28.4 The Takeover Process
Use the following information to answer the question(s) below.
Rearden Metal has earnings per share of $2. It has 10 million shares outstanding and is trading at
$20 per share. Rearden Metal is thinking of buying Associated Steel, which has earnings per
share of $1.25, 4 million shares outstanding, and a price per share of $15. Rearden Metal will
pay for Associated Steel by issuing new shares. There are no expected synergies from the
transaction.
1) If Rearden offers an exchange ratio such that, at current pre-announcement share prices for
both firms, the offer represents a 20% premium to buy Associated Steel, then the price per share
of the combined corporation after the merger will be closest to:
A) $19.12
B) $20.00
C) $26.00
D) $17.20
2) If Rearden offers an exchange ratio such that, at current pre-announcement share prices for
both firms, the offer represents a 20% premium to buy Associated Steel, then the price per share
of the Rearden immediately after the announcement will be closest to:
A) $15.00
B) $17.20
C) $18.60
D) $19.10
3) If Rearden offers an exchange ratio such that, at current pre-announcement share prices for
both firms, the offer represents a 20% premium to buy Associated Steel, then the price per share
of the Associated Steel immediately after the announcement will be closest to:
A) $15.00
B) $17.20
C) $18.60
D) $19.10
4) If Rearden offers an exchange ratio such that, at current pre-announcement share prices for
both firms, the offer represents a 20% premium to buy Associated Steel, then actual premium
Rearden will pay will be closest to:
A) 14.7%
B) 18.0%
C) 20.0%
D) 22.4%
5) Taggart Transcontinental and Phoenix-Durango have entered into a stock swap merger
agreement whereby Taggart will pay a 30% premium over Phoenix-Durango’s premerger price.
If Taggart’s premerger price per share was $15 and Phoenix-Durango’s was $30, then the
exchange ratio that Taggart will offer is closest to:
A) 0.4:1
B) 1.8:1
C) 2.0:1
D) 2.6:1
6) Consider the following equation:
<
The term A in this equation refers to:
A) the premerger, or standalone, value of the acquirer.
B) new shares to pay for the target.
C) the value of the synergies created by the merger.
D) the premerger (standalone) value of the target.
7) Consider the following equation:
<
The term S in this equation refers to:
A) the premerger (standalone) value of the target.
B) the premerger, or standalone, value of the acquirer.
C) the value of the synergies created by the merger.
D) new shares to pay for the target.
8) Consider the following equation:
<
The term x in this equation refers to:
A) the value of the synergies created by the merger.
B) the premerger, or standalone, value of the acquirer.
C) new shares to pay for the target.
D) the premerger (standalone) value of the target.
9) Consider the following equation:
<
The term T in this equation refers to:
A) the premerger, or standalone, value of the acquirer.
B) the value of the synergies created by the merger.
C) the premerger (standalone) value of the target.
D) new shares to pay for the target.
10) Which of the following questions is FALSE?
A) The method of payment (cash or stock) affects how the value of the target’s assets is recorded
for tax purposes and it affects the combined firm’s financial statements for financial reporting.
B) The combined firm must mark up the value assigned to the target’s assets on the financial
statements by allocating the purchase price to target assets according to their fair market value.
C) Any goodwill created in a merger deal can be amortized for tax purposes over 15 years.
D) Many transactions are carried out as acquisitive reorganizations under the tax code. These
structures allow the target shareholders to defer their tax liability on the part of the payment
made in acquirer stock but they do not allow the acquirer to step up the book value of the target
assets.
11) Which of the following questions is FALSE?
A) Any acquirer shares received in full or partial exchange for target shares triggers an
immediate tax liability for target shareholders.
B) In a friendly takeover, the target board of directors supports the merger, negotiates with
potential acquirers, and agrees on a price that is ultimately put to a shareholder vote.
C) How the acquirer pays for the target affects the taxes of both the target shareholders and the
combined firm.
D) If the acquirer purchases the target assets directly (rather than the target stock), then it can
step up the book value of the target’s assets to the purchase price.
12) Which of the following questions regarding risk arbitrage is FALSE?
A) Once a tender offer is announced, the uncertainty about whether the takeover will succeed
reduces the volatility of the stock price. This uncertainty creates an opportunity for investors to
speculate on the outcome of the deal without bearing the risk of volatility.
B) Traders known as risk-arbitrageurs, who believe that they can predict the outcome of a deal,
take positions based on their beliefs.
C) A potential profit arises from the difference between the target’s stock price and the implied
offer price, and is referred to as the merger-arbitrage spread.
D) However, it is not a true arbitrage opportunity because there is a risk that the deal will not go
through. If the takeover did not ultimately succeed, the risk-arbitrageur would eventually have to
unwind his position at whatever market prices prevailed.
13) Which of the following questions is FALSE?
A) Once the acquirer has completed the valuation process, it is in the position to make a tender
offer—that is, a public announcement of its intention to purchase a large block of shares for a
specified price.
B) If we view the pre-bid market capitalization as the stand-alone value of the target, then from
the bidder’s perspective, the takeover is a positive-NPV project only if the synergies created do
not exceed the premium it pays.
C) Purchasing a corporation usually constitutes a very large capital investment decision, so it
requires a more accurate estimate of value that includes careful analysis of both operational
aspects of the firm and the ultimate cash flows the deal will generate.
D) A stock-swap merger is a positive-NPV investment for the acquiring shareholders if the share
price of the merged firm (the acquirer’s share price after the takeover) exceeds the premerger
price of the acquiring firm.
14) KT corporation has announced plans to acquire MJ corporation. KT is trading for $45 per
share and MJ is trading for $25 per share, with a premerger value for MJ of $3 billion dollars. If
the projected synergies from the merger are $750 million, what is the maximum exchange ratio
that KT could offer in a stock swap and still generate a positive NPV?
28.5 Takeover Defenses
1) A rights offering that gives existing target shareholders the right to buy shares in either the
target or the acquirer at a deeply discounted price once certain conditions are met is called a:
A) golden parachute.
B) poison pill.
C) classified board.
D) white knight.
2) A situation where every director serves a three-year term and the terms are staggered so that
only one-third of the directors are up for election each year is called a:
A) white knight.
B) classified board.
C) poison pill.
D) golden parachute.
3) When a hostile takeover appears to be inevitable, a target company will sometimes look for
another, friendlier company to acquire it called a:
A) poison pill.
B) classified board.
C) golden parachute.
D) white knight.
4) An extremely lucrative severance package that is guaranteed to a firm’s senior managers in the
event that the firm is taken over and the managers are let go is called a:
A) golden parachute.
B) white knight.
C) poison pill.
D) classified board.
5) Which of the following statements regarding poison pills is FALSE?
A) Companies with poison pills are harder to take over, and when they are taken over, the
premium that existing shareholders receive for their stock is higher.
B) Because a poison pill increases the cost of a takeover, all else equal, a target company must be
in better shape to justify the expense of waging a takeover battle.
C) Poison pills also increase the bargaining power of the target firm when negotiating with the
acquirer because poison pills make it difficult to complete the takeover without the cooperation
of the target board.
D) By adopting a poison pill, a company effectively entrenches its management by making it
much more difficult for shareholders to replace bad managers, thereby potentially destroying
value.
6) What is a white knight?
7) Which of the following statements regarding recapitalization as a takeover defense is FALSE?
A) Another defense against a takeover is a recapitalization, in which a company changes its
capital structure to make itself less attractive as a target.
B) Restructuring itself can produce efficiency gains, often removing the principal motivation for
the takeover in the first place.
C) By increasing leverage on its own, the target firm can reap the benefit of the interest tax
shields.
D) In many cases, a substantial portion of the synergy gains that an acquirer anticipates from a
takeover are savings from a decrease in leverage as well as other cost reductions.
28.6 Who Gets the Value Added from a Takeover?
Use the following information to answer the question(s) below.
You work for a leveraged buyout firm and are evaluating a potential buyout of Associated Steel.
Associated Steel’s stock price is $15 and it has 10 million shares outstanding. You believe that if
you buy the company and replace its management, its value will increase by 50%. You are
planning on doing a leveraged buyout of Associated Steel, and will offer $20 per share for
control of the company.
1) Assuming you get 50% control of Associated Steel, then the price of the non-tendered shares
will be closest to:
A) $12.50
B) $15.00
C) $17.50
D) $20.00
2) Regarding your tender offer, shareholders will:
A) not tender their shares since the post LBO price is higher than the offer price.
B) not tender their shares since the post LBO price is higher than the current price.
C) tender their shares since the post LBO price is higher than the offer price.
D) tender their shares since the post LBO price is lower than the current price.
3) Assuming you get 50% control of Associated Steel, then your gain from this transaction will
be closest to:
A) $50.0 million
B) $65 million
C) $75 million
D) $125 million
4) Which of the following statements is FALSE?
A) SEC rules make it difficult for investors to buy much more than about 10% of a firm in secret.
After an acquirer acquires such an initial stake in the target, called a toehold, they would have to
make their intentions public by informing investors of his large stake.
B) With the availability of both the freezeout merger and the leveraged buyout as acquisition
strategies, most of the value added accrues to the acquiring shareholders.
C) The laws on tender offers allow the acquiring company to freeze existing shareholders out of
the gains from merging by forcing non-tendering shareholders to sell their shares for the tender
offer price.
D) Premiums in LBO transactions are often quite substantial—while they can avoid the free-
rider problem acquirers must still get board approval to overcome other defenses such as poison
pills, as well as outbid other potential acquirers.
5) You work for a levered buyout firm and are evaluating a potential buyout of Boogle Inc.
Boogle’s stock price is $18, and it has 3 million shares outstanding. You believe that if you buy
the company and replace its dismal management team, its value will increase by 50%. You are
planning on doing a levered buyout of Boogle and will offer $25 per share for control of the
company. Assuming you get 50% control, what will your gain from the transaction be?