M&A Process OverviewBy Thomas McKeown

Introduction

•Definition and description of overall process

•The M&A market (The Acquisition Market) (P4)

•Financial /Strategic objectives in a M&A deal

•The benefits and risks of M&A

Summary• Sales side

▫ Eight steps to closing a sale▫ Seeking a financial advisor- areas and FA should have experience▫ Assembling the deal team

Legal counsel, accounting and actuaries▫ Types of sales process

Control led auction Target auction negotiated process

▫ Deal structuring Asset versus entity sale Taxes

▫ Premarketing Preparing the buyer list Preparing marketing materials- CA,CIM, Teaser, Bid process letter Actuarial appraisal and reserve review Comparing data room

▫ Marketing Initial contact with prospective buyer and follow up

▫ Preliminary bids and review▫ Preliminary due diligence and strategy▫ Data room strategy and management presentation▫ Break out session strategy

Summary• Buy side

▫ Evaluating the opportunity Pre screening the opportunity Retaining a buying side FA Review of opportunity Market analysis Preliminary valuation of target Financial modeling

▫ Preliminary due diligence▫ Final bids▫ Negotiation LOI▫ Due diligence, deal financing, rating agencies▫ Negotiation

Analysis Management updates Purchase agreement Key conveyance Deal protection Employment agreements

▫ The path to closing Presentation to board of directors Regulatory issues, antitrust issues, SEC review

▫ Public announcement ▫ Shareholder approval and closing

Concepts and Purpose

• Merger- A combination of two or more companies in which the assets and liabilities and liabilities of the selling firm are absorbed by the buying firm.

• Acquisition- The purchase of an asset (I.E- plant, division, entire company).

• The M&A market- based on:▫ Availability of financing-loan and debt & equity markets.▫ Rising Stock Prices and rising P/E multiples- lead to higher

cash flow.▫ Ongoing restructuring▫ Tax Implications▫ Wealth transfer b/w generations▫ Market Psychology▫ Financial objectives in a M&A deal ▫ Strategic objectives▫ The benefits and risks of M&A

Financial/Strategic ObjectivesFinancial Objectives Strategic objectives

• Primary Objective- Promote Corporate Growth.

• Increase perceived future earnings.

• Expense Reduction Strategy- acquiring “orphan blocks” of life insurance.

• Revenue Synergies- Increased sales of different product lines.

• Improving the buyer’s long term competitive position by:▫ Elimination of

competition▫ Gain access to more

markets▫ Creating economies of

scale▫ Leveraging Tech▫ Gain share/pricing

power▫ Improving Distribution.

Financial/Strategic Objectives (continued) Horizontal vs. Vertical Integration

Other Potential Objectives

• Horizontal Integration- acquisition of market share in a company’s existing competency (typically at the expense of rivals).

• Geographic Integration is part of Horizontal Integration.

• Vertical Integration- Gaining control over additional “links” in the value chain.

• Diversification- could lead to less volatile earnings. I.E) Variable annuities and fixed annuities are inversely correlated.

• Regulation• Accounting and Tax• Research & Development

Benefits and Risks of M&ABenefits Risks

• Can provide short/long term benefits to acquirer’s shareholders. This increased cash flow and drives up value of share holder equity.

• Can provide immediate strategic benefits- impractical to generate organically.

• Financial Risks- possibility of overpaying due to overly optimistic revenue synergies or cost savings.

• Strategic Risks- “channel conflict.”

• Execution Risk- everything goes right except integration.

The Sell Side

Eight Steps to Closing a Sale

1) Preparing to Sell2) Pre-Marketing3) Marketing4) Review Preliminary Bids5) Due Diligence of Seller6) Final Bids & Negotiations7) Executive Definitive & Regulatory

Filings8) Closing

Seeking and Acquiring a FA• Strategic Alternatives- A financial Advisor (FA) is typically

retained to formally review the seller’s options. • The advantages to hiring an FA:

▫ An Investment Bank is impartial.▫ Investment banks may present options management has not

considered.▫ They have insight into the most feasible as opposed to most

desirable alternative. • A FA should have experience in:

▫ the relevant industry or sector▫ Valuation expertise▫ Relevant M&A experience▫ Financial structuring experience▫ Strategic vision▫ Process Prowess▫ Negotiating skills

Assembling a Deal Team

•Senior Management time is scarce and valuable, efficiency is important.

•Coordination of efforts- Effective communication, generally done by FA

•Need to seek a Financial Advisor•Legal Council- bids, contracts, agreements•Accountants- “Quality of Earnings” report,

taxes, employee benefits, risk management, IT. (Play a larger role on the buy side).

•Actuaries- Character of seller’s liabilities.

Controlled Auction

Advantages Disadvantages

• Broad number of strategic and financial buyers.

• Maximizes likelihood all possible buyers will be contacted.

• Breadth of process maximizes risks of leaks

• Creates maximum competition.

Target AuctionAdvantages Disadvantages

Flexibility in timing and buyer selection

Maintenance of confidentiality

Limited approach to strategic buyers and broad approach to financial buyers

May omit certain potential buyers

Negotiated Process

Advantages Disadvantages

Opportunity to accelerate closing

Highest degree of confidentiality

Limited number of strategic and financial buyers

Difficult to create Competitive pressure.

Deal Structuring

•Will seller’s shareholders accept cash, stock, or combination?

•Asset Vs. Entity- Operations and liabilities or a book of business.

•Insurance Industry- An Asset Acquisition is typically a block of policies or line of business.

Tax Issues

•How are gains calculated?

•Are there tax efficient ways to sell the business?

•Can buyer increase tax basis to reflect seller’s purchase price.

Pre- Marketing• Preparing the Buyer List- FA provides list of qualified buyers.

Issues to Consider

Affordability of financing

Proper move strategically

Anti-trust issues.

With insurance companies, one should consider impact on liquidity, operating leverage, financial leverage, etc.

The buyer’s capability to complete the transaction

Should “out of market” companies be considered?

Due Diligence of Advisors- 2 Purposes

To ensure the seller shares and understands any and all issues that may arise during the process.

To ensure that any statements made on offering documents are accurate.

Key Marketing Documents The Teaser- brief 1-3 page document that is prepared and distributed

by FA to attract potential investors. The document highlights attractive attributes of company, provides financial summary, and may contain financial projections. If the potential buyer remains interested, the bankers send out the: Confidentiality Agreement (CA)

Confidentiality Agreement(CA)- Between Seller and Potential buyer. The CA is intended to protect the seller from unauthorized sharing of information by the buyer. Upon agreement of the CA by the buyer, the seller sends the Confidential Information Memorandum (CIM).

Confidential Information Memorandum (CIM)- Primary document used to market to the seller. Describes seller’s industry, contains: Executive summary Key investment characteristics Overview of Organization Detailed historical and financial operating performance Financial projections.

Bid Process Letter- accompanies CIM when sent to prospective bidder. Includes description of general process and establish deadlines. It may also contain the identity of acquiring entity, source of financing and other detailed information.

Actuarial Appraisal

• It is a wise idea to hire an outside firm for valuation due to impartiality. • Ideally, this is completed before the

formal marketing begins. • Compiling the Data Room• FA leads charge to build a “Data Room.”

Consists of detailed, highly sensitive information to seller. This generally supports the actuarial appraisal.

Marketing Initial contact with Prospective Buyers- teaser Follow-up with interested parties- issuance of CA, CIM, and bid

process letter. Reviewing Preliminary Bids- A FA must manage a seller’s

expectations. FA and seller determines which bids go to a second round and which are excluded.

Preliminary Due-Diligence- Seller may invite one or more potential buyers to further negotiate based on strategy.

Due-Diligence- Must form proper strategy as acquirer’s spend significant amount of time analyzing seller’s business. Data Room Strategy- FA of the seller must ensure information

and technology is prepared for a smooth process. Management Presentation- The seller’s opportunity to “tell the

story.” Should provide key investment considerations and an overview of the operating and management history.

Break-Out Session Strategy- Various disciplines go one on one.

The Buy Side

Evaluating the Opportunity

• Pre-Screening the Opportunity • Retaining a buy-side FA- use of financial models to value past

and future, value private companies, prepare LOI, negotiate terms of agreement and financing, and to close transactions.

• Market Analysis- evaluate short and long term potential for combined company.

• Preliminary Valuation of Target- Determines price of target.a) Public Company Comparable Valuationb) Comparable transaction Valuationc) Discounted Cash Flow (DCF) or Dividend Discount Valuation.d) Financial buyer valuatione) Actuarial Appraisal

• Financial Modeling- This shows if acquisition makes sense within a range of potential offer prices given the buyer’s financial objectives.

EXAMPLE FROM ACRETION DELUTION

MULTIPLE ANALYSIS

ACQUIRER CIRCUIT CITY Proforma

BEST BUY Current Offer Combined Companies

FD Shares Outstanding 498.4 178.0 178.0 589.0

Share Price $51.08 $23.49 $26.00 $51.08

Equity Value $25,457.4 $4,180.8 $4,627.5 $30,084.9

Plus: Debt (less converted) $278.0 $87.0 $87.0 $365.0

Plus: Preferred Equity $0.0 $0.0 $0.0 $0.0

Plus: Minority Interest $31.0 $0.0 $0.0 $31.0

Less: Cash $2,668.0 $599.6 $599.6 $3,267.6

Total Enterprise Value $23,098.4 $3,668.2 $4,115.0 $27,213.3

TEV / Revenue

2006/LTM 0.71x 0.30x 0.34x 0.61x

2007E 0.65x 0.28x 0.32x 0.56x

2008E 0.54x 0.26x 0.29x 0.48x

TEV / EBITDA

2006/LTM 10.0x 7.7x 8.7x 9.8x

Preliminary Due Diligence

• Opportunity for Buyer to: Decide whether to submit a bid Ascertain information needed to form

meaningful bid Protect itself from downside risks

• Final Bids- As a result of Due-Diligence, Management decides whether to continue or not.

• Negotiation of the Letter of Intent, LOI- Describes the ground rules for buyer and seller. Typically deal with management and policies of a transaction.

Due Diligence- buy side

•A potential investor may dispatch a team of 50 or more individuals.

•All issues are addressed as: 1) adjusting the bid price or by 2) adding protection mechanisms.

•Deal Financing- FA assists management in raising financing.

•Rating Agencies

Negotiation

Analysis of negotiated terms. Management updates Purchase agreement- terms of LOI plus

numerous legal, financial, and operational contingencies.

Key covenants- pertains to matters over time Deal protection- “no shop clause,” liability

issues, intellectual property protection. Employment agreements- deals with

incentivizing employees in integration processes and may prevent an exodus of talent.

Path to Closing

•Presentation to the Board of Directors- once deal is arranged, buyer and seller both present to the boards of their respected companies. The seller’s board of directors will ask for a “fairness opinion.”

•Regulatory Issues- State, Anti-trust, SEC Review

•Presentation of deal to the Public: Announcement

•Shareholder Approval•Closing