Question

What are the motives of a merger? What are the accounting considerations? What are the premium offers and stock price movements?

Answer 1

Solution:-

Motives of a merger:

There are various reasons because of which two companies may choose to merge their operations and operate as a merged entity. Following are the key motives behind the mergers:

• To gain competitive advantage in a fiercely competitive industry on the basis of combined market shares, bigger economies of scale, vertical integration, stronger brand, etc.
• To achieve synergies by combining two entities, wherein the synergies could be strategic, financial, cost based, etc.
• To unlock the potential of increase in cumulative shareholder's wealth as the market may give a higher valuation multiple to the merged entity as compared to the individual entities
• One of the best ways to destroy competition is to make your competitor a part of you. Many companies do this as they acquire or merge their prime competitors to destroy competition (e.g. ride-sharing cabs are prime examples recently)
• To enter new markets by doing merger with the existing players in those markets
• To take benefits of unlapsed tax losses of any entity by merging it with a profitable entity

Accounting considerations:

The primary accounting considerations of a merger transaction are as follows:

• Combining financial statements of the merged entities, including balance sheet, profit & loss, cash flow statement, etc
• Purchase price allocation under which the entity which has merged the other entity in itself allocates the merger consideration to the assets and liabilities that have come as part of the merger
• Goodwill is booked in accounts on the basis of purchase price allocation, i.e. the merger consideration over and above the value of net assets acquired is transferred to goodwill. This represents the value for intangibles, i.e. the part of merger consideration that was paid over and above the value of net assets acquired.

Premium offers and stock price movements:

A premium offer refers to the offer wherein the offer value for an entity in the merger is higher or at a premium as compared to the existing stock price. For e.g.- If the stock price of a company is $10, but it receives an offer for merger from company B at a value of $12, it means that the offer has been made at a 20% premium.

Whenever a premium offer is made and the merger is expected to successfully close, the price of the entity who has received a premium offer as compared to its existing price would see its stock going up towards the offer levels in the merger. For e.g.- If the stock price of a company is $10, but it receives an offer for merger from company B at a value of $12, it means that the offer has been made at a 20% premium. In this case, the price of stock A is expected to rise 20% and reach close to the offer value.

There are various other types of stock price movements associated with a merger deal. Following are the key types:

• Price movements (Rise or fall) due to rumours of a possible merger are very common. Whenever there are speculations that two entities are considering merger, their stock prices may go up and down depending how the market is expecting the deal to play out
• Positive price movement in stocks of both entities: If the market views the terms of merger beneficial for both companies, the prices of both companies in the market may go up. The extent of rise depends upon the terms of payment in the merger deal and the expected benefits
• Negative price movement in stocks of both entities: If the market views the terms of merger harmful for both companies, the prices of both companies in the market may go down. The extent of fall depends upon the terms of payment in the merger deal and the expected losses
• Positive price movement for one company and negative for other: If the market views the terms of merger as beneficial for one entity and harmful for other, the prices of those entities may reflect that with the entity expected to benefit seeing its price go up and vice-versa.