FINA 4315 Exam 2 Review

Comprehensive vocabulary flashcards covering IPOs, underwriting methods, mergers and acquisitions, antitrust regulations, defensive takeover tactics, and corporate divestitures for FINA 4315 Exam 2.

Angel Investors

Wealthy individuals who buy equity in small firms.

Venture Capital Firms

Limited partnerships that specialize in raising money to invest in private equity firms.

Corporate Investors

Corporations that invest in private companies.

Advantages of Going Public

1. Liquidity increased; 2. Easier to raise capital; 3. Establishes firm value; 4. Increases customer recognition.

Disadvantages of Going Public

1. Must file many reports; 2. Operating data must be disclosed (competitors may know the business); 3. Managing investor relations is time-consuming.

Primary Offering

New shares being offered to the public in an IPO.

Secondary Offering

Shares owned by existing shareholders (insiders selling shares after the IPO); does not raise capital for the firm.

Seasoned Equity Offering (SEO)

The sale of additional stock that is already publicly traded (after an IPO).

Mixed Offering

An offering consisting of a mixture of primary and secondary shares.

Lock-Up Agreement

An agreement in an IPO that prohibits insiders and other pre-IPO shareholders from selling any of their shares for a specific period.

Benefit of a Lock-Up Agreement

Provides a credible signal that insiders are not attempting to cash out in advance of bad news.

Tombstone

The advertisement of an IPO published in financial newspapers.

Methods of Issuing Securities for Cash

1. Firm Commitment; 2. Best Efforts; 3. Dutch Auction.

Firm Commitment

An issuing arrangement (most common in the US) where the issuing firm sells the entire issue to the underwriting syndicate, which then resells to the public, earning money from the spread.

Best Efforts

An underwriting arrangement where the underwriter must make their best effort to sell securities at an agreed offering price, but bears the risk of not being able to sell all of them.

Dutch Auction

A security issuing method where the underwriter accepts a series of bids with share counts and prices, setting the highest price that results in all shares being sold (Google was the first to use this).

IPO Process Steps

Approval from the board of directors, select an investment bank, file Form S-1 with the SEC, choose a price range in the preliminary ('red herring') prospectus, go on an investor roadshow, and set the final offer price for the public offering and sale.

IPO Valuation Methods

Discounted Cash Flow Method and Market Multiples Method.

Direct Costs of an IPO

The underwriter spread (difference between offering price and proceeds to issuer) plus direct payments to lawyers, printers, accountants, etc.

Indirect Costs of an IPO

Money left on the table (opportunity cost), calculated as: (First day closing price - Offering price) × Number of shares sold in the IPO.

Reverse Merger

An alternative way to go public where a privately held company merges with a publicly held company that has no business purpose other than finding a private firm to acquire (often called a 'shell').

Basic Forms of Acquisitions

1. Merger or consolidation; 2. Acquisition of stock; 3. Acquisition of assets.

Acquisition of Stock

A form of acquisition executed via a tender offer made by the bidder directly to the target shareholders.

Acquisition of Assets

A form of acquisition where a firm acquires another firm by purchasing all of its assets, requiring a formal vote of the target stockholders.

Horizontal Acquisition

An acquisition involving firms competing in the same industry.

Vertical Acquisition

An acquisition involving firms operating at different steps of the production process.

Conglomerate Acquisition

An acquisition where the acquiring firm and the acquired firm operate in unrelated industries.

1960s Merger Wave

Dominated by conglomerate mergers; notable example includes ITT, which completed many conglomerate mergers that failed to create value and was later forced to deconglomerate.

1980s Merger Wave

Characterized by hostile takeovers and bust-up takeovers, where acquired companies were broken up and sold piece-by-piece for profit.

1990s Merger Wave

Dominated by strategic mergers, which were friendly mergers aimed at expanding the company globally.

Synergy

The combined effect of two or more companies producing a greater outcome than the sum of their individual parts ($2 + 2 = 5$).

Sources of Synergy

1. Revenue Enhancement (marketing and strategic gains); 2. Cost Reduction (economies of scale, vertical integration, replacing inefficient managers); 3. Tax Gains (net operating loss carryforwards, unused debt capacity/larger interest tax shield); 4. Reduced capital requirements.

Reasons for Bad Mergers

1. Artificial earnings growth (an accounting illusion that makes earnings appear to grow without adding real value); 2. Diversification (individual shareholders can diversify cheaper on their own by buying stock in different firms).

Friendly Takeover

A takeover where the target company's board of directors recommends that the offer be accepted by the shareholders.

Hostile Takeover

A takeover where the target board rejects the offer and the bidder continues pursuit, or where the bidder makes an offer without prior notification to the target board.

Tender Offer

An organized public bid directly to shareholders to purchase their shares, typically offered at a premium.

Proxy Fight

An attempt to gather shareholder voting proxies to vote out existing board members and replace them with a slate favorable to the takeover.

Williams Act of 1968

Merger legislation requiring acquirers to disclose holdings and intentions within 10 days of acquiring 5% of a stock, disclose funding sources, keep tender offers open for at least 20 days, and pass any price increases on to all shareholders who tendered prior.

Pre-Play Takeover Defenses

Deterrent tactics established before a bid is made, including Classified/Staggered Boards, Poison Pills, and Golden Parachutes.

Classified Board (Staggered Board)

A corporate governance structure where only a fraction of the board members are elected each year to prevent an immediate board takeover via a proxy fight.

Poison Pill

A defense mechanism that allows non-hostile existing shareholders to purchase stock at a discounted price, thereby diluting the hostile bidder's ownership percentage.

Golden Parachute

A generous severance package guaranteed to senior management in the event that the firm is taken over.

In-Play Takeover Defenses

Defensive tactics executed after an active takeover bid begins, including Greenmail, White Knight defenses, and Exclusionary Self-Tenders.

Greenmail

A targeted share repurchase where the target firm buys back its stock from a hostile bidder at a substantial premium to eliminate the takeover threat.

White Knight

A friendly suitor sought out by a target firm to acquire it on favorable terms instead of succumbing to a hostile acquirer.

Exclusionary Self-Tender

A defensive tender offer where the target company buys back a specific amount of its own stock from shareholders while explicitly excluding the hostile bidder.

Sherman Antitrust Act of 1890

The foundational US antitrust legislation designed to prevent the formation of trusts and monopolies.

Clayton Act of 1914

Antitrust law created to strengthen the Sherman Act; Section 7 prohibits stock acquisitions if the effect substantially lessens competition.

Federal Trade Commission Act of 1914

Legislation that established the Federal Trade Commission (FTC) as a regulatory agency to complement the Department of Justice (DOJ) as an antitrust watchdog.

Celler-Kefauver Act of 1950

Antitrust amendment that severely limited the possibility of obtaining regulatory approval for horizontal mergers.

Hart-Scott-Rodino Act of 1976

Federal legislation requiring pre-merger notification, allowing the FTC or DOJ to rule on the permissibility of a merger prior to consummation.

Role of Investment Banks in Mergers

1. Arranging mergers; 2. Developing defensive tactics; 3. Establishing fair value through valuation analysis; 4. Arranging merger financing when excess cash is needed.

Merger Arbitrage

An investment strategy where investors speculate on the outcome of a deal after a merger is announced, profiting from the spread and closing uncertainty.

Risk Arbitrageurs

Traders who believe they can forecast deal outcomes and take trading positions based on those expectations.

Merger Value Distribution

The empirical tendency in M&A transactions where target firm shareholders virtually reap all the economic benefits created by the merger.

Leveraged Buyout (LBO)

The acquisition of a company financed primarily with a large amount of debt, where the acquiring group becomes the new equity holders.

Divestiture

The sale of a company's operating assets or an entire business division.

Reasons for Divestitures

Defending against a hostile takeover, raising cash/liquidity to survive, making the firm easier to value, focusing on the core business, or settling antitrust lawsuits (e.g., AT&T breakup).

Spin-Off

A divestiture method where a parent firm converts a division into a separate, independent corporate entity and distributes shares to the parent's existing stockholders for free.

Equity Carve-Out

A divestiture method where a parent company separates a division into a new legal entity and then sells shares in that division to the public via an offering.