Fundamentals of corproate finance 3e chapter 22

Chapter Twenty-two
Mergers, Acquisitions and
Takeovers

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Chapter Organisation
22.1
22.2
22.3
22.4
22.5
22.6
22.7
22.8
22.9

The Legal Forms of Acquisitions
Regulation of Business Combination
Taxes and Acquisitions
Gains from Acquisition
Some Financial Side-effects of Acquisitions
The Cost of an Acquisition
Defensive Tactics
Some Evidence on Acquisitions
Summary and Conclusions

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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.

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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
management.
–

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target

company’s

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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.

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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.

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A Note on Takeovers
Merger or consolidation

Takeovers

Acquisition

Acquisition of stock

Proxy contest

Acquisition of assets

Going private
(leveraged buyouts)

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Takeover Situations
•

Creeping takeover
–

•

Off market bid
–

•

Holdings in a target company can be increased by no more than
3 per cent every six months.
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.

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The Legal Framework
Common law

Contract law

Enacted law
(legislation)

Stock Exchange
Rules

Law of tort

Trade Practices
Act 1974

Corporations Act
2001

Australian Securities
Commission Act
1989

Corporations
Regulations

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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).

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Gains from Acquisition
•

Synergy → the value of the combined companies is higher
than the sum of the value of the individual companies.

V AB > VA + VB
∆V = VAB − (VA + VB )
•

Need to determine incremental cash flows.

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Incremental Cash Flows
= ∆Revenue – ∆Cost – ∆Tax – ∆Capital requirements
•

A. Increased revenues
1. Gains from better marketing efforts.
2. Strategic benefits—‘beachhead’ into new markets.
3. Increased market power—monopoly.

•

B. Decreased costs
1. Economies of scale.
2. Economies of vertical integration.
3. Complementary resources.

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Incremental Cash Flows
•

C. Tax gains
1. 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.

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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.

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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.

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Acquisitions and EPS Growth
Before and after merger financial positions
100 000 Stop ’n’ Go shares to Pizza Shack holders
25 000 Stop ’n’ Go shares to Checkers holders

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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.

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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.

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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.

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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.
–

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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.
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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:

VB ∗ = ∆V + VB
= $500 + $560
= $1060
•

How much does Firm A have to give up?

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Example—Cash Acquisition
•

Cost of acquiring Firm B is $675.

•

NPV of the cash acquisition is:

NPV = VB * − Cost
= $1060 − $675 = $385
•

The value of Firm A after the merger is:

VAB = VA + (VB ∗ − Cost )

= $1800 + ( $1060 − $675) = $2185

•

Price per share after the merger is $18.20.

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Example—Share Acquisition
•

The value of the merged firm:

VAB = VA + VB + ∆V
= $1800 + $560 + $500 = $2860
•

Firm A must give up $675/$15 = 45 shares.

•

After the merger there will be 165 shares outstanding, valued
at $17.33 per share.

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Example—Share Acquisition
•

True cost of the acquisition:
45 shares × $17.33 = $779.85

•

NPV of the merger to Firm A:

NPV = VB * − Cost
= $1060 − $779.85 = $280.15
•

Cash acquisition preferred (higher NPV).

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