Case 70

Computer Concepts/CompuTech

Merger Analysis

QUESTIONS
Question 1 Several factors have been proposed as providing a rationale for mergers. Among the more prominent ones are (1) tax considerations, (2) diversification, (3) control, (4) purchase of assets below replacement cost, and (5) synergy. From the standpoint of society, which of these reasons are justifiable? Which are not? Why is such a question relevant to a company like CompuTech, which is considering a specific acquisition? Explain your answers.
Answer: Synergy is by far the most socially justifiable reason for mergers. Synergy occurs when the value of the combined enterprise exceeds the sum of the values of the pre-merger firms. (If synergy exists, the whole is greater than the sum of the parts, hence, synergy is often described as "2 + 2 = 5.") A synergistic merger creates value, which must be allocated between the shareholders of the acquiring and the acquired firms. Synergy can arise from many sources, the most prominent being (1) operating economies of scale in management, production, marketing, or distribution; (2) financial economies, which could include higher debt capacity, lower transactions costs, or better coverage by securities' analysts which can lead to higher demand for the combined company's stock, and hence to higher stock prices; (3) differential managerial efficiency, which implies that a new management can increase the value of the firm's operating assets; and (4) increased market power due to reduced competition. Operating and financial economies are socially desirable, as are mergers that increase managerial efficiency, but mergers that reduce competition are undesirable, and antitrust laws are in place to prohibit such mergers.
If one agrees that our tax laws are reasonable, and that tax avoidance is reasonable, tax considerations represent a socially valid