Mergers and Acquisitions. Basic Forms of Acquisitions There are three basic legal procedures that one firm can use to acquire another firm: Merger or.

Mergers and Acquisitions

Basic Forms of Acquisitions

There are three basic legal procedures that one firm can use to acquire another firm:

Merger or ConsolidationAcquisition of StockAcquisition of Assets

MERGER One firm is acquired by another firm

Acquiring firm(i)retains its name & identity and (ii)acquires all Assets & Liabilities of the acquired

firm

Acquired firm ceases to exist

Consolidation

Entirely new firm is created from combination of existing firms.

Acquiring and acquired firm terminate their previous legal existence

&becomes part of the new firm

Acquisition of Stock A firm can be acquired by another firm through purchase

of voting shares of the firm’s stock

Tender offer – public offer to buy shares of a target firm

Factors affecting Stock acquisition– 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

Classifications

Horizontal – both firms(acquirer & acquired) are in the same industry

Vertical – firms are in different stages of the production process

Conglomerate – firms are unrelated

TAKEOVERS

Transfer of control* of a firm from one group of shareholders to another* Control- majority vote on the Board of Directors

Bidder & Target firmBidder firm- offers to pay cash or securities to obtain

stock of assets of another company

Target firm- will give up control over its assets or stock in exchange for consideration

Varieties of Takeovers

Takeovers

Acquisition

Proxy Contest

Going Private(LBO)

Merger

Acquisition of Stock

Acquisition of Assets

Proxy Contest

Group of shareholders attempt to gain seat on the Board of Directors

Written authorization for one shareholder to vote the stock for another

Going Private Transactions

Small group of investors purchases ALL EQUITY SHARES of a public firm.

Shares of the firm are delisted from stock exchanges & no longer can be purchased in the open market

Synergy Suppose firm A is contemplating acquiring firm B. The synergy from the acquisition is

Synergy = VAB – (VA + VB)

i.e. synergy= VAB > (VA + VB)

The synergy of an acquisition can be determined from the standard discounted cash flow model:

Synergy =CFt

(1 + r)tt = 1

T

Sources of Synergy

• Revenue Enhancement• Cost Reduction– Replacement of ineffective managers– Economy of scale or scope

• Tax Gains – Net operating losses– Unused debt capacity

• Incremental new investment required in working capital and fixed assets

Revenue Enhancement

Marketing gains

Strategic benefits

Market power

Cost Reduction

Economy of scale or scope

Technology transfer(GM & Hughes Aircraft)

Replacement of ineffective managers

Tax Gains

Net operating losses

Unused debt capacity

Calculating Value in case of Mergers and Acquisitions

Points to be remembered:1.Do not ignore market values

2.Estimate only Incremental cash flows

3.Use the correct discount rate

4.Do not forget transactions costs

Cash AcquisitionThe NPV of a cash acquisition is:

NPV = (VB + ΔV) – cash cost = VB* – cash cost

Value of the combined firm is:VAB = VA + (VB* – cash cost)

Often, the entire NPV goes to the target firm.

Stock AcquisitionFirm A is acquiring firm and Firm B is a target firm , then:

1.Value of combined firmVAB = Value of firm A + Value of firm B + Synergical benefits(in

terms of NPV)

2.Cost of acquisition= Merger Price* – Value of firm B*(No. of shares offered by firm A to firm B X market price per share of firm A)

3. NPV = Synergical benefits - Costs of acquisition (in terms of NPV)

Q. XYZ Inc. plans to acquire ABC Corporation for which the following information has been provided:

Particulars XYZ Inc. ABC Corp.Market price / share Rs. 150 Rs.60No. of shares 1,000 500Market value Rs. 1,50,000 Rs. 30,000

The merger of two firms is expected to bring benefits of which the NPV is estimated at Rs.30,000. XYZ Inc. offers 250 shares to the shareholders of ABC Corp. for merger proposal.Required: NPV of the merger decision and Value of merged

firm?

Ans.NPV = Synergical benefits (NPV terms) – *Cost of acquisition = Rs.30,000 – Rs.7,500

= Rs.22,500Value of merged firm = Value of XYZ Inc.+ Value of ABC Corp.+

synergical benefits = Rs.1,50,000+ Rs.30,000+ Rs.30,000

= Rs.2,10,000*Cost = Merger Price** – Value of ABC Corp. = Rs.37,500 – Rs.30,000

= Rs.7,500 **Merger Price = 250 shares x Rs.150 = Rs. 37,500

Q. Firm A is planning to acquire Firm B by way of merger. The following data is available as under:Particulars Firm A Firm BEarnings after tax Rs.2,00,000 Rs. 60,000No. of equity shares 40,000 10,000Market value/share Rs.15 Rs.12(i) If the merger goes through by exchange of equity share & the

exchange ratio is based on the current market price, what is the new earnings per share for Firm A?

(ii)Firm B wants to be sure that the earnings available to the shareholders will not be diminished by the merger. What

should be the exchange ratio in this case?

Ans.(i) New EPS for Firm A= Rs.2,60,000 = Rs.5.4248,000*

Firm B will get 8,000 shares (Rs.12/Rs.15 x 10,000)*Total no. of shares = 40,000 + 8,000= 48,000

(ii) Calculation of exchange ratio to maintain earnings:Present EPS of two firmsFirm A = Rs.2,00,000/40,000 = Rs.5Firm B = Rs. 60,000/10,000 = Rs.6Exchange ratio= 6/5, i.e. 1.20No. of new shares= 10,000 x 1.20= 12,000EPS after merger = Rs.2,60,000/(40,000+12,000) = Rs.5

Friendly vs. Hostile Takeovers

• In a friendly merger, both companies’ management are receptive.

• In a hostile merger, the acquiring firm attempts to gain control of the target without their approval.

• Tender offer• Proxy fight

Defensive Tactics

• Golden parachutes• Targeted repurchase • Standstill agreements• Poison pills (share rights plans)• Leveraged buyouts

Accounting for Acquisitions

The Purchase MethodAssets of the acquired firm are reported at their fair

market value.Any excess payment above the fair market value is

reported as “goodwill.”Earlier, goodwill on acquisition was amortized. Now it remains on the books of accounts until it is

deemed “impaired.”

Going Private and Leveraged Buyouts

The existing management buys the firm from the shareholders and takes it private.

If it is financed with a lot of debt, it is a leveraged buyout (LBO).

The extra debt provides a tax deduction for the new owners, while at the same time turning the pervious managers into owners.