30-0

McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Corporate Finance
Ross Westerfield Jaffe
Sixth Edition
Mergers and Acquisitions
30-1
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Chapter Outline
30.1 The Basic Forms of Acquisitions
30.2 The Tax Forms of Acquisitions
30.4 Determining the Synergy from an Acquisition
30.5 Source of Synergy from Acquisitions
30.6 Calculating the Value of the Firm after an Acquisition
30.8 Two "Bad" Reasons for Mergers
30.10 Defensive Tactics
30.11 Some Evidence on Acquisitions
30.12 Summary and Conclusions
30-2
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Varieties of Takeovers
Takeovers
Acquisition
Proxy Contest
Going Private
(LBO)
Merger
Acquisition of Stock
Acquisition of Assets
30-3
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
30.1 The Basic Forms of Acquisitions
There are three basic legal procedures that one firm
can use to acquire another firm:
Merger
Acquisition of Stock
Acquisition of Assets
.
30-4
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Merger or Consolidation
A merger
refers to the absorption of one firm by another
The acquiring firm retains its
Name
Identity
A consolidation
is the same as a merger
except new firm is created.
30-5
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Advantage and Disadvantage
An advantage of using
a merger to acquire a firm is that it is
legally straightforward
does not cost as much as other forms of acquisition.
A disadvantage is that a merger
must be approved by a vote of the shareholders of each
firm.

30-6
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Acquisition of Stock
A firm can acquire
By another firm by purchasing target firms voting stock
in exchange for cash, shares of stock, or other securities.

Acquisition of Assets
One firm can acquire another by buying all of its
assets.
A formal vote of the shareholders of the selling firm
is required.

30-7
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
A Classification Scheme
Financial analysts typically classify acquisitions
into three types:
Horizontal acquisition: when the acquirer and the target
are in the same industry.

Vertical acquisition: when the acquirer and the target are
at different stages of the production process; example: an
airline company acquiring a travel agency.

Conglomerate acquisition: the acquirer and the target are
not related to each other.
30-8
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Two "Bad" Reasons for Mergers
Earnings Growth
Only 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.

30-9
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Determining the Synergy from an
Acquisition
The concept that the value and performance of two
companies combined will be greater than the sum of
the separate individual parts.

when Synergy exist the following will effect
Cost
Revenue
Taxes
Capital requirement
) ( Synergy
B A AB
V V V
30-10
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Source of Synergy from Acquisitions
Revenue Enhancement
Market Gains
Mergers and acquisitions can produce greater
operating revenues from improved marketing.

Monopoly Power
One firm may acquire another to reduce competition. If so,
prices can be increased and monopoly profits obtained
Cost Reduction
Economies of scale
the average cost of production falls while the level of
production


30-11
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Economies of vertical
Integration
The main purpose of vertical acquisitions
is to make coordination of closely related
operating activities easier
Complementary Resources
Some firms acquire others to make better
use of existing resources
or to provide the missing ingredient for
success.
30-12
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Elimination of Inefficient
Management
There are firms whose value could
be increased
with a change in management
30-13
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Tax Gains
Net Operating Losses

Unused Debt Capacity

Surplus Funds
The Cost of Capital

30-14
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Calculating the Value of the Firm after an
Acquisition
Avoiding Mistakes
Do not Ignore Market Values
Estimate only Incremental Cash Flows
Use the Correct Discount Rate
Dont Forget Transactions Costs
30-15
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Divestitures
Divestiture can take three forms:
Sale of assets: usually for cash
Spinoff: parent company distributes shares of a
subsidiary to shareholders
Issuance if tracking stock: a class of common stock
whose value is connected to the performance of a
particular segment of the parent company.
30-16
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
The Corporate Charter
If one individual or group owns 51-percent of a companys
stock, this control block makes a hostile takeover virtually
impossible.
30-17
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Repurchase Standstill Agreements
Standstill agreements are contracts where the bidding
firm agrees to limit its holdings of another firm.
30-18
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Going Private and LBOs
If the existing management buys the firm from the
shareholders and takes it private.
30-19
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Other Defensive Devices
Golden parachutes are compensation to outgoing
target firm management.
Crown jewels are the major assets of the target. If
the target firm management is desperate enough,
they will sell off the crown jewels.
White Knight is a friendly bidder who promises to
maintain the jobs of existing management.
Poison pills are measures of true desperation to
make the firm unattractive to bidders. They reduce
shareholder wealth.

30-20
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
30.11 Some Evidence on Acquisitions: Stock Price
Changes in Successful U.S. Corporate Takeovers
Takeover Successful
Technique Targets Bidder

Tender offer 30% 4%
Merger 20% 0%
Proxy contest 8% NA
30-21
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Abnormal Returns in Successful Canadian
Mergers

Target Bidder
Mergers 1964--83 9% 3%
Going private
Transactions 1977--89 25% NA
- Minority buyouts 27% NA
- Non-controlling bidder 24% NA
30-22
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Comparison of U.S. vs. Canadian
Mergers
The evidence both in U.S. and Canada strongly
suggests that shareholders of successful target firms
achieve substantial gains from takeovers.
Shareholders of bidding firms earn significantly less
from takeovers. The balance is more even for
Canadian mergers than for U.S. ones.
The reasons may be:
There is less competition among bidders in Canada.
The Canadian capital market is smaller.
There are federal government agencies to review foreign
investments.


30-23
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
30.12 Summary and Conclusions
The three legal forms of acquisition are
1. Merger and consolidation
2. Acquisition of stock
3. Acquisition of assets
M&A requires an understanding of complicated
tax and accounting rules.
The synergy from a merger is the value of the
combined firm less the value of the two firms as
separate entities.
) ( Synergy
B A AB
V V V
30-24
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
Summary and Conclusions
The possible synergies of an acquisition come
from the following:
Revenue enhancement
Cost reduction
Lower taxes
Lower cost of capital
The reduction in risk may actually help existing
bondholders at the expense of shareholders.