Mergers and Acquisitions PDF

A financial merger is a merger transaction SPECIAL TOPIC (FINALS) undertaken with the goal of restructuring the acquired company to improve its cash flow MERGERS AND ACQUISITION Merger Fundam...

A financial merger is a merger transaction SPECIAL TOPIC (FINALS) undertaken with the goal of restructuring the acquired company to improve its cash flow MERGERS AND ACQUISITION Merger Fundamentals: Motives for Merging Merger Fundamentals: Terminology The overriding goal for merging is maximization of the owners’ wealth as Corporate restructuring is the activities reflected in the acquirer’s share price. involving expansion or contraction of a firm’s operations or changes in its asset or financial More specific motives include: (ownership) structure. Growth or Diversification A merger is the combination of two or more Synergy firms, in which the resulting firm maintains the identity of one of the firms, usually the larger. Fund raising Consolidation is the combination of two or Increased managerial skill or more firms to form a completely new technology corporation. Tax considerations A holding company is a corporation that has voting control of one or more other Increased ownership liquidity corporations. Defense against takeover Subsidiaries are the companies controlled by a holding company. A tax loss carryforward is, in a merger, the tax loss of one of the firms that can be The acquiring company is the firm in a merger transaction that attempts to acquire applied against a limited amount of future another firm. income of the merged firm over 20 years or The target company is the firm in a merger until the total tax loss has been fully transaction that the acquiring company is recovered, whichever comes first. pursuing. A company with a tax loss could acquire a A friendly merger is a merger transaction profitable company to utilize the tax loss. endorsed by the A tax loss may also be useful when a target firm’s management, approved by its profitable firm acquires a firm that has such a stockholders, and easily consummated. loss. A hostile merger is a merger transaction that Merger Fundamentals: Types of Mergers the target firm’s management does not support, forcing the acquiring company to try to gain A horizontal merger is a merger of two control of the firm by buying shares in the firms in the same line of business, while a marketplace. vertical merger is a merger in which a firm A strategic merger is a merger transaction acquires a supplier or a customer. undertaken to achieve economies of scale.  A congeneric merger is a merger in which becomes an independent company through the one firm acquires another firm that is in the issuance of shares in it, on a pro rata basis, to the same general industry but is neither in the parent company’s shareholders. same line of business nor a supplier or customer, while a conglomerate merger is a The final and least popular approach to merger combining firms in unrelated businesses. divestiture involves liquidation of the operating unit’s individual assets. LBOs and Divestitures Regardless of the method used to divest a A leveraged buyout (LBO) is an acquisition firm of an unwanted operating unit, the goal technique involving the use of a large amount of typically is to create a more lean and focused debt to purchase a firm; an example of a operation that will enhance the efficiency as financial merger. well as the profitability of the enterprise and An attractive candidate for acquisition via a create maximum value for shareholders. leveraged buyout should possess three key Comparisons of post divestiture and pre attributes: divestiture market values have shown that the 1. It must have a good position in its breakup value—the value of a firm industry, with a solid profit history and reasonable expectations of growth. measured as the sum of the values of its 2. The firm should have a relatively low operating units if each were sold separately— of level of debt and a high level of “bankable” many firms is significantly greater than their assets that can be used as loan collateral. combined value. 3. It must have stable and predictable cash flows that are adequate to meet interest and Analyzing and Negotiating Mergers: Merger principal payments on the debt and provide Negotiation Process adequate working capital. Investment bankers are financial An operating unit is a part of a business, intermediaries who, in addition to their role in such as a plant, division, product line, or selling new security issues, can be hired by subsidiary, that contributes to the actual acquirers in mergers to find suitable target operations of the firm. companies and assist in negotiations. A divestiture is the selling of some of a firm’s assets for various strategic reasons. The investment banker is typically Firms divest themselves of operating units by compensated with a fixed fee, a commission tied a variety of methods. to the transaction price, or a combination of fees One involves the sale of a product line to and commissions. another firm. A second method that has become popular involves the sale of the unit to To initiate negotiations, the acquiring firm existing management. This sale is often must make an offer either in cash or based on a achieved through the use of a leveraged stock swap with a specified ratio of exchange. buyout (LBO). The target company then reviews the Sometimes divestiture is achieved offer and, in light of alternative offers, through a spin-off, which is a form of accepts or rejects the terms presented. divestiture in which an operating unit  Normally, it is necessary to resolve takeover defense in which the target firm pays a certain non-financial issues related to the large debt-financed cash dividend, increasing the existing management, product line policies, firm’s financial leverage and thereby deterring financing policies, and the independence of the takeover attempt. the target firm. The key factor, of course, is the per-share Golden parachutes are provisions in price offered in cash or reflected in the ratio of the employment contracts of key executives exchange. that provide them with sizable compensation if When negotiations for an acquisition break the firm is taken over; deters hostile down, tender offers may be used to negotiate a “hostile merger” directly with the firm’s takeovers to the extent that the cash outflows stockholders. required are large enough to make the takeover unattractive. A tender offer is a formal offer to purchase a given number of shares of a firm’s Shark repellents are antitakeover stock at a specified price. The offer is made to all amendments to a corporate charter that the stockholders at a premium above the market constrain the firm’s ability to transfer price. managerial control of the firm as a result of a merger. Occasionally, the acquirer will make a two-tier offer, a tender offer in which the terms offered are more attractive to those who tender shares early. Analyzing and Negotiating Mergers: Holding Takeover defenses are strategies for Companies fighting hostile takeovers. A holding company is a corporation that has A white knight is a takeover defense in voting control of one or more other which the target firm finds an acquirer more to corporations. its liking than the initial hostile acquirer and The holding company may need to own prompts the two to compete to take over the only a small percentage of the outstanding firm. shares to have this voting control. A poison pill is a takeover defense in A holding company that wants to obtain which a firm issues securities that give their voting control of a firm may use direct market holders certain rights that become effective purchases or tender offers to acquire needed when a takeover is attempted; these rights shares. make the target firm less desirable to a hostile The primary advantage of holding acquirer. companies is the leverage effect that permits Greenmail is a takeover defense under the firm to control a large amount of assets which a target firm repurchases, through with a relatively small dollar investment. private negotiation, a large block of stock at a Disadvantages of holding companies include premium from one or more shareholders to end a the increased risk resulting from the leverage hostile takeover attempt by those shareholders. effect, double taxation, and the high cost of administration. Other takeover defenses include: A leveraged recapitalization is a Business Failure Fundamentals: Types of Business Failure Fundamentals: Voluntary Business Failure Settlements A firm may fail because its returns are negative or low. A voluntary settlement is an arrangement A firm that consistently reports between an insolvent or bankrupt firm and its operating losses will probably experience a creditors enabling it to bypass many of the decline in market value. costs involved in legal bankruptcy A second type of failure, insolvency, occurs when a firm is unable to pay its liabilities as they proceedings. come due. When a firm is insolvent, its assets are An extension is an arrangement still greater than its liabilities, but it is whereby the firm’s creditors receive confronted with a liquidity crisis. payment in full, although not immediately. Bankruptcy occurs when the stated value of A composition is a pro rata cash a firm’s liabilities exceeds the fair market settlement of creditor claims by the debtor value of its assets. firm; a uniform percentage of each dollar A bankrupt firm has a negative owed is paid. stockholders’ equity. Creditor control is an arrangement in which the creditor committee replaces the firm’s operating management and operates Business Failure Fundamentals: Major Causes of the firm until all claims have been settled. Business Failure Liquidation can be carried out in two ways— The primary cause of business failure is privately or through the legal procedures mismanagement. provided by bankruptcy law. Overexpansion, poor financial actions, an The objective of the voluntary ineffective sales force, and high the liquidation process is to recover as much per dollar owed as possible. production costs can all singly or in combination cause failure. Assignment is a voluntary liquidation procedure by which a firm’s creditors pass the Economic activity can contribute to the power to liquidate the firm’s assets to an failure of a firm. adjustment bureau, a trade association, If the economy goes into a recession, sales or a third party, which is designated the assignee. may decrease abruptly, leaving the firm with high fixed costs and insufficient revenues to cover them. Rapid rises in interest rates just prior to a recession can further contribute to cash flow problems and make it more difficult for the firm to obtain and maintain needed financing. A final cause of business failure is corporate maturity. Reorganization and Liquidation in Bankruptcy: Reorganization and Liquidation in Reorganization in Bankruptcy (Chapter 11) Bankruptcy: Liquidation in Bankruptcy (Chapter 7) There are two basic types of reorganization petitions— voluntary and involuntary. The liquidation of a bankrupt firm usually Voluntary reorganization is a petition occurs once the bankruptcy court has filed by a failed firm on its own behalf for determined that reorganization is not reorganizing its structure and paying its feasible. creditors. Involuntary reorganization is a petition When a firm is adjudged bankrupt, the initiated by an outside party, usually a creditor, judge may appoint a trustee to perform the for the reorganization and payment of creditors many routine duties required in administering of a failed firm. the bankruptcy. The trustee is given the responsibility to Because reorganization activities are largely in liquidate the firm, keep records, examine the hands of the debtor in possession (DIP), it is creditors’ claims, disburse money, furnish useful to understand the DIP’s responsibilities. information as required, and make final reports The DIP’s first responsibility is the on the liquidation. valuation of the firm to determine whether It is the trustee’s responsibility to reorganization is appropriate. liquidate all the firm’s assets and to distribute Recapitalization is the reorganization the proceeds to the holders of provable claims. procedure under which a failed firm’s debts are generally exchanged for equity or the After the trustee has liquidated all the maturities of existing debts are extended. bankrupt firm’s assets and distributed the Once the revised capital structure has proceeds to satisfy all provable claims in the been determined, the DIP must establish a appropriate order of priority, he or she makes a plan for exchanging outstanding obligations for final accounting to the bankruptcy court and new securities. creditors. Once the debtor in possession has determined the new capital structure and Secured creditors are creditors who have distribution of capital, it will submit the specific assets pledged as collateral and, in reorganization plan and disclosure statement liquidation of the failed firm, receive proceeds to the court as described. from the sale of those assets. Unsecured, or general, creditors are Creditors who have a general claim against all the firm’s assets other than those specifically pledged as collateral