AE 321

COURSE LEARNING OUTCOMES

At the end of the module, you should be
able to:
1. Explain mergers and acquisitions
including the process, advantages,
disadvantages, factors to consider
and types.
2. Recommend strategies to prevent
hostile takeovers.

AE 321
MODULE 5
MERGERS
& ACQUISITIONS

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 Mergers and Acquisition
Mergers and acquisitions are terms used in the combination or consolidation of two companies
under specific circumstances. Although often used interchangeably, there are slight differences
between the two terms.
• MERGER – A merger is the combination of two firms into one new entity, with the acquirer
assuming the assets and liabilities of the target firm. The two companies involved in a
merger are generally of the same size.
• ACQUISITION – An acquisition is the takeover of a firm by purchase of another company’s
common stock or assets. The acquirer is regarded as a larger company which absorbs the
smaller company.

A. Rationale for Mergers and Acquisitions

1. Stronger Market Power
• Market power is the capability of the firm to influence prices of its products or
services in the overall market. Mergers and acquisitions may provide control over
a firm’s supply chain and even competitors, thus resulting to a stronger market
power.
2. Diversification
• Another common reason for mergers is diversification. Diversification may reduce
market risk by stabilizing a company’s earnings. This is especially true for
companies in cyclical industries.
3. Higher Growth
• Mergers and acquisitions result to faster growth. With two companies plowing in
revenues from their previous market bases, higher revenues are surely expected.
Technological know-how and other up-to-date capabilities is another aspect of
growth that can be achieved faster in acquiring or merging with another
company.
4. Tax Consideration
• A more uncommon reason for mergers and acquisitions is the “tax benefit” of
acquiring a firm with accumulated tax losses to offset against a firm’s high tax
bracket.
5. Synergy
• The main reason for mergers and acquisitions is creating synergies. A synergy is
created when the combined value of the two companies involved is greater
than the sum of the values of each company taken separately. Literally, it is
the embodiment of 1+1 = 3. Synergy can be:
• Operating
- Can create strategic advantages that result in higher returns on investment
and the ability to make more investments and more sustainable excess returns
over time.
• These often results from vertical mergers and acquisitions – when entities
along a supply chain are merged.

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 • Functional integration may also create strategic advantages by making
the most out of the individual entity’s strengths in marketing, human
resources, operations and other functions of the business.
- Can also result in economies of scale, allowing the acquiring company to save
costs in current operations, whether it be through bulk trade discounts from
increased buyer power, or cost savings by eliminating redundant business lines.
• These can often be seen from horizontal mergers and acquisitions– when
entities in similar markets combine.
• Financial
- creates tax benefits, increased debt capacity and diversification
benefits.
- In terms of tax benefits, an acquirer may enjoy lower taxes on earnings
due to higher depreciation claims or combined operating loss
carryforwards.
- A larger company may be able to incur more debt, reducing its overall
cost of capital.
- Diversification may reduce the cost of equity, especially if the target is a
private or closely held firm.

B. Potential Drawbacks of Mergers and Acquisitions

1. Increased prices of products or services
• A merger results in reduced competition and a larger market share. Thus, the
new company can gain a monopoly and increase the prices of its products
or services. This may result to lower customer goodwill.
2. Communication and cultural gap
• The companies that have agreed to merge may have different cultures. It
may result in a gap in communication and affect the performance of the
employees.
3. Unemployment
• In an aggressive merger, a company may opt to eliminate the
underperforming assets of the other company. It may result in employees
losing their jobs.
4. Prevents economies of scale of unrelated entities
• In cases where there is little in common between the companies, it may be
difficult to gain synergies. Also, a bigger company may be unable to motivate
employees and achieve the same degree of control. Thus, the new company
may not be able to achieve economies of scale.

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 C. Factors to Consider in Merger and Acquisition Decisions
The goal of firm growth including mergers and acquisitions is increasing shareholder wealth.
Achieving the desired ROI of shareholders is paramount in the selection of target firms. With this
in mind, screening targets for acquisitions must be in line with the firm’s strategic objectives. A
clear rationale for a merger or acquisition is integral in identifying potential targets. Selection
criteria may include but is not limited to the following:
• Size and profitability • Type of product or service
• Industry position • Customer segmentation
• Market share • Synergies
• Geography and region

D. Types of Mergers and Acquisitions According to Purpose

1. Horizontal
• combines businesses which sell same products to the same market. The primary
purpose is to combine the market shares between the competing businesses.
Added benefits include reduced costs in operations administration and fixed
overhead.
o Example: low-end phones producer and another low-end phone
producer
2. Vertical
• combines business which belong to the same supply chain. The primary purposes
are (1) to lower input costs or improve gross profits and/or (2) to improve control
over the manufacturing process (usually through improved supply-demand
forecasting).
o Example: low-end phone producer and electrical part manufacturer
3. Product- extension
• combines businesses that sell different but related products to the same market
o Example: low-end phone producer and low-end earphone producer
4. Market-extension
• combines businesses that sell similar products to different markets
o Example: low-end phone producer and high-end phone producer
5. Congeneric
• combines business which sell somewhat related products to not- clearly
separated markets.
o Example: low-end phone producer and sim cards manufacturer
6. Conglomerate
• combines businesses which belong to unrelated industries. This type of merger
diversifies the acquirer's operations.
o Example: low-end phone producer and restaurant business

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 E. Types of Mergers and Acquisitions According to Approach Towards
the Acquiree
1. Friendly
• These is amicable discussion and agreement between the acquirer and the
acquired-to-be. The process commonly includes a proposal of the acquirer and
the board and management of the acquired-to-be.
2. Hostile
• There is no or little attempt to communicate and discuss with the acquired
business entity to the acquisition. Oftentimes, the transaction would come as a
surprise to the shareholder, board, and/or management.
• Kinds of Hostile Takeovers:
a. One-time Tender Offer – the acquirer makes a public offer at a fixed price to
acquire a large number of shares.
b. Creeping Tender Offer and/or Step Acquisition - the acquirer makes a public
offer at a fixed price to acquire a large number of shares multiple times over
a period to eventually reach majority stake in the to-be-acquired
corporation.
c. Premium Raid – a type of tender offer wherein the acquirer makes a public
offer at a significantly higher price to acquire a large number of shares.
d. Dawn Raid – a type of tender offer wherein the acquirer suddenly makes a
public offer at a fixed price to acquire a large number of shares.
e. Proxy Fight – persuasion of a majority of shareholders to replace the board of
directors with a new set that would approve the takeover.

F. Financing Modes
1. Cash Purchase – The acquiring firm simply pays the existing shareholders cash in
exchange for the shares of the target company.
2. Equity Swap – One of the most commonly used method for mergers and acquisitions.
Shareholders of the target company are given shares of the acquiring company.
3. Combination of Cash and Equity

G. Anti-Hostile Takeover Strategies

Not all corporations want to be acquired by another entity. The following can be done
depending on the circumstances of the to-be-acquired business to fight off a potential merger
or acquisition.

1. Staggered Board of Directors – The positions in the board of directors are not filed at the
same time. Only a fraction (usually a third) of the members of the board of directors are
elected each year. Should the bidding company win in the recent election, they would
still not have majority votes to acquire the target firm.
2. Supermajority Provisions – requires shareholder approval of a number of votes which is
more than what is legally for all transactions involving change of control, mergers and
takeovers.
3. Back-end Plans – The target company provides existing shareholders, with the exception
of the company attempting the takeover, with the ability to exchange existing securities

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 for cash or other securities valued at a price determined by the company’s board of
directors.
4. Share Buyback – Shares are bought out by the target firm from the market in order to
reduce the number of shares that are on the market and can be bought by the
acquiring firm.
5. Greenmail/ Target Repurchase – Shares are repurchased by the target firm away from
the bidder or acquiring firm at a higher price which makes the bidder happy to leave
the target alone.
6. Standstill Agreement – A contract that contains provisions that restricts how a bidder of
a company can purchase or dispose stocks of the target company. A standstill
agreement can effectively stall or stop the process of a hostile takeover if the parties
cannot negotiate a friendly deal.
7. People Pill – threatens the acquiring firm that the acquiree management will quit en
masse in the event of a successful hostile takeover.
8. Poison Pill or Shareholder Rights Plan – gives a prospective acquiree’s shareholders the
right to buy shares of the firm bought by anyone at a deep discount.
9. Suicide Pill/ Jonestown Defense – extreme poison pill that may lead to the bankruptcy of
the target corporation.
10. Pacman Defense – the target firm also attempts to take over the acquiring firm.
11. Macaroni Defense – allows the acquiree to issue a large number of bonds that must be
redeemed at a higher value if the company is taken over. It suddenly expands or
increases the cost of a hostile takeover.
12. Nancy Reagan Defense – When the acquiring firm makes a formal bid to the
shareholders to buy their shares, the board of directors of the target firm simply denies or
“just says no” to the bid.
13. Silver and Golden Parachutes – allows the all employees (silver) or top management
(golden) a large lump-sum cash compensation in the event that they are eliminated
from their positions as a decision by the acquirer.
14. Pension Parachutes – allows the cash in the pension fund of the acquiree firm to be
solely used for the pension plan participants. The fund remains to be the property of the
plan’s participants, e.g., the original employees.
15. Whitemail – The target company sells significantly discounted stocks to a friendly third
party.
16. White Squire – A friendly company buys a stake in a target company to prevent a hostile
takeover.
17. White Knight – A friendly company buys a significant number of shares to prevent a
hostile takeover while allowing it to have control over the target firm
*Black knight – the unfriendly company or acquiring firm
*Gray knight – a second unsolicited acquiring firm
*Yellow knight – an unfriendly company which has backed out from its plans on
acquiring a firm but instead offers to have a merger of equals.
18. Crown Jewel – The target company sells some of its most valuable assets to a third party
to reduce the value of the company.
19. Scorched Earth – The target company seeks to make itself less attractive to hostile
bidders (sell valuable assets, increase debt, etc.).

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 20. Killer Bees – The target company employs several experts (investment bankers,
accountants, attorneys, tax, specialists) who can provide various anti-takeover
strategies.
21. Lobster Traps – The target firm includes a provision that prevents individuals with more
than 10% ownership of convertible securities from transferring these securities to voting
shares.

H. Regulatory Framework and Processes

Mergers and acquisitions are covered under the Corporation Code of the Philippines and the
Philippine Competition Act. The Corporation Code identifies the process upon which a merger
or a consolidation will arise. It defines a merger as two or more corporations combining into one
of the constituent corporations and a consolidation as two or more corporations combining to
become a new single corporation. Sec 20 – 21 of the Philippine Competition Act relate to the
mergers and acquisitions. Prohibited therein are mergers and acquisitions that substantially
prevent, restrict or lessen competition.

A plan for merger or consolidation must be put forward and approved by the board of
directors or trustees of the corporations. This is subject to the approval of at least 2/3 of the
outstanding capital stock of each corporation for stock corporations or 2/3 of members for
non-stock corporations. A notice for the plan of merger or consolidation should be submitted to
the Philippine Competition Commission for review. After which, the articles of merger or
consolidation is submitted to the Securities and Exchange Commission which shall issue a
certificate of merger or consolidation.

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means, electronic, mechanical, photocopying, recording, or otherwise of any part of this document, without the prior written permission of SLU, is strictly prohibited. 7