Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

VIII. Topics in Corporate

Finance

25. Mergers and
    Acquisitions

(^868) © The McGraw−Hill
Companies, 2002
mailing is used in a tender offer. This is not common, however, because a general mail-
ing requires the names and addresses of the stockholders of record. Obtaining such a list
without the target firm’s cooperation is not easy.
The following are some factors involved in choosing between an acquisition by stock
and a merger:

1. In an acquisition by stock, no shareholder meetings have to be held and no vote is
   required. If the shareholders of the target firm don’t like the offer, they are not
   required to accept it and need not tender their shares.


2. In an acquisition by stock, the bidding firm can deal directly with the shareholders
   of the target firm by using a tender offer. The target firm’s management and board
   of directors can be bypassed.


3. Acquisition is occasionally unfriendly. In such cases, a stock acquisition is used in
   an effort to circumvent the target firm’s management, which is usually actively
   resisting acquisition. Resistance by the target firm’s management often makes the
   cost of acquisition by stock higher than the cost of a merger.


4. Frequently, a significant minority of shareholders will hold out in a tender offer. The
   target firm cannot be completely absorbed when this happens, and this may delay
   realization of the merger benefits or may be costly in some other way. For example,
   if the bidder ends up with less than 80 percent of the target firm’s shares, it must pay
   tax on 20 to 30 percent of any dividends paid by the target firm to the bidder.


5. Complete absorption of one firm by another requires a merger. Many acquisitions
   by stock are followed up with a formal merger later.

Acquisition of Assets

A firm can effectively acquire another firm by buying most or all of its assets. This ac-

complishes the same thing as buying the company. In this case, however, the target firm

will not necessarily cease to exist; it will have just sold off its assets. The “shell” will

still exist unless its stockholders choose to dissolve it.

This type of acquisition requires a formal vote of the shareholders of the selling firm.

One advantage to this approach is that there is no problem with minority shareholders

holding out. However, acquisition of assets may involve transferring titles to individual

assets. The legal process of transferring assets can be costly.

Acquisition Classifications

Financial analysts typically classify acquisitions into three types:

1.Horizontal acquisition.This is acquisition of a firm in the same industry as

the bidder. The firms compete with each other in their product markets. The

Wachovia/First Union bank merger we discussed to open the chapter is a good

example. Additional examples are easy to find, including the combination

of regional telephone companies Bell Atlantic and GTE that produced

telecommunications giant Verizon. Such mergers have been common in the

petroleum industry. A recent example would be the 2001 combination of Chevron

and Texaco.

2.Vertical acquisition.A vertical acquisition involves firms at different steps of the

production process. The acquisition by an airline company of a travel agency would

be a vertical acquisition. For example, America Online’s (AOL’s) purchase of

Netscape for $4.21 billion in 1998 was essentially a vertical merger. AOL is a huge

on-line service provider, while Netscape provides Internet and electronic commerce

software.

844 PART EIGHT Topics in Corporate Finance

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