Because learning changes everything.

Corporate Finance
Thirteenth Edition
Stephen A. Ross / Randolph W. Westerfield / Jeffrey F. Jaffe /
Bradford D. Jordan

Chapter 29

Mergers, Acquisitions, and Divestitures

© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
 Key Concepts and Skills
• Be able to define the various terms associated with M&A
activity.
• Understand the various reasons for mergers and whether
or not those reasons are in the best interest of
shareholders.
• Understand the various methods for paying for an
acquisition.
• Understand the various defensive tactics that are available.

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 Chapter Outline
29.1 The Basic Forms of Acquisitions.
29.2 Synergy.
29.3 Sources of Synergy.
29.4 Two Financial Side Effects of Acquisitions.
29.5 A Cost to Stockholders from Reduction in Risk.
29.6 The NPV of a Merger.
29.7 Friendly versus Hostile Takeovers.
29.8 Defensive Tactics.
29.9 Have Mergers Added Value?
29.10 The Tax Forms of Acquisitions.
29.11 Accounting for Acquisitions.
29.12 Going Private and Leveraged Buyouts.
29.13 Divestitures.

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 29.1 The 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.

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 Merger versus Consolidation
Merger
• One firm is acquired by another.
• Acquiring firm retains name and acquired firm ceases to exist.
Consolidation
• Similar to a merger, except an entirely new firm is created from
the combination of existing firms.

Advantage: legally simple.

Disadvantage: must be approved by stockholders of both
firms.

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 Acquisitions
A firm can be acquired by another firm or individual(s) who purchases
voting shares of the firm’s stock.
Tender offer: public offer to buy shares.
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;
complete absorption requires a merger.

Asset acquisition
• Acquire most or all of the assets (not liabilities) of a selling firm.

Classifications
• Horizontal: both firms are in the same industry.
• Vertical: firms are in different stages of the production process.
• Conglomerate: firms are unrelated.

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 Varieties of Takeovers

Access the text alternative for slide images

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 29.2 Synergy
Most acquisitions fail to create value for the acquirer.
The main reason why they do not lies in failures to integrate
two companies after a merger.
• Intellectual capital often walks out the door when acquisitions
are not handled carefully.
• Traditionally, acquisitions deliver value when they allow for scale
economies or market power, better products and services in the
market, or learning from the new firms.

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

Synergy  VAB  (VA  VB )

The synergy of an acquisition can be determined from the

standard discounted cash flow model:

T
CFt
Synergy  
t 1 (1  R ) t

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 29.3 Sources of Synergy
Revenue Enhancement.
Cost Reduction.
• Replacement of ineffective managers.
• Economy of scale or scope.
Tax Gains
• Net operating losses.
• Unused debt capacity.
• Use of surplus funds.
Reduced Capital Requirements.

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 Calculating Value
Avoiding Mistakes.
• Do not ignore market values.
• Estimate only incremental cash flows.
• Use the correct discount rate.
• Do not forget transactions costs.

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 29.4 Two Financial Side Effects of Acquisitions

Earnings Growth
• If there are no synergies or other benefits to the merger, then
the growth in EPS is just an artifact of a larger firm and is not
true growth (that is, an accounting illusion).

Diversification
• Shareholders who wish to diversify can accomplish this at much
lower cost with one phone call to their broker than can
management with a takeover.

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 29.5 A Cost to Stockholders from Reduction in
Risk
The Base Case
• If two all-equity firms merge, there is no transfer of synergies to
bondholders, but if…
Both Firms Have Debt
• The value of the levered shareholder’s call option falls.
How Can Shareholders Reduce their Losses from the
Coinsurance Effect?
• Retire debt premerger and/or increase postmerger debt usage.

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 29.6 The NPV of a Merger
Typically, a firm would use NPV analysis when making
acquisitions.
The analysis is straightforward with a cash offer, but it gets
complicated when the consideration is stock.

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 Cash Acquisition
The NPV of a cash acquisition is
• NPV  (VA  V)  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.

Remember that a zero-NPV investment may also be
desirable.

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 Stock Acquisition
Value of combined firm.
• VAB  VA  VB  V
Cost of acquisition.
• Depends on the number of shares given to the target
stockholders.
• Depends on the price of the combined firm’s stock after the
merger.

Considerations when choosing between cash and stock.

• Sharing gains: target stockholders do not participate in stock price
appreciation with a cash acquisition.
• Taxes: cash acquisitions are generally taxable.
• Control: cash acquisitions do not dilute control.
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 29.7 Friendly versus Hostile Takeovers

In a friendly merger, both companies’ managements are

receptive.
In a hostile merger, the acquiring firm attempts to gain control
of the target without their approval.
• Tender offer.
• Proxy fight.

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 29.8 Defensive Tactics
Corporate charter.
• Classified board (that is, staggered elections).
• Supermajority voting requirement.

Golden parachutes.
Poison pills (share rights plans).
Targeted repurchase (also called “greenmail”).
Standstill agreements.
Leveraged buyouts.

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 More (Colorful) Terms
• Crown jewel: Target sells its most valuable assets
• White knight: 'friendly' individual or company acquires a corporation at fair value
• White squire:A white squire only buys a partial stake, unlike a white knight
• Scorched earth policy: Target does everything in its power to make itself less
attractive
• Shark repellent:special amendments to its charter or bylaws that become active
only when a takeover attempt is announced or presented to shareholders
(staggered boards)
• Bear hug:The acquirer makes a generous offer to acquire the company at a
price that exceeds what other bidders are willing to pay
• Fair price provision: Acquirer must pay a fair price to targeted shareholders.
The formula for determining a fair price may be indicated in the bylaws;
• Dual class capitalization: Dual class capitalization (or dual class stock) refers to
shares of common stock with different voting rights.
• Countertender offer: the target responds to an unfriendly overture by offering to
buy the bidder.

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 29.9 Have Mergers Added Value?
Shareholders of target companies tend to earn excess
returns in a merger:
• Shareholders of target companies gain more in a tender offer
than in a straight merger.
• Target firm managers have a tendency to oppose mergers, thus
driving up the tender price.

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 Have Mergers Added Value?
Shareholders of bidding firms earn a small excess return in a
tender offer, but none in a straight merger:
• Anticipated gains from mergers may not be achieved.
• Bidding firms are generally larger, so it takes a larger dollar gain
to get the same percentage gain.
• Management may not be acting in stockholders’ best interest.
• Takeover market may be competitive.
• Announcement may not contain new information about the
bidding firm.

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 29.10 The Tax Forms of Acquisitions
If it is a taxable acquisition, selling shareholders need to
figure their cost basis and pay taxes on any capital gains.
If it is not a taxable event, shareholders are deemed to have
exchanged their old shares for new ones of equivalent value.

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 29.11 Accounting for Acquisitions
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.”
• Historically, goodwill was amortized. Now it remains on the
books until it is deemed “impaired.”

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 29.12 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 previous
managers into owners.
This reduces the agency costs of equity.

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 29.13 Divestitures
Divestiture: company sells a piece of itself to another
company.
Spin-off: company creates a new company out of a
subsidiary and distributes the shares of the new company to
the parent company’s stockholders.
Equity carve-out: company creates a new company out of a
subsidiary and then sells a minority interest to the public
through an IPO.
Tracking stock: company creates a separate stock to track
the performance of a division.

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 Quick Quiz
What are the different methods for achieving a takeover?
How do we account for acquisitions?
What are some of the reasons cited for mergers? Which of
these may be in stockholders’ best interests and which
generally are not?
What are some of the defensive tactics that firms use to
thwart takeovers?
How can a firm restructure itself? How do these methods
differ in terms of ownership?

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