Mergers & Acquisition and Restructuring

8/8/2019 Mergers & Acquisition and Restructuring

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&ergers &ergers cquisition andcquisition andRestructuringestructuring


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OTIVES FOROTIVES FORMERGERSERGERS ACQUIRE UNDER VALUED FIRMS

DIVERSIFY TO REDUCE RISK

CREATE OPERATING OR FINANCIAL SYNERGY


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OTIVES FOROTIVES FORMERGERSERGERSACQUIRE UNDERVALUED FIRMS: Firms that

are undervalued by financial markets can betargeted for acquisition by those whorecognize this mispricing as the Acquirer cangain the difference between the value and the

purchase price.

Profit = Actual value Market Value


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OTIVES FOR MERGERSOTIVES FOR MERGERSACQUIRE UNDERVALUED FIRMS:

A capacity to find firms that trade at less than true value. It requires a lot offinancial and market analysis skills to understand and estimate the difference inmarket value and actual value and can sometimes end up as bad investment forAcquirer.

To acquire these undervalued firms the acquirer should have access to large capitalthat is required to buy these firms. Also the acquirer should have understanding of

buying and post merger integration of acquisition so as to take full benefit ofmerger.

The acquirer should have great negotiation skills so that the target company bebought below the actual value of company.

The buying of undervalued firms require a lot of intuitive appeal as it daunting taskespecially when acquiring publicly traded firms in reasonably efficient market,


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OTIVES OF MERGEROTIVES OF MERGERDIVERSIFY TO REDUCE RISK:

The companies operating with single or few stakeholderswould like to buy companies so as diversify their businessand reduce the volatility of income gains by having cash

inflows from businesses in different industries.


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OTIVES FOROTIVES FORMERGERSERGERSSYNERGY: Synergy is the additional value that isgenerated by combining two firms, creatingopportunities that would not been available tothese firms operating independently

Value of A + Value of B = Value (AB)+ Synergy


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OTIVES FOR MERGERSOTIVES FOR MERGERSTYPES OF SYNERGIES:

OPERATIONAL SYNERGIES (stock holders ofacquiring firm are really keen to know aboutOperational synergies.

FINANCIAL SYNERGIES


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OTIVES FOR MERGERSOTIVES FOR MERGERS( )ynergies)ynergiesOPERATING Synergies include: Operating synergies can

affect margins, returns and growth, and through thesethe value of the firms involved in the merger oracquisition.

Economies of scale

Greater pricing power

Combination of different functional strengths

Higher growth in new or existing markets


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OTIVES FOR MERGERSOTIVES FOR MERGERS( )ynergies)ynergiesEconomies of scale: may arise from themerger, allowing the combined firm to becomemore cost-efficient and profitable. In general,we would expect to see economies of scales in

mergers of firms in the same business(horizontal mergers) two banks comingtogether (JP Morgan & Chase) to create alarger bank or two steel companies combiningto create a bigger steel company.


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OTIVES FOR MERGERSOTIVES FOR MERGERS( )ynergies)ynergiesGreater pricing power: fromreduced

competition and higher market share, whichshould result in higher margins and operatingincome. This synergy is also more likely toshow up in mergers of firms in the samebusiness and should be more likely to yieldbenefits when there are relatively few firms inthe business to begin with. Thus, combiningtwo firms is far more likely to create anoligopoly with pricing power.


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OTIVES FOR MERGERSOTIVES FOR MERGERS( )ynergies)ynergiesCombination of different functional

strengths , as would be the case when a firm withstrong marketing skills acquires a firm with a good

product line. This can apply to wide variety of mergerssince functional strengths can be transferable across

businesses.


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OTIVES FOR MERGERSOTIVES FOR MERGERS( )ynergies)ynergiesHigher growth in new or existingmarkets: arising from the combination of thetwo firms. This would be case, for instance,when a US consumer products firm acquiresan emerging market firm, with an established

distribution network and brand namerecognition, and uses these strengths toincrease sales of its products.


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OTIVES FOR MERGERSOTIVES FOR MERGERS( )ynergies)ynergiesFinancial Synergies: With financial synergies, thepayoff can take the form of either higher cash

flowsor a lower cost of capital (discount rate) or both.

A combination of a firm with excess cash, or

cash slack

Debt capacity

Tax benefits


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OTIVES FOR MERGERSOTIVES FOR MERGERS( )ynergies)ynergiesA combination of a firm with excess cash, orcash slack, (and limited projectopportunities): afirm with high-return projects (and limited cash)can yield a payoff in terms of higher value for thecombined firm. The increase in value comes fromthe projects that can be taken with the excess

cash that otherwise would not have been taken.This synergy is likely to show up most often whenlarge firms

acquire smaller firms, or when publicly traded

firms acquire private businesses.


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OTIVES FOR MERGERSOTIVES FOR MERGERS( )ynergies)ynergiesDebt capacity: can increase, because when

two firms combine, their earnings and cashflows may become more stable andpredictable. This, in turn, allows them toborrow more than they could have as

individual entities, which creates a tax benefitfor the combined firm. This tax benefit usuallymanifests itself as a lower cost of capital forthe combined firm.


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OTIVES FOR MERGERSOTIVES FOR MERGERS( )ynergies)ynergiesTax benefits: can arise either from theacquisition taking advantage of tax laws towrite up the target companys assets or fromthe use of net operating losses to shelterincome. Thus, a profitable firm that acquires amoney-losing firm may be able to use the net

operating losses of the latter to reduce its taxburden. Alternatively, a firm that is able toincrease its depreciation charges after anacquisition will save in taxes and increase itsvalue.


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YPES OF MERGERYPES OF MERGER Horizontal Mergers

Vertical Mergers

Conglomerate Mergers


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YPES OF MERGERSYPES OF MERGERSHorizontal Mergers:

A horizontal merger involves two firms operating and competing in the same kind of business. Themerger of JP Morgan and Chase Manhattan is a horizontal merger.

A horizontal mergers generally create synergy through economies of scale. The horizontalmergers create economies of scale mainly for those companies carrying large scale operations.

Horizontal mergers are regulated by the government for their potential negative effect oncompetition in an given industry as the horizontal mergers reduce the number of companiesoperating in given industry.

Also horizontal mergers can create profit through monopoly. Horizontal mergers are also believedby many as potential creating monopoly power on the part of the combined firm enabling it toengage in anticompetitive practices.

A horizontal merger is when two companies competing in the same market merge or join together'


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ypes of Mergersypes of MergersVertical Mergers:

vertical mergers occur between firms in different stages of production operation forexample By directly merging with suppliers, a company can decrease reliance andincrease profitability. An example of a vertical merger is a car manufacturerpurchasing a tire company.

A vertical merger is one in which a firm or company combines with a supplier ordistributor. This type of merger can be viewed as anticompetitive because it canoften rob supply business from its competition.

If a contractor has been receiving a material from two separate firms, and thendecides to acquire the two supplying firms, the vertical merger could cause thecontractors competitors to go out of business (say, if General Motors were to buyup Bridgestone Tyres and Michelin Tyres).


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YPES OF MERGERSYPES OF MERGERSExamples of Vertical Mergers: Vertical mergers can best beunderstood from examining real world deals.

One such merger occurred between Time Warner Incorporated, amajor cable operation, and the Turner Corporation, whichproduces CNN, TBS, and other programming. In this merger, the

Federal Trade Commission (FTC) was alarmed by the fact thatsuch a merger would allow Time Warner to monopolize much ofthe programming on television. Ultimately, the FTC voted to allowthe merger but stipulated that the merger could not act in theinterests of anti-competitiveness to the point at which the publicgood was harmed.


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YPES OF MERGERSYPES OF MERGERSConglomerate Mergers:

Conglomerate mergers involve firms engaged inunrelated types of business activity. There arethree types of mergers.

Product Extension mergers

Geographic (Market) Extension mergers

Pure conglomerate mergers


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YPES OF MERGERSYPES OF MERGERSConglomerate Mergers: Production extension mergers

Product extension merger: takes place between twobusiness organizations that deal in products thatare related to each other and operate in the samemarket.

The product extension merger allows the mergingcompanies to group together their products and getaccess to a bigger set of consumers. This ensuresthat they earn higher profits.

Product extension merger is meant to add to theexisting variety of products and services offered by


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YPE OF MERGERSYPE OF MERGERSConglomerate Mergers: Market extension mergers

market extension merger takes place betweentwo companies that deal in the same productsbut in separate markets. The main purpose ofthe market extension merger is to make surethat the merging companies can get access toa bigger market and that ensures a biggerclient base.

Market-Extension Merger occurs between twocompanies that sell identical products in

different markets. It basically expands themarket base of the roduct.


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YPES OF MERGERSYPES OF MERGERSConglomerate mergers: Pure Conglomerate

Pure conglomerate merges often referred to as mergers involvingunrelated business activities.

Pure conglomerate mergers do not qualify as Product extension

or market extension mergers.

Conglomerate companies unlike Private equity funds control thecompanies to whey they make major investments. Theconglomerates control all the investments, operations, strategyand board of respective companies under the big umbrella ofconglomerate. Also the diversification is achieved mainly byacquisitions and not by internal development.


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONApproval of Board of Directors for thescheme :

Board of Directors for transferor and

transferee companies are required to approvethe scheme of amalgamation.


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONApproval of the scheme by specializedfinancial institutions/ banks/trustees :

for debenture holders The Board of Directorsshould in fact approve the scheme only after ithas been cleared by the financial

institutions/banks, which have granted loansto these companies or the debenture trusteesto avoid any major change in the meeting ofcreditors to be convened at the instance of theCompany Courts under section 391 of the

Companies Act, 1956.


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONApproval of Reserve Bank of India:

is also needed where the scheme of amalgamationcontemplates issue of share/payment of cash to non-resident Indians or foreign national under theprovisions of Foreign Exchange Management

(Transfer or Issue of Security by a Person ResidentOutside India) Regulations, 2000.

In particular, regulation 7 of the above regulationsprovide for compliance of certain conditions in thecase of scheme of merger or amalgamation asapproved by the court.


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONIntimation to Stock Exchange about

proposed amalgamation:

Listing agreements entered into betweencompany and stock exchange require the

company to communicate price-sensitiveinformation to the stock exchangeimmediately and simultaneously whenreleased to press and other electronic media

on conclusion of Board meeting accordinga roval to the scheme.


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONApplication to Court for directions:

The next step is to make an application under section 39(1) to theHigh Court having jurisdiction over the Registered Office of thecompany, and the transferee company should make separateapplications to the High Court. The application shall be made by aJudges summons in Form No. 33 supported by an affidavit in FormNo. 34 (see rule 82 of the Companies (Court) rules, 1959). Thefollowing documents should be submitted with the Judgessummons:

(a)A true copy of the Companys Memorandum and Articles

(b) A true copy of the Companys latest audited balance sheet

(c) A copy of the Board resolution, which authorizes the Director to


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONHigh Court directions for membersmeeting :

Upon the hearing of the summons, the HighCourt shall give directions fixing the date, timeand venue and quorum for the membersmeeting and appoint an Advocate Chairman topreside over the meeting and submit a report tothe Court.

Similar directions are issued by the court forcalling the meeting of creditors in case such arequest has been made in the application.


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONApproval of Registrar of High Court to notice forcalling the meeting of members/creditors:

Pursuant to the directions of the Court, the transferor aswell as the transferee companies shall submit for approvalto the Registrar of the respective High Courts the draftnotices calling the meetings of the members in Form No.36 together with a scheme of arrangements andexplanations, statement under section 393 of theCompanies Act and

form of proxy in Form No. 37 of the Companies (Court) Rulesto be sent members along with the said notice.

Once Registrar has accorded approval to the notice, it

should be got signed by the Chairman appointed formeeting by the High Court who shall preside over the


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONDispatch of notices tomembers/shareholders

Once the notice has been signed by thechairman of the forthcoming meeting asaforesaid it could be dispatched to themembers under certificate of posting at least21 days before the date of meeting (Rule 73 ofCompanies (Court) Rules, 1959).


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONAdvertisement of the notice of members meetings:

The Court may direct the issuance of notice of the meeting ofthese shareholders by advertisement. In such case rule 74 of theCompanies (Court) Rules provides that the notice of the meetingshould be advertised in; such newspaper and in such manner asthe Court might direct not less than 21 clear days before the datefixed for the meeting. The advertisement shall be in Form No. 38appended to the Companies (Court)Rules.

The companies should submit the draft for the notice to bepublished in Form No. 38 in an English daily together with atranslation thereof in the regional language to the Registrar ofHigh Court for his approval. The advertisement should bereleased in the newspapers after the Registrar approves the

draft.


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONConfirmation about service of the notice:

Ensure that at least one week before the dateof the meeting, the Chairman appointed forthe meeting files an Affidavit to the Courtabout the service of notices to theshareholders that the directions regarding theissue of notices and advertisement have beenduly complied with.


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONHolding the shareholders general meeting andpassing the resolutions:

The general meeting should be held on the appointeddate. Rule 77 of the Companies (Court) Rulesprescribes that the decisions of the meeting heldpursuant to the court order should be ascertained onlyby taking a poll. The amalgamation scheme should beapproved by the members, by a majority in number ofmembers present in person or on proxy and voting onthe resolution and this majority must represent at least this in value of the shares held by the members who

vote in the poll.


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONFiling of resolutions of general meeting with Registrarof Companies:

Once the shareholders general meeting approves theamalgamation scheme by a majority in number ofmembers holding not less than 3/4 in value of the equityshares, the scheme is binding on all the members of thecompany.

A copy of the resolution passed by the shareholdersapproving the scheme of amalgamation should be filedwith the Registrar of Companies in Form No. 23 appendedto the Companies (Central Governments) General Rulesand Forms, 1956 within 30 days from the date of passingthe resolution.


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONSubmission of report of the chairman of thegeneral meeting to Court:

The chairman of the general meeting of theshareholders is required to submit to the Courtwithin seven days from the date of the meeting areport in Form No. 39, Companies (Court) Rules,

1959 setting out therein the number of personswho attend either personally or by proxy, and thepercentage of shareholders who voted in favor ofthe scheme as well as the resolution passed by themeeting.


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONSubmission of Joint petition to court for

sanctioning the scheme:

Within seven days from the date on which theChairman has submitted his report about the result ofthe meeting to the Court, both the companies shouldmake a joint petition to the High Court for approvingthe scheme of amalgamation.

This petition is to be made in Form No. 40 ofCompanies (Court) Rules. The Court will fix a date ofhearing of the petition. The notice of the hearingshould be advertised in the same papers in which thenotice of the meeting was advertised or in such othernewspapers as the Court may direct, not less than 10


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONIssue of notice to Regional Director,Company Law Board under section 394

A

On receipt of the petition for amalgamationunder section 391 of Companies Act, 1956 the

Court will give notice of the petition to theRegional Director, Company Law Board andwill take into consideration

the representations, if any, made by him.


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONHearing of petition and confirmation of scheme

Having taken up the petition by the Court for hearingit will hear the objections first and if there is no

objection to the amalgamation scheme from RegionalDirector or from any other person who is entitled tooppose the scheme, the Court may pass an orderapproving the scheme of amalgamation in; Form No.41 or Form No. 42 of Companies (Court) Rules.

The court may also pass order directing that all theproperty, rights and powers of the transferorcompany specified in the schedules annexed to theorder be transferred without further act or deed to

the transferee company and that all the liabilities andduties of the transferor company be transferred


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONFiling of Court order with ROC by both the

companies

Both the transferor and transferee companiesshould obtain the Courts order sanctioning thescheme of amalgamation and file the same withROC with their respective jurisdiction as required

vide section 394(3) of the Companies Act, 1956within 30 days after the date of the Courts orderin Form No. 21 prescribed under the (CentralGovernments) General Rules and Forms, 1956.


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATION

Court order to be annexed to memorandumof transferee company

It is the mandatory requirement vide section391(4) of the Companies Act, 1956 that after thecertified copy of the Courts order sanctioningthe scheme of amalgamation is filed withRegistrar, it should be annexed to every copy ofthe Memorandum issued by the transfereecompany.

Failure to comply with requirement renders the


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Transfer of the assets and liabilities

Section 394(2) vests power in the High Courtto order for the transfer of any property orliabilities from transferor company totransferee company.

In pursuance of and by virtue of such ordersuch properties and liabilities of thetransferor shall automatically standtransferred to transferee company without

any further act or deed from the date the


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Preservation of books and papers ofamalgamated Co.

Section 396A of the Act requires that thebooks and papers of the amalgamatedcompany should be preserved and not be

disposed of without prior permission of theCentral Government.


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EGAL ASPECTS OFEGAL ASPECTS OF/ERGER AMALGAMATIONERGER AMALGAMATIONThe Post merger secretarial obligations:

These formalities include filing of returns with Registrar

of Companies, transfer of investments of transferorcompany in; the name of the transferee.

intimating banks and financial institutions, creditorsand debtors about the transfer of the transferorcompanys assets and liabilities in the name of thetransferee company, etc.

All these aspects along with restructuring of

organization and management and capital arediscussed in chapter relating to post-merger


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Withdrawal of the Scheme notpermissible

Once the scheme for merger has beenapproved by requisite majority of shareholdersand creditors, the scheme cannot be

withdrawn by subsequent meeting ofshareholders by passing Resolution forwithdrawal of the petition submitted to thecourt under section 391 for sanctioning the

scheme.


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Cancellation of the scheme and order ofwinding-up:

If scheme is cancelled under section 392(2) onthe ground that it cannot be satisfactorilyworked and a winding-up order is passed

under section 433.


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cheme ofcheme ofAmalgamationmalgamationScheme of amalgamation: The scheme ofamalgamation should be prepared by the

companies, which have arrived at a consensusto merge. There is no specific form prescribedfor scheme of amalgamation but schemeshould generally contain the following

information:


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cheme ofcheme ofAmalgamationmalgamationScheme of Amalgamation:

Particulars about transferee and transferorcompanies

Appointed date

Main terms of transfer of assets from transferorto transferee with power to execute on behalf or

for transferee the deed or documents beinggiven to transferee.

Main terms of transfer liabilities from transferorto transferee covering any conditions attached

to loans/debentures/bonds/other liabilities from


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cheme ofcheme ofAmalgamationmalgamation Effective date when the scheme will come into

effect

Conditions as to carrying on the businessactivities by transferor between appointed ate

and effective date.

Description of happenings and consequences ofthe scheme coming into effect on effective date.

Share capital of transferor company specifying

authorized capital, issued capital and subscribedand aid u ca ital


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cheme ofcheme ofAmalgamationmalgamation Share capital of transferee company covering above

heads. Description of proposed share exchange ratio, any

conditions attached thereto, any fractional sharecertificates to be issued, transferee companysresponsibility to obtain consent of concernedauthorities for issue and allotment of shares andlisting.

Surrender of shares by shareholder of transferor

company for exchange into new sharecertificates.

Conditions about payment of dividend, ranking of

equity shares, pro rata dividend declaration and


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cheme ofcheme ofAmalgamationmalgamation Status of employees of the transferor companies from

effective date and the status of the provident fund,gratuity fund, super annuity fund or any special scheme or

funds created or existing for the benefit of the employees.

Treatment on effective date of any debit balance oftransferor company balance.

Miscellaneous provisions covering income-tax dues,contingencies and other accounting entries deservingattention or treatment.

Commitment of transferor and transferee companies

towards making applications/petitions under section 391and 394 and other applicable provisions of the con


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cheme ofcheme ofAmalgamationmalgamation

Enhancement of borrowing limits of thetransferee company upon the scheme coming

into effect.

Transferor and transferee companies give assentto change in the scheme by the court or otherauthorities under the law and exercising thepowers on behalf of the companies by theirrespective Boards.

Description of powers of delegate of transferee

to give effect to the scheme.


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cheme ofcheme ofAmalgamationmalgamation

Qualification attached to the scheme, whichrequires approval of different agencies, etc.

Description of revocation/cancellation of thescheme in the absence of approvals qualifiedin clause 20 above not granted by concernedauthorities.

Statement to bear costs etc. in connectionwith the scheme by the transferee company


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aluation ofaluation of&usiness for M A&usiness for M A Status Quo Valuation of Company

Valuation of Optimal Operation

Valuation of Synergy


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tatus Quotatus QuoValuationaluation Cash flow Basis

Dividends discount model (Earnings basis)

Relative valuation


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ash Flowash FlowValuationaluationCash flow valuation requires:

Calculation of Wt. average Cost of Capital

Growth rate analysis of Cash flows.


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ash flow Valuationash flow ValuationWACC: Wt. average cost of capital requires:

Beta that defines equity risk which in turn is used tocalculate Cost of Equity.

Interest coverage ratio analysis for synthetic debt ratingwhich derives the cost of debt based on debt ratings.

Interest expense as percentage of long term debt analysisto find cost of debt.

Book value of equity and book value of debt of most

recent year filing.


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WACCACCBeta Bottoms Up Approach:

Breaking down betas into their business,operating leverage and financial leveragecomponents provides us with an alternativeway of estimating betas.


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WACCACCProcess of finding bottoms up Beta:

Identify the business or businesses thatmake up the firm, whose beta we are tryingto estimate. Most firms provide a breakdown

of their revenues and operating income bybusiness in their annual reports and financialfilings.


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WACCACCEstimate the average unlevered betas of otherpublicly traded firms that are primarily or only ineach of these businesses. Following are consideredwhile making the estimate:

Comparable firms: In most businesses, there are

at least a few comparable firms and in somebusinesses, there can be hundreds. Begin with anarrow definition of comparable firms, and widenit if the number of comparable firms is too small.


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WACCACCBeta Estimation: Once a list of comparablefirms has been put together, we need to

estimate the betas of each of these firms.

Unlever first or last: We can compute anunlevered beta for each firm in thecomparable firm list, using the debt to equityratio and tax rate for that firm, or we cancompute the average beta, debt to equity ratioand tax rate for the sector and unlever using

the averages.


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WACCACCUnlevered beta for respective comparables iscalculate by using:

Unlevered beta = levered beta/ (1+ D/E *(1-taxes))


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WACCACCTo the cost of equity we need levered beta, risk free rate andrisk premium:

Cost of equity = risk free rate + Beta * (Market rate riskfree rate)

The risk free rate is like investing government securitiesand should be taken for high growth rate period only (fore.g.. If you are valuing a company with high growth periodof 5 years then take the government bond risk free rate for5 years)

Take market risk premium as the expectancy of market to

perform in relative to risk free market (for example if riskfree rate for 5 year government bond is 5% then take risk


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WACCACCCost of Debt: We determine cost of debt in three steps:

1. First, take historical interest expense for at least 3 years and

divide these by respective years Total long term debt. Thentake average of all these years ratios (interestexpense/total long term debt) and you will get cost of debtas expressed by interest expense.

2.3. Second, calculate historical interest coverage ratio (EBIT/Interest

expense) for at least 3 historical years and then comparethem with industry debt ratings and default spread toanalyze the respective ratings for every years. After this youcan take weighted average of default rates for thesehistorical years.

4.

5. Last, we take the average of cost of debt from interest expenseand cost of debt from synthetic ratings to determine Cost of


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WACCACCCost of preferred shares

Cost of preferred equity = preferreddividends/ preferred shares.

generally preferred shares have fixed

dividends which they get before commonshare holders (for simplicity of model youcan take total dividends for calculating costof preferred shares).


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WACCACCWACC = Cost of equity * wt. of equity + cost of debt *(1-taxes) * wt. of debt + cost of preferred equity * wt.of preferred equity.

Wt. of equity = total common equity/ (preferred sharesvalue + long term debt + total common equity)

Wt. of debt = total long term debt/ (total long termdebt + total common shares + total preferred sharesvalue)

Wt. of preferred shares = total preferred share value /

(total preferred shares + total common equity + total


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuationThe elements of Growth rate in Cash flows are :

Re-Investment rate

Return on Capital


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuationRe-Investment rate:

is the proportion of after-tax operating incomethat goes into net new investments.

is the rate which is invested by the company aspercentage of EBIT*(1- taxes) to run thecompany so as to see growth in cash flows.


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuation

Re-Investment rate:

The cash flow to the firm is computed afterreinvestments. Two components go intoestimating reinvestment.

The first is net capital expenditures, which is thedifference between capital expenditures anddepreciation.

The other is investment in non-cash workin


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Net Capital Expenditures

In estimating net capital expenditures, wegenerally deduct depreciation from capitalexpenditures. The rationale is that the positivecash flows from depreciation pay for atleast aportion of capital expenditures and it is only theexcess that represents a drain on the firms cash

flows.

While information on capital spending anddepreciation are usually easily accessible in mostfinancial statements, forecasting these

expenditures can be difficult for three reasons.


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuationNet Capital Expenditure: Problems in calculation

The first is that firms often incur capital spending

in chunks a large investment in one year canbe followed by small investments in subsequentyears.

The second is that the accounting definition of

capital spending does not incorporate thosecapital expenses that are treated as operatingexpenses such as R&D expenses.

The third is that acquisitions are not classified by

accountants as capital expenditures. For firms


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Net Capital Expenditure: Two ways to normalize CapitalExpenditure

The simplest normalization technique is to average capitalexpenditures over a number of years.

For instance, we could estimate the average capitalexpenditures over the last three years for a manufacturingfirm and use that number rather the capital expendituresfrom the most recent year. By doing so, we could capturethe fact that the firm may invest in a new plant everythree years.

In regard to number of historical years used to calculate

Net Cap expenditure The answer will vary across firms andwill depend upon how infrequently the firm makes large


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Net Capital Expenditure: Two ways to normalize CapitalExpenditure

If instead, we had used the capital expenditures fromthe most recent year, we would either have overestimated capital expenditures (if the firm built a newplant that year) or under estimated it (if the plant

had been built in an earlier year).

For firms with a limited history or firms that havechanged their business mix over time, averagingover time is either not an option or will yield numbersthat are not indicative of its true capital expenditureneeds. For these firms, industry averages for capital


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuationNet Capital Expenditure: Two ways to normalize

Capital Expenditure: why industry average forcompanies with limited history

Since the sizes of firms can vary across anindustry, the averages are usually computed withcapital expenditures as a percent of a base input revenues and total assets are common choices.We prefer to look at capital expenditures as apercent of depreciation and average this statisticfor the industry.

In fact, if there are enough firms in the sample, wecould look at the average for a subset of firms thatare at the same stage of the life cycle as the firm


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuationWorking capital is usually defined to be the differencebetween current assets and current liabilities. However,we will modify that definition when we measure

working capital for valuation purposes:

Current assets:

We will back out cash and investments in marketable

securities from current assets. This is because cash isusually invested by firms in treasury bills, short termgovernment securities or commercial paper. Whilethe return on these investments may be lower thanwhat the firm may make on its real investments, theyrepresent a fair return for riskless investments.


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuationWorking capital: Current assets

Unlike inventory, accounts receivable andother current assets, cash then earns a fairreturn and should not be included inmeasures of working capital.


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuationWorking capital: Current Liabilities

We will also back out all interest bearing debt short-term debt and the portion of long termdebt that is due in the current period fromthe current liabilities. This debt will be

considered when computing cost of capitaland it would be inappropriate to count it twice.


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuationEstimating Expected Changes in non-cash

Working Capital

While we can estimate the non-cash workingcapital change fairly simply for any yearusing financial statements, this estimate hasto be used with caution.

Changes in non-cash working capital areunstable, with big increases in some years

followed by big decreases in the following


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuation To ensure that the projections are not the result of anunusual base year, we should tie the changes inworking capital to expected changes in revenues orcosts of goods sold at the firm over time.

The non-cash working capital as a percent ofrevenues/operating margin can be used, inconjunction with expected revenue/operating marginchanges each period, to estimate projected changesin non-cash working capital over time.

We can obtain the non-cash working capital as apercent of revenues/operating margin by looking atthe firms history or at industry standards.


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuation The best way is to base our changes on thenon-cash working capital as a percent of

revenues/operating margin over a historicalperiod. For instance, non-cash working capitalas a percent of revenues between 2000 and2004 averaged out to 8% of revenues.

The advantage of this approach is that itsmoothes out year-to-year shifts, but it maynot be appropriate if there is a trend (upwards

or downwards) in working capital.


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuationRe-Investment:

Once the historical average Net Capitalexpenditure and historical average Change inNon Cash working capital are determined wework on determining the average historical re-investment rate:

Re-investment rate = (Net Cap exp + changein non cash W.C. )/ EBIT*(1-Taxes)


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Future Re-Investment rate: you need to brain storm byreading MD&A (Management discussion and analysis) ofrespective companies 10-k report to determine the futuregrowth. By this we mean the following:

Is the company going to invest more in Capitalexpenditure (property plant and equipment, R&D ).

Is it going to increase working capital in the future

Or the Re-Investment rate will remain the same.

A subjective analysis will make us understand and determine

the amount by which the change will in Re-investment ratewill ha en if an .


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuationRETURN ON CAPITAL: EBIT*(1-Taxes)/(debt +

equity)

The return on capital is often based upon thefirm's return on existing investments, where thebook value of capital is assumed to measure thecapital invested in these investments.

Implicitly, you assume that the currentaccounting return on capital is a good measureof the true returns earned on existinginvestments and that this return is a good proxy

for returns that will be made on future


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuationRETURN ON CAPITAL: the assumption ofcurrent accounting return on capital willremain the same is open to questions for the

following questions:

The book value of capital might not be a goodmeasure of the capital invested in existinginvestments, since it reflects the historical cost of

these assets and accounting decisions ondepreciation. When the book value understatesthe capital invested, the return on capital will beoverstated; when book value overstates thecapital invested, the return on capital will beunderstated. This problem is exacerbated if the

book value of capital is not adjusted to reflect the


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Assumptions issues continued:

The operating income, like the book value ofcapital, is an accounting measure of the earningsmade by a firm during a period. All the problemsin using unadjusted operating income describedin Chapter 4 continue to apply.

Even if the operating income and book value ofcapital are measured correctly, the return oncapital on existing investments may not be equalto the marginal return on capital that the firm

expects to make on new investments, especially


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuationAssumptions about Return on capital:

Given the concerns mentioned in previous slides,you should consider not only a firms currentreturn on capital, but any trends in this return aswell as the industry average return on capital. If

the current return on capital for a firm issignificantly higher than the industry average, theforecasted return on capital should be set lowerthan the current return to reflect the erosion thatis likely to occur as competition responds.


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuationAssumptions about Return on capital:

Finally, any firm that earns a return on capitalgreater than its cost of capital is earning anexcess return. The excess returns are theresult of a firms competitive advantages orbarriers to entry into the industry. High excessreturns locked in for very long periods implythat this firm has a permanent competitiveadvantage


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuationCandidates for Changing Average Return on

Capital

What types of firms are likely to see their return on capital change overtime?

One category would include firms with poor returns on capitalthat improve their operating efficiency and margins, and

consequently their return on capital. In these firms, the expectedgrowth rate will be much higher than the product of thereinvestment rate and the return on capital. In fact, since thereturn on capital on these firms is usually low before the turn-around, small changes in the return on capital translate into bigchanges in the growth rate. Thus, an increase in the return oncapital on existing assets of 1% to 2% doubles the earnings(resulting in a growth rate of 100%).


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ASH FLOW ANALYSISASH FLOW ANALYSIS( )usiness valuation)usiness valuationGrowth Rate in EBIT = Re-investment rate *ROC

ROC = return on capital


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ength of High Growthength of High GrowthPeriodPeriod The question of how long a firm will be able to

sustain high growth is perhaps one of the mostdifficult questions to answer in a valuation, but

two points are worth making.

First One is that it is not a question of whetherbut when firms hit the stable growth wall. All

firms ultimately become stable growth firms, inthe best case, because high growth makes a firmlarger and the firms size will eventually becomea barrier to further high growth. In the worst-case scenario, firms may not survive and will be


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ength of High Growthength of High GrowthPerioderiod

Second Point:

The second is that high growth in valuation, or at least

high growth that creates value, comes from firmsearning excess returns on their marginal investments.In other words, increased value comes from firmshaving a return on capital that is well in excess of thecost of capital (or a return on equity that exceeds the

cost of equity). Thus, when you assume that a firm willexperience high growth for the next 5 or 10 years, youare also implicitly assuming that it will earn excessreturns (over and above the required return) duringthat period. In a competitive market, these excessreturns will eventually draw in new competitors and the

excess returns will disappear. ow ong can a rmw ong can a rm


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aintain high growthaintain high growthPerioderiodWe should look at three factors when considering how

long a firm will be able to maintain high growth

1. Size of the firm: Smaller firms are much more likely

to earn excess returns and maintain these excessreturns than otherwise similar larger firms. This isbecause they have more room to grow and a largerpotential market. Small firms in large markets shouldhave the potential for high growth (at least in

revenues) over long periods. When looking at the sizeof the firm, you should look not only at its currentmarket share, but also at the potential growth in thetotal market for its products or services. A firm mayhave a large market share of its current market, but itmay be able to grow in spite of this because the entire

market is growing rapidly. ow long can a firmow long can a firm


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aintain high growthaintain high growthPerioderiod

2. Existing growth rate and excess returns:Momentum does matter, when it comes to

projecting growth. Firms that have beenreporting rapidly growing revenues are

more likely to see revenues grow rapidly atleast in the near future. Firms that are

earnings high returns on capital and highexcess returns in the current period are likelyto sustain these excess returns for the nextfew years.


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ow long can a firmow long can a firmaintain high growthaintain high growthPerioderiod

3. Magnitude and Sustainability of CompetitiveAdvantages:

This is perhaps the most critical determinant ofthe length of the high growth period. If there aresignificant barriers to entry and sustainablecompetitive advantages, firms can maintain highgrowth for longer periods. If, on the other hand,

there are no or minor barriers to entry or if thefirms existing competitive advantages are fading,you should be far more conservative aboutallowing for long growth periods. The quality ofexisting management also influences growth.Some top managers have the capacity to makethe strategic choices that increase competitive


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erminal Valueerminal ValueSince you cannot estimate cash flows forever,you generally impose closure in discounted

cash flow valuation by stopping yourestimation of cash flows sometime in thefuture and then computing a terminal valuethat reflects the value of the firm at that point.


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erminal Valueerminal Value the growth rate in cash flow is actually the

economic growth rate of economy.

the Return on capital in terminal growth rateis Industry average growth rate.

the Re-investment rate in terminal period =economic growth rate/ ROC (Industryaverage)


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erminal Valueerminal ValueCost of capital in terminal period:

Cost of equity: take beta as industry averageBeta (or market beta).

Weighted average Cost of debt remains the

same.

Debt to equity ratio can be taken as industryaverage debt to equity ratio (or can be taken as

average of last five years).


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erminal Valueerminal ValueTerminal value = Cash flow in last year of high

growth period * (1+ g)/(cost of capital in highgrowth period- growth rate in economic growthrate)

Then find the present value of Terminal value= Terminal value/(1+cost of capital)^n

n is the length of high growth period.


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ash flow analysisash flow analysis.igh growth period.igh growth period2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0

E B I T * ( 1 - T a x e s )7 9 9 7 1 1 8 1 4 4 1 7R e - I n v e s t m e n t R a t e6 9 8 4 1 0 2 1 2 5 1 5

C a s h F l o w s t o F i r m1 1 1 3 1 6 1 9 2

P r e s e n t v a l u e o f C F$ 5 5


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erminal Valueerminal ValueGrowth Rate 5.00% Termianal Value 947

ROC 10.00% WACC 7.63

Re-Investment rate 50.00% P.V. Terminal Value 65

Beta 1

Cost of Equity 11.00%

Cost of debt 10.20%

Terminal Value (Value of cash flows after high growt


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alue of Businessalue of Business Value of business = present value of cash

flows in high growth period + present value

of terminal value.

Value of equity = value of business longterm debt + total cash (cash + short term

investment + marketable securities)


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arnings Basedarnings BasedModelodel

First Determine Cost of equity ( it isdetermined the same way it is determined in

Cash flow basis model)

Second determine Cash flows


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arnings Basedarnings BasedModelodel To Determine cash flows we need the

following:

Re-Investment rate

Return on Equity


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arnings basedarnings basedmodelodelRe-Investment rate:

In recent years companies around the globe have

increasingly turned to stock buybacks as a way ofreturning cash to stockholders.

Focusing strictly on dividends paid as the only cashreturned to stockholders exposes us to the risk thatwe might be missing significant cash returned tostockholders in the form of stock buybacks.

In addition, firms may sometimes buyback stock asway of increasing financial leverage.


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arnings Basedarnings BasedModelodelRe-Investment rate:

Modified dividend payout ratio = (dividends+ stock buybacks long term debt issues)/Net Income

Consequently, a much better estimate of themodified payout ratio can be obtained bylooking at the average value over a four orfive year period.


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arnings Basedarnings BasedModelodelRe-Investment rate:

Re-Investment rate = 1- average modifiedpayout ratio


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arnings Based Modelarnings Based ModelReturn on Equity:

ROE = ROC + D/E (ROC Net cost of debt)

ROC = Return on Capital

D/E = Debt to equity ratio

Net cost of debt = Cost of debt* (1- tax rate)


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Why ROE = ROC + D/E (ROC Net cost of debt)

Return on equity affected by the leverage of thefirm

The advantage of this formulation is that itallows the analyst valuing the firm to bring in theeffect of the investment, financing and dividenddecisions of the firm, not only in current periods

but also in the future periods.


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arnings Basedarnings BasedModelodelGrowth in Net Income in high growth period =Re-Investment rate * Return on equity


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arnings Based Modelarnings Based ModelHigh Growth Period:

2010 2011 2 012 201 3 201

N I 98 .33 113 .75131 .58152.21176.

D i v i d e d p ay o u t R at io28 .8 4%28. 84%28 .8 4%28. 84 %28. 8

Ex p e cte d D iv id e n d s28.35 32.8 0 37.9 4 43.8 9 50.

P r e se n t v a l u e o f D i v i d e n d s24 .87 25 .24 25 .62 26 .00 26 .


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arnings Basedarnings BasedModelodelTerm inal V a

M o d i f ie d D i vi d e n d P ay o u50.0

F u tu re N o m al ize d R O E10.0

B ETA 1.0

R e - In ve stm e n t 50.0

C o st o f e q u i ty 11.0

E xp e ct e d G r o w t h i n E ar n i n5.00

T e r m i n a l V a l u e8 4 6 . 2 7

1 8 4 . 8 9t e r m i n a l c a s h5 0 . 0 0 %d i v i d e n d p a y o

9 2 . 4 4e x p e c t e d d i v i d

4 3 9 . 6 9( P . V . o f T e r m i


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arnings Basedarnings BasedModelodelTerminal Value:

Cost of equity : take Beta as industry average or marketbeta depending upon industry judgment and determine

cost of equity.

Return on equity should be taken as Industry averagereturn on equity.

Growth in Net Income should be taken as EconomicGrowth rate.

Re-Investment rate = growth in net income / return onequity


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Terminal Value:

Terminal value = Net income last year ofhigh growth * (1 + economic growth rate)/(cost of equity economic growth rate)

Present value of Terminal Value = Terminalvalue / (1+ terminal cost of equity)^n

n is length of high growth period.


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Value of equity = Present value of cash flowsin high growth period + Present value of

Terminal value.

alue of Businessalue of Business


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nder Optimalnder OptimalConditionsonditionsValue of optimal conditions is actually value of control. The

value of controlling a firm derives from the fact that youbelieve that you or someone else would operate the firmdifferently from the way it is operated currently.

Value of the company as if optimally managed. This willusually mean that investment, financing and dividendpolicy will be altered:

Investment policy: high returns on projects and divestingunproductive projects.

Financing policy: move to a better financing structure e.g.optimal capital structure.

alue of Businessalue of Business


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nder Optimalnder OptimalConditionsonditions

For value under Optimal conditions we will focuson reducing the Cost of Financing.

The cost of capital for a firm was defined earlierto be a composite cost of debt and equityfinancing. The cash flows generated over timeare discounted back at the cost of capital.

Holding the cash flows constant, reducing thecost of capital will increase the value of the firm

ue o us nessue o us nessnder Optimal


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nder OptimalConditionsonditionsSteps in finding Optimal debt ratio:

first take different debt ratios like 0%, 10%, 20% etc.and the calculate debt to equity ratio at different

debt levels.

Then take Unlevered beta of the company and applydebt to equity ratio to find Levered beta for everydebt ratio. Based on this beta calculate cost of equityfor respective betas.

Take Debt ratio data for Respective Industries fromS&P 500 including cost of debt at different debtratios.


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alue of Synergyalue of SynergyValue of combined firm with synergy built in. Thismay include:

higher growth rate in cash flows from increase inre-investment rate and/or return oncapital/return on equity.

Higher margins because of economies of scale

Lower cost of debt because of financing synergy.

Higher debt ratio because of lower risk: debtcapacity.


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alue of Equityalue of EquityMaximum Value of equity for M&A = StatusQuo Valuation + Optimal value + SynergyValue.

Maximum value of business = value of equity

+ long term debt - cash


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inancing Mergersinancing Mergers There are many ways to finance a mergers andthese are:

merger can be financed by taking debt on assetsof acquirer or the target.

Also the acquirer can issue new equity to raisecash to pay to the target company (dont

confuse this with exchange ratio).

Also if the acquirer is cash rich then it can usecash to buy the target.


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inancing Mergersinancing MergersDebt and equity instruments to raise cash:

Senior secured debt can be raised by using

assets of target or acquirer to raise cash formerger. These debt holders are first ones to getpaid if bankruptcy happens.

Unsecured debt can be raised based on

credibility of acquire and/or target to raise cash.

Mezzanine debt can raised by acquirer to getcash. The mezzanine debt as debt life of 3 to 5years and after that has a option to be converted

to equity shares. omputation of Impactomputation of Impact


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(n EPS Earnings(n EPS Earnings)odel)odelSteps in computation of impact on EPS for Earnings based

model;

Add up the Net Income of both target and acquirer to

come up with combined Net Income for the most recentyear filing.

based on dividend pay ratio for respective years followingmerger calculate dividend paid year on year basis.

Next to check impact on EPS share = (Net Income Dividends)/ Total shares outstanding for ever year.

Then check growth in EPS on year on year basis by =

omputation of Impactomputation of Impact


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(n EPS Cash flow(n EPS Cash flow)odel)odelSteps in computation of impact on EPS for cash flow based model:

Add up the EBIT of both target and acquirer to come up withcombined EBIT for the most recent year filing.

Then after determining synergy growth rate of cash flows forcombined growth , calculate EBIT for respective future years.

After that, take weighted average cost of debt and calculate

interest expense by multiplying cost of debt with long term debt. Then take taxes out based on tax rate and subtract interestexpense and tax rate from EBIT to Net Income.

EPS = Net Income/ Total shares

= etermining Exchangeetermining Exchange


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Ratioatio first perform status quo valuation, optimal valuation

and synergy valuation for target companys equity.

Maximum value of target equity = Status quovaluation + optimal valuation + synergy valuation.

Second negotiate the premium to be paid foracquisition.

Third value of equity for M&A = status quo valuation+ premium

Exchange ratio = Value of target equity (negotiated

equity)/ value of acquirer.


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/BO LBOBO LBOINTRODUCTION:

A leveraged buyout (Bootstrap" transaction) occurs when aninvestor, typically financial sponsor, acquires a controllinginterest in a company's equity and where a significant

percentage of the purchase price is financed throughleverage (debt).

The assets of the acquired company are used as collateralfor the borrowed capital, sometimes with assets of theacquiring company.

Typically, leveraged buyout uses a combination of variousdebt instruments from bank and debt capital markets. Thebonds or other paper issued for leveraged buyouts arecommonly considered not to be investment grade becauseof the significant risks involved.

o u r c e s a n d U s e so u r c e s a n d U s e s


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f F u n d sf F u n d sIn reality, a large leveraged buyout will likely befinanced with multiple tranches of debt that couldinclude (in decreasing order of seniority) some orall of the following:

A revolving credit facility (bank revolver)is a source of funds that the bought-out firmcan draw upon as its working capital needsdictate.

Term debt, which is often secured by theassets of the bought-out firm, is also provided


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o u r c e s a n d U s e so u r c e s a n d U s e sf F u n d sf F u n d s Mezzanine Financing is so named

because it exists in the middle of thecapital structure and generally fills the gapbetween bank debt and the equity in atransaction. Mezzanine financing is junior tothe bank debt incurred in financing theleveraged buyout and can take the form of

subordinated notes from the privateplacement market or high-yield bonds fromthe public markets, depending on the sizeand attractiveness of the deal.

ources and Usesources and Uses


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f Fundsf FundsIn addition to the debt component of an LBO, there isalso an equity component in financing the transaction:

Private equity firms typically invest alongside

management to ensure the alignment ofmanagement and shareholder interests. In largeLBOs, private equity firms will sometimes team up tocreate a consortium of buyers, thereby reducing theamount of capital exposed to any one investment.

Another potential source of financing for leveragedbuyouts is preferred equity. Preferred equity is oftenattractive because its dividend interest paymentsrepresent a minimum return on investment while its

equity ownership component allows holders to BO CandidateBO Candidate


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CriteriariteriaGiven the proportion of debt used in financing a transaction, afinancial buyers interest in an LBO candidate depends on theexistence of, or the opportunity to improve upon, a number offactors. Specific criteria for a good LBO candidate include:

Steady and predictable cash flow

Divestible assets

Clean balance sheet with little debt

Strong management team

Strong, defensible market position

Viable exit strategy


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/BO MBOBO MBO Limited working capital requirements

Synergy opportunities

Minimal future capital requirements

Potential for expense reduction

Heavy asset base for loan collateral


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efense Againstefense Againstostile Take Overostile Take OverPoison Pill

An antitakeover tactic in which warrants areissued to a firm's stockholders, giving themthe right to purchase shares of the firm's stockat a bargain price in the event that a suitor

hostile to management acquires a stipulatedpercentage of the firm's stock. The poison pillis intended to make the takeover so expensivethat any attempt to take control will be

abandoned


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oison Pilloison PillFlip-over: If a hostile takeover occurs, investorshave the option to purchase the bidders shares ata discount, thereby devaluing the acquirers stockand diluting its stake in the company.

Flip-in: Management offers shares to investors at adiscount if an acquirer merely purchases a certainpercentage of the company. The discount is notavailable to the acquirer, and so it becomes

extremely expensive for that acquirer to completethe takeover. Experts estimate that it would costan unwanted bidder, on average, four to five timesmore to swallow a poison pill in order to acquirea target.


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ear Hugear HugBear Hug:

The name "bear hug" reflects the persuasivenessof the offering company's overly generous offer tothe target company. By offering a price far inexcess of the target company's current value, theoffering party can usually obtain an agreement.

The target company's management is essentiallyforced to accept such a generous offer because itis legally obligated to look out for the bestinterests of its shareholders.


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GreenmailreenmailA situation in which a large block of stock isheld by an unfriendly company. This forces the

target company to repurchase the stock at asubstantial premium to prevent a takeover.

It is also known as a "bon voyage bonus" or a

"goodbye kiss".


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PACMANACMAN To employ the Pac-Man defense, a company willscare off another company that had tried toacquire it by purchasing large amounts of the

acquiring company's stock. By doing so, thedefending company signals to the acquiringcompany that it is resistant to a takeover and willuse the majority, if not all, of its assets to preventthe acquisition.

The resisting company may even sell off non-vital

Documents

Mergers & Acquisition and Restructuring