ISBN: 0-03-028931-9
Chapter 21 Mergers, LBOs, Derivatives, and Holding Companies
This chapter included discussions of mergers, divestitures, holding companies, and LBO's. The key concepts covered are listed below:
A merger occurs when two firms combine to form a single company. The primary motives for mergers are (1) synergy, (2) tax considerations, (3) purchase of assets below their replacement costs, (4) diversification, and (5) gaining control over a larger enterprise.
A synergy exists when the post-merger value of the new firm exceeds the sum of the separate companies' pre-merger values. Synergistic effects in a merger can arise from one of four sources: (1) operating economies – economies of scale in management, marketing, production, or distribution; (2) financial economies – lower transaction costs and better coverage by security analysts; (3) differential efficiency – management of one firm is more efficient and will make better use of the weaker firm's assets after the merger; and (4) increase market power – due to reduced competition.
Mergers can provide economic benefits through economies of scale, and through putting assets in the hands of more efficient managers. However, mergers also have the potential for reducing competition, and for this reason they are carefully regulated by governmental agencies.
In most mergers, one company (the acquiring firm) initiates action to take over another (the target firm).
Breakup value is the value of a firm if its assets are sold off as separate pieces.
A horizontal merger occurs when two firms in the same line of business combine.
A vertical merger combines a firm with one of its customers or suppliers.
A congeneric merger involves firms in related industries, but where no customer-supplier relationship exists.
Horizontal and vertical mergers tend to offer greater synergistic operating benefits, but are also the most likely to be attacked by government regulators for being anti-competitive.
There have been five major "merger waves", the last of which is still ongoing. The first was in the late 1800's and was spear-headed by mergers in the oil, steel, and tobacco industries. In the 1920's, the stock market boom encouraged financial promoters to consolidate firms in a number of industries. In the 1960's, conglomerate mergers were popular. And during the 1980's, LBO firms began using junk bonds to finance all kinds of acquisitions.
In a friendly merger, the managements of both firms approve the merger, whereas in a hostile merger, the target firm's management opposes it.
A tender offer is the offer of one firm to buy the stock of another by going directly to the stockholders, frequently over the opposition of the target company's management.
In a proxy fight, an attempt will be made to gain control of a firm by soliciting stockholders to vote for a new management team.
Beginning in the mid-1960's, corporate raiders began using tender offers as a vehicle for takeovers, rather than proxy fights. The chief advantage to entering a tender offer was that it afforded management less time to mount a defense against the takeover.
A defensive merger involves a firm entering into a merger agreement for the sole purpose of making the firm less vulnerable to possible takeover.
An operating merger is one where the operations of the two firms are combined. A financial merger is one where the firms continue to operate separately, hence no operating economies are expected.
In a merger analysis, the key issues to be resolved are (1) the price to be paid for the target firm and (2) the employment/control situation.
Two methods are commonly used to determine the value of the target firm: (1) the discounted cash flow (DCF) method and (2) the market multiple method.
Acquiring firms in a takeover must be careful as to how it structures its takeover bid, which can be in the form of cash, stock of the acquiring firm, debt of the acquiring firm, or some combination thereof. The structure of a takeover bid affects: (1) the capital structure of the postmerger firm, (2) the tax treatment of both the acquiring and target firms' stockholders, (3) the ability of the target firm's stockholders to benefit from future merger-related gains, and (4) the types of federal and state regulations to which the acquiring firm will be subjected.
The accounting implications of a merger are generally handled in one of two ways: (1) as a pooling of interests or (2) as a purchase. If a merger is handled as a pooling of interests, the balance sheets of the two companies are simply added to one another, and thus creating a consolidated balance sheet. If the merger is treated like a purchase, it shows up on the acquiring firm's financial statements as would any capital asset. If the price paid for the target firm is exactly equal to the net asset value of the firm, the acquiring firm's financial statements will be identical to its financial statements had the merger been treated as a pooling of interests. If the price paid for the target firm exceeds the net asset value, the acquiring firm's assets will be increased to reflect the price actually paid, and vice-versa.
Investment bankers can be involved in mergers in a number of ways: (1) they help arrange mergers, (2) they help target companies develop and implement defensive tactics, (3) they help value target companies, (4) they help finance mergers, and (5) they invest in the stocks of potential merger candidates.
In merger terminology, a white knight is a company that is acceptable to the management of a firm under the threat of a hostile takeover and that will compete with the potential acquirer. A white squire is an individual or company who is friendly to current management and will buy enough of the target firm's shares to block a hostile takeover. A poison pill is an action that will seriously hurt a company if it is acquired by another. Lastly, golden parachutes are large payments made to the managers of a firm if it is acquired.
While most researchers agree that shareholders of target firms enjoy increases in wealth, it is still unclear whether acquiring firms necessarily enjoy that same benefit.
A joint venture is a corporate alliance in which two or more companies combine some of their resources to achieve a specific, limited objective.
A divestiture is the sale of some of a company's operating assets. A divestiture may involve (1) selling an operating unit to another firm, (2) spinning off a unit as a separate company, or (3) the outright liquidation of a unit's assets.
The reasons for a divestiture include to settle antitrust suits, to clarify what a company actually does, to enable management to concentrate on a particular type of activity, and to raise capital needed to strengthen the corporation's core business.
A leveraged buyout is a situation in which a small group of investors borrows heavily to buy all the shares of a company.
A holding company is a corporation that owns sufficient stock in another firm to control it. The holding company is also known as the parent company, and the companies which it controls are called subsidiaries, or operating companies.
Advantages to holding company operations include (1) control can often be obtained for a smaller cash outlay, (2) risks may be segregated, and (3) regulated companies can operate separate subsidiaries for their regulated and unregulated businesses.
Disadvantages to holding company operations include (1) tax penalties and (2) the fact that incomplete ownership, if it exists, can lead to control problems.
A leveraged buyout (LBO) is a transaction in which a firm's publicly owned stock is acquired in a mostly debt-financed tender offer, and a privately owned, highly leveraged firm results. Often, the firm's own management initiates the LBO.
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