Question

•What are the different methods for achieving a takeover? •How do we account for acquisitions? •What...

•What are the different methods for achieving a takeover?

•How do we account for acquisitions?

•What are some of the reasons cited for mergers? Which may be in stockholders’ best interest, and which generally are not?

•What are some of the defensive tactics that firms use to thwart takeovers?

•How can a firm restructure itself? How do these methods differ in terms of ownership?

Homework Answers

Answer #1

A takeover is the purchase of one company (the target) by another (the acquirer, or bidder). There are several different types of takeover. The types are:

  • Friendly Takeover- The acquiring(bidding) company will approach the directors of the target company to discuss and agree an offer before proposing it to the shareholders of that company. The bidding company will also have an opportunity to look at the accounts of the business they want to buy - a process known as due diligence.
  • Hostile Takeover- the company bidding has their offer rejected or does not approach the board of the company they wish to buy before making an offer to shareholders. This also means they will not have access to private information about the company - increasing the risk of the takeover. Banks are usually more cautious about lending money for hostile takeovers.
  • Reverse Takeover- the final common type of takeover is the reverse takeover. This happens when a private (not traded on the stock market) company buys a publicly-traded company as a means of acquiring public status without having to list itself.
  • Backflip takeover- this type is any sort of takeover in which the acquiring company turns itself into a subsidiary of the purchased company. This type of takeover can occur when a larger but less well-known company purchases a struggling company with a very well-known brand.

Motivation for Mergers

The dominant rationale used to explain merger/acquisition activity is that acquiring firms seek improved financial performance or reduce risk. The following motives are considered to improve financial performance or reduce risk:

  1. Economy of scale: This refers to the fact that the combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins.
  2. Economy of scope: This refers to the efficiencies primarily associated with demand-side changes, such as increasing or decreasing the scope of marketing and distribution, of different types of products.
  3. Increased revenue or market share: This assumes that the buyer will be absorbing a major competitor and thus increase its market power (by capturing increased market share) to set prices.
  4. Synergy: For example, managerial economies such as the increased opportunity of managerial specialization. Another example is purchasing economies due to increased order size and associated bulk-buying discounts.
  5. Taxation: A profitable company can buy a loss maker to use the target's loss as their advantage by reducing their tax liability.

The above 5 reasons cited for mergers can be considered as ones which are in the stockholders’ best interest.

  1. Geographical or other diversification: This is designed to smooth the earnings results of a company, which over the long term smoothens the stock price of a company, giving conservative investors more confidence in investing in the company. However, this does not always deliver value to shareholders.
  2. Resource transfer: resources are unevenly distributed across firms (Barney, 1991) and the interaction of target and acquiring firm resources can create value through either overcoming information asymmetry or by combining scarce resources.
  3. Vertical integration: Vertical integration occurs when an upstream and downstream firm merge (or one acquires the other). There are several reasons for this to occur. One reason is to internalise an externality problem. A common example of such an externality is double marginalization. Double marginalization occurs when both the upstream and downstream firms have monopoly power and each firm reduces output from the competitive level to the monopoly level, creating two deadweight losses. After a merger, the vertically integrated firm can collect one deadweight loss by setting the downstream firm's output to the competitive level.
  4. Hiring: some companies use acquisitions as an alternative to the normal hiring process. This is especially common when the target is a small private company or is in the startup phase.
  5. Absorption of similar businesses under single management: similar portfolio invested by two different mutual funds namely united money market fund and united growth and income fund, caused the management to absorb united money market fund into united growth and income fund.
  6. Access to hidden or nonperforming assets (land, real estate).
  7. Acquire innovative intellectual property.
  8. Manager's hubris: manager's overconfidence about expected synergies from M&A which results in overpayment for the target company.

The above 8 reasons cited for mergers can be considered as ones which are NOT in the stockholders’ best interest.

Various steps companies take to prevent to prevent hostile takeovers.

  1. Shareholders Rights Plan - The most common form of takeover defense is the shareholders' rights plans, which activates the moment a potential acquirer announces its intentions. Under such plans, shareholders can purchase additional company stock at an attractively discounted price, making it far more difficult for the corporate raider to take control.
  2. Voting Rights Plans - Targeted companies may also implement a voting-rights plan, which separates certain shareholders from their full voting powers at a predetermined point. For instance, shareholders who already own 20% of a company may lose their ability to vote on such issues as the acceptance or rejection of a takeover bid.
  3. Staggered Board of Directors - Clauses involving shareholders are not the only escape routes available to targeted companies. A staggered board of directors, in which groups of directors are elected at different times for multiyear terms, can challenge the prospective raider. The raider now has to win multiple proxy fights over time and deal with successive shareholder meetings to successfully take over the company. It's important to note, however, that such a plan holds no direct shareholder benefit.
  4. Greenmail - A company may also pursue the greenmail option by buying back its recently acquired stock from the putative raider at a higher price to avoid a takeover.
  5. White Knight - If a determined hostile bidder thwarts all defences, a possible solution is a white knight, a strategic partner that merges with the target company to add value and increase market capitalization. Such a merger can not only deter the raider but can also benefit shareholders in the short term if the terms are favourable, as well as in the long term if the merger is a good strategic fit.
  6. Increasing Debt - Increasing debt as a defensive strategy has been deployed in the past. By increasing debt significantly, companies hope to deter raiders concerned about repayment after the acquisition. However, adding a large debt obligation to a company's balance sheet can significantly erode stock prices.
  7. Acquiring the Acquirer - Ironically, a takeover defence that has been successful in the past, albeit rarely, is to turn the tables on the acquirer and mount a bid to take over the raider. This requires resources and shareholder support, and it removes the possibility of activating the other defensive strategies.
  8. Triggered Option Vesting - A triggered stock option vesting strategy for large stakeholders in a company can be used as a defence, but it rarely benefits anyone involved because it often results in massive talent migration.
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