Chapter 11&12

•Mergers and Acquisitions

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
 Content
Mergers and Acquisitions I
•Forms of Takeovers
•Means of Acquisition
•Types of Acquisitions
•Accounting Treatment of Merger and Acquisition
Mergers and Acquisitions II
•NPV of a merger - cash or shares
•Defensive Tactics

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 Key Concepts and Skills
• Be able to define the various terms
associated with M&A activity
• Understand the various reasons for
mergers and whether or not those reasons
are in the best interest of shareholders
• Understand the various methods for a
paying for an acquisition
• Understand the various defensive tactics
that are available
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 Merger versus Consolidation
• Merger
• One firm is acquired by another
• Acquiring firm retains name and acquired firm stop
to exist (i.e. Firm A + Firm B)
• Advantage – legally simple
• Disadvantage – must be approved by stockholders
of both firms
• Consolidation
• Entirely new firm is created from combination of
existing firms.(i.e. Firm A + Firm B = Firm C)
• The individual firms totally cease to exist under their
original names and simply become one entity.
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 Acquisitions
• A firm can be acquired by another firm or individual(s) by
purchase the assets of another firm or purchasing (use
cash) voting shares of the firm’s stock or exchange stock
or combination of cash and stock.
• More to friendly takeover with mutual agreement and
permission.
• Stock acquisition
• Tender offer – public offer to buy shares at a premium over the
current market price.
• 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
• Asset acquisition-buying most or all of its assets, the company not
necessarily will stops to exist, it just sold off its asset. 25-5
 Classifications

• Horizontal – both firms are in the same

industry. The target firm may thus a competitor
selling similar products or services.
• Vertical – firms are in different stages of the
production process. Example a restaurant
acquiring a chicken farm.
• Conglomerate – firms are unrelated.
Combination of two or more firms which have
nothing in common. Example, a pet shop may
acquire a book store.

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 Takeovers
• Control of a firm transfers from one group to another. Unfriendly
takeover without mutual agreement and
permission(unwillingness).
• Possible forms:
• Acquisition
• Merger or consolidation
• Acquisition of stock
• Acquisition of assets
• Proxy contest-an attempt to gain control of a firm by soliciting a
sufficient number of stockholder votes to replace existing
management.
• Going private-i) LBOs (some of a small group of outside investors
and management buy a share of public firm at open market by
using huge leverage/debt financing) or ii) MBOs(management
heavily involve to buy share).
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 Accounting Treatment of Merger and
Acquisition
• Taxes and Acquisitions
-If one firm buys another firm, the transaction may be
taxable or tax-free.
-In taxable acquisition, the shareholders of the target
firm are considered to have sold their shares, and
they will have capital gains or losses that will be
taxed.
-In a tax-free acquisition, the acquisition is
considered an exchange instead of a sale, so no
capital gain or loss occurs at the time of the
transaction.
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Advantages and Disadvantages
of M & A
• Advantages:
1)Faster Expansion
2)Reduced Cost
3)Acquiring intangible assets
4)Easier expansion to foreign markets
5)Tax benefits
6)Gearing benefit

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Advantages and Disadvantages
of M & A
• Disadvantages
1)Organisational Cultural misfit
2) Exposure to risk
3) Lack of managerial competence

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 Synergy
• The acquisition will be beneficial if the
combined firm will have greater value than
the sum of the values of separate firms.
VAB > VA + VB
Where; VAB is value of the merged firm,
VA is value of firm A: MPS(Firm A) x NOS(Firm A)
VB is value of firm B

• Δ V = VAB – (VA+ VB)

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 Merger Premium
• The premium is defined as the sum paid to the target firm B
over and above what it is worth before the merger (VB)
• Merger Premium (in RM) = Amount paid to B – VB
• Merger Premium (in %) = Amount paid to B – VB X 100
VB

• Merger Premium Per Share = Amount paid to B – VB

NOS Firm B
Or Amount paid to B - MPs of Firm B
NOS Firm B
*Amount paid to B = Cost of the merger (for cash acquisition only)
* Use value of shares or Worth of shares to replace “Amount paid to B” if
stock acquisition.
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 Cash Acquisition
• Value of the combined firm is
• VAB = VA + (VB* - cash cost)

• New MPs per share = …… VAB………………

NOS Firm A

• V B* = VB + Δ V ; where V B* is value of Firm B to Firm A

• The NPV of a cash acquisition is

• NPV = VB* – cash cost
• Remember that a zero-NPV investment is also desirable
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 Stock Acquisition
• Value of combined firm
• VAB = VA + VB + V

• New MPs = ……………………. VAB………………………

per share NOS Firm A + Additional shares
 Additional shares = Value of shares / MPs of Firm A
OR Exchange ratio x no. of share of Firm B

• V B* = VB + Δ V ; where V B* is value of Firm B to Firm A

• The NPV of a stock acquisition is

• NPV = VB* – True cost (New MPs x additional shares)
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 Tutorial & Homework
• APRIL 2008 (Q7) – EXAMPLE
• APRIL 2010 (Q7) – EXAMPLE
• DEC 2019 FIN544 Q5 (a)
• DEC 2019 FIN538 Q5 (a)
• JUN 2019 FIN544 Q5 (a)
• DEC 2018 FIN544 Q5(a)

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 Tutorial & Homework
• JAN 2012 (Q6)
• OCT 2010 (Q6)
• OCT 2008 Q7 (a)

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 APRIL 2008 (Q7) – EXAMPLE
i) Merger premium = RM25, 000 – RM22
per share 1000 shares
= RM3
ii) VAB (Cash) = (RM31,500 + RM22,000 + RM4,000)-
RM25,000
= RM32,500
New MPs = RM32,500/1,500 shares
= RM21.67

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 APRIL 2008 (Q7) – EXAMPLE
VAB (Stock) = RM31,500 + RM22,000 + RM4,000
= RM57,500
New MPs = RM57,500/1,500 shares + 1,190.47 shares
= RM21.37
Additional shares = RM25,000/RM21
= 1,190.47 shares

Therefore, cash basis is better because higher in MPs.

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 APRIL 2008 (Q7) – EXAMPLE
NPV(Cash) = (RM22,000 + RM4,000) - RM25,000
= RM1,000

NPV(Stock) = (RM22,000 + RM4,000) – (RM25,440.34)

= RM1,000
True cost = 1,190.47 shares x RM21.37
= RM25,440.34

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 APRIL 2010 (Q7)- EXAMPLE
a) New EPS = Net Income A + Net Income B
No.of share A + Additional
shares
EPS Firm A = Net Income A
No.share Firm A
RM2 = Net Income A
No.share Firm A

No.share Firm A = Market Value of Firm A

Market Price per share*
*substitute with par value price since IPO 25-20
 APRIL 2010 (Q7)- EXAMPLE
No.share Firm A = RM3,000,000
RM1
= 3,000,000 units
Therefore, Net Income A = 3, 000, 000 units x RM2
=RM6,000,000

EPS Firm B = Net Income B

No.share Firm B
RM2 = Net Income B
No.share Firm B

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 APRIL 2010 (Q7)- EXAMPLE
No.share Firm B = Market Value of Firm B
Market Price per share*
*substitute with par value price since IPO

No.share Firm B = RM2,000,000

RM1
= 2,000,000 units
Therefore, Net Income B = 2, 000, 000 units x RM2
=RM4,000,000

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 APRIL 2010 (Q7)- EXAMPLE
a) New EPS = RM6,000,000+ RM4,000,000
3,000,000 + RM7,000,000/RM5
=RM2.27
b) i) Merger Premium = RM7,000,000 -RM3
per share 2,000,000 units
= RM0.50
Merger Premium =RM7,000,000 - (RM3 x 2,000,000 units)
=RM1,000,000
ii) New MPs = RM15,000,000 + RM6,000,000 + RM2,000,000
per share 3,000,000 + RM7,000,000/RM5
=RM5.23
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 Defensive Tactics
• Corporate charter- Government establishes conditions that allow for a
takeover. But the firm will frequently amend this condition by make
acquisition more difficult. Example: Usually two-thirds (67%) of
shareholders are be needed to approve the merger, but the firm amends it
to 80%.Therefore, it will discourage takeover due to supermajority voting
requirement.
• Targeted repurchase aka greenmail -payment made to the bidder to
eliminate unfriendly takeover.
• Standstill agreements-make an agreement contract where the bidding
firm agree to limit its holding in target firm. It will end takeover attempt.
• Poison pills (share rights plans)-Poison pill is a financial device
designed to make unfriendly takeover never happen. The share rights
plan is allowing the existing shareholders to buy a stock at fixed price if
outside takeover bid come up, it will discourage takeover attempt.

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 More (Colorful) Terms
• Golden parachute-some compensation is made for the top-level
management if takeover occurs. These executives will have to be paid
very huge compensations.
• Poison put-variation of poison pill. It will forces the firm to buy back the
securities at a set price.
• Crown jewel-firm will treat to sell a major asset if takeover occur.
• White knight-firm facing an unfriendly merger offer might arrange to be
acquired by friendly merger offer(rescue by white knight)
• Lockup-offer by target firm to friendly firm (white knight) to purchase
stock or some of major asset(crown jewel) at a fixed price in the event
of unfriendly takeover.
• Shark repellent-any tactic designed to discourage unfriendly merger
offer.
• Bear hug-is an unfriendly takeover offer designed to be so attractive so
that the target firm’s management has little choice but need to accept it.
• Counter tender offer (Pac Man defense)-the target firm responds to an
unfriendly takeover/offer by offering to buy the bidder.
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Chapter 11&12

•End of Chapter

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.