Merger

29.5 A Cost to Stockholders from Reduction in Risk:

The risk reduction reflected diversification. Diversification also happens in a merger. When two firms merge, the volatility of their combined value is usually less than their volatilities as separate entities. An individual benefits from portfolio diversification, diversification from a merger may actually hurt the stockholders. The reason is that the bondholders are likely to gain from the merger because their debt is now “insured” by two firms, not just one. It turns out that this gain to the bondholders is at the stockholders expense.

Coinsurance effect:

Makes the debt less risky and more valuable than before. There is no net benefit to the firm as whole. The bondholders gain the coinsurance effect, and the stockholders lose the coinsurance effect. Some general conclusions are:

1. Mergers usually help bondholders .The size of the gain to bondholders depends on the reduction in the probability of bankruptcy after the combination. That is, the less risky the combined firm is, the greater are the gains to bondholders.

2. Stockholders are hurt by the amount that bondholders gain.

3. Conclusion 2 applies to mergers without synergy. In practice, much depends on the size of the synergy.

29.6 The NPV of a Merger

Firms typically use NPV analysis when making acquisitions. The analysis is relatively straightforward when the consideration is cash. The analysis becomes more complex when the consideration is stock.

Cash:

Value of firm after the acquisition = Value of combined firm-Cash paid

We can also value the NPV of a merger to the acquirer:

NPV of a merger to acquirer = Synergy – Premium

Common Stock:

Value of Firm Stockholders after Merger = New Shares Issued

Old Shares New Shares Issued

29.7 Friendly versus Hostile Takeovers:

Mergers are generally initiated by the acquiring, not the acquired, firm. The acquirer...