Level 2 SS9

Step 3: Calculate free cash flows using the pro forma data. Starting with net income, we can calculate free cash flows as:

***note that unleveed net income also equals earnings before interest and taxes multiplied by 1 minus the tax rate and that you may be required to back into the tax rate by dividing taxes by net income before tax.

When an acquirer is negotiating with a target over the method of payment, there are three main factors that should be considered:

1. Distribution between risk and reward for the acquirer and target shareholders A. in stock offering, they share in the risk related to the ultimate value that is realized from the merger. B. in a cash offering, all of the risk related to the value of the post-merger company is borne by the acquirer. as a result, when the acquirer is highly confident in the synergies and value that will be created by the merger, it is more inclined to push for a cash offering. 2. Relative valuations of companies involved A. if acquirers shares are considered over valued, the acquirer is likely to want to use its overpriced shared as currency in the merger transaction 3. Changes in capital structure A. different payment structures have an impact on the acquiring firms capital structure. If the acquirer borrows money to raise cash for a cash offering, the associated debt will increase the acquirers financial leverage and risk. Issuing new stock for a securities offering can dilute the ownership interest for the acquirers existing shareholders.

Estimating the value of a merger target using comparable transaction analysis

1. Identify a set of recent takeover transactions A. ideally, all of the takeovers will involve firms in the same industry as the target and have a similar capital structure. These sorts of deals can be difficult to find, so the analyst will have to use some judgement as to what recent merger deals are most applicable to the analyst. 2. Calculate various relative value measures based on completed deal prices for the companies in the sample. A. the measures used here are the same as those used in comparable company analysis (e.g., P/E, P/CF), but they are based on price for completed M&A deals rather than current market prices. 3. Calculate descriptive statistics for the relative value metrics and apply those measures to the target firm. A. again, will typically calculate the mean, median, and range for the chosen relative value measures and apply those to the firm statistics for the target to determine the target's value

Step 5:determine the terminal value and discount it back to the present

:determine the terminal value and discount it back to the present. the terminal value can be determined in two ways.. The first to use a constant growth model that assumes the company grows in perpetuity at a constant rate. The constant growth formula can be used when the terminal growth rate is less than the discount rate: The second method applies a market multiple that the analyst believes that the firm will trade at the end of the first stage (e.g. projected price/free cash flow ratio): Terminal valuet = FCF t x (P/FCF)

Discounted Cash Flow (DCF)

To calculate free cash flow (FCF) for a target company and estimate its value using DCF analysis, we can use the following steps: ◦Step 1: determine which free cash flow model to use for the analysis. basic free cash flow models come in two stage or three stage varieties. we will use two, during high growth phase and a stable growth phase. ◦Step 2: describe pro forma financial estimates: these projected financial statements form the estimates that are the basis for our analysis. Step 3: Calculate free cash flows using the pro forma data Step 4: Discount free cash flows back to the present at the appropriate discount rate. Step 5:determine the terminal value and discount it back to the present Step 6: Add the discounted FCF values for the first stage and the terminal value to determine the value of the target firm.

Step 4: Discount free cash flows back to the present at the appropriate discount rate

Usually, this discount rate is simply the target's weighted average cost of capital (WACC), but in the context of evaluating a potential merger target, we want to adjust the targets WACC to reflect an changes in the targets risk or capital structure that may result from the merger (WACCadj).

Fair price amendment

a fair price amendment restricts a merger offer unless a fair price is offered to current shareholders. This fair price is usually determined by some formula or independent appraisal.

LOS 29 f: Distinguish among pre-offer and post-offer takeover defense mechanisms

two classes: pre-offer and post offer. but should try and do a pre one - hold up better in court

LOS 29.b: Explain common motivations behind M&A activity

• synergies: two companies are more together than apart. reducing costs or increasing revenues. • achieving rapid growth: especially in mature industries • increased market power: • gaining access to unique capabilities: • diversification: doesn't make sense for shareholders • bootstrapping EPS: • personal benefits for managers: • tax benefits: one company has large tax loss carry forwards. can lower its tax liability. • unlocking hidden value: gut the place, and make better. • achieving international business goals: ◦taking advantage of market inefficiencies ◦working around disadvantageous government policies ◦use technology in new markets ◦product differentiation ◦provide support to existing multinational clients

LOS 29.m: Describe the characteristics of merger and acquisition transactions that create value

• targets gain approx 30% and acquirers lose sock value of between 1 and 3% • longer term performance studies of post merger companies show that acquirers tend to underperform their peers. Average returns for acquirers three years after a merger are -4% with over 60% of acquiring firms lagging their peer group. Some believe that these results are due to a failure to capture promised synergies after a merger is completed.

Share Repurchase

• the target company can submit a tender offer for its own shares. • this forces the acquirer to raise its bid in order to stay competitive with the targets offer and also increases the use of leverage in the targets capital structure that makes the target less attractive while delivering value to shareholders

What are the five steps of the comparable company analysis?

‣ Step 1: Identify the set of comparable firm • industry, similar size and capital structure ‣ Step 2: Calculate various relative value measures based on the current market prices of companies in the sample. • enterprise value, free cash flow, EV to ebitda, and ev to sales. • look at multiples like pe or pb ratios and price to sales ‣ Step 3: Calculate descriptive statistics for the relative value metrics and apply those measures to the target firm. • calculate the mean, median and range for the chosen relative value measures and apply those to the estimates for the target to determine the target's value • value is equal to the multiple times the appropriate variable; for example, using the P/E ratio: ◦Value = ESP x (P/E) • Step 4: Estimate a takeover premium: a takeover premium is the amount that the takeover price of each of the target's shares must exceed the market price in order to persuade the target shareholders to approve the merger deal. This premium is usually expressed as a percentage of the target's stock price and is calculated as: ◦TP = DP - SP / SP ◦TP = takeover premium ◦DP = deal price per share ◦SP = target company's stock price • Step 5: Calculate the estimated takeover price for the target as the sum of estimated stock value based on comparables and the takeover premium ◦the estimated takeover price is considered a fair price to pay for control of the target company. once the takeover price is computed, the acquirer should compare it to the estimated synergies from the merger to make sure the price makes economic sense.

Effect of Payment method

◦Cash offer: in a cash offer, the acquirer assumes the risk and receives the potential reward from the merger, while the gain for the target shareholders is limited to the takeover premium. If an acquirer makes a cash offer in a deal, but the synergies realized are greater than expected, the takeover premium for the target would remain unchanged while the acquirer reaps the additional reward. Likewise, if synergies were less than expected, the target would still receive the same takeover premium, but the acquirer's gain may evaporate. ◦Stock offer: in a stock offer, some of the risks and potential rewards from the merger shift to the target firm. When the target receives stock as payment, the target's shareholders become a part owner of the acquiring company. This means that if estimates of the potential synergies are wrong, the target will share in the upside if the actual synergies exceed expectations, but will also share in the downside if the actual synergies are below expectations.

Attitude of Target Management

◦Friendly merger offers: usually beging with management approaching management. then both parties do due diligence. kept secret. then announced by both, get shareholders vote. ◦Hostile merger offers: submit proposal straight to target's board of directors in a process called a bear bug ◦if the bear bug is unsuccessful, the next step is to appeal directly to the targets shareholders using one of two methods - a tender offer or a proxy battle. ‣ in a tender offer, the acquirer offers to buy the shares directly from the target shareholders, and each individual shareholder either accepts or rejects the offer ‣ in a proxy battle, the acquirer seeks to control the target by having shareholders approve a new "acquirer approved" board of directors. a proxy solicitation is approved by regulators and then sent to the targets shareholders. If the shareholders elect the acquirers slate of directors, the new board may replace the target's management and the merger offer may become friendly

Disadvantages of comparable company analysis

◦The approach implicitly assumes that the market's valuation of the comparable companies is accurate. ◦using comparable companies provides an estimate of a fair stock price, but not a fair takeover price. An appropriate takeover premium must be determined separately. ◦it is difficult to incorporate merger synergies or changing capital structures into the analysis. ◦Historical data used to estimate a takeover premium may not be timely, and therefore may not reflect current conditions in the M&A market.

Supermajority voting provision for mergers

◦a supermajority provision in the corporate charter requires shareholder support in excess of a simple majority

White knight defense

◦a white knight is a friendly third party that comes to the rescue of the target company. ◦the target will usually seek out a third party with a good strategic fit with the target that can justify a higher price than the hostile acquirer. ◦in many cases, the white knight defense can start a bidding war between the hostile acquirer and the third party, resulting in the target receiving a very good price when a deal is ultimately completed. This tendency for the winner to overpay in a competitive bidding situation is called the winners curse

Gains Accrued to the Acquirer

◦acquires are willing to pay a takeover premium because they expect to generate their own gains from any synergies created by the transaction. ◦The acquirer's gain is therefore equal to the synergies received less the premium paid to the target's shareholders, or: ‣ GainA = S - TP = S- (Pt - Vt) ‣ where GainA = gains accrued to the acquirer's shareholders ‣ note that in a cash deal the cash paid to the target shareholders (C) is equal to the price paid for the target (Pt) ‣ also, the gains of the acquirer and the gains for the target leave us with S, or synergies from the deal. It's the gain resulting from the estimated value of cost reduction synergies or revenue enhancement synergies that the acquirer and the target are dividing.

Crown Jewel Defense

◦after a hostile takeover offer, a target may decide to sell a subsidiary or major asset to a neutral third party ◦if the hostile acquirer views this asset as essential to the deal (i.e. a crown jewel), then it may abandon the takeover attempt. ◦the risk here is that courts may declare the strategy illegal if a significant asset sale is made after the hostile bid is announced

Pac-man defense

◦after a hostile takeover offer, the target can defend itself by making a counteroffer to acquire the acquirer. ◦in practice, the pac man defense is rarely used because it means a smaller company would have to acquire a larger company, and the target may also lose the use of other defense tactics as a result of its counteroffer.

LOS 29.c: Explain how earnings per share (EPS) bootstrapping works, and calculate a company's postmerger EPS.

◦bootstrapping is a way of packaging the combined earnings from two companies after a merger so that the merger generates an increase in the earnings per share of the acquirer, even when no real economic gains have been achieved. ◦the bootstrap effect occurs when a high P/E firm (generally a firm with high growth prospects) acquires a low PE firm (low growth prospects) in a stock transaction. ◦post merger, the earnings of the combined firm are simply the sum of the respective earnings prior to the merger. ◦however, by purchasing the firm with a lower P/E, the acquiring firm is essentially exchanging higher-priced shares for lower priced shares. ◦As a result, the number of shares outstanding for the acquiring firm increases, but as a ratio that is less than 1 for 1. ◦when we compute the EPS for the combined firm, the numerator (total earnings) is equal to the sum of the combined firms, but the denominator (total shares outstanding) is less than the sum of the combined firms. The result is a higher reported EPS, even when the merger creates no additional sumergistic value.

Cash Offerings

◦cash offerings are straight forward in that the acquirer simply pays an agreed upon amount of cash for the target companys shares

Restrictive Takeover Laws

◦companies in the United States are incorporated in specific states, and the rules of that state apply to the corporation ◦some states are more target friendly than others when it comes to having rules to protect against hostile takeover attempts. ohio and penns have a lot.

LOS 29.j: Estimate the value of a target company using comparable company and comparable transaction analyses

◦comparable company analysis uses relative valuation metrics for similar firms to estimate market value and then adds a takeover premium to determine a fair price for the acquirer to pay for the target.

Advantages of comparable company analysis

◦data for comparable companies is easy to access. ◦assumption that similar assets should have similar values is fundamentally sound ◦estimates of value are derived directly from the market rather than assumptions and estimates about the future.

LOS 29.o: Explain common reasons for restructuring

◦decision no longer fits into managements long term strategy ◦lack of profitability: ◦individual parts are worth more than the whole: reverse synergy ◦infusion of cash:

Divestitures

◦divestitures refer to a company selling, liquidating, or spinning off a division or subsidiary. Most divestitures involve a direct sale of a portion of a firm to an outside buyer. The selling firm is typically paid in cash and gives up control of the portion of the firm sold

LOS 29.1: Explain the effects of price and payment method on the distribution of risks and benefits in a merger transaction

◦effect of price ‣ with any merger deal, the acquirer and the target are on opposite sides of the table because both parties want to extract as much value as possible for themselves out of the deal. This means that the acquirer will want to pay the lowest possible price (the ore-merger value of the target, Vt), while the target wants to receive the highest possible price (the premerger value of the target plus the expected synergies, Vt + S)

Equity carve-outs:

◦equity carve-outs create a new, independent company by giving an equity interest in a subsidiary to outside shareholders. ◦Shares of the subsidiary are issued in a public offering of stock, and the subsidiary becomes a new legal entity whose management team and operations are separate from the parent company.

Restricted voting rights

◦equity ownership above some threshold level (e.g. 15% or 20%) triggers a loss of voting rights unless approved by the board of directors. ◦this greatly reduces the effectiveness of a tender offer and forces the bidder to negotiate with the board of directors directly.

Greenmail

◦essentially, greenmail is a payoff to the potential acquirer to terminate the hostile takeover attempt ◦greenmail is an agreement that allows the target to repurchase its share from the acquiring company at a premium to the market price. ◦the agreement is usually accompanied by a second agreement that the acquirer will not make another takeover attempt for a defined period of time. ◦greenmail used to be popular in the United States in the 1980s, but it has been rarely used after a 1986 change in tax laws added a 50% tax on profits realized by acquirers through greenmail.

Golden parachutes

◦golden parachutes are compensation agreements between the target and its senior management that give the managers lucrative cash payouts if they leave the target company after a merger ◦in practice, payouts to managers are generally not big enough to stop a large merger deal, but they do ease the target managements concern about losing their jobs.

Types of mergers

◦horizontal merger: the two business operate in the same or similar industries, and may often be competitors. ◦vertical merger: in a vertical merger, the acquiring company seeks to move up or down the product supply chain. For example, an ice cream manufacturer decides to acquire a restaurant chain so it can have an outlet for its products and not rely on supermarkets or other restaurants. This is an example of forward integration, where the acquirer is moving up the supply chain toward the ultimate consumer. If the same ice cream manufacturer purchases a farm so it can supply its own milk and cream for its products, it is called backward integration because the company is moving down the supply chain toward the raw material inputs. ◦conglomerate merger: the two companies operate in completely separate industries. As such, there are expected to be few, if any, synergies from combining the two companies. For example, Burgerworlds decision to venture into the oil exploration business via acquisition represents a conglomerate merger because there are no apparent benefits (other than perhaps feeding hungry workers)

LOS 29 g.: Calculate and interpret the herfindahl-hirschman index, and evaluate the likelihood of an antitrust challenge for a given business combination.

◦in 1982, the herfindahl hirscman index (HHI) replaced market share as the key measure of market power for determining potential antitrust violations. The HHI is calculated as the sum of the squared market shares for all firms within an industry. • if the post merger HHI is less than 1,000, the industry is considered competitive and an antitrust challenge is unlikely. • a post merger HHI value between 1,000 and 1,800 will place the industry in the moderately concentrated category. • in this case, regulators will compare the pre merger and post merger HHI. • if the change is greater than 100 points, the merger is likely to be challenged on antitrust grounds. • a greater HHI calculation greater than 1,800 implies a highly concentrated industry • regulators will again compare the pre merger and post merger HHI calculations, but in this case, if the change is greater than 50, the merger is likely to be challenged. The guidelines for determining the likelihood of an antitrust challenge are summarized in figure 3.

Leveraged recapitalization

◦in a leveraged recapitalization, the target assumes a large amount of debt that is used to finance share repurchases ◦like the share repurchase, the effect is to create a significant change in capital structure that makes the target less attractive while delivering value to shareholders.

Stock purchase

◦in a stock purchase, the acquirer gives the target firm shareholders cash and or securities in exchange for shares of the target company's stock. There are several important issues regarding stock purchases of which you should be aware. ‣ shareholders must approve merger with majority vote. ‣ shareholders will bear any tax consequences associated with the transaction ‣ finally, most stock purchases involve purchasing the entire company and not just a portion of it. not only get assets, but also get liabilities.

Cash Payment Versus Stock Payment

◦in addition to the price paid, the ultimate gain to the acquirer or the target is also affected by the choice of payment method. ◦mergers can be either financed through cash or through an exchange of shares of the combined firm. ◦The chosen payment method typically reflects how confident both parties are about the estimated value of the synergies resulting form the merger. ◦This is because different methods of payment will give the acquirer and the target different risk exposures with respect to misestimating the value of synergies. ◦With a cash offer, the target firms shareholders will profit by the amount paid over its current share price (i.e. the takeover premium). However, this gain is capped at that amount ◦with a stock offer, the gains will be determined in part by the value of the combined firm, because the target firms shareholders do not receive cash and just walk away, but rather ownership in the new firm. Accordingly, for a stock deal we must adjust our formula for the price of the target: ‣ PT = (N x PAt) • where N = number of new shares the target receives • PAT = price per share of combined firm after the merger announcement • note use of PAT which is market price of AT and not Vat - value of AT in the formula

Asset purchase

◦in an asset purchase, the acquirer purchases the target company's assets, and payment is made directly to the target company. ‣ unless the assets are substantial (ie. more than 50% of the company), shareholder approval is generally not required. ‣ payment is made to the company, so there is no direct tax consequences for shareholder. the target company will pay any capital gains taxes associated with the transaction at the corporate level. ‣ asset purchase acquisitions usually focus on specific parts of the company that are of particular interest to the acquirer, rather than the entire company, which means that the acquirer generally avoids assuming any of the target company's liabilities. However, an asset purchase for the sole purpose of avoiding the assumption of liabilities is generally not allowed from a legal standpoint. Figure 2 summarizes the key differences between stock purchase and an asset purchase.

Post-Merger Value of an Acquirer

◦in any merger that makes economic sense, the combined firm will be worth more than the sum of the two separate firms. ◦This difference is the gain, which is a function of synergies created by the merger and any cash paid to shareholders as part of the transaction.

Gains Accrued to the Target

◦in most merger transactions, acquirers must pay a takeover premium to entice the target's shareholders to approve the merger. ◦the target company's management will try to negotiate the highest possible premium relative to the value target company. ◦From the target's perspective, the takeover premium is the amount of compensation received in excess of the pre-merger value of the target's shares or: ‣ Gaint = TP = Pt - Vt

Mature growth phase:

◦in the mature phase, new competition has reduced industry profit margins, but the potential still exists for above average growth ◦merger motivations are generally focused on operational efficiencies as companies want to generate economies of scale to reduce costs to keep profit margins high. ◦as a result, horizontal and vertical mergers that provide synergies and expand market power are most common in this phase.,

Pioneer/development phase

◦in the pioneer phase, it is generally still uncertain whether consumers will accept a firm's product or service. ◦the industry typically has large capital needs to fund development, but is not generating profits. ◦in this stage, younger, smaller companies may seek to sell themselves to larger, more mature companies that have ample resources and want to find a new growth opportunity, or they may merge with a similar firm that will allow both companies to share management talents and financial resources. ◦as a result, the common types of mergers seen in this stage are conglomerate mergers and horizontal mergers.

stabilization growth phase:

◦in the stabilization phase, competition has eliminated most of the growth potential in the industry, and the rate of growth is in line with that of the overall economy. Companies in this phase seek mergers to generate economies of scale in order to compete with a lower cost structure. ◦they may also acquire smaller companies that can provide stronger management and a wider financial base ◦in this phase, horizontal mergers are the most common as the stronger companies acquire the weaker companies to consolidate market share and reduce costs.

Staggered Board

◦in this strategy, the board of directors is split into roughly three equal sized groups. ◦each group is elected for a 3 year term in a staggered system: in the first year the first group is elected, the following year the next group is elected,and in the final year the third group is elected. ◦the implications are straight forward- in any particular year, a bidder can win at most one third of the board seats. It would take a potential acquirer at least two years to gain majority control of the board since the terms are overlapping for the remaining board members. this is usually longer than a bidder would wan to wait and can deter a potential acquirer.

Advantages of discounted cash flow analysis

◦it is relatively easy to model any changes in the target company's cash flow resulting from operating synergies or changes in cost structure that may occur after the merger. ◦the estimate of company value is based on forecasts of fundamental conditions in the future rather than on current data ◦the model is easy to customize

Post-Offer Defense Mechanisms

◦just say no defense ◦litigation ◦greenmai ◦share repurchase ◦leveraged recapitalization ◦crown jewel defense ◦pacman defense ◦white knight defense ◦white squire defense

Liquidations

◦liquidations break up the firm and sell its asset piece by piece. Most liquidations are associated with bankruptcy

Pre-Offer Defense Mechanisms

◦poison pill: poison pills are extremely effective anti-takeover devices and were the subject of many legal battles in their infancy. ‣ in its most basic form, a poison pill gives current shareholders the right to purchase additional shares of stock at extremely attractive prices (i.e., at a discount to current market value), which causes dilution and effectively increases the cost to the potential acquirer ‣ the pills are usually triggered when a shareholders equity stake exceeds some threshold level. ‣ specific forms of a poison pill are a flip in pill, where the target company;s shareholders have the right to buy the targets shares at a discount, and a flip over pill, where the targets shareholders have then right to buy the acquirers shares at a discount. ‣ in case of a friendly merger offer, most poison pill plans give the board of directors the right to redeem the pill prior to a triggering event.

What are the two methods of payments?

◦securities offering and a cash offering and sometimes a mix of these

Advantages of comparable transaction analysis

◦since the approach uses data from actual transactions, there is no need to estimate a separate takeover premium. ◦estimates of value are derived directly from recent prices for actual deals completed in the marketplace rather than from assumptions and estimates about the future. ◦use of prices established by recent transactions reduces the risk that the target's shareholders could file a lawsuit against the target's managers and board of directors for mispricing the deal.

Spin-offs:

◦spin-offs are like carve-outs in that they create a new independent company that is distinct from the parent company. ◦the primary difference is that shares are not issued to the public, but are instead distributed proportionately to the parent company's shareholders. ◦this means that the shareholder base of the spin-off will be the same as that of the parent company, but the management team and operations are completely separate. ◦since shares of the new company are simply distributed to existing shareholders, the parent company does not receive any cash in the transaction.

Split-offs

◦split-offs allow shareholders to receive new shares of a division of the parent company in exchange for a portion of their shares in the parent company. the key here is that shareholders are giving up a portion of their ownership in the parent company to receive the new shares of stock i the division

Forms of Integration

◦statutory merger: The acquiring company acquires all of the target's assets and liabilities. As a result, the target company ceases to exist as a separate entity. Note that in a statutory merger, the target company is usually smaller than the purchaser, but this is not always the case. ◦Subsidiary merger: the target company becomes a subsidiary of the purchaser. Most subsidiary mergers typically occur when the target has a well known brand, that the acquirer wants to retain (e.g. proctor and gamble buying gillette) ◦consolidation: both companies cease to exist in their prior form, and they come together to form a completely new company. Consolidations are common in mergers when both companies are of a similar size.

Acquirers are likely to earn positive returns on a deal characterized by:

◦strong buyer: Acquirers that have exhibited strong performance (in terms of earnings and stock price growth) in the prior three years. ◦low premium: the acquirer pays a low takeover premium ◦few bidders: the lower the number of bidders, the greater the acquirer's future returns. ◦favorable market reaction: positive market price reaction to the acquisition announcement is a favorable indicator for the acquirer.

Disadvantages of comparable transaction analysis

◦the approach implicitly assumes that the M&A market valued past transactions accurately. If past transactions were over or underpriced, the mispricings will be carried over to the estimated value for the target. ◦There may not be enough comparable transactions to develop a reliable data set for use in calculating the estimated target value. If the analyst isn't able to find enough similar companies, she may try to use M&A deals from other industries that are not similar enough to the deal being considered. ◦It is difficult to incorporate merger synergies or changing capital structures into the analysis.

Litigation

◦the basic idea is to file a lawsuit against the acquirer that will require expensive and time consuming legal efforts to fight. ◦the typical process is to attack the merger on anti trust grounds or for some violation of securities law. ◦the courts may disallow the merger or provide a temporary injunction delaying the merger, giving managers more time to load up their defense or seek a friendly offer from a white knight

Decline Phase

◦the decline phase is characterized by overcapacity, declining profit margins, and lower demand as tastes may have changed and consumers seek new technologies. ◦in this stage, all three types of mergers are common ◦a company may seek a horizontal merger simply to survive, vertical mergers may be used to increase efficiencies and increase profit margins, and conglomerate mergers may occur as companies acquire smaller companies in different industries to try to find new growth opportunities.

LOS 29.d: Explain, based on industry life cycles, the relation between merger motivations and types of mergers

◦the industry life cycle recognizes that industries go through certain phases based on their rates of growth. the motivations that a company may have for entering into a merger and the type of merger can depend a great deal on what phase of the industry life cycle the company is in.

Disadvantages of discounted cash flow analysis

◦the model is difficult to apply when free cash flows are negative. for example, a target company experiencing rapid growth may have negative free cash flows due to large capital expenditures ◦estimates of cash flows and earnings are highly subject to error, especially when those estimates are for time periods far in the future. ◦discount rate changes over time can have a large impact on the valuation estimate ◦estimation error is a major concern since the majority of the estimated value for the target is based on the terminal value, which is highly sensitive to estimates used for the constant growth rate and discount rate

Whats the main factor that affects the method of payment decision is confidence in the estimate of merger synergies:

◦the more confident both parties are that synergies will be realized, the more the acquirer will prefer to pay cash and the more the target will prefer to receive stock. ◦Conversely, if estimates of synergies are uncertain, the acquirer may be willing to shift some of the risk (and potential reward) to the target by paying for the merger with sock, but the target may prefer the guaranteed gain that comes from a cash deal.

Rapid growth phase

◦the rapid growth is characterized by high profit margins and accelerating sales and earnings. ◦the product or service provided by the company is accepted by consumers, but there is little competition in the industry. ◦merger motivations in this stage are usually driven by capital requirements as companies look for more resources to finance their expansion. The common types of mergers seen in this stage are conglomerates, as larger, more mature companies are able to provide capital, and horizontal mergers as similar firms combine resources to finance further growth

White Squire defense

◦the squire analogy means that the target seeks a friendly third party that buys a minority stake in the target without buying the entire company. ◦the idea is for the minority stake to be big enough to block the hostile acquirer from gaining enough shares to complete the merger. ◦in practice, the white squire defense involves a high risk of litigation, depending on the details of the transaction, especially if the third party acquires shares directly from the company and the targets shareholders do not receive any compensation.

Securities Offering

◦the target shareholders receive shares of the acquirers common stock in exchange for their shares in the target company. ◦the number of the acquirers shares received for each target company share is based on the exchange ratio. ◦the total compensation ultimately paid by the acquirer in a stock offering is based on three factors: ‣ the exchange ratio ‣ the number of shares outstanding of the target company ‣ and the value of the acquirers stock on the day the deal is completed

Form of Acquisition

◦the two basic forms of acquisition are a stock purchase or an asset purchase

Just say No defense

◦the first step in avoiding a hostile takeover offer is to simply say no ◦if the potential acquirer goes directly to shareholders with a tender offer or a proxy fight, the target can make a public case to the shareholders concering why the acquirers offer is not in the shareholders best interests

Poison Put

◦this anti takeover device is different from the others, as it focuses on bondholders. ◦these puts give bondholders the option to demand immediate repayment of their bonds if there is a hostile takeover. ◦this additional cash burden may fend off a would be acquirer.