Transcript MA Section 2b: Acquisition interactions

Mergers & acquisitions
Section 2b:
The M&A dance
Prof. Amitai Aviram
[email protected]
University of Illinois College of Law
Copyright © Amitai Aviram. All Rights Reserved
S16D
The M&A dance
Overview of Section 2b
1. Y decides terms of offer
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Y's calculus
Composition of XS's compensation (financing the deal)
2. Friendly approach
3. Why would XB resist?
4. Hostile approach
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Y decides terms of offer
Y’s calculus
• M&A is a complex game between YB, XB & XS
– Y + XB alliance: friendly deal (one that is supported by XB)
– Y + XS alliance: hostile deal (a transaction that doesn’t require XB‘s approval)
– XB + XS alliance: no deal
• Y decides what to offer based on:
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Value of X to Y
Alternatives, for X & for Y, to doing the deal
Support for Y among XS
Strength of takeover defenses
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Y decides terms of offer
Support for Y among XS
• Likely enemies: XS who are unlikely to sell to Y
– E.g., shares held by directors/officers, SHs supportive of board, index funds
• Likely allies: XS who are likely to sell to Y
– E.g., SHs who must sell now; disgruntled SHs; merger arbitrageurs (arbs)
• Arbs are investors who identify companies that they expect will be
taken over, buy shares, and sell to Y @ premium. Example:
– X’s shares sell for $10; Y makes bid @ $15, but XB resists
– Market believes 80% chance board will succeed in blocking deal (& no chance
better deal will come up), so shares sell for $11
– Anna the arb believes Y will succeed. She buys @$11
• Typically arbs use mostly borrowed money to leverage the “bet”
• Arbs’ purchases gradually push price up, deterring long-term investors
– Y succeeds: Anna sells to Y @$15 (+$4); Y fails: price drops to $10, Anna sells (-$1)
• Playing the Arb card
– The larger the number of shares held by arbs, the more likely Y succeeds
– Arbs pile in if they believe the Y will succeed, so it’s a self-fulfilling prophecy: if Y
persuades arbs it will succeed, Arbs buy more shares, making Y’s success more likely
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– Because they use borrowed money, arbs lose interest if it looks like takeover
contest will take time
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Y decides terms of offer
Strength of takeover defenses
• Takeover defenses analysis
– Which defenses does X have in place or XB can implement without SH approval?
• Why does Y focus on defenses that don’t require SH approval?
• Section 2b2 will address takeover defenses
– Strength of legal challenge to existing & expected defenses
• Section 2b3 will address legal challenges to takeover defenses
• Y offers terms aimed to ally with one of the other parties
– Hostile approach (ally with XS) if Y has strong XS support & takeover defenses
are weak, or if a friendly approach failed: appeal to XS via price & compensation
composition
– Otherwise, friendly approach (ally with XB): appeal to XB via golden parachutes
or positions in the merged firm
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Y decides terms of offer
Compensation composition: what do XS get?
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Cash
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XS prefer this (complete certainty about compensation), but it reduces Y’s cash
Variation: leveraged buyout (LBO) – borrow the cash used to pay XS (increases
Y’s debt & financing must be secured before acquisition is done)
Variation: paying with Y’s bonds (increases Y’s debt & adds uncertainty to XS)
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•
Shares
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XS receive uncertain value; dilutes Y’s SHs
Requires approval by the SH meeting if:
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Popular when Y’s stock price is high; not popular when Y has a controller
Assuming X’s debt
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Newly issued shares will exceed authorized # of shares (under DGCL); or
X listed on NYSE or NASDAQ & shares issued increase the # of outstanding
shares by more than 20% (under NYSE/NASDAQ listing rules)
Increases Y’s debt
X’s creditors benefit, not XS; why would XS tolerate this form of compensation?
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Y decides terms of offer
Compensation composition: financing an LBO
• If Y borrows money to acquire X (an LBO), Y wants to:
– Pay as little interest as possible; and
– Isolate Y’s other businesses from the acquisition (i.e., if X fails, Y does not want
creditors to take Y’s other assets)
• Solution: have X assume the loan, or use X’s assets as collateral
– Can Y do that before it owns 100% of X?
• To address this problem, structure of LBO financing is often:
1.
2.
3.
Bridge financing: creditor lends to Y for short time & at high interest rate (at
same time, parties may agree on terms of long-term loan (step 3))
Y uses bridge financing to pay XS for 100% of X
Once Y owns 100% of X, Y either:
•
Negotiates long-term loan using X’s assets as collateral (lower interest rate)
•
Causes X to take a long-term loan & transfer the money to Y as dividend
(Either way, Y uses new money to repay the bridge financing)
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The M&A dance
Overview of Section 2b
1.
2.
3.
4.
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Y decides terms of offer
Friendly approach
Why would XB resist?
Hostile approach
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Friendly approach
The "love letter"
• Y usually prefers a friendly acquisition if possible
– Overcoming X’s takeover defenses is costly & sometimes impossible
– Hostile deal alienates X’s management & risks managers quitting if Y succeeds
– Some institutional investors that finance acquisitions refuse to participate in
hostile deals
• Y sends XB a “love letter”
– Usually a private message with a non-threatening tone
– Outlines proposal & price, invites XB to negotiate
– Y hopes this will lead to private talks with XB and ultimately to agreement on a
friendly acquisition
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Friendly approach
Less friendly approach: “bear hug”
• A more aggressive approach than a “love letter” is for Y to send XB a
(public) “bear hug” letter (see MSFT 8-K, 2/1/08)
– Love us: praise synergies of proposed deal
– Fear us: suggest that Y may go hostile
– Fear your SHs: hint at FD breach if X refuses
• XB rejects A’s “bear hug” offer
– “Soft” rejection: typically emphasizes that board
deliberated, consulted with advisors & found
that Y’s offer significantly undervalued X
– “Hard” rejection: objects to fundamental aspects
of Y’s proposed deal (e.g., Y’s plans for X, ability
to finance the deal or get regulatory approval)
• Harder for XB to later accept improved offer
from Y, but gives XB broader grounds to reject
– Why is a rejection so likely?
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Friendly approach
Due diligence
• Y reviews X’s records to determine interest in deal/X’s value
• This presents risks to X
– Y may use info to compete with X, sell it to X’s rivals, or insider trade
– Y may use info to launch a hostile acquisition (posing as a friendly acquirer to
get info, then going hostile, is called a “Lady Macbeth strategy”)
• To address these risks, Y is typically required to sign
– Confidentiality agreement
• Limits who sees info; Y promises not to sell info, poach employees, etc.
• SEC Rule 10b5-2: illegal to trade on info when person agrees to maintain info in
confidence (addresses insider trading risk)
– Standstill agreement
• Y agrees, for a period of time, not to acquire X’s shares without XB’s permission
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Friendly approach
Selecting an acquirer
• Option 1: Auction (simultaneous negotiations with multiple Ys)
– XB asks potential acquirers for firm (i.e., binding) offers following preliminary
due diligence
• Y can sometimes “soften” the firmness of the offer by adding conditions
– Depending on predetermined auction format, XB may:
• Pick the best offer & finalize the agreement with them
• Have additional rounds of bidding
• Option 2: Bilateral negotiation followed by “shopping” the agreement
– Instead of simultaneous negotiations, X may sign an agreement with Y then use
it as leverage to get Y2 to negotiate a better deal (“shopping” the agreement)
– Sometimes XB is interested in a deal with Y, if no better deal is “shopped”; other
times Y is just used to set a minimum price, and the goal is to sell at a higher
price to some other acquirer (Y is then called the “stalking horse”)
– Why would Y agree to be a stalking horse?
– When would XB want to use a stalking horse?
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Friendly approach
Letter of intent
• Signed by both sides’ representatives, contains the issues that have
been agreed upon thus far
– Letter of intent (“LoI”) is sometimes called a Memorandum of Understanding or
a Term Sheet
• Enforceability: usually parties don’t want LOI to be a binding contract
– Why sign an LOI if parties don’t want it to be binding?
– Common (alternative) terms addressing enforceability
• LOI is subject to the execution of a definitive agreement
• LOI only memorializes preliminary understandings & is not intended to be
binding on either party
• Survivability
– LoI states what obligations are enforceable even if deal collapses
(confidentiality, writing requirement)
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Friendly approach
Definitive acquisition agreement & beyond
• Content of acquisition agreements discussed in Section 2b3
– Typically, Y does more thorough due diligence while final details of the
acquisition agreement are negotiated
– Why not do all due diligence in step 1?
• Progressing towards closing
– XB “shops” for better offers
– Y secures financing (if not done earlier)
– Approvals: from regulators, SHs, etc. (as needed)
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The M&A dance
Overview of Section 2b
1. Y decides terms of offer
2. Friendly approach
3. Why would XB resist?
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–
–
Entrenchment
Long-term plans
Holding out for a better offer
4. Hostile approach
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Why would XB resist?
Entrenchment
•
XB resists either because they think Y will fire them, or they want to
force Y to give them a side-payment to allow the deal to go through
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•
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Side payment is in the form of a golden parachute
If this is XB’s motivation, it’s not in XS‘s interest
Why not just outlaw golden parachutes?
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Why would XB resist?
Long-term plans
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•
Allow contrarian, innovative strategies (but also inefficient ones)
Example
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XB wants to invest in developing solar-powered cars (eco-friendly but slower &
more expensive than gas-powered cars)
XB anticipates that concern for the environment & higher gas prices will
increase demand for solar cars in a decade
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The market’s common wisdom is that solar cars will never be profitable, so
when X undertakes the investment, its stock price drops
This makes X more susceptible to takeovers
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It wants X to be the leader in solar cars at that point
Y could buy X at the depressed price, ditch the solar cars & profit from the
rebound in X’s price
XB hopes to maintain the strategy until the market realizes its wisdom
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Why would XB resist?
Holding out for a better offer
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XB resists to force Y to offer a better price – which is in XS’s interest
Example
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•
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X’s shares trade @ $10/share; Y values X @ $20/share
Y offers XB a cash-out merger for $15/share
If XB can prevent Y from acquiring X @$15/share, then Y has the choice
between walking away (profit: 0), or making a better offer, say, $19/share
(profit: $1/share)
The delay may also give Y2 time to make a bid, creating competition that drives
up the price
Why do XS need XB to hold out for a better offer? Can’t XS hold out?
Reason: when no SH currently controls X, Y can play XS against each other &
acquire control without paying a control premium
Example: Suppose that X’s shares are trading for $10/share, but are worth
$20/share to Y
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Why would XB resist?
Holding out for a better offer
• Y offers to buy 51% of X in tender offer @$15/share (“front end”)
• To encourage SHs to tender, Y announces that if tender offer
succeeds & Y gains control of X, it will merge X with Y’s wholly-owned
subsidiary, cashing out remaining X SHs for $10/share (“back end”)
– This is known as a two-tier front-loaded tender offer
• Alternative back end: instead of a $10/share merger at the back end,
Y can announce plans to manage X so that the value of economic
rights is reduced to $10/share
– E.g., no dividends, reinvest profits in very long-term investments or
currently unpopular investments
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Why would XB resist?
Holding out for a better offer
• XS expect that if Y fails, its rival Y2 will buy X for $20/share
– Or that if Y fails to buy @$15, Y will improve the offer to $20/share
– What would a XS do if she could coordinate with all other XS (or if she owned all
of X’s shares)?
• What would a XS do if she couldn’t coordinate with other SHs?
• Each XS faces the following possible outcomes:
– SH tenders the stock & tender offer succeeds: SH receives $15/share for at
least 51% of her stock (more, if total # of shares tendered is <100%), and
$10/share for the rest ($12.55/share if 100% tender)
– SH does not tender the stock but tender offer succeeds: SH receives $10/share
for all of her stock
– Tender offer fails: It doesn’t matter if SH tendered; Y2 buys shares from SH for
$20/share (or Y improves offer to $20/share)
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Why would XB resist?
Holding out for a better offer
The decision tree
Tender
succeeds
$12.55$15/share
Tender
fails
$20/share
SH tenders
SH does
not tender
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Tender
fails
$20/share
Tender
succeeds
$10/share
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Why would XB resist?
Holding out for a better offer
MSH’s decision tree
Tender
succeeds
$12.55$15/share
Better
SH tenders
Tender
fails
22
Same
$20/share
Tender
fails
SH does
not tender
$20/share
Worse
Tender
succeeds
$10/share
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Why would XB resist?
Holding out for a better offer
Controller’s decision tree
Tender
succeeds
$12.55/share
Tender
fails
$20/share
SH tenders
SH does
not tender
23
Tender
fails
$20/share
Tender
succeeds
$10/share
© Amitai Aviram. All rights reserved.
The M&A dance
Overview of Section 2b
1.
2.
3.
4.
24
Y decides terms of offer
Friendly approach
Why would XB resist?
Hostile approach
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Hostile approach
Paths to going hostile
• XB is against deal but most of XS support it
– If XS are also against, the deal isn’t happening…
• Two paths to going hostile
1. Proxy contest to gain control of XB, then engage in friendly
merger or asset sale
2. Hostile share acquisition to gain control of XB (often followed by
a freezeout via merger or asset sale)
• Y will pick path with the fewest defenses (or may try both)
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Hostile approach
Path 1: proxy contest
• How?
– Elect insurgent slate of directors @ annual SH meeting
– Call special meeting or create a written consent that either –
• Removes existing directors (without cause) & fills vacancies
• Expands board size & fills vacancies
• If Y wins control of XB : back to a friendly acquisition
– Likely a merger or asset sale (to avoid SH hold-outs)
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Hostile approach
Path 2: hostile share acquisition
• Y needs an acquisition technique that doesn’t require approval by XB
– Stock acquisition (not merger or asset sale, which require XB approval)
• Typically Y wants 100% of X, so it then needs to freeze out MSHs
– Via merger or asset sale (once Y has control of X)
• Two-tier tender offer
– Step 1: Y takes control of XB via stock acquisition
– Step 2: Y cashes out remaining XS in friendly deal via SFM (if ≥90%), LFM or
asset sale
• If PStep1>PStep2 offer is front-loaded; if PStep1<PStep2 offer is back-loaded
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Hostile approach
The remainder of the M&A dance
• Y & XB try to gain leverage over each other
– Both Y & XB lobby major XS
– XB deploys/enhances takeover defenses
– Y tries to overcome the takeover defenses
• Pushing through despite the defenses
• Suing XB to force them to dismantle the defenses
– Defects in procedural or substantive authority
– Breach of board’s FD in implementing the defenses
• Replacing XB & having new XB dismantle the defenses
• Endgame
– Y & XB agree on a friendly deal
– Y goes ahead with the tender offer
– Y gives up on the deal
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