Key Concepts in Mergers and Acquisitions

NPV Analysis in Mergers

Typically, a firm uses Net Present Value (NPV) analysis when making acquisitions. The analysis is straightforward with a cash offer, but it becomes more complicated when the consideration is stock.

Friendly vs. Hostile Takeovers

• In a friendly merger, the management of both companies are receptive to the deal.
• In a hostile merger, the acquiring firm attempts to gain control of the target without its management's approval. This can be done through a:
  • Tender offer
  • Proxy fight

Merger and Acquisition Defensive Tactics

Target companies may use several tactics to defend against a hostile takeover:

• Corporate charter amendments:
  • Classified board (i.e., staggered elections for directors)
  • Supermajority voting requirement
• Golden parachutes: Lucrative compensation for executives who lose their jobs as a result of a takeover.
• Targeted repurchase (a.k.a. greenmail): The target buys back its own stock from the acquirer at a premium.
• Standstill agreements: A contract where the bidding firm agrees not to acquire any more stock for a specified period.
• Poison pills (share rights plans): Gives existing shareholders the right to buy more shares at a discount, diluting the ownership of the acquirer.
• Leveraged buyouts (LBOs): Management or another party buys the company, often taking on significant debt.

Do Mergers Actually Add Value?

• Shareholders of target companies tend to earn excess returns in a merger.
  • They gain more in a tender offer than in a straight merger.
  • Target firm managers have a tendency to oppose mergers, which can drive up the tender price.
• Shareholders of bidding firms earn a small excess return in a tender offer, but typically none in a straight merger. This can be due to several factors:
  • Anticipated gains from the merger may not be achieved.
  • Bidding firms are generally larger, so it takes a larger dollar gain to achieve the same percentage gain.
  • Management may not be acting in the stockholders’ best interests.
  • The takeover market may be highly competitive.
  • The announcement may not contain new information about the bidding firm.

Tax Implications of Acquisitions

• In a taxable acquisition, selling shareholders must calculate their cost basis and pay taxes on any capital gains.
• In a non-taxable event, shareholders are deemed to have exchanged their old shares for new ones of equivalent value, deferring any tax liability.

Accounting for Corporate Acquisitions

The 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.”

Going Private and Leveraged Buyouts (LBOs)

A “going private” transaction is when the existing management buys the firm from the public shareholders and takes it private. If this is financed with a significant amount of debt, it is a leveraged buyout (LBO).

• The extra debt provides a tax deduction for the new owners, while simultaneously turning the previous managers into owners.
• This structure reduces the agency costs of equity, as managers now have a direct ownership stake.