Deck 1: Introduction to Mergers, Acquisitions, and Other Restructuring Activities

Question 1

Discuss why mergers and acquisitions occur.

Answer 1

The primary motivations for M&As include an attempt to realize synergy by combining the acquiring and target firms, diversification, market power, strategic realignment, hubris, buying what are believed to be undervalued assets, so-called agency problems, managerialism, and tax considerations. Synergy is the notion that combining two firms results in a valuation of the combined firms that exceeds the sum of the two firms valued on a standalone basis. Synergy represents the incremental cash flows only achievable by combining the acquirer and target firms. Synergy is often realized by achieving economies of scale, the spreading of fixed costs over increasing levels of production, or economies of scope, the utilization of a specific set of skills or an asset currently employed to produce a specific product to produce related products. Financial synergy represents another source of increased value that may be realized by lowering the combined firm's cost of capital if the new firm experiences lower overall transaction costs in raising capital and a better matching of investment opportunities with internally generated funds. Diversification may be either related or unrelated. Both forms represent an effort by the acquirer to shift assets away from a lower growth, less profitable focus to a higher growth, potentially more profitable area. Strategic realignment represents a radical departure from a firm's primary business to another area of focus often because of changes in regulations or technology, which makes obsolete the firm's primary business.
Hubris is often the motivation for M&As even if the market correctly values a firm, since the acquiring firm's management may believe that there is value in the target firm that investors do not see. Firms may also be motivated to buy another firm if the firm's market value is less than what it would cost to replace such assets. Agency problems arise when there is a difference between the interest of incumbent managers and the firm's shareholders. By acquiring the firm, value is created when managers whose interests are more aligned with shareholders replace current management; and, as such, these new managers are more inclined to make value enhancing investments rather than those intended to entrench management or contribute to their overall compensation. Firms may acquire another firm to achieve greater market share in an effort to be able to gain more control over pricing. Managerialism is a situation in which a firm's managers acquire other firms simply to increase the acquiring firm's size and their own compensation. Finally, an acquirer with substantial taxable income may wish to acquire a target firm with significant loss carryforwards and investment tax credits in order to shelter more of their taxable income.

Question 2

are the critical assumptions that Microsoft is making in buying Nokia? Do you believe these assumptions are realistic? Explain your answer.

Answer 2

The key assumption Microsoft is making is that the marketplace wants an alternative to Google's Android and Apple's IOS operating systems. The marketplace consists of distributors, handset manufacturers, app developers, and end users. Distributors such as Verizon, AT&T, and Vodafone can use the option of another operating system to gain leverage in their negotiations with vendors. The same thing is true with handset manufacturers such as Samsung and HTC. However, app developers may be less enthusiastic about Windows Phone 8 powered Nokia handsets, because they represent such a small installed base of users. From the viewpoint of end users (those actually using the smartphone), the existing operating systems (Android and IOS) and hardware manufacturers such as Apple and Samsung have created huge entry barriers for Microsoft such as their wide appeal and huge user bases. It is unclear if Microsoft teaming with Nokia can come up with a demonstrably superior product to drive customers away from existing operating systems and handset vendors.
Examination Questions and Answers
True/False: Answer True or False to the following questions:

Question 3

Using the motives for mergers and acquisitions described in Chapter 1, which do you think apply to Microsoft's acquisition of Nokia? Discuss the logic underlying each motive you identify. Be specific.

Answer 3

Microsoft has been struggling to strategically realign itself into a leading global mobile technology competitor due to the market shift to smartphones and tablet computers to offset the substitution of these new technologies for its PC products. The failure to do so threatened the entire Microsoft franchise. Initially, the firm tried to introduce its own smartphone operating system and to license it to wireless carriers with little success. This was followed with an unsuccessful partnership with Nokia. Frustrated in these efforts, the firm achieved complete control by acquiring Nokia. This move represented related diversification in that Microsoft was vertically integrating into the handset business in an effort to integrate its Windows Phone 8 operating system with hardware (handsets). It should be considered related diversification in that it represented the sale of existing products (i.e., a Microsoft operating system powered handset) that it had been selling under the prior partnership with Nokia to its current customers.
Microsoft also was motivated to buy Nokia's undervalued assets in that such a move represented a less expensive alternative to building a handset manufacturing capability within Microsoft. Potential operating synergies could be realized by merging global marketing and distribution activities and administrative overhead. Also, certain purchase price discounts could be realized by buying chips commonly used in both smartphones and tablets in larger volumes. Tax considerations also may have played a role in that Microsoft was able to avoid paying a high tax rate on profits repatriated to the U.S. by using such profits to pay for the takeover of Nokia.

Question 4

divestiture is the sale of all or substantially all of a company or product line to another party for cash or securities.

Question 5

In your opinion, what are the motivations for two mergers or acquisitions in the news?

Question 6

Dow Chemical, a leading chemical manufacturer, announced that it had reached an agreement to acquire in late
2008 Rohm and Haas Company for $15.3 billion. While Dow has competed profitably in the plastics business for
years, this business has proven to have thin margins and to be highly cyclical. By acquiring Rohm and Haas,
Dow will be able to offer less cyclical and higher margin products such as paints, coatings, and electronic
materials. Would you consider this related or unrelated diversification? Explain your answer. Would you
consider this a cost effective way for the Dow shareholders to achieve better diversification of their investment
portfolios?

Question 7

In 2000, AOL acquired Time Warner in a deal valued at $160 billion, excluding assumed debt. Time Warner is
the world's largest media and entertainment company, whose major business segments include cable networks,
magazine publishing, book publishing and direct marketing, recorded music and music publishing, and film and
TV production and broadcasting. AOL viewed itself as the world leader in providing interactive services, Web
brands, Internet technologies, and electronic commerce services. Would you classify this business combination
as a vertical, horizontal, or conglomerate transaction? Explain your answer.

Question 8

On September 30, 2000, Mattel, a major toy manufacturer, virtually gave away The Learning Company, a
maker of software for toys, to rid itself of a disastrous foray into software publishing that had cost the firm
literally hundreds of millions of dollars. Mattel, which had paid $3.5 billion for the firm in 1999, sold the unit
to an affiliate of Gores Technology Group for rights to a share of future profits. Was this related or unrelated
diversification for Mattel? How might this have influenced the outcome?

Question 9

Joint ventures are cooperative business relationships formed by two or more separate parties to achieve common strategic objectives

Question 10

merger of equals is a merger framework usually applied whenever the merger participants are comparable in size, competitive position, profitability, and market capitalization.

Question 11

a time when natural gas and oil prices were at record levels, oil and natural gas producer, Andarko
Petroleum, announced on June 23, 2006 the acquisition of two competitors, Kerr-McGee Corp. and Western Gas Resources, for $16.4 billion and $4.7 billion in cash, respectively. These purchase prices represent a substantial 40 percent premium for Kerr-McGee and a 49 percent premium for Western Gas. The acquired assets strongly complement Andarko's existing operations, providing the scale and focus necessary to cut overlapping expenses and to concentrate resources in adjacent properties. What do you believe were the primary forces driving Andarko's acquisition? How will greater scale and focus help Andarko to reduce its costs? Be specific. What are the key assumptions implicit in your argument?

Question 12

Pfizer, a leading pharmaceutical company, acquired drug maker Pharmacia for $60 billion. The purchase price
represented a 34 percent premium to Pharmacia's pre-announcement price. Pfizer is betting that size is what
matters in the new millennium. As the market leader, Pfizer was finding it increasingly difficult to sustain the
double-digit earnings growth demanded by investors. Such growth meant the firm needed to grow revenue by $3-
$5 billion annually while maintaining or improving profit margins. This became more difficult due to the
skyrocketing costs of developing and commercializing new drugs. Expiring patents on a number of so-called
blockbuster drugs intensified pressure to bring new drugs to market. In your judgment, what were the primary
motivations for Pfizer wanting to acquire Pharmacia? Categorize these in terms of the primary motivations for
mergers and acquisitions discussed in this chapter.

Question 13

Nokia takeover is an example of vertical integration. How does vertical integration differ from horizontal integration? How are the two businesses (software and hardware) the same and how are they different? What are the potential advantages and disadvantages of this vertical integration for Microsoft? Be specific.

Question 14

target company is the firm being solicited by the acquiring company.

Question 15

What are the arguments for and against corporate diversification through acquisition? Which do you support and why?

Question 16

What is the role of the investment banker in the M&A process?

Question 17

vertical merger is one in which the merger participants are usually competitors.

Question 18

What are the primary differences between operating and financial synergy? Give examples to illustrate your statements.

Question 19

Speculate as to why Microsoft used cash rather than some other form of payment to acquire Nokia?

Question 20

Speculate as to why Microsoft and Nokia initially decided to form a partnership rather than have Microsoft simply acquire Nokia? Why was the partnership unsuccessful?

Question 21

A horizontal merger occurs between two companies within the same industry.

Question 22

Holding companies can gain effective control of other companies by owning significantly less than 100% of their outstanding voting stock.

Question 23

An acquisition occurs when one firm takes a controlling interest in another firm, a legal subsidiary of another firm, or selected assets of another firm. The acquired firm often remains a subsidiary of the acquiring company.

Question 24

A conglomerate merger is one in which a firm acquires other firms, which are highly related to its current core business.

Question 25

In a statutory merger, the acquiring company assumes the assets and liabilities of the target firm in accordance with the prevailing federal government statutes.

Question 26

In a consolidation, two or more companies join together to form a new firm.

Question 27

Holding companies and their shareholders may be subject to triple taxation.

Question 28

When investment bankers are paid by a firm's board to evaluate a proposed takeover bid, their opinions are given in a so-called "fairness letter."

Question 29

A leveraged buyout is the purchase of a company using as much equity as possible.

Question 30

Operational restructuring refers to the outright or partial sale of companies or product lines or to downsizing by closing unprofitable or non-strategic facilities.

Question 31

The acquisition of a coal mining business by a steel manufacturing company is an example of a vertical merger.

Question 32

Only interest payments on ESOP loans are tax deductible by the firm sponsoring the ESOP.

Question 33

The merger of Exxon Oil Company and Mobil Oil Company was considered a horizontal merger.

Question 34

primary advantage of a holding company structure is the potential leverage that can be achieved by gaining effective control of other companies' assets at a lower overall cost than would be required if the firm were to acquire 100 percent of the target's outstanding stock.

Question 35

A joint venture rarely takes the legal form of a corporation.

Question 36

Investment bankers offer strategic and tactical advice and acquisition opportunities, screen potential buyers and sellers, make initial contact with a seller or buyer, and provide negotiation support for their clients.

Question 37

Financial restructuring generally refers to actions taken by the firm to change total debt and equity structure.

Question 38

Large investment banks invariably provide higher quality service and advice than smaller, so-called boutique investment banks.

Question 39

In a statutory merger, both the acquiring and target firms survive.

Question 40

Most M&A transactions in the United States are hostile or unfriendly takeover attempts.

Question 41

Because of hubris, managers of acquiring firms sometimes believe their valuation of a target firm is superior to the market's valuation. Under these circumstances, they often end up overpaying for the firm. True and False

Question 42

Takeover attempts are likely to increase when the market value of a firm's assets is more than their replacement value.

Question 43

Tax benefits, such as tax credits and net operating loss carry-forwards of the target firm, are often considered the primary reason for the acquisition of that firm.

Question 44

An acquisition is the purchase of an entire company or a controlling interest in a company.

Question 45

Deregulated industries often experience an upsurge in M&A activity shortly after regulations are removed.

Question 46

Overpayment is the leading factor contributing to the failure of M&As to meet expectations.

Question 47

A statutory merger is a combination of two corporations in which only one corporation survives with the merged corporation goes out of existence.

Question 48

Mergers and acquisitions rarely pay off for target firm shareholders, but they are usually beneficial to acquiring firm shareholders.

Question 49

Post-merger returns to shareholders often do not meet expectations. However, this is also true of such alternatives to M&As as joint ventures, alliances, and new product introductions.

Question 50

Consolidation occurs when two or more companies join to form a new company.

Question 51

Operating synergy consists of economies of scale and scope. Economies of scale refer to the spreading of variable costs over increasing production levels, while economies of scope refer to the use of a specific asset to produce multiple related products or services.

Question 52

Although there is substantial evidence that mergers pay off for target firm shareholders around the time the takeover is announced, shareholder wealth creation in the 3-5 years following a takeover is often limited.

Question 53

Growth is often cited as an important factor in acquisitions. The underlying assumption is that that bigger is
better to achieve scale, critical mass, globalization, and integration.

Question 54

Market power is a theory that suggests that firms merge to improve their ability to set product and service selling prices.

Question 55

A leveraged buyout is the purchase of a company financed primarily by debt. This is a term commonly applied to a firm going private financed primarily by debt.

Question 56

Pre-merger returns to target firm shareholders can exceed 30% around the announcement date of the transaction.

Question 57

A subsidiary merger is a merger of two companies where the target company becomes a subsidiary of the parent.

Question 58

During periods of high inflation, the market value of assets is often less than their book value. This often creates an attractive M&A opportunity.

Question 59

Most empirical studies support the conclusion that unrelated diversification benefits a firm's shareholders.

Question 60

Synergy is the notion that the combination of two or more firms will create value exceeding what either firm could have achieved if they had remained independent.

Question 61

Which of the following is true only of a consolidation?

A) More than two firms are involved in the combination
B) One party to the combination disappears
C) All parties to the combination disappear
D) The entity resulting from the combination assumes ownership of the assets and liabilities of the acquiring firm only.
E) One company becomes a wholly owned subsidiary of the other.

Question 62

Which of the following represent disadvantages of a holding company structure?

A) Potential for triple taxation
B) Significant number of minority shareholders may create contentious environment
C) Managers may have difficulty in making the best investment decisions
D) A, B, and C
E) A and C only

Question 63

Financial considerations, such as an acquirer believing the target is undervalued, a booming stock market or falling interest rates, frequently drive surges in the number of acquisitions.

Question 64

Institutional investors in private companies often have considerable influence approving or disapproving proposed mergers. Which of the following are generally not considered institutional investors?

A) Pension funds
B) Insurance companies
C) Bank trust departments
D) United States Treasury Department
E) Mutual funds

Question 65

Arbitrageurs often adopt which of the following strategies in a share for share exchange just before or just after a merger announcement?

A) Buy the target firm's stock
B) Buy the target firm's stock and sell the acquirer's stock short
C) Buy the acquirer's stock only
D) Sell the target's stock short and buy the acquirer's stock
E) Sell the target stock short

Question 66

The empirical evidence supports the presumption that bigger is always better when it comes to acquisitions.

Question 67

Which of the following represent alternative ways for businesses to reap some or all of the advantages of M&As?

A) Joint ventures and strategic alliances
B) Strategic alliances, minority investments, and licensing
C) Minority investments, alliances, and licensing
D) Franchises, alliances, joint ventures, and licensing
E) All of the above

Question 68

Regulatory and political change seldom plays a role in increasing or decreasing the level of M&A activity.

Question 69

The empirical evidence shows that unrelated diversification is an effective means of smoothing out the business cycle.

Question 70

Buyers often prefer "friendly" takeovers to hostile ones because of all of the following except for:

A) Can often be consummated at a lower price
B) Avoid an auction environment
C) Facilitate post-merger integration
D) A shareholder vote is seldom required
E) The target firm's management recommends approval of the takeover to its shareholders

Question 71

Individual investors can generally diversify their own stock portfolios more efficiently than corporate managers who diversify the companies they manage.

Question 72

Which of the following is an example of economies of scope?

A) Declining average fixed costs due to increasing levels of capacity utilization
B) A single computer center supports multiple business units
C) Amortization of capitalized software
D) The divestiture of a product line
E) Shifting production from an underutilized facility to another to achieve a higher overall operating rate and shutting down the first facility

Question 73

firm may be motivated to purchase another firm whenever

A) The cost to replace the target firm's assets is less than its market value
B) The replacement cost of the target firm's assets exceeds its market value
C) When the inflation rate is accelerating
D) The ratio of the target firm's market value is more than four times its book value
E) The market to book ratio is greater than one and increasing

Question 74

Which of the following are not true about ESOPs?

A) An ESOP is a trust
B) Employer contributions to an ESOP are tax deductible
C) ESOPs can never borrow
D) Employees participating in ESOPs are immediately vested
E) C and D

Question 75

Which one of the following is not an example of a horizontal merger?

A) NationsBank and Bank of America combine
B) U.S. Steel and Marathon Oil combine
C) Exxon and Mobil Oil combine
D) SBC Communications and Ameritech Communications combine
E) Hewlett Packard and Compaq Computer combine

Question 76

ESOPs may be used for which of the following?

A) As an alternative to divestiture
B) To consummate management buyouts
C) As an anti-takeover defense
D) A, B, and C
E) A and B only

Question 77

Which of the following are often participants in the acquisition process?

A) Investment bankers
B) Lawyers
C) Accountants
D) Proxy solicitors
E) All of the above

Question 78

Which of the following are generally considered restructuring activities?

A) A merger
B) An acquisition
C) A divestiture
D) A consolidation
E) All of the above

Question 79

of the following are considered business alliances except for

A) Joint ventures
B) Mergers
C) Minority investments
D) Franchises
E) Licensing agreements

Question 80

The purpose of a "fairness" opinion from an investment bank is

A) To evaluate for the target's board of directors the appropriateness of a takeover offer
B) To satisfy Securities and Exchange Commission filing requirements
C) To support the buyer's negotiation effort
D) To assist acquiring management in the evaluation of takeover targets
E) A and B