BAF.

608E

Mergers and Acquisitions

Professor Martin Dierker
Lecture Notes Part 5
From Making an Offer
to Finalizing a Deal
From Making an Offer
to Finalizing a Deal
The Beginning
Initiating an M&A transaction
A merger can be initiated by the bidder or the
seller
 Bidder may search for candidate
 But sometimes, the target believes it wants to

be taken over
◦ By exclusive negotiation by one candidate of choice
(at a time)
◦ Or by one of several potential candidates
 Resembles closed auction
◦ Infrequent: Target open to all bidders
 Open auction format
Starting M&A negotiations
 Typically, contact is made through investme
nt bank representatives
◦ Investment bankers must have good network
◦ But be aware of potential conflicts of interest
 Bidder-initiated bids are less common
 Target-initiated bids are more common

◦ Both exclusive negotiations and closed-auction fo

rmats are often used
Keep in mind
 Bidder should have some rough valuation
 Important for bidder:

◦ Possible to make one-shot offer?

 Take it or leave it – can offer more
◦ Or longer negotiations possible?
 Do not bid too much in first round!
◦ Can deal price be contingent on important facts s
uch as
 Approval of a new drug
 Anti-trust approval
Friendly and hostile takeovers…
 .. are both possible
 Friendly: with board approval of target
 Hostile: without board approval of target
◦ Go directly to target shareholders via
 Tender offer or
 Proxy statements
◦ Only possible for publicly traded firms
 Hostile takeovers are costly
◦ They also have low success rates (15-30%)
◦ As opposed to >85% for friendly takeovers
 Therefore, they are uncommon
◦ But occur often as high-profile news events
◦ Often are a last resort
From Making an Offer
to Finalizing a Deal
The M&A Negotiation Process
Starting on finding a deal
 Negotiations usually start friendly
 Difficult to find common ground due to

complexity, missing info, lack of trust

 To solve these issues:

◦ Parties often sign confidentiality agreements

◦ So they can share info
◦ Bidder needs info to value target accurately
◦ BUT: Details on bidder interest are also confidential
 Careful: May need to file lawsuit to enforce!
 May sign exclusivity agreement
Valuation
 Buyer uses this information to carefully value
the target
◦ Need to conduct proper due diligence
 In case of a stock deal:
 Seller must also value the bidder

◦ Need to conduct proper due diligence as well

 Details on valuation, especially of synergies,
is discussed separately.
Early negotiations
 Occur not only on price and cash vs stock,
but many other dimensions
◦ Investors may care about tax, accounting choice
 Early stage agreement
◦ Bidder may put terms into a term sheet.
◦ Expecting those may find approval by own company
and target
◦ When agreement gets closer, this may be followed
by a letter of intent.
◦ Contents vary from case to case
Speculation on merger negotiation
 It may be very profitable to guess which
companies may merge or be bought
 Such speculation can cause large price swings
 Therefore: Disclosure regulation

◦ Companies may not willingly lie about ongoing merg

er negotiations
 US Supreme Court: Basic v. Levinson
◦ Precise timing of disclosure need is unclear BUT
◦ Company cannot just let info leak over time
◦ Once info start to come out, or prior statements are
no longer true, company needs to disclose.
Negotiation completed
 Then lawyers of both sides will draw up a
merger agreement.
 Needs to include many details

◦ Necessary approval by regulators or shareholders

◦ Price, legal deal structure, cash vs stock
◦ Disclosures and protections for both sides
◦ What actions will buyer undertake
 Spin off divisions/units to win anti-trust approval
◦ Conditions for the deal to complete or not
◦ which info is made public to shareholders
Merger approval
 Based on the merger agreement, the target
board can vote to approve or not
 If so, company files Schedule 14A with SEC to

inform shareholders
◦ Must include terms and reasons for deal
◦ Financial statements and regulatory compliance
◦ Accounting and tax treatment of deal
 Shareholders can then vote – typically approve
 Next: File with state regulators
 File Schedule 15 with SEC
Conflicts of interest may occur
 At the board level: Form special committee
excluding conflicted directors
◦ Ex: RJR-Nabisco
 Given the importance of the deal:
 Board members may ask outside investment

bank for a fairness opinion

◦ Protects board from lawsuits
◦ Protects shareholders from receiving low price
◦ BUT: Cannot remove all moral hazard
 Ex: Barclay’s – Del Monte case
From Making an Offer
to Finalizing a Deal
Finishing the M&A Deal
The Negotiation Process…
 … is typically “friendly”
◦ In its legal definition, otherwise still tough
 Can be very fast: Pfizer buying Wyeth for $68
bn in 2009
 Careful: Making a deal too fast may lead buyer

to overpay (AT&T acquisition of TCI)

 Rivals Moore Corp. and Wallace Computer Ser-

vices spent months on friendly negotiations

◦ Break down -> hostile takeover of Wallace by Moore
 Started hostile: Oracle bid for Peoplesoft
Negotiation Process
 Is highly regulated in all developed markets
 In US: SEC regulated both process and discl
osures
 Process takes long time (6-12 months, more)
 Publicly traded target: Long time intervals requ
ired for target shareholders to be informed
and vote on deal
 Even if deal agreed, another bidder can make a hi
gher (“topping bid”).
 Or buyer may be forced to raise price to coun
ter topping bid / appease shareholders
Break fees
 Because SEC requires the deal to take time…
 … and a topping bid may be made …
 … initial bids often stipulate a break fee in

case target walks away from initial bid

◦ To compensate for efforts and costs
◦ Break fees are subject to board fiduciary duties
 So cannot be too large
◦ Around 2-5% range
 Maybe 2.5% for cash, 3.5% for stock deals is common
 OR: Bidder may have right to match topping
bid
Reverse break fees
 A deal may also fall through because the
bidder walks away
◦ Fail to obtain regulatory approval
◦ Fail to get financing
 This causes expenses and trouble for target
shareholders
◦ So they may include a reverse break fee in deal.
◦ Works in opposite direction of break fee.
◦ Funnily, it is not subject to target or bidder board
duties, so size varies much more.
Effectively…
 SEC regulation makes bids for public targets
similar to open auctions
◦ i.e., others can make better bids
 Though the process rarely starts as open
auction

 What target may or may not do to get better d

eal is part of the initial deal contract
 E.g., deal may explicitly allow target to search

for a better offer at certain time (“go shop”)

Other causes for delays
 Reasons for possible delays:
◦ Obtaining anti-trust approval
◦ Needed for all deals above ~75 US$ million
◦ Obtain financing
◦ Separate regulatory approval needed in certain
industries
 Banking/Finance
 Utilities
 Telecom
 Applies to both private and public deals
Because of the delays
 Deals usually include material adverse change c
lause
◦ Allows either party to walk away in case of signify- c
ant adverse changes
◦ Could be recession, financial crisis
◦ Also material changes in underlying business
 Ex: June 2005: J&J agreed to buy Guidant for 25
.4$ billion
◦ J&J invoked clause to renegotiate down to $21.5b
◦ Guidant seemed to agree but
◦ Was then bought by Boston Scientific for $27b
◦ J&J sued for breach of confidentiality agreement
Private target deals
 Are less regulated
 Take less time
 Other differences:

◦ Absence of audited financial statements

◦ More info asymmetries
 So buyer in private deal may insist on legal
protections
◦ E.g. against litigation liabilities
◦ E.g. possible environmental problems