Mergers and Acquisition
Table of Contents
Mergers and acquisition create value by providing growth opportunities and synergies, enhancing market power, unlocking hidden value, and exploiting unique resources or capabilities (Balmaceda 2009, p. 454). In 2009, Volkswagen Group (VW AG), a globally renowned automotive manufacturing company, purchased a 49.9% stake in Porsche SE (Bryant 2012). Later, in August 2012, VW AG bought the remainder stake in Porsche SE for $5.58 billion and one ordinary share of VW (Bryant 2012). Porsche joined a stable of 12 VW brands and offered VW AG an opportunity to exploit the synergies in car production, development, purchase, and sales (Bryant 2012). The acquisition reinforced VW’s bid to be the world’s largest carmaker in terms of sales and leveraged new growth opportunities within the high-margin premium segment. The paper examines when and why an acquirer should pay for the transaction using cash, share, or a mixture of both. This discussion is framed in the light of the horizontal merger between Porsche SE and VW AG.
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The Distinction Between Cash and Stock Payment Methods
Research studies have shown that the methods of payment have a significant impact on the announcement returns. The mode of payment can provide investors with valuable insights on how an acquirer judges the value of the firm and on the synergies anticipated to be realized from a merger or acquisition (Rani, Yadav & Jain 2015, p. 293). When choosing between paying in cash, securities, or by means of a combination of both methods, an acquirer must take into consideration such factors as the possible presence of other bidders, target’s payment preference and readiness to sell, transaction costs, tax implications, and capital structure (Liargovas & Repousis 2011, p. 89).
The core distinction between stock and cash transactions is that in cash transactions, an acquirer shoulders all risks if the anticipated synergy value fails to materialize, while in stock transactions, all shareholders share risks, and the synergy is shared in proportion to the percentage of the combined entity the acquiring and selling shareholders own (Alexandridis, Mavrovitis & Travlos 2011, p. 663). The payment in cash signals the acquirer’s confidence in the acquisition, while the payment in stock shows an acquirer’s uncertainty concerning the possible synergies from a merger (Chemmanur, Paeglis & Simonyan 2009, p. 523). As such, the greater the degree of an acquirer’s overvaluation is, the greater is the probability of the acquirer using a stock offer.
When and Why an Acquirer Should Pay for a Target in Cash
In a cash deal, the functions of the parties are straightforward, and the exchange of money for shares completes the transfer of ownership. An acquirer should choose paying for stocks in cash if an acquirer believes the deal will create synergy in the future. Moreover, acquirers should settle the deal in cash if they believe the shares will be worth more after the realization of the synergies from the merger (Koller et al. 2015, 586). Several studies have shown that all-cash acquisitions deliver higher returns to acquirers compared to share-exchange acquisitions (Ismail 2008, p.72; Martynova & Renneboog 2008, p.2148). This draws from the fact that the announcement of a cash acquisition signals that an acquirer believes that the target’s shares are underpriced. In addition, an acquirer may choose a cash offer in an attempt to deter competing bids (Isa & Lee 2011, p.177).
When and Why an Acquirer Should Pay for an Acquisition in Stock
An acquirer may select to pay for a stake in a target company in stock if an acquirer is less confident about the firm’s comparative valuation. If an acquirer believes that the acquirer’s shares are overvalued compared to the target’s ones, then stock is a suitable type of transaction currency (Chatterjee & Yan 2008, p. 1001). The presence of a comparative overvaluation (mispricing) between an acquirer and a target is necessary for an acquirer to benefit from an acquisition (Gu & Lev 2011, p. 1995). However, overvalued acquirers occasionally substantially overpay for their targets, and acquisitions may not necessarily yield synergy gains. Furthermore, paying in stock gives an acquirer the capacity to share some of the implementation risks of an acquisition with a target (Fu, Lin & Officer 2013, p. 24). For example, during a bubble, an acquirer should pay in shares in order to ensure that all parties share the burden occasioned by a market correction.
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When and Why an Acquirer should pay for a Target in a Combination of Cash and Stock
An acquirer may opt to pay in a combination of cash and stock in order to create an optimal capital structure. Such a payment method is an antidote to an acquirer who overextends credit lines or generates a debt burden, especially when synergies fail to materialize (Risberg, King & Meglio 2016, p. 192; Graham, Smart & Megginson 2010, p. 808). If the capital structure of the consolidated entity cannot shoulder any additional debt incurred by paying for an acquisition in cash, then an acquirer should consider paying partially or wholly in shares, irrespective of a desire to share risks among the shareholders of the combined entity.
Mergers and acquisitions generate value for a target company shareholder within short term. In some cases, acquirers overpay in merger bids and tend to underperform within long term owing to the incapacity to fully exploit the synergies from a merger. The payment method chosen by an acquirer functions as a signaling device regarding an acquiring firm’s stock value. In the majority of cases, investors construe cash offers as good news, and share offers are considered bad news. The acquirer firm’s managers should opt for cash offers if they consider that the acquiring firm’s shares are undervalued. Cash acquisitions usually generate positive returns for an acquirer irrespective of the target firm’s status. Overvalued firms usually have the highest incentive to choose the stock payment method. Thus, they may acquire the assets of less overvalued targets at an effective discount obtained at the expense of the target’s long-term shareholders.