Chapter 12
Financing
mergers and acquisitions
Study guide
Compare various sources of financing cash-based acquisition
Advantages and disadvantages of a financial offer using pure or mixed mode financing
Impact of financial offer on the reported financial position and performance of the acquirer
Methods of financing mergers
Cash offer (purchases): shares of acquirer will not change
Paper offer
Purchases by share exchange: there will be an increase in the issued share capital of the predator company
Purchases by convertible loan stock: convertible loan stock is a loan which gives the holder the right to convert to other securities, normally ordinary shares, at a predetermined price/rate and time.
Funding cash offers
A cash offer can be financed by:
The company’s retained earnings
The proceeds of a debt issues after the bid is accepted
A loan facility from a bank before the bid is accepted
Mezzanine finance(+p354 )
Short-to-medium term
Unsecured
Much higher rate of interest
Give the lender the option to exchange the loan for shares after the takeover
Raise cash on the stock market (share issue)
Sale of existing assets
Earn-out arrangement
The choice between
cash offer and paper offer
Factors to consider from perspective of bidding company
Dilution of EPS
Costs to the company
Gearing
Control
Authorized share capital increase
Borrowing limits increase
Factors to consider from perspective of target company
Taxation
Income
Future investments
Share price
Adv. and disadv. of cash offer
(Kaplan)
For the acquirer
Advantages
Merger can be achieved quickly
Consideration is likely to be less, since less risk to shareholders
Retains control
Disadvantages
Cash flow strain
May increase gearing or issue new shares
For target shareholders
Advantages
Certainty about bids value
Freedom to invest in a wide portfolio
Disadvantages
Liable to CGT
Do not participate in new group
Assess a given offer
——share price
Shareholders of both companies in a merger will be sensitive to the effect of the merger on share prices
Companies that make takeover bids with a share exchange offer are always concerned that the market value of their shares should not fall during the takeover negotiations.
If the market price of the target company’s share rises above the offer price during the course of a takeover bid, the takeover is likely to fail.
Assess a given offer
—— EPS
When an company acquires another by issuing shares:
if the target company’s shares are bought at a lower P/E ratio than the predator company’s share, the predator company’s share will benefit from a rise in EPS. (P356 example )
If the target company’s shares are bought at a higher P/E ratio than the predator company’s share, the predator company’s share will suffer a fall in EPS. (P356 example )
If an acquisition strategy involves buying companies on a higher P/E ratio, it is essential for the continuing EPS growth that the acquired companies offer prospects of strong profit growth. (p357 example)
Other considerations:
quality of acquired company’s earnings
net assets per share (p357 Q&A)
Effect of offer on
financial position and performance
Effects on earnings
Dilution of EPS occurs when the P/E ratio paid for the target exceeds the P/E ratio of the acquiring company. (P359 Q&A)
The size of the target’s earnings is also important: the larger the target’s earnings are relative to the acquirer, the greater the increase to EPS for the combined company.
Effects on balance sheet
Assignment
2012/6-1(b) cash offer vs. share offer
2006/12- 1(bc): type of payment; shareholders mix; other factors to consider
