Lecture 3

Question 1

Two forms of acquisitions

Answer 1

1. Stock purchase - when the acquirer pays the shareholders for acquiring the stock of the target company
2. Asset Purchase - when the acquirer purchases the target assets from a company and pays directly to the company

Question 2

Major Differences between stock purchase and asset purchase

Answer 2

SP - payment made to target shareholders in exchange for their shares, shareholder approval required, corporate taxes n.a., shareholder capital gains taxes, acquirer assumes target’s liabilities

AP - payment made to the selling company rather than directly to the shareholders, shareholders approval might not be required, corporate capital gains tax, no shareholder taxes, liabilities depends

Question 3

What are the advantages of purchasing the assets directly?

Answer 3

• Faster transaction because
in most cases it doesn’t need shareholders approval
Shorter DD
The acquirer can cherry pick the asset/ business
Liabilities might not be assumed by the acquirer

Question 4

Name three different methods of payment

Answer 4

• Cash offering - method of payment in cash
• Securities offering - method of payment in securities
• Mixed offering - a combination of cash and securities

Question 5

What is securities offering?

Answer 5

• Each shareholder of the target company receives new shares based on the number of target shares he/she owns multiplied by the exchange ratio
• The exchange ratio determines the number of new shares that stockholders in the target company receive in exchange for each of their shares in the target company
• Because the value of listed companies fluctuates frequently, the exchange ratio is typically negotiated in advance for a range of stock prices
• The acquirer’s cost is the product of the exchange ratio, the number of outstanding shares of the target company, and the value of the stock given to target shareholders

Question 6

Name different types of deal structuring

Answer 6

• Stock Vs. Cash
• Contingent payments
• Sequential engagement

Question 7

Stock deal structuring: advantages and disadvantages for acquired shareholders

Answer 7

+ shared risk with target
+ Cheap currency if acquirer stock is overvalued
- Dilution of control of existing shareholders

Question 8

Stock deal structuring: advantages and disadvantages for target shareholders

Answer 8

Tax advantage vs. delayed realized gains

Question 9

How are stock deals financed?

Answer 9

The issue of new stock or use shares in treasury

Question 10

Cash deal: advantages and disadvantages for acquired shareholders

Answer 10

+ No dilution of control
+ Signal acquirer’s confidence in achieving expected shareholders
+ Tax efficiencies (debt tax shield) for cash deal financed by debt
- Full risk with acquirer
- Necessary for the acquirer if the stock is undervalued or if not so attractive

Question 11

Cash deal: advantages and disadvantages for target shareholders

Answer 11

Upfront realized gains vs tax disadvantage

Question 12

How are cash deals financed?

Answer 12

Cash in balance, issue of debt, sale of new shares to other investors

Question 13

What contingent payments?

Answer 13

Payments that are not due when deal is closed, but when certain aspects of the deal is met

Question 14

What are elements that need to be structured for contingent payments? (6)

Answer 14

• Earnout plans
• Clawback provision
• Escrow funds
• Holdback allowances
• Stock options
• Bonus payment to management

Question 15

Sequential engagement

Answer 15

Buying a little first before taking over
• Prior alliances with target increase likelihood of acquisition and performance
• Learn from venture capital investment model: staged investment to address high level of uncertainty
• Minority investments provide opportunity to reduce uncertainty about target, synergies and fit and build trust
• Initial block holding also makes subsequent investments easier

Question 16

Name some pre-offer takeover defense mechanism (7)

Answer 16

• Poison pills
• Poison puts
• Staggered board of directors
• Restricted voting rights
• Supermajority voting provisions
• Fair price amendments
• Golden parachutes

Question 17

What is a poison pill?

Answer 17

Legal device that makes it prohibitively costly for an acquirer to take control of a target without the prior approval of the target’s board of directors

Question 18

Name different types of poison pills? (4)

Answer 18

1. Flip-in-pill
2. Flip-over-pill
3. Dead hand provision
4. Poison puts

Question 19

What is a flip-in-pill?

Answer 19

common shareholder of the target company has the right to buy its shares at a discount. The pill is triggered when a specific level of ownership is exceeded. Because the acquiring company is generally prohibited from participating in the purchase through the pill, the acquirer is subject to a significant level of dilution. Most plans give the target’s board of directors the right to redeem the pill prior to any triggering event

Question 20

What is a flip-over-pill?

Answer 20

the target company’s common shareholders receive the right to purchase shares of the acquiring company at a significant discount from the market price, which has the effect of causing dilution to all existing acquiring company shareholders. Again, the board of the target generally retains the right to redeem the pill should the transaction become friendly

Question 21

What is a dead-hand provision?

Answer 21

This provision allows the board of the target to redeem or cancel the poison pill only by a vote of the continuing directors. Because continuing directors are generally defined as directors who were on the target company’s board prior to the takeover attempt, this provision has the effect of making it much more difficult to takeover a target without prior board approval

Question 22

What is a staggered board of directors?

Answer 22

A company may arrange to stagger the terms for board members so that only a portion of the board seats are due for election each year. For example, if the company has a board consisting of 9 directors, members could be elected for 3 year terms with only 3 directors coming up for election each year. The effect of this staggered board is that it would take at least 2 years to elect enough directors to take control of the board

Question 23

What is restricted voting rights?

Answer 23

• some target companies adopt a mechanism that restricts stockholders who have recently acquired large blocks of stock from voting their shares. Usually, there is a trigger stockholding level, such as 15 or 20 percent. Shareholders who meet or exceed this trigger point are no longer able to exercise their voting rights without the target company’s board releasing the shareholder from the constraint. The possibility of owning a controlling position in the target without being able to vote the shares serves as a deterrent

Question 24

What is super majority voting provisions?

Answer 24

Many target companies change their charter and bylaws to provide for a higher percentage approval by shareholders for mergers than normally is required. A typical provision might require a vote of 80 percent of the outstanding shares of the target company (as opposed to a simple 51 percent majority). This supermajority requirement is triggered by a hostile takeover attempt and is frequently accompanied by a provision that prevents the hostile acquirer from voting its shares. Thus, even if an acquirer is able to accumulate a substantial portion of the target’s shares, it may have great difficulty accumulating enough votes to approve a merger

Question 25

What is fair price amendments?

Answer 25

Fair price amendments are changes to the corporate charter and bylaws that disallow mergers for which the offer is below some threshold.

For example, a fair price amendment might require an acquirer to pay at least as much as the highest stock price at which the target has traded in the public market over a specified period. Fair price amendments protect targets against temporary declines in their share prices by setting a floor value bid. Additionally, fair price amendments protect against two-tiered tender offers where the acquirer offers a higher bid in a first step tender offer with the threat of a lower bid in a second step tender offer for those who do not tender right away

Question 26

What is golden parachutes?

Answer 26

Golden parachutes are compensation agreements between the target company and its senior managers. These employment contracts allow the executives to receive lucrative payouts, usually several years’ worth of salary, if they leave the target company following a change in corporate control. In practice, golden parachutes do not offer much deterrent, especially for large deals where the managers’ compensation is small relative to the overall takeover price.

One reason they persist is that they help alleviate target management’s concerns about job loss. Golden parachutes may encourage key executives to stay with the target as the takeover progresses and the target explores all options to generate shareholder value. Without a golden parachute, some contend that target company executives might be quicker to seek employment offers from other companies to secure their financial future. Whether this is actually the case and whether golden parachutes are fair and in the best interest of shareholders is the subject of considerable debate among shareholder rights activists and senior managers

Question 27

Name nine post-offer takeover defense mechanisms

Answer 27

• “Just Say No” Defense
• Litigation
• Greenmail
• Share repurchase (including LBO)
• Leveraged Recapitalization
• “Crown Jewel” Defense
• Pac-Man Defense
• White Knight Defense
• White Squire Defense

Question 28

What is a just say no defense

Answer 28

• probably the simplest place for a target company to start when confronted with a hostile takeover bid is to rely on pre-takeover defenses and to decline the offer. If the acquirer attempts a bear hug or tender offer, then target management typically lobbies the board of directors and shareholders to decline and build a case for why the offering price is inadequate or why the offer is otherwise not in the shareholders’ best interests. This strategy forces the hopeful acquirer to adjust its bid or further reveal its own strategy in order to advance the takeover attempt

Question 29

What is litigation (take over defense)?

Answer 29

A popular technique used by many target companies is to file a lawsuit against the acquiring company based on alleged violations of securities or antitrust laws. In the United States, these suits may be filed in either state or federal courts. Unless there is a serious antitrust violation, these suits rarely stop a takeover bid. Instead, lawsuits often serve as a delaying tactic to create additional time for target management to develop other responses to the unwanted offer

Question 30

What is greenmail?

Answer 30

This technique involves an agreement allowing the target to repurchase its own shares back from the acquiring company, usually at a premium to the market price. Greenmail is usually accompanied by an agreement that the acquirer will not pursue another hostile takeover attempt of the target for a set period. In effect, greenmail is the termination of a hostile takeover through a payoff to the acquirer. The shareholders of the target company do not receive any compensation for their shares. Greenmail was popular in the United States during the 1980s, but its use has been extremely restricted since 1986 when the US Internal Revenue Code was amended to add a 50 percent tax on profits realized by acquirers through greenmail

Question 31

What is the share repurchase (including LBO)?

Answer 31

Rather than repurchasing only the shares held by the acquiring company, as in greenmail, a target might use a share repurchase to acquire shares from any shareholder. For example, a target may initiate a cash tender offer for its own outstanding shares.

An effective repurchase can increase the potential cost for an acquirer by either increasing the stock’s price outright or by causing the acquirer to increase its bid to remain competitive with the target company’s tender offer for its own shares. Additionally, a share repurchase often has the effect of increasing the target company’s use of leverage because borrowing is typically required to purchase the shares. This additional debt makes the target less attractive as a takeover candidate

Question 32

What is levered recapitalisation?

Answer 32

A technique somewhat related to the leveraged buyout is the leveraged recapitalization. A leveraged recapitalization involves the assumption of a large amount of debt that is then used to finance share repurchases (but in contrast to a leveraged buyout, in a recapitalization, some shares remain in public hands). The effect is to dramatically change the company’s capital structure while attempting to deliver a value to target shareholders in excess of the hostile bid

Question 33

What is a Crown Jewel defense?

Answer 33

A target may decide to sell off a subsidiary or asset to a third party. If the acquisition of this subsidiary or asset was one of the acquirer’s major motivations for the proposed merger, then this strategy could cause the acquirer to abandon its takeover effort. When a target initiates such a sale after a hostile takeover bid is announced, there is a good chance that the courts will declare this strategy illegal

Question 34

What is Pac Man defense?

Answer 34

The target can defend itself by making a counteroffer to acquire the hostile bidder. This technique is rarely used because, in most cases, it means that a smaller company (the target) is making a bid for a larger entity

Question 35

What is a White Knight Defense?

Answer 35

Often the best outcome for target shareholders is for the target company’s board to seek a third party to purchase the company in lieu of the hostile bidder. This third party is called a white knight because it is coming to the aid of the target. A target usually initiates this technique by seeking out another company that has a strategic fit with the target. Based on a good strategic fit, the third party can often justify a higher price for the target than what the hostile bidder is offering. In some cases, because of the competitive nature of the bidders, the winner’s curse can prevail and the target company shareholders may receive a very good deal. Winner’s curse is the tendency for the winner in certain competitive bidding situations to overpay, whether because of overestimation of intrinsic value, emotion, or information asymmetries

Question 36

What is a white squire defense?

Answer 36

In the white squire defense, the target seeks a friendly party to buy a substantial minority stake in the target—enough to block the hostile takeover without selling the entire company.

Although the white squire may pay a significant premium for a substantial number of the target’s shares, these shares may be purchased directly from the target company and the target shareholders may not receive any of the proceeds. The use of the white squire defense may carry a high litigation risk depending on the details of the transaction and local regulations. Additionally, stock exchange listing requirements sometimes require that target shareholders vote to approve these types of transactions, and shareholders may not endorse any transaction that does not provide an adequate premium to them directly

Question 37

Name four reasons for corporate restructuring

Answer 37

• Change in strategic focus
• Poor fit
• Reverse synergy
• Financial or cash flow needs

Question 38

Name 6 forms of divesture

Answer 38

• Sale
• Equity carve out
• Spin-off
• Split-off
• Split-up
• Liquidation

Question 39

What is an equity carve out?

Answer 39

Creation of a new legal entity and sales of equity in it to outsiders

Question 40

What is a spin-off?

Answer 40

Shareholders of the parent company receive a proportional (pro-rata) number of shares in a new, separate entity. Whereas the sale of a division results in an inflow of cash to the parent company, a spin-off does not. A spin-off simply results in shareholders owning stock in two different companies where there used to be one. When the parent company retains a minority interest in the newly created entity it will be a partial spin-off

Question 41

What is a split-off?

Answer 41

Where some of the parent company’s shareholders are given shares in a newly created entity in exchange for their shares of the parent company

Question 42

What is a split-up?

Answer 42

Where the parent company distributes the shares of its subsidiaries to its shareholders and then the parent company dissolves. Following the split-up the

Question 43

What is liquidation as a form of divesture?

Answer 43

involves breaking up a company, division, or subsidiary and selling off its assets piecemeal. For a company, liquidation is typically associated with bankruptcy