Ch. 1 - Mergers, Acquisitions and Corporate Restructurings

Merger

A + B = C (new company formed)

Acquisition

A + B = A (assets fall under corporate umbrella)

Merger of equals

When two companies or equal size and equal power enter in a new conglomeration

• One company usually ends up being the dominant one

Earn-out

Payment to the target contingent on future target performance

Holdback provision

Payment to target withheld to account for potential litigation or other adverse events

Horizontal mergers (mergers of competitors)

• Merger between firms in the same business activity

• In the hopes of developing economies of scale & scope, and synergies (combining best practices)

• Gov’t regulation high due to potential anticompetitive effects

Vertical mergers (buyer-seller relationship)

• Combinations between firms at different stages

• Goal is information and transaction efficiency

Merger waves

1. Mitchell & Mulherin, Journal of Financial Economics (1996)

   • 3 types of shocks: economic, technological, regulatory

2. Jarrad Hartford, Journal of Financial Economics (2005)

   • Found that sufficient capital liquidity was also needed in order to have a wave - not only the 3 shocks above

Tender offers

• Offer made directly to shareholders

• Hostile when offer made without approval of the board

Conglomerate merger

When companies are not competitors and do not have a buyer-seller relationship

Types of tender offers and provisions

• Conditional vs unconditional

• Restricted vs unrestricted

• Any-or-all tender offer

• Contested offers

Fairness opinions

Opinion issued by a firm (often investment bankers) on the value of the company being acquired

• Reduces potential liabilities of directors

• Can create a conflict of interest within advisory fees and financing fees

Liabilities in acquisitions

• Buyer often assumes both the assets & liabilities of seller

Successor liability: When all target shares purchased, liabilities assumed as well

Trust Funds doctrine: If a buyer purchases a “substantial” portion of target assets, then the buyer is responsible for target liabilities

Holding companies advantages

• Lower cost - do not have to buy 51%

• No control premium

• May get control without soliciting target shareholder approval

Holding companies disadvantages

• Triple taxation of dividends

  • If parents owns 80% or more, dividends are exempt from taxation

• Easier to disassemble if Justice Dept finds Antitrust/Anticompetitive Problems

• Shareholders disagreements more likely

Implied Valuation Range in Valuation Paradigm

• Comparable companies analysis

• Precedent transactions analysis

• Discounted cash flow analysis

• Leveraged buyout analysis

Common Value Drivers within Valuation Paradigm

• Sector performance and outlook

• Company performance (size, margins and growth profile, historical & projected fin’l performance)

• Company positioning (market share, ability to differentiate products, quality of management)

• General economic and financing market conditions

Auction

Staged process where a target is marketed to multiple prospective buyers

Drawbacks of auctions

• Information leakage into the market from bidders

• Negative impact on employee morale

• Possible collusion among bidders

• Reduced negotiating leverage once a “winner” is chosen

• “Taint” in the event of a fialed auction

Broad Auction Advantages

• Heightens competitive dynamics

• Maximizes profitability of achieving maximum sale price (competitive)

• Helps to ensure that all likely bidders are approached

• Limits potential buyers’ negotiating leverage

• Enhances board’s comfort that it has satisfied its fiduciary duty to maximize value

Broad Auction Disadvantages

• Difficult to preserve confidentiality

• Highest business disruption risk

• Some prospective buyers decline participating in broad auctions

• Unsuccesful outcome can create perception of undesirable asset

• Industry competitors may participate just to gain access to sensitive information

Targeted Auction Advantages

• Higher likelihood of preserving confidentiality

• Reduces business disruption

• Reduces the potential of a failed auction by signaling a desire to select a partner

• Maintains perception of competitive dynamics

• Serves as a “market check” for board to meet its fiduciary duties

Targeted Auction Disadvantages

• Potentially excludes non-obvious, but credible, buyers

• Potential to leave “money on the table” if certain buyers excluded

• Lesser degree of competition

• May afford buyers more leverage in negotiations

• Provides less market data on which board can rely to satisfy its fiduciary duties

Auction structure

• 2 round bidding process that spans from 3-6 months until purchase/sale agremeent (definitive agreement)

• Time of post signing (closing) depends on regulatory approvals/third party consents, financing, shareholder approval

• Entire auction process consists of multiple stages and discrete milestones within each of these stages

Stages of an auction process

1. Organization and preparation

2. First Round

3. Second Round

4. Negotiations

5. Closing

Organization and Preparation stage

• Identify seller objectives and determine approriate sale process

• Perform sell-side advisor due diligence and preliminary valuation analysis

• Select buyer universe

• Prepare Marketing materials

• Prepare confidentiality agreement

Organization and Preparation: Prepare Marketing Materials

Teaser

• first marketing document presented to prospective buyers

• brief ½ page synopsis of the target, including company overview, investment highlights, and summary financial information

Organization and Preparation: Prepare Marketing Materials

Confidential Information Memorandum (CIM)

• Written description of the target that serves as a primary marketing document for the target

• Contains a detailed financial section presenting historical and projected financial info with narrative

• Involves normalizing historical financials and crafting an accompanying MD&A

• Provides additional information to help guide buyers toward potential growth/acquisition scenarios for the target

Confidential Information Memorandum topics

• Executive Summary

• Investment Considerations

• Industry Overview

• Company Overview

• Operations Overview

• Financial Information

• Appendix

Organization & Preparation: Prepare Confidentiality Agremeent

Covers provisions including the following:

• Use of information

• Term

• Permitted disclosures

• Return of confidential information

• Non solitication/hire

• Standstill agreement

• Restrictions on clubbing

First Round

• Contact Prospective Buyers

• Negotiate and Execute Confidentiality Agreements with interested parties

• Distribute confidential information memorandum and initial bid procedures letter

• Prepare management presentation

• Setup data room

• Prepare Stapled Financing Package (if applicable)

• Reveive initial bids and select buyers to proceed to Second Round

First Round: Contact Prospective Buyers

• Sell-side advisory team initiates and provides the delivery teaser

• Sell-side advisor normally keeps a record of all interactions with prospective buyers: contact log

First Round: Negotiate and Execute CA with Interested Parties

• Following the execution of the CA, they can distribute the CIM and initial bid procedures to letter to a prospective buyer

Use of information

States that all information furnished by the seller, whether oral or written, is considered proprietary information and should be treeated as confidential and used solely to make a decision regarding the proposed transaction

Term

Designates the time period during which the confidentiality restrictions remain in effect

Permitted disclosures

Outlines under what limited cirumstances the prospective buyer is permitted to disclose the confidential information provided; also prohibits disclosure that the two parties are in negotiations

Return of confidential information

Mandates return or destruction of all provided documents once prospective buyer exits process

Non-solicitation/no hire

Prevents prospective buyers from soliticiting to hire (or hiring) target employees for designated time period

Standstill Agreement

For public targets, precludes prospective buyers from making unsolicited offers or purchases of the target’s shares, or seeking to control/influence the target’s management, board of directors, policies

Restrictions on clubbing

Prevents prospective buyers from collaborating with each other or with outside financial sponsors/equity providers without the prior consent of the target

First Round: Distribute confidential information memorandum and Initial Bid Procedures Letter

• Prospective buyers are given weeks to review the CIM, study the target and its sector

• Buyers can engage investment banks who can help their clients with fair valuations

First Round: Distribute confidential Information Memorandum and Initial Bid Procedures Letter

Initial Bid Procedures Letter

• States the exact date and time by which parties must submit their written, non-binding preliminary indications of interest

• Also defines information that should be included in bid, like:

  • Indicative purchase price

  • Key assumptions to arrive at the stated purchase price

  • Structural and other considerations

  • Information on financing sources

  • Treatment of management and employees

  • Timing for completing a deal and diligence that must be performed

  • Key conditions to singing and closing

  • Required approvals

  • Buyer contact information

First Round: Prepare management presentation

• The management presentation is typically structured as a slideshow with accompanying hardcopy handout

First Round: Set up data room

• Hub for the buyer due diligence that takes place in the second round of the process

• Contains essential company information, documentation, analyses

• Data room also allows the buyer to do more detailed confirmatory due diligence prior to consummating a transactions

First Round: Prepare Stapled Financing Package

• Investment bank running the auction process may prepare a pre-packaged financing structure in support of the target being sold

Second Round

• Conduct Management Presentations

• Facilitate Site Visits

• Provide Data Room Access

• Distribute Final Bid Procedures Letter and Draft Definitive Agremeent

• Receive Final Bids

Second Round: Conduct Management Presentations

• Target’s management team formally presents the buyer a detailed overview of the company

• Core team presenting is normally target CEO, CFO, and other operational executives

Second Round: Facilitate Site Visits

• Provides firsthand view of target’s operations

• Presentation takes place near a company facility

Second Round: Provide Data Room Access

• Contains all detailed information about all aspects of the target (business, financial, accounting, tax, legal)

• Through data analysis and interpretation, buyer seeks to identify the key opportunities and risks presented by the target

  • Also provides an opportunity for buyer to identify outstanding risks and issues that should be satisfied prior to submitting a formal bid

• Data room access may be tailored to individual bidders/specific members of bidder teams

Second Round: Distribute Final Bid Procedures Letter and Draft Definitive Agreement

• Final bid procedures letter is distributed to remaining prospective buyers often along the draft definitive agreement

Final Bid Procedures Letter includes:

• Exact date and guidelines for submitting a final, legally binding bid package

• Purchase price details (exact dollar and form, like cash or stock)

• Markup of the draft definitve agreement provided by the seller in a firm that the buyer would be willing to sign

• Evidence of committed financing and information on financing sources

• Attestation to completing of due diligence

• Attestation that offer is binding

• Required regulatory approvals and timeline for completion

• Board of directors approvals

• Estimated time to sign and close transaction

• Buyer contact information

Second Round: Definitive agreement

• Legally binding contract between buyer and seller detailing terms and conditions of sale transaction

• Format:

  • Overview of transaction structure

  • Representations and warranties

  • Pre-closing commitments

  • Closing conditions

  • Termination provisions

  • Indemnities

  • Associated disclosure schedules and exhibits

Negotiations

• Evaluate Final Bids

• Negotiate with preferred buyers

• Select winning bidder

• Render Fairness Opinion

• Receive board approval and execute definitive agreement

Negotiations: Evaluate Final Bids

• Sell-side advisor works with seller and legal councel to conduct an analysis of the price, structure and conditionality of bids

• Purchase price is assessed within the context of the first round bids and target’s recent financial performance, as well as valuation owrk performed by sell-side advisors

Negotiations: Negotiate with Preferred Buyers

• Sell-side advisor recommends that seller negotiates with two or more parties

• Advisor seeks to maintain a level playing field to not favor one bidder

Negotiations: Select Winning Bidder

• Sell-side advisor and legal counsel negotiate a final definitive agreement with winning bidder, which is then presented to target’s board of directors for approval

• Seller can reject any bids, and buyer was withdraw whenever prior to the binding agreement

Negotiations: Render Fairness Opinion

• Opinion letter on the fairness offered in a transaction

• Prior to the delivery of the fairness opinion to the board of directors, sell-side advisory team must receive approval from its internal fairness opinion committee

• Publicly discplised and described in detail

Negotiations: receive board approval and execute definitive agreement

• Once seller’s board of directors votes to approve the deal, definitive agreement is executed by the buyer and seller

• Formal transaction announcement agreed to by both parties is made with key deal terms disclosed depending on the situation

• Two parties then proceed to satisfy all of the closing conditions to the deal

Closing

• Obtain necessary approvals

• Financing and Closing

Closing: Regulatory Approval

• Hart-Scott-Rodino Antitrust Improvements Act of 1976 (HSR Act)

• Depending on the size of the transaction, HSR Act requires both parties in an M7A transaction to file respective notifications and report forms with the Federal Trade Commission (FTC) and the Antitrust Division of the Department of Justice (DOJ)

Closing: Shareholder Approval - one-step merger

• Target shareholders vote on whether to approve or reject the proposed transaction at a formal shareholder meeting pursuant to relevant state law

• Once approved by the SEC, document is mailed to shareholders and there is a meeting to approve the deal

Closing: Shareholder Approval

• Step 1: Tender offer is made to target’s public shareholders with target’s approval pursuant to a definitive agreement

  • If the buyer only succeeds in acquiring a majority of shares in a tender offer, it would then have to complete the shareholder meeting and approval mechanics in accordance to the one-step merger plan

• If the threshold is reached as designed (typically 90%), they can then squeeze out the minority shareholders and proceed with a short form merger