Ch 13 Flashcards
Defences against hostile takeover bids
directors of a company subject to a hostile bid should act in sh/h interests, in practice should also consider views of other st/h (employees, themselves)
range of pre-bid and post-bid options exist
Pre-Bid Defences against hostile takeovers
effective sh/h comms
PR officer specializing in financial matters keeping analysts informed, speaking to journalists
revalue NCAs
to current values to ensure sh/h aware of true asset value per share
poison pill
steps to make an org less attractive to potential bidder
most common = existing sh/h given rights to buy future bonds/preference shares - if a bid is made before date of exercise of rights, rights automatically converted into full ordinary shares
change Articles of Association to require “super majority” takeover approval
eg. 80% threshold in favor of vote
Post-Bid Defences against hostile takeovers
appeal to their own sh/h
e.g. by saying that value placed on shares is too low vs real value/earning power, or that market price of bidder’s shares is unjustifiably high/not sustainable
attack the bidder
concentrate on mgmt style, overall strategy, lack of capital investment, dubious A/C policies, how they grow EPS
White Knight
directors offer themselves up to more friendly outside interest - only as last resort as all independence goes
acceptable tactic provided that any information given to preferred bidden is also shared with hostile bidder
counterbid - “pacman” defence
where the target starts trying to take over the bidder
refer the bid to the Competition Authorities
to be effective, would need to prove that the takeover was against public interest
Characteristics of well-managed defence campaign against takeover
aggressive publicity - ideally before a bid received
investors made aware of strong research ideas and mgmt potential, or simply more aware of company achivements
direct comms with sh/h stressing financial and strategic reasons to remain independent
Two questions regarding form of consideration for a takeover
(1) WHAT FORM SHOULD BE OFFERED?
cash / share exchange / earn-out
(2) IF CASH, HOW IS IT RAISED?
debt finance / rights issue (if entity doesn’t already have the cash)
Advantages - Cash as consideration in a takeover
quick and low cost - provided bidder has the money
target company sh/h have certainty about bid’s value vs e.g. shares in bidding company
increased liquidity to sh/h of target company - accepting cash in a takeover = good way of realizing investment
less risk to target org sh/h => acceptable consideration likely less than with a share exch => reduced overall cost to bid for bidder
Disadvantages - Cash as consideration in a takeover
bidder must often borrow in cap mkts or issue new shares to raise cash => adverse gearing and increased COC due to increased risk
in some jurisdictions, target org sh/h are taxed if shares sold for cash; gain may not be immediately chargeable to tax under a share exchange
target sh/h perhaps unhappy to be “bought out” of participation in new group // to the bidding company’s advantage if they seek full control
Takeover Forms of Consideration - Cash vs Share Exchange
CASH
target sh/h are offered a fixed sum per share
likely only suitable for smaller acqns unless bidder has accumulation of cash
SHARE EXCHANGE
bidder issues new shares and exchanges them with target company sh/h
target sh/g thus own shares in bidder, and target shares all in bidder’s possession
large acqns almost always involve a full or partial exchange
Advantages - Share Exchange as consideration in takeover
bidder does not need to raise cash
bidder can boot strap EPS if it has higher P/E ratio than target
shareholder capital increased and gearing improved b/c target sh/g become sh/h in post-acq company
share exchange can be used to finance very large acquisitions
Disadvantages - Share Exchange as consideration in takeover
bidder’s existing sh/h need to share future gains with acquired entity, and existing sh/h will have lower proportion of control and profit share than previously
price risk - market price of bidder’s shares at risk of falling during bid process, may result in bid failure
e.g. if a 1-for-2 share exchange is offered b/c bidder’s shares worth approximately 2x target’s, fall in bidder price may result in target sh/h refusing to sell
Definition - Earn-Out Arrangement
a procedure whereby owners/mgrs selling an entity receive a portion of their consideration linked to the fin perf of the business during a specified point after the sale
the arrangement gives a measure of security to new owners who pass some fin risk associated with purchase to the sellers
possible structure = initial payment and deferred balance, some of which dependent on specified performance targets
Earn-Out Agreement in practice
often used when buyers/sellers disagree about expected growth/perf in the future
typical earn-out takes place over 3- to 5-year period after acqn and may involve 10-50% of purchase price being deferred, paid across the period
popular amont private equity investors - they don’t have expertise to run a target business, and so can keep the previous owners involved post-acq
Example - Earn-Out Agreement
entrepreneur selling a business seeking $2m based on projected earnings
buyer willing to pay $1m based on past performance
earn-out provision might be such that entrepreneur will receive more than 1m only if certain targets are met
e.g. 1m plus 10% of grosss sales over next three years
Earn-Out Targets
may include revenue, net income, EBITDA, EBIT targets
sellers prefer revenue as simplest measure, but revenue can be boosted through business activities which hurt bottom line
buyers prefer net income as best reflection of overall economic performance, but can be manipulated downward by capex and other opex frontloading
some earnouts may include non-fin targets e.g. development of product, execution of contract
Limitations of earn-outs
generally work best when the business is operated as envisioned at time of tx – rather than where business plan changes due to change in business environment
in some txs, buyer may have ability to block earn-out targets from being met
outside factors may also affect company’s ability to achieve earn-out targets
sellers need to negotiate the targets very carefully factoring in all of the above
Forms of consideration in a takeover - perspectives of different stakeholders
TARGET COMPANY SH/H
may want to retain an interest in business, in which case cash offer unwelcome
however, cash offer brings greater certainty of value (share prices fluctuate so appropriate value in a share exch is uncertain)
BIDDING COMPANY AND ITS SH/H
share exch requires new shares which may require sh/h general meeting consent
sh/h concern if their % control of bidding company will be diluted by issue and share exch
impact of takeover on bidder’s F/S - potential EPS reduction if new shares are issued, gearing impact if debt taken on to fund a cash offer
Methods of financing a cash takeover offer
INTERNAL SURPLUS
accumulated retained earnings - not the case in most takeovers
DEBT
borrowed from bank or bonds issued in the mkt
advantage = low servicing cost
disadv = increase to gearing = increase risk to existing sh/h which they may not accept
RIGHTS ISSUE
if existing sh/h don’t want + risk from debt finance, bidding org could offer rights issue to existing sh/h
funds raised would then be used to buy shares in target entity and gearing levels would be protected
however, sh/h themselves have to find the money to invest, not guaranteed
Taking over an entity with debt
the amount of finance raised will need to include this
the target entity’s lenders often stipulate in a debt covenant that the debt will be repaid in a takeover scenario by the bidder
thus the bidding company’s total cash req wil need to cover cost of purchase and value of target entity debt
Evaluating a share-for-share offer
vitally important to be able to identify likely synergy generated in an acqn in order to accurately assess attractiveness of offer
(1) Value the predator as an independent entity and hence calculate the value of one share in that company
(2) Repeat for the victim
(3) Calculate the value of the combined company post integration:
Value of standalone predator + Value of standalone victim + Value of any synergy
(4) Calculate number of shares post-integration:
shares originally in predator + # shares issued to victim
(5) Calculate value of one share in combined company, use this to assess change in sh/h wealth post takeover
Example - evaluating a share-for-share exchange
A has 200m shares @ 4/share
B has 90m @ 2/share
A offers 3 new shares for every 5 in B
present value of synergies = 40m
Expected value per share in combined company
MV(A) + MV(B) + PV synergies = 1,020m
new shares = 200m (A) + 3/5 * 90m (B) = 254m
New share price = 1,020m / 254m = 4.02
From A’s perspective:
MV = 1,020m * (200/254) = 804 [originally 800]
From B’s perspective:
MV = 1,020m * (54/254) = 216 [originally 180]
increase of 20% in wealth => they should accept the offer
Illustration - Boot strapping and post-acquisition values
Company C: post-tax profit 10m, P/E 16, pre-acq value 160m
Company D: post-tax profit 1m, P/E 8, pre-acq value 8m
if C takes over D, post-acq value of combined company can be estimated by applying C’s P/E ratio to combined post-tax profit, aka BOOTSTRAPPING
based on assumption that market will assume that mgmt of larger company will be able to apply common approach to both companies after takeover, thus improving D’s performance using methods from C
Value of C+D post-acq = 16 * (10m+1m) = 176m
thus value of synergy is 176m less individual companies pre-acq valuation =
176m - (160m + 8m) = 8m
Overview - Treatment of Target Entity’s Debt
consideration often needs to be greater to handle “material adverse change clauses” - meaning the target entity’s borrowings should be repayable if the company is sold
thus the bidder needs to have sufficient funding both to purchase shares from target’s sh/h AND repay the debt in the target entity
Illustration - Treatment of a Target’s debt during Takeover
P considering taking over H, which has 2.2m of repayable borrowings
P considering 4.9m in cash (2.7m to sh/h + financing repayment of loan) OR
exchange two P$0.50 shares for each H share held, plus 2.2m to finance repayment of loan)
CRITICAL TO ASSESS whether valuation figure of entity already includes both debt and equity, or whether solely and equity valuation
- applying an appropriate P/E ratio to earnings or discounting forecast CF to equity using COE gives VALUE OF EQUITY
- discounting forecast cash flows to all investors using WACC gives value of WHOLE ENTITY (equity plus debt)
Druker’s Five Golden Rules to apply to post-acquisition integration
(1) ensure a “common core of unity” between acquiree and acquirer - shared tech or markets
(2) acquirer shouldn’t only think “what’s in it for us”, also “what can we offer them”
(3) acquirer must treat prods, mkts, cust of acquiree with respect
(4) within 1 year, acquirer should provide appropriately skilled top mgmt for the acquiree
(5) within 1 year, acquirer should make several x-entity promotions of staff
Considerations when determining post-acquisition strategy for a combined entity
Integration strategy finalized BEFORE acquisition finalized:
Harmonization of corporate objectives
Evaluate risks of the acquisition
Review each BU for potential cost cutting, synergies, asset disposals; consider selling non-core elements
Consider likely redundancy numbers and costs
Risk diversification may lower COC and thus increase entity value => re-evaluate COC
Make positive effort communicate post-acq intentions to prevent de-motivation and avoid adverse post-acq effects on staff morale
Identify and evaluate economies of scale
Consider more aggressive mktg strategy
Impact of acquisition on acquirer’s post-acq share price
highly important - post-acq effect on acquirer’s EPS and impact on the share price and P/E ratio arising from mkt perceived views on acquisition
detailed analysis of accounts and comparisons with other companies in similar sectors required to assess whether impact of acqn will be favorable
Example - impact on EPS of an acqn
new entity has prospective EPS of 13.1c based on acquirer and acquiree combo profits of 8.3m, 64m shares in issue, if these earnings could be maintained in year 1 post-acq they would appear not to be diluted
however, if acquirer is expected from previous performances to attain 10% annual growth in money terms, then year 1 EPS should be 14.4c and anything less would suggest dilution
serious threat to acquirer’s EPS is “getting to know you” costs and “reverse synergy” effects of 2+2=3 – seems the fate of numerous acqns
major question - whether PV of combined earnings, including assumed l/t profit improvements, really factors in all downsides of putting two entities together, each with its own mgmt style
