Mergers and Other Forms of Corporate Restructuring

Undoubtedly today we live in a time of significant economic change. Mergers and

acquisitions have become common business tools, implemented by thousands of
companies in world. Driven by a philosophy of shareholder value they not only form a
new economic, social and cultural environment, but also enable strong companies grow
faster than competitors and provide entrepreneurs rewards for their efforts, ensuring
weaker companies are more quickly swallowed, or worse, made irrelevant through
exclusion.

Mergers and acquisitions take place for many strategic business reasons, but the
most common reasons for any business combination are economic at their core.

What is Corporate Restructuring?

Any change in a company’s:
1. Capital structure,
2. Operations, or
3. Ownership
that is outside its ordinary course of business.

Why Engage in Corporate Restructuring?

• Sales enhancement and operating economies
Economies of Scale – The benefits of size in which the average unit cost
falls as volume increases.
Merger – The combination of two or more companies in which only one
firm survives as a legal entity.
• Improved management
• Information effect
• Wealth transfers
• Tax reasons
• Leverage gains
 • Hubris hypothesis
• Management’s personal agenda

Mergers

• Horizontal merger: combining two companies in the same line of business.

• Vertical merger: expansion towards the ultimate consumer or backwards towards

the source of raw material.

• Conglomerate merger: combining two unrelated line of business.

• Divestiture: desire to strategic change. – internal capabilities (capital, plant and

people), the external product markets and competitors.

Types of Merger

Merger with Consolidation - both companies terminate their legal existence and
a new company arises.

Statutory merger - referred to as an acquisition, one company ceases to exist. All

of its assets and liabilities are subsumed in the acquiring party.

Subsidiary merger - the acquired party becomes a subsidiary of the acquiring

party.

Parties to the acquisitions:

• The target company (or target) is the company being acquired.

• The acquiring company (or acquirer) is the company acquiring the

target.
 Classified based on endorsement of parties’ management:

• A hostile takeover is when the target company board of directors objects

to a takeover offer.

• A friendly transaction is when the target company board of directors

endorses the merger or acquisition offer.

Classified by the relatedness of business activities of the parties to the combination:

Type Characteristic Example

Horizontal merger Companies are in the same line of San Miguel Purefoods acquire La
business, often competitors. Pacita.

Vertical merger Companies are in the same line of San Miguel acquire Australian
production (e.g., supplier– bottler Barossa. (wine bottling and
customer). packaging)

Conglomerate Companies are in unrelated lines San Miguel acquires Philippine

merger of business. Daily Inquirer.

Economies of Scale – The benefits of size in which the average unit cost falls as volume
increases.

Strategic Acquisitions Involving Common Stock

Strategic Acquisition – Occurs when one company acquires another as part of its
overall business strategy.

When the acquisition is done for common stock, a “ratio of exchange,” which
denotes the relative weighting of the two companies with regard to certain key
variables, results.
 A financial acquisition occurs when a buyout firm is motivated to purchase
the company (usually to sell assets, cut costs, and manage the remainder more
efficiently), but keeps it as a stand-alone entity.

What About Earnings Per Share (EPS)?

• Merger decisions should not be made without considering the long-term

consequences.

• The possibility of future earnings growth may outweigh the immediate dilution of
earnings.
Market Value Impact

• The above formula is the ratio of exchange of market price.

• If the ratio is less than or nearly equal to 1, the shareholders of the acquired firm
are not likely to have a monetary incentive to accept the merger offer from the
acquiring firm.

• The market price per share = (P/E) x (Earnings).

• Therefore, the increase in the market price per share is a function of an expected
increase in earnings per share and the P/E ratio NOT declining.

• The apparent increase in the market price is driven by the assumption that the P/E
ratio will not change and that each dollar of earnings from the acquired firm will
be priced the same as the acquiring firm before the acquisition (a P/E ratio of 18).

Empirical Evidence on Mergers

 • Target firms in a takeover receive an average premium of 30%.

• Evidence on buying firms is mixed. It is not clear that acquiring firm shareholders
gain. Some mergers do have synergistic benefits.

Developments in Mergers and Acquisitions

Roll-Up Transactions – The combining of multiple small companies in the same

industry to create one larger company.

• Idea is to rapidly build a larger and more valuable firm with the acquisition of
small- and medium-sized firms (economies of scale).

• Provide sellers cash, stock, or cash and stock.

• Owners of small firms likely stay on as managers.

• If privately owned, a way to more rapidly grow towards going through an initial
public offering

Developments in Mergers and Acquisitions

An Initial Public Offering (IPO) is a company’s first offering of common stock to

the general public.

IPO Roll-Up – An IPO of independent companies in the same industry that

merge into a single company concurrent with the stock offering.

Acquisitions and Capital Budgeting

An acquisition can be treated as a capital budgeting project. This requires an analysis

of the free cash flows of the prospective acquisition.

• Free cash flows are the cash flows that remain after we subtract from expected
revenues any expected operating costs and the capital expenditures necessary to
sustain, and hopefully improve, the cash flows.
 • Free cash flows should consider any synergistic effects but be before any
financial charges so that examination is made of marginal after-tax operating cash
flows and net investment effects.

Other Acquisition and Capital Budgeting Issues

• Noncash payments and assumption of liabilities

• Estimating cash flows

• Cash-flow approach versus earnings per share (EPS) approach

Generally, the EPS approach examines the acquisition on a short-run

basis, while the cash-flow approach takes a more long-run view.

Closing the Deal

Consolidation – The combination of two or more firms into an entirely new firm.
The old firms cease to exist.

• Target is evaluated by the acquirer

• Terms are agreed upon

• Ratified by the respective boards

• Approved by a majority (usually two-thirds) of shareholders from both firms

• Appropriate filing of paperwork

• Possible consideration by The Antitrust Division of the Department of Justice or

the Federal Trade Commission
Taxable or Tax-Free Transaction

At the time of acquisition, for the selling firm or its shareholders, the transaction is:

• Taxable – if payment is made by cash or with a debt instrument.

• Tax-Free – if payment made with voting preferred or common stock and the
transaction has a “business purpose.” (Note: to be a tax-free transaction a few
more technical requirements must be met that depend on whether the purchase is
for assets or the common stock of the acquired firm.)

Accounting Treatments

• In a stock purchase, the acquirer provides cash, stock, or combination of cash

and stock in exchange for the stock of the target firm.

• A stock purchase needs shareholder approval.

• Target shareholders are taxed on any gain.

• Acquirer assumes target’s liabilities.

• In an asset purchase, the acquirer buys the assets of the target firm,
paying the target firm directly.

• An asset purchase may not need shareholder approval.

• Acquirer likely avoids assumption of liabilities.

Purchase (method) – A method of accounting treatment for a merger based on the

market price paid for the acquired company.

Pooling of Interests (method) – A method of accounting treatment for a merger based

on the net book value of the acquired company’s assets. The balance sheets of the two
companies were simply combined.
Method of Payment

 Cash offering

Cash offering may be cash from existing acquirer balances or from a debt
issue.

• Securities offering

• Target shareholders receive shares of common stock, preferred stock, or

debt of the acquirer.

• The exchange ratio determines the number of securities received in

exchange for a share of target stock.

• Factors influencing method of payment:

• Sharing of risk among the acquirer and target shareholders.

• Signaling by the acquiring firm.

Capital structure of the acquiring firm

Treatment of Goodwill

Goodwill – The intangible assets of the acquired firm arising from the acquiring
firm paying more for them than their book value.

Tender Offers- – An offer to buy current shareholders’ stock at a specified price,

often with the objective of gaining control of the company. The offer is often made by
another company and usually for more than the present market price. Allows the
acquiring company to bypass the management of the company it wishes to acquire.

• It is not possible to surprise another company with its acquisition because the
SEC requires extensive disclosure.
 • The tender offer is usually communicated through financial newspapers and direct
mailings if shareholder lists can be obtained in a timely manner.

• A two-tier offer may be made with the first tier receiving more favorable terms.
This reduces the free-rider problem.

Two-tier Tender Offer – Occurs when the bidder offers a superior first-tier price
(e.g., higher amount or all cash) for a specified maximum number (or percent) of
shares and simultaneously offers to acquire the remaining shares at a second-tier
price.

• Increases the likelihood of success in gaining control of the target firm.

• Benefits those who tender “early.”

Defensive Tactics

The company being bid for may use a number of defensive tactics including:

(1) persuasion by management that the offer is not in their best interests,
(2) taking legal actions, (3) increasing the cash dividend or declaring a
stock split to gain shareholder support, and (4) as a last resort, looking for
a “friendly” company (i.e., white knight) to purchase them.

White Knight – A friendly acquirer who, at the invitation of a target company,

purchases shares from the hostile bidder(s) or launches a friendly counter-bid in
order to frustrate the initial, unfriendly bidder(s).

Antitakeover Amendments and Other Devices

Motivation Theories:

Managerial Entrenchment Hypothesis - This theory suggests that

barriers are erected to protect management jobs and that such actions work to the
detriment of shareholders.
 Shareholders’ Interest Hypothesis - This theory implies that contests for
corporate control are dysfunctional and take management time away from profit-making
activities.

Shark Repellent – Defenses employed by a company to ward off potential

takeover bidders – the “sharks.”

• Stagger the terms of the board of directors

• Change the state of incorporation

• Supermajority merger approval provision

• Fair merger price provision

• Leveraged recapitalization

• Poison pill

• Standstill agreement

• Premium buy-back offer

Empirical Evidence on Antitakeover Devices

• Empirical results are mixed in determining if antitakeover devices are in the best
interests of shareholders.

• Standstill agreements and stock repurchases by a company from the owner of a

large block of stocks (i.e., greenmail) appears to have a negative effect on
shareholder wealth.

• For the most part, empirical evidence supports the management entrenchment
hypothesis because of the negative share price effect.
Strategic Alliance

Strategic Alliance – An agreement between two or more independent firms to

cooperate in order to achieve some specific commercial objective.

• Strategic alliances usually occur between (1) suppliers and their customers, (2)
competitors in the same business, (3) non-competitors with complementary
strengths.

• A joint venture is a business jointly owned and controlled by two or more

independent firms. Each venture partner continues to exist as a separate firm, and
the joint venture represents a new business enterprise.

Takeover Defenses

Pre-offer takeover defense mechanisms:

Poison pills

 device that makes it more expensive for the acquirer to take control of the target
without the target board’s approval
 Triggered by a change in control; can be rescinded if the offer becomes friendly
 Flip-in pill: Target shareholders have the right to buy shares of the target at a
discount.
 Flip-over pill: Target shareholders have the right to buy shares of the acquirer at a
discount.

Poison puts

 Allows the bondholders of the target to put the shares back to the target
company
 Intended to reduce the cash stores of the target company
 Incorporation in a state with restrictive takeover laws (United States)
  Some states give target companies more power to fend off an unwanted
takeover.

Staggered board of directors -By having board terms staggered through time, it
takes longer to get control through a proxy fight.

Restricted voting rights - Provision that prevents shareholders who have recently
acquired large blocks of shares (objective: hostile acquirer) from voting
Supermajority voting provisions - Require a percentage of votes larger than simply
a majority for change of control votes

Fair price amendments - Specify the minimum price in an acquisition

Golden parachutes - Compensation agreement between the target firm and

executives of the target firm in which these employees receive substantial payments if
there is a change in control

Post-offer takeover defense mechanisms

“Just say no” defense - Board of directors rejects offer. If bear hug, the board would
make the case for a higher bid.

Litigation - Lawsuit based on violation of securities laws or on anticompetitive

grounds is filed.

Greenmail - The target repurchases shares from the party attempting to acquire the
target.

Share repurchase - Perform a stock repurchase, which may raise the price of the
stock

Leveraged recapitalization - Borrow heavily to finance a share repurchase, which

makes the target more levered and, hence, unattractive.
“Crown jewels” defenses - Sell an asset, division, or subsidiary that is attractive to the
acquiring company.

“Pac-Man” defense - Offer to buy acquirer.

White knight defense - Find a friendly third party to buy the target.

White squire defense - Find a friendly third party to buy a minority (yet substantial)
interest in the target.

Divestiture

Divestiture – The divestment of a portion of the enterprise or the firm as a whole.

Liquidation – The sale of assets of a firm, either voluntarily or in bankruptcy.

Sell-off – The sale of a division of a company, known as a partial sell-off, or the

company as a whole, known as a voluntary liquidation.

Spin-off – A form of divestiture resulting in a subsidiary or division becoming an

independent company. Ordinarily, shares in the new company are distributed to
the parent company’s shareholders on a pro rata basis.

Equity Carve-out – The public sale of stock in a subsidiary in which the parent
usually retains majority control.

Ownership Restructuring

Going Private – Making a public company private through the repurchase of stock by
current management and/or outside private investors.

• The most common transaction is paying shareholders cash and merging the
company into a shell corporation owned by a private investor management group.

• Treated as an asset sale rather than a merger.

Ownership Restructuring

Going Private – Making a public company private through the repurchase of stock by
current management and/or outside private investors.

• The most common transaction is paying shareholders cash and merging the
company into a shell corporation owned by a private investor management group.

• Treated as an asset sale rather than a merger.

Motivation and Empirical Evidence for Going Private

Motivations:

• Elimination of costs associated with being a publicly held firm (e.g., registration,
servicing of shareholders, and legal and administrative costs related to SEC
regulations and reports).

• Reduces the focus of management on short-term numbers to long-term wealth

building.

• Allows the realignment and improvement of management incentives to enhance

wealth building by directly linking compensation to performance without having
to answer to the public.

Motivations (Offsetting Arguments):

• Large transaction costs to investment bankers.

• Little liquidity to its owners.

• A large portion of management wealth is tied up in a single investment.

Empirical Evidence: - Shareholders realize gains (+12 to +22%) for cash offers in these
transactions.

Ownership Restructuring

Leverage Buyout (LBO) – A primarily debt financed purchase of all the

stock or assets of a company, subsidiary, or division by an investor group.

The debt is secured by the assets of the enterprise involved. Thus, this
method is generally used with capital-intensive businesses.

A management buyout is an LBO in which the pre-buyout management

ends up with a substantial equity position.

Mergers and acquisitions are understood as a general global trend associated with
a global corporate restructuring across industries. They are the vital part of any healthy
economy and the primary way that companies are able to provide returns to owners and
investors.
References :

http://www.dummies.com/business/corporate-finance/mergers-and-acquisitions/the-
reasons-for-mergers-and-acquisitions/

http://www.tksi.org/JOURNAL-KSI/PAPER-PDF-2009/2009-4-03.pdf

http://whatis.techtarget.com/definition/mergers-and-acquisitions-MA

Fundamental of Financial Management – 11th Edition – Eugene F. Bringham & Joel F.

Houston

Fundamental of Financial Management- 13th Edition – James C. Van Horne & John M.
Wachowicz Jr.
 Desserie Ann Delavin, 24 years old, She is currently residing at 1000 Bagong
Silang St. Nangka Marikina City. She graduated at Pamantasan ng Lungsod ng Marikina
with a course of Bachelor of Science in Business Administration major in Financial
Management. She took up internship in United Coconut Planters Bank & Wyeth
Philippines and these Interships serves as her advantage to be hired in one of the largest
conglomerate in Philippines – San Miguel Group.

She is currently employed at San Miguel Foods Inc as Finance Analyst for almost
4 years. She is working as a finance Analyst with a very challenging yet a very good
opportunity for her grow and development professionaly. It enhances her skills and
ability in numerous ways.

During her college year, She graduated with a full scholar in CHED and last
2016 she became Certified Trained Panelist of San Miguel R&D Council. Being
involved in different CSR of San Miguel Group, she became the 1st ever awardee of San
Miguel Foundation – Team Malasakit Hero Award. As one of the so-called “millenials”
of our modern year, she see so much going wrong in the world and she want to try do to
something on her own to make it better. She like to do what she can and she want to
make a difference.