Merger Fundamentals

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Merger Fundamentals

Firms sometimes use mergers to expand externally by acquiring control of another firm. The objective for a merger should be to improve the firm’s share value, a number of more immediate motivations such as diversification, tax considerations, and increasing owner liquidity frequently exist. Sometimes mergers are pursued to acquire specific assets owned by the target rather than by a desire to run the target as a going concern.

Mergers, Consolidations, and Holding Companies

• A merger occurs when two or more firms are combined and the resulting firm maintains the identity of one of the firms. Usually, the assets and liabilities of the smaller firm are merged into those of the larger firm.

• Consolidation involves the combination of two or more firms to form a completely new corporation. The new corporation normally absorbs the assets and liabilities of the companies from which it is formed.

• A holding company is a corporation that has voting control of one or more other corporations. Having control in large, widely held companies generally requires ownership of between 10% and 20% of the outstanding stock.

• Subsidiaries are the companies controlled by a holding company. Control of a subsidiary is typically obtained by purchasing a sufficient number of shares of its stock.

Acquiring versus Target Companies

• Acquiring company is the firm in a merger transaction that attempts to acquire another firm.

• Target Company is the firm that the acquiring company is pursuing.

Generally, the acquiring company identifies, evaluates, and negotiates with the management and/or shareholders of the target company. Occasionally, the management of a target company initiates its acquisition by seeking out potential acquirers.

Friendly versus Hostile Takeovers

Mergers can occur on either a friendly or a hostile basis. Typically, after identifying the target company, the acquirer initiates discussions. If the target management is receptive to the acquirer’s proposal, it may endorse the merger and recommend shareholder approval.

• Friendly merger - If the stockholders approve the merger, the transaction is typically consummated either through a cash purchase of shares by the acquirer or through an exchange of the acquirer’s stock, or some combination of stock and cash for the target firm’s shares.

• Hostile merger - If the takeover target’s management does not support the proposed takeover, it can fight the acquirer’s actions. In this case, the acquirer can attempt to gain control of the firm by buying sufficient shares of the target firm in the marketplace. This is typically accomplished by using a tender offer, which is a formal offer to purchase a given number of shares at a specified price.

Hostile mergers are more difficult to consummate because the target firm’s management acts to deter rather than facilitate the acquisition. Regardless, hostile takeovers are sometimes successful.

Strategic versus Financial Mergers

• Strategic mergers seek to achieve various economies of scale by eliminating redundant functions, increasing market share, improving raw material sourcing and finished product distribution, and so on. In these mergers, the operations of the acquiring and target firms are combined to achieve synergies, thereby causing the performance of the merged firm to exceed that of the pre-merged firms. An interesting variation of the strategic merger involves the purchase of specific product lines (rather than the whole company) for strategic reasons.

• Financial mergers are based on the acquisition of companies that can be restructured to improve their cash flow. These mergers involve the acquisition of the target firm by an acquirer, which may be another company or a group of investors that may even include the target firm’s existing management. The objective of the acquirer is to cut costs drastically and sell off...
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