Mergers--Background

 Mergers are capital budgeting problems, but:

 Benefits like “strategic fits” hard to quantify
 Accounting, tax, and regulatory issues can be very complex
 Corporate control issues arise
 Sometimes involve “unfriendly” transactions

 Mergers--legal forms
 Merger or consolidation
 Acquisition of stock
 Acquisition of assets

 Mergers--jargon
 Firm seeking to buy or merge is the “bidder”
 Firm that is sought is the “target”
 Payment (cash or securities) is the “consideration”
How to Make a Merger Work

 Are there any rules of thumb for merger success? Consider the
following.
 1. Don’t rush the wedding - do your homework carefully to prevent
morning-after surprises.
 2. Know what you’re buying - not just the financials, but the
corporate culture.
 3. Adopt each partner’s best practices - don’t assume the bigger
company or the acquirer has all the answers.
 4. Be honest with employees about how a merger will affect them -
start early and communicate honestly with them.
 5. Take the time to do internal recruiting - make sure the managers
you want to keep don’t go wandering off to a competitor.
Adapted from “How to Make a Merger Work”, Fortune magazine, January 24, 1994.
The Mechanics of Mergers & Acquisitions

 Merger
 Advantages
Simplicity (buyer assumes all assets and liabilities)

 Disadvantages
All liabilities assumed (including potential litigation)
Two thirds of shareholders (most states) of both
firms must approve
Dissenting shareholders can sue to receive their
“fair” value
Management cooperation needed
The Mechanics of Mergers & Acquisitions (concluded)

 II. Acquisition of Assets

 Advantages
Buyer acquires assets with no minority shareholders
Only 50% of seller’s shareholders need approve
 Disadvantages
Individual transfer of assets may be costly in legal
fees

 III. Acquisition of Stock (Tender Offer)

 Advantage
No shareholder (or even management) approval
necessary
 Disadvantage
Integration difficult without 100% of shares
Resistance can raise price
Minority holdouts
What is a “Takeover?”

Merger or consolidation

Acquisition Acquisition of stock

Takeovers Proxy contest Acquisition of assets

Going private
Classifying acquisitions

 Horizontal
 same industry

 Vertical
 different steps in production/distribution process

 Conglomerate
 unrelated lines of business
Taxes and acquisitions

 Sale of shares (taxable) versus exchange (non-taxable)

 For tax-free status, in general:

 Must be a continuation of equity interest
 Must be a business (i.e., non-tax) reason for acquisition

 Which is better--Taxable or tax-exempt?

 Capital gains effect
 Write-up effect

 Tax status versus accounting treatment

 Purchase accounting
 Pooling of interests
More on taxes and acquisitions--issues and recent developments

 Does goodwill matter?

 Purchased R&D

 Asset purchases
Reasons for Mergers & Acquisitions

 I. Synergy--the whole versus the sum of the parts

 II. Incremental Cash Flows

= ∆ rev – ∆costs – ∆taxes – ∆capital

requirements
A. Increased revenues
1. Gains from better marketing efforts
- Ineffective media programming/advertising
- Distribution network enhancements
- Product mix
2. Strategic benefits
- Beachhead” into new markets
- Market power
Reasons for Mergers & Acquisitions (continued)

B. Decreased costs
1. Economies of scale
2. Economies of vertical integration
3. Complementary resources
4. Elimination of inefficiencies
C. Taxes
1. Transfer of net operating losses
2. Unused debt capacity
3. “Free cash flow”—reinvestment of surplus funds as
an alternative to paying dividends or repurchasing
stock
D. Reduced investment needs
Reasons for Mergers & Acquisitions (concluded)

 III. Financing — risk reduction through

coinsurance effect
— usually helps bondholders

and not shareholders

 IV. Undervalued assets

 V. Inefficient management
Bad reasons for merger and merger costs

 Bad reasons for mergers and acquisitions

 Diversification--conglomerate mergers
 EPS growth

 NPV of a merger
 Cash acquisition
 Stock acquisition

 Which is better, cash or stock?

 Sharing gains--and losses
 Taxes
 Control
 Financing
Acquisitions and EPS Growth

 Pizza Shack and Checkers Pizza are merging to form Stop

’N Go Pizza. The merger isn’t expected to create any
additional value. Stop ’N Go, valued at $1,875,000, is to
have 125,000 shares outstanding at $15 per share

Before and after merger financial positions

100,000 Stop ’N Go shares to Shack holders

25,000 Stop ’N Go shares to Checkers holders
Acquisitions and EPS Growth (concluded)

Stop
Pizza Checkers ’N
Shack Pizza Go

Earnings per share $ 1.50 $ 1.50 $ 1.80

Price per share 15.00 7.50 15.00
P/E ratio 10 5 8.33
Number of shares 100,000 50,000 125,000
Total earnings $ 150,000 $ 75,000 $225,000
Total value $1,500,000 $ 375,000 $1,875,000
Defensive Tactics

Managers who believe their firms are likely to become

takeover targets and who wish to fend off unwanted
acquirers often implement one or more takeover
defenses. These defensive tactics take several forms:

 The Corporate Charter

 Repurchase/Standstill Agreements

 Exclusionary Self-Tenders

 Poison Pills and Share Rights Plans (SRPs)

 Going Private and Leveraged Buyouts (LBOs)

More on defensive tactics

 Supermajority provisions/staggered board

 Share rights plans

 “deadhand” provisions
 “chewable” poison pills
 the poison in the pill

 The lingo
 “Greenmail”
 Golden parachutes
 White knights
 Crown jewels
 Lockup
 Shark repellent
 Bear hug
Adoption of a Share Rights Plan (SRP) (Figure 23.1)

Dear Stockholder:
In the current corporate takeover environment, Contel is concerned about
certain abusive techniques that are sometimes employed during takeover
attempts. The use of such tactics is increasing and often threatens the
investment position of a company’s stockholders. In response to the
increasing use of these abusive tactics, your Board of Directors has adopted a
share rights plan designed to ensure that stockholders are treated fairly by
anyone who might seek to obtain control of the company. The plan consists of
a preferred stock rights agreement and a dividend distribution of one preferred
stock purchase right on each outstanding share of Contel common stock.
The share rights plan was not adopted because of any current effort by another
party to acquire the company. In fact, we are not aware of any such effort.
Rather, it is a precautionary step that will increase the Board’s ability to
represent effectively the interests of the company’s stockholders in the event
of an unsolicited takeover attempt. While the share rights plan will not prevent
a takeover, it should encourage anyone seeking to acquire Contel to negotiate
first with the Board of Directors. In adopting the share rights plan, the Board
also considered the fact that more than 650 public companies, including many
major independent telephone companies, have adopted share rights plan.
(continued)
Adoption of a Share Rights Plan (Figure 23.1) (continued)

Under the share rights plan, you will receive one right for each share of Contel
common stock you own. Each right will entitle you to buy one one-hundredth
of a share of a new series of preferred stock at an exercise price of $120. The
rights can only be exercised if a person or group acquires 20 percent or more
of Contel common stock or announces a tender offer for 30 percent or more of
Contel common stock.
If certain triggering events occur, each right would entitle you to receive Contel
common stock or, in certain circumstances, cash, property or other Contel
securities with a value equal to twice the exercise price. Triggering events
include the acquisition by a person or group of 20 percent or more of Contel
common stock, or a merger with a company that owns 20 percent or more of
Contel common stock in which Contel is the surviving company.
If Contel were acquired in certain other mergers or business combinations, or
if 50 percent of the company’s assets or earning power is sold or transferred,
each right would entitle you to receive common stock in the acquiring
company with a value equal to twice the exercise price. Contel can redeem the
rights for 1 cent each at any time prior to 10 days following the date that a
person or group acquires 20 percent or more of Contel common stock. The
details of the rights plan are explained in the attachment to this letter. We urge
you to read it carefully.
(continued)
Adoption of a Share Rights Plan (Figure 23.1) (concluded)

The dividend distribution is payable to stockholders of record on December 7,

1988, and one right will attach to each new share of common stock issued after
the record date and prior to the time someone acquires 20 percent or more of
Contel common stock or announces a tender offer for 30 percent or more of
Contel common stock. The rights will become part of your existing stock
certificate and no separate rights certificates will be issued at this time.

*****

Sincerely,

Charles Wohlstetter
Chairman

Donald W. Weber
President and Chief Executive Officer