Part II. Solutions to End-of-Chapter Questions, Problems, and Cases
Chapter 1. The Takeover Process
1.1
A merger is a negotiated transaction which meets certain technical and legal requirements. Usually
these negotiations are done between the management/board of the target and the acquirer and are
mostly friendly. In a tender offer the acquirer makes an initial bid to the board of directors
(management) of the target company. The board of directors (management) of the target company
may be unwilling to recommend to the shareholders that they tender their shares. In such case, the
bidder may make an offer (hostile) directly to the shareholders. In the 1980s perhaps 20-30% of
tender offers were hostile. In the 1990s probably no more than 6-8% of tender offers were hostile.
1.2
A horizontal merger involves two firms operating and competing in the same kind of business
activity. Forming a larger firm may have the benefits of (a) economies of scale; (b) achieving
market power; (c) economies of scope; (d) combining complementary capabilities.
1.3
Vertical mergers differ in that they occur between firms in different stages of production, and thus
economic advantages occur along the production process. Other possible economic benefits of
vertical integration are: (a) technological economies; (b) transactions within a firm may eliminate
price searching and other costs; (c) reduces costs of transportation and communication; (d)
planning is improved due to more efficient information flow.
1.4
Pure conglomerate mergers involve unrelated business activities. A conglomerate firm controls a
range of activities in various industries that require different skills in the specific managerial
functions of research, applied engineering, production, marketing, and so on. The diversification is
achieved mainly by external acquisitions and mergers, not by internal development. Financial
conglomerates provide a flow of funds to each segment of their operations, exercise control, and are
the ultimate financial risk takers. In theory, financial conglomerates undertake strategic planning
but do not participate in operating decisions. Management conglomerates not only assume
financial responsibility and control, but also play a role in operating decisions and provide staff
expertise and staff services to the operating entities. Managerial conglomerates provide managerial
counsel and interactions on the generic management functions of planning, organizing, directing,
,and controlling.
The difference between the managerial conglomerate and the concentric company is based on the
distinctions between the general and specific management functions. If the activities of the
segments brought together are so related that there is carryover of specific management functions
(research, manufacturing, finance, marketing, personnel, and so on) or complementary in relative
strengths among these specific management functions, the merger should be termed concentric
rather than conglomerate.
1.5
A sells 1.5 B for $45 and buys T at $44. Assuming 50% margin, the investment is .5 ($45 + $44) =
$44.5. In one month, A uses T to cover 1.5 B. The dollar gain is $1. The percentage gain is
[($1/$44.5)] * 12 = 26.97% less the interest on the $44.5 borrowed on margin. If A invested the full
$89, the gain would be ($1/$89) * 12 = 13.48%.
Appendix A to Chapter 1:
To illustrate this exercise, we will examine the 1998 merger of Compaq and Digital Equipment
(DEC).
A1.1
The transaction was taxable.
A1.2
The transaction was part stock and part cash. Shareholders of DEC would receive $30 cash
and .945 shares of Compaq for each DEC share.
A1.3
Compaq developed and marketed hardware, software, and computer services. It's products
included business solutions, networking and communications products, commercial desktop and
portable products, and consumer PCs.
,DEC was a leader in the implementation and support of networked business solutions.
The merger should be highly related (possibly an 8 or higher). Arguments for the relatedness
would be that both firms are multinational information technology companies. They both provide
networking systems. However, Compaq has a wide product line, making it difficult to determine
what its specific focus is. An argument can be made that the merger was changing Compaq's from
its PC business to its networking business.
A1.4
Horizontal mergers are combinations of firms performing the same business activity.
Vertical mergers are combinations of firms at different stages in the supply chain.
Conglomerates are combinations that involve firms in different types of business activities.
The combination would most accurately be termed a horizontal merger because both Compaq and
DEC were in the networking business.
A1.5
Reasons for the merger included: Compaq sought to strengthen its networking capabilities in order
to become a leader in enterprise solutions. The merger combined DEC's networking with Compaq's
capabilities in the PC and related products market.
A1.6
Termination of the merger agreement resulting from DEC's actions would require payment of $240
million to Compaq.
A1.7
Dissenting shareholders who filed an objection and did not vote for the merger had a right to
payment of an appraisal value of the stock.
A1.8
Options of DEC stock would be exchanged for Compaq options that were fully vested and
exercisable.
, A1.9
The financial advisors looked at:
Premiums paid in similar transactions
Comparable company analysis
Comparable transaction analysis
In the prospectus, the DCF method is not explicitly referred to. It is implicit in some of the things
the financial advisors looked at: Pro Forma effects of the combination, synergy estimates, estimates
of the future performance of the firms.
Appendix B to Chapter 1:
B1.1
These are different kinds of businesses. Integrating organizations is always a major challenge in a
merger. Traditional corporations, such as Time Warner, are likely to have a more hierarchical
organization structure. This means that there are several layers of reporting to higher levels of
managerial authority. The organization of the Internet / high tech firms has had a flatter structure.
This means that executives have a greater degree of freedom in making independent decisions.
Developing a cohesive organization system with clear reporting lines and responsibilities will be a
challenge for the combined firm. Newspaper articles at the time of the merger announcement
indicated that Bob Pittman, the president and chief operating officer of AOL, who was active in the
negotiations, would play a key role in integrating the two organizations. Pittman had been
president of Time Warner Entertainment, an important segment of the Time Warner operations,
before resigning to become president of AOL. Thus, he had established relationships with the top
management at Time Warner.
Time Warner already combined a wide range of activities with different products and business
management requirements. Its organization structure grouped similar activities extending the
principle of subsidiaries with their own presidents within the larger corporate umbrella. An
extension of this organization structure could combine the diverse activities from AOL. Also, some
of the operations of Time Warner, such as its strong position in cable, represented natural
extensions of AOL operations.
B1.2
Chapter 1. The Takeover Process
1.1
A merger is a negotiated transaction which meets certain technical and legal requirements. Usually
these negotiations are done between the management/board of the target and the acquirer and are
mostly friendly. In a tender offer the acquirer makes an initial bid to the board of directors
(management) of the target company. The board of directors (management) of the target company
may be unwilling to recommend to the shareholders that they tender their shares. In such case, the
bidder may make an offer (hostile) directly to the shareholders. In the 1980s perhaps 20-30% of
tender offers were hostile. In the 1990s probably no more than 6-8% of tender offers were hostile.
1.2
A horizontal merger involves two firms operating and competing in the same kind of business
activity. Forming a larger firm may have the benefits of (a) economies of scale; (b) achieving
market power; (c) economies of scope; (d) combining complementary capabilities.
1.3
Vertical mergers differ in that they occur between firms in different stages of production, and thus
economic advantages occur along the production process. Other possible economic benefits of
vertical integration are: (a) technological economies; (b) transactions within a firm may eliminate
price searching and other costs; (c) reduces costs of transportation and communication; (d)
planning is improved due to more efficient information flow.
1.4
Pure conglomerate mergers involve unrelated business activities. A conglomerate firm controls a
range of activities in various industries that require different skills in the specific managerial
functions of research, applied engineering, production, marketing, and so on. The diversification is
achieved mainly by external acquisitions and mergers, not by internal development. Financial
conglomerates provide a flow of funds to each segment of their operations, exercise control, and are
the ultimate financial risk takers. In theory, financial conglomerates undertake strategic planning
but do not participate in operating decisions. Management conglomerates not only assume
financial responsibility and control, but also play a role in operating decisions and provide staff
expertise and staff services to the operating entities. Managerial conglomerates provide managerial
counsel and interactions on the generic management functions of planning, organizing, directing,
,and controlling.
The difference between the managerial conglomerate and the concentric company is based on the
distinctions between the general and specific management functions. If the activities of the
segments brought together are so related that there is carryover of specific management functions
(research, manufacturing, finance, marketing, personnel, and so on) or complementary in relative
strengths among these specific management functions, the merger should be termed concentric
rather than conglomerate.
1.5
A sells 1.5 B for $45 and buys T at $44. Assuming 50% margin, the investment is .5 ($45 + $44) =
$44.5. In one month, A uses T to cover 1.5 B. The dollar gain is $1. The percentage gain is
[($1/$44.5)] * 12 = 26.97% less the interest on the $44.5 borrowed on margin. If A invested the full
$89, the gain would be ($1/$89) * 12 = 13.48%.
Appendix A to Chapter 1:
To illustrate this exercise, we will examine the 1998 merger of Compaq and Digital Equipment
(DEC).
A1.1
The transaction was taxable.
A1.2
The transaction was part stock and part cash. Shareholders of DEC would receive $30 cash
and .945 shares of Compaq for each DEC share.
A1.3
Compaq developed and marketed hardware, software, and computer services. It's products
included business solutions, networking and communications products, commercial desktop and
portable products, and consumer PCs.
,DEC was a leader in the implementation and support of networked business solutions.
The merger should be highly related (possibly an 8 or higher). Arguments for the relatedness
would be that both firms are multinational information technology companies. They both provide
networking systems. However, Compaq has a wide product line, making it difficult to determine
what its specific focus is. An argument can be made that the merger was changing Compaq's from
its PC business to its networking business.
A1.4
Horizontal mergers are combinations of firms performing the same business activity.
Vertical mergers are combinations of firms at different stages in the supply chain.
Conglomerates are combinations that involve firms in different types of business activities.
The combination would most accurately be termed a horizontal merger because both Compaq and
DEC were in the networking business.
A1.5
Reasons for the merger included: Compaq sought to strengthen its networking capabilities in order
to become a leader in enterprise solutions. The merger combined DEC's networking with Compaq's
capabilities in the PC and related products market.
A1.6
Termination of the merger agreement resulting from DEC's actions would require payment of $240
million to Compaq.
A1.7
Dissenting shareholders who filed an objection and did not vote for the merger had a right to
payment of an appraisal value of the stock.
A1.8
Options of DEC stock would be exchanged for Compaq options that were fully vested and
exercisable.
, A1.9
The financial advisors looked at:
Premiums paid in similar transactions
Comparable company analysis
Comparable transaction analysis
In the prospectus, the DCF method is not explicitly referred to. It is implicit in some of the things
the financial advisors looked at: Pro Forma effects of the combination, synergy estimates, estimates
of the future performance of the firms.
Appendix B to Chapter 1:
B1.1
These are different kinds of businesses. Integrating organizations is always a major challenge in a
merger. Traditional corporations, such as Time Warner, are likely to have a more hierarchical
organization structure. This means that there are several layers of reporting to higher levels of
managerial authority. The organization of the Internet / high tech firms has had a flatter structure.
This means that executives have a greater degree of freedom in making independent decisions.
Developing a cohesive organization system with clear reporting lines and responsibilities will be a
challenge for the combined firm. Newspaper articles at the time of the merger announcement
indicated that Bob Pittman, the president and chief operating officer of AOL, who was active in the
negotiations, would play a key role in integrating the two organizations. Pittman had been
president of Time Warner Entertainment, an important segment of the Time Warner operations,
before resigning to become president of AOL. Thus, he had established relationships with the top
management at Time Warner.
Time Warner already combined a wide range of activities with different products and business
management requirements. Its organization structure grouped similar activities extending the
principle of subsidiaries with their own presidents within the larger corporate umbrella. An
extension of this organization structure could combine the diverse activities from AOL. Also, some
of the operations of Time Warner, such as its strong position in cable, represented natural
extensions of AOL operations.
B1.2
