mergers and acquisitions potashcorp/stakeholder_communications/2010/09/07/774/

1. Chapter 23 mergers and acquisitionshttp://www.potashcorp.com/stakeholder_communications/2010/09/07/774/

2. Definition • The phrase mergers and acquisitions (abbreviated M&A) refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling and combining of different companies that can aid, finance, or help a growing company in a given industry grow rapidly without having to create another business entity.

3. Business valuation The five most common ways to valuate a business are • asset valuation, • historical earnings valuation, • future maintainable earnings valuation, • relative valuation (comparable company & comparable transactions), • discounted cash flow (DCF) valuation

4. Chapter Outline • The Legal Forms of Acquisitions • Accounting for Acquisitions • Gains from Acquisition • The Cost of an Acquisition • Defensive Tactics • Some Evidence on Acquisitions • Divestitures and Restructurings

5. Legal Forms of Acquisitions • Merger or consolidation • Acquisition of stock • Acquisition of assets

6. Merger versus Consolidation • Merger • One firm is acquired by another • Acquiring firm retains name and acquired firm ceases to exist • Consolidation • Entirely new firm is created from combination of existing firms

7. Stock Acquisition (1) • A firm can be acquired by purchasing voting shares of the firm’s stock • Tender offer – public offer to buy shares • Circular bid – takeover bid communicated to shareholders by direct mail • Stock exchange bid – takeover bid communicated to shareholders through a stock exchange

8. Stock Acquisition (2) • 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

9. Acquisition Classifications • Horizontal – both firms are in the same industry • Vertical – firms are different stages of the production process • Conglomerate – firms are unrelated

10. Takeovers • Control of a firm transfers from one group to another • Possible forms • Acquisition • Proxy contest • Going private (LBO vs. MBO)

11. Alternatives to Merger • Strategic alliance = agreement between firms to cooperate in pursuit of a joint goal • Joint venture = an agreement between firms to create a separate, co-owned entity established to pursue a joint goal

12. Accounting for Acquisitions • The Purchase Method • Assets of acquired firm are written up to fair market value • Goodwill is created – difference between purchase price and estimated fair market value of net assets

13. Gains from Acquisition • Synergy • Revenue enhancement • Cost reductions • Tax gains

14. Synergy • The whole is worth more than the sum of the parts • Synergies should create enough benefit to justify the cost

15. Revenue Enhancement • Marketing gains • Advertising • Distribution network • Product mix • Strategic benefits • Market power

16. Cost Reductions • Economies of scale • Ability to produce larger quantities while reducing the average per unit cost • Economies of vertical integration • Coordinate operations more effectively • Reduced search cost for suppliers or customers • Complimentary resources

17. Taxes • Tax losses • Unused debt capacity • Surplus funds • Asset write-ups

18. Reducing Capital Needs • Firms may be able to manage existing assets more effectively under one umbrella • Some assets may be sold if they are not needed in a combined firm

19. Diversification • Diversification, in and of itself, is not a good reason for a merger • Stockholders can diversify their own portfolio cheaper than a firm can diversify by acquisition

20. EPS Growth • Mergers may create the appearance of growth in earnings per share • 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 • In this case, the P/E ratio should fall because the combined market value should not change

21. The Cost of Acquisition: Cash Acquisition • The NPV of a cash acquisition is • NPV = VB* – cash cost • Value of the combined firm is • VAB = VA + (VB* - cash cost)

22. The Cost of Acquisition: Stock Acquisition • Value of combined firm • VAB = VA + VB + V • Cost of acquisition • Depends on the number of shares given to the target stockholders • Depends on the price of the combined firm’s stock after the merger

23. Shares vs. Common Stock • Sharing rights • Taxes • Control

24. Defensive Tactics(1) • Corporate charter • Establishes conditions that allow for a takeover • Supermajority voting requirement • Targeted repurchase (Greenmail) • Standstill agreements • Exclusionary offers • Poison pills • Share rights plans

25. Defensive Tactics (2) • Leveraged buyouts (LBO) • Other defensive tactics • Golden parachutes • Crown jewels • White knight

26. Evidence on Acquisitions • Shareholders of target companies tend to earn excess returns in a merger • Shareholders of target companies gain more in a tender offer than in a straight merger • Target firm managers have a tendency to oppose mergers, thus driving up the tender price

27. More Evidence • Shareholders of bidding firms do not earn much excess return in either a tender offer or a straight merger • Anticipated gains from mergers may not be achieved • Bidding firms are generally larger, so it takes a larger dollar gain to get the same percentage gain • Management may not be acting in stockholders best interest • Takeover market may be competitive • Announcement may not contain new information about the bidding firm

28. Divestitures and Restructurings • Divestiture = sale of assets, operations, or divisions to a third party • Equity carve-out • Spin-off • Split-up