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1) Summarize the article (in 250 words).

2) What key messages do you take away from this article? (in 200 words)

 

3) Do research and find a company (or companies) that had similar experience discussed in the article ? (in 100 words) [Please ensure to cite your reference]

 

The form of payment refers to the composition of the purchase price for a target firm and can be structured in many different ways. This section discusses alternative structures that can be used as payment in negotiating with a target firm’s board and management and how these various forms of payment can be used to bridge differences between the seller’s asking price and the price the acquirer is willing to pay.

Cash

Cash is the simplest and most commonly used means of payment for acquiring shares or assets. Although cash payments generally result in an immediate tax liability for the target company’s shareholders, there is no ambiguity about the value of the transaction as long as no portion of the payment is deferred. Whether cash is used as the predominant form of payment depends on a variety of factors, including the acquirer’s current leverage, potential near-term earnings per share dilution, the seller’s preference for cash or acquirer stock, and the extent to which the acquirer wishes to maintain control.

A bidder may choose to use cash rather than issue voting shares if the voting control of its dominant shareholder is threatened as a result of the issuance of voting stock to acquire the target firm. [4] Issuing new voting shares would dilute the amount of control held by the dominant shareholder. The preference for using cash appears to be much higher in Western European countries, where ownership tends to be more heavily concentrated in publicly traded firms, than in the United States. In Europe, 63% of publicly traded firms have a single shareholder who directly or indirectly controls 20% or more of the voting shares; the U.S. figure is 28%. [5]

Noncash

The use of common equity may involve certain tax advantages for the parties involved—especially shareholders of the selling company. However, using shares is much more complicated than cash because it requires compliance with the prevailing security laws and may result in long-term earnings per share dilution. Using convertible preferred stock or debt can be attractive to both buyers and sellers. These securities offer holders the right (but not the obligation) to convert to common stock at a predetermined “conversion” price. Convertible preferred stock provides some downside protection to sellers in the form of continuing dividends, while providing upside potential if the acquirer’s common stock price increases above the conversion point. Acquirers often find convertible debt attractive because of the tax deductibility of interest payments.

The major disadvantage in using securities of any type is that the seller may find them unattractive because of the perceived high risk of default associated with the issuer. When offered common equity, shareholders of the selling company may feel that the growth prospects of the acquirer’s stock may be limited or that the historical volatility of the stock makes it unacceptably risky. Debt or equity securities may also be illiquid because of the small size of the resale market for such securities.

Acquirer stock may be a particularly useful form of payment when valuing the target firm is difficult, such as when the target firm has hard to value intangible assets, new product entries whose outcome is uncertain, or large research and development outlays. In accepting acquirer stock, a seller may have less incentive to negotiate an overvalued purchase price if it wishes to participate in any appreciation of the stock it receives. However, a seller could attempt to negotiate the highest price possible for its business and immediately sell its stock following closing. [6]

Other forms of noncash payment include real property, rights to intellectual property, royalties, earn-outs, and contingent payments. These are discussed later in this chapter.

Cash and Stock in Combination

The bidding strategy of offering target firm shareholders multiple payment options increases the likelihood that more target firm shareholders will participate in a tender offer. It is a bidding strategy common in “auction” environments or when the bidder is unable to borrow the amount necessary to support an all-cash offer or unwilling to absorb the potential earnings per share dilution in an all-stock offer. The multiple-option bidding strategy does, however, introduce a certain level of uncertainty in determining the amount of cash the acquirer ultimately will have to pay out to target firm shareholders, since the number of shareholders choosing the all-cash or cash-and-stock option is not known prior to completion of the tender offer.

Acquirers resolve this issue by including a proration clause in tender offers and merger agreements that allows them to fix—at the time the tender offer is initiated—the total amount of cash they will ultimately have to pay out. For example, assume that the total cost of an acquisition is $100 million, the acquirer wishes to limit the amount of cash paid to target firm shareholders to one-half of that amount, and the acquirer offers the target firm’s shareholders a choice of stock or cash. If the number of target shareholders choosing cash exceeds $50 million, the proration clause enables the acquirer to pay all target firm shareholders tendering their shares one-half of the purchase price in cash and the remainder in stock.

[4]Faccio and Marsulis, 2005

[5]Faccio and Lang, 2002

[6]In a sample of 735 acquisitions of privately held firms between 1995 and 2004, Officer et al. (2007) found that acquirer stock was used as the form of payment about 80% of the time. The unusually high (for acquirers) 3.8% abnormal return earned by acquirers in this sample around the announcement suggests that sellers willing to accept acquirer stock were more likely to see significant synergies in merging with the acquiring firm.

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