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Unformatted text preview: hostile merger;
and (d) strategic merger and financial merger.
17–2 Briefly describe each of the following motives for merging: (a) growth or
diversification, (b) synergy, (c) fund raising, (d) increased managerial skill
or technology, (e) tax considerations, (f) increased ownership liquidity,
and (g) defense against takeover.
17–3 Briefly describe each of the following types of mergers: (a) horizontal, (b)
vertical, (c) congeneric, and (d) conglomerate. LG2 17.2 LBOs and Divestitures
Before we address the mechanics of merger analysis and negotiation, you need to
understand two topics that are closely related to mergers—LBOs and divestitures.
An LBO is a method of structuring an acquisition, and divestitures involve the
sale of a firm’s assets. 5. A discussion of the key concepts underlying the portfolio approach to the diversification of risk was presented in
Chapter 5. In the theoretical literature, some questions exist about whether diversification by the firm is a proper
motive consistent with shareholder wealth maximization. Many scholars argue that by buying shares in different
firms, investors can obtain the same benefits as they would realize from owning stock in the merged firm. It appears
that other benefits need to be available to justify mergers. 718 PART 6 Special Topics in Managerial Finance Leveraged Buyouts (LBOs)
leveraged buyout (LBO)
An acquisition technique involving the use of a large amount of
debt to purchase a firm; an
example of a financial merger. Hint The acquirers in LBOs
are other firms or groups of
investors that frequently
include key members of the
firm’s existing management. A popular technique that was widely used during the 1980s to make acquisitions
is the leveraged buyout (LBO), which involves the use of a large amount of debt
to purchase a firm. LBOs are a clear-cut example of a financial merger undertaken to create a high-debt private corporation with improved cash flow and
value. Typically, in an LBO, 90 percent or more of the purchase price is financed
with debt. A large part of the borrowing is secured by the acquired firm’s assets,
and the lenders, because of the high risk, take a portion of the firm’s equity. Junk
bonds have been routinely used to raise the large amounts of debt needed to
finance LBO transactions. Of course, the purchasers in an LBO expect to use the
improved cash flow to service the large amount of junk bond and other debt
incurred in the buyout.
An attractive candidate for acquisition via a leveraged buyout should possess
three key attributes:
1. It must have a good position in its industry, with a solid profit history and
reasonable expectations of growth.
2. The firm should have a relatively low level of debt and a high level of “bankable” assets that can be used as loan collateral.
3. It must have stable and predictable cash flows that are adequate to meet interest and principal payments on the debt and provide adequate working capital.
Of course, a willingness on the part of existing o...
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