Wednesday, November 5, 2008

Economic Advantages of Combinations

Business combination. ys are typically viewed as a way to jump-start economies of scale. Saving may result from the elimination of duplicative assets. Perhaps both companies will utilize common facilities and share fixed costs. There may be further economies as one management team replaces two separates sets of managers. It may be possible to better coordinate production, marketing and administrative actions.
Horizontal combinations involve those where competitors serving similiar functions hope to economize by combining those functions, such as the SBC acquisition of Ameritech Corporation. The following comments from the 1999 Annual Report of SBC Communications Inc. refer to its acquisition of Ameritech Corporation :

We grew our customer vase significantly through the acquisition of Ameritech Corporation, wich made us the local communications provider to about 53 million American homes and business. Being the incumbent provider is a huge advantage in a marketplace where customers invreasingly look to one company to provide all their communications needs. This much larger customer base give us the scope to achieve significant merger synergies and expand to 40 new major US markets within the next two years.

Vertical combination
are the combinations of companies that were at different levels within the marketing chain. An example would be the acquisition of a food distribution company by a restaurant chain. The intended benefit of the vertical combination is the closer coordination of different levels of activity in a given industry. Recently, manufacturers have purchased retail dealers to control the distributin of their products. For example, the major automakers have been actively acquiring auto dealerships.

Conglomeratesi are combinations of dissimilar business. A company may want to diversify by entering a new industry. The purchase of Nabisco Holdings Corporations, a food product company, by Philip Morris, a tobacco company, was just such a diversification.

Tax Advantages of Combinations

Perhaps the most universal economic benefit in business combinations is a possible tax advantage. The owners of a small business, whether sole, proprietors, partners, or shareholders, may wish to retire from active management of the company. If they were to sell their interest to cash or accept debt instruments, they would have an immediate taxable gain. if, however, they accept the common stock of another corporation in exchange for their interest and carefully craft the transaction as a "tax-free reorganization," they may account for the transaction as a tax-free exchange. No taxes are paid until the shareholders sell the share received in the business combination. The shareholders records the share received (for tax purposes) at the book value of the sahres exchanged for the new shares. For example, SBC Communications Inc. informed Ameritech investors that they would receive 1.136 SBC shares per share of Ameritech stock owned. The SBC Website (http://www.sbc.com/Investor/Shareholder/AIT) has information that explains the tax-free nature of the exchange to Ameritech stockholders and helps them to calculate their new cost basis.

The further tax advantages exist when the target company has reported losses on its tax returns in prior periods. Internal Revenue Code provides that operating losses can be carried back two years to obtain a refund of taxes paid in previous years. Should the loss not be offset by income, this eliminating or reducing income taxes that would otherwise be payable. These loss maneuvers have little or no value to a target company that has no had income in the two perior years and does not expect profitable operations in the near future. However, tax losses are transferable in a business combinations. To an acquiring company that has a profit in the current year and/or expects profitable periods in the future, the tax losses of a target company may have real value. That value, viewed as an asset by the acquiring company, will be reflected in the price paid. However, the acquiring company must exercise cautions anticipating the benefits of tax loss carryovers. The realization of the tax benefits may be denied if it can be shown that the primary motivations for the combination was the transfer of the loss benefit.

A tax benefit may also be available in a subsequent period as a single consolidated tax return is filed by a single remaining corporation. The losses of one of the affiliated companies can be used to offset the net income of another affiliated company to lessen the taxes that would otherwise be paid by the profitable company. in some cases, it may be disadvantageous to file as a consolidated company. Companies with low incomes may fare better by being taxed separately due to the progressive income tax rate structure. The marginal tax rate of each company mat be lower than that resulting when the incomes of the two companies are combined.

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