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Introduction to

Mergers, Acquisitions,
& Other Restructuring
Activities

If you give a man a fish, you feed him for a day.


If you teach a man to fish, you feed him for a life time.
Lao Tze

Course Layout: M&A & Other


Restructuring Activities

Part I: M&A
Environment

Part II: M&A


Process

Part III: M&A


Valuation &
Modeling

Part IV: Deal


Structuring &
Financing

Part V:
Alternative
Strategies

Motivations for
M&A

Business &
Acquisition
Plans

Public Company
Valuation

Payment &
Legal
Considerations

Business
Alliances

Regulatory
Considerations

Search through
Closing
Activities

Private
Company
Valuation

Accounting &
Tax
Considerations

Divestitures,
Spin-Offs &
Carve-Outs

Takeover Tactics
and Defenses

M&A Integration

Financial
Modeling
Techniques

Financing
Strategies

Bankruptcy &
Liquidation

Cross-Border
Transactions
3

Course Learning Objectives

Define what corporate restructuring is and why it occurs


Identify commonly used valuation techniques
Describe how corporate restructuring creates/destroys value
Identify commonly used takeover tactics and defenses
Develop a highly practical planning based approach to
managing the M&A process
Identify challenges and solutions associated with each phase
of the M&A process
Describe advantages and disadvantages of alternative M&A
deal structures
Describe how to plan, structure, and manage JVs, partnerships,
alliances, licensing arrangements, equity partnerships,
franchises, and minority investments
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Current Chapter Learning Objectives


Primary objective: What corporate restructuring is and
why it occurs
Secondary objective: Provide students with an
understanding of
M&A as a form of corporate restructuring
Alternative ways of increasing shareholder value
M&A activity in an historical context
The primary motivations for M&A activity
Key empirical findings
Primary reasons some M&As fail to meet expectations
5

Motivations for M&A

Strategic realignment
Technological change
Deregulation
Synergy
Economies of scale/scope
Cross-selling
Diversification (Related/Unrelated)
Financial considerations
Acquirer believes target is
undervalued
Booming stock market
Falling interest rates
Market power dominate pricing
Ego/Hubris I can do it
Tax considerations-tax free, NOLs

Why Do Most M&As Fail?


Acquirers do not think systematically about what
they are buying and what it might do for them.
Extend business but not fundamentally change
how you compete.
Reinvent your business, need a new business
model to complement, extend or replace.
Inadequate Due Diligence
Inadequate Integration

The New M&A Playbook, Christensen, HBR March 2011 See website
7

Five Myths About Emerging


Markets
Emerging markets growing much faster but stock market losses
much stepper.
Growth
Market Losses
US 1.8%
-0.9%
Brazil 3.1%
-16.5%
Russia 4.5%
-10.9%
India 7.3%
-23.0%
China 9.0%
-22.2%
Myth 1 High valuations less important in fast growing
economies. Expensive vs. valuation measures PE ratios
Pollock, Five Myths About Emerging Markets, Wall Street Journal, December 5, 2011, Page C5

Five Myths About Emerging


Markets
Myth 2 EM stocks well insulated global financial
problems. Not so today-NY & London; consider risk
= small cap
Myth 3 EM growth strategy only Bonds &
dividend paying stocks Wisdom 8.5%
Myth 4 EM currencies as $ declines. Long term
maybe but weak vs $
Myth 5 Concentrate on few of strongest emerging
nations. Piled into country specific ETFs, less
diversification, liquid, easy to trade. Use broad
based EM.
9

M&As as a Form of
Corporate Restructuring

Restructuring Activity
Corporate Restructuring
Balance Sheet
Assets Only
Financial Restructuring
(liabilities only)
Operational Restructuring

Potential Strategy
Redeploy Assets
Mergers, Break-Ups, &
Spin-Offs
Acquisitions,
divestitures, etc.
Increase leverage to lower
cost of capital or as a
takeover defense
Divestitures, widespread
employee reduction, or
reorganization

10

Alternative Ways of
Increasing Shareholder Value
Solo venture (AKA going it
alone or organic growth)
Partnering
(Marketing/distribution alliances,
JVs, licensing, franchising, and
equity investments)
Mergers and acquisitions
Minority investments in other
firms. (EMC discussion)
Asset swaps (Real Estate)
Financial restructuring
Operational restructuring
11

Remembering the Past


Those who do not remember the past
are condemned to relive it.
Alexis De Tocqueville

13

Merger Waves1
(Boom Periods)

Horizontal Consolidation (18971904)


Increasing Concentration (19161929)
The Conglomerate Era (19651969)
The Retrenchment Era (19811989)
Age of Strategic Megamerger
(1992-2000)
Age of Cross Border and
Horizontal Megamergers (20032007)

Periods characterized by robust increases in the number and value of transactions.


14

Causes and Significance


of M&A Waves

Factors contributing to merger waves:


Shocks (e.g., technological change, deregulation, and
escalating commodity prices)
Ample liquidity and low cost of capital
Overvaluation of acquirer share prices relative to target share
prices
Why it is important to anticipate M&A waves:
Financial markets reward firms pursuing promising (often
undervalued) opportunities early on and penalize those that
follow later in the cycle.
Acquisitions made early in the wave often earn substantially
higher financial returns than those made later in the cycle.
15

Horizontal Consolidation (1897-1904)


Spurred by
Drive for efficiency,
Lax enforcement of antitrust laws
Westward migration, and
Technological change
Resulted in concentration metals, mining and
transportation industry. (GM/DuPont)
M&A boom ended by 1904 stock market
crash and fraudulent financing
16

Increasing Concentration (1916-1929)


Spurred by
Entry of U.S. into WWI
Post-war boom
Boom ended with
1929 stock market crash
Passage of Clayton Act which more clearly
defined monopolistic practices

17

The Conglomerate Era (1965-1969)


Conglomerates buy earnings streams to boost
share price (diversified portfolio) LTV,UTC
Overvalued firms acquired undervalued high
growth firms
Number of high-growth undervalued firms
declined as conglomerates bid up their prices
Higher purchase price for target firms and
increasing leverage of conglomerates brought
era to a close. Supply and demand
18

The Retrenchment Era (1981-1989)


Strategic U.S. buyers and foreign multinationals
dominated first half of decade
Second half dominated by financial buyers
Buyouts often financed by junk bonds
Drexel Burnham provided market liquidity
Era ended with bankruptcy of several large
LBOs and demise of Drexel Burnham (Michael
Milken)
19

Age of Strategic Megamerger


(1992-2000)
Dollar volume of transactions reached record in each
year between 1995 and 20001
Purchase prices reached record levels due to
Soaring stock market
Consolidation in many industries
Technological innovation
Benign antitrust policies
Period ended with the collapse in global stock markets
and worldwide recession
The cumulative dollar value of M&As during this period in the U.S. was $6.5 trillion, With $3.5 trillion
taking place in the last two years (55%).
20
1

Age of Cross Border and


Horizontal Megamergers (2003 2007)
Average merger larger than in 1980s and 1990s, mostly
horizontal, and cross border
Concentrated in banking, telecommunications, utilities,
healthcare, and commodities (e.g., oil, gas, and metals)
Spurred by
Continued globalization to achieve economies of
scale and scope;
Ongoing deregulation;
Low interest rates;
Increasing equity prices, and
Expectations of continued high commodity prices
Period ended with global credit market meltdown and
2008-2009 recession
21

Debt Financed 2003-2007 M&A Boom

Low
LowInterest
Interest
Rates
Rates&&Declining
Declining
Risk
Aversion
Risk Aversion
Drive
DriveIncreasing
Increasing
--Sub-Prime
--Sub-Prime
Mortgage
MortgageLending
Lending
--LBO
Financing
--LBO Financing&&
Other
OtherHighly
Highly
Leveraged
Leveraged
Transactions
Transactions

Investment
InvestmentBanks:
Banks:
Repackage
Repackage &&
Underwrite
Underwrite
--Mortgage
--Mortgage
Backed
Backed
--High
--HighYield
Yield
Bonds
Bonds

Banks
Banks&&
Hedge
HedgeFunds
Funds
Create:
Create:
--Collateralized
--Collateralized
Debt
DebtObligations
Obligations
(CDOs)
(CDOs)
--Collateralized
--Collateralized
Loan
LoanObligations
Obligations
CLOs)
CLOs)

Foreign
Foreign
Investors
Investors
Buy
BuyHighest
Highest
Rated
RatedDebt
Debt

Hedge
Hedge
Funds
Funds
Buy
BuyLower
Lower
Rated
Rateddebt
debt

Investment Banks Lend to Hedge


Funds

22

Similarities and Differences


Among Merger Waves
Similarities
Occurred during periods of sustained high economic
growth
Low or declining interest rates
Rising stock market
Access to cash corporate cash - $2 trillion
Differences
Emergence of new technology (e.g., railroads, Internet)
Industry focus
Type of transaction (e.g., horizontal, vertical,
conglomerate, strategic, or financial)
Per President Obama, December 2012-13

23

PwC - M & A Activity

24

M & A Activity 2012


Uncertain global economy
Volatile equity markets
Surprise- uptick in M&A, more strategic
Execute target growth strategies
Reshape business prosper current economy
Close deals in pipeline

Corporate cash reserves S&P - $1.5T

Dealmakers in Pursuit of Strategic M&A Opportunities, PwC, July 18, 2012

25

M & A Activity 2012


Specifics disclosed deals
First half 2012 - 3,870 deals, $350B value
First half 2011- 4,606 deals, $592B value
Q 2 2012, 1,891 deals, $218B
Q 1 2012, 1,979 deals, $132B
June 2012, $76B, best month since 2011
Midmarket deals 35%value, 98% volume
Where the market is, value driven up
Challenging debt market, through process and due
diligence

We expect deal activity to increase 2nd half


26

M & A Activity YTD 2012


Divestitures increasing - 28% versus 22%
Sell off orphans
Non strategic assets
Sell side due diligence to enhance value

Private Equity activity increasing


Pursuing middle market deals
17% deal value
Does contribute to IPO activity by exiting.

40% CEOs planning emerging market deal


28% CEOs planning other deals

27

2013 and Beyond per KPMG


Optimism on Deal Environment
Significantly more optimistic
More optimistic
About the same
Less optimistic
Significantly less optimistic

0% 10% 20%

Multiple responses permitted

30% 40% 50%

.
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Factors Facilitating Deal Activity


Large cash reserves/commitments
Availability of credit on favorable terms
Opportunities in emerging markets
Improved consumer confidence
Resolution of European economic crisis
Improving equity markets
Improved employment numbers
Recovery of financial services sector
30

Other

Illustrating Economies of Scale


Period 1: Firm A (Pre-merger)
Assumptions:

Price = $4 per unit of output sold

Variable costs = $2.75 per unit of output

Fixed costs = $1,000,000

Firm A is producing 1,000,000 units of output per


year

Firm A is producing at 50% of plant capacity

Period 2: Firm A (Post-merger)


Assumptions:

Firm A acquires Firm B which is producing


500,000 units of the same product per year

Firm A closes Firm Bs plant and transfers


production to Firm As plant

Price = $4 per unit of output sold

Variable costs = $2.75 per unit of output

Fixed costs = $1,000,000

Profit = price x quantity variable costs


fixed costs
= $4 x 1,000,000 - $2.75 x 1,000,000
- $1,000,000
Revenue $4,000,000
= $250,000
V/C
( 2,750,000)
F/C
( 1,000,000)
Profit
$ 250,000
Profit margin (%)1 = $250,000 / $4,000,000 = 6.25%
Fixed costs per unit = $1,000,000/1,000,000 = $1

Profit = price x quantity variable costs


fixed costs
= $4 x 1,500,000 - $2.75 x 1,500,000
- $1,000,000
= $6,000,000 - $4,125,000 - $1,000,000
= $875,000
Profit margin (%)2 = $875,000 / $6,000,000 = 14.58%
Fixed costs per unit = $1,000,000/1.500,000 = $.67

Key Point: Profit margin improvement is due to spreading fixed costs over more units of output.
Margin per $ of revenue = $4.00 - $2.75 - $1.00 = $.25
Margin per $ of revenue = $4.00 - $2.75 - $.67 = $.58

1
2

31

Illustrating Economies of Scope


Pre-Merger:

Post-Merger:

Firm As data processing center


supports 5 manufacturing facilities
Firm Bs data processing center
supports 3 manufacturing facilities
Assume capacity

Firm As and Firm Bs data


processing centers are combined
into a single operation to support
all 8 manufacturing facilities
By combining the centers, Firm A
is able to achieve the following
annual pre-tax savings:
Direct labor costs = $840,000.
Telecommunication expenses
= $275,000
Leased space expenses =
$675,000
General & administrative
expenses = $230,000

Key Point: Cost savings due to expanding the scope of a single center to
support all 8 manufacturing facilities of the combined firms.
32

Empirical Findings

Around transaction announcement date, abnormal returns average


20% for target shareholders in friendly transactions; 30-35%
in hostile transactions. Bondholders also benefit.
Bidders shareholders (and bondholders) on average earn zero
to slightly negative returns.
Enterprise values (EV) for target & bidders volatile.
EV targets surge after announcement; EV bidders - negative
Positive abnormal returns to bidders often are situational and
include the following:
Target is a private firm or a subsidiary of another firm
The acquirer is relatively small (large firm management subject
to hubris)
The target is small relative to the acquirer
Cash rather than equity used to finance the transaction ??
Transaction occurs early in the M&A cycle
No evidence that alternative strategies (e.g., solo ventures,
alliances) to M&As are likely to be more successful

Branch, Mergers and Acquisitions and the Universal Investor, Investor Responsibility Research Center
Institute, January 2012-3

33

Primary Reasons Some M&As Fail


to Meet Expectations
Overpayment due
to over-estimating
synergy (price
tag), goodwill ??
Slow pace of
integration
Poor strategy
34

Things to Remember

Motivations for acquisitions:


Strategic realignment
Synergy
Diversification
Financial considerations
Hubris
Common reasons M&As fail to meet expectations
Overpayment due to overestimating synergy
Slow pace of integration
Poor strategy
M&As typically reward target shareholders far more than
bidder shareholders
Success rate of M&A not significantly different from alternative
ways of increasing shareholder value
37