Spring 2022 Corporate Acquisition Final Exam Solutions – Columbia University
Discuss How Financial Bargain Can Affect the Choice of An Acquisition
How Does Discount to Asset Value Affect the Choice of An Acquisition?
How Does Increase in Earnings Per Share Impact Acquisitions?
- An all-share offer by the acquiror for 100% of the shares of the target company.
- The terms are based on the market prices of the shares of the two companies.
|Number of shares in issue||1000||1000|
|Earnings per share||0.10||0.05|
|Multiple on which shares are related||12 times||8 times|
|Terms of offer (based on respective market prices)||1 new share||3 existing shares|
|Enlarged issued share capital||1000+333||--||1333|
|New earnings per share||(150 divided by 1333) assume acquiror’s rating unchanged||0.1125|
|Multiple on which shares are related||12|
|New share price||0.1125 x||12||1.35|
|New market capitalisation||1333 x||1.35||1800|
The increase in earnings per share, from 0.10 to 0.1125, is a simple question of mathematics, following from the assumption that the terms of the share exchange are based on respective market prices. (This is in fact an over-simplification, as normally a premium over market would have to be paid for the target.) The increase in the market price of the acquiror after the offer from $1.20 to $1.35 depends on whether the combined group remains rated at the multiple of the acquiror prior to the offer, that is 12 times. If it does, or at least holds at above the weighted average multiple of the acquiror and the target (weighted by size of earnings), the market capitalisation of the combined group will be higher than that of the two companies separately.
An aggressive company may have gained for itself a high market rating on the expectation of rapid growth in profits. These expectations can be fulfilled, at least in the short term, be acquisitions on terms such as those illustrated in the example. Indeed, they may be self-fulfilling for the moment in that the ability to grow by acquisition (apparently proved) may be part of the reason for the premium rating.
However, unless the acquisitions are very skillful ones, the rating of the acquiror will in due course suffer as the proportion of earnings contributed by lowly-rated companies increases. In addition, the size and number of acquisitions at low ratings needed to maintain this strategy over a period of time becomes ever larger, leading to its collapse unless the acquiror and/or the companies acquired are also capable of achieving organic growth.
In the case of a cash offer, a similar effect will be achieved if the return from the business acquired at the purchase price is higher than the funding cost. The funding cost in the short term (as it will affect the reported earnings) could be considered either to be the cost of debt incurred to finance the purchase or, if surplus cash is used, the interest foregone on the cash deposits. In the longer term, if acquisitions are funded purely by cash or borrowings, the increased gearing is likely to require further equity issues.
What Is the Role of Financial Gearing in Acquisitions?
An acquisition by means of a share exchange of a company which has low borrowings or surplus cash is likely to reduce the financial gearing of the enlarged group. In an extreme form, the acquiring company may issue shares to purchase an investment trust or other company with highly liquid assets. This type of transaction may be seen more as a disguised equity issue than a true acquisition.
An acquiror may take the opportunity to change the balance of its capital structure. The terms of an acquisition may include the issue of unsecured loan stock or convertible securities in addition to ordinary shares and cash. By juggling with the proportions of such elements in the total consideration, the acquiring group can increase or decrease the proportion of long-term debt in its balance sheet and adjust its overall gearing.
How Does Ambition Affect the Occurrence of An Acquisition?
Prestige and compensation in an organization may depend more on size than results. Acquisitions are the quickest way of building up the size of the group. An element of small-town boy makes good' may come into play. An individual who has built up his company reaches a stage where he seeks to acquire more established and well-known organizations. Sometimes these are companies he has admired in the past or had to ask for help during his rise.
A successful acquisition often brings with it extensive publicity. Certain noted corporate raiders and their advisers have become national figures for a time. The exposure may mainly be a matter of ego. However, it can also be justified in terms of increased corporate and management visibility. This may lead to improved ratings in the stock market and a larger number of acquisition opportunities being presented by brokers. A high degree of determination on the part of an individual or group is usually necessary to bring an acquisition to a successful conclusion, particularly if it is contested. During the course of an acquisition, occasions almost always arise where the parties concerned are ready to call it off. In these circumstances, the motivation and drive of a particular individual can be a critical factor.
Explain How Defense Can Lead to An Acquisition
It is commonly believed that the bigger the group is, the harder it is to swallow. Companies therefore sometimes attempt acquisitions principally in order to grow too big to be taken over by a feared rival. In addition, the more complex a group is, the greater is the likelihood that regulatory authorities or some other interested parties will find grounds to raise objections to a takeover. A company in a sensitive area, for example communications and broadcasting, may be particularly favoured as an acquisition partly for this reason.
Companies espousing this philosophy should be wary of creating their own downfall. Ill-conceived acquisitions can lead to criticisms and disaffection from shareholders. Weakening the financial position of the group through expensive purchases ultimately plays into an acquiror's hands.
Can Good Management Ignite an Acquisition?
Some acquisitions are made primarily to the of a manager or management team who have proved themselves competent at running a particular type of company or handling a particular type of crisis. Sometimes the specialized professional expertise or contacts of individuals are what is sought. An example would be the purchase of a stockbroker or insurance agency by a bank. In such cases, an important task is for groups of people with a different approach to conducting business to learn to work together effectively.
Explain How Tax Losses Can Lead to An Acquisition
Companies which have been unsuccessful may have accumulated considerable losses for taxation purposes which may in certain circumstances be utilized by an acquiring group. Usually, the company is valued on the basis of a discount to the amount of tax which will be saved. The feasibility of such an acquisition depends critically on the tax regulations in the country concerned and the current interpretation of them.
How Can the Ease to Obtain a License Facilitate an Acquisition?
A license, for example to conduct a banking business or operate a TV station may be more easily obtained by acquiring a company which already holds such a license than by a fresh application. Care must be taken to ensure that a change of control in the company acquired does not jeopardize the continuity or validity of the license. If it is practical, this matter should be cleared in advance with the authority responsible for granting the license or regulating companies which hold it. This may not always be possible for tactical reasons; in which case any agreement should be conditional on the appropriate clearance being obtained
This chapter has discussed the main motives for making takeovers. The motives are divided into commercial, financial and customized. An acquisition which is undertaken for a specialized purpose may also have a commercial basis and be capable of justification in financial terms.