21: Mergers, Acquisitions and Corporate Controlexchange could be tax free even if the target shareholders experience a capital gain, while a cash offer is
taxable to target shareholders if they earn a capital gain. However, this depends on the jurisdiction and
tax regulations in place. For example, when St George shareholders were offered Westpac shares in a
scrip merger bid in 2008 (referred to as a scrip for scrip rollover by the Australian Taxation Office), they
were able to defer paying capital gains tax until they disposed of their new Westpac shares.
Mergers are often financed with a combination of cash and securities in transactions known as mixed
offerings. For example, in January 2005, SBC Communications offered AT&T shareholders a combination
of SBC shares worth $18.41 per share plus $1.30/share in cash. Occasionally, target shareholders are also
offered a choice for the medium of exchange. For example, target shareholders could be offered the choice
of either $30 cash or 1.25 shares of the surviving company’s shares for each share that they hold. This way,
the shareholders can decide whether the exchange ratio is sufficient for them to remain shareholders in
the surviving company or whether they should take the money and run with the cash offer.
Table 21.3 indicates that target shareholders fare well in pure share-for-share transactions, and even
better in all-cash deals. Bidders, on the other hand, nearly break even when cash is involved in the
purchase and lose on all scrip deals. Note also that a higher percentage of bidders earn positive returns
in all cash deals.
Several theories have been offered to
explain the differential returns between
cash and scrip offers. The first relates
to the signalling model first described
in Chapter 14. In the context of this
model, the mode of payment offered
by acquiring companies signals inside
information to the capital markets.
If managers use shares to make an
acquisition, it can be interpreted by the
market as a signal that the company’s
equity is overvalued. Receiving this signal, the capital markets downwardly revise the value of the acquirer’s
equity. Other theories concerning the differential returns due to financing method include the tax and pre-
emptive bidding hypotheses. The tax hypothesis postulates that target shareholders must be paid a capital
gains tax premium in cash offers (because they have to turn around and pay tax to the government on any
profits earned), which may not be required in a scrip offer. The pre-emptive bidding hypothesis asserts that
acquirers who wish to ward off other potential bidders for a target will offer a substantial initial takeover
premium in the form of cash. Finally, the lower returns for bidders in scrip deals may reflect the fact that
scrip deals are typically dilutive to bidder EPS, which may be received negatively by the share market.
An interesting variant of financing acquisitions is a debt-for-equity swap. For example, in late
2012, Nine Entertainment Co Pty Ltd (the owner of Channel Nine) was able to stave off bankruptcy
by entering into a debt-for-equity swap with its lenders, swapping its $2.7 billion in debt (owed to
Goldman Sachs, and hedge funds Apollo Global Management and Oaktree Capital Group) for equity
in the company.
21-3d RETURNS TO BONDHOLDERS
Ordinary equity is not the only security affected in corporate control activities; bonds and preferred
equity can also be affected. When an acquisition increases the stability of cash flows relative to the
mixed offerings
A merger financed with a
combination of cash and
securitiesTABLE 21.3 ABNORMAL RETURNS TO TARGETS AND BIDDERS
IN TWO-DAY WINDOW CONDITIONAL ON METHOD
OF PAYMENT (TENDER OFFERS IN SDC, 2000–10)All cash All equity
Target two-day returns 26.96% 12.22%
Bidder two-day returns –0.72% –2.24%
Combined two-day returns 2.62% –0.50%
% deals with positive returns for bidders 45.56% 23.08%
% deals with positive returns for target 93.27% 81.25%
Source: SDC and authors’ calculations. © Reuters. Used with permission.