When might a tender offer be withdrawn or reformulated?

If not enough shares are tendered to meet the bidder’s desired percentage of total voting shares.

How is a tender offer typically communicated to shareholders?

Through public announcements such as newspaper advertisements or, less commonly, general mailings.

What is one advantage of acquisition by stock compared to a merger?

No shareholder meetings or votes are required.

In an acquisition by stock, how can the bidding firm bypass the target’s management?

By dealing directly with shareholders through a tender offer.

Why are stock acquisitions sometimes unfriendly?

Because they can be used to circumvent target management, which often resists acquisition.

What can happen if a significant minority of shareholders refuse a tender offer?

The target cannot be completely absorbed, delaying or reducing merger benefits.

What tax issue can arise if a bidder acquires less than 80% of a target’s shares?

The bidder must pay tax on 20–30% of any dividends received from the target firm.

What is an acquisition of assets?

A firm effectively acquires another by buying most or all of its assets.

What are the three main classifications of acquisitions?

Horizontal acquisition, vertical acquisition, and conglomerate acquisition.

What is a horizontal acquisition?

The acquisition of a firm in the same industry as the bidder.

What is a vertical acquisition?

An acquisition between firms at different stages of the production process.

What is a conglomerate acquisition?

A merger where the bidder and target are in unrelated lines of business.

What is a takeover?

A general term referring to the transfer of control of a firm from one group of shareholders to another.

What is a proxy contest?

An attempt to gain control of a firm by soliciting enough stockholder votes to replace existing management.

What is a proxy?

The right to cast someone else’s votes.

What is a going-private transaction?

A transaction in which all publicly owned stock in a firm is replaced with complete equity ownership by a private group.

What is a leveraged buyout (LBO)?

A going-private transaction in which a large percentage of the money used to buy the stock is borrowed.

What is a management buyout (MBO)?

A leveraged buyout in which incumbent management is heavily involved.

What happens to a firm’s shares in a going-private transaction?

They are delisted from stock exchanges and can no longer be purchased on the open market.

What is a strategic alliance?

An agreement between firms to cooperate in pursuit of a joint goal.

What is a joint venture?

An agreement between firms to create a separate, co-owned entity established to pursue a joint goal.

What is the first step in determining the gains from an acquisition?

Identify the relevant incremental cash flows, or the source of value.

When does acquiring another firm make sense?

Only if the target firm is expected to be worth more in the acquirer’s hands than by itself.

Define synergy in mergers and acquisitions.

The positive incremental net gain associated with the combination of two firms; it occurs when the value of the merged firm exceeds the sum of the separate firms’ values.

How is the incremental net gain from a merger calculated?

ΔV = VAB − (VA + VB), where VAB is the value of the combined firm.

How do you calculate the value of the target firm to the acquirer?

VB* = VB + ΔV, where VB* is the value of Firm B to Firm A.

What are incremental cash flows (ΔCF)?

The difference between the cash flows of the combined company and the sum of the cash flows of the two companies considered separately.

What is the formula for incremental cash flows in terms of revenue, cost, taxes, and capital requirements?

ΔCF = ΔRevenue − ΔCost − ΔTax − ΔCapital requirements

How can a merger increase revenues?

Through marketing gains, strategic benefits, and increases in market power.

What are strategic benefits in an acquisition?

Opportunities to enhance management flexibility or exploit competitive advantages; often compared to options.

How can acquisitions increase market power?

By increasing market share, allowing higher prices and reducing competition.

What is a primary reason for cost reductions in mergers?

he combined firm may operate more efficiently than the two separate firms.

What are economies of scale?

Reductions in average cost per unit as the level of production increases.

What are complementary resources in mergers?

Assets from another firm that help better utilize existing resources or fill missing components for success.

How can mergers provide tax benefits?

Through using net operating losses, unused debt capacity, surplus funds, and asset write-ups.

What is a net operating loss (NOL)?

Tax losses from periods when a firm has negative pretax earnings.

How can unused debt capacity benefit a merger?

Debt can be added, and interest payments are tax-deductible, reducing taxes.

How can surplus funds influence mergers?

Firms can use excess free cash flow to acquire other companies instead of paying dividends or repurchasing shares.

How do asset write-ups affect taxable acquisitions?

They increase depreciation deductions, but may be offset by taxes due on the revalued assets.

Which discount rate should be used for acquisition analysis?

The required rate of return for the incremental cash flows of the target firm (reflecting its risk).

How do acquisitions help inefficiently managed firms?

Mergers can replace management, increasing firm value even if existing management is not dishonest or negligent.

How can an acquisition create the appearance of EPS growth?

By increasing the earnings per share of the merged firm even if no new value is created, which can fool investors into thinking the firm is doing better.

How does a “smart” market respond to EPS growth after a merger?

It recognizes that total value hasn’t changed, so the price-earnings ratio falls.

How might a “fooled” market respond to EPS growth?

It may mistake the EPS increase for true growth, keeping the P/E ratio unchanged and inflating the perceived value of the firm

Why is diversification often cited as a benefit of mergers?

It reduces unsystematic risk by combining different businesses.

Does diversification create real value in a merger?

No, because unsystematic risk is not priced, and shareholders can diversify themselves without paying a premium.

Why might cash-rich firms pursue diversification?

They may articulate a “need” for diversification to deploy surplus cash.

In a cash acquisition, what is the cost to the acquiring firm?

The actual cash paid to acquire the target.

In a stock acquisition, why is the cost higher?

Because B’s shareholders receive stock in the merged firm and share in the merger gains.

How is the true cost of a stock acquisition calculated?

Multiply the number of shares issued to B’s shareholders by the post-merger share price.

What is a key difference between cash and stock financing in mergers?

Cash does not share acquisition gains with target shareholders; stock financing does.

What factors influence the choice between cash and stock?

Sharing gains, taxes, and control implications

Which type of financing is more common overall?

Cash, though stock financing is more common in very large deals.

How can target firm management resist takeovers?

Press releases, legal action, competing bids, and defensive corporate measures.

What is a supermajority amendment?

Increasing the shareholder approval requirement for mergers (e.g., from 67% to 80%).

What is a staggered or classified board?

A board with staggered elections, making rapid takeover approvals difficult.

What are standstill agreements?

Contracts where the bidder agrees to limit holdings in the target, ending takeover attempts.

What is greenmail?

Paying a premium to potential bidders to stop unfriendly takeovers.

What is a poison pill or share rights plan (SRP)?

A tactic giving existing shareholders rights to buy stock at a discount to repel hostile takeovers.

What triggers a poison pill?

Typically when an outsider acquires a large percentage (e.g., 20%) of stock or announces a tender offer.

What is a flip-in provision?

Allows shareholders to buy stock at a discount during an unfriendly takeover, diluting the raider’s ownership.

What is a flip-over provision?

Allows shareholders to buy stock in the merged company at a discount after a takeover.

What is a deadhand pill?

Gives the directors who installed the pill (or their successors) sole authority to remove it, limiting shareholder influence.

Golden parachute vs. golden handcuff?

Parachute: compensation for leaving during takeover; Handcuff: incentives to stay post-takeover.

Poison put?

Forces the firm to buy back securities at a set price.

Crown jewel / scorched earth strategy?

Threatening or selling major assets to deter a takeover.

White knight?

A friendly firm that acquires the target to prevent a hostile takeover.

Lockup?

Gives a friendly suitor rights to buy stock or assets at a fixed price during a hostile bid.

Shark repellent?

Any tactic to discourage unwanted takeover offers.

Bear hug?

A takeover offer so attractive the target has little choice but to accept.

Fair price provision?

Ensures all selling shareholders receive the same price.

Dual-class capitalization?

Voting power concentrated in a class of stock not held by the public, preventing hostile control.

Countertender / Pac-Man defense?

Target firm offers to buy the bidder to resist takeover.

Who benefits from mergers and acquisitions?

Target firm shareholders usually gain significant premiums; bidding firm shareholders see minimal average gains.

Why do bidding firm shareholders often see small gains?

Overestimated gains, larger firm size (lower % gain), managerial self-interest, competitive markets, or pre-announcement of merger intentions.

What is a divestiture?

Sale of assets, divisions, or segments to a third party.

Why do divestitures occur?

Antitrust regulations, raise cash, unprofitable units, strategic misfit, or financial distress.

What is an equity carve-out?

Selling a portion of a wholly owned subsidiary via IPO.

What is a spin-off?

Distribution of subsidiary shares to existing parent company shareholders.

What is a split-up?

Breaking a company into two or more new companies, swapping old shares for new ones