1 / 30

Case 28: Made For Each Other?

Case 28: Made For Each Other?. Case Discussion. Objectives. Discuss the reasons why firms undertake acquisitions. Calculate the offer price for acquisitions. Analyze alternative payment methods for acquisitions. Discuss how firms can attempt to block takeovers.

neil-weaver
Télécharger la présentation

Case 28: Made For Each Other?

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Case 28: Made For Each Other? Case Discussion

  2. Objectives • Discuss the reasons why firms undertake acquisitions. • Calculate the offer price for acquisitions. • Analyze alternative payment methods for acquisitions. • Discuss how firms can attempt to block takeovers. • Examine tax and accounting issues related to takeovers.

  3. Background Information • Innovative Concepts, a fairly large-sized manufacturing firm had enjoyed significant growth over the years. • Over the past two years, due to economic recession and fierce competition, the firm’s growth rate had slowed considerably. • Managers were hard pressed to look for other avenues for growth. • Dan Peterman has to justify why QuickResolve Products is the best candidate for acquisition.

  4. Question 1: • Using the formula for free cash flow, explain the various reasons why firms undertake mergers and acquisitions? • Which of these reasons are most likely to apply to the acquisition that Innovative Concepts is considering?

  5. Answer 1 • Firms undertake mergers and acquisitions to increase EBIT, either by enhancing revenues or reducing costs; • lower taxes; and • Reduce capital needs. Free Cash Flow = dEBIT + dDepreciation – dTaxes – dCapital requirements Innovative Concepts is considering the acquisition of Innovative Concepts to try and boost their earnings via a reduction in production and marketing costs. They also feel that they could achieve some diversification benefits since QuickResolve is involved in a totally different industry.

  6. Question 2: • Comment on the director’s suggestion of playing the “relative P/E game.” • For your calculations assume that QuickResolve shareholders have agreed to an exchange ratio of 1 share of Innovative Concepts for every 2 shares held in QuickResolve. • Also, assume that the combined net income of the two firms is the sum of their net incomes prior to the completion of the deal.

  7. Answer 2 • Playing the relative P/E game refers to the strategy of acquiring a firm with a low P/E ratio in order to create an illusion of growth in the combined firm’s earnings per share (EPS)… • with the expectation that the market will be fooled and offer a high price for the shares of the combined firm. • For example:

  8. Answer 2 (Continued) Whether this strategy works or not depends on whether the market is fooled. In most cases, however, the analysts and investors are smart and do not bid the price up.

  9. Question 3 • Using the free cash flow method of valuation calculate the maximum offer price that Innovative Concepts would be justified in making for QuickResolve Products.

  10. Answer 3 Value of QuickResolve to Innovative = Value of QuickResolve + PV of Synergy Where Value of QuickResolve = $750m PV of Synergy = Incremental cash flows/WACC = $45m/0.16 =$281.25m Value of QuickResolve to Innovative = $750m+$281.25m = $1031.25m The maximum offer price = VQR to Innovative/# of shares of QR = $1031.25/20.625m =$20.625

  11. Question 4 • Let’s say that Innovative Concepts is able to close the deal at a price of $1,000m by paying cash or by exchanging 1 of its shares for 2 of QuickResolve’s shares. • Should it use cash or stock as the payment mechanism? Why? • What are the pros and cons of each payment mechanism for the acquiring and the target firm respectively?

  12. Answer 4 CASH ACQUISITION NPV of Cash Acquisition = Value of QR to Innovative – Cash Price = $1031.25m - $1000m = $31.25m Price per share after merger = (Value of Innovative + NPV)/# of shares = $5,531,250,000/100,000,000 = $55.31 Increase in price = $55.31 - $45 = $10.31 per share

  13. Answer 4 (continued) STOCK ACQUISITION • Value of combined firm = Value of Innovative + Value of QR to Innovative • =$4,500,000,000 + $1,031,250,000 =$5,531,250,000 Number of shares in combined firm given to QR’s shareholders = Current # of shares outstanding * Exchange ratio = 50,000,000 * 0.5 = 25,000,000 Number of shares outstanding in combined firm = 100m+25m = 125m shares

  14. Answer 4 (continued) Cost of acquisition = 25,000,000 shares * $44.25 = $1,106,250 NPV of stock acquisition = Value of QR to Innovative – Cost =1,031,250,000 - $1,106,250 = -$75,000,000 The calculations show that the cash method would be better since it would have a positive net present value ($31.25m).

  15. Advantages of using cash Cost does not depend on the acquisition gains. No loss of control since shareholding structure is not changed. Acquiring firm does not have to share potential gains with target.

  16. Disadvantages of using cash • Shareholders of target firm have to pay taxes on gains. • Involves cash outflow for acquiring firm • If deal is bad, losses have to be entirely borne by acquiring firm. Note: If stock is used as a payment mechanism, the advantages and disadvantages would just be reversed.

  17. Question 5 • If QuickResolve wants to block the takeover attempt what can it do? • Please explain the rationale and possible outcome of each suggestion.

  18. Answer 5 (continued) • Defensive tactics that QuickResolve could use include: • Supermajority amendment: requiring about 80% or so of the shareholders’ approval for M&A deals.

  19. Answer 5 (continued) • Repurchase using greenmail and standstill agreements: whereby QuickResolve could undertake a targeted repurchase of its stock at a substantial premium, while holding Innovative at bay via a standstill agreement.

  20. Answer 5 (Continued) • Poison pill: whereby QuickResolve might offer its shareholders share rights plans allowing them to purchase stock at a fixed price in case there is hostile takeover attempt. The increased number of shares would dilute the EPS and make the target less attractive to the bidder.

  21. Answer 5 (continued) Going private and leveraged buyout: The mangers could borrow money buy a majority of shares in the open market and take the firm private.

  22. Answer 5 (continued) • White knight: Arrange for a friendly company to takeover the firm • Crown jewel: QuickResolve might sell off its most printable divisions or assets to make it less attractive.

  23. Question 6 If the book value of the net fixed assets of QuickResolve are at only 80% of their current market value, and Innovative Concepts decides to step up the basis of the assets for depreciation after the deal is closed, what would the balance sheet of the combined firm look like under the purchase method of accounting for mergers and acquisitions? Assume that the deal is completed at an exchange ratio of 0.5 (i.e. 1 share of Innovative Concepts for 2 shares of QuickResolve).

  24. Answer 6 • Number of shares in combined firm = 125,000,000 • Book Value of QuickResolve’s Net fixed Assets = $1,000m • Current market value of QuickResolve’s Net Fixed Assets = $1,000m/0.8 = $1,250m • See spreadsheet (click here)

  25. Question 7   What are some tax issues that must be considered by Innovative Concepts’ management team when making the bid?

  26. Answer 7 • Some tax issues that must be considered include: • Any gains to target stockholders will be taxed if cash is paid. • If QuickResolve has unused debt capacity, it could be used by Innovative to get tax shields. • Surplus funds available to Innovative can be used to purchase QuickResolve (instead of a stock repurchase) and thus avoid the taxes paid by Innovative’s shareholders that would be required if dividends were paid. • The asset write-up will help Innovative get an additional tax write-off due to increased depreciation.

  27. Question 8 What are some tax issues that must be considered by Innovative Concepts’ management team when making the bid?

  28. Answer 8 • Some tax issues that must be considered include: • Any gains to target stockholders will be taxed if cash is paid. • If QuickResolve has unused debt capacity, it could be used by Innovative to get tax shields. • Surplus funds available to Innovative can be used to purchase QuickResolve (instead of a stock repurchase) and thus avoid the taxes paid by Innovative’s shareholders that would be required if dividends were paid. • The asset write-up will help Innovative get an additional tax write-off due to increased depreciation.

  29. Question 9     One of the M&A committee members had told Dan that the main advantage of this deal to Innovative Concepts is the diversification benefit that exists from the two companies being in totally different industry sectors and that it be stressed the most in the presentation. Do you agree? Explain.

  30. Answer 9 • Although diversification does reduce total risk, it should not be the main reason why firms attempt to acquire other firms. • Shareholders can easily achieve diversification themselves by buying firms that operate in different industries. • They are generally not willing to pay a premium for the stock of companies that attempt acquisitions to achieve diversification.

More Related