Stockholder’s approval needed for both firms
Consolidation – Target firm and acquiring firm combine to become new firm. Stockholder’s approval needed for both firms Tender Offer – Target firm continues to exist as long as there are dissident shareholders. Successful tender becomes merger. No approval needed
Acquisition of assets – Target firm remains a shell company. Its assets are transferred to acquiring firm. Ultimately target firm is liquidated
Buyout – managers and outside investors buyout target firm which continues to exist. Accomplished with a tender offer.
Taking advantage of economies of scale – When one firm can perform a function more efficiently than two. Improving target management – A firm systematically underperforming than industry average. Bad luck, poor investment or operating decisions or pursuing of personal goals by management
Combining complimentary resources – A firm with strong R&D skills can merge with a firm with strong distribution unit
Capturing tax benefits – Acquisition of operating tax losses.
Increase in leverage.
Providing low cost financing to financially constrained target.
Newly formed high growth companies
Increasing product market rents – Two small firms can join to become dominant firm in the market. Subject to security regulations in place.
Cash slag – Firms with surplus cash make acquisition to increase their size.
Diversification – Investors can diversify on their own. Not a very good motive.
Managerial self interest – Empire building, managerial ego, managerial compensation contracts
__________________Acquisition Price of target
__________________Market Price of the target firm
__________________Book Value of Equity of target Firm prior to acquisition
Book value of Equity
Acquire undervalued firms
A capacity to find firms that trade less than their true value
Access to funds that will be needed to complete acquisition
Skill in execution. The stock price of target may go up during acquisition
Operating Synergy –
Economies of scale
Greater pricing power from reduced competition and higher market share
Combination of different functional Strength
Higher growth in new or existing markets
A combination of firms with excess cash or cash slack
Debt capacity can increase reducing cost of debt. Higher leverage effects
Tax benefits – Advantage from tax laws
V(AB) > V(A) +V(B)
V(AB) Value of a firm created by combining A and B
V(A) = Value of firm operating independently
V(B) = Value of firm B, operating independently
Combined firm will become more profitable or grow at a faster rate after the merger. An improvement in firm performance (profitability and growth ) relative to the competitors will prove synergy
Acquiring poorly managed firm and changing the management may add value
The poor performance should be attributable to managerial policies and practices not market conditions
Increased cash flow, increased growth rate, reduce cost of capital.
Current market price should reflect status quo.
Trades at price below the estimated value – undervaluation Diversification – in a business different from the existing Operating Synergy – Cost saving in the same business through economies of scale. Higher growth (open up new markets)
Financial Synergy – Tax Saving, Debt capacity or cash Slack
Control – badly managed
Manager’s interest – Meet CEO’s ego and power needs
Compare premium in similar mergers
Premium is higher for hostile takeovers as compared to friendly mergers (Differences – 30%)
A friendly merger provides benefits such as access to internal records whereas a hostile bid attracts competing bids.
The stock price increases in anticipation of a possible merger. Stock price prior to one month before acquisition can be used as reference.
Value of target after the merger = value of