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Mergers and Acquisitions Overview

  How do companies grow ?

  74,000 acquisitions between 1996 and 2001   45,151 acquisitions between 2005 and 2008   In 2003 alone there were 8,385 acquisitions

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Most acquisitions fail

  Acquiring companies:   Share prices of companies that announce acquisitions decline by

about 0.34% to 1% in the 10 days after the announcement   Target companies:

  Stock prices rise by about 30%

Daimler - Chrsyler merger ?? Intel’s acquisition of DSP Communications ??

On the other hand…. The story of Cisco.

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 Mergers:

 Absorption of one firm by another  Acquiring firm buys all the assets, liabilities and franchises of

the acquired firm  Acquired firm ceases to exist  Stockholders of both firms must approve the merger

 Example: In June 2006, Anadarko Petroleum Corp (AP) acquired all the outstanding common stock of Kerr-McGee Corp, an oil and gas exploration and production company, via tender offer, for $70.5 in cash per share or a total value of $16.087 bil. The transaction had been subject to shareholder and regulatory approvals.

 Subsidiary Merger: Target company becomes a subsidiary or part of subsidiary of acquirer.

  Example: In 2005, Targa Resources Inc (TR), an entity backed by EM Warburg Pincus LLC, acquired the midstream natural gas business of Dynegy Inc, a wholesaler of natural gas products, for $2.445 bil in cash. The transaction was subject to regulatory approval.

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 Consolidation: Merger results in a new corporation.

  Exxon and Mobil

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Takeovers

Acquisitions

Proxy Control

Going Private

Merger or Consolidation

Acquisition of Stock

Acquisition of Assets

Proxy

 What is a proxy ?

  When shareholders are required to vote, they are sent a document that provides material facts concerning the vote

  The shareholders send back a written authorization casting their vote or permitting the firm's management, to cast a vote on their behalf.

  Proxy contest- A proxy contest occurs when the acquiring firm attempts to convince shareholders to use their proxy votes to install new management that is open to the takeover.

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Types of Mergers

  Horizontal Mergers: Combination of erstwhile competitors (e.g., Exxon + Mobil = Exxon Mobil)--- greatest scrutiny from FTC.

  Vertical Mergers: Combination of upstream and downstream companies (e.g., Merck + Medco).

  Conglomerate Mergers: Mergers across industries (or industry segments) (e.g., Phillip Morris + Kraft)

Acquisition

  Acquisition of stock:   Example: US – In 2005 Norsk Hydro ASA acquired all the

outstanding common stock of Spinnaker Exploration Co, a provider of oil and gas exploration and production services, for $65.5 in cash per share, or a total value of $2.448 bil. The largest seller in the transaction was Warburg Pincus Ventures. The transaction was subject to customary conditions and regulatory approvals.

  Purchase the firm’s voting stock in exchange for cash, shares or other securities   Tender offers

 Public offer to buy shares of a target firm  Public announcements  General mailings

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 Acquisition of assets:

  Example: Eni SpA, through its Eni Petroleum Co unit, acquired the production, development and exploration assets, located in the Gulf of Mexico, of Dominion Resources Inc, an electric and gas utility and holding company, for $4.757 bil. The transaction had been subject to regulatory approvals.

  Example: US - Norway state-owned StatoilHydro ASA acquired a 32.5% stake in Marcellus shale property (MS) of Chesapeake Energy Corp (CE), an oil and gas exploration and production company, for $3.375 bil. On completion, MS was operated as a joint venture. Originally, in September 2008, CE announced that it was seeking a buyer for its undisclosed minority stake in its MS unit.

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Leveraged Buy-Out (LBO)

  Buy out a company’s assets using debt

  New firm’s capital structure is primarily debt   RJR – Nabisco   Use the combined firm’s assets to borrow   Use the opportunity to create value via leverage

  Types of LBOs:   Management buyout (MBO)   Employee buyout(EBO)   Restructuring

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Reasons for M&A

 Synergy

  = VAB - (VA + VB ) – (P + E)

 P = Premium paid, E = Transaction Expenses

Sources of Synergy

  Strategic Benefits

  Integration: Vertical or horizontal

  Expansion

  DuPont – Conoco merger – supply of oil for DuPont   P&G’s acquisition of Charmin Paper – integrate paper products   GE – Hughes aircraft merger – technology transfer   Phillips and Getty Oil – led to more efficient management being put

in place   HP- Compaq merger was driven by the goal of reducing

redundancies in resources

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Tax Gains

  In the U.S. tax law permits tax loss carryforwards   A firms with NOL this year can get refunds of income taxes paid in

the last 3 years   This benefit can be carried forward for 15 years   M&A can result in tax gains over and above this   T1_tax_gains.xls

  Diversification   U.S. Steel’s acquisition of Marathon Oil

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Strategic Planning for M&A   Begins with a discussion between the board of directors and

management   Elements to consider:

  Internal:   Mission and vision statements –   XOM:

  We are the world's largest publicly traded international oil and gas company, providing energy that helps underpin growing economies and improve living standards around the world…

  We are committed to meeting the world's growing demand for energy in an economically, environmentally and socially responsible manner.

  Core competencies and assets   Culture

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  External elements:   Business environment – scenarios   Customers – product, price, service and quality   Competitors   Suppliers – contracts and bargaining power   Alliances – affiliations with customers and suppliers

  Checklist of items:   Physical asset   Financial assets   Intellectual assets / Organizational assets   Risks

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Define Acquisition Objectives

  Primary objectives:

  Horizontal/vertical integration

  Geographic expansion (regional/national/international)

  Other

  Other objectives/issues:

  Accretive to earnings

  Synergies

  Form of consideration

  Accounting, tax, legal and regulatory

  Cultural (e.g., management and employees)

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Candidate Investigation

Preparation Phase

Marketing Phase

Final Agreement

Phase

Valuation

Descriptive Memorandum

Candidate Analysis

Analysis of Proposal(s)

Candidate(s) Due Diligence

Selecting a Marketing Strategy

Approaching Potential Candidates

Solicitation of Proposals

Negotiations

Closing

Steps in the Sale Process

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M&A Intermediaries

  Business brokers

  Accountants

  Lawyers

  Consultants

  Business valuation firms

  Commercial banks

  Investment banks

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Financial Advisory Services Sale Engagement

  Value company

  Assist in selecting sale strategy

  Assist in identifying potential purchasers

  Contact potential purchasers

  Assist in evaluating offers

  Assist in responding to offers

  Assist in negotiations with potential purchasers

  Assist in negotiating ancillary agreements

  Fairness Opinion

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Financing the Acquisition

 Financing sources:

  Internal Capital

  Private placements of debt or equity

  Public offerings of debt or equity

  Seller notes

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Due Diligence

 Due diligence is the process of identifying and confirming or disconfirming the business reasons for the proposed M&A transaction.

 Several functions are involved in due diligence: Strategy, finance, legal, marketing, operations, human resources, and internal audit services.

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The Due Diligence Process

  Interview management

  Collect company/industry information

  Understand drivers of business

  Build financial models

  Valuation

  Assessment of post-Acquisition Operation Plans

Why Due Diligence ?

  Guard against the Winner’s Curse:

 Groucho Marx:

  “I would never join a club that would have me for a member.”

 Woody Allen (paraphrase):

  “I would never marry a woman who would accept me as a husband..”

 M&A Analogy:

  “I will not do an acquisition that other potential buyers have passed on.”

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 Most major sales and acquisitions (especially in energy) either implicitly or explicitly involve auctions.

 The winners curse says that in an auction, since the most optimistic bidder usually wins, the winning bidder tends to be overly optimistic and may thus overvalue the auctioned property.

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 A rigorous due diligence in valuation (and financing) is needed to allow management to account for the winners curse.

  In other words, management must ask,

   “How big must be the shareholder value-add from the acquisition, before it makes sense to take the investment?”

Target firms resistance

  Provisions in the corporate charter:   Boards – classified vs not   Voting – supermajority vs not

  Golden Parachutes

  Poison pills   Peoplesoft (PS)’s poison pill (2005)–

 Once a bidder acquired 20% of their shares, all shareholders except the acquirer could buy more shares from the corporation at half price.

 PS had 400 million shares outstanding so if a bidder acquired 80 million shares, each existing shareholder (except the bider) could buy 16 more shares for every share held

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  If all shareholders exercised the right PS would have to issue 0.8 x 400 x 16 = 5.12 billion shares

  The total number of shares outstanding = 5.12 +0.4 = 5.52 illion   Stock price would drop to half because the existing shareholders can

buy at half price   Hence the bidder’s proportion of the firm’s onwership will drop to 80

million / 5.52 billion = 1.45%   Greenmail

  In 1986 Ashland Oil Ince, a large independent oil refiner had 28 million shares outstanding. The firm’s share price closed at 49.75 on April 1, 1986. On April 2, the board decided to buy 2.6 million shares from the Belzberg family of Canada so as to prevent the family from taking over the firm. The same day, the board also authorized the firm to repurchase 7.5 million shares and to set up an ESOP funded with 5.3 million shares.

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Regulatory considerations   Antitrust: Some businesses need clearance from the Federal Trade

Commission or the Dept of Justice (DOJ)   Hart-Scott-Rodino (HSR) Act of 1976

  Parties to a transaction are required to furnish certain information about themselves to the FTC and the DOJ

  Information on the nature of the business and the revenues based on the industry classification of the firms

  This information is used to determine if the deal could unleash anticompetitive forces

  Some mergers are exempt from the HSR Act (small asset size, little voting control)

  Horizontal mergers – use the Herfindahl-Hirschman Index (HHI) to determine postmerger share of the new entity

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Planning is important…   While planning may take up only 20% of the M&A process it requires

80% of the energy involved   Strategic planning:

  Hiring the right advisors   Doing the research   Studying the regulatory factors

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Global Environment of Business

  Case discussion:

  HBR article – The Dubious Logic of Global Megamergers (Ghemawat and Ghadar)

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