Chapter 23: Mergers and Other Forms of Corporate Restructuring

QUESTION NO 1

1. Explain why a company might decide to engage in corporate restructuring?

Answer

Following are the reasons due to which company might decide to engage in corporate restructuring

 Sales enhancement and operating economies

Sales enhancement can occur because of market share gain, technological advancements to the
product table, and filling a gap in the product line.

Operating economies can be achieved because of the elimination of duplicate facilities or operations
and personnel.

Synergy – Economies realized in a merger where the performance of the combined firm exceeds that
of its previously separate parts

2 Calculate and explain the impact on earnings and on market value of companies involved in
mergers.

Answer

In a merger or acquisition transaction, valuation is essentially the price that one party will pay for the
other, or the value that one side will give up to make the transaction work. Valuations can be made via
appraisals or the price of the firm’s stock if it is a public company, but at the end of the day valuation is
often a negotiated number

The acquiring company's stock typically falls during an acquisition. Since the acquiring company must
pay a premium for the target company, it may have exhausted its cash or had to use a large amount of
debt to finance the acquisition. As a result, the stock might suffer.
There are other factors and scenarios that could lead to the acquirer's stock price to fall during an
acquisition:

Investors believe the takeover price is too costly or the premium for the target company is too high

A turbulent integration process, such as regulatory issues or problems associated with integrating
different workplace cultures

Lost productivity because of management power struggles

Additional debt or unforeseen expenses incurred as a result of the purchase

It is important to consider both the short-term and the long-term impact on the acquiring company's
stock price. If the acquisition goes smoothly, it will be good for the acquiring company in the long run
and likely lead to a higher stock price.

3 Describe what merger benefits, if any, accrue to acquiring company shareholders and to
selling company shareholders?

Answer

Mergers affect the shareholders of both companies in different ways and are influenced by several
factors, including the prevailing economic environment, size of the companies and management of the
merger process. However, the conditions of the merger may have different effects on the stock prices of
each participant in the merger.

The merger of two companies causes significant volatility in the stock price of the acquiring firm and
that of the target firm. Shareholders of the acquiring firm usually experience a temporary drop in share
value in the days preceding the merger, while shareholders of the target firm see a rise in share value
during the period.

The stock price of the newly merged company is expected to be higher than that of both the acquiring
and target firms, and it is usually profitable for the target firm's shareholders, who benefit from the
resulting stock price arbitrage. In the absence of unfavorable economic conditions, shareholders of the
merged company usually experience greatly improved long-term performance and dividends.

4 Analyze a proposed merger as a capital budgeting problem?

 Noncash payments and assumption of liabilities

Answer

 Develop an acquisition strategy – Developing a good acquisition strategy revolves around the
acquirer having a clear idea of what they expect to gain from making the acquisition – what their
business purpose is for acquiring the target company (e.g., expand product lines or gain access
to new markets)
Set the M&A search criteria – Determining the key criteria for identifying potential target companies
(e.g., profit margins, geographic location, or customer base)
 Search for potential acquisition targets – The acquirer uses their identified search criteria to
look for and then evaluate potential target companies
 Begin acquisition planning – The acquirer makes contact with one or more companies that
meet its search criteria and appear to offer good value; the purpose of initial conversations is to
get more information and to see how amenable to a merger or acquisition the target company
is
 Perform valuation analysis – Assuming initial contact and conversations go well, the acquirer
asks the target company to provide substantial information (current financials, etc.) that will
enable the acquirer to further evaluate the target, both as a business on its own and as a
suitable acquisition target
 Negotiations – After producing several valuation models of the target company, the acquirer
should have sufficient information to enable it to construct a reasonable offer; Once the initial
offer has been presented, the two companies can negotiate terms in more detail
 M&A due diligence – Due diligence is an exhaustive process that begins when the offer has
been accepted; due diligence aims to confirm or correct the acquirer’s assessment of the value
of the target company by conducting a detailed examination and analysis of every aspect of the
target company’s operations – its financial metrics, assets and liabilities, customers, human
resources, etc.
 Purchase and sale contracts – Assuming due diligence is completed with no major problems or
concerns arising, the next step forward is executing a final contract for sale; the parties will
make a final decision on the type of purchase agreement, whether it is to be an asset purchase
or share purchase
 Financing strategy for the acquisition – The acquirer will, of course, have explored financing
options for the deal earlier, but the details of financing typically come together after the
purchase and sale agreement has been signed.
 Closing and integration of the acquisition – The acquisition deal closes, and management teams
of the target and acquirer work together on the process of merging the two firms.

6. Describe different ways to defend against an unwanted takeover

Answer

A corporate takeover is a complex business transaction pertaining to one company purchasing another
company. Takeovers often take place for a number of logical reasons, including anticipated synergies
between the acquiring company and Target Company, potential for significant revenue enhancements,
likely reduced operating costs and beneficial tax considerations.

There are three ways to take over a public company: vertical acquisition, horizontal acquisition and
conglomerated acquisition. The main reason for the hostile execution of acquisition, at least in theory, is
to remove ineffective management and board

7. Discuss strategic alliances and understand how outsourcing has contributed to the formation of
virtual corporations

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

8. Explain what “divestiture” is and how it may be accomplished

Divestment is the process of selling subsidiary assets, investments or divisions in order to maximize the
value of the parent company. Also known as divestiture, it is the opposite of an investment and is
usually done when that subsidiary asset or division is not performing up to expectations. Companies can
choose to deploy this strategy to satisfy financial, social or political goals.

The most common reason for divestment is the selling of non-core businesses. Companies may own
different business units that operate in different industries which can be quite distracting for their
management teams. Divesting a nonessential business unit can free up time for a parent company's
management to focus on its core operations and competencies. For instance, in 2014, General Electric
made a decision to divest its non-core financing arm by selling shares of Synchrony Financial on the New
York Stock Exchange.

Additionally, companies divest their assets to obtain funds, shed an underperforming subsidiary,
respond to regulatory action and realize value through a break-up. Finally, companies may engage in
divestment for political and social reasons, such as selling assets contributing to global warming

9. Understand what “going private” means and what factors may motivate management to take a
company 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
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 large transaction costs to investment bankers.
Little liquidity to its owners. A large portion of management wealth is tied up in a single investment

10. What a leveraged buyout is and what risk it details. Explain?

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 The company has gone through a
program of heavy capital expenditures (i.e., modern plant). There are subsidiary assets that can be sold
without adversely impacting the core business, and the proceeds can be used to service the debt
burden. Stable and predictable cash flows. A proven and established market position less cyclical
product sales. Experienced and quality management.