Introduction to Introduction to MERGERS & ACQUISITIONSMERGERS & ACQUISITIONS

Massimo LapucciMassimo Lapucci

Learning ObjectivesLearning Objectives

1.1. The different types of acquisitionsThe different types of acquisitions

2.2. How a typical acquisition proceedsHow a typical acquisition proceeds

3.3. What differentiates a friendly from a hostile What differentiates a friendly from a hostile acquisitionacquisition

4.4. Different forms of combinations of firmsDifferent forms of combinations of firms

Types of TakeoversTypes of TakeoversGeneral GuidelinesGeneral Guidelines

TakeoverTakeover–– The transfer of control from one ownership group to The transfer of control from one ownership group to

another.another.AcquisitionAcquisition

–– The purchase of one firm by anotherThe purchase of one firm by anotherMergerMerger

–– The combination of two firms into a new legal entityThe combination of two firms into a new legal entity–– A new company is createdA new company is created–– Both sets of shareholders have to approve the Both sets of shareholders have to approve the

transaction.transaction.

Types of TakeoversTypes of TakeoversHow the Deal is FinancedHow the Deal is Financed

Cash TransactionCash Transaction–– The receipt of cash for shares by shareholders in the The receipt of cash for shares by shareholders in the

target company.target company.Share TransactionShare Transaction

–– The offer by an acquiring company of shares or a The offer by an acquiring company of shares or a combination of cash and shares to the target combination of cash and shares to the target companycompany’’s shareholders.s shareholders.

Going Private Transaction (Issuer bid)Going Private Transaction (Issuer bid)–– A special form of acquisition where the purchaser A special form of acquisition where the purchaser

already owns a majority stake in the target company.already owns a majority stake in the target company.

General Intent of the LegislationGeneral Intent of the Legislation

Transparency Transparency –– Information DisclosureInformation Disclosure•• To ensure complete and timely information be available To ensure complete and timely information be available

to all parties (especially minority shareholders) to all parties (especially minority shareholders) throughout the process while at the same time not letting throughout the process while at the same time not letting this requirement stall the process unduly.this requirement stall the process unduly.

Fair TreatmentFair Treatment•• To avoid oppression of minority shareholders.To avoid oppression of minority shareholders.•• To permit competing bids during the process and not To permit competing bids during the process and not

have the first bidder have special rights. (In this way, have the first bidder have special rights. (In this way, shareholders have the opportunity to get the greatest shareholders have the opportunity to get the greatest and fairest price for their shares.)and fairest price for their shares.)

•• To limit the ability of a minority to frustrate the will of a To limit the ability of a minority to frustrate the will of a majority. majority.

Friendly AcquisitionFriendly Acquisition

The acquisition of a target company that is willing to The acquisition of a target company that is willing to be taken over.be taken over.

Usually, the target will accommodate overtures and Usually, the target will accommodate overtures and provide access to confidential information to facilitate provide access to confidential information to facilitate the scoping and due diligence processes.the scoping and due diligence processes.

Friendly AcquisitionsFriendly AcquisitionsThe Friendly Takeover ProcessThe Friendly Takeover Process

1.1. Normally starts when the target voluntarily puts itself into plaNormally starts when the target voluntarily puts itself into play.y.•• Target uses an investment bank to prepare an Target uses an investment bank to prepare an offering offering

memorandummemorandum–– May set up a data room and use confidentiality agreements to perMay set up a data room and use confidentiality agreements to permit mit

access to interest parties practicing due diligenceaccess to interest parties practicing due diligence–– A signed letter of intent signals the willingness of the partiesA signed letter of intent signals the willingness of the parties to move to move

to the next step to the next step –– (usually includes a no(usually includes a no--shop clause and a shop clause and a termination or break fee)termination or break fee)

–– Legal team checks documents, accounting team may seek advance Legal team checks documents, accounting team may seek advance tax ruling from CRAtax ruling from CRA

–– Final sale may require negotiations over the structure of the deFinal sale may require negotiations over the structure of the deal al including:including:

»» Tax planningTax planning»» Legal structuresLegal structures

2.2. Can be initiated by a friendly overture by an Can be initiated by a friendly overture by an acquisitoracquisitor seeking seeking information that will assist in the valuation process.information that will assist in the valuation process.

Friendly AcquisitionFriendly Acquisition

FIGURE 1

Friendly Acquisition

Information memorandum

Approachtarget

Sign letterof intent

Final saleagreement

Confidentialityagreement

Main duediligence

Ratified

Friendly TakeoversFriendly TakeoversStructuring the AcquisitionStructuring the Acquisition

In friendly takeovers, both parties have the In friendly takeovers, both parties have the opportunity to structure the deal to their opportunity to structure the deal to their mutual satisfaction including:mutual satisfaction including:

1.1. Taxation Issues Taxation Issues –– cash for share purchases trigger capital cash for share purchases trigger capital gains so share exchanges may be a viable alternativegains so share exchanges may be a viable alternative

2.2. Asset purchases rather share purchases that may:Asset purchases rather share purchases that may:•• Give the target firm cash to retire debt and restructure Give the target firm cash to retire debt and restructure

financingfinancing•• Acquiring firm will have a new asset base to maximize CCA Acquiring firm will have a new asset base to maximize CCA

deductionsdeductions3.3. Earn outsEarn outs where there is an agreement for an initial where there is an agreement for an initial

purchase price with conditional later payments depending purchase price with conditional later payments depending on the performance of the target after acquisition.on the performance of the target after acquisition.

Hostile TakeoversHostile Takeovers

A takeover in which the target has no desire to be A takeover in which the target has no desire to be acquired and actively rebuffs the acquirer and acquired and actively rebuffs the acquirer and refuses to provide any confidential information.refuses to provide any confidential information.

The acquirer usually has already accumulated an The acquirer usually has already accumulated an interest in the target (20% of the outstanding shares) interest in the target (20% of the outstanding shares) and this preemptive investment indicates the and this preemptive investment indicates the strength of resolve of the acquirer.strength of resolve of the acquirer.

Hostile TakeoversHostile TakeoversCapital Market Reactions and Other DynamicsCapital Market Reactions and Other Dynamics

Market clues to the potential outcome of a Market clues to the potential outcome of a hostile takeover attempt:hostile takeover attempt:

1.1. Market price jumps above the offer priceMarket price jumps above the offer price•• A competing offer is likely orA competing offer is likely or•• The bid price is too lowThe bid price is too low

2.2. Market price stays close to the offer priceMarket price stays close to the offer price•• The offer price is fair and the deal will likely go throughThe offer price is fair and the deal will likely go through

3.3. Little trading in the sharesLittle trading in the shares•• A bad sign for the acquirer because shareholders are A bad sign for the acquirer because shareholders are

reluctant to sell.reluctant to sell.

Hostile TakeoversHostile TakeoversDefensive TacticsDefensive Tactics

Shareholders Rights PlanShareholders Rights Plan•• Known as a poison pill or deal killerKnown as a poison pill or deal killer•• Can take different forms but oftenCan take different forms but often

Gives nonGives non--acquiring shareholders get the right to buy 50 percent more acquiring shareholders get the right to buy 50 percent more shares at a discount price in the event of a takeover.shares at a discount price in the event of a takeover.

Selling the Crown JewelsSelling the Crown Jewels•• The selling of a target companyThe selling of a target company’’s key assets that the acquiring s key assets that the acquiring

company is most interested in to make it less attractive for takcompany is most interested in to make it less attractive for takeover.eover.•• Can involve a large dividend to remove excess cash from the targCan involve a large dividend to remove excess cash from the targetet’’s s

balance sheet.balance sheet.

White KnightWhite Knight•• The target seeks out another acquirer considered friendly to makThe target seeks out another acquirer considered friendly to make a e a

counter offer and thereby rescue the target from a hostile takeocounter offer and thereby rescue the target from a hostile takeoverver

Classifications Mergers and AcquisitionsClassifications Mergers and Acquisitions

1.1. HorizontalHorizontal•• A merger in which two firms in the same industry combine.A merger in which two firms in the same industry combine.•• Often in an attempt to achieve economies of scale and/or Often in an attempt to achieve economies of scale and/or

scope.scope.2.2. VerticalVertical

•• A merger in which one firm acquires a supplier or another firm A merger in which one firm acquires a supplier or another firm that is closer to its existing customers.that is closer to its existing customers.

•• Often in an attempt to control supply or distribution channels.Often in an attempt to control supply or distribution channels.3.3. ConglomerateConglomerate

•• A merger in which two firms in unrelated businesses combine.A merger in which two firms in unrelated businesses combine.•• Purpose is often to Purpose is often to ‘‘diversifydiversify’’ the company by combining the company by combining

uncorrelated assets and income streamsuncorrelated assets and income streams4.4. CrossCross--border (International) border (International) M&AsM&As

•• A merger or acquisition involving a Canadian and a foreign firm A merger or acquisition involving a Canadian and a foreign firm a either the acquiring or target company.a either the acquiring or target company.

Mergers and Acquisition ActivityMergers and Acquisition Activity

•• M&A activity seems to come in M&A activity seems to come in ‘‘waveswaves’’ through through the economic cycle domestically, or in the economic cycle domestically, or in response to globalization issues such as:response to globalization issues such as:–– Formation and development of trading zones or Formation and development of trading zones or

blocks (EU, North America Free Trade Agreementblocks (EU, North America Free Trade Agreement–– DeregulationDeregulation–– Sector booms such as energy or metalsSector booms such as energy or metals

Motivations for Mergers and AcquisitionsMotivations for Mergers and AcquisitionsCreation of Synergy Motive for Creation of Synergy Motive for M&AsM&As

The primary motive should be the creation of The primary motive should be the creation of synergy.synergy.

Synergy value is created from economies of Synergy value is created from economies of integrating a target and acquiring a company; integrating a target and acquiring a company; the amount by which the value of the combined the amount by which the value of the combined firm exceeds the sum value of the two firm exceeds the sum value of the two individual firms.individual firms.

Creation of Synergy Motive for Creation of Synergy Motive for M&AsM&As

Synergy is the additional value created (Synergy is the additional value created (∆∆V) :V) :

Where:Where:VVTT == the prethe pre--merger value of the target firmmerger value of the target firmVVA A -- TT == value of the post merger firmvalue of the post merger firmVVAA == value of the prevalue of the pre--merger acquiring firmmerger acquiring firm

)V-(VVV TATA +=∆ −[ 15-1]

Value Creation Motivations for Value Creation Motivations for M&AsM&AsOperating SynergiesOperating Synergies

Operating SynergiesOperating Synergies1.1. Economies of ScaleEconomies of Scale

•• Reducing capacity (consolidation in the number of firms in the Reducing capacity (consolidation in the number of firms in the industry)industry)

•• Spreading fixed costs (increase size of firm so fixed costs per Spreading fixed costs (increase size of firm so fixed costs per unit unit are decreased)are decreased)

•• Geographic synergies (consolidation in regional disparate Geographic synergies (consolidation in regional disparate operations to operate on a national or international basis) operations to operate on a national or international basis)

2.2. Economies of ScopeEconomies of Scope•• Combination of two activities reduces costsCombination of two activities reduces costs

3.3. Complementary StrengthsComplementary Strengths•• Combining the different relative strengths of the two firms creaCombining the different relative strengths of the two firms creates tes

a firm with both strengths that are complementary to one anothera firm with both strengths that are complementary to one another. .

Value Creation Motivations for M&AValue Creation Motivations for M&AEfficiency Increases and Financing SynergiesEfficiency Increases and Financing Synergies

Efficiency IncreasesEfficiency Increases–– New management team will be more efficient and New management team will be more efficient and

add more value than what the target now has.add more value than what the target now has.–– The combined firm can make use of unused The combined firm can make use of unused

production/sales/marketing channel capacityproduction/sales/marketing channel capacityFinancing SynergyFinancing Synergy

–– Reduced cash flow variabilityReduced cash flow variability–– Increase in debt capacityIncrease in debt capacity–– Reduction in average issuing costsReduction in average issuing costs–– Fewer information problemsFewer information problems

Managerial Motivations for Managerial Motivations for M&AsM&As

Managers may have their own motivations to pursue Managers may have their own motivations to pursue M&AsM&As. The two most common, are not necessarily in . The two most common, are not necessarily in the best interest of the firm or shareholders, but do the best interest of the firm or shareholders, but do address common needs of managersaddress common needs of managers

1.1. Increased firm sizeIncreased firm size–– Managers are often more highly rewarded financially for buildingManagers are often more highly rewarded financially for building a a

bigger business (compensation tied to assets under administratiobigger business (compensation tied to assets under administration for n for example)example)

–– Many associate power and prestige with the size of the firm.Many associate power and prestige with the size of the firm.2.2. Reduced firm risk through diversificationReduced firm risk through diversification

•• Managers have an undiversified stake in the business (unlike Managers have an undiversified stake in the business (unlike shareholders who hold a diversified portfolio of investments andshareholders who hold a diversified portfolio of investments and dondon’’t t need the firm to be diversified) and so they tend to dislike risneed the firm to be diversified) and so they tend to dislike risk k (volatility of sales and profits)(volatility of sales and profits)

•• M&AsM&As can be used to diversify the company and reduce volatility (riscan be used to diversify the company and reduce volatility (risk) k) that might concern managers.that might concern managers.