M&As (Class4)

 

MERGERS AND ACQUISITIONS • M&As are financial transactions that involve a change in the control of a company:

Control Change

Operation Changes: - New controlling shareholders - New board of directors - New management - New business strategy

• M&As are a conseuence of changing mar!ets and competitive competitiv e environments

 

MERGERS AND ACQUISITIONS • The buyer or acquiror may be: - An operating operating company "the most common# - A group of managers - A group of financial investors - A combination of the three • The seller side may be: - $he board of directors - A controlling shareholder 

 

MERGERS AND ACQUISITIONS • Fiacial !us"i#ica"io: $he acuisition will increase the per-share value of the acuirer over the long term OR

Cash %lows from the transaction  Cost of the Acuisition

• $he seller will be immediately paid for the acuisition's e(pected benefits "if made in cash# OR

• $he seller will reali)e a premium over the trading mar!et stoc! price "if made for stoc!s#

 

MERGERS AND ACQUISITIONS • Geerally Acce$"ed Rules o M%As& *+ ,ure conglomerate conglomerate acuisitions acuisitions do not necessarily necessarily create new shareholder value + Counter cyclical acuisitions acuisitions do do not necessaril necessarily y create value .+ $he mar!et does not reward purely acuisiti acuisition-induced on-induced growth

 

MERGERS AND ACQUISITIONS • Geerally Acce$"ed Rules o M%As& "cont+# /+ 0elated diversification diversification can be an important important means of creating value in acuisitions 1+ Acuisitions Acuisitions can can be an important important means of reachi reaching ng a critical mass2 where si)e is an important industry factor  3+ Acuisitions Acuisitions are are a ta(-effic ta(-efficient ient means of investing investing e(cess corporate funds

 

MERGERS AND ACQUISITIONS • There are "hree di##ere" 'alui( $ar"ies i a acquisi"io&

*+ $he 4uyer

5alue 6 7C% of: - 8ong-term operating business business - $otal or partial liuidation of the business - 9ynergies from the restructuring of both businesses

+ $he 9eller

5alue 6 7C% of the best available alternatives

.+ A ,otential Competing 4uyer 

 

MERGERS AND ACQUISITIONS • )alua"io Techiques& - DCF& $he most fundamental method of measuring value "cash# - Acquisi"io Mul"i$les& 4enchmar! values based on multiples of earnings2 boo! value2 etc+ - *remium o'er Mar+e" Tradi( )alue& ,ercentage premium paid to public shareholders shareholders - ,iquida"io )alue& Amount of cash that could be reali)ed if a company sells all of its assets and pays off its liabilities in the near future - Re$laceme" )alue& Cost of starting up a similar

company from scratch

 

MERGERS AND ACQUISITIONS )alua"io Techiques& DCF • )alua"io - S"e$ ./a valuation of historical and pro;ections of operating characteristics of the company2 specifically: < =nit growth rate of sales < 0ate of price increases < Cost of goods sold as a percentage of sales < 7epreciation as a percentage of net fi(ed assets < of 9elling2 sales general2 and administrative e(penses as a percentage < ffective ta( rate < >or!ing capital reuired as a percentage of sales < Net fi(ed assets reuired as a percentage of sales

 

MERGERS AND ACQUISITIONS )alua"io Techiques& DCF • )alua"io - S"e$ ./b 7efinition of specific economic and industry assumptions: < ?nflation < ?ndustry si)e and unit growth rate < Mar!et share changes within the industry

- S"e$ ./c 7efinition of scenarios by grouping varying sets

of the economic assumptions into: ACC "!#: Optimum 8evel of 7ebt 6 B - 1B debt to total capital

>ACC >A CC "weighted average cost of debt and euity# is defined by: + = +E>? equi"y@  +$>. - "@>? deb"@B 6here&

 +E  +$

6 cost of euity 6 cost of debt "pre-ta(#

"

6 marginal ta( rate

?deb"

6 percentage of debt to total capital ? equi"y 6 percentage of euity to total capital

 

MERGERS AND ACQUISITIONS )alua"io Techiques& DCF • )alua"io - S"e$ 4/ Calculate >ACC "!#:"cont+# Cost of 7ebt >+$@ 6 medium to long-term borrowing rate Cost of uity >+E@ = r #  >r m - r # @E where

 r f  6 long-term ris! free rate  r m 6 long-term return on the mar!et  β 6 systematic ris! factor of the company and its industry  r m - r f  6 long-term real return on the mar!et "usually estimated between . and D+1#

 

MERGERS AND ACQUISITIONS )alua"io Techiques& DCF • )alua"io - S"e$ 5/ 7C% 5alue Calculation 5firm "7C% value# 6 5debt F 5euity

7C% 7C %v val alue ue

6c cash ash flow flow co comp mpon onen entt F tter ermi mina nall co comp mpon onen entt 6 ,5 of unleveraged %C%s for each pro;ection year

"discounted at !# F ,5 of the terminal value of the firm at the end of the pro;ection period "discounted at !#

=nleveraged %C% 6 %C% F "interest e(pense#"* - ta( rate#

 

MERGERS AND ACQUISITIONS • )alua"io Techiques& Acquisi"io Mul"i$les - Eari(s Mul"i$les& =se unleveraged acuisition multiples 6 gross acuisition price G operating earningsE @ross a ac cu uiisition pr price

6 total pr pricedebt pa paidowed ffo or e e by uityacuired Fm ma ar!ecompany tv va alue o off

Operating arnings

6 earnings before interest and ta(es "4?$# 6 preta( earnings F interest e(pense

*ossible Dis"or"ios&  < Non-comparable accounting principles underlying earnings < Amount Amount of debt associated with an acuired company < Cyclicality of earnings

 

MERGERS AND ACQUISITIONS • )alua"io Techiques& Acquisi"io Mul"i$les - Eari(s Mul"i$les& "cont+# E0am$le& *remiums $aid i selec"ed mer(ers i "he commercial c ommercial ba+i( idus"ry

Da"es

Acquiror

Acquiree

3G 3G-/ -/GGH*

>achovia Co Corrp+

9outh Carolina National Corp+G>achovia Corp+

G*1GH* G--GH* DG*-GH* HG*-GH* *BG-DGH* *BG.BGH*

Chemical 4an!ing Corp+ NCN4 Corp+ 4an! America Corp+ %irst America 4an! Corp+ Comeri ca ?nc+ National City Corp+

Manufacturers Kanover Corp+ C&9G9ovran Corp+ 9ecurity ,aci fic Corp+ 9ecurity 4ancorp2 ?nc+ Manufacturers Nati onal Corp+ Merchants National Corp+

*rice $aid as a mul"i$le mul"i$le o# acquiree acqu iree Trasac"io Coo+ Mar+e" )alue )alue Eari(s )alue

I

D.1+BB -*.3+*B /.*3+*B /*DB+.B 1/+BB *BD1+-B 311+/B

*+J

*3+-J

*+J

B+ *+/ * -+D *+. *+H

-B -.+ *3+/ *+D H+*3+

*+*+1 *+1 *+D * *+D

 

MERGERS AND ACQUISITIONS • )alua"io Techiques& Acquisi"io Mul"i$les - oo+ )alue Mul"i$les& =seful ON8L for industries where a company's boo! value plays a role in determining future profitability+ (amples: < ?n rate-of-return regulated industries2 such as telephone2 electric2 and gas utilities2 where the company's future earnings are limited to a defined return on the company's euity mer(er@&  Y  merges  merges into X  to  to form XY  AN7  AN7 at least /B-1B of the consideration paid for Y  consists  consists of euity securities of X  3/ Reor(aia"io >s"oc+ $urchase@&   X  purchases  purchases at least DB of the voting stoc! of Y 2 using only voting stoc! of X  in  in payment

 

MERGERS AND ACQUISITIONS • Fiaci( a Acquisi"io& Ob"aii( Ta0 De#errals

>co"/@

4/ Reor(aia"io >asse" $urchase@&  Y  transfers  transfers all of its assets "with or without liabilities# to X  in  in e(change for voting stoc! of  X  5/ Reor(aia"io >#or6ard "ria(ular mer(er@&   Y  merges  merges in to S "a subsidiary of X # and X  retains  retains *BB ownership of S+ Y’s former shareholders shareholders receive /B to 1B euity securities of X  to  to satisfy the continuity-of-in continuity-of-interest terest

test

 

MERGERS AND ACQUISITIONS • Fiaci( a Acquisi"io& Ob"aii( Ta0 De#errals

>co"/@

:/ Reor(aia"io >re'erse "ria(ular mer(er@&  S merges in to Y  "a  "a subsidiary of X # and X  receives  receives all of the voting securities of Y + Y’s former shareholde shareholders rs receive solely voting stoc! in X  - The most commonly commonly used structures for tax-free acquisitions are (4) (4) and  and (5) (5),, the triangular mergers

 

MERGERS AND ACQUISITIONS • Fiaci( a Acquisi"io& Ob"aii( Ta0 De#errals

>co"/@

ha" ha$$es "o "he selli( shareholders i a "a0 #ree reor(aia"io 

- ?f shareholders shareholders receive euity securities from the acuiror  he maintains a carry over basis in the new security ?f shareholders receive "s#he owes a capital cash or debt gains ta( on his gain - ?f shareholders receive a mi(ture

"s#he may have dividend treatment on the cash portion

Recognition of gain or loss by shareholders will have no imact on the

target comany   

MERGERS AND ACQUISITIONS • Fiaci( a Acquisi"io& Ob"aii( Ta0 De#errals

>co"/@

Subsidiary Di'es"i"ures&  - Section !"" of the #R$ allows a comany to distribute a subsidiary to its stoc%holders in & ways' ./ S$i-o##& the shares in the subsidiary are distributed as

a pro-rata dividend to the company's common stoc!holders 3/ S$li"-o##& one or more stoc!holders of the company e(change their shares for shares in the subsidiary2 on a nonpro rata basis

 

MERGERS AND ACQUISITIONS • Fiaci( a Acquisi"io& Ob"aii( Ta0 De#errals Subsidiary Di'es"i"ures& 

>co"/@

- Section !"" restrictions'

< 4oth2 distributing company and subsidiary must have conducted an active trade or business for 1 years preceding the date of the transaction2 and not have been acuired during that period < $he distribution transaction must transfer at least DB control of the subsidiary from the company to its stoc!holders < $he transaction must be supported by a non ta( corporate business purpose

 

MERGERS AND ACQUISITIONS • Fiaci( a Acquisi"io& Ob"aii( Ta0 De#errals

>co"/@

Subsidiary Di'es"i"ures&  - Section !"" conditions to be used as a tax saving device for divestitures' divestitures'

< $he divesting company cannot arrange to sell the subsidiary to a third party < $he distributing company receives no cash consideration for its euity in the subsidiary and is effectively shrin!ing its capitali)ation

 

MERGERS AND ACQUISITIONS • Fiaci( a Acquisi"io& Accou"i( As$ec"s - $here are two principal methods of accounting accounting for

acuisitions of control of a company: < (ooling )ethod *ccounting' which applies e(clusively to acuisitions using the acuiror's common stoc!s < (urchase )ethod' which applies to all other forms of acuisitions

 

MERGERS AND ACQUISITIONS Accou"i( "i( • Fiaci( a Acquisi"io& Ob"aii( *ooli( Accou *ooli( o# I"eres" Me"hod o# Accou"i(&  - +enefit' %avorable effects on the reported earnings per

share ",9# of an acuiror when the target is being acuired for a high multiple of its earnings - Requirements '

< $he merger must be for common stoc!s of the acuiror  < No subsidiaries < Mutual independence