632598256894

where it‟s ultimately buried. Such vertical integration is seen as crucial for success in the waste
business. Owning landfill space gives a trash company control over its single biggest cost,
disposal fees, and, equally important, produces substantial economies of scale.
—Wall Street Journal/New England, July 28, 1999, NE3
One firm may acquire another to better utilize its existing resources. A chain of ski retailers might
combine with golf or tennis equipment stores to better utilize warehouse and store space. These types
of transactions—dependent upon complementary resources—are typical in industries with seasonal or
very volatile revenue and earnings patterns.
Personnel reductions are often used to reduce costs after an acquisition. The savings can come from
two sources, one being the elimination of redundancies and the second the replacement of inefficient
managers. When firms combine, there may be overlapping functions (e.g., payroll, accounts payable,
information systems, etc.). By moving some or all of the acquired firm‟s functions to the bidder,
significant cost savings may be possible. In the second case, the target firm managers may actually be
making decisions that limit or destroy firm value. By acquiring the firm and replacing them with
managers who will take value-maximizing actions, or at least cease the ones that destroy value, the
bidder can effect positive changes.
The U.S. oil industry in the late 1970s provides an excellent example of this. Excess production,
structural changes in the industry, and macroeconomic factors resulted in declining oil prices and high
interest rates. Exploration and development costs were higher than selling prices, and companies were
losing money on each barrel of oil they discovered, extracted, and refined. The industry needed to
downsize, but most oil company executives were unwilling to take such action and, as a result,
continued to destroy shareholder value. T. Boone Pickens of Mesa Petroleum was one of the few
industry participants who not only understood these trends, but was also willing to act. By acquiring
several other oil companies and reducing their exploration spending, Pickens created significant
wealth for his and the targets‟ shareholders. 12
Tax Savings
Corporations in the United States pay billions of dollars each year in corporate income taxes. M&A
activity may create tax savings that would not be possible absent the transaction. While acquisitions
made solely to reduce taxes would be disallowed, substantial value may result from tax savings in
deals initiated for valid business purposes. We consider the following three ways that tax incentives
may motivate acquisition activity:
1. Unused operating losses.
2. Excess debt capacity.
3. Disposition of excess cash.
Operating losses can reduce taxes paid, provided that the firm has operating profits in the same
period to offset. If this is not the case, the operating losses can be used to claim refunds for taxes paid
in the three previous years or carried forward for 15 years. In all cases, the tax savings are worth less
than if they were earned today due to the time value of money.