Changing the size of the firm quickly

MERGERS, CORPORATE
RESTRUCTURING, AND
MORE
Overview
 Mergers and acquisitions (M&A)
◦ Takeovers
 Leveraged buy-out
◦ Privatization
 Other forms of corporate restructuring
◦ Divestiture
◦ Holding company
AT&T Breakup Saga
The well-know ones and the trends

RECENT MERGERS
AROUND THE WORK
Sensible Reasons for Mergers
 Economies of scale
◦ A larger firm may be able to reduce its per
unit cost by using excess capacity or
spreading fixed costs across more units.

Reduces costs

$ $ $
Sensible Reasons for Mergers
 Economies of vertical integration
◦ Control over suppliers “may” reduce costs.
◦ Over integration can cause the opposite
effect.
Pre-integration Post-integration
(less efficient) (more efficient)
Company Company
S
S S S
S
S S S
Sensible Reasons for Mergers
 Combining complementary resources
◦ Merging may results in each firm filling in the
“missing pieces” of their firm with pieces
from the other firm.

Firm A

Firm B
Sensible Reasons for Mergers
 Mergers as a use for surplus funds
◦ If your firm is in a mature industry with few, if
any, positive NPV projects available,
acquisition may be the best use of your funds.
Sensible Reasons for Mergers
 Elimination of inefficiencies
◦ Poor management may waste money, make
poor decisions, conduct improper risk/return
investments and harm the value of the
company. Sometimes, the only way to remedy
the situation is to change management.
Sensible Reasons for Mergers
 Industry consolidation
◦ The biggest opportunities to improve
efficiency seem to come in industries with too
many firms and too much capacity. These
conditions often trigger a wave of mergers
and acquisitions, which then force companies
to cut capacity and employment and release
capital for reinvestment elsewhere in the
economy.
Sensible Reasons for Mergers
 Synergy
◦ The primary motivation for most mergers is
to increase the value of the combined
enterprise.
◦ Sources of synergy
 Operating economies, which result from economies
of scale in management, marketing, production, or
distribution.
 Financial economies, including lower transaction
costs and better coverage by security analysts.
Sensible Reasons for Mergers
 Synergy
◦ Sources of synergy
 Tax effects, in which case the combined enterprise
pays less in taxes than the separate firms would pay.
 Differential efficiency, which implies that the
management of one firm is more efficient and that
the weaker firm’s assets will be more productive
after the merger.
Sensible Reasons for Mergers
 Synergy
◦ Sources of synergy
 Increased market power due to reduced
competition. Operating and financial economies are
socially desirable, as are mergers that increase
managerial efficiency, but mergers that reduce
competition are socially undesirable and illegal.
 Bank of America Family Tree

Note: Ironically, MBNA was once owned by a previous version of

Bank of America, which sold it in an IPO.
Dubious Reasons for Mergers
 Diversification
◦ Investors should not pay a premium for
diversification since they can do it themselves.
 Dubious Reasons for Mergers
 The Bootstrap Game
Acquiring firm has high P/E ratio

Selling firm has low P/E ratio (due to low

number of shares)

After merger, acquiring firm has short-

term EPS rise

Long term, acquirer will have slower than

normal EPS growth due to share dilution
 Dubious Reasons for Mergers
 The Bootstrap Game
World Enterprises
World Enterprises (after buying Muck
(before merger) Muck and Slurry and Slurry)
EPS $ 2.00 $ 2.00 $ 2.67
Price per share $ 40.00 $ 20.00 $ 40.00
P/E Ratio 20 10 15
Number of shares 100,000 100,000 150,000
Total earnings $ 200,000 $ 200,000 $ 400,000
Total market value $ 4,000,000 $ 2,000,000 $ 6,000,000
Current earnings
per dollar invested
in stock $ 0.05 $ 0.10 $ 0.067
Dubious Reasons for Mergers
Estimating Merger Gains
 Questions
◦ Is there an overall economic gain to the
merger?
◦ Do the terms of the merger make the
company and its shareholders better off?
PV(AB) > PV(A) + PV(B)
Estimating Merger Gains

Gain  PVAB  (PVA  PVB )  PVAB

Cost  cash paid  PVB

NPV  gain  lost

 PVAB  (cash  PVB )
Estimating Merger Gains
Example – Two firms merge creating $25
million in synergies. If A buys B for $65
million, the cost is $15 million.
PVA  $200
PVB  $50
Gain  PVAB  $25
PVAB  $275 million
Cost  cash paid  PVB
 65  50  $15 million
Estimating Merger Gains
Example – The NPV to A will be the
difference between the gain and the cost.

NPVA  25  15  $10 million

NPVA  wealth with merger - wealth without merger

 (PVAB  cash )  PVA
 (275  65)  200
 $10 million
Estimating Merger Gains
 Economic gain
Economic gain = PV(increased earnings)
new cash flows from synergies
=
discount rate
Accounting for A Merger
Accounting for the merger of A Corp and B Corp
assuming that A Corp pays $18 million for B
Corp.
Initial Balance Sheets

A Corporation B Corporation
NWC 20 30 D NWC 1 0 D
FA 80 70 E FA 9 10 E
100 100 10 10

Balance Sheet of AB corporation

NWC 21 30 D
FA 89 88 E
Goodwill 8
118 118
Tax Considerations
 Taxable acquisition
◦ Payment is made in the form of cash.
◦ The selling stockholders must pay tax on any
capital gains.
◦ The assets of the selling firms are revalued.
 The resulting write-up or write-down is treated as
taxable gain or loss and tax depreciation is
recalculated on the basis of the restated asset
values.
Tax Considerations
 Tax-free acquisition
◦ Payment is made largely in the form of shares.
◦ The selling stockholders view the acquisition
as exchanging their old shares for similar new
ones.
◦ The merged firm is taxed as if the two firms
had always been together.
Tax Considerations
 An Example
◦ In 2005, Captain B purchased a fishing boat
for $300,000 and the boat is depreciated on a
straight-line basis over 20 years.
 Annual depreciation = $300,000/20 = $15,000
◦ In 2015, Captain B was sold to Baycorp for
$330,000.
 The market value of the boat was $280,000.
 Captain B also had $50,000 of marketable securities.
 Tax Considerations

Taxable Merger Tax-free Merger

Capital gain can be deferred

Captain B must recognize a
Impact on Captain B until Captain B sells the
$30000 capital gain.
Baycorp shares.

Boat is revalued at $280000.

Tax depreciation increases to Boat's value remains at
Impact on Baycorp $280000/10=$28000 per year $150000, and tax depreciation
(assuming 10 years of continues at $15000 per year.
remaining life)
Oracle Acquiring PeopleSoft
Takeover Methods
 Tools used to acquire companies

Proxy Tender Offer

Contest

Acquisition Merger

Leveraged Managemen
Buy-Out t Buy-Out
Hostile versus Friendly Takeovers
 Definitions
◦ Acquiring company
 A company that seeks to acquire another firm.
◦ Target company
 The one that acquiring company seeks to purchase.
Hostile versus Friendly Takeovers
 In the vast majority of merger situations
◦ An acquiring company identifies a possible
target.
◦ The acquiring company
 Establish a suitable price, or range of prices.
 Decide on the terms of payment—will it offer cash,
its own common stock, bonds, or some
combination?
 Decide how to approach the target company’s
managers.
Hostile versus Friendly Takeovers
 In the vast majority of merger situations
◦ An agreement is reached.
◦ The two management groups will issue
statements to their stockholders.
◦ The target company’s shareholders vote on
whether to be acquired.
◦ This is a friendly merger!
Hostile versus Friendly Takeovers
 If the target company’s management
resists the merger.
◦ Why would the target company’s managers
resists the merger?
◦ The acquiring firm’s offer is said to be hostile.
◦ The acquiring firm must make a direct appeal
to the target firm’s stockholders.
 Tender offer
◦ The target company’s management team
could defend the takeover.
Takeover Defenses
Takeover Defenses
 White knight
◦ Friendly potential acquirer sought by a target
company threatened by an unwelcome suitor.
 Shark repellent
◦ Amendments to a company charter made to
forestall takeover attempts.
Takeover Defenses
 Poison pill
◦ Measure taken by a target firm to avoid
acquisition; for example, the right for existing
shareholders to buy additional shares at an
attractive price if a bidder acquires a large
holding.
Leveraged Buy-Outs
Leveraged Buy-Outs
 Unique features of LBOs
Large portion of buy-out
financed by debt

Shares of the LBO no

longer trade on the open
market
Leveraged Buy-Outs
 The difference between leveraged
buyouts and ordinary acquisitions
◦ A large fraction of the purchase price is debt
financed.
◦ The LBO goes private, and its share is no
longer trade on the open market.
Leveraged Buy-Outs
 The three main characteristics of LBOs
◦ High debt
◦ Incentives
◦ Private ownership
Leveraged Buy-Outs
 Potential sources of value in LBOs
◦ Junk bond market
◦ Leverage and taxes
◦ Other stakeholders
◦ Leverage and incentives
◦ Leverage restructurings
◦ LBOs and Leverage restructurings
Leveraged Buy-Outs
 Motives for privatization
◦ Increased efficiency
◦ Share ownership
◦ Revenue for the government
Private vs. Public
Divestitures
 Four types of divestitures
◦ Sale to another firm
◦ Spin-off
◦ Carve-out
◦ Liquidation
 The assets of a division are sold off piecemeal to
many purchasers rather than as an single operating
entity to one purchaser.
Holding Companies
 A corporation whose sole purpose is to
own the stocks of other companies.
 Two principal advantages of a holding
company
◦ Control with fractional ownership
◦ Isolation of risks
 The various operating companies in a holding
company system are separate legal entities.
Other Ways To Join Forces
 Alliances allow firms to create
combinations that focus on specific
business lines that offer the most
potential synergies. These alliances take
many forms, from simple marketing
agreements to joint ownership of
worldwide operations.
Other Ways To Join Forces
 Joint venture
◦ Partners agree to form a separate,
independent organization for some business
purpose.
◦ A joint venture is controlled by a management
team consisting of representatives of the two
(or more) parent companies.
Other Ways To Join Forces
 Strategic alliances
◦ Agreements made between entities that have
complementary strengths.
◦ Partners share resources and knowledge in
developing new products or building
production facilities.