Mergers and acquisitions are complex transactions. The process often involves not only the acquiring and target companies but also a variety of other stakeholders, including competition law regulatory agencies. To fully evaluate a merger, analysts must ask two fundamental questions: First, will the transaction create value; and second, does the acquisition price outweigh the potential benefit? This reading has made the following important points.

• An acquisition is the purchase of some portion of one company by another. A merger represents the absorption of one company by another such that only one entity survives following the transaction.

• Mergers can be categorized by the form of integration. In a statutory merger, one company is merged into another; in a subsidiary merger, the target becomes a subsidiary of the acquirer; and in a consolidation, both the acquirer and target become part of a newly formed company.

• Horizontal mergers occur among peer companies engaged in the same kind of business. Vertical mergers occur among companies along a given value chain. Conglomerates are formed by companies in unrelated businesses.

• Merger activity tends to be concentrated in industries undergoing changes, such as deregulation or technological advancement.

• The motives for M&A activity include synergy, growth, market power, the acquisition of unique capabilities and resources, diversification, increased earnings, management’s personal incentives, tax considerations, and the possibilities of uncovering hidden value. Cross-border motivations may involve technology transfer, product differentiation, government policy, and the opportunities to serve existing clients abroad.

• A merger transaction may take the form of a stock purchase (when the acquirer gives the target company’s shareholders some combination of cash or securities in exchange for shares of the target company’s stock) or an asset purchase (when the acquirer purchases the target company’s assets and payment is made directly to the target company). The decision of which approach to take will affect other aspects of the transaction, such as how approval is obtained, which laws apply, how the liabilities are treated, and how the shareholders and the company are taxed.

• The method of payment for a merger can be cash, securities, or a mixed offering with some of both. The exchange ratio in a stock or mixed offering determines the number of shares that stockholders in the target company will receive in exchange for each of their shares in the target company.

• Hostile transactions are those opposed by target managers, whereas friendly transactions are endorsed by the target company’s managers. There are a variety of both pre- and post-offer defenses a target can use to ward off an unwanted takeover bid.

• Examples of pre-offer defense mechanisms include poison pills and puts, incorporation in a jurisdiction with restrictive takeover laws, staggered boards of directors, restricted voting rights, supermajority voting provisions, fair price amendments, and golden parachutes.

• Examples of post-offer defenses include the “just say no” defense, litigation, greenmail, share repurchases, leveraged recapitalization, “crown jewel” defense, Pac-Man^® defense, or finding a white knight or a white squire.

• Competition law prohibits mergers and acquisitions that impede competition.

• Three major tools for valuing a target company are discounted cash flow analysis (which involves discounting free cash flows estimated with pro forma financial statements), comparable company analysis (which estimates a company’s intrinsic value based on relative valuation metrics for similar companies), and comparable transaction analysis (which derives valuation from details of recent takeover transactions for comparable companies).

• In a merger bid, the gain to target shareholders is measured as the control premium, which equals the price paid for the target company in excess of its value. The acquirer gains equal the value of any synergies created by the merger minus the premium paid to target shareholders. Together, the bid and the method of payment determine the distribution of risks and returns among acquirer and target shareholders with regard to realization of synergies as well as correct estimation of the target company’s value.

• The empirical evidence suggests that merger transactions create value for target company shareholders. Acquirers, in contrast, tend to accrue value in the years following a merger. This finding suggests that synergies are often overestimated or difficult to achieve.

• When a company decides to sell, liquidate, or spin off a division or a subsidiary, it is referred to as a divestiture. Companies may divest assets for a variety of reasons, including a change in strategic focus, poor fit of the asset within the corporation, reverse synergy, or cash flow needs.

• The three basic ways that a company divests assets are a sale to another company, a spin-off to shareholders, and liquidation.