Mergers and Acquisitions
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Transcript Mergers and Acquisitions
Mergers and Acquisitions
Chapter 19
Mergers and Acquisitions
• Corporations strive to increase their earnings
per share over time.
• Methods
– “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
A Brief History of Mergers and Acquisitions
• 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
How Companies Can Work Together
• 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
How Companies Can 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
How Companies Can Work Together
• Acquisition: acquired company becomes
subsidiary of purchasing company
– Most permanent
– Eliminates governance and economic fairness
issues
– Forms of acquisitions
• Merger
• Stock acquisition
• Asset acquisition
How Companies Can Work Together
• 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)
How and Why to do an Acquisition
• 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
How and Why to do an Acquisition
• 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)
How and Why to do an Acquisition
• Companies will hire a group of advisors to
assist in evaluating and consummating
transaction investment bank, law firm with
expertise in mergers and acquisitions,
accounting firm, valuation firm
How and Why to do an Acquisition
• 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
How and Why to do an Acquisition
• 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
How and Why to do an Acquisition
• 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
1. Which entity will survive or be parent company
2. What will new company’s board of directors look
like
3. Who will manage company day-to-day
The Politics and Economics of an
Acquisition
• 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
LBOs, Hostile Takeovers and Reverse M&A
• Three major events altered landscape to reduce
incidence of hostile takeovers:
1. Creation of poison pills: companies issued convertible
preferred stock to exiting shareholders with provisions
which made a potential tender offer prohibitively
expensive
2. 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
3. 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
LBOs, Hostile Takeovers and Reverse M&A
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
LBOs, Hostile Takeovers and Reverse M&A
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
LBOs, Hostile Takeovers and Reverse M&A
3. Split-off: shareholder in parent corporation
elects to take shares in subsidiary being splitoff, 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