Computech Company Case Mergers free essay sample

Company Profile of CompuTech Company Marco Garibaldi was a computer hacker and began to develop computer programs in the basement of his parents’ home. His first software program named as â€Å"WordPro† aroused great interest among the academic and the business communities. That was the story behind the establishment of â€Å"CompuTech Industries† in 1983. The company went to public in 1990 for the first time. By the end of 1995, CompuTech’s stock price was $25 per share and its outstanding shares were 10,000,000. CompuTech has developed a solid reputation especially for reliability and timely introduction of new products. Besides, it supplies a toll-free telephone service in order to identify and correct program bugs. Its products are perceived as innovative, easy to use and relatively free from errors. However, diversity of the products offered by the company is limited. CompuTech is expert on just one type of software: word processing and presentation programming. On the other hand, trends in the market are changing so fast, office packages that combine multiple programs and spreadsheets are so popular. Garibaldi thinks that CompuTech should combine its force with another software company, which specializes in accounting, finance and tax return software programs. Computer Concepts Inc. (CCI) is considered as a potential candidate for the acquisition. CCI went public in 1993 and now it has 2. 5 million shares sold with price of $1. 25 per share. Management owns 30% of the company. Garibaldi doesn’t know whether management will be willing for merger or not. Yet, he is quite sure that CCI’s managers didn’t have discussions with anyone else about a merger. That’s a good point for CompuTech. Whether CompuTech should make an offer and if so should it be friendly deal or hostile takeover will be analysed in this paper. Besides from these, there will be suggestions about the value of an offer and how they should make a payment. To sum up, MA from all dimensions is the main concern of this report. Rationale for Mergers and Acquisition In today’s competitive world, companies should seek different alternatives for maximizing firm value. One of them is Mergers Acquisitions (MA) and there are basically five rationales claimed by proponents of mergers. First of all, tax consideration is a motive. When acquirer has accounting profit whereas target firm has negative accounting profit, firms will enjoy tax advantages. Acquirer’s tax liability reduces depending upon the loss incurred by other firm. Thus, tax payment made by the firm with positive net income will be much more less in total. It is especially preferable when corporate tax rates are high. Second, diversification benefits should be considered. Diversification is absolutely beneficial to employees, customers and managers of firms. From external investors point of view this doesn’t be a concern since they can create a portfolio, indeed easily than firms do, which eliminates unsystematic risk by diversification. Thus companies don’t need to do that internally at all. But the point is that diversification (especially from different industries) will reduce the variability on EBIT. Firm can get advantage of low cost of capital and debt. Decreased risk associated with the company reduces discount rate used by the firm as well. Consequently, management will be more confident about future earnings, and this gives them flexibility in financial decisions. Third one is purchase assets below replacement cost. Purchasing assets is less costly than developing the necessary production capacity by itself as a single firm. Companies consider replacing systems or assets with the ones of acquired firm can purchase these assets below replacement cost. In order to determine whether the purchase of assets is reasonable or not, acquirer firm should implement a cost-benefit analysis for the assets of target firm. If benefits exceed the costs, we can say that merger will provide a cost reduction for acquirer. The next one is control of the firm. If a company attempts to take control over another firm, MA is a way for achieving it. MA is useful especially when the management of target firm is not so successful. After acquisition new management can increase value of the target firm by well managing, decreasing costs and increasing efficiency. The last one is about synergy. When two firms are combined, an extra value for occurs for the companies apart from the summation of their standalone entity. It refers to synergy. From society’s point of view synergy is the most justifiable motive. Shared know-how, intangible resources (generally human resources, corporate culture, business creation etc. ), more efficiently used physical resources, economies of scale, reduced costs lead more successful business. They are advantages for different stakeholder parties within the company as well. Also it increases competitiveness in the industry. It turns into offering best efforts for the wellbeing of customers. It can be seen as an equation, which gives more than its numerical total: one plus one is more than two for every one. Another socially justifiable motive is control. Changing the control of the firm will increase shareholders’ wealth (that is the ultimate goal in business) and thus it increases benefits of shareholders. After MA most of the companies are managed and controlled more successfully than the previous managers. On the other side, there are some motives, which can’t be justified socially. Tax consideration can’t be justifiable from the perspective of society. Firm can decrease their tax obligations by MA; thus , state can collect less money. It reduces the income of the government consequently limits the amount spending to projects and services for the welfare of the citizens. CompuTech Company can use the advantage of MA in terms of synergy, diversification and purchase assets below its replacement cost. Controls of the firm and tax concerns are not applicable in CompuTech’s case at all. CompuTech wants to increase its variety of products. Also it pursues a large market share. It has no tax concerns and no intention to take the control over the other firm because of the strategic reasons. Its purpose is much more in economic sense rather than strategic. Types of Mergers (Hostile vs. Friendly) A merger is joining of two firms in order to form a single firm and it can be distinguished as friendly and hostile. In friendly mergers, management of the target firm is willing -at least neutral- to merge. Friendly merger takes place if management of target company will agree on the issue with the acquirer. In that kind of mergers, management of both sides come together and discuss about the terms of contract (including the merger price, restrictive covenants and flexibilities). However in hostile mergers, target company doesn’t want to get into a merger or deal is not achieved by negotiation process or even the targeted company doesn’t know intention of the acquirer in advance. Acquirer firm prepares merger contracts in general. Determining the types of payment (by cash o by stock), amount of offer, price and other legal and technical issues underwent by that company. Then the offer is disseminated to the management of targeted firm and the negotiation process begins. However, in some cases, consensus may not be reached. Then there are different tactics implemented by acquirer firm. Acquirer can make a tender offer. It means that acquirer goes directly to the shareholders of targeted company and buys their shares in return for some premium over the current market price. Before tender offer, there is asymmetric information between parties. Shareholders require a premium because they are informed. Perception to the targeted company in the market changes as fast as possible. We conclude that it is likely to see an overbidding in a hostile merger rather than a friendly merger. The reason is that the acquiring firm may inevitably pay higher premiums in order to gain at least 51% of target firm’s shares and shareholders can be convinced to sell their shares if the target’s management notified them about not to sell. Valuation Analysis The discounted cash flow (DCF) method to valuing a business includes the applications of capital budgeting procedures to an entire firm rather than to a single project. However, differently from common capital budgeting procedures, interest expense is involved in the analysis and deducted in merger cash flow statements. The reason is that the debt related to merger is more complex than issue of new debt related to capital budgeting projects. Acquiring firms often assume that the debt of target is part of the deal. Moreover, the acquisition is often financed partially by debt. In order for the growth of target firm in the future, management will have to issue new debt. Therefore, the interest expense is typically deducted in the merger cash flow statements. Furthermore, earning retentions are deducted to obtain the free cash flows. The reason is that the subsidiary needs -like any other firm- to reinvest some of its earnings in order to maintain its growth.