merger & acquisition

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Merger, Acquisition & Corporate Restructuring 1

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M & A Lectures

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Page 1: Merger & Acquisition

Merger, Acquisition &

Corporate Restructuring

1

Page 2: Merger & Acquisition
Page 3: Merger & Acquisition

What is a Corporation?

An artificial legal entity being

created by government

charter

Page 4: Merger & Acquisition

Advantages of Organizing as a

Corporation

Greater amounts of capital can be raised by the corporation (stocks and bonds).

Corporate owner’s liability is limited to the amount of investment.

Corporation ownership shares are easily transferred. Corporations usually have longer lives than other

forms of business ownership. Professional management talent usually runs

corporations. Corporations lack “mutual agency.” (Only authorized

individuals may bind the corporation to contracts.

Page 5: Merger & Acquisition

Disadvantages of Being Organized

as a Corporation Double taxation

- Corporate earnings are taxed twice

(earnings before taxes and

stockholder’s dividends).

Subject to extensive government

regulation (SECP etc.)

Corporate ownership is separated from

control of operations.

Page 6: Merger & Acquisition

Board of Directors and

Management TeamBoard of Directors

Elected by stockholders.

Responsible for management of the corporation, establishing policy, specific decision making.

Management Team

Hired by board of directors.

Responsible for day-to-day operations of the corporation.

Page 7: Merger & Acquisition

Any change in a company’s:

1. Capital structure,

2. Operations, or

3. Ownership

that is outside its ordinary course of business.

So where is the value coming

from (why restructure)?

What is Corporate

Restructuring?

Page 8: Merger & Acquisition

Sample Corporation

Organization Chart

Stockholders

Board of

Directors

President

Vice-President

Finance

Vice-President

Marketing

Corporate

Secretary

Vice-President

Production

Vice-President

Personnel

Treasurer Controller

The president is the The controller’s chief executive officer responsibilities include(CEO) with direct 1 maintaining the responsibility for accounting recordsmanaging the business. 2 maintaining adequateThe chief accounting internal control systemofficer is the controller. 3 preparing financial

statements, tax returns and internal reports.

Page 9: Merger & Acquisition

Stockholder’s Equity

Common Stock- Represents the primary ownership of

stock in a corporation.- Is the only issue form if only one class

of stock is issued. Preferred Stock

- Gives stockholders certain privileges not given to common stockholders(i.e. rights to dividends)

Page 10: Merger & Acquisition

Rights of Common Stockholders

Receive a certificate of ownership. Transfer shares through sale or gift. Vote at stockholder meeting (one vote per share

owned). Right to purchase a portion of any new shares

issued to maintain their percentage ownership (preemptive rights).

To receive dividends declared by the board of directors

To receive a portion of assets remaining when the corporation liquidates.

Page 11: Merger & Acquisition

CORPORATE CAPITAL

Owner’s equity in a corporation is identified as stockholder’s equity, shareholders’ equity, or corporate capital

Two main sections of stockholder’s equity:

1. Paid-in (contributed) capital- Investments contributed by

stockholders (common stock, preferredstock).

2. Retained Earnings- Earned capital “retained” by the

corporation.

Page 12: Merger & Acquisition

Characteristics of Stock

Stock Outstanding (issued)

- Stock shares currently in the “hands” of

stockholders.

Par Value

- Arbitrary monetary figure assigned by

the corporation to a share of capital

stock.

Page 13: Merger & Acquisition

PREFERRED STOCK

Preferred stock has contractual provisions that give a preference over common stockholders as follows:

1. Dividends2. Assets in the event of liquidation

Transactions are the same as for common stock transactions.

Page 14: Merger & Acquisition

CASH DIVIDENDS

A dividend is distribution by a corporation to its stockholders on a pro rata (equal) basis.

A cash dividend is a pro rata distribution of cash to stockholders.

For a cash dividend to occur, a corporation must have:1 retained earnings,2 adequate cash, and3 declared dividends.

Page 15: Merger & Acquisition

STOCK DIVIDENDS A stock dividend is a pro rata distribution of the

corporation’s own stock to stockholders.

A stock dividend results in a decrease in retained

earnings and an increase in paid-in capital.

Corporations usually issue stock dividends for one or

more of the following reasons:

1 To satisfy stockholders’ dividend expectations

without spending cash.

2 To increase the marketability of its stock by

increasing the number of shares outstanding and

thereby decreasing the market price per share.

3 To emphasize that a portion of stockholders’ equity

has been permanently reinvested in the business and

therefore is unavailable for cash dividends.

Page 16: Merger & Acquisition

16

Merger and Acquisition

Legal combination of two or more corporations (A & B) after which only A corporation remains. A’s articles of incorporation are amended to include articles of merger. After merger, A continues as the surviving corporation with all of B’s rights and obligations.

A B

A

Page 17: Merger & Acquisition

17

Consolidation

Occurs when two or more corporations (A & B) combine such that both cease to exist and a newcorporation emerges which has all the rights and obligations previously held by A and B.

C’s articles of consolidation take the place of the original articles of A and B.

A B

C

Page 18: Merger & Acquisition

18

Takeovers

Alternative to merger or consolidation is

the purchase of a controlling interest

(e.g., 51%) of a “target” corporation’s

stock giving the purchaser corporation

controlling interest in the target.

The aggressor deals entirely with the

target’s shareholders.

Page 19: Merger & Acquisition

M&A Terminology

Merger & Acquisition• Horizontal merger• Vertical merger• Vertical Integration• Congeneric mergers• Conglomerate mergers

Strategic Alliance• Joint venture• Outsourcing through Virtual companies

Page 20: Merger & Acquisition

M&A Terminology

Divestitures• Voluntary Corporate liquidation• Partial Sell offs• Corporate Spin off• Equity Carve outs

Ownership Structure• Going private• Leverage buyout

Restructuring — changes to improve operations, policies, and strategies

Page 21: Merger & Acquisition

M&A Terminology

Merger• Negotiated deals• Mutuality of negotiations• Mostly friendly

Tender offers• Offer made directly to the shareholders• Hostile when offer made without

approval of the board

Page 22: Merger & Acquisition

Types of Mergers

Horizontal mergers • Between firms in same business activity

• Rationale

– Economies of scale and scope

– Synergies (ex. combining of best practices)

• Government regulation due to potential

anticompetitive effects

Vertical mergers• Combinations between firms at different stages

• Goal is information and transaction efficiency

Page 23: Merger & Acquisition

Vertical Integration

Vertical Integration

• Refers to the merger of two companies in

the same industry that make products

required at different stages of the

production cycle

Page 24: Merger & Acquisition

Vertical Integration (cont'd)

A major benefit of vertical integration

is coordination.

• For example, Apple Computers makes

both the operating system and the

hardware.

However, not all not all successful

corporations are vertically integrated.

• For example, Microsoft makes the

operating system but not the computers.

Page 25: Merger & Acquisition

Types of Mergers

Congeneric mergers• merger where two companies are in the

same or related industries but do not offer the same products. In a congeneric merger, the companies may share similar distribution channels, providing synergies for the merger

Page 26: Merger & Acquisition

Types of Mergers

Conglomerate mergers• Firms in unrelated business activities

Distinctions between conglomerate and nonconglomerate firms• Investment companies – diversify to reduce

portfolio risk• Financial diversified – provide funds and

expertise on generic management functions of planning and control

• Concentric diversified – combine with firms in less related activities to broaden potential markets

Page 27: Merger & Acquisition

Types of Mergers

Stock Swap

• Target shareholders are swapping old

stock for new stock in either the acquirer

or a newly created merged firm

Term sheet

• Summary of price and method of

payment

• Consideration paid to target shareholders

can be very complex

Page 28: Merger & Acquisition

Joint Ventures

JV characteristics

• Combination of assets from 2 or more parent

firms place into a separate business entity

• Limited scope and duration

• May not affect competitive relationships

• Examples: R&D, joint production of single

product

JV timing similar to M&As (correlation over

0.95) – driven by same factors affecting total

investment activity

Page 29: Merger & Acquisition

Joint Ventures

JVs and business strategy:• JVs a part of multiple paths to value growth

(Geis & Geis, 2001)• Used over 782 JVs and alliances to:

– Develop new product markets• Cable TV – NBC alliance –• Online gaming – JV with Dreamworks to

produce games –– Expand into new geographic areas (ex. deals

to expand in Japan)– Participate in new technologies (ex. wireless

deals with Qualcomm, Ericsson)

Page 30: Merger & Acquisition

Joint Ventures

JVs and restructuring – JVs can be used as transitional mechanism in broad restructuring (Nanda & Williamson, 1995)• Buyer can better determine value of seller's

brands, personnel, etc.• Risk of making mistakes is reduced through

direct involvement with business• Customers moved to buyer over a period of

time in which both firms are involved in JV• Buyer builds up expertise in JV• Seller is able to realize higher value from sale

following JV due to increased buyer knowledge of assets

Page 31: Merger & Acquisition

Joint Ventures

Other benefits• Knowledge acquisition is goal of at least 50%

of JVs – best for “learning by doing” with complex processes

• Risk reduction – expansion of activities with smaller required investment

• Tax aspects – contribution of patent or technology may be more tax effective than licensing (depreciation may offset revenues)

• International aspects – reduces risk of foreign expansion (some nations require firms to take a local partner)

Page 32: Merger & Acquisition

Joint Ventures

Reasons for failure (70% disbanded early)• Technology never developed• Inadequate preplanning• Disagreement over basic objectives• Managers refuse to share expertise with

counterparts from other firm Requirements for success

• Participants have something of value to JV• JV should be carefully preplanned• Agreement should provide flexibility • Should include provisions for termination• Key executives involved in implementation

Page 33: Merger & Acquisition

Joint Ventures

Empirical tests• Business and economic patterns (Berg et al,

1982)– Industry JV participation increases with:

firm size, capex, profitability– Technologically oriented JVs: substitute for

long-term R&D more often than short-term– JVs and R&D are complements at industry

level• Event returns (McConnell & Nantell, 1985)

– Value of gains evenly divided between firms– No change of mgmt. – gains must be from

synergy

Page 34: Merger & Acquisition

Joint Ventures

Authors Year JV Type Return

McConnell,

Nantell

1985 All 0.73%

Koh,

Venkatraman

1991 IT sector 0.87%

Crutchley et al 1991 Japan-US 1.05%

Chen et al 1991 China-US 0.71%

Johnson,

Houston

2000 WSJ

announced

1.67%

Page 35: Merger & Acquisition

Strategic Alliances

SA characteristics• Informal or formal agreement between two or

more firms to cooperate in some way• Created due to industry uncertainty and

ambiguity – value chains, new technology, etc.• Need not create new entity• Relative size of firms may be highly unequal• Difficult to anticipate consequences –

relationships evolve, firm boundaries blur• Firms pool resources and expertise hoping for

synergy from learning capabilities, etc.• Allow firms much flexibility

Page 36: Merger & Acquisition

Strategic Alliances

Examples•

Cooperation on system for voice commands for the internet (VXML)

•Joint offering of international 2-day delivery

•Combined research and purchasing in 6 JVs

• AOL followed strategy of providing subscribers with many benefits through alliance– Partnerships with brick & mortar retailers– Deals with software developers

Sumitomo Rubber

Page 37: Merger & Acquisition

Strategic Alliances

2.6% of SAs result in M&As – more likely in mature industries (Hagedorn, Sadowski, 1999)

Types of alliances (Bleeke & Ernst, 1995)• Collisions between competitors – tensions

cause failure• Alliances of the weak – weak grow weaker• Disguised sales – strong competitor buys weak• Bootstrap alliances – weak firm improved by

strong until alliance becomes on equal footing• Evolution to a sale – successful SA becomes

sale when tension emerges• Alliances of complementary equals – SA

succeeds due to compatibility

Page 38: Merger & Acquisition

Strategic Alliances

Authors Year SA Type Return

Chan et al 1997 All

High tech

Low tech

0.64%

1.12%

0.10%

Das et al 1998 Technology

Marketing

Over 1%

Negative

Kale et al 2002 SA function

No SA func.

1.35%

0.18%

Chen et al 1991 China-US 0.71%

Page 39: Merger & Acquisition

Strategic Alliances

Requirements for success• Well defined strategic themes• Organization relationships should facilitate

communication to share decision making• SAs viewed in real options framework – allows

portfolio of potential growth opportunities• High level management should be involved• Must be positive incentive to overcome tension• SA governance must adapt to different types of

alliances• SAs must seek out growth opportunities to

augment core capabilities

Page 40: Merger & Acquisition

Tender Offers

Bidder seeks target's shareholders approval

Minority shareholders• Terms may be "crammed down"• May be subject to "freeze-in"• Minority may bring legal actions• 2001-2002, many minority squeeze-outs

–Usually reversing equity carve-out–Parents often make high bid to avoid

shareholder lawsuits

Page 41: Merger & Acquisition

Tender Offers

Kinds of tender offers and provisions

• Conditional vs. unconditional

• Restricted vs. unrestricted

• "Any-or-all" tender offer

• Contested offers

• Two-tier offers

• Three-piece suitor

Page 42: Merger & Acquisition

Relative Roles

Acquisitions• Rapid augmentation of firm capabilities• Consequences are long lasting• Often costly due to takeover premium• Challenges of combining organizations

Joint ventures• Reduce relative size of investments and risks• Create new entities and relationships• Can develop learning and new opportunities

Strategic alliances• Broaden range of potential opportunities • Relationships are more ambiguous – greater

need for communication

Page 43: Merger & Acquisition

Numerical

ABC company wants to buy certain assets of XYZ company. However, XYZ

Company wants to sell out its entire business. The balance Sheet of XYZ follows:-

Cash 3000 A/R 7000 Inventories 12000 Plants 15000

Refinery 25000 Equipment's 40000 Buildings 100000 T.A. 202000

Total liabilities 90000 shareholder’s equity 112000

ABC needs only Refinery and equipment and the buildings. The other assets

excluding cash can be sold for 30,000. The total cash received is therefore 33,000

(30000+3000 initial cash balance. XYZ want 45000 for the entire business. XYZ will

thus have to pay a total of 135000 which is 90000in total liabilities and 45000 for its

owner. The actual net cash outlay is therefore 102000 (135000-33000). It is expected

that the after tax cash inflows from the new arrange will be 25000 per year for the

next 6 years. The cost of capital is 10 percent.

Year 102000x1 (102000)

Year 1-6 25000x4.355) 108875

6875

NPV is positive then acquisition recommended

XYZ has equipment that ABC desired so the ABC is thinking of acquiring the XYZ for

50000. XYZ has liabilities 75000. The remaining assets would be sold for 58000. By

acquiring the equipment ABC will have an increase in cash flow 17000 each year for

the next 12 yerars. The WACC 10%.The nets cost of the equipment 50000+75000-58000 =67000

ABC should make the acquisition on the basis of following NPV 67000 x 1 67000

Year 1-12 17000x6.814 115838

NPV 48838