MERGER & ACQUISITION

Prof. Dr. Sawidji Widoatmodjo, SE, MM, MBA, CGRCOP, CRFM

 OVERVIEW
• Differences between Merges and Acquisitions
• Difference between hostile and friendly taking
over.
• Motives behind M & A
 Definitions
• Merger: One firm absorbs the assets and
liabilities of the other firm in a merger. The
acquiring firm retains its identity. In many cases,
control is shared between the two management
teams. Transactions were generally conducted on
friendly terms.
• Mergers must comply with applicable state laws.
Usually, shareholders must approve the merger by
a vote.
• In a consolidation, an entirely new firm is created.
 Definitions
• Acquisition: Traditionally, the term described a situation
when a larger corporation purchases the assets or stock of a
smaller corporation, while control remained exclusively with
the larger corporation.
• Often a tender offer is made to the target firm (friendly) or
directly to the shareholders (often a hostile takeover).
• Transactions that bypass the management are considered
hostile, as the target firm’s managers are generally opposed
to the deal.
 Merger negotiations

• Friendly Acquisition:
The acquisition of a target company that is willing to be
taken over. Usually, the target will accommodate overtures
and provide access to confidential information to facilitate
the scoping and due diligence processes.
• Hostile Takeover:
A takeover in which the target has no desire to be acquired
and actively rebuffs the acquirer and refuses to provide any
confidential information.
The acquirer usually has already accumulated an interest in
the target (20% of the outstanding shares) and this
preemptive investment indicates the strength of resolve of
the acquirer.
 Some Understandings

• Target: the corporation being purchased, when there is

a clear buyer and seller.
• Bidder: The corporation that makes the purchase,
when there is a clear buyer and seller. Also known as
the acquiring firm.
• Friendly: The transaction takes place with the approval
of each firm’s management
• Hostile: The transaction is not approved by the
management of the target firm.
Types of Mergers

• Horizontal Mergers
- Between competing companies
• Vertical Mergers
- Between buyer-seller relation-ship companies
• Conglomerate Mergers
- Neither competitors nor buyer-seller relationship
 Objective

• 1. Synergy: The most used word in M&A is synergy, which is

the idea that by combining business activities, performance
will increase and costs will decrease. Essentially, a business
will attempt to merge with another business that has
complementary strengths and weaknesses.

• Mv (A) + Mv(B) < Mv(AB)

 Objective
2. Revenue Synergy :
• Market power , larger company will attract more
customers (more brand awareness).
• Complementary products .
• Reduce competion.
 Cost Synergy

• Bulk discounts : be able to attract better prices.

• Market efficiency : one entity doing advertisements instead
of two.
• Reduced fixed overhead costs : overlapping departments
and resources.
 Financial Synergy

• Borrow in Bulk : get better rates (borrowing

interest rates)
• Save in Bulk : get better rates (deposit saving rates)
• Diversification of Risk : more companies in
portfolio, less systemic risk.
• Offsetting tax losses.
 Objective
3. Growth: Mergers can give the acquiring company an
opportunity to grow market share without having to really
earn it by doing the work themselves - instead, they buy a
competitor's business for a price. Usually, these are called
horizontal mergers. For example, a beer company may choose
to buy out a smaller competing brewery, enabling the smaller
company to make more beer and sell more to its brand-loyal
customers.
 Increased
market power
Learning and
Overcoming
developing
entry barriers
new capabilities

Reshaping firm’s Making an Cost of new

Acquisition product
competitive scope
development

Increased Increase speed

diversification Lower risk than to market
developing new
products

Ideal M & A
 Deversification
• “Don’t put all your eggs in one basket.” Current finance
literature seriously questions the merits of this reasoning:
Why does the management know better than the
shareholders how to achieve diversification?
• It is usually the case that shareholders can diversify much
more easily than can a corporation.
• Individuals can easily diversify by buying shares in mutual
funds.
 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

April 2013
 Merger financing
How the Deal is Financed

Cash Transaction
• The receipt of cash for shares by shareholders in the target
company.
Share Transaction
• The offer by an acquiring company of shares or a combination
of cash and shares to the target company’s shareholders.
Going Private Transaction (Issuer bid)
• A special form of acquisition where the purchaser already
owns a majority stake in the target company.

April 2013
 Merger financing
How the Deal is Financed

Leveragedbuyouts (LBO)
In a LBO a buyer uses debt to finance the acquisition
of a company (usually LBOs are a way to take a public
company private, or put a company in the hands of the
current management, MBO).

April 2013
 Corporate restructuring

• Reasons: poor performance of a division, financial

exigency, or a change in the strategic orientation of the
company.
• Different forms of corporate selloffs: disinvestitures,
corporate downsizing (cost and workforce
restructuring), financial restructuring (alternation in the
capital structur of the firm).

April 2013
 Merger Approval
Procedures
• In the United States, each state has a statute that autorizes
merges and acquisitions of corporations.
• Special Committees of the Board of Directors:
The board of directors may choose to form a special
committee of the to evaluate the merger proposal.
• Fairness Options:
It’s common for the board to retain an outside valutation
firm.

April 2013
 Purchase of assets compared
with purchase of stock
• The most common form of merger and acquisition
involves purchasing the stock of the merged or
acquired concern.
• An alternative is to purchase the target company’s
assets.

April 2013
 Assumption of the seller’s
liabilities
• If the acquirer buys all the target’s stock, it
assumes the seller’s liabilities (successor
liability).
• In cases in which a buyer purchases a
substantial portion of the target’s assets, the
courts have ruled that the buyer is responsible
for the seller’s liabilities (de facto merger).

April 2013 Internaitonal Banking / Prof. G.Vento

 Reverse mergers
• A reverse merger is a merger in which a
private company may go public by
merging with an already public company
that often is inactive or a corporate shell.

April 2013 Internaitonal Banking / Prof. G.Vento

 Holding Companies
• The acquiring company may choose to purchase
only a portion of the target’s stock and act as a
holding company, which is a company that owns
sufficient stock to have a controlling interest in the
target.

April 2013
 Advantages of holding
companies
• Lower cost. With a holding company structure, an acquired can attain
control of a target for a much smaller investment than would be
necessary in a 100% stock acquisition.
• No control premium. Because 51% of the shares were not purchased.
• Control with fractional ownership. As noted, working control may
be established with less than 51% of the target company’s shares.
• Approval not required. To the extent that it is allowable under
federal and state laws, a holding company may simply purchase
shares in a target without having to solicit the approval of the target
company’s shareholders.

April 2013
 Disadvantages
• Multiple taxation. The holding company structure adds
another layer to the corporate structure. Normally,
stockholders income is subject to double taxation.
• Antitrust problems. A holding company combination may face
some of the same antitrust concerns with which an outright
acquisition is faced.
• Lack of 100% ownership. Although the fact that a holding
company can be formed without a 100% share purchase may
be a source of cost savings, it leaves the holding company
with other outside shareholders who will have some
controlling influence in the company. This may lead to
disagreements over the direction of the company.
April 2013
 Strategic Alliances
• An alternative to joint venture.
• More flexible concept than joint venture. The added flexibility
allows to the firms to quickly establish links when they are
needed.
• The downside of alliances is the greater potential for
opportunistic behavior by the partners.
• Given the usual loose nature of alliances, there is a tendency to
have posturing by the partners so that they create a need for
each other.

April 2013
 History of Merger Waves
• 1st wave 1895-1905 Horizontal mergers
End with the passage and enforcement of antitrust
legislation.
• 2nd wave 1920-1929 Vertical mergers
Ends with stock market crash.
• 3rd wave 1960-1971 Conglomerate mergers
Ends with recession and oil shocks of early 1970s.
• 4th wave 1982-1989 Hostile takeovers, LBOs, MBOs
Ends with recession of late 1980s
• 5th wave 1993-2000 Stock-based friendly mergers
May have ended with the burst of internet bubble

April 2013
The following data on a merger is given:

Firm A Firm B Firm AB

Price per share $100 $10
Total earnings $500 $300
Shares outstanding 100 40
Total value $10,000 $400 $11,000

Questions
1. Firm A has proposed to acquire Firm B at a price of $20 per share for Firm B's stock. Calculate the NPV
of the merger.
2. What will be the post-merger price per share for Firm A's stock if Firm A pays in cash?
3. Calculate the post merger P/E ratio for Firm A assuming cash is used in the acquisition.

Answer
1. NPV = Gain - cost; (11000-10400) - ((20)(40)-400) = 200
2. P = (10,000+200)/100 = 102
3. EPS = (500+300)/100 = $8.00
4. P/E ratio = 102/8 = 12.75
 Step 1: Calculate the NPV of the Merger

Firm A is proposing to acquire Firm B for $20 per share, with Firm B having 40 shares outstanding.
1. Cost of Acquisition (in cash):
Cost = Price per share × Shares outstanding
= 20×40=800

2. Total Value of Combined Firm AB after the Merger:

Total Value of Firm AB = Value of Firm A + Value of Firm B
=10,000 + 400 =11,000
* After the acquisition, the value of the combined firm will include Firm A’s cash payment to
Firm B’s shareholders, so we’ll subtract this payment from the total value to find the Net
Present Value (NPV) of the merger

3. NPV of the Merger:

NPV = (Value of Firm A + Value of Firm B) − Acquisition Cost
= 11,000 - 800 = 10,200

Therefore, the NPV of the merger for Firm A is 10,200

Step 2: Calculate the Post-Merger Price Per Share for Firm A's Stock
(Cash Payment)
Post-merger, the total number of shares outstanding for Firm A remains the same because Firm A pays in cash. We
can calculate the new price per share by dividing the new total value of Firm AB by the number of Firm A's shares.
1.Total Earnings of the Combined Firm:
Total Earnings = Earnings of Firm A + Earnings of Firm B
=500+300=800

2. Total Number of Shares Outstanding for Firm A (No Change):

Total Shares = Shares of Firm A=100

3. Post-Merger Price per Share:

Step 3: Calculate the Post-Merger P/E Ratio for Firm A