Tuesday, 4 June 2013



Definition of Merger
Combining of two business entities under common ownership (Arnold 2005)
Two firms coalesce and share resources in order to realise a common goal
One party almost always dominates so
Corporations strive to increase their earnings per share over time.
Definition of  Acquisition
One firm buys the assets or shares of another
Takeover implies the acquiring firm is larger than the target
Reverse takeover if the target is larger than the acquirer

    “Organic” approaches:
    Increase sales of existing divisions while maintaining level operating margins
    Increase operating margins with constant sales
    Mergers and Acquisitions:
    Seek to merge or acquire another corporation, with resulting corporation’s size and earnings enhanced by combination
A Brief History of Mergers and Acquisitions
    M&A transactions date back to 19th century
    Horizontal acquisitions: acquiring competitors in the same industry and then systematically reducing costs of acquired company by integrating its operations into acquirer's company
    Vertical acquisitions: acquiring companies in own supply chain
    Enormous trusts, or business holding companies

A Brief History of Mergers and Acquisitions
In the 1920’s, 1960’s, and 1980’s, M&A activity reached historic highs and corresponded to positive performance of the stock market.
      1920’s: combinations of firms within industries
      1960’s: conglomerate approach (e.g. LTV, ITT)
      1980’s: use of large amounts of debt as the means to finance acquisitions of companies with cheaply priced assets through leveraged buyouts
        In the 2000’s, Wall Street declined due to lower asset values and increased government regulation; strategic horizontal mergers are becoming more common.
     Strong banks are absorbing weak ones before/after FDIC seizes them.
     Chemical, pharmaceutical and commodities firms are merging in order to increase global reach and reduce cost per unit of production.
     Leveraged buyout firms (now private equity firms) have decreased their activity due to losses from 2007/2008 vintage investments and reduction in debt availability.
     Completed deals have lower levels of debt and therefore, either a lower price or more equity.

How Companies Can Work Together
    Article 2 of the Uniform Commercial Code (UCC): set of contractual rules for sale of goods between companies
    Vendor-customer relationships are governed by purchase orders (POs): short form of contract, containing standard provisions and blank spaces for price, quantity, and shipment date of goods involved
    Strategic alliance (or teaming agreement): parties work together on a single project for a finite period of time
      Do not exchange equity
      Do not create permanent entity to mark relationship
      Written memorandum of understanding (MOU): memorializes strategic alliance and sets forth how parties plan to work together
    Joint venture: parties work together for lengthy or indeterminate period of time
    Form new, third entity
    Divide ownership and control of new entity, determine who will contribute what resources
    Advantage: two entities can remain focused on their core businesses while letting joint venture pursue the new opportunity
    Downside: governance issues and economic fairness issues create friction and eventual disbandment
       Acquisition: acquired company becomes subsidiary of purchasing company
      Most permanent
      Eliminates governance and economic fairness issues
      Forms of acquisitions
     Stock acquisition
     Asset acquisition
       Merger: two companies legally become one
        All assets and liabilities being merged out of existence become assets and liabilities of surviving company
       Stock acquisition: acquired company becomes subsidiary of acquiring company
       Asset acquisition: assets but not liabilities become assets of acquiring firm

How and Why to do an Acquisition
       If acquisition will create positive present value when weighing outflow (acquisition price) versus future inflow (cash flow of acquired company plus any synergies), then transaction makes financial sense.
      Difficulty: determine what exactly are the outflows, inflows, and synergies (both revenue/cost synergies)
        Common synergies
        Cost Savings:
    One has lower existing costs due to efficiency, scale, etc.
    One has better cost management
    Combined company has greater economies of scale
    One has better credit rating/balance sheet and therefore cheaper financing costs
    Transactions costs eliminated in vertical merger
    Reduction in employee costs (layoffs)
    Reduction in taxes if acquirer has NOLs and is not limited by Section 382 of IRC

       Common synergies (continued)
       Revenue enhancements:
      Use of each other’s distributors and other channels
      “Bundling” opportunities from combined product offering makes company more attractive
      Combined company can raise prices (greater market power)

       Companies will hire a group of advisors to assist in evaluating and consummating transaction à investment bank, law firm with expertise in mergers and acquisitions, accounting firm, valuation firm
       Investment bank
        Primary financial advisor
        Puts together financial model to analyze cash flows of combined company on pro forma basis
        Evaluates comparable transaction in order to render advice on price
        Offers advice on tax and accounting structure for transaction
        Helps raise capital needed to complete transaction

       Law firm
      Responsible for drafting and negotiation of transaction documents
      Reviews appropriate tax, employment, environmental, corporate governance, securities, real property, and other applicable international, federal, state and local laws
      Advise Board of Directors on fulfilling its fiduciary duties of care and loyalty to shareholders
       Accounting firm
      Advise company on proper tax and accounting treatment of transaction
      Assist in valuing certain specific assets
      “Comfort letter” on certain accounting issues
      Consent letter needed if publicly registered securities offering is made in connection with transaction

The Politics and Economics of Acquisitions
       Key political elements of a transaction
                  Which entity will survive or be parent company
                  What will new company’s board of directors look like
                  Who will manage company day-to-day
       Smaller company will typically become subsidiary of larger company
      Smaller company may have token representation on Board of Directors of parent
      Management of smaller company will typically either remain at subsidiary or exit

The Politics and Economics of an Acquisition – Merger of Equals
       Board positions often allocated 50/50
       “Office of the Chairman” or “Office of CEO”: formed to share management authority
       Murky lines of authority or shared power can lead to difficulty and conflict

      The Politics and Economics of an Acquisition
       Buyer will offer price based on whether transaction will be accretive: increases earnings per share of acquiring company
       Seller will seek premium over its existing stock price (if public) or price in line with public traded comparables or recent public disclosed M&A transaction multiples based on price to earnings, price to EBITDA or price to sales (if private)

LBOs, Hostile Takeovers and Reverse M&A
        Leveraged Buy Outs (LBOs): purchases of stock of company where a significant percentage of purchase price is paid for with proceeds of debt
    Became prominent in 1970’s and 1980’s with rise of LBO shop
    Debt financing to fund:
    High yield (junk) bonds
    Hostile takeovers: acquisition in which “target’s” board of directors does not consent to transaction
    Tender offer: Potential buyer or “raider” makes cash offer directly to shareholders, thereby bypassing board of directors
        Three major events altered landscape to reduce incidence of hostile takeovers:
                   Creation of poison pills: companies issued convertible preferred stock to exiting shareholders with provisions which made a potential tender offer prohibitively expensive
                   State of Delaware passed new provision of Delaware General Corporate Law, Section 203: requires hostile buyer to acquire at least 85% of target company in order to consummate hostile takeover
                   U.S. Congress passed revision of tax code: limited tax deductibility of certain high yield debt (HYDO rules), thus reducing attractiveness of junk bonds as means of financing acquisitions

Reverse M&A (add value through divestiture)
       Four forms of reverse M&A:
1.      Simple sale of division or subsidiary: asset sale, stock sale, or merger

2.      Spin-off: corporation issues dividend of shares of subsidiary to be spun-off corporation’s shareholders
Shareholders of parent participate in spin-off on pro rata based on their ownership percentage in parent
Prior to spin-off, parent may extract cash from subsidiary
“19.9% IPO”: subsidiary is taken public and all or large portion of proceeds are then allocated to parent
Transfer certain debts to subsidiary so that parent ends up with less leveraged balance sheet post spin-off
Parent has subsidiary dividend to parent a portion of subsidiary’s cash

3.      Split-off: shareholder in parent corporation elects to take shares in subsidiary being split-off, but ends up with fewer shares of parent corporation
4.      Split-up: shareholder elects to take shares in one part of split company or other
Less common than spin-offs and split-offs because most shareholders like having parts of both parent and entity divested

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