Week 1 06

BUSINESS ACQUISITIONS

FIRST CLASS

COURSE DESCRIPTION

MOTIVATION FOR ACQUISITIONS

MERGER & ACQUISITION BASICS

© 2006 Joseph D. Lehrer

BUSINESS ACQUISITIONS

An Interdisciplinary Approach Towards Teaching the Skills

of a Business Lawyer

PREMISE OF THE COURSE

The Role of the Transactional Attorney is

to Add Value to a

Business Transaction

ADDING VALUE TO A TRANSASCTION

By structuring the transaction to enhance financial return, reduce risk and limit costs.

Using multiple skill sets to shepherd the Transaction.

Working as a member of a team, including the client and other professionals.

Facilitating the consummation of a beneficial Transaction

BASIC ROLES OF THE ACQUISTION ATTORNEY

• Design the Structure of the Transaction

• Implement Reduction of Risk

• Negotiate the Details of the Transaction

• Prepare Documentation of the Transaction

Create Congruency Between: (i) the Business Goals and Expectations for the Transaction and (ii) The Structure and Documentation of the Transaction

COMMON RISKS

• Financial Risks• Environmental• Employment Laws• Employee Benefits• Commercial Litigation• Tax• Intellectual Property Infringement• Antitrust

THE COURSE WILL EMPHASIZE THE USE OF

INTERDISCIPLINARY SKILLS

Interdisciplinary Skills Include Legal, Financial and Business

Skills

INTERDISCIPLINARY LEGAL SKILLS

• Corporations• Contracts• Tax• Real Estate• Labor and

Employment• Employee Benefits

• Intellectual Property • Antitrust• Securities• Environmental• Uniform Commercial

Code• Insurance

EXTRA-LEGAL INTERDISCIPLIANRY

BUSINESS SKILLS

• Managerial and Cost Accounting

• Finance

• Marketing

• Valuation

• Negotiations

DOCUMENTATION OF THE TRANSACTION

• Provide Congruency among the expectation of the client, the negotiated transaction and the documentation of the transaction

• Coordinate the Documentation with the results of Due Diligence

• Use Familiar Formats and Procedures of Documentation to Reflect the Transaction

THE ACQUIRED SKILL

TO APPLY MULTI- LEGAL AND EXTRA-LEGAL DISCIPLINES IN A SEAMLESS MANNER WITHIN

A SINGLE TRANSACTION

CLIENTS EXPECT THE BUSINESS ATTORNEY

• To Be a Constructive Counselor Regarding Price and Structure of a Transaction

• Possess Multiple Legal and Business Skills Based Upon Interdisciplinary Education and Experience of Many “Deals”

• Be a Facilitator Who Finds Solutions for Both the Buyer and Seller

• Be a Constructive Negotiator Who Creatively Avoids Impasse

WHAT IS THIS COURSE ABOUT?

(What is the Common Goal of the Buyer and Seller?)

$

$

$

$

MONEY

THE LANGUAGE OF MONEY

• Financial Statements

• Projections

• Valuation Analysis

• Financial Terms of Art

DETERMINING PRICE REQUIRES VALUATION

ANALYSIS• Basic Knowledge of Financial Statements

– Analysis of the Balance Sheet, Income Statement and Statement of Cash Flows

– Additional Information of Target Disclosed in Notes to Financial Statements

– Analysis of Financial Projections

• Basic Valuation Drivers and Techniques• Identification and Analysis of Synergies

– Marketing and Revenue Enhancement

– Expense Savings

CRTITICAL CONCEPUTAL ANALYSIS OF “VALUE”

• Value Based on Target’s Assets and Liabilities– Those Reflected on the Balance Sheet– Those Not Reflected on the Balance Sheet

• Value Based on Historical Financial Results

• Value Based on Financial Projections

• Value Based upon Comparable Companies’ Stock Market Values

• Value Based Upon Perceived Synergies

CRTITICAL CONCEPUTAL ANALYSIS OF “VALUE”

• Value Based Upon Net Discounted Future Cash Flow of the Business– How to Predict Future Cash Flow– What Discount Rate to Use Based Upon

Expected Return, Perceived Risk and Cost of Funds

– How to Integrate Synergies of Multiple Businesses Within Such Analysis

NEW CONCEPTS AND TERMS

• EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) and Cash Flow

• Leverage and Leveraged Buy-Out (LBO)

• Multiples

• Discount Rate and Present Value

• Cost of Capital

• ROI (Return on Equity)

• IRR (Internal Rate of Return)

STRUCTURING THE TRANSACTION

• Considerations for the Structure– Acquiring the Attributes and Avoiding

Unwanted Liabilities– Accounting Issues– Tax Issues

• Basic Acquisition Structures

PRELIMINARY NEGOTIATIONS AND

INVESTIGATION

• Confidentiality Agreements

• Letter of Intent

• Due Diligence Investigation

IDENTIFICATION OF REGULARLY RECURRING

ISSUES

• Successor Liability

• Labor and Employment Issues

• Intellectual Property Issues

• Corporate Law Issues

• Environmental Issues

ISSUES RELATED TO DOCUMENTATION

• What is being Acquired

• Purchase Price Payment Provisions

• Representations and Warranties

• Covenants

• Conditions for Closing

• Indemnity Provisions

FINANCING THE TRANSACTION

• Working Knowledge of Financing Techniques (Secured, Unsecured, Mezzanine…etc.)

• Interplay of Finance, Accounting, Creditors’/Debtors’ Rights and Securities Law

CORPORATE GOVERNANCE

• Decision Making Process of Public Vs. Private Corporation

• Duties of Directors• Who Decides Whether to Sell, to Whom

and for How Much?– The Shareholders?– The Directors?– The Courts?

• Takeover Defenses

SPECIFIC ISSUES RELATED TO PUBLICLY HELD

TARGETS

• Takeover Techniques• Hostile Bids and Defensive Techniques to a

Hostile Bid• The Role of the Board, Shareholders &

Courts• The Special Case of the Management Buy-

Out• The Role of State Statutes

ANTITRUST ISSUES

• General Antitrust Principals

• Determination of Undue Share of Market

• Pre-Merger Notification Requirements

COURSE PROCEDURES• Assignments will be sent by E-Mail and will be

Posted at the Business Acquisitions Web Site– Readings in Adobe, Word or as an HTML– Usually before the weekend– Assignments are not necessarily fully covered in class

• I will try to have all written assignment materials downloadable from the Course Web Site

• Use of Links to the Internet For Some Assignments

• Each Class PowerPoint Presentation will be in a Printable Form on the Web Site Prior to Class

COURSE PROCEDURES• Attendance is expected. Attendance roles will not

be regularly taken, but the right is reserved to contact the student who doesn’t attend class.

• Preparation is expected , and students who are not prepared for Class “volunteer” for extra assignments

• Class participation will not always be Voluntary• Teacher may miss some classes -- make up on

Fridays to be announced (MLK class will be rescheduled for “Negotiation” Session)

• Grades will be primarily based upon examination, but Teacher reserves the right to take into account attendance and class participation.

COURSE PROCEDURES• This year the examination will be an 8 hour

open book exam.

• The Exam Will Test Students’ Ability to Apply Interdisciplinary Skills, and will Hopefully also be a Learning Experience.

• The Test Will Cover the Assignment Materials and Emphasize the Items Covered in Class (Including Items Not Contained on the Power Point Presentations).

JOSEPH D. [email protected]

I can be reached at:

Merger & Acquisitions

BASIC CONCEPTS

MERGER & ACQUISITION BASICS

• An Acquisition is the Purchase of a Business– Acquisition of Assets of a Corporation– Acquisition of the Stock of a Corporation

• A Merger is the Combination of Two Corporations

MERGER WAIVES• 1893-1904: Consolidation of Railroads,

Oils, Steel, ..etc. (Rockefeller, Vanderbilt, Carnegie)– Motivated in large part by New Technologies– Consolidation of Fragmented Industries (e.g.,

Railroads)– Fueled by Foreign Money (Instituted by J. P.

Morgan)

MERGER WAIVES

• 1919-1929: Further Consolidation and Vertical Integration (e.g., automobile industry)

• Motivated by New Technologies: Automobile, Airplanes, Movies and Radio

• Personalities: Ford, Durant,

MERGER WAIVES

• 1955-1973: Era of the Conglomerate

• Large Players: ITT (Harold Geneen), LTV (Jimmy Ling)

• Diversification, not Consolidation, was the Driver

• The Hodge Podge Acquisitions look Irrational in Retrospect

MERGER WAIVES

• The 1980’s: The Growth of LBO’s, Financial Buyers, MBO’s, and the Hostile Takeover, Break Up LBO’s, …etc.

• Spurred in Large Part by Sophisticated Financing and Leverage

• Personalities: Milken, T. Boone Pickens, KKR, Perelman,..etc.

MERGER WAIVES• 1993-2000: Merger Mania

• Motivated by:– Deregulation (Banks, Broadcasting, …etc.)– Relaxation of Antitrust Restraints– Technology– Foreign Investment– Cheap Money– Globalization

• Fueled by the “Irrational Exuberance” of Stock Market Valuations

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1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Num

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Volume of M&A ActivityVolume of M&A ActivityBillion Dollar Deals Year by YearBillion Dollar Deals Year by Year

Source: Thomson Financial Securities DataSource: Thomson Financial Securities Data

R a n k V a l u e ( $ m m ) ( 1 ) S e lle r B u y e r1 $ 5 7 , 9 2 0 . 3 4                    G i l le t t e C o    P r o c t e r & G a m b le C o .2 $ 3 4 , 7 7 8 . 9 4                    B u r l in g t o n R e s o u r c e s , I n c .   C o n o c o P h i l l ip s3 $ 3 4 , 3 5 5 . 2 4                    M B N A C o r p .    B a n k o f A m e r ic a C o r p .4 $ 2 3 , 8 8 9 . 4 1                    G u id a n t C o r p .    B o s t o n S c ie n t ifi c C o r p .5 $ 1 7 , 7 0 4 . 5 9                    U n o c a l C o r p .    C H E V R O N T E X A C O C O R P6 $ 1 7 , 6 6 0 . 0 0                    A d e lp h ia C o m m .    T im e W a r n e r , I n c . / C o m c a s t C o r p .7 $ 1 5 , 0 4 3 . 9 4                    A T & T C o r p .    S B C C o m m u n ic a t io n s , I n c .8 $ 1 5 , 0 0 0 . 0 0                    F o r d ( H e r t z )    T h e C a r ly le G r o u p L L C , e t . a l .9 $ 1 2 , 4 9 4 . 8 4                    G e o r g ia - P a c ifi c C o r p .   K o c h I n d u s t r ie s , I n c .

1 0 $ 1 1 , 8 0 6 . 6 6                  C i t ig r o u p , I n c .    M e t L i f e , I n c .

Top 10 Deals of 2005

Source: Mergerstat

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Despite Recovery, Volumes Below Historical LevelsDespite Recovery, Volumes Below Historical Levels

10%9%

8%

14%

11%

4%3%

5%

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Source: Thomson Financial Securities DataSource: Thomson Financial Securities Data

U.S. Merger Volume as a % of Equity Market CapU.S. Merger Volume as a % of Equity Market Cap

Source: Bank of America Capital Business Capital

MOTIVATIONS OF BUYER AND SELLER

What Causes The Urge to Merge?

TYPES OF BUYERS

• Strategic Buyer– Buyer Who Has a Strategic Reason to Purchase

the Business which will Enhance Revenue and/or Reduce Expenses

• Financial Buyer– Buyer who Purchases the Business Based

Solely upon the Value of the Business and the Financial Expectancies of the Business without any Synergies

SYNERGISTIC TRANSACTIONS

• Horizontal - Combining Similar Products or Services

• Vertical - Combining Two Firms Along Value-Chain (Such as a Supplier and Customer)

• Conglomerate - Two Companies in Completely Different Industries Combine

MOTIVATIONS OF A BUYER• Creation of Synergies -- The Value of the

Whole Exceeds the Sum of the Parts– Reduction or Elimination of Redundant

Expenses– Enhance Revenues by Access to Customers,

Technology and/or Marketing

• Gain Human Resources -- Intellectual Capital and Resources

• Utilize Buyer’s Equity as Currency

MOTIVATIONS OF A BUYER

• Diversification

• Perceived Undervalued Target (e.g., assets at below replacement cost or break-up value)

• Perceived Additional Management Value

• Managerial Ego, Ambition and Hubris

MOTIVATIONS OF A SELLER

• Privately Held Companies:– Family and Estate Planning Issues– Successorship Issues– Price Offered is Higher than Present Value of

Business – Diversify Wealth– Lifestyle Issues

MOTIVATIONS OF A SELLER

• Publicly Held Company– Value to Shareholders– Desire for an “Exit” for Large Shareholders– Management’s Desire (Possibly because of

Stock Options)– Internal Political Reasons– Financial or Liquidity Pressures

Lipton’s Article Identifies Exogenous Factors and Autogenous

Factors Affecting Mergers• Exogenous Factors: Regulatory, Political,

Markets, Taxes, Financing, Currency Fluctuations, …etc,

• Autogenous Factors: Diversification, Response to Technological Change, Vertical Integration, Horizontal Integration, Quest for Global Market, Cost Cutting, Pressure to Grow Shareholder Value, Response to Industrial Consolidation, …etc.

WASSERSTEIN’S FIVE PISTONS FOR M&A

• Regulatory and Political Change

• Technological Developments

• Fluctuations in the Financial Markets

• Leadership Style

• Drive for Scale

DO MERGERS SUCCEED?

Is The Economist right when saying (January 9, 1999 After the deal ):

"Study after study of past merger waves have shown that two of every three deals have not worked; the only winners are the shareholders of the acquired firm, who sell their company for more than it is really worth."

GRADING ACQUISITIONS

• McKinsey says that 74% of Acquisitions Fail to Create Shareholder Value

• KPMG Says that it is 83%

Returns to Investors in LBO’s Have Not Equaled the Risk of an LBO

CAUSES FOR BAD ACQUISTIONS

• Too High of a Purchase Price– Caught up in Auction Atmosphere– Overestimate Growth and Buyer’s Capabilities– Overestimate Synergies With Existing Business

• Poor Due Diligence Investigation of Target• Poor Integration of Target Into Existing

Business• Inadequate Protection From Risks

MERGER & ACQUISITION BASICS

• An Acquisition is the Purchase of a Business– Acquisition of Assets of a Corporation– Acquisition of the Stock of a Corporation

• A Merger is the Combination of Two Corporations

TYPES OF TARGETS

• Acquisition of a Privately Held Company

• Acquisition of a Publicly Held Company

THREE BASIC ACQUISITION STRUCTURES

• Stock Purchase

• Asset Purchase

• Merger

STOCK PURCHASE

• Buyer purchases all of the issued and outstanding stock of the Target’s shareholders

• As a consequence, all assets and all liabilities are acquired by virtue of Buyer owning target as wholly owned subsidiary

Think of a Corporation as a Box

In an Acquisition Structured as a Stock Purchase, the Acquirer Purchases the Entire Corporation (i.e., the entire box) including everything inside of the Box (i.e., all assets and all liabilities)

But without Investigation, the Buyer may not Know what is Inside the Box

There could be an Unpleasant Surprise Inside the Box

BUYERSHAREHOLDERS

STOCK

TARGET

PurchasePrice

Stock Purchase Transaction

BUYERSHAREHOLDERS

Cap Gains Tax

STOCK

TARGET

PurchasePrice

As a result of Stock Purchase

ASSET PURCHASE

• Buyer Purchases Selected assets of the Corporation

• Assumption of selected liabilities of the business

• The Selling Company may retain specified assets and liabilities

• Normally, the selling corporation liquidates after the transaction is completed

• Inefficient tax consequences if the corporate seller is not S Corporation or an LLC

In an Asset Purchase the Buyer can Choose what Assets and Liabilities are Acquired

TARGET BUYERAssets

AssumedLiabilities

PurchasePrice

ShareholdersAsset

Purchase

Statutory Stock Merger• A statutory merger of the Target into the

Buyer (or its subsidiary)

• The Target’s shareholders receive a Buyer’s Shares of Stock in Exchange for Target’s shares.

• The Combined Corporation Surviving the Merger Possesses All of the Assets, Liabilities and Obligations of Each of the Two Corporations.

USING THE ANLAOGY OF THE BOX

• Assume that everything in one box is poured into the other box -- Everything is Combined

• There is no opportunity to pick and choose which liabilities are going into the combined box

• The owners of both boxes end up owning the combined box, as the survivor to the Merger.

Target

TargetS-H’s

BuyerMerger

Buyer’s Stock

Buyer’sS-H’s

Statutory Merger A Reorg.

TargetS-H’s

BUYERTarget’s

Assets & Liabilities

Buyer’s S-H’s

As a result of the Merger