MERGERS & ACQUISITIONS

Vehicle for growth

DEFINITIONS

Merger

- Agreement where two firms agree to integrate their operations on a relatively coequal basis
- Because, they have resources and capabilities that together may create a competitive advantage
o Not very common

Acquisition

- A transaction where one firm buys another firm with the intent of more effectively using a core
competency
- by making the acquired firm a subsidiary within its portfolio of businesses

Takeover

- An acquisition where the acquired firm did not solicit the bid of the acquiring firm

Leveraged buy-out (LBO)

- An acquisition financed primarily by debt

o Usually involves the acquisition of a public firm by a closely-held entity

Horizontal

- Same industry, same leg of value chain

Vertical

- Same industry, backward / forward in the value chain

Conglomerate

- Unrelated entity

STRATEGY

M&A programme must be aligned with the overall strategy

Considerations

- Why want to undertake M&A

- Success factors
- Other growth opportunities
- International vs local
o Consider experience in market
 - List of potential targets

REASONS FOR MERGERS

Operating economies (Synergies)

Synergy
- Purchasing
- Standardisation of products, spread R&D Vxy > Vx + Vy
- Combination of production facilities
- Reduction of retail outlets
- Combination of IT and Admin functions
- Consolidation of R&D programmes

Managerial skills

- People = one of the most valuable resources a company can have

Tax considerations (Should not be the reason, only a consideration)

- Assets v shares
- Withholding tax, CGT
- Assessed losses
- Marketable securities tax .25%

Excess cash resources

Credit rating + Ethics
Diversification important for ITC

Lower financing costs (Credit ratings)

Replacement costs (company cheaper than assets)

Technology

PURCHASING ASSETS VS COMPANY

- Deductibility of interest
o On asset purchases 100%
o S24O applies, then 100%
 Else, 1/3 added to base cost of shares
- W&T allowances on higher value
o Assets purchased = W&T on full amount
- Only by 50.1% of shares to obtain control
o Full value of asset needed to be purchased
- Offer directly to shareholders of company (hostile takeover)
o Asset purchase negotiated with management
- Contracts – EEs, leases, loans, JVs
o Obtain if purchase shares
o Lost if purchase assets
- Registration costs and transfer fees
o A lot more admin in purchasing shares
- Obtaining finance for acquisition
o Assets as security, often can receive full value of assets as loan (asset value is stable)
 o Shares as security, cant receive full value of shares as a loan (shares are volatile)
- Skeletons in the cupboard
o Litigations, warranty obligations
o Think: what could go wrong
- Purchasing of assets, can only buy the assets you want

SUCCESS OF MERGERS & ACQUISITIONS

Most of the time unsuccessful

REASONS FOR FAILURE

- Lack of post-acquisition integration
- Excessive financial leverage
- Timing delays in disposal of non-core divisions
- Poor business fit (acquiring entity does not fully understand the targets business)
- Clash of corporate cultures
- Disagreements / divisions at board level Success measures:
- Regulatory delays – affect ability to realise synergy
- Inadequate due diligence - Share price
- Loss of key customers and staff - Achievement of synergies
- Higher than expected costs - Factors in this list
- Loss in brand value
- Ineffective and poor communication with EEs, customers and suppliers
- Moving into fundamentally unprofitable industries (or staying there)
- Deal entered into for wrong reasons

WHY COMMON IF UNSUCCESFUL

- Rapid means of corporate growth
- Creation of new synergies / economies of scale / scope
- Increased market share and market power
- Internalisation of crucial upstream / downstream activities
- Transfer of assets to more effective management
- Means of gaining new competencies / knowledge

FACTORS WHICH RESULT IN A PURCHASE FOR < NAV

- Restrained its dividends
- Inefficient capital structure
- Current losses
- Management / shareholders are unaware of true value of assets or unable to properly manage assets
- Typically, poor or inadequate profits, returns or growth

WHEN DO M&AS MAKE SENSE

- Friendly takeover
o Hostile will usually fail
- Resource complementarity is crucial
- M&As as mode of entry (vs alliances / greenfield)
- Exit strategy from maturing industry
 - Acquisition of competitive advantage at a different point in the value chain
- When you are the target

DEFENSIVE TACTICS

Management of target is not in favour of merger

Proactive measures – steps in advance before bid is made to make merger difficult

Reactive measures – steps to counter bid once it has been made

Shareholders wealth = important discussion point , often mergers fuck with shareholders wealth

PROACTIVE MEASURES
- Improve performance
o Increase share price
- Increase dividends
o Increase share price
- Amendments to memorandum and articles
o Conditions where pay-outs to management are required on change in control
- Sale of valuable assets
o Business less appealing
- Management contracts
o Conditions where pay-outs to management are required on change in control
- Pyramids
- Share split
- Poison pills
o Internal reorganisation, tax effects only kick in on change in ownership

DEFENSIVE MEASURES
- Circular from BoD
- Alternative friendly merger
- Counter attack (pac-man defence)
o Make offer to buy bidder
- Disclosure of new information
o Making acquisition less appealing
- Litigation and court actions
- Greenmail
o Bribe

GENERAL PROCESS

1. Pre-acquisition

– Determine need for take-over (e.g. skills, economies of scale etc.)

– Link to strategy

2. Identify and evaluate potential targets

– Link to strategy
 3. Investigate targets

– Initial investigation

– Information needs

– Due diligence

– Link with valuations

4. Determine structure

– Purchase assets vs shares

5. Negotiations

– Assess value to you

– Other interested parties and their financial position

– Bargaining power

– Behavioural finance e.g. anchoring

6. Payment / Financing Plan

– Cash, shares or other

– Link to sources of finance

– Exchange ratios

7. Post-merger integration

– E.g. managing corporate cultures etc.

– Crucial

– Involvement of executives

– Communication NB!

PRICE AND PAYMENT

Final terms determined by negotiating power

Payment options

- Cash (if certain about synergies)

- Shares (if unsure of synergies, spreads risk)
- Alternatives and combinations

Consider impact of payment method on:

- Balance sheet
 - Existing shareholders (target and acquirer)
- Sellers

Price set per a valuation

FUNDING MY SHARE ISSUE

Need to calculate exchange ratio: how many acquirers shares for how many target shares

Market value basis:

MPS of target company

ER
= MPS of acquiring
company

Earnings basis:

EPS of target company

E
R
EPS of acquiring
=
company

When you bring synergy into things (to calculate the maximum and minimum exchange ratios) you
follow a two-step process:

Step 1: Recalculate the MPS or EPS (depending on which method you are using) of the relevant party
taking into account ALL the synergy

Step 2: Use this “adjusted” MPS or EPS in the basic formula

Maximum exchange ratio:

Remember, this is where the TARGET company’s shareholders get the “full benefit” of the synergy
(and therefore the acquirer is “paying” for all the synergy), therefore:

Step 1: Recalculate the MPS or EPS of the TARGET company taking into account ALL the synergy

Step 2: Use this “adjusted” MPS or EPS for the TARGET in the basic formula

Minimum exchange ratio:

Remember, this is where the ACQUIRING company’s shareholders get the “full benefit” of the synergy
(and therefore they “don’t pay” the target for any of the synergy), therefore:
Step 1: Recalculate the MPS or EPS of the ACQUIRING company taking into account ALL the synergy

Step 2: Use this “adjusted” MPS or EPS for the ACQUIRER in the basic formula