Mergers and Acquisitions

This chapter discusses the rationale for mergers, different types of mergers, and merger analysis. The primary motives for mergers include: synergy, tax considerations, the purchase of assets below replacement cost, diversification, personal incentives, and breakup value. Synergy is the condition in which the whole is greater than the sum of its parts, so in a synergistic merger the post-merger value exceeds the sum of the separate companies' pre-merger values.

Economists have classified mergers into four types: horizontal, vertical, congeneric, and conglomerate. A-Select-

congeneric

conglomerate

vertical

horizontal

Item 1

merger is a combination of two firms that produce the same type of good or service. A-Select-

congeneric

conglomerate

vertical

horizontal

Item 2

merger is a merger between a firm and one of its suppliers or customers. A-Select-

congeneric

conglomerate

vertical

horizontal

Item 3

merger is a merger of firms in the same general industry, but for which no customer or supplier relationship exists. A-Select-

congeneric

conglomerate

vertical

horizontal

Item 4

merger is a merger of companies in totally different industries.

In the vast majority of mergers, one firm decides to purchase another company, negotiates a price with the management of that company, and then acquires that company. It is more common for a firm to seek acquisitions than to seek to be acquired. The acquiring company is a company that seeks to acquire another firm, while the target company is a firm that another company seeks to acquire. A tender offer is the offer of one firm to buy the stock of another company by going directly to the stockholders, frequently (but not always) over the opposition of the target company's management.

A friendly merger is a merger whose terms are approved by the managements of both companies, while a hostile merger is a merger in which the target firm's management resists acquisition. A(n)-Select-

operating

offensive

financial

defensive

Item 5

merger is designed to make a company less vulnerable to a takeover. A-Select-

operating

offensive

financial

defensive

Item 6

merger is a merger in which the firms involved will not be operated as a single unit and from which no operating economies are expected. An-Select-

operating

offensive

financial

defensive

Item 7

merger is a merger in which operations of the firms involved are integrated in hope of achieving synergistic benefits.

Several methodologies are used to value target firms, but this chapter concentrates on the two most common methods: the discounted cash flow approach and the market multiple method. The discounted cash flow approach to valuing mergers used in this chapter is considered a(n)-Select-

debt

equity

preferred

Item 8

residual method because the cash flows are residuals and belong solely to the acquiring firm's-Select-

preferred shareholders

bond investors

common shareholders

Item 9

. The discount rate used to value these residual cash flows should be the cost of-Select-

equity

preferred

debt

Item 10

and the discount rate should reflect the risk of the cash flows shown in the merger analysis. That risk is that of the target firm, not that of the acquiring firm or the post-merger firm. So, the discount rate used in the merger analysis should be the target firm's post-merger cost of-Select-

debt

preferred

equity

Item 11

. The market multiple analysis is a method of valuing a target company that applies a market-determined multiple to net income, earnings per share, sales, book value, etc. While the DCF approach applies valuation concepts in a precise manner focusing on cash flows, the market multiple analysis is more judgmental.

The recent merger activity has raised two questions about mergers. Do mergers create value? And, if they do create value, how do the parties share the value? Most researchers agree that takeovers increase the wealth of the shareholders of target firms; otherwise, they would not agree to the offer. However, there is a debate as to whether mergers benefit the acquiring firm's shareholders. On balance, the evidence from merger research indicates that mergers do create value but that shareholders of target firms reap virtually all the benefits.