Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 22-1 Chapter Twenty-two Mergers, Acquisitions and Takeovers
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Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
22-1
Chapter Twenty-two
Mergers, Acquisitions and Takeovers
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
22-2
22.1 The Legal Forms of Acquisitions
22.2 Regulation of Business Combination
22.3 Taxes and Acquisitions
22.4 Gains from Acquisition
22.5 Some Financial Side-effects of Acquisitions
22.6 The Cost of an Acquisition
22.7 Defensive Tactics
22.8 Some Evidence on Acquisitions
22.9 Summary and Conclusions
Chapter Organisation
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
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Chapter Objectives
• Discuss the legal forms of acquisitions.• Understand the legal framework for mergers,
acquisitions and takeovers.• Discuss the gains from acquisition.• Explain the financial side-effects of acquisitions.• Calculate the costs and NPV of an acquisition.• Identify and discuss possible defensive tactics to a
takeover attempt.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
22-4
Legal Forms of Acquisitions• Merger complete absorption of one company by
another.• Consolidation creation of a new firm by combining
two existing firms.• Advantages of mergers and consolidations:
– simplicity (buyer assumes all assets and liabilities)– inexpensive.
• Disadvantages of mergers and consolidations:– shareholders of both firms must approve– difficulty in obtaining cooperation of target company’s
management.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
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Legal Forms of Acquisitions
• Acquisition of assets transfer of assets and liabilities of the target company to the acquiring company.
• Acquisition of shares (tender offer) acquire sufficient voting shares to gain management control via a direct public offer for the shares.
• Majority control versus effective control.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
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Acquisition Classifications
• Horizontal acquisition between two firms in the same industry.
• Vertical acquisition the buyer expands backwards by acquiring a firm with the source of raw materials or forwards by acquiring a firm that is closer in the direction of the ultimate consumer.
• Conglomerate acquisition involves companies in unrelated industries.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
22-7
A Note on Takeovers
Takeovers
Acquisition
Proxy contest
Going private(leveraged buyouts)
Merger or consolidation
Acquisition of stock
Acquisition of assets
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
22-8
Takeover Situations
• Creeping takeover– Holdings in a target company can be increased by no
more than 3 per cent every six months.
• Off market bid– A formal written offer is made to acquire the shares of a
target company.
• Market bid– An announcement by a stockbroker that a broking firm will
stand in the market to purchase the target company’s shares for a specified price for a specified period.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
22-9
The Legal Framework
Common law Enacted law(legislation)
Stock ExchangeRules
Contract law Law of tort
Trade PracticesAct 1974
Corporations Act2001
Australian SecuritiesCommission Act
1989
CorporationsRegulations
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
22-10
Taxes and Acquisitions
• Generally, assets purchased after 19 September 1985 are subject to capital gains tax (CGT) when sold.
• CGT can be deferred under rollover provisions.• CGT still applies when the consideration is shares,
and when more than 50 per cent of pre-19 September 1985 shareholders have changed (regardless of purchase date).
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
22-11
Gains from Acquisition
• Synergy the value of the combined companies is higher than the sum of the value of the individual companies.
• Need to determine incremental cash flows.
BAAB
BAAB
V V V V
V V V
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
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Incremental Cash Flows
= Revenue – Cost – Tax – Capital requirements
• A. Increased revenues1. Gains from better marketing efforts.
2. Strategic benefits—‘beachhead’ into new markets.
3. Increased market power—monopoly.
• B. Decreased costs1. Economies of scale.
2. Economies of vertical integration.
3. Complementary resources.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
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Incremental Cash Flows
• C. Tax gains1. Use of net operating losses.
2. Use of excess or unused franking credits.
3. Use of unused debt capacity.
4. Asset revaluations.
• D. Changing capital requirements
1. Reduced investment needs.
2. More efficient asset management.
3. Sell redundant assets.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
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Mistakes to Avoid
• Do not ignore market values.• Estimate only incremental cash flows.• Use the correct discount rate.• Be aware of transactions costs.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
22-15
Acquisitions and EPS Growth
Pizza Shack and Checkers Pizza are merging to form Stop ’n’ Go Pizza. The merger is not expected to create any additional value. Stop ‘n’ Go, valued at $1 875 000, is to have 125 000 shares outstanding at $15 per share.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
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Acquisitions and EPS Growth
Before and after merger financial positions100 000 Stop ’n’ Go shares to Pizza Shack holders 25 000 Stop ’n’ Go shares to Checkers holders
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
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Acquisitions and EPS Growth
• EPS has increased (and the P/E ratio has decreased) because the total number of shares is less.
• The merger has not ‘created’ value.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
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Diversification
• Does not create value in a merger.• Is not, in itself, a good reason for a merger. • Reduces unsystematic risk.
BUT• Shareholders can do this for themselves more
easily and less expensively.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
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The Cost of an Acquisition
• The net incremental gain from a merger of Firms A and B is:
V = VAB – (VA + VB)
• The total value of Firm B to Firm A is:
VB* = VB + V
• The NPV of the merger is:
NPV = VB* – Cost to Firm A of the acquisition
• The cost of the acquisition to Firm A depends on the medium of exchange used to acquire Firm B—cash or shares.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
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The Cost of an Acquisition
• Whether cash or shares are used to finance the acquisition depends on the following factors:
– Sharing gains: If cash is used, the selling firm’s shareholders will not participate in the potential gains (or losses) from the merger.
– Control: Control of the acquiring firm is unaffected in a cash acquisition. Acquisition with voting shares may have implications for control of the merged firm.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
22-21
Example—Cash or Shares?
Pre-merger information for Firm A and Firm B:
Both firms are 100 per cent equity financed.
The estimated incremental value of the acquisition is $500.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
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Example—Cash or Shares? (Continued)
• Firm B has agreed to a sale price of $675, payable in cash or shares.
• The value of Firm B to Firm A is:
• How much does Firm A have to give up?
1060$
560$500$
V V V BB
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
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Example—Cash Acquisition
• Cost of acquiring Firm B is $675.• NPV of the cash acquisition is:
• The value of Firm A after the merger is:
• Price per share after the merger is $18.20.
385$675$1060$
CostNPV
* V B
2185$675$1060$1800$
Cost
V V V BAAB
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
22-24
Example—Share Acquisition
• The value of the merged firm:
• Firm A must give up $675/$15 = 45 shares.
• After the merger there will be 165 shares outstanding, valued at $17.33 per share.
2860$500$560$1800$
V V V V BAAB
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
22-25
Example—Share Acquisition
• True cost of the acquisition:
45 shares × $17.33 = $779.85
• NPV of the merger to Firm A:
• Cash acquisition preferred (higher NPV).
15280$85779$1060$
CostNPV
. .
* V B
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
22-26
Defensive TacticsManagers who believe their firms are likely to become takeover targets and who wish to fend off unwanted acquirers often implement one or more takeover defences. These defensive tactics take several forms:
– Friendly shareholders offer the best defence.– Poison pills—designed to ‘repel’ takeover attempts.– Share rights plans—allow existing shareholders to purchase
shares at some fixed price in the event of a takeover bid.– Going private and leveraged buyouts—the publicly owned
shares in a firm are replaced with complete equity ownership by a private group (often financed by debt).
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
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Terminology of Defensive Tactics
• Golden parachutes—compensation to top-level management.
• Poison puts—purchase securities back at a set price.• Crown jewels—selling off of major assets.• White knights—acquisition by a ‘friendly’ firm.• Lockups—option for a ‘friendly’ firm to purchase
shares or assets at a fixed price.• Shark repellant—designed to discourage unwanted
mergers.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
22-28
Evidence on Acquisitions
• Shareholders of target companies involved in successful takeovers gain substantially.
• Abnormal gains of around 25 per cent reflect merger premium.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright
22-29
Evidence on Acquisitions
• Shareholders of bidding firms involved in successful takeovers only experience gains of 5 per cent. There are a variety of explanations for this:
– Overestimated anticipated gains– Scale effect (bidders usually larger than targets)– Agency problem– Competitive market for takeovers– Gains already reflected in bidder’s price (no new
information)
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