Chapter 13: Structuring the Deal:
Tax and Accounting Considerations
Answers to End of Chapter Discussion Questions
12.1 When does the IRS consider a transaction to be non-taxable to the target firm’s shareholders? What is the
justification for the IRS’ position?
Answer: Under the law, tax-free transactions contemplate substantial continuing involvement of the target
company’s shareholders. To demonstrate continuity of interests (COI), target shareholders must continue to
12.2 What are the advantages and disadvantages of a tax-free transaction for the buyer? Be specific.
Answer: The principal advantage of a tax-free reorganization to the buyer is that the seller may be willing
to accept a lower purchase price if the transaction is structured as non-taxable to the selling firm’s
shareholders. However, there are a number of drawbacks. If the transaction is tax-free, the acquiring
12.3 Under what circumstances can the assets of the acquired firm be increased to fair market value when the
transaction is deemed a taxable purchase of stock?
Answer: The acquirer and target firms can jointly elect Section 338 of the Internal Revenue Code and
thereby record assets and liabilities at their fair market value for tax purposes. According to Section 338 of
the U.S. tax code, a purchaser of 80% or more of the stock of the target may elect to treat the acquisition as
12.4 What is goodwill and how is it created?
Answer: In purchase accounting, the acquiring firm records the target at the actual purchase price.
Acquisitions are viewed as conceptually similar to buying a single asset such as a piece of equipment.
12.5 Under what circumstances might an asset become impaired? How might this event affect the way in which
acquirers bid for target firms?
12.6 Why do boards of directors of both acquiring and target companies often obtain so-called “fairness
opinions” from outside
investment advisors or accounting firms? What valuation methodologies might be employed in
constructing these opinions? Should stockholders have confidence in such opinions? Why/why not?
12.7 Archer Daniel Midland (ADM) wants to acquire AgriCorp to augment its ethanol manufacturing capability.
AgriCorp wants the transaction to be tax-free for its shareholders. ADM wants to preserve AgriCorp’s
significant investment tax credits and tax loss carryforwards so that they transfer in the transaction. Also,
ADM plans on selling certain unwanted AgriCorp assets to help finance the transaction. How would you
structure the deal so that both parties’ objectives could be achieved?
12.8 Tangible assets are often increased to fair market value following a transaction and depreciated faster than
their economic lives. What is the potential impact on post-transaction EPS, cash flow, and balance sheet?
Answer: Substantial increases in asset values could have a significant impact on future earnings per share,
as the incremental depreciation expense erodes earnings available for common equity. Liabilities may also
12.9 Discuss how the form of acquisition (i.e., asset purchase or stock deal) could impact the net present value or
internal rate of return of the deal calculated post-closing.
12.10 What are some of the important tax-related issues the boards of the acquirer and target companies may need
to address prior to entering negotiations? How might the resolution of these issues impact the form of
payment and form of acquisition?
Answer: The target’s board needs to consider if the transaction is to be tax-free to its shareholders. Often
the acquirer may try to offer a lower purchase price in exchange for the transaction to be tax-free. If so,
how much of a reduction in the purchase price, if any, would the target’s board be willing to accept? The
Solutions to Practice Problems and Exercises
12.11 Target Company has incurred $5,000,000 in losses during the past 3 years; Acquiring Company anticipates
pre-tax earnings of $3,000,000 in each of the next 3 years. What is the difference between total taxes that
would have been paid before the merger compared to actual taxes paid by the Acquiring Company after the
merger assuming a marginal tax rate of 40 percent? Show your work.
Answer: $2,000,000
Starting in the column headed Tax Loss Carryforward, $3,000,000 of $5,000,000 tax loss carryforward in
Year 1 is used to offset the $3,000,000 in pretax earnings. The unused portion of the loss carryforward of
12.12 Acquiring Company buys 100% of Target Company’s equity for $5,000,000 in cash. As an analyst, you
are given the following pre-merger balance sheets for the two companies. Assuming plant and equipment
is
revalued upward by $500,000, what will be the combined companies’ shareholders’ equity plus total
liabilities? What is the difference between Acquiring Company’s shareholders’ equity and the shareholders’
equity of the combined companies? Show your work.
Balance Sheets (Dollars)
Acquiring Company
Current Assets
600,000
Plant and Equipment
1,200,000
Total Assets
1,800,000
Long-Term Debt
500,000
Shareholders’ Equity
1,300,000
Shareholders’ Equity +
Total
Liabilities
1,800,000
Answer: The combined companies’ shareholders’ equity plus total liabilities is $7,100,000 and the change
between the combined companies’ and Acquiring Company’s shareholders’ equity is $5,000,000, an
amount equal to the purchase price. The change in the Acquiring Company’s shareholders’ equity is equal
to the fair market value of the acquired net book assets ($2,500,000) plus good will, the components
comprising the purchase price.
Solutions to Chapter Case Study Questions
BRISTOL MYERS SQUIBB BUYS CALGENE IN
BIGGEST BIOPHARMA DEAL IN HISTORY
Discussion Questions and Answers:
1. What is the form of payment used in this deal? Why might this form have been selected? What are the
advantages and disadvantages of the form of payment used?
Balance Sheets (Dollars)
Current Assets
Plant and Equipment
Goodwill
Total Assets
Debt
Equity
Shareholders’
+ Total Liabilities
Answer: The form of payment for Celgene is a combination of cash and stock. This combination may have
been used because an all-cash deal would have required a substantial increase in borrowing burdening Bristol
with substantial leverage; using only stock may not have attracted enough Celgene shareholders to vote to
2. What is the form of acquisition used in this deal? Why might this form have been chosen? What are the
advantages and disadvantages of the form of acquisition?
Answer: The form of acquisition reflects what is being acquired (stock or assets) and how ownership is
3. Would you characterize this as a reverse or forward merger? Based on your answer why might this type of
reorganization have been selected by Bristol?
Answer: This is a reverse merger in which the merger sub is merged into the target with the target surviving.
4. How would this deal be treated for financial reporting purposes? Briefly describe how the methodology you
have identified might be applied to how Celgene’s financial data would be presented on Bristol’s consolidated
financial statements.
Answer. For financial reporting purposed, business combinations must be accounted for using the purchase or
5. Assume it is determined by auditors during the next several years that Bristol overpaid significantly for
Calgene. What is the most likely reason this determination could happen? How might this impact the firm’s
reported earnings per share and in turn its share price? Be specific.
Answer: The most likely reason for auditors to determine that Bristol overpaid is that the projected sales of new
True/False Questions: Answer True or False to the following questions:
1. Taxes are an important consideration in almost any transaction, and they are often the primary motivation
for an acquisition.
True or False
2. From the viewpoint of the seller or target company shareholder, transactions may be tax-free or entirely or
partially taxable.
True or False
3. The sale of stock, rather than assets, is generally preferable to the target firm shareholders to avoid double
taxation, if the target firm is structured as a limited liability company.
True or False
4. A transaction generally will be considered non-taxable to the seller or target firm’s shareholder if it
involves the purchase of the target’s stock or assets for substantially all cash, notes, or some other
nonequity consideration. True or False
5. In a triangular cash merger, the target firm may either be merged into an acquirer’s operating or shell
acquisition subsidiary with the subsidiary surviving or the acquirer’s subsidiary is merged into the target
firm with the target surviving.
True or False
6. A transaction is usually taxable to the target firm’s shareholders, if the acquirer’s stock is used to purchase
at least 30% of the target firm’s stock or assets. True or False
7. The major advantages of using a triangular structure are limitations of the voting rights of acquiring
shareholders and that the acquirer gains control of the target through a subsidiary without being directly
responsible for the target’s known and unknown liabilities. True or False
8. It is seldom important that the buyer and seller agree on the allocation of the sales price among the assets
being sold, since the allocation will determine the potential tax liability that would be incurred by the seller
but that could by passed on to the buyer through to terms of the sales contract. True or False
8. The form of payment does not affect whether a transaction is taxable to the seller’s shareholders. True or
False
10. If a transaction involves a cash purchase of target stock, the target company’s tax cost or basis in the
acquired stock or assets is increased or “stepped up” automatically to their fair market value (FMV), which
is equal to the purchase price paid by the acquirer.
True or False
11. In a cash purchase of assets. the target’s shareholders could be taxed twice, once when the firm pays taxes
on any gains and a second time when the proceeds from the sale are paid to the shareholders either as a
dividend or distribution following liquidation of the corporation.
12. Empirical studies generally show that the tax shelter resulting from the ability of the acquiring firm to
increase the value of acquired assets to their FMV is a highly important motivating factor for a takeover.
True or False
13. Taxable transactions usually involve the purchase of the target’s voting stock, because the purchase of
assets automatically will trigger a taxable gain for the target if the fair market value of the acquired assets
exceeds the target firm’s tax basis in the assets.
True or False
14. In a taxable purchase of target stock with cash, the target firm does not restate (i.e., revalue) its assets and
liabilities for tax purposes to reflect the amount that the acquirer paid for the shares of common stock.
Rather, the tax basis (i.e., their value on the target’s financial statements) of assets and liabilities of the
target before the acquisition carries over to the acquirer after the acquisition.
True or False
15. According to Section 338 of the U.S. tax code, a purchaser of 80% or more of the assets of the target may
elect to treat the acquisition as if it were an acquisition of the target’s assets for tax purposes.
True or False
16. The IRS generally views forward triangular cash mergers as a purchase of target stock followed by a
liquidation of the target for which target shareholders will recognize a taxable gain or loss as if they had
sold their shares.
True or False
17. Under purchase accounting, the difference between the combined firm’s shareholders’ equity immediately
following closing and the acquiring firm’s shareholders’ equity equals the purchase price paid for the target
firm.
True or False
18. Under purchase price accounting, the excess of the purchase price paid over the book value of equity of the
target firm is assigned only to the tangible assets up to their fair market value or to goodwill. True or False
19. Purchase accounting affects only the cash flow of the combined firms but not the reported net income.
True or False
20. As a general rule, a transaction is taxable to the target company shareholders if they receive the acquiring
firm’s stock and non-taxable if they receive cash. True or False
21. Tax free reorganizations generally require that all or substantially all of the target company’s assets or
shares be acquired in order to ensure that the acquiring firm has a continuing ownership interest in the
combined firms. True or False
22. Tax benefits that result from an acquisition should always be considered as among the most important
justification for paying a very high premium for the target firm. True or False
23. In a forward triangular merger, the target firm’s tax attributes in the form of any tax loss carry forwards or
carrybacks or investment tax credits carry over to the acquirer because the target ceases to exist. True or
False
24. The IRS treats the reverse triangular cash merger as a purchase of target shares, with the target firm,
including its assets, liabilities, and tax attributes, ceasing to exist. True or False
25. If the acquirer invokes a 338 election no taxes will have to be paid on any gains on assets written up to their
fair market value. True or False
26. With the purchase of target stock, the acquirer retains the target’s tax attributes, but there is no step up in
the basis of the acquired assets unless the acquirer adopts a 338 election. True or False
27. As a result of a 338 election, the IRS treats the purchase of target shares as a taxable purchase of assets
which can be stepped up to fair market value. Only the buyer has to agree to the 338 election. True or
False
28. In a purchase of assets, the buyer retains the target’s tax attributes. True or False
29. In a statutory merger, the buyer retains the target’s tax attributes. True or False
30. In a reverse triangular merger, the acquirer retains the target’s tax attributes. True or False
31. In a tax-free reorganization, the buyer is never required to get shareholder approval. True or False
32. Transactions may be partially taxable if the target shareholders receive some nonequity consideration, such
as cash or debt, in addition to the acquirer’s stock. True or False
33. Acquirers and targets planning to enter into a tax-free transaction seldom seek to get an advance ruling
from the IRS to determine its tax-free status. True or False
34. If the transaction is tax-free, the acquiring company is able to transfer or carry over the target’s tax basis to
its own financial statements. True or False
35. The tax-free structure is generally not suitable for the acquisition of a division within a corporation. True or
False.
36. To demonstrate continuity of interests (COI), target shareholders must continue to own a substantial part of
the value of the combined target and acquiring firms. True or False
37. Nontaxable transactions also are called tax-free reorganizations. True or False
38. Tax–free reorganizations generally require that all or substantially all of the target company’s assets or
shares be acquired. True or False
39. A buyer may divest a significant portion of the acquired company immediately following closing without
jeopardizing the tax-free status of the transaction. True or False
40. Tax-free reorganizations require that substantially all of the consideration received by the target’s
shareholders be paid in cash. True or False
41. Tax–free reorganizations require that substantially all of the consideration received by the target’s
shareholders be paid in common or preferred stock. True or False
42. Since the IRS requires that target shareholders continue to hold a substantial equity interest in the acquiring
company, the tax code defines what constitutes a substantial equity interest. True or False
43. Triangular mergers are rarely used for tax-free transactions. True or False
44. To qualify for a Type A reorganization, the transaction must be either a merger or a consolidation. True or
False
45. Type A reorganizations are generally viewed as the least flexible of the various types of tax-free
reorganizations. True or False
46. The acquirer must be careful that not too large a proportion of the purchase price be composed of cash,
because this might not meet the IRS’s requirement for continuity of interests of the target shareholders and
disqualify the transaction as a Type A reorganization. True or False
47. In a type B stock-for-stock reorganization, the acquirer must purchase an amount of voting stock that
comprises at least 50% of the voting power of all of the target’s voting stock outstanding. True or False
48. A type C reorganization is a stock-for-assets reorganization with the requirement that at least 50% of the
FMV of the target’s assets, as well as the assumption of certain specified liabilities, are acquired solely in
exchange for voting stock. True or False
49. The Type C reorganization is used when it is essential for the acquirer not to assume any undisclosed
liabilities. True or False
50. A forward triangular merger is the most commonly used form of reorganization for tax-free stock
acquisitions in which the form of payment is acquirer stock. It involves three parties: the acquiring firm,
the target firm, and a shell subsidiary of the target firm. True or False
51. Asset sales by the target firm just prior to the transaction may threaten the tax-free status of the deal.
Moreover, tax-free deals are disallowed within ten-years of a spin-off. True or False
52. The disadvantages of the forward triangular merger may include the requirement of the buyer to get
shareholder approval. True or False
53. A section of the U.S. tax code known as 1031 forbids investors to make a “like kind” exchange of
investment properties. True or False
54. To qualify for a 1031 exchange, the property must be an investment property or one that is used in a trade
or business (e.g., a warehouse, store, or commercial office building). True or False
55. Although NOLs represent a potential source of value, their use must be monitored carefully to realize the
full value resulting from the potential for deferring income taxes. True or False
56. Subchapter S Corporation shareholders, and LLC members, are taxed at their personal tax rates. True or
False
57. So-called Morris Trust transactions tax code rules restrict how certain types of corporate deals can be
structured to avoid taxes. True or False
58. Goodwill no longer has to be amortized over its projected life, but it must be written off if it is deemed to
have been impaired. Impairment reviews are to be taken annually or whenever the firm has experienced an
event which materially affects the value of its assets. True or False
59. For tax purposes, goodwill created after July 1993 may be amortized up to 15 years and is tax deductible.
Goodwill booked before July 1993 is also tax deductible. True or False
60. The sale of assets by a target firm will result in a taxable gain if the fair market value is less than the book
value? True or False
Multiple Choice (Circle only one)
1. Which of the following is not true about mergers and acquisitions and taxes?
a. Tax considerations and strategies are likely to have an important impact on how a deal is
structured by affecting the amount, timing, and composition of the price offered to a target firm.
b. Tax factors are likely to affect how the combined firms are organized following closing, as the tax
ramifications of a corporate structure are quite different from those of a limited liability company
or partnership.
c. Potential tax savings are often the primary motivation for an acquisition or merger.
d. Transactions may be either partly or entirely taxable to the target firm’s shareholders or tax-free.
b. None of the above
2. Which of the following is not true about purchase accounting?
a. For financial reporting purposes, all M&As must be recorded using the purchase method of
accounting.
b. Under the purchase method of accounting, the excess of the purchase price over the target’s net
asset value is treated as goodwill on the combined firm’s balance sheet.
c. Goodwill may be amortized up to 40 years.
d. If the fair value of the target’s net assets later falls below its carrying value, the acquirer must
record a loss equal to the difference.
e. None of the above
3. Which of the following is true about purchase accounting?
a. Cash and accounts receivable, reduced for bad debt and returns, are valued at their values on
the books of the target before the acquisition..
b. Marketable securities are valued at their realizable value after transactions costs.
c. Property, plant and equipment are valued at fair market value.
d. Intangible assets are booked at their appraised values.
e. All of the above.
4. Which of the following is not true about goodwill ?
a. Goodwill must be written off over 20 years.
b. Goodwill must be checked for impairment at least annually.
c. The loss of key customers could impair the value of goodwill.
d. Goodwill does not have to be amortized.
e. Goodwill is shown as an asset on the balance sheet.
5. Which of the following are not true of net operating loss carrybacks and carryforwards?
a. Net operating loss carrybacks enable firms to recover previous taxes paid.
b. Net operating loss carryforwards enable firms to shelter future taxable income.
c. Net operating loss carryforwards may be applied to income up to 5 years into the future.
d. Loss corporations” cannot use a net operating loss carry forward unless they remain viable and in
essentially the same business for at least 2 years following the closing of the acquisition.
e. None of the above
6. Which of the following is not considered a tax-free reorganization?
a. Type A transactions
b. Type B transactions
c. Type C Transactions
d. Forward triangular merger
e. Cash purchase of assets
7. Which of the following is not true of a 338 election ?
a. It applies to asset purchases only.
b. It applies to stock purchases only.
c. It allows a purchase of stock to be treated as an asset purchase for tax purposes.
d. The buyer must adopt the 338 election.
e. The seller must agree with the adoption of the 338 election.
8. Which of the following is not true of a forward triangular cash merger?
a. It is considered by the IRS as a purchase of target assets.
b. It is generally followed by a liquidation of the target firm.
c. Target shareholders must recognize a gain or loss as if they had sold their shares.
d. The target’s tax attributes carry over to the buyer.
e. Taxes are paid by the target firm on any gain on the sale of its assets and again by shareholders
who receive a liquidating dividend.
9. Which of the following is not true of purchase accounting?
a. Total purchase price paid for the target firm is reflected on the books of the combined companies
b. All liabilities are transferred at the NPV of their future cash payments
c. The cost of the acquired entity becomes the new basis for recording the acquirer’s investment in
the assets of the target company.
d. Goodwill equals the difference between the purchase price paid for the target firm and the book
value of acquired assets.
e. Goodwill must be reduced if it is believed to be impaired.
10. Which of the following is not true of taxable asset purchases?
a. Net operating losses carry over to the acquiring firm
b. The acquiring firm may step up its basis in the acquired assets.
c. The target firm is subject to recapture of tax credits and excess depreciation
d. Target firm shareholders’ are subject to a potential immediate tax liability
e. Target firm net operating losses and tax credits cannot be transferred to the acquiring firm
11. Which of the following is not true of a taxable purchase of stock?
a. Taxable transactions usually involve the purchase of the target’s voting stock with acquirer stock.
b. Taxable transactions usually involve the purchase of the target’s voting stock, because the
purchase of assets automatically will trigger a taxable gain for the target if the fair market value of
the acquired assets exceeds the target firm’s tax basis in the assets.
c. All stockholders are affected equally in a taxable purchase of assets.
d. The target firm does not pay any taxes on the transaction.
e. The effect of the tax liability will vary depending on the individual shareholder’s tax basis.
12. The tax status of the transaction may influence the purchase price by
a. Raising the price demanded by the seller to offset potential tax liabilities
b. Reducing the price demanded by the seller to offset potential tax liabilities
c. Causing the buyer to reduce the purchase price if the transaction is taxable to the target firm’s
shareholders
d. Forcing the seller to agree to defer a portion of the purchase price
e. Forcing the buyer to agree to defer a portion of the purchase price
13. Which of the following represent taxable transactions?
a. Purchase of assets with cash
b. Purchase of stock with cash
c. Purchase of stock or assets with cash
d. Statutory cash merger or consolidation
e. All of the above
14. Which of the following are true?
a. Taxes are important in any transaction.
b. Taxes should never be the overarching reason for the transaction.
c. Tax savings accruing to the buyer should simply reinforce the decision to acquire.
d. The sale of stock, rather than assets, is generally preferable to the target firm shareholders to avoid
double taxation, if the target firm is structured as a C corporation.
e. All of the above.
15. Which of the following are non-taxable transactions?
a. Statutory stock merger or consolidation
b. Stock for stock merger
c. Stock for assets merger
d. Triangular reverse stock merger
e. All of the above
16. Which of the following are required for an acquisition to be considered tax-free?
a. Continuity of interest
b. A legitimate business purpose other than tax avoidance
c. The use of predominately acquirer shares to buy the target’s shares
d. An all cash acquisition of the target firm’s shares
e. A, B, and C only
17. Which one of the following statements is true?
a. Target firm shareholders may accept cash or acquirer stock in exchange for their shares for the
transaction to be considered tax free
b. To be tax free, the target firm shareholders must receive acquirer firm shares for all of the target
firm’s shares outstanding
c. At least one-half of the assets of the target firm are recorded on the balance sheet of the acquirer at
their book rather than market value in a tax free transaction
d. If the assets of a firm are written up to fair market value as part of the transaction, the increase in
value is considered a taxable gain
e. Target firm shareholders are required by law to pay taxes on any writeup of the firm’s assets to
fair market value
18. Purchase accounting requires that
a. The excess amount paid for the target firm be recorded as an intangible asset on the books of the
acquirer and immediately written off
b. Target firm assets must be recorded on the acquirer’s balance sheet at their fair market value
c. The excess of the purchase price of the purchase price of the target firm must be recorded as asset
and expensed over a period of 10 years
d. Goodwill once established is never written off
e. Target firm liabilities are recorded on the balance sheet of the acquirer at their book value
19. For financial reporting purposes, goodwill resulting from an acquisition
a. Must equal the fair market value of the target firm’s assets
b. Immediately impacts the acquirer’s profits
c. Is expensed over 20 years
d. Is reviewed annually or whenever there is reason to believe it has lost value and amortized to the
extent its value has declined
e. Never affects the profits of the acquirer
Case Study Short Essay Examination Questions
INSIDE M&A: CVS’S TAKEOVER OF AETNA BLURS TRADITIONAL ROLES IN THE US
HEALTHCARE INDUSTRY
_____________________________________________________________________________
Key Points:
• Cash and stock is commonly used in combination in megamergers to
—Appeal to a wider array of target shareholders,
—Provide cash to allow target shareholders to pay tax liabilities, and
—Finance a portion of the purchase price with a noncash form of payment
• Fixed exchange ratios often are used to allow the buyer to better determine potential dilution to current
shareholders from issuing new shares
• Deal structures can be used to preserve valuable intangible property such as brand names, tradenames,
franchises, contracts, etc.
_____________________________________________________________________________________
With US healthcare spending at 18% of gross domestic product in 2018, healthcare delivery companies are
struggling to lower costs. An aging population, expensive new drugs and costly technologies, and an inefficient
delivery system combine to stoke the upward spiral in healthcare costs. Pharmacy chains struggled to compete in the
e-commerce space, where they are being undercut on price by online drug sellers. To make matters worse,
Amazon.com, already offering over-the-counter drugs, showed interest in selling prescription medications. Seeing
the threat, large healthcare providers pondered their response to the changing competitive landscape.
CVS has more than 9,800 retail locations and more than 1,100 walk-in clinics across the US. The firm is also a
leading pharmacy benefits manager with more than 94 million plan members, serves more than one million patients
annually through its senior pharmacy care business, and is a leading standalone Medicare Part D prescription drug
plan. As one of the leading diversified healthcare benefits firms, Aetna served 37.9 million people as of the end of
2017. Aetna offers a broad array of health insurance products, Medicaid healthcare management services, Medicare
Advantage and Medicare supplement plans, and workers compensation administrative services.
Characterized as a community based open healthcare model, CVS and Aetna see their combination as a means
of using CVS’ retail stores to slow escalating healthcare costs. The hope is to attract more people to walk-in clinics,
keeping them out of more expensive emergency rooms. The combined firms expect to improve the quality of care
To transfer ownership, CVS created a wholly owned subsidiary, Merger Sub, which will be merged with
Aetna at closing, with Aetna surviving. Known as a reverse triangular merger, this structure generally eliminates the
need for parent firm shareholder approval of the merger, as the parent is the sole shareholder in the Merger Sub.
Because of potential for significant current shareholder dilution, CVS did seek shareholder approval to issue 280
million new shares which it overwhelmingly received at a special shareholders’ meeting on March 13, 2018. Since
Aetna survives the merger, it retains any franchise, lease, or other valuable contract rights that otherwise may have
To ensure that financial returns are not misstated, acquired Aetna assets and assumed liabilities are recorded at
their fair values on the combined firms’ balance sheet using the acquisition method of accounting. Fair value is the
END OF CHAPTER CASE STUDY:
JOHNSON & JOHNSON PLACES A BIG BET
ON BIOPHARMACEUTICAL COMPANY ACTELION
____________________________________________________________________________
Case Study Objectives: To illustrate
• The importance of deal structure in getting a deal done;
• The application of common takeover tactics;
• The form of payment and form of acquisition; and
• Tax and accounting considerations.
______________________________________________________________________________
Getting a deal done usually requires satisfying the highest priority needs of the parties involved. For Swiss
biopharmaceutical company Actelion Pharmaceuticals Ltd. (Actelion),1 the founder and CEO and his wife wanted to
retain control of the creative part of the business that most interested them. While price was important for the firm’s
public shareholders, it was less so for the founders. For U.S. healthcare giant Johnson & Johnson Inc. (J&J) it was
acquiring new products that offered the potential for jumpstarting the firm’s revenue and profit growth. The
overarching constraint for J&J was not overpaying for the deal.
After talks stalled in November, J&J confirmed in late December 2016 that they had resumed discussions with
Actelion. Actelion is known for its treatments for pulmonary arterial hypertension or high blood pressure in the
lungs. Actelion had been rumored to be in advanced talks with French drug manufacturer Sanofi, which may have
Following closing, Actelion became a subsidiary of Janssen. With the completion of the tender offer, Actelion
spun off its drug R&D operations and early-stage clinical development assets into a newly created Swiss
biopharmaceutical firm, Idorsia Ltd. (Idorsia). Shares of Idorsia were distributed to Actelion’s shareholders as a
stock dividend and began trading on the SIX Swiss Exchange. Janssen will initially hold 9.9% of Idorsia’s
outstanding equity and through a convertible note will have the right to an additional 22.1%. Actelion’s research
avoided the payment of taxes on these funds if they had been repatriated to the U.S.2
The acquisition gives J&J access to the Swiss firm’s line-up of high margin medicines for rare diseases. It also
helps diversify its drug portfolio as its largest revenue generating drug, Remicade for the treatment of arthritis, is
facing intensifying competition from cheaper drugs. The takeover hinged on finding an arrangement acceptable to
Jean-Paul and Martine Clozel, Actelion’s founders. Jean-Paul Clozel was Actelion’s CEO and a board member.
Martine Clozel was the firm’s Chief Scientist. When J&J walked away on December 13, 2016 only to return to the
negotiating table within two weeks, Mr. Clozel had started holding talks with Sanofi.
Discussion Questions and Answers:
1. Speculate as to how J&J’s overseas cash hoard may have influenced the purchase price paid for Actelion.
Answer: As of yearend 2017, U.S. firms had cash holdings abroad exceeding an estimated $2.6
billion. Repatriation of those earnings to the U.S. would have required the U.S. firms to pay the maximum statutory
2. How did the deal structure involving a spin-off of the Actelion’s R&D organization make the takeover of
Actelion possible?
3. What is the form of payment in this deal? Why might this form have been selected? What are the
advantages and disadvantages of the form of payment used in this deal?
Answer: The form of payment for Actelion is cash. Actelion’s shareholders may have been less impressed
with the appreciation potential of J&J’s shares in view of the firms lagging sales and profits in recent years.
4. What is the form of acquisition used in this deal? Why might this form have been chosen? What are the
advantages and disadvantages of the form of acquisition?
Answer: The form of acquisition reflects what is being acquired (stock or assets) and how ownership is
5. Assume it is determined by auditors during the next several years that J&J overpaid significantly for
Actelion. What is the most likely reason this determination could happen? How could this impact the firm’s
reported earnings per share and in turn its share price? Be specific.
Answer: The most likely reason for auditors to determine that J&J overpaid is that the projected sales of the
proprietary Actelion drugs do not materialize suggesting that future cash flows do not support the fair
6. Did the sale of Actelion require a vote by the firm’s shareholders? Explain your answer.
7. What are the acquisition vehicle and postclosing organization in this transaction?
INSIDE M&A: THE PLANNED PFIZER AND ALLERGAN MERGER
THWARTED BY CHANGING TAX REGULATIONS
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Key Points:
• Different corporate tax rates among countries can distort the global M&A market.
• Frequent regulatory changes to close “loop holes” that should be done legislatively impede investment by
creating uncertainty in corporate boardrooms.
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While M&As rarely are undertaken solely for potential tax benefits, tax laws can sometimes distort the underlying
economic motives for doing deals. Tax laws (and regulations) distort corporate decision making. Current U.S.
corporate tax rates, the highest in the world, encourage U.S. corporations to relocate to countries offering
substantially more favorable tax rates. Corporations viewing taxes as any other operating expense have a fiduciary
responsibility to shareholders to pare costs to remain competitive.
total compensation for U.S. workers is lower, and employment may be concentrated in different industries and
regions (even though total employment is not significantly affected.”3
On April 5, 2016, the Treasury announced new regulations, more far reaching than previous regulatory changes
in 2014 and 2015, aimed at “serial inverters” (i.e., companies that have grown through a succession of acquisitions
resulting in inversions). The new regulations consisted of two parts. First, the government would disregard U.S.
The first part of the new rules deals with the determination of whether or not a firm engaging in a corporate
inversion can indeed be taxed at the lower foreign rate under current U.S. law. As of 2015, the U.S. Treasury
regulations applying to U.S. acquirers of foreign targets implementing corporate inversions focused on the
continuing percentage ownership stake of the acquirer’s shareholders following closing. If the continuing stake is
80% or more, earnings from U.S. operations are taxed at U.S. rates; between 60% and 80%, some portion of the
earnings are taxed at U.S. rates; below 60%, earnings are taxed at the foreign parent’s rate.
What seems to have prompted the new regulations is one of the biggest takeovers in U.S. history. U.S.
based pharmaceutical giant Pfizer announced a planned merger with Dublin, Ireland based Allergan, the
maker of Botox, in late 2015. This megamerger would have been the biggest example an American
company shedding its U.S. corporate residence to lower its tax burden. From a business perspective, Pfizer
was the acquirer since it was clearly in control of the combined firms. Why? It was the larger of the two
In the wake of the new rules, Pfizer announced on April 7, 2016 that it would pay a termination fee of as much as
$400 million to withdraw from the merger. Why? Merging with Allergan would no longer provide the anticipated
tax savings. Allergan, perhaps the poster company for inversions, is a result of a string of cross-border deals. The
first inversion started in 2013 with Ireland based Warner Chilcott being acquired by Actavis Inc., a small New
Allergan’s market capitalization made it too small to serve as Pfizer’s inversion partner and still qualify to have
income generated by its U.S. operations taxed at Irish corporate tax rates.
While both Pfizer and Allergan argued that the Treasury had overstepped its authority by changing rapidly tax
laws and applying them retroactively, neither was willing to sue the government in federal courts due to the prospect
ABBVIE PLACES A BIG BET ON CANCER DRUG MAKER PHARMCYCLICS
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Case Study Objectives: To illustrate
• Form of payment and of acquisition;
• The application of common takeover tactics;
• Tax and accounting considerations; and
• The importance of discipline during negotiations
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Successful takeovers require a sound business strategy, an intelligent takeover plan, unwavering discipline during
the negotiations, and excellent postmerger execution. The AbbVie business strategy seems to have consisted of
placing a high risk bet on a single drug intended to restore and sustain the firm’s growth in revenue and profits. Prior
failed takeover attempts may have made AbbVie an undisciplined bidder contributing potentially to overpaying for
the target. In this case study, we discuss the circumstances leading up to the deal, how they may have affected the
deal, and tactics common to transactions of this type.
AbbVie’s board and management in justifying the price paid argued that the companies’ shared expertise,
combined with AbbVie’s five late-stage oncology drugs in its development pipeline set to launch during the next
several years, has the potential to transform cancer treatment protocols and improve patient outcomes and quality of
life. Pharmacyclics’ Imbruvica has been approved in 50 countries for mid–to-late stage cancers and offers broad
international expansion.
The risk to AbbVie is clear. Can it earn enough from Imbruvica to enable it to earn back the hefty premium paid
for Pharmacyclics and still earn its cost of capital? Some analysts question whether Imbruvica can reach the lofty
sales goals, unless the drug can prove effective against other kinds of tumor types and different diseases. Failure to
reach these ambitious sales goals could result in substantial future write-offs. But the real risk may have been one of
entering into a deal when you are feeling desperate.
An important objective for AbbVie was to gain complete control of Pharmacyclics through a tender offer to gain
Discussion Questions & Answers:
1. What is the form of payment used in this deal? Why might this form have been selected? What are the
advantages and disadvantages of the form of payment used in this deal?
Answer: The form of payment for Pharmacyclics is a combination of cash and stock. This combination may