Lecture 7

Question 1

What is the Herfindahl- Hirschman Index (HHI)?

Answer 1

The index replaced market share as the key measure of market power/concentration for determining potential antitrust violations

Question 2

How is it calculated?

Answer 2

As the sum of the squared market shares for all firms within an industry.

Takes into account the relative size and distribution of the firms in a market

Question 3

Does the HHI approach zero as the market consists of a large number of firms of equal size?

Answer 3

Yes

Question 4

Does the HHI increase both as the number of firms in the market decreases and as the disparity in size between those firms increases?

Answer 4

Yes

Question 5

When is the HHI considered to be moderately concentrated?

Answer 5

Between 1000-1800 points

Question 6

What are the implications if the the post-merger HHI index change is 50 points or more? In a highly concentrated industry

Answer 6

Antitrust challenge is almost certain

Question 7

What are the implications if the the post-merger HHI index change is 100 points or more in a moderately concentrated industry?

Answer 7

Antitrust is a possible challenge

Question 8

What is takeover / control premiums?

Answer 8

The difference between the value of a portfolio interest (trading value) and the value of a controlling interest (takeover value) is commonly referred to as the control premium

Question 9

Why are control premiums paid?

Answer 9

Control premiums are paid in return for achieving various benefits that flow to those who can significantly influence a business

Question 10

Name some examples of ownership benefits of controlling a firm 100%

Answer 10

• controls the composition of the board and management
• controls all decision making
• has the power to pass special resolutions
• has direct access to the cashflows of the business
• may be able realize synergistic benefits by merging the acquired business with their existing business
• may be able to utilize tax losses by ‘tax grouping’ at a consolidated level

Question 11

Which two elements influence the observed control premium?

Answer 11

1. Pure control premium (stand alone)

2. The extent of any synergies (specific to the acquirer) that are included in the purchase price

Question 12

Additional Fact (no question)

Answer 12

Generally speaking, the acquirer will be reluctant to pay over much (if any) of the value of the potential synergies to the vendor, nevertheless, it is inevitable that, in a competitive bidding environment, the price paid will include some component of expected synergies

Question 13

How large are the control premiums observed in listed transactions?

Answer 13

Generally between 20% – 50% of the portfolio (or trading) value.

Note: In a non-competitive bidding process such a premium is not guaranteed

Question 14

What is IRR?

Answer 14

IRR is the primary metric by which Sponsors gauge the attractiveness of a potential LBO as well as the performance of their existing investments (e.g. 20%+ IRR)

Question 15

How does leverage enhance IRR?

Answer 15

A combination of (1) debt repayment or deleveraging, (2) growth of EV by operational improvements such as EBITDA-margin improvements, (3) deductibility of the interest costs => increase in FCF

Question 16

What is the Cash-on-Cash multiple?

Answer 16

CoC is calculated as the final value of the equity investment at exit divided by the initial equity investment, and is expressed as a multiple. Typical LBO investments return 2.0x - 5.0x cash-on-cash

Question 17

When can integration processes fail?

Answer 17

Before and after the transaction

Question 18

Name some challenges during the transaction process

Answer 18

• Preparation of compelling marketing materials
• Identification of potential deal issues / solutions
• Coaching of management / commitment from management towards the transaction
• Significant time and attention from key members of the target’s management team
• Selection of an appropriate group of prospective buyers
• Agreement on post-merger organizational chart and reporting lines (the “little boxes problem”)
• Accuracy of information provided / Business Plan assumptions / current trading
• Manage seller’s expectations (ideally in the beginning of the transaction)

Question 19

Name some challenges after the transaction process

Answer 19

• A transaction is always disruptive in a company, and creates insecurities => several crucial issues must be addressed during the Post-Merger Integration (PMI) process:
o Investing in a good and clear communication strategy is key
o what and how to communicate with internal/external stakeholders
o Include the teams / feeling of being part of the process boosts integration
o define a clear vision and strategy
o identify synergies and how to achieve them
o put in place a strong, dedicated and solid PMI team / clear project leadership and ownership
o draw up an integration master plan and set strategic integration priorities o track progress of the integration plan and its several agreed milestones, correcting deviations
o how to keep employees focused on customers and business during the PMI process
o how to retain key talent
o assess cultural differences

Question 20

Why is it important to have a sense of urgency to immediatley capture the synergies during the first year?

Answer 20

In studies over successful integation, it was concluded 85% of the synergies was capture in the first year, and rest in second year

Synergies has a time value, and value can be destroyed after year 3

Question 21

What are top problems identified in the integration process?

Answer 21

1. Poor communication
2. Newco with many disperesd companies
3. Expected synergies are overestimated

=> Managers have a crucial role

Question 22

Name 6 best practices for successful integration processes

Answer 22

1) open, timley and frequent communication, 2) swiftly select managmenet theam and keep focus on clients 3) put in place a strong and solid integration team, 4) manage risks 5) manage cultural differences, 6) establish clear goals and manage expectations

Question 23

What are some consequences of failed integration processes?

Answer 23

1) missed targets
2) loss of key people
3) poor performance in day-to-day business

Question 24

Main reason behind failed post-merger integrations

Answer 24

1) lack of synergy management and incomplete integration
2) lack of compatibility between corporate cultures
3) price /premium too high
4) management egos & organisational deficits
5) no or wrong strategic logic