Ch 11 Flashcards
Definition - Merger
used to describe the joining together of 2+ entities
strictly speaking, if one takes majority shareholding in another = acquisition
if two entities join their identities together into a new entity = merger
however, merger often used when acquisition has taken place, sounds more like partnership between equals
Three types of merger/acquisition
HORIZONTAL INTEGRATION
two entities from same line of business combine - e.g. bank and building society
VERTICAL INTEGRATION
acquisition of one entity by another which is at a different level in supply chain - e.g. UK brewers now heavily invested in pubs
CONGLOMERATE
combination of two unrelated businesses
Specific reasons for merger / acquisition
Increased market share / power
Economies of scale
Combining complementary needs - small org with unique product, large entity with established engineering and sales depts
Improving efficiency - e.g. if unable to exploit opportunities in existing market, maybe someone else can (easier than sacking yourself)
lack of profitable investment opportunities // surplus cash – orgs with extra cash are often acq’n targets, thus “buy or be bought”
tax relief - cannot be obtained if profits insufficient, thus buy an entity which has sufficient profits
reduced competition
asset stripping
big data opportunities – better competitive advantage
Definitiion - Big Data
large volumes of data beyond the normal processing, storage, analysis capacity of typical DB application tools
often includes more than simple fin info - e.g. operational org data along with internal/external data which is unstructured in form
key challenge = identifying repeatable patterns in the unstructured data, leading to comp adv, improved productivity, increased innovation
Benefits of managing big data successfully
driving innovation - less time to answer key business questions and make decisions
gaining competitive advantage
improving productivity
Relevance of big data in M&A
innovation / comp adv / productivity
combining complementary needs
e.g. buying an org with a large customer DB = access to their customers and also their know-how in assembling the “big data”
Questionable Reasons for merger/acquisition
DIVERSIFICATION
not relevant to sh/h, who can easily diversify their own holdings
more likely done to reduce risk to mgr/employee jobs, and thus likely to drive complacency (to detriment of sh/h returns)
SHARES OF TARGET ENTITY ARE “UNDERVALUED”
sh/h of buying entity would derive the same benefit by buying the shares themselves (at lower admin costs)
assumes that buying org has better valuation insights than other professional investors
Definition - Synergy
two or more entities coming together to produce a result not obtainable independently
e.g. merged entity will only need one marketing department - thus savings vs two separate entities
Importance of synergy in M&A
ideal situation
MV (AB) > MV (A) + MV (B)
often expressed as 2+2=5
synergy is not automatic - in an efficienc stock market, A and B are correctly valued before the combination, so important to ask HOW synergy will be achieved
Sources of Synergy
OPERATING ECONOMIES
e.g. economies of scale, elimination of inefficiency
FINANCIAL SYNERGY
e.g. reduced risk due to diversification
OTHER SYNERGISTIC EFFECTS
e.g. market power
Synergies from operating economies
ECONOMIES OF SCALE
cost red’ns thus profit increases in prod’n, marketing, finance areas (horizontal combo)
marketing and finance only (conglomerate)
diseconomies also possible
ECONOMIES OF VERTICAL INTEGRATION
increasing profits by cutting out the middle man
COMPLEMENTARY RESOURCES
synergistic result = e.g. one org strong in R&D, another strong in marketing
ELIMINATION OF INEFFICIENCY
if victim org is poorly managed - improvements particularly in prod’n, marketing, finance
FINANCIAL SYNERGY
DIVERSIFICATION
reduction of risk means increased value even if earnings of merged companies stay the same
DIVERSIFICATION AND FINANCING
variability in future operating CFs may be stabilized leading to increased attractiveness for creditors => cheaper financing
BOOT STRAP / P/E GAME
sometimes argued that high P/E ratio dirms can impose their high ratio on victim firms to increase value
Other Synergistic Effects
SURPLUS MANAGERIAL TALENT
highly skilled managers are only useful if there are problems to solve - buying inefficient companies gives them problems
SURPLUS CASH
acquisition may be seen as only possible application of funds - increased dividends may be rejected due to tax or dividend stability
MARKET POWER
horizontal combos leading to monopoly and increaswed productivity - although this would attract the competition authorities
SPEED
acquisition is faster than organic growth
Impact of Mergers and Acquisitions on Stakeholders
ACQUIRING COMPANY SH/H
all companies have primary objective of max’ing sh/h wealth - thus if synergy can be achieved, an acqn should benefit the sh/h
TARGET COMPANY SH/H
acquiring company often pays a premium to these sh/h to encourage them to sell, thus in their financial interest
LENDERS/DEBT HOLDERS
debt often repayable in event of change of control - bank borrowings almost certainly b/c risk profile of new owner may be quite different from previous – thus the acquirer will likely need new financing in advance of the takeover
STAFF
target staff worry about deduplicative redundancies, acquiring staff demand higher pay for managing a bigger org; to guarantee continuity of knowledge, the org may seek assurance/contractual guarantee that certain key staff remain for certain period of time
SOCIETY
govts can intervene if not in societal interest - competition laws to prevent monopolies taking advantage of customers
Challenges with Acquisitions
synergy will not automatically occur - mgmt teams have to work together effecftively
often, expected synergy is not attained - perhaps premium paid on acquisition was too highthus sh/h value actually reduced
cultural clashes are challenging to integration
opportunity cost of the investment - acquirer realizing that funds used to acquire could have been better used elsewhere
Why Mergers/Acquisitions Fail
Lack of fit - mgmt style, corporate culture
Lack of fit - industrial or commercial
even though buying a supplier/buyer means you know what you’re getting, there may be unexpected aspects of their operations which cause problems – careful planning required
Lack of goal congruence
not only to the target entity - also, more dangerously, to the acquirer whereby unclear how to treat the newly acquired company
“Cheap” purchases
need to consider mgmt time and resources required to “turn around” a target - often a high multiple of a “bargain” ticket price
Paying too much (too much to satisfactorily increase the l/t wealth of sh/h)
Failure to integrate effectively
Inability to manage change
effective planning req’d before and after if failure is to be avoided - this requires and ability to accept change from established routines/practices
Failures to integrate effectively - causing M&A failure
acquirer needs to have clear plan of how to integrate target company, how much autonomy to grant
plan needs to consider differences in mgmt style, incompatibilities in data systems, continued pushback from target staff
better chance of resolving issues before bidding action is taken than after
there may also be a need to adapt one’s own operations in order to ensure they will flex to the new activities - especially their own existing IT systems
Three primary tax implications of merges/acquisitions
Differences in tax rates / double tax treaties
Group loss relief
Withholding tax
Differences in tax rates / double tax treaties
if one org acquires another from another country, different tax rates likely
OECD publishes model Double Taxation Convention - primary function to avoid double taxation and decide which country shall have the right to tax income
Group Loss Relief
members of a group of companies can surrender losses to other profitable group members - the losses can be set against the claimant company’s taxable total profits of a “corresponding” accounting period (one which falls entirely or partly within that of the claimant company)
tax planning = saving the most tax = offsetting losses against highest-taxed profits first
group relief only for losses/profits generated after an entity joins a group, ceases once arrangements made to sell the shares of a company
Withholding Tax
government requirement for the payer of an item of income to withhold tax from the govt
when one company makes payments to another (dividends, interest on loans), w/holding taxes need to be considered
typically treated by govt as a payment on account of the recipient’s final tax liability
may be refunded if determined, when tax return is filed, that receipient’s tax liability to govt receiving the w/holding tax is less than amount of tax withheld OR addnl tax due if liability > amount withheld
Role of Competition Authorities
to monitor takeovers and mergers on behalf of national governments
General Principles - Competition Authorities
to strengthen competition
to prevent/reduce anti-competitive activities
to consider the public interest
- power to block or impose conditions if proposed merger/takeover found to be anti-competition
“Anti-competitive” mergers/acquisitions
one that leads to a substantial lessening of competition, one that would significantly impede effective competition
deemed in many countries as creation of new entity having 25%+ of market share
“Public Interest” in eyes of competition authorities
consideration of factors such as:
national security (security of energy, food supplies)
media quality
financial stability (e.g. protecting stability of banks, fin svcs)
Competition Authority Investigations
merger placed on hold for several months - giving target company valuable time to organize a defence
acquirer may abandon the bid not wanting to become embroiled in a time-consuming investigation
authorities may then accept, reject, or impose conditions
Definition of Divestment
Disposal of part of its activities by an entity
Reasons for Divestment
SUM OF PARTS > VALUE OF WHOLE
where business is spending a lot of money trying to integrate BUs together where no apparent benefits exist - thus divestment should be considered
DIVESTING UNWANTED / LESS PROFITABLE PARTS
high opportunity cost from holding onto underperforming BU – important to consider interrelation of BUs, as selling off one may affect another which previously sourced materials there
STRATEGIC CHANGE (shift strategic focus onto core activities)
e.g. a part of the business in a different market sector from the rest of the group
RESPONSE TO CRISIS
Most common types of divestment
Sell-off / trade sale
sale of part of an entity to a third party, usually in exchange for cash
Spin-off / demerger
creation of new entity whose shares are owned by the sh/h of the original org transfering assets into the new entity - thus two entities each owning some assets of the original single entity
Management buyout
Reasons for a sell-off / trade sale
diverst of a less profitable BU if an acceptable offer is received - incl through management buyout
protect the rest of the business from takeover - sell the part which is attractive to a purchaser, keep the rest
generate cash in time of crisis
remember - sell-offs are disruptive if key staff/products from within organization are part of the BU being sold off
Spin-off / demerger
new entity created
shares of new entity are owned by sh/h of old entity which transferred assets into new entity
two entities each with some of the assets of the original single entity
ownership has not changed, in theory the value of the two individual entities should be the same as the value of the original single entity
Reasons for spin-offs
allow investors to identify the true value of a business that was hidden within a large conglomerate
should lead to clearer mgmt structure
reduce the risk of a takeover bid for the core entity
Definition - management buyout
Purchase of a business from existing owners by members of the mgmt team, generally in association with a financing institution
Management Buyout - considerations for the divesting company
members of the buyout team will have detailed/confidential knowledge of other parts of the vendor business, vendor will thus require satisfactory warranties
key members of MBO team may have skills vital to vendor’s operation, especially in regard to information services and networking
vendor may be reluctant to allow key players to end their contracts to participate in MBO, because losing vital operational skills cannot be compensated by forms of warranty
Management Team Considerations before an MBO
DESIRE OF CURRENT OWNERS TO SELL
easier and cheaper if they do
POTENTIAL OF THE BUSINESS
mgrs flipping from safe salaried positions to risky ownership positions - need to have solid business plan to ensure victim business will be l/t profit-generator
LOSS OF HEAD OFFICE SUPPORT
many of the services taken for granted in a large firm (finance, computing, R&D) may need to be purchased externally at great expense
QUALITY OF MANAGEMENT TEAM
good representation from all fnl areas (marketing, sales, prod, fin); united approach to negotiations req’d and everyone bought into the risks
PRICE
mgrs likely have a clearer idea about future prospects of firm - including IP as well as physical assets - and also clear definition of responsibility for redundancy costs
Financing a Management Buyout
unlikely that many managers could raise the large amounts involved in some buyouts
several institutions specialize in providing funds for MBOs - venture capitalists, banks, private equity firms, other fin institutions
Definition - Leveraged Buyout
occurs when an investor, typically a private equity firm, acquires a controlling interest in a company’s equity and where a sginificant % of the purchase price is financed through leverage (borrowing)
leveraged buyouts involve institutional investor and financial sponsors (e.g. private equity firms) making large acquisitions without committing all the capital required for the acquisition
Role of venture capitalists in Management Buyout scenario
generally prepared to advance funds for 5-10 years and will expect annual returns of 25%+ (compounded and received at exit)
normally expect a seat on the BOD (but not a majority)
specific types of finance and conditions vary, but key points include the form of finance, exit strategy, and level of ongoing support
Venture Capitalists in MBO - Form of Finance
mgmt team may need venture capitalists to fund >50% but will always want to keep at least 50% controlling stake of equity
raising too much from the venture capitalist as debt capital can push up gearing (especially if debt covenants exist)
thus, venture capitalists often provide a mix of debt and equity - giving themselves security (debt) while allowing participation if things go well (equity)
convertible preference shares often used as a compromise - venture capitalist can convert to equity in case of l/t success, in s/t the control remains with mgmt teams
these conv pref shares tend to carry covenants to protect the vent capitalist position - limit the actions that can be taken without the vent cap’s approval (e.g. payment of dividends on ordinary shares, amending Articles of Association, selling assets)
Venture Capitalists in MBO - Exit Strategy
any investing institution wants to know how and when they get their money back
important part of agreement to advance money in the first place
Venture Capitalists in MBO - Ongoing Support
mgmt team should consider the venture capitalist’s willingness to provide funds for later expansion plans
some also offer mgmt consultancy of similar svcs
Role of Private Equity firms in MBOs
private equity often confused with venture cap as both refer to firms which invest in companies and exit through selling their investments (e.g. IPOs)
major differences exist between the two
PE firms mostly buy established mature companies - they may be deteriorating or underperforming and PE firms streamline ops to increase revenues
VC firms mostly invest in start ups with high growth potential
PE often buy 100% ownership whereas VC firms invest in 50% or less of equity
most VC firms prefer to spread risk and invest in multiple different companies; if one startup fails the VC fund is not substantially affected
conversely, PE firms prefer to put all eggs into one company - company is mature thus risk of total loss is minimal
Details on Financing MBOs
financiers favor estbalished businesses with reliable CF (to pay down debt) and clear exit route
they like definitive plans (but brief and to the point)
emphasis in plans should be on competences of the team, market opportunity to be exploited, how key services previously provided by group depts or other subs will be replicated – detailed CF figures as an appendix
mgrs need to invest some of their money - will take form of shares with special features, such as a high proportion of any disposal value
Multiple levels of capital structure for an MBO
SECURED BORROWINGS
obtained from a bank, with first charge on the assets taken over by the venture
SENIOR DEBT
requires first-ranking security over all assets in the venture plus the capital of the MBO as evidenced by shares in the new entity
security will also involve MBO team undertakings regarding providing fin info and setting restrictions on MBO ability to raise other debt / dispose of assets
JUNIOR DEBT (mezzanine finance)
intermediate between senior debt and equity finance in terms of risk and return
return on mezz fin can be a mix of debt interest and ability to convert part of debt into equity (e.g. conversion of warrants)
thus lender can in time have a share in premium resulting from eventual exit from venture
the debt interest will carry a risk premium as subordinate to senior debt and with less security (indeed can even be unsecured)
VENTURE CAPITAL
form of equity provided mainly by institutional investors
reward in form of dividends (prob preferntial) plus appreciation of MBO equity holding building to capital gain when investment is realized
EQUITY HOLDING GRANTED TO MBO TEAM
if activities are successful, will provide a substantial capital gain when venture is exited through flotation or other means
meanwhile, MBO mgmt draws salaries or fees for services
Key points for investors when deciding whether to support an MBO
what is actually for sale and why?
(something which doesn’t fit, separable assets?)
are activities profitable, is CF satisfactory?
promised returns must justify risks involved
is mgmt strong enough?
especially fin and mktg skills in the MBO’s sector
is price reasonable, are mgrs making sufficient contribution?
future prospects for entity should be demonstrable, especially in turnaround situation
Reasons for MBO failure
bid price offered by MBO team may be too high
lack of experience in key areas such as financial mgmt
loss of key staff who either perceive buyout as too risky, or cannot afford to invest
lack of finance
problems in convincing employees and fellow employees of need to change working practices / accept redundancy
MBO Considerations for Financiers
investors backing the MBO will initially hold a majority of equity with a small minority of shares held by the mgrs
although the backers must be prepared to hold inv for l/t, they and mgrs are looking to entity growing successful to point where IPO is possible - at this stage, MV can be obtained for equity and some portion of investment can be realized
where backers desire lower risk element in investment, they can require a portion as redeemable conv pref shares - thus priority income as preference dividend and preferential repayment rights in event of failure
in this case, also prospect of redemption if entity does not develop as hoped; or increased equity holding possible if entity does succeed
Overview - Exit Strategies
Investors/Financiers in MBO will want to realize a profit from investment in medium term
Debt finance normally has a specified repayment date - thus debt providers will have a clear exit route (assuming borrowing company can afford to repay the debt as planned)
Exit Strategies for equity holders
exit route not as easy to identify as for debt providers - the most common exit route if through sales of shares to another investor in one of the following ways:
TRADE SALE
if MBO company receives offer for all shares from another company, financiers able to realize investment
this means that all shares are acquired including those of mgmt
thus mgmt unhappy to once again reporting to sh/h rather than owning themselves
IPO
financiers get the chance to sell shares on stock market, mgrs can hold onto theirs if desired
however, joining the stock exch requires meeting stringent criteria and implies significant costs
shares more freely traded post-IPO which increase marketability and value; however - company also becomes more susceptible to takeover
INDEPENDENT SALE TO ANOTHER SH/H
mgrs may attempt to buy out the other financiers
would be expensive but would prevent external sh/h having a say in the running of the business
