Mergers and Acquisitions
Basic Forms of Acquisitions
 There are three basic legal procedures that
one firm can use to acquire another firm:
Merger or Consolidation
Acquisition of Stock
Acquisition 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 firm
Bidder 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
Merger
Takeovers
Acquisition
Acquisition of Stock
Proxy Contest
Acquisition of Assets
Going Private
(LBO)
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:
S
T
Synergy =
t=1
DCFt
(1 + r)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 Acquisition
The 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 Acquisition
Firm A is acquiring firm and Firm B is a target firm , then:
1.Value of combined firm
VAB = 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.60
No. of shares
1,000
500
Market 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.22,500
Value 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 B
Earnings after tax
Rs.2,00,000
Rs. 60,000
No. of equity shares
40,000
10,000
Market 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.5.42
48,000*
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 firms
Firm A = Rs.2,00,000/40,000 = Rs.5
Firm B = Rs. 60,000/10,000 = Rs.6
Exchange ratio= 6/5, i.e. 1.20
No. of new shares= 10,000 x 1.20= 12,000
EPS 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 Method
Assets 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.