Corporate Finance
AF4801
12/13/2022 Syed Muhammad Ali Raza
Mergers & Acquisitions
The term merger & acquisitions or M&A for short generally refers to two businesses combining in some manner. A
casual reading of the headlines indicates mergers and acquisitions take a variety of forms (friendly or hostile) but
almost always someone is left unhappy (usually the managers that are removed or workers that are laid off).
Although M&A is often used as a generic term that refers to any business combination, we can differentiate between
mergers & acquisitions.
An Acquisition transaction may involve the purchase of an asset or a distinct business segment from another company.
If the acquirer absorbs the entire target company, the transaction is considered a merger. Once a merger is completed
only one company remains and the other is cease to exist.
Whether a transaction is a merger or an acquisition, the initiator of the venture is called the bidder or acquirer, while
the opposite side of the transaction is called the target.
12/13/2022 Syed Muhammad Ali Raza
Mergers & Acquisitions
Forms of Integration:
• Statuary Merger
• Subsidiary Merger
• Consolidation
Types of Merger:
• Horizontal Merger
• Vertical Merger (forward integration, backward integration)
• Conglomerate merger
12/13/2022 Syed Muhammad Ali Raza
Mergers & Acquisitions
Common Motivation behind M&A activities:
• Synergies
• Achieving more rapid growth
• Increased market power
• Gaining Access to Unique Capabilities
• Diversification
• Bootstrapping EPS
• Personal benefits for managers
• Tax Benefits
• Unlocking Hidden Value
• Achieving International Business Goals (Taking advantage of market inefficiencies, Working around disadvantageous
government policies, Using technology in a new market, product differentiation, provide support to existing
multinational clients)
12/13/2022 Syed Muhammad Ali Raza
Mergers & Acquisitions
Common Motivation behind M&A activities:
Bootstrapping EPS: Bootstrapping is a way of packaging the combined earnings from two companies after a merger so
that the merger generates an increase in the earnings per share of the acquirer, even when no real economic gains
have been achieved.
Example: Fastgro Inc. Is planning to acquire Slowgro. Inc in a merger transaction. Financial information for the two
companies both prior to and after the merger are shown in the following table. Calculate Fastgro post-merger EPS and
determine whether the merger created economic gains.
Fastgro.Inc Slowgro Inc Fastgro- Post Merger
Stock Price $80 $40 $80
EPS $3 $2
P/E Ratio 26.7 20
Total Share Outstanding 200,000 100,000 250,000
Total Earnings $600,000 $200,000 $800,000
Market Capitalization $16,000,000 $4,000,000 $20,000,000
12/13/2022 Syed Muhammad Ali Raza
Mergers & Acquisitions
Answer:
Fastgro.Inc Slowgro Inc Fastgro- Post Merger
Stock Price $80 $40 $80
EPS $3 $2 $3.20
P/E Ratio 26.7 20
Total Share Outstanding 200,000 100,000 250,000
Total Earnings $600,000 $200,000 $800,000
Market Capitalization $16,000,000 $4,000,000 $20,000,000
No economic value was created by the merger.
12/13/2022 Syed Muhammad Ali Raza
Mergers & Acquisitions
Merger Motivations in the Industry life cycle
The industry life cycle recognizes that industries go through certain phases based on their rates of growth. The
motivation company may have for entering into a merger and a type of merger may depend on a great deal on what
phase of the industry life cycle the company is in.
• Pioneer/development phase
• Rapid growth phase
• Mature growth phase
• Stabilization Phase
• Decline Phase
12/13/2022 Syed Muhammad Ali Raza
Mergers & Acquisitions
Merger Motivations in the Industry life cycle
Industry Life Industry Characterstics Merger Motivations Commmon types
Cycle of merger
Pioneer / • Unsure of product acceptance • Gainaccess to capital from more • Conglomerate
developments • Large Capital requirements and low profit mature business • Horizontal
margins • Share management talent
Rapid Growth • High Profit margins • Gain access to capital • Conglomerate
• Accelarating sales & earnings • Expand capacity to grow • Horizontal
• Competition still low
Mature Growth • Lots of new competition • Increase operational efficiencies • Horizontal
• Still opportunties for above average • Economies of scale / synergies • Vertical
growth
Stabilization • Competition has reduced growth potential • Economies of scale / reduce costs • Horizontal
• Capacity constraints • Improve management
Decline • Consumer tastes have shifted • Survival • Horizontal
• Overcapacity / shrinking profit margins • Operational Efficiencies • Vertical
• Acquire new growth opportunities • COnglomerate
12/13/2022 Syed Muhammad Ali Raza
Mergers & Acquisitions
Characteristics of merger transactions by the form of acquisitions: The two basic form of acquistions are stock
purchase or asset purchase:
Stock Purchase Asset Purchase
Payments Made directly to target company Made directly to target company
shareholders in exchange for their shares
Approval Majority shareholders approval required No shareholder approval needed unless
asset sales is substantial
Corproate Taxes None Target company pay capital gain taxes
Shareholder Taxes Shareholder pay capital gain taxes None
Liabilities Acquirer assumes liabilities target Acquirer usually avoids assumption of
target’s liabilities
12/13/2022 Syed Muhammad Ali Raza
Mergers & Acquisitions
Characteristics of merger transactions by the method of Payments: The two basic methods of payment are security
offering and cash offering. Both methods can be used in combination which is referred to as mixed offerings.
Security Offerings: The target shareholder receive shares of the acquirer’s common stock in exchange for their shares
in the target company. The number of the acquirer’s shares received for each target company share is based on the
exchange ratio. In practice, the exchange ratios are negotiated in advance of the merger due to the daily fluctuations
that can occur in stock prices. The total compensation ultimately paid by the acquirer is based on three factors:
• Exchange Ratio
• No. Of shares outstanding of the target company
• The value of the acquirer’s stock on the day the deal is completed.
Cash Offering: It is a straightforward method the acquirer simply pays agreed-upon amount of cash for the target
company’s shares.
When the acquirer is negotiating with the target over the method of payment. There are three main factors that should
be considered:
• The Distribution between the risk and reward for the acquirer and the target share holders
• Relative Valuations of companies involved
• Changes in capital structure
12/13/2022 Syed Muhammad Ali Raza
Mergers & Acquisitions
Characteristics of merger transactions by the Attitude of Target Management: A merger offer will be viewed as either
friendly or hostile by the target company’s management because it shapes how the merger is completed and the
process that is followed:
Friendly Merger Offers:
A friendly merger occurs when one corporation acquires another with both boards of directors approving the
transaction.
Hostile Merger Offers: Typically follow a much different process than a friendly merger if the target Company’s
management does not support the deal, the acquirer submits a merger proposal directly to the target’s board of
directors in a process called a bear hug. If the bear hug is unsuccessful, the next step is to appeal directly to the target’s
shareholders using one of two methods – a tender offer or a proxy battle.
• In a tender offer, the acquirer offers to buy the shares directly from the target shareholders, and each individual
shareholder either accepts or rejects the offer.
• In a proxy battle, the acquirer seek to control the target by haiseekshareholders approve a new “acquirer approved”
board of directors. A proxy solicitation is approved by the regulators and sent to shareholders. If the shareholders
elect the acquirer’s alte of directors, the new board may replace the target’s management and the merger offer
become friendly.
12/13/2022 Syed Muhammad Ali Raza
