Chapter 9 : Mergers and Acquisitions
“Purchase by a company of a controlling interest in the voting share capital of another company”
“Merger is a business combination that results in the creation of a new reporting entity formed from the combining parties”
(Mutual sharing of risks and benefits)
Reasons for Mergers/Take Overs:
1. Synergy (1+1=11)
2. Eliminating competition
3. Entry in new market
4. Spread risk (diversification)
5. Acquisition is cheaper than internal expansion
6. Assets backing
7. Management acquisition
8. Operating economies (by eliminating duplicate and competing facilities)
9. Improvement of liquidity and finance-raising ability
Deciding factors in a takeover decision:
a. Earning basis
b. Assets basis
c. Prospects for sale and growth basis
d. Saving brought and additional expenditure basis
3. Will it be desirable for shareholders and stock market
4. What will be form of purchase consideration
a. Cash (borrowed)
b. Equity shares
d. Convertible Loan Stock
5. How takeover would be reflected in published accounts
Risks for shareholders of acquiring company in takeover:
1. Decrease in EPS of own company
2. Decrease in Share Price of own company
3. Decrease in Assets backing per share (decrease in net assets)
4. Entry in risky industry
When takeover resisted by Target Company:
Unwilling to sell
Unattractive after tax value
Terms are poor
Opposed by employees
Founder appeals loyalty of shareholders
Counter steps by Target Company:
1. Issuing a forecast of attractive future profits and dividends.
2. Launching advertising campaign against the takeover bid.
3. Finding a “White Knight”, i.e. a company which will make a welcome takeover bid.
4. Making a counter bid for the predator company.
5. Arranging a management buyout
6. Introducing a “Poison-Pill” , i.e. anti takeover advice
Tactics by Acquiring company:
Persuading dissatisfied shareholders
High prices Payment Methods
- Cash Purchase
- Share exchange
- Use of convertible loan stock
- Earn out arrangements
Methods are affected by
- Availability of cash
- Desired level of gearing
- Changes in control
- Changes in structure
Choice of Cash or Paper offer or Both for payment depends on view of parties:
Acquiring company and its shareholders:
If purchase consideration is in equity shares, EPS might fall.
If purchase consideration is in debentures (or cash borrowed elsewhere), it will be cheaper because Interest will be
allowable for tax purposes and earnings will not be diluted.
Issue of additional loan stock will be unacceptable for parties if company is highly geared.
Issuance of large new shares will significantly change controlling structure.
Payment in shares preserves cash available.
Company might have to increase authorized share capital or borrowing limits.
If Cash is received, tax on capital gain will become payable immediately.
If other consideration is received, it is to be ensured that
o Existing income is at least maintained, and
o Shares retain their value.
If shareholders want to have stake in business, they will prefer shares.
Mezzanine Finance: (by biding company; to pay for shares)
Lies between equity and debt finance.
It is short to medium term, unsecured, high rate of return loan
It has option to exchange loan for share after takeover.
It is also used in MBO.
When consideration is payable upon the target company reaching certain performance targets.
EPS before and after a takeover:
Share purchased at higher P/E ratio will give fall in EPS, and vice versa.
Company may accept dilution of earnings on acquisition if:
There is increase in net assets backing.(from a company having more assets and less earnings)
Quality of earnings is superior.
Post acquisition integration: (Drucker’s 5 golden rules)
1. There must be common core of unity.
2. Acquirer must ask, “What is in for us” and “ What we can offer”
3. Acquirer must treat product, market and customers of acquired company with respect.
4. Acquirer must provide top management with relevant skills within one year