Mergers and Acquisitions: Forms, Synergy, and Financial Effects

CHAPTER 9: MERGERS AND ACQUISITIONS

1. The Basic Forms of Acquisitions

• Merger or Consolidation
• Acquisition of Stock
• Acquisition of Assets

Merger vs. Consolidation

Merger

• One firm is acquired by another
• Acquiring firm retains name and acquired firm ceases to exist
• Advantage – legally simple
• Disadvantage – must be approved by stockholders of both firms

Consolidation

• Entirely new firm is created from combination of existing firms

Acquisition

A firm can be acquired by another firm or individual(s) purchasing 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
• Classifications
  • 1. Horizontal – both firms are in the same industry
  • 2. Vertical – firms are in different stages of the production process
  • 3. Conglomerate – firms are unrelated

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.

Sources of Synergy

• Revenue Enhancement
• Cost Reduction
  • Replacement of ineffective managers
  • Economy of scale or scope
• Tax Gains
  • Net operating losses
  • Unused debt capacity
• Incremental new investment required in working capital and fixed assets

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 (i.e., 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.
• Cost to stakeholders to reduce 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.
• So, How Can Shareholders Reduce their Losses from the Coinsurance Effect?
  • Retire debt pre-merger and/or increase post-merger debt usage.