279

Mergers and acquisitions Basics - doaei.comdoaei.com/Books/22-Mergers-Acquisitions-2011.pdf · Mergers, acquisitions, business alliances, and corporate restructuring activi- ties

  • Upload
    lydang

  • View
    225

  • Download
    0

Embed Size (px)

Citation preview

Mergers and acquisitions Basics

Mergers and acquisitions BasicsAll You Need To Know

donald dePamphilis

Amsterdam • Boston • Heidelberg • LondonNew York • Oxford • Paris • San Diego

San Francisco • Singapore • Sydney • Tokyo

Academic Press is an imprint of Elsevier

 Academic Press is an imprint of Elsevier30 Corporate Drive, Suite 400, Burlington, MA 01803, USAElsevier, The Boulevard, Langford Lane, Kidlington, Oxford, OX5 1GB, UK

Copyright © 2011 Elsevier Inc. All rights reserved

No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any information storage and retrieval system, without permission in writing from the publisher. Details on how to seek permission, further information about the Publisher’s permissions policies and our arrangements with organizations such as the Copyright Clearance Center and the Copyright Licensing Agency, can be found at our website: www.elsevier.com/permissions.

This book and the individual contributions contained in it are protected under copyright by the Publisher (other than as may be noted herein).

NoticesKnowledge and best practice in this field are constantly changing. As new research and experience broaden our understanding, changes in research methods, professional practices, or medical treatment may become necessary.

Practitioners and researchers must always rely on their own experience and knowledge in evaluating and using any information, methods, compounds, or experiments described herein. In using such information or methods they should be mindful of their own safety and the safety of others, including parties for whom they have a professional responsibility.

To the fullest extent of the law, neither the Publisher nor the authors, contributors, or editors, assume any liability for any injury and/or damage to persons or property as a matter of products liability, negligence or otherwise, or from any use or operation of any methods, products, instructions, or ideas contained in the material herein.

Library of Congress Cataloging-in-Publication DataDePamphilis, Donald M. Mergers and acquisitions basics: all you need to know/Donald DePamphilis. p. cm. Includes bibliographical references. ISBN 978-0-12-374948-2 1. Consolidation and merger of corporations—United States—Management.

2. Corporate reorganizations—United States—Management. 3. Organizational change— United States—Management. I. Title. HG4028.M4D47 2011

658. 1620973—dc22 2010023983

British Library Cataloguing-in-Publication DataA catalogue record for this book is available from the British Library.

For information on all Academic Press publications visit our website at www.elsevierdirect.com

Printed in The United States of America

10 11 12 13 9 8 7 6 5 4 3 2 1

xiii

Why We Need to UNderstaNd the role of Mergers aNd acqUisitioNs iN today’s World

Mergers, acquisitions, business alliances, and corporate restructuring activi-ties are increasingly commonplace in both developed and emerging econ-omies. Given the frequency with which such activities occur, it is critical for business people and officials at all levels of government to have a basic understanding of why and how they take place and how they can affect economic growth. A lack of understanding of the role mergers and acqui-sitions (M&As) play in a modern economy can mean the failure to use such transactions as an effective means of implementing a business strat-egy. Moreover, ignorance can lead to overregulation of what are important means of disciplining incompetent managers and transferring ownership of operating assets to those who can utilize them most efficiently.

This book seeks to bring clarity to what is a complex, sometimes frus-trating, and ultimately exciting subject. It presents an integrated way to think about the myriad activities involved in mergers and acquisitions. Although various types of business alliances and aspects of corporate restructuring are addressed in brief, the primary focus is on M&As.

The Book’s Unique FeaturesThis book is unique among books of this type in several specific ways. First, it is aimed primarily at practitioners who need a quick overview of the sub-ject without getting bogged down in minutiae. Rather than provide inten-sive coverage of every aspect of mergers and acquisitions, as might be found in a comprehensive textbook, or “dumb down” the subject matter to provide only superficial—and perhaps inaccurate or misleading explanations—the text occupies a middle ground. No significant knowledge of finance, eco-nomics, or accounting is required, although a passing acquaintance with these disciplines is helpful. While reader-friendly, the text also draws on academic studies to substantiate key observations and conclusions that are empirically based. Details of these studies are often found in chapter footnotes.

Each chapter concludes with a section called “A Case in Point” that illustrates the chapter material with a real-world example. These sections include thought-provoking questions that encourage you, the reader, to apply the concepts explored in the chapter.

PreFace

Prefacexiv

Who Should read This BookThis book is aimed at buyers and sellers of businesses, financial analysts, chief executive officers, chief financial officers, operating managers, invest-ment bankers, and portfolio managers. Others who may have an interest include bank lending officers, venture capitalists, government regulators, human resource mangers, entrepreneurs, and board members. In addition, the book may be used as a companion or supplemental text for under-graduate and graduate students in courses on mergers and acquisitions, corporate restructuring, business strategy, management, governance, and entrepreneurship. Supplemented with newspaper and magazine articles, the book could serve as the primary text in an introductory course on mergers and acquisitions.

For a more rigorous and detailed discussion on mergers and acquisitions and other forms of corporate restructuring, the reader may wish to see the author’s textbook on the subject, Mergers, Acquisitions, and Other Restructuring Activities. The 5th edition (2009) is published by Academic Press. The reader also may be interested in the author’s Mergers and Acquisitions Basics: Negotiation and Deal Structuring, also published by Academic Press in 2010.

xv

I would like to express my sincere appreciation for the many resources of Academic Press/Butterworth-Heinemann/Elsevier in general and for the ongoing support provided by Karen Maloney, Managing Editor, and J. Scott Bentley, Executive Editor, as well as Scott M. Cooper, who helped streamline this manuscript for its primary audience. Finally, I would like to thank Alan Cherry, Ross Bengel, Patricia Douglas, Jim Healy, Charles Higgins, Michael Lovelady, John Mellen, Jon Saxon, David Offenberg, Chris Manning, and Maria Quijada for their many constructive comments.

Acknowledgments

�Mergers and Acquisitions Basics� ©�2011�Elsevier�Inc.ISBN:�����0�12��������2�� ��I: �ll ri���s reserve�.����0�12��������2�� ��I: �ll ri���s reserve�.�����I:� �ll�ri���s�reserve�.

CHAPTER

201110.1016/B����0�12��������2.00001��

Introduction to Mergers and Acquisitions

T�e�firs���eca�e�of���e�new�millennium��eral�e��an�era�of��lobal�me�a�mer�ers.� Like� ��e�mer�ers� an�� acquisi�ions� (M&�s)� frenzy� of� ��e� 1��0s�an��1��0s���several�fac�ors�fuele��ac�ivi�y���rou���mi��200�:�rea�ily�avail�able� cre�i���� �is�orically� low� in�eres�� ra�es��� risin�� equi�y� marke�s��� �ec�no�lo�ical� c�an�e��� �lobal� compe�i�ion��� an�� in�us�ry� consoli�a�ion.� In� �erms�of��ollar�volume���M&���ransac�ions�reac�e��a�recor�� level�worl�wi�e� in�200�.�Bu��ex�en�e���urbulence�in���e��lobal�cre�i��marke�s�soon�followe�.

T�e� specula�ive� �ousin�� bubble� in� ��e� Uni�e�� S�a�es� an�� elsew�ere���lar�ely� finance��by��eb����burs���urin�� ��e� secon���alf�of� ��e�year.�Banks���concerne��abou����e�value�of�many�of���eir�own�asse�s���became�excee�in�ly�selec�ive�an��lar�ely�wi���rew�from�financin����e��i��ly�levera�e���ransac��ions���a���a��become�commonplace���e�previous�year.�T�e�quali�y�of�asse�s��el��by�banks���rou��ou��Europe�an���sia�also�became�suspec����reflec�in����e��lobal�na�ure�of���e�cre�i��marke�s.��s�cre�i���rie��up���a�malaise�sprea��worl�wi�e�in���e�marke��for��i��ly�levera�e��M&���ransac�ions.

By�200����a�combina�ion�of�recor���i���oil�prices�an��a�re�uce��avail�abili�y�of�cre�i��sen��mos��of���e�worl�’s�economies�in�o�recession���re�uc�in���lobal�M&��ac�ivi�y�by�more� ��an�one���ir�� from�i�s�previous��i��.�T�is� �lobal� recession� �eepene�� �urin�� ��e� firs�� �alf� of� 200�—�espi�e� a��rama�ic��rop�in�ener�y�prices�an���i��ly�s�imula�ive�mone�ary�an��fiscal�policies—ex�en�in����e�slump�in�M&��ac�ivi�y.

In� recen�� years��� �overnmen�s� worl�wi�e� �ave� in�ervene�� a��ressively�in��lobal�cre�i��marke�s�(as�well�as�in�manufac�urin��an��o��er�sec�ors�of���e� economy)� in� an� effor�� �o� res�ore� business� an�� consumer� confi�ence���res�ore� cre�i��marke�� func�ionin���� an��offse�� �efla�ionary� pressures.�W�a��impac���ave�suc��ac�ions��a��on�mer�ers�an��acquisi�ions?�I��is��oo�early��o��ell���bu����e�implica�ions�may�be�si�nifican�.

M&�s�are�an�impor�an��means�of��ransferrin��resources��o�w�ere���ey�are�mos��nee�e��an��of�removin��un�erperformin��mana�ers.�Governmen���ecisions��o�save�some�firms�w�ile�allowin��o��ers��o�fail�are�likely��o��is�rup����is�process.�Suc���ecisions�are�of�en�base��on���e�no�ion���a��some�

1

Mergers and Acquisitions Basics�

firms� are� simply� �oo� bi�� �o� fail� because� of� ��eir� po�en�ial� impac�� on� ��e�economy—consi�er��IG� in� ��e� Uni�e�� S�a�es.� ���ers� are� clearly� mo�i�va�e��by�poli�ics.�Suc��ac�ions��isrup����e�smoo���func�ionin��of�marke�s���w�ic��rewar�s��oo���ecisions�an��penalizes�poor�ones.��llowin��a�business��o�believe� ��a�� i�� can� ac�ieve� a� size�“�oo�bi�� �o� fail”�may�crea�e�perverse�incen�ives.�Plus�����ere�is�very�li��le��is�orical�evi�ence���a���overnmen�s�are�be��er���an�marke�s�a���eci�in��w�o�s�oul��fail�an��w�o�s�oul��survive.

In� ��is� c�ap�er��� you� will� �ain� an� un�ers�an�in�� of� ��e� un�erlyin���ynamics�of�M&�s�in���e�con�ex��of�an�increasin�ly�in�erconnec�e��worl�.�T�e� c�ap�er� be�ins�wi��� a� �iscussion�of�M&�s� as� c�an�e� a�en�s� in� ��e�con�ex��of�corpora�e�res�ruc�urin�.�T�e�focus�is�on�M&�s�an��w�y���ey��appen��� wi��� brief� consi�era�ion� �iven� �o� al�erna�ive� ways� of� increasin��s�are�ol�er�value.�You�will�also�be�in�ro�uce���o�a�varie�y�of� le�al�s�ruc��ures�an��s�ra�e�ies���a��are�employe���o�res�ruc�ure�corpora�ions.

T�rou��ou����is�book���a�firm���a��a��emp�s��o�acquire�or�mer�e�wi���ano��er�company�is�calle��an�acquiring company���acquirer���or�bidder.�T�e�target company�or�target�is���e�firm�bein��solici�e��by���e�acquirin��com�pany.�Takeovers�or�buyouts�are��eneric��erms�for�a�c�an�e�in���e�con�rol�lin��owners�ip�in�eres��of�a�corpora�ion.

Wor�s� in�bold italics� are� ��e�ones�mos�� impor�an�� for�you� �o�un�er�s�an��fully;���ey�are�all�inclu�e��in�a��lossary�a����e�en��of���e�book.

Mergers and acquisitions as change agents

Businesses�come�an���o�in�a�con�inuin��c�urn���per�aps�bes��illus�ra�e��by���e� ever�c�an�in�� composi�ion� of� ��e� so�calle�� For�une� 500—��e� 500�lar�es��U.S.�corpora�ions.��nly��0�of���e�firms�on���e�ori�inal�1�55�lis��of�500�are�on��o�ay’s�lis����an��some�2��000�firms��ave�appeare��on���e�lis��a��one��ime�or�ano��er.�Mos���ave��roppe��off���e�lis��ei��er���rou���mer�er���acquisi�ion��� bankrup�cy��� �ownsizin���� or� some� o��er� form� of� corpora�e�res�ruc�urin�.�Consi�er� a� few�examples:�C�rysler���Be��le�em�S�eel���Sco���Paper���Zeni�����Rubbermai����Warner�Lamber�.�T�e�popular�me�ia��en�s��o�use� ��e� �erm� corporate restructuring� �o� �escribe� ac�ions� �aken� �o� expan��or�con�rac��a� firm’s�basic�opera�ions�or� fun�amen�ally�c�an�e� i�s� asse��or�financial�s�ruc�ure.1

1� T�e�broa��array�of�ac�ivi�ies�fallin��un�er���is�ca�c�all��erm�runs���e��amu��from�reor�anizin��business�uni�s��o��akeovers�an��join��ven�ures��o��ives�i�ures�an��spin�offs�an��equi�y�carve�ou�s.�����e�aile���iscussion�of���ese�al�erna�ive�forms�of�res�ruc�urin��is�beyon����e�scope�of���is�book.��To�learn�more���see�Mergers, Acquisitions, and other Restructuring Activities�by��onal��M.��ePamp�ilis���now�in�i�s�fif���e�i�ion�an��available���rou����ca�emic�Press.

Introduction to Mergers and Acquisitions �

Why Mergers and acquisitions happen

T�e�prevalence�of�M&�s�an����e�impor�ance�of�various�fac�ors���a���ive�rise��o�M&��ac�ivi�y�varies�over��ime.�Ex�ibi��1�1�lis�s�some�of���e�more�prominen����eories�abou��w�y�M&�s��appen���eac��of�w�ic��is��iscusse��in��rea�er��e�ail�in���e�followin��sec�ions.

EXHIBIT 1-1 Common Theories of What Causes Mergers and Acquisitions

Theory Motivation

Operating SynergyEconomies of ScaleEconomies of Scope

Improve operating efficiency through economies of scale or scope by acquiring a customer, supplier, or competitor

Financial Synergy Lower cost of capitalDiversification

New Products/Current MarketsNew Products/New MarketsCurrent Products/New Markets

Position the firm in higher growth products or markets

Strategic RealignmentTechnological ChangeRegulatory and Political

Change

Acquire capabilities to adapt more rapidly to environmental changes than could be achieved if they were developed internally

Hubris (Managerial Pride) Acquirers believe their valuation of target more accurate than the market’s, causing them to overpay by overestimating synergy

Buying Undervalued Assets (Q-Ratio)

Acquire assets more cheaply when the equity of existing companies is less than the cost of buying or building the assets

Mismanagement (Agency Problems)

Replace managers not acting in the best interests of the owners

Managerialism Increase the size of a company to increase the power and pay of managers

Tax Considerations Obtain unused net operating losses and tax credits, asset write-ups, and substitute capital gains for ordinary income

Market Power Increase market share to improve ability to set prices above competitive levels

Misvaluation Investor overvaluation of acquirer’s stock encourages M&As

Mergers and Acquisitions Basics�

SynergySynergy�is���e�ra��er�simplis�ic�no�ion���a���wo�(or�more)�businesses�in�com�bina�ion�will�crea�e��rea�er�s�are�ol�er�value���an�if���ey�are�opera�e��sepa�ra�ely.�I��may�be�measure��as���e�incremen�al�cas��flow���a��can�be�realize����rou���combina�ion�in�excess�of�w�a��woul��be�realize��were���e�firms��o�remain�separa�e.�T�ere�are��wo�basic��ypes�of�syner�y:�opera�in��an��financial.

Operating Synergy (Economies of Scale and Scope)Operating synergy� comprises�bo��� economies�of� scale� an��economies�of�scope��� w�ic�� can� be� impor�an�� �e�erminan�s� of� s�are�ol�er� weal��� cre�a�ion.2�Gains�in�efficiency�can�come�from�ei��er�fac�or�an��from�improve��mana�erial�prac�ices.

Sprea�in��fixe��cos�s�over�increasin��pro�uc�ion�levels�realizes�economies of scale���wi��� scale��efine��by� suc�� fixe�� cos�s� as� �eprecia�ion�of� equip�men��an��amor�iza�ion�of�capi�alize��sof�ware;�normal�main�enance�spen��in�;� obli�a�ions� suc�� as� in�eres�� expense��� lease� paymen�s��� an�� lon���erm�union���cus�omer���an��ven�or�con�rac�s;�an�� �axes.�T�ese�cos�s�are� fixed� in���a����ey�canno��be�al�ere��in���e�s�or��run.�By�con�ras����variable�cos�s�are���ose� ��a�� c�an�e�wi��� ou�pu�� levels.�Consequen�ly��� for� a� �iven� scale� or�amoun��of� fixe�� expenses��� ��e��ollar� value�of� fixe�� expenses�per�uni��of�ou�pu��an��per��ollar�of�revenue��ecreases�as�ou�pu��an��sales�increase.

To�illus�ra�e���e�po�en�ial�profi��improvemen��from�economies�of�scale���le�’s� consi�er� an� au�omobile� plan�� ��a�� can� assemble� 10� cars� per� �our�an�� runs� aroun�� ��e� clock—w�ic�� means� ��e� plan�� pro�uces� 2�0� cars�per��ay.�T�e�plan�’s� fixe��expenses�per��ay�are�$1�million��� so� ��e�avera�e�fixe��cos��per�car�pro�uce��is�$���16��(i.e.���$1��000��000/2�0).�Now�ima�ine�an� improve�� assembly� line� ��a�� allows� ��e� plan�� �o� assemble� 20� cars� per��our���or���0�per��ay.�T�e�avera�e�fixe��cos��per�car�per��ay�falls��o�$2��0���(i.e.��� $1��000��000/��0).� If� variable� cos�s� (e.�.��� �irec�� labor)�per� car��o�no��increase��� an�� ��e� sellin��price�per�car� remains� ��e� same� for�eac��car��� ��e�profi�� improvemen��per�car��ue� �o� ��e��ecline� in�avera�e� fixe��cos�s�per�car�per��ay�is�$2��0���(i.e.���$���16��–�$2��0��).

�� firm�wi��� �i��� fixe�� cos�s� as� a� percen�a�e� of� �o�al� cos�s� will� �ave��rea�er� earnin�s� variabili�y� ��an�one�wi��� a� lower� ra�io�of� fixe�� �o� �o�al�cos�s.�Le�’s�consi�er��wo�firms�wi���annual�revenues�of�$1�billion�an��oper�a�in��profi�s�of�$50�million.�T�e�fixe��cos�s�a����e�firs��firm�represen��100�percen��of��o�al�cos�s���bu��a����e�secon��fixe��cos�s�are�only��alf�of�all�cos�s.�If�revenues�a��bo���firms�increase��by�$50�million�����e�firs��firm�woul��see�

2� �eLon��(200�);�Hous�on���James���an��Ryn�aer��(2001).

Introduction to Mergers and Acquisitions �

income�increase��o�$100�million���precisely�because�all�of�i�s�cos�s�are�fixe�.�Income�a����e�secon��firm�woul��rise�only��o�$�5�million���because��alf�of���e�$50�million�increase��revenue�woul���ave��o��o��o�pay�for�increase��variable�cos�s.

Usin��a�specific�se��of�skills�or�an�asse��curren�ly�employe���o�pro�uce�a� �iven� pro�uc�� or� service� �o� pro�uce� some��in�� else� realizes� economies of scope���w�ic��are�foun��mos��of�en�w�en�i��is�c�eaper��o�combine�mul��iple� pro�uc�� lines� in� one� firm� ��an� �o� pro�uce� ��em� in� separa�e� firms.�Proc�er�&�Gamble��� ��e�consumer�pro�uc�s��ian����uses� i�s��i��ly� re�ar�e��consumer�marke�in�� skills� �o� sell� a� full� ran�e� of� personal� care� as�well� as�p�armaceu�ical�pro�uc�s.�Hon�a�knows��ow��o�en�ance�in�ernal�combus��ion� en�ines��� so� in� a��i�ion� �o� cars��� ��e� firm��evelops�mo�orcycles��� lawn�mowers���an��snow�blowers.�Sequen��Tec�nolo�y�le�s�cus�omers�run�appli�ca�ions� on� UNIX� an�� NT� opera�in�� sys�ems� on� a� sin�le� compu�er� sys��em.�Ci�i�roup�uses���e�same�compu�er�cen�er��o�process�loan�applica�ions����eposi�s����rus��services���an��mu�ual�fun��accoun�s�for�i�s�bank’s�cus�omers.�Eac��is�an�example�of�economies�of�scope���w�ere�a�firm�is�applyin��a�spe�cific�se��of�skills�or�asse�s��o�pro�uce�or�sell�mul�iple�pro�uc�s�����us��enera��in��more�revenue.

Financial Synergy (Lowering the Cost of Capital)Financial synergy�refers��o���e�impac��of�mer�ers�an��acquisi�ions�on���e�cos��of�capi�al�of���e�acquirin��firm�or�newly�forme��firm�resul�in��from�a�mer�er�or�acquisi�ion.�T�e�cos��of�capi�al�is���e�minimum�re�urn�require��by�inves�ors�an��len�ers��o�in�uce���em��o�buy�a�firm’s�s�ock�or��o�len���o���e�firm.

In� ��eory��� ��e� cos�� of� capi�al� coul�� be� re�uce�� if� ��e� mer�e�� firms��ave�cas��flows���a���o�no��move�up�an���own�in��an�em�(i.e.���so�calle���co�insurance)��� realize� financial� economies� of� scale� from� lower� securi�ies�issuance�an���ransac�ions�cos�s���or�resul��in�a�be��er�ma�c�in��of�inves�men��oppor�uni�ies�wi���in�ernally��enera�e��fun�s.�Combinin��a�firm���a���as�excess�cas��flows�wi���one�w�ose�in�ernally��enera�e��cas��flow�is�insuf�ficien���o�fun��i�s�inves�men��oppor�uni�ies�may�also�resul��in�a�lower�cos��of�borrowin�.��� firm� in�a�ma�ure� in�us�ry�experiencin�� slowin���row���may�pro�uce�cas��flows�well�in�excess�of�available�inves�men��oppor�uni��ies.��no��er�firm�in�a��i����row���in�us�ry�may�no���ave�enou���cas���o�realize�i�s�inves�men��oppor�uni�ies.�Reflec�in����eir��ifferen���row���ra�es�an��risk�levels�����e�firm�in���e�ma�ure�in�us�ry�may��ave�a�lower�cos��of�capi�al���an���e�one�in���e��i����row���in�us�ry���an��combinin����e��wo�firms�coul��lower���e�avera�e�cos��of�capi�al�of���e�combine��firms.

Mergers and Acquisitions Basics�

DiversificationBuyin��firms�ou�si�e�a�company’s�curren��primary�lines�of�business�is�calle��diversification���an��is��ypically�jus�ifie��in�one�of��wo�ways.��iversifica�ion�may� crea�e� financial� syner�y� ��a�� re�uces� ��e� cos�� of� capi�al��� or� i�� may�allow�a�firm��o�s�if�� i�s�core�pro�uc�� lines�or�marke�s� in�o�ones���a���ave��i��er��row���prospec�s���even�ones���a��are�unrela�e���o���e�firm’s�curren��pro�uc�s�or�marke�s.�T�e�ex�en���o�w�ic���iversifica�ion�is�unrela�e���o�an�acquirer’s�curren��lines�of�business�can��ave�si�nifican��implica�ions�for��ow�effec�ive�mana�emen��is�in�opera�in����e�combine��firms.

Ex�ibi��1�2� is�a�pro�uc�–marke��ma�rix� ��a�� i�en�ifies�a� firm’s�primary��iversifica�ion�op�ions.��� firm� facin�� slower��row��� in� i�s� curren��marke�s�may�be�able��o�accelera�e��row�����rou���rela�e���iversifica�ion�by�sellin��i�s�curren��pro�uc�s� in�new�marke�s� ��a��are�somew�a��unfamiliar�an���� ��ere�fore���more�risky.�Suc��was� ��e�case�w�en�p�armaceu�ical��ian�� Jo�nson�&�Jo�nson�announce��i�s�ul�ima�ely�unsuccessful��akeover�a��emp��of�Gui�an��Corpora�ion� in� la�e� 200�.� J&J� was� seekin�� an� en�ry� poin�� for� i�s� me�ical��evices�business�in���e�fas���rowin��marke��for�implan�able��evices���in�w�ic��i�� �i��no�� ��en�par�icipa�e.��� firm�may� a��emp�� �o� ac�ieve��i��er� �row���ra�es� by� �evelopin��or� acquirin�� new�pro�uc�s�wi���w�ic�� i�� is� rela�ively�unfamiliar�an����en�sellin����em�in�familiar�an��less�risky�curren��marke�s.�Re�ailer�JCPenney’s�acquisi�ion�of���e�Ecker���ru�s�ore�c�ain�or�J&J’s�$16�billion�acquisi�ion�of�Pfizer’s�consumer��eal��care�pro�uc�s�line�in�2006�are��wo�examples�of� rela�e���iversifica�ion.� In�eac�� ins�ance��� ��e� firm�assume��a��i�ional�risk���bu��less�so���an�unrela�e���iversifica�ion�if�i���a���evelope��new�pro�uc�s� for� sale� in�new�marke�s.�T�ere� is�consi�erable�evi�ence� ��a��inves�ors��o�no��benefi��from�unrela�e���iversifica�ion.

Firms���a��opera�e�in�a�number�of�lar�ely�unrela�e��in�us�ries���suc��as�General�Elec�ric���are�calle��conglomerates.�T�e�s�are�prices�of�con�lomera�es��

EXHIBIT 1-2 Product–Market MatrixMarkets

ProductsCurrent New

Current Lower Growth/Lower Risk Higher Growth/Higher Risk (Related Diversification)

New Higher Growth/Higher Risk (Related Diversification)

Highest Growth/Highest Risk (Unrelated Diversification)

Introduction to Mergers and Acquisitions �

of�en� �ra�e� a�� a� �iscoun�—as� muc�� as� 10� �o� 15� percen��—compare�� �o�s�ares� of� focuse�� firms�or� �o� ��eir� value�were� ��ey� broken�up.�T�is� �is�coun��is�calle����e�conglomerate discount�or�diversification discount.�Inves�ors�of�en�perceive�companies��iversifie�� in�unrela�e��areas� (i.e.��� ��ose� in��if�feren�� s�an�ar�� in�us�rial� classifica�ions)� as� riskier� because� mana�emen���as� �ifficul�y� un�ers�an�in�� ��ese� companies� an�� of�en� fails� �o� provi�e�full� fun�in�� for� ��e�mos�� a��rac�ive� inves�men��oppor�uni�ies.��Moreover���ou�si�e� inves�ors� may� �ave� a� �ifficul�� �ime� un�ers�an�in�� �ow� �o� value���e� various� par�s� of� �i��ly� �iversifie�� businesses.5� Researc�ers� �iffer� on�w�e��er���e�con�lomera�e��iscoun��is�overs�a�e�.6

S�ill���al��ou�����e�evi�ence�su��es�s���a��firms�pursuin��a�more�focuse��corpora�e�s�ra�e�y�are�likely��o�perform�bes������ere�are�always�excep�ions.

Strategic RealignmentT�e�strategic realignment���eory�su��es�s���a��firms�use�M&�s��o�make�rapi��a�jus�men�s��o�c�an�es�in���eir�ex�ernal�environmen�s.��l��ou���c�an�e�can�come�from�many��ifferen��sources�����is���eory�consi�ers�only�c�an�es�in���e�re�ula�ory�environmen��an���ec�nolo�ical�innova�ion—�wo�fac�ors���a����over���e�pas��20�years����ave�been�major�forces�in�crea�in��new�oppor�uni�ies�for��row�����an����rea�enin����or�makin��obsole�e���firms’�primary�lines�of�business.

Regulatory ChangeT�ose�in�us�ries���a���ave�been�subjec���o�si�nifican���ere�ula�ion�in�recen��years—financial� services��� �eal��� care��� u�ili�ies��� me�ia��� �elecommunica�ions���

�� Ber�er�an���fek�(1��5);�Lins�an��Servaes�(1���).�� Morck���S�leifer���an��Vis�ny�(1���).5� Bes��an��Ho��es�(200�).6� Some�ar�ue���a���iversifyin��firms�are�of�en�poor�performers�before���ey�become�con�lomera�es�

(Campa�an��Simi���2002;�Hylan����2001)���w�ereas�o��ers�conclu�e���a����e�con�lomera�e��iscoun��is�a�resul��of��ow���e�sample�s�u�ie��is�cons�ruc�e��(Gra�am���Lemmon���an��Wolf���2002;�Villalon�a���200�).�Several�su��es����a����e�con�lomera�e��iscoun��is�re�uce��w�en�firms�ei��er��ives��or�spin�off�businesses�in�an�effor���o�ac�ieve��rea�er�focus�on���e�core�business�por�folio�(�i��mar�an��S�iv�asani���200�;�S�in�an��S�ulz���1���).�S�ill�o��ers�fin��evi�ence���a����e�mos��successful�mer�ers�are���ose���a��focus�on��eals���a��promo�e���e�acquirer’s�core�business�(Har�in��an��Rovi����200�;�Me��inson�e��al.���200�).�Rela�e��acquisi�ions�may�even�be�more�likely��o�experience��i��er�financial�re�urns���an�unrela�e��acquisi�ions�(Sin���an��Mon��omery���200�).�T�is�s�oul��no��be�surprisin��in���a��rela�e��firms�are�more�likely��o�be�able��o�realize�cos��savin�s��ue��o�overlappin��func�ions�an��pro�uc��lines���an�are�unrela�e��firms.�T�ere�is�even�an�ar�umen����a���iversifie��firms�in��evelopin��coun�ries���w�ere�access��o�capi�al�marke�s�is�limi�e����may�sell�a��a�premium��o�more�focuse��firms�(Fauver���Hous�on���an��Narran�o���200�).�Un�er���ese�circums�ances���corpora�e��iversifica�ion�may�enable�more�efficien��inves�men��because��iversifie��firms�may�use�cas���enera�e��by�ma�ure�subsi�iaries��o�fun����ose�wi����i��er��row���po�en�ial.

Mergers and Acquisitions Basics�

�efense—�ave�been�a�� ��e�cen�er�of�M&��ac�ivi�y��because��ere�ula�ion�breaks��own�ar�ificial�barriers�an��s�imula�es�compe�i�ion.��urin����e�firs���alf� of� ��e� 1��0s��� for� ins�ance��� ��e� U.S.� �epar�men�� of� �efense� ac�ively�encoura�e�� consoli�a�ion� of� ��e� na�ion’s� major� �efense� con�rac�ors� �o�improve���eir�overall�opera�in��efficiency.

U�ili�ies�now�require��in�some�s�a�es��o�sell�power��o�compe�i�ors���a��can�resell���e�power�in���e�u�ili�y’s�own�marke�place�respon��wi���M&�s��o�ac�ieve��rea�er�opera�in��efficiency.�Commercial�banks���a���ave�move��beyon�� ��eir� �is�orical� role� of� accep�in�� �eposi�s� an�� �ran�in�� loans� are�mer�in�� wi��� securi�ies� firms� an�� insurance� companies� ��anks� �o� ��e�Financial�Services�Mo�erniza�ion��c��of�1������w�ic��repeale�� le�isla�ion��a�in��back��o���e�Grea���epression.�T�e�Ci�icorp–Travelers�mer�er�a�year�earlier�an�icipa�e����is�c�an�e���an��i�� is�probable���a����eir�represen�a�ives�were�lobbyin��for���e�new�le�isla�ion.�T�e�final�c�ap�er��as�ye���o�be�wri���en:� ��is� �ren�� �owar���u�e� financial� services� companies�may�ye�� be� s�y�mie��by�new�re�ula�ion�passe��in�2010�in�response��o�excessive�risk��akin�.

T�e��elecommunica�ions�in�us�ry�offers�a�s�rikin��illus�ra�ion.�His�orically���local� an�� lon���is�ance� p�one� companies� were� no�� allowe�� �o� compe�e�a�ains��eac��o��er���an��cable�companies�were�essen�ially�monopolies.�Since���e�Telecommunica�ions��c��of�1��6���local�an��lon���is�ance�companies�are�ac�ively�encoura�e���o�compe�e�in�eac��o��er’s�marke�s���an��cable�companies�are�offerin��bo���In�erne��access�an��local��elep�one�service.�W�en�a�fe�eral�appeals�cour��in�2002�s�ruck��own�a�Fe�eral�Communica�ions�Commission�re�ula�ion�pro�ibi�in��a�company�from�ownin��a�cable��elevision�sys�em�an��a�broa�cas��TV�s�a�ion�in���e�same�ci�y���an����rew�ou����e�rule���a��barre��a�company�from�ownin��TV�s�a�ions���a��reac��more���an��5�percen��of�U.S.��ouse�ol�s���i��encoura�e��new�combina�ions�amon����e�lar�es��me�ia�com�panies�or�purc�ases�of�smaller�broa�cas�ers.

Technological ChangeTec�nolo�ical�a�vances�crea�e�new�pro�uc�s�an�� in�us�ries.�T�e��evelop�men�� of� ��e� airplane� crea�e�� ��e� passen�er� airline��� avionics��� an�� sa�elli�e�in�us�ries.�T�e�emer�ence�of�sa�elli�e��elivery�of�cable�ne�works��o�re�ional�an��local�s�a�ions�i�ni�e��explosive��row���in���e�cable�in�us�ry.�To�ay���wi�����e�expansion�of�broa�ban���ec�nolo�y���we�are�wi�nessin����e�conver�ence�of�voice����a�a���an��vi�eo��ec�nolo�ies�on���e�In�erne�.�T�e�emer�ence�of��i�i�al�camera��ec�nolo�y��as�re�uce���rama�ically���e��eman��for�analo��

�� Mi�c�ell�an��Mul�erin�(1��6);�Mul�erin�an��Boone�(2000).

Introduction to Mergers and Acquisitions �

cameras� an�� film�an�� sen���ouse�ol��names� suc�� as�Ko�ak� an��Polaroi��scramblin���o�a�ap�.�T�e��row���of�sa�elli�e�ra�io�is�increasin��i�s�s�are�of���e�ra�io�a�ver�isin��marke��a����e�expense�of��ra�i�ional�ra�io�s�a�ions.

Smaller���more�nimble�players�ex�ibi��spee��an��crea�ivi�y�many�lar�er���more�bureaucra�ic�firms�canno��ac�ieve.�Wi���en�ineerin���alen��of�en�in�s�or��supply�an��pro�uc��life�cycles�s�or�enin������ese�lar�er�firms�may�no���ave� ��e� luxury�of� �ime�or� ��e� resources� �o� innova�e.�So��� ��ey�may� look��o�M&�s�as�a�fas��an��some�imes�less�expensive�way��o�acquire�new��ec��nolo�ies� an��proprie�ary�know��ow��o� fill� �aps� in� ��eir� curren��pro�uc��por�folios�or��o�en�er�en�irely�new�businesses.��cquirin���ec�nolo�ies�can�also� be� a� �efensive� weapon� �o� keep� impor�an�� new� �ec�nolo�ies� ou�� of���e��an�s�of�compe�i�ors.�In�2006���eBay�acquire��Skype�Tec�nolo�ies�����e�In�erne��p�one�provi�er��� for�$�.1�billion� in�cas���� s�ock���an��performance�paymen�s����opin����a����e�move�woul��boos���ra�in��on�i�s�online�auc�ion�si�e� an�� limi�� compe�i�ors’� access� �o� ��e� new� �ec�nolo�y.� By� Sep�ember�200����eBay��a���o�a�mi����a��i���a��been�unable��o�realize���e�benefi�s�of�ownin��Skype�an��was�sellin����e�business��o�a�priva�e�inves�or��roup�for�$2.�5�billion.

Hubris and the “Winner’s Curse”Mana�ers� some�imes�believe� ��a�� ��eir� own�valua�ion�of� a� �ar�e�� firm� is�superior��o���e�marke�’s�valua�ion.�T�us��� ��e�acquirin��company��en�s��o�overpay� for� ��e� �ar�e���� �avin�� been�overop�imis�ic�w�en� evalua�in�� syn�er�ies.�Compe�i�ion� amon��bi��ers� also� is� likely� �o� resul�� in� ��e�winner�overpayin��because�of�hubris���even�if�si�nifican��syner�ies�are�presen�.��In�an�auc�ion�environmen��wi���bi��ers�����e�ran�e�of�bi�s�for�a��ar�e��com�pany�is� likely��o�be�qui�e�wi�e���because�senior�mana�ers� �en���o�be�very�compe�i�ive� an�� some�imes� self�impor�an�.�T�eir� �esire� no�� �o� lose� can��rive���e�purc�ase�price�of�an�acquisi�ion�well�in�excess�of�i�s�ac�ual�eco�nomic�value�(i.e.���cas���enera�in��capabili�y).�T�e�winner�pays�more���an���e� company� is� wor��� an�� may� ul�ima�ely� feel� remorse� a�� �avin�� �one�so—�ence�w�a���as�come��o�be�calle����e�winner’s curse.

Buying Undervalued Assets (The Q-Ratio)T�e�q-ratio�is���e�ra�io�of���e�marke��value�of���e�acquirin��firm’s�s�ock��o���e�replacemen��cos��of�i�s�asse�s.�Firms�in�eres�e��in�expansion�can�c�oose��o�inves��in�new�plan�s�an��equipmen��or�ob�ain���e�asse�s�by�acquirin��a�

�� Roll�(1��6).

Mergers and Acquisitions Basics�0

company�wi���a�marke��value�less���an�w�a��i��woul��cos���o�replace���e�asse�s� (i.e.���q�ra�io��1).�T�is� ��eory�was�very�useful� in�explainin��M&��ac�ivi�y��urin����e�1��0s���w�en��i���infla�ion�an��in�eres��ra�es��epresse��s�ock�prices�well�below���e�book�value�of�many�firms.�Hi���infla�ion�also�cause�� ��e� replacemen�� cos�� of� asse�s� �o� be�muc���i��er� ��an� ��e� book�value�of� asse�s.�Book�value� refers� �o� ��e�value�of� asse�s� lis�e��on� a� firm’s�balance� s�ee�� an�� �enerally� reflec�s� ��e� �is�orical� cos�� of� acquirin�� suc��asse�s�ra��er���an���eir�curren��cos�.

W�en� �asoline� refiner�Valero� Ener�y� Corp.� acquire�� Premcor� Inc.�in� 2005��� ��e� $�� billion� �ransac�ion� crea�e�� ��e� lar�es�� refiner� in� Nor����merica.� I��woul���ave�cos�� an�es�ima�e���0�percen��more� for�Valero� �o�buil��a�new�refinery�wi���equivalen��capaci�y.�

Mismanagement (Agency Problems)Agency problems� arise� w�en� ��ere� is� a� �ifference� be�ween� ��e� in�eres�s�of�incumben��mana�ers�(i.e.�����ose�curren�ly�mana�in����e�firm)�an����e�firm’s�s�are�ol�ers.�T�is��appens�w�en�mana�emen��owns�a�small�frac�ion�of���e�ou�s�an�in��s�ares�of���e�firm.�T�ese�mana�ers���w�o�serve�as�a�en�s�of���e�s�are�ol�er���may�be�more�incline���o�focus�on���eir�own�job�secu�ri�y�an��lavis��lifes�yles���an�on�maximizin��s�are�ol�er�value.�W�en���e�s�ares�of�a�company�are�wi�ely��el������e�cos��of�suc��mismana�emen��is�sprea��across�a�lar�e�number�of�s�are�ol�ers���eac��of�w�om�bears�only�a�small�por�ion.�T�is�allows�for��olera�ion�of���e�mismana�emen��over�lon��perio�s.�Mer�ers�of�en��ake�place��o�correc��si�ua�ions�in�w�ic����ere�is�a�separa�ion�be�ween�w�a��mana�ers�an��owners� (s�are�ol�ers)�wan�.�Low�s�ock� prices� pu�� pressure� on� mana�ers� �o� �ake� ac�ions� �o� raise� ��e� s�are�price� or� become� ��e� �ar�e�� of� acquirers��� w�o� perceive� ��e� s�ock� �o� be�un�ervalue�10�an��w�o�are�usually�in�en��on�removin����e�un�erperform�in��mana�emen��of���e��ar�e��firm.

��ency� problems� also� con�ribu�e� �o� mana�emen��ini�ia�e�� buyou�s���par�icularly� w�en� mana�ers� an�� s�are�ol�ers� �isa�ree� over� �ow� excess�cas��flow�s�oul��be�use�.11�Mana�ers�may��ave�access��o�informa�ion�no��rea�ily� available� �o� s�are�ol�ers� an�� may� ��erefore� be� able� �o� convince�len�ers��o�provi�e�fun�s��o�buy�ou��s�are�ol�ers�an��concen�ra�e�owner�s�ip�in���e��an�s�of�mana�emen�.

����� Zellner�(2005).10� Fama�an��Jensen�(1���).11� Me�ran�an��Peris�iani�(2006).

Introduction to Mergers and Acquisitions ��

ManagerialismT�e� managerialism theory� for� acquisi�ions� asser�s� ��a�� mana�ers� make�acquisi�ions�for�selfis��reasons���w�e��er��o�a����o���eir�pres�i�e���buil����eir�sp�eres�of�influence���au�men����eir�compensa�ion���or�for�self�preserva�ion.12��Bu�� ascribin�� acquisi�ion� �o� ��e� mana�erialism� mo�ive� i�nores� ��e� pres�sure�mana�ers�of�lar�er�firms�are�un�er��o�sus�ain�earnin�s��row����o�sup�por����eir�firms’�s�are�price.��s���e�marke��value�of�a�firm�increases���senior�mana�ers� are� compelle�� �o� make� ever� lar�er� inves�men�� be�s� �o� sus�ain�increases�in�s�are�ol�er�value.�Small�acquisi�ions�simply��o�no���ave�suffi�cien��impac��on�earnin�s��row����o�jus�ify���e�effor��require���o�comple�e���em.� Consequen�ly��� even� ��ou��� ��e� resul�in�� acquisi�ions� may� �es�roy�value��� ��e�mo�ive� for�makin�� ��em�may�be�more� �o� suppor�� s�are�ol�er�in�eres�s���an��o�preserve�mana�emen��au�onomy.

Tax ConsiderationsTax�benefi�s���suc��as�loss�carry�forwar�s�an��inves�men���ax�cre�i�s���can�be�use�� �o�offse�� ��e� �axable� income�of� firms� ��a��combine� ��rou���M&�s.��cquirers�of�firms�wi���accumula�e��losses�may�use���em��o�offse��fu�ure�profi�s��enera�e��by���e�combine��firms.�Unuse���ax�cre�i�s��el��by��ar�e��firms�may�also�be�use���o�lower�fu�ure��ax�liabili�ies.����i�ional��ax�s�el��er�(i.e.����ax�savin�s)�is�crea�e���ue��o���e�purc�ase�me��o��of�accoun�in����w�ic�� requires� ��e� book� value� of� ��e� acquire�� asse�s� �o� be� revalue�� �o���eir� curren�� marke�� value� for� purposes� of� recor�in�� ��e� acquisi�ion� on���e�books�of���e�acquirin��firm.�T�e�resul�in���eprecia�ion�of���ese��ener�ally��i��er�asse��values�also�re�uces���e�amoun��of�fu�ure��axable�income��enera�e��by���e�combine��companies�as��eprecia�ion�expense�is��e�uc�e��from�revenue�in�calcula�in��a�firm’s��axable�income.

T�e��axable�na�ure�of���e��ransac�ion�of�en�plays�a�more�impor�an��role�in� �e�erminin�� w�e��er� a� mer�er� �akes� place� ��an� any� �ax� benefi�s� ��a��accrue��o���e�acquirin��company.�T�e�seller�may�view���e��ax�free�s�a�us�of� ��e� �ransac�ion�as� a�prerequisi�e� for� ��e��eal� �o� �ake�place.���properly�s�ruc�ure���ransac�ion�can�allow���e��ar�e��s�are�ol�ers��o��efer�any�capi��al��ain�resul�in��from���e��ransac�ion�un�il���ey�ac�ually�sell���e�acquirer’s�s�ock� receive�� in� exc�an�e� for� ��eir� s�ares.� If� ��e� �ransac�ion� is� no�� �ax�free��� ��e�seller� �ypically�will�wan��a��i��er�purc�ase�price� �o�compensa�e�for���e��ax�liabili�y�resul�in��from���e��ransac�ion.1�

12� Gro�on�e��al.�(200�);�Masulis���Wan����an��Xie�(200�).1�� �yers���Lefanowicz���an��Robinson�(200�).

Mergers and Acquisitions Basics��

Market PowerT�e� ��eory� of�market power� su��es�s� ��a�� firms�mer�e� �o� improve� ��eir�monopoly�power��o�se��pro�uc��prices�a��levels�no��sus�ainable�in�a�more�compe�i�ive� marke�.� However��� ��ere� is� li��le� evi�ence� ��a�� ��is� is� �rue����espi�e� �ow� of�en� ��e� popular� press� publis�es� i�� as� ��e� reason� mer�ers�s�oul�� no�� be� allowe�.� In� fac���� increase�� mer�er� ac�ivi�y� is� muc�� more�likely� �o� con�ribu�e� �o� improve�� opera�in�� efficiency� of� ��e� combine��firms���an��o�increase��marke��power���as�you�will�learn�la�er�in���is�c�ap�er.

MisvaluationT�e� presump�ion� ��a�� marke�s� are� efficien�� implies� ��a�� a� �ar�e�’s� s�are�price� reflec�s� accura�ely� all� informa�ion� abou�� ��e� firm� an�� ��erefore� i�s��rue�economic�value�(i.e.���po�en�ial�for��enera�in��cas�).�W�en�impor�an��informa�ion� is� no�� wi�ely� known� abou�� a� firm��� �owever��� inves�ors� may�over��or�un�ervalue���e�firm.�T�ere�is�subs�an�ial�evi�ence�of�a��isconnec�����owever:� over� �ime��� asse�� values� �o��� in�ee���� reflec�� ��eir� �rue� economic�value���bu��a��specific�momen�s���ey�may�no�.

Some�su��es����a��acquirers�can�perio�ically�profi��by�buyin��un�erval�ue���ar�e�s�for�cas��a��a�price�below���eir�ac�ual�value�or�by�usin��equi�y�(even� if� ��e� �ar�e�� is� overvalue�)��� so� lon�� as� ��e� �ar�e�� is� less�overvalue����an� ��e� bi��in�� firm’s� s�ock.1�� �vervalue�� s�ares� enable� ��e� acquirer��o�purc�ase� a� �ar�e�� firm� in� a� s�are�for�s�are� exc�an�e�by� issuin�� fewer�s�ares���w�ic�� re�uces� ��e� probabili�y� of� �ilu�in�� ��e� owners�ip� posi�ion�of�curren�� acquirer� s�are�ol�ers� in� ��e�newly�combine��company.�T�a�’s�impor�an�� because� �ilu�ion� represen�s� a� si�nifican�� cos�� �o� ��e� curren��s�are�ol�ers� of� ��e� acquirin�� firm;� ��eir� s�ares� represen�� claims� on� ��e�firm’s�earnin�s���cas��flows���asse�s���an��liabili�ies.

W�enever� a� firm� increases� i�s� s�ares� ou�s�an�in���� i�� re�uces� ��e� pro�por�iona�e�owners�ip�posi�ion�of�curren��s�are�ol�ers.��vervalue��s�ares��en���o�re�uce���is�cos�.�Consi�er�an�acquirer�w�o�offers���e��ar�e��firm�s�are�ol�ers� $10� for� eac�� s�are� ��ey� own.�T�e� acquirer’s� curren�� s�are�price�is�$10.�T�e�acquirer�woul���ave��o�issue�one�new�s�are�for�eac���ar��e��s�are�ou�s�an�in�.�If���e�acquirer’s�s�are�price�is�value��a��$20���only�0.5�new�s�ares�woul���ave��o�be�issue����an��so�for��.�Consequen�ly�����e�ini�ial��ilu�ion�of���e�owners�ip�posi�ion�of�curren��acquirer�s�are�ol�ers�in���e�new�firm�is�less���e��i��er���e�acquirer’s�s�are�price�compare���o���e�price�offere��for�eac��s�are�of��ar�e��s�ock�ou�s�an�in�.

1�� �n��an��C�en��(2006);��on��e��al.�(2006).

Introduction to Mergers and Acquisitions ��

alternative ForMs oF corporate restructuring

Corpora�e�res�ruc�urin��ac�ivi�ies�are�of�en�broken�in�o��wo�specific�ca�e�o�ries.�Operational restructuring��ypically�refers��o���e�ou�ri����or�par�ial�sale�of�companies�or�pro�uc��lines�or��o��ownsizin��by�closin��unprofi�able�or�nons�ra�e�ic�facili�ies.�Financial restructuring��escribes�ac�ions�by�a�firm��o�c�an�e�i�s��o�al��eb��an��equi�y�s�ruc�ure���suc��as�s�are�repurc�ases�or�a���in���eb��ei��er��o�lower���e�corpora�ion’s�overall�cos��of�capi�al�or�as�par��of�an�an�i�akeover��efense�(�iscusse��in�more��e�ail�in�C�ap�er��).�T�e�rela�ive�propor�ions�of��eb��an��equi�y��el��by�a�firm�are���e�firm’s�capi�al�s�ruc�ure.

Mergers and ConsolidationsMer�ers� can� be� �escribe�� from� a� le�al� an�� an� economic� perspec�ive—a��is�inc�ion� impor�an�� �o� �iscussions� of� �eal� s�ruc�urin���� re�ula�ion��� an��s�ra�e�ic�plannin�.

A Legal PerspectiveT�e�le�al�s�ruc�ures�may��ake�on�many�forms��epen�in��on���e�na�ure�of�a��ransac�ion.���merger�is�a�combina�ion�of��wo�or�more�firms�in�w�ic��all�bu��one�cease��o�exis�� legally;���e�combine��or�aniza�ion�con�inues�un�er���e�ori�inal�name�of���e�survivin��firm.�In�a��ypical�mer�er���s�are�ol�ers�of� ��e� �ar�e�� firm—af�er� vo�in�� �o� approve� ��e� mer�er—exc�an�e� ��eir�s�ares�for���ose�of���e�acquirin��firm.�T�ose�no��vo�in��in�favor�(minori�y�s�are�ol�ers)�are�require���o�accep����e�mer�er�an��exc�an�e���eir�s�ares�for���ose�of���e�acquirer.

T�ere�are�several��ifferen���ypes�of�mer�ers.�If�a�mer�er�involves���e�sub�si�iary�of� a�paren�� firm�bu��no�� ��e�paren���� an�� ��e�paren�� is� ��e�primary�s�are�ol�er� in� ��e� subsi�iary��� ��e�mer�er� �oes�no�� require� approval� of� ��e�paren�’s� s�are�ol�ers� (a�� leas�� in� mos�� U.S.� s�a�es).� Suc�� a� mer�er� is� calle��a�s�or��form�mer�er.�T�e�principal�requiremen��is���a����e�paren�’s�owner�s�ip�excee�s���e�minimum���res�ol��se��by���e�s�a�e.�For�example����elaware�allows�a�paren��corpora�ion��o�mer�e�wi���a�subsi�iary�wi��ou��a�s�are�ol�er�vo�e�if���e�paren��owns�a��leas���0�percen��of���e�ou�s�an�in��vo�in��s�ares.

��statutory merger�is�one�in�w�ic����e�acquirin��company�assumes���e�asse�s� an�� liabili�ies� of� ��e� �ar�e�� in� accor�ance� wi��� ��e� s�a�u�es� of� ��e�s�a�e�in�w�ic����e�combine��companies�will�be�incorpora�e�.���subsidiary merger�involves���e��ar�e��becomin��a�subsi�iary�of���e�paren�.�To���e�pub�lic��� ��e� �ar�e�� firm�may�be�opera�e��un�er� i�s�bran��name���bu�� i��will�be�owne��an��con�rolle��by���e�acquirer.

Mergers and Acquisitions Basics��

�l��ou��� ��e� �erms� merger� an�� consolidation� of�en� are� use�� in�er�c�an�eably���a�statutory consolidation—w�ic��involves��wo�or�more�compa�nies�joinin���o�form�a�new�company—is��ec�nically�no��a�mer�er.��ll�le�al�en�i�ies���a��are�consoli�a�e��are��issolve���urin����e�forma�ion�of���e�new�company���w�ic��usually��as�a�new�name.�In�a�mer�er���ei��er���e�acquirer�or���e��ar�e��survives.�T�e�1����combina�ion�of��aimler�Benz�an��C�rysler��o�form��aimlerC�rysler� is�an�example�of�a�consoli�a�ion.�T�e�new�cor�pora�e� en�i�y� crea�e�� as� a� resul�� of� consoli�a�ion� or� ��e� survivin�� en�i�y�followin�� a�mer�er�usually� assumes�owners�ip�of� ��e� asse�s� an�� liabili�ies�of���e�mer�e��or�consoli�a�e��or�aniza�ions.�S�ock�ol�ers�in�consoli�a�e��companies��ypically�exc�an�e���eir�s�ares�for�s�ares�in���e�new�company.

��merger of equals�is�a�mer�er�framework�usually�applie��w�enever���e�mer�er�par�icipan�s�are�comparable�in�size���compe�i�ive�posi�ion���profi�abil�i�y���an��marke��capi�aliza�ion�(i.e.�����e��o�al�value�of�a�firm’s�s�ares)���an��so�i�� is� unclear�w�e��er� one� par�y� is� ce�in�� con�rol� �o� ano��er� an��w�ic��par�y� is� provi�in�� ��e��rea�es�� syner�y.� I�� is� �ypical� for� ��e�CE�s�of� ��e�mer�e��firms��o�become�co�equal�mana�ers�of���e�new�firm�an��for���e�new�firm’s�boar��of��irec�ors��o��ave�equal�represen�a�ion�from���e�boar�s�of���e�mer�e��firms.�Tar�e��firm�s�are�ol�ers�rarely�receive�any�si�nifican��premium� for� ��eir� s�ares� in� a�mer�er�of�equals.15� I�� is�qui�e�uncommon�for� ��e� owners�ip� spli�� �o� be� equally� �ivi�e�.16�T�e� 1���� forma�ion� of�Ci�i�roup�from�Ci�ibank�an��Travelers�is�an�example�of�a�mer�er�of�equals.

An Economic PerspectiveBusiness� combina�ions� may� also� be� �efine�� �epen�in�� on� w�e��er� ��e�mer�in��firms�are�in���e�same�or��ifferen��in�us�ries�an��on���eir�posi�ions�in���e�corpora�e�value�c�ain.1��T�ese��efini�ions�are�par�icularly�impor�an��for�an�i�rus��analysis.

��horizontal merger�occurs�be�ween��wo�firms�wi��in���e�same�in�us��ry;�Proc�er�&�Gamble�an��Gille��e�(2006)�in��ouse�ol��pro�uc�s����racle�an��PeopleSof�� (200�)� in� business� applica�ion� sof�ware��� oil� �ian�s� Exxon�an��Mobil� (1���)���SBC�Communica�ions�an���meri�ec�� (1���)� in� �ele�communica�ions���an��Na�ionsBank�an��Bank�merica�(1���)�in�commer�cial�bankin��are�all�examples.���conglomerate merger� is�one� in�w�ic����e�

1�� Por�er�(1��5).

15� Wulf�(200�)�su��es�e����a����e�CE�s�of��ar�e��firms�of�en�ne�o�ia�e��o�re�ain�a�si�nifican���e�ree�of�con�rol�in���e�mer�e��firm�for�bo�����eir�boar��an��mana�emen��in�exc�an�e�for�a�lower�premium�for���eir�s�are�ol�ers.

16� �ccor�in���o�Mallea�(200�)���only�1��percen���ave�a�50/50�spli�.

Introduction to Mergers and Acquisitions ��

acquirin��company�purc�ases�a�firm�in�a�lar�ely�unrela�e��in�us�ry���suc��as���e�mi��1��0s�acquisi�ion�by�U.S.�S�eel�of�Mara��on��il��o�form�USX.

Vertical mergers�involve�firms���a��par�icipa�e�a���ifferen��s�a�es�of���e�pro�uc�ion�or�value�c�ain�(see�Ex�ibi��1��).���simple�value�c�ain� in� ��e�basic�s�eel�in�us�ry�may��is�in�uis��be�ween�raw�ma�erials���suc��as�coal�or�iron�ore;�s�eel�makin����suc��as�“�o��me�al”�an��rollin��opera�ions;�an��me��als��is�ribu�ion.�Similarly���a�value�c�ain�in���e�oil�an���as�in�us�ry�woul��separa�e� explora�ion� ac�ivi�ies� from� pro�uc�ion��� refinin���� an�� marke�in�.��n�In�erne��value�c�ain�mi�����is�in�uis��be�ween�infras�ruc�ure�provi��ers� suc��as�Cisco���con�en��provi�ers� suc��as��ow�Jones���an��por�als� suc��as�Ya�oo!� an��Goo�le.� In� a� ver�ical�mer�er��� companies� ��a�� �o�no�� own�opera�ions�in�eac��major�se�men��of���e�value�c�ain�“backwar��in�e�ra�e”�by�acquirin��a� supplier�or�“forwar�� in�e�ra�e”�by�acquirin��a��is�ribu�or.�W�en� paper�manufac�urer�Boise�Casca�e� acquire���fficeMax��� an� office�pro�uc�s��is�ribu�or���in�200������e�$1.1�billion��ransac�ion�was�forwar��in�e��ra�ion.��merica��nline’s�purc�ase�of�me�ia� an��con�en��provi�er�Time�Warner�in�2000�is�an�example�of�backwar��in�e�ra�ion.1�

Acquisitions, Divestitures, Spinoffs, Carve-Outs, and BuyoutsGenerally� speakin����an�acquisition�occurs�w�en�one�company� �akes�a�con��rollin��owners�ip�in�eres��in�ano��er�firm���a�le�al�subsi�iary�of�ano��er�firm���or� selec�e��asse�s� (e.�.��� a�manufac�urin�� facili�y)�of� ano��er� firm.��n�acqui�si�ion�may� involve� ��e� purc�ase� of� ano��er� firm’s� asse�s� or� s�ock���wi��� ��e�acquire�� firm�con�inuin�� �o�exis�� as�a� le�ally�owne�� subsi�iary.� In�con�ras�����

1�� �ccor�in���o�Gu�ler���Mueller���Yur�o�lu���an��Zule�ner�(200�)����orizon�al���con�lomera�e���an��ver�ical�mer�ers�accoun�e��for��2�percen����5��percen����an����percen����respec�ively���of���e��5��000��ransac�ions�analyze��be�ween�1��1�an��1���.

EXHIBIT 1-3 Corporate Value Chain

Purchases of Manufacturing/ Strategy/ Product Delivery Postsale SupportRaw Materials & IT Operations PromotionServices

Forward Integration

Backward Integration

Note: IT refers to information technology.

InboundLogistics

Operations/Production

Marketing Distribution/Sales

CustomerSupport

Purchases of Manufacturing/ Strategy/ Product Delivery Postsale SupportRaw Materials & IT Operations PromotionServices

Forward Integration

Backward Integration

Note: IT refers to information technology.

InboundLogistics

Operations/Production

Marketing Distribution/Sales

CustomerSupport

Mergers and Acquisitions Basics��

a�divestiture�is���e�sale�of�all�or�subs�an�ially�all�of�a�company�or�pro�uc��line��o�ano��er�par�y�for�cas��or�securi�ies.�In�a�spinoff���a�paren��crea�es�a�new�le�al�subsi�iary�an���is�ribu�es�s�ares�in���e�subsi�iary��o�i�s�curren��s�are�ol�ers�as�a� s�ock� �ivi�en�.��n� equity carve-out� �escribes� a� �ransac�ion� in�w�ic�� ��e�paren��firm�issues�a�por�ion�of�i�s�s�ock�or���a��of�a�subsi�iary��o���e�public.

�� leveraged buyout� (LB�)�or�highly leveraged transaction� involves� ��e�purc�ase�of�a�company�finance��primarily�by��eb�.��l��ou���LB�s��ypi�cally�involve�priva�ely�owne��firms�����e��erm�of�en�is�applie��w�en�a�firm�buys�back�i�s�s�ock�usin��primarily�borrowe��fun�s��o�conver��from�a�pub�licly��o�a�priva�ely�owne��company.

Ex�ibi��1���summarizes���e�various�forms�corpora�e�res�ruc�urin��may��ake.

Friendly versus hostile takeovers

In�a�friendly takeover�of�con�rol�����e��ar�e�’s�boar��an��mana�emen��are�recep��ive� �o� ��e� i�ea� an�� recommen�� s�are�ol�er� approval.�To��ain� con�rol��� ��e�acquirin��company�usually�mus��offer�a�premium��o���e�curren��s�ock�price.�T�e�excess�of���e�offer�price�over���e��ar�e�’s�premer�er�s�are�price�is�calle��a�purchase premium�or�acquisition premium1��an��reflec�s���e�perceive��value�of�ob�ainin��a�con�rollin��in�eres��(i.e.�����e�abili�y��o��irec����e�ac�ivi�ies�of���e�firm)�in���e��ar�e������e�value�of�expec�e��syner�ies�(e.�.���cos��savin�s)�resul��in��from�combinin����e��wo�firms���an��any�overpaymen��for���e��ar�e��firm.��verpaymen��is���e�amoun��an�acquirer�pays�for�a��ar�e��firm�in�excess�of���e�presen��value�of�fu�ure�cas��flows���inclu�in��syner�y.�Presen��value�is�an�es�i�ma�e�of���e�curren��value�of�fu�ure�cas��flows����akin��in�o�accoun����e�mini�mum�financial�ra�es�of�re�urn�require��by�inves�ors�an��len�ers.�Cas��receive���o�ay��as�a��i��er�value���an�cas��receive��a��a�la�er��a�e�because�i��can�be�reinves�e��a��some�ra�e�of�in�eres����so�fu�ure�cas��flows�mus��be�re�uce��by�po�en�ial�accumula�e��in�eres��earnin�s��o�es�ima�e���eir�value��o�ay.

�nalys�s� of�en� a��emp�� �o� i�en�ify� ��e� amoun�� of� premium� pai�� for� a�con�rollin�� in�eres�� (i.e.��� control premium)� an�� ��e� amoun��of� incremen�al�

1�� U.S.�mer�er�premiums�avera�e��abou�����percen��be�ween�1����an��1����(�n�ra�e���Mi�c�ell���an��S�affor����2001).�Rossi�an��Volpin�(200�)��ocumen��an�avera�e�premium�of����percen���urin����e�1��0s�for�U.S.�mer�ers.�T�e�au��ors�also�fin��premiums�in����coun�ries�ran�in��from�10�percen��for�Brazil�an��Swi�zerlan���o�120�percen��for�Israel�an��In�onesia.�T�e�wi�e�ran�e�of�es�ima�es�may�reflec����e�value�a��ac�e���o���e�special�privile�es�associa�e��wi���con�rol�in�various�coun�ries.�For�example���insi�ers�in�Russian�oil�companies��ave�been�able��o�cap�ure�a�lar�e�frac�ion�of�profi�s�by�sellin��some�of���eir�oil�a��below�marke��prices��o�firms���ey�own.

Introduction to Mergers and Acquisitions

��

EXHIBIT 1-4 Corporate Restructuring Process

CorporateRestructuring

OperationalRestructuring

FinancialRestructuring

Divestiture,Spinoff, orCarve-Out

Takeover orBuyout

HostileTender Offer

Leveraged/Management

Buyout

Reorganization/Liquidation

Stock Buyback

Statutory

Subsidiary

HostileTakeover

FriendlyTakeover

Merger

Consolidation

Acquisition ofAssets

In Bankruptcy

OutsideBankruptcy

Joint Venture/StrategicAlliance

WorkforceReduction/

Realignment

CorporateRestructuring

OperationalRestructuring

FinancialRestructuring

Divestiture,Spinoff, orCarve-Out

Takeover orBuyout

HostileTender Offer

Leveraged/Management

Buyout

Reorganization/Liquidation

Stock Buyback

Statutory

Subsidiary

HostileTakeover

FriendlyTakeover

Merger

Consolidation

Acquisition ofAssets

In Bankruptcy

OutsideBankruptcy

Joint Venture/StrategicAlliance

WorkforceReduction/

Realignment

Mergers and Acquisitions Basics��

value�crea�e����a����e�acquirer�is�willin���o�s�are�wi�����e��ar�e�’s�s�are�ol��ers.��n�example�of�a�pure control premium�is�a�con�lomera�e�willin���o�pay�a�price�si�nifican�ly�above���e�prevailin��marke��price�for�a��ar�e��firm��o��ain�a�con�rollin��in�eres����even���ou���po�en�ial�opera�in��syner�ies�are�limi�e�.�In�suc��an�ins�ance�����e�acquirer�of�en�believes�i��will�recover���e�value�of���e�con�rol�premium�by�makin��be��er�mana�emen���ecisions�for���e��ar�e��firm.�I��is�impor�an���o�emp�asize���a��w�a��is�of�en�calle��a�con�rol�premium��in���e�popular�or��ra�e�press�is�ac�ually�a�purc�ase�or�acquisi�ion�premium���a��inclu�es�bo���a�premium�for�syner�y�an��a�premium�for�con�rol.

T�e�offer��o�buy�s�ares�in�ano��er�firm���usually�for�cas����securi�ies���or�bo�����is�calle��a�tender offer.��l��ou����en�er�offers�are�use��in�a�number�of� circums�ances��� ��ey� mos�� of�en� resul�� from� frien�ly� ne�o�ia�ions� (i.e.���ne�o�ia�e���en�er�offers)�be�ween���e�boar�s�of���e�acquirer�an����e��ar��e��firm.�T�ose���a��are�unwan�e��by���e��ar�e�’s�boar��are�referre���o�as�hostile tender offers. Self-tender offers�are�use��w�en�a�firm�seeks��o�repur�c�ase�i�s�own�s�ock.

�n� unfriendly takeover� or� hostile takeover� occurs� w�en� ��e� ini��ial� approac�� was� unsolici�e���� ��e� �ar�e�� was� no�� seekin�� a� mer�er��� ��e�approac��was�con�es�e��by���e��ar�e�’s�mana�emen����an��con�rol�c�an�e���an�s�(i.e.���usually�requirin����e�purc�ase�of�more���an��alf�of���e��ar�e�’s�vo�in��common�s�ock).�T�e�acquirer�may�a��emp���o�circumven��mana�e�men��by�offerin���o�buy�s�ares��irec�ly�from���e��ar�e�’s�s�are�ol�ers�(i.e.���a� �os�ile� �en�er� offer)� an�� by� buyin�� s�ares� in� a� public� s�ock� exc�an�e�(i.e.���an�open market purchase).

Frien�ly� �akeovers� are� of�en� consumma�e�� a�� a� lower� purc�ase� price���an��os�ile��ransac�ions.����os�ile��akeover�a��emp��may�a��rac��new�bi���ers�w�o�mi����no��o��erwise��ave�been�in�eres�e��in���e��ar�e�—calle��pu��in����e��ar�e��in play.�In���e�ensuin��auc�ion�����e�final�purc�ase�price�may�be�bi��up��o�a�poin��well�above���e�ini�ial�offer�price.��cquirers�pre�fer�frien�ly��akeovers�because���e�pos�mer�er�in�e�ra�ion�process�is�usually�more�expe�i�ious�w�en�bo���par�ies�are�coopera�in�� fully.�For� ��ese�rea�sons���mos���ransac�ions��en���o�be�frien�ly.

alternative Ways to increase shareholder value

��business alliance�refers��o�a�form�of�combina�ion�o��er���an�M&�.�Suc��alliances� inclu�e� join�� ven�ures��� s�ra�e�ic� alliances��� minori�y� inves�men�s���franc�ises���an��licenses.

�� joint venture� (JV)� is� a� coopera�ive� business� rela�ions�ip� forme�� by��wo� or� more� separa�e� par�ies� �o� ac�ieve� common� s�ra�e�ic� objec�ives.�

Introduction to Mergers and Acquisitions ��

W�ile���e�JV�is�of�en�an�in�epen�en��le�al�en�i�y�suc��as�a�corpora�ion�or�par�ners�ip�forme��for�a�specific�perio��an��for�a�specific�purpose���i��may��ake�any�or�aniza�ional�form��eeme��appropria�e�by���e�par�ies�involve�.�Eac�� JV� par�ner� con�inues� �o� exis�� as� a� separa�e� en�i�y.� JV� corpora�ions��ave���eir�own�mana�emen��repor�in���o�a�boar��of��irec�ors�comprisin��represen�a�ives�of���e�par�icipa�in��companies.

��strategic alliance��enerally�falls�s�or��of�crea�in��a�separa�e�le�al�en�i�y.���s�ra�e�ic�alliance�may�be�an�a�reemen���o�sell�eac��firm’s�pro�uc�s��o���e�o��er’s�cus�omers�or� �o�co��evelop�a� �ec�nolo�y���pro�uc����or�process.�T�e��erms�of�suc��an�a�reemen��may�be�le�ally�bin�in��or�lar�ely�informal.

��minority investment�requires�li��le�commi�men��of�mana�emen���ime�an��may�be��i��ly�liqui��if���e�inves�men��is�in�a�publicly��ra�e��company.���company�may�c�oose��o�assis��small�or�s�ar�up�companies�in���e��evel�opmen��of� pro�uc�s� or� �ec�nolo�ies� i�� fin�s�useful��� receivin�� represen�a��ion�on���e�boar��in�exc�an�e�for���e�inves�men�.�Suc��inves�men�s�may�also� be� oppor�unis�ic� in� ��a�� passive� inves�ors� �ake� a� lon���erm� posi�ion�in�a�firm�believe���o��ave�si�nifican��apprecia�ion�po�en�ial.�For�example���Warren�Buffe��’s�Berks�ire�Ha��away�firm�inves�e��$5�billion�in�Gol�man�Sac�s�in�200��by�acquirin��conver�ible�preferre��s�ock���a��pays�a�10�per�cen�� �ivi�en�.� Berks�ire� Ha��away� also� receive�� warran�s� �o� purc�ase��$5�billion�of�Gol�man�Sac�s�common�s�ock�a��$115�per�s�are.�T�is�exer�cise�price�is�less���an�one��alf�of���e�s�are�price�only�a�year�earlier.

�� license���w�ic��requires�no�ini�ial�capi�al���provi�es�a�convenien��way�for� a� company� �o� ex�en�� i�s� bran�s� �o� new� pro�uc�s� an�� new� marke�s.�T�e�company�simply�licenses�i�s�bran��names��o�o��ers.���company�may�also� �ain� access� �o� a� proprie�ary� �ec�nolo�y� ��rou��� ��e� licensin�� pro�cess.���franchise�is�a�specialize��form�of�a�license�a�reemen����a���ran�s�a�privile�e��o�a��ealer�from�a�manufac�urer�or�franc�ise�service�or�aniza�ion��o�sell���e�franc�iser’s�pro�uc�s�or�services�in�a��iven�area.�Suc��arran�e�men�s�can�be�exclusive�or�nonexclusive.�Un�er�a�franc�ise�a�reemen������e�franc�iser� may� offer� ��e� franc�isee� consul�a�ion��� promo�ional� assis�ance���financin����an��o��er�benefi�s�in�exc�an�e�for�a�s�are�of���e�franc�ise’s�rev�enue.� Franc�ises� represen�� a� low�cos�� way� for� ��e� franc�iser� �o� expan����because� ��e� franc�isee� usually� provi�es� ��e� nee�e�� capi�al.�T�e� success�of�franc�isin������ou������as�been�lar�ely�limi�e���o�in�us�ries�suc��as�fas��foo��services�an��re�ail�in�w�ic��a�successful�business�mo�el�can�be�easily�replica�e�.

T�e� major� a��rac�ion� of� ��ese� al�erna�ives� �o� ou�ri���� acquisi�ion� is���e�oppor�uni�y�for�eac��par�ner��o��ain�access��o���e�o��er’s�skills���pro��uc�s��� an�� marke�s� a�� a� lower� overall� cos�� in� �erms� of� mana�emen�� �ime�

Mergers and Acquisitions Basics�0

an��money.�Major��isa�van�a�es�inclu�e�limi�e��con�rol�����e�nee���o�s�are�profi�s���an����e�po�en�ial�loss�of��ra�e�secre�s�an��skills��o�compe�i�ors.

*�*�*

Mer�ers� an�� acquisi�ions� are� an� impor�an�� c�an�e� a�en�.� Businesses�are�cons�an�ly�c�urnin����an��only���e�mos��innova�ive�an��nimble�survive.�W�en�companies��o� fall� �o� ��e� compe�i�ion��� i�� is�of�en� ��rou���mer�er���acquisi�ion��� bankrup�cy��� �ownsizin���� or� some� o��er� form� of� corpora�e�res�ruc�urin�.�T�e�pace�a��w�ic��failin��businesses��isappear�of�en��epen�s�on� ��eir� size��� ��e� perceive��po�en�ial� impac�� ��ey��ave�on� ��e� economy���an�� �ow� cri�ical� ��ey� are� �o� na�ional� securi�y.� Lar�e� businesses�may� lin��er�for�an�ex�en�e��perio��as���eir�cre�i�ors�rene�o�ia�e�loans.�To�ay�����e�concep��of�“�oo�bi���o�fail”��as�le���o��u�e��overnmen��subsi�ies��o��yin��businesses��o�preven��w�a��may�be�inevi�able.

W�ile�M&�s�are�a�cri�ical�componen��in���e�business�s�ra�e�y�of�some�firms���i��is�impor�an���o�remember���a����ey�represen��only�one�of�several�ways�of�execu�in��business�plans.�T�ere�are�al�erna�ives��� from���e�various�forms�of�business�alliances� �o��oin�� i��on�your�own���rou���a� solo�ven��ure.�W�ic��me��o�� is�c�osen��epen�s�on�mana�emen�’s��esire� for�con��rol���willin�ness��o�accep��risk���an����e�ran�e�of�oppor�uni�ies�presen��a��a�par�icular�momen��in��ime.

A Case in Point: Mars Buys Wrigley in One Sweet DealWrigley Corporation, a U.S.-based leader in gum and confectionary products, had been losing market share since �00� to Cadbury Schweppes in the U.S. gum market. Mars Corporation, a privately owned candy company with annual glo-bal sales of $�� billion, sensed an opportunity to achieve sales, marketing, and distribution synergies by acquiring Wrigley. On April ��, �00�, Mars announced that it had reached an agreement to merge with Wrigley for $�� billion in cash.

The terms of the agreement were approved unanimously by the boards of both firms. Wrigley shareholders would receive $�0.00 in cash for each share of common stock outstanding. The purchase price represented a �� percent pre-mium to Wrigley’s closing share price of $��.�� on the announcement date. The merged firms would, in �00�, enjoy a ��.� percent share of the global confec-tionary market, annual revenue of $�� billion, and ��,000 employees worldwide.

When the deal was consummated in September �00�, it was a strategic blow to the efforts of Cadbury Schweppes to continue as the market leader in the global confectionary market with its gum and chocolate business. Prior to the announcement, Cadbury had a �0 percent worldwide market share.

Introduction to Mergers and Acquisitions ��

Wrigley became a separate standalone subsidiary of Mars, with $�.� billion in sales. The deal helps Wrigley augment its sales, marketing, and distribution capabilities. To provide more focus to the Mars brands and stimulate growth, Mars transferred its global nonchocolate confectionery sugar brands to Wrigley. Bill Wrigley, Jr., remains Executive Chairman of Wrigley, and the Wrigley man-agement team remains in place. The combined companies now have substan-tial brand recognition and product diversity in six growth categories: chocolate, nonchocolate confectionery, gum, food, drinks, and pet-care products. The resulting confectionery powerhouse also expects to achieve significant cost sav-ings by combining manufacturing operations and having a substantial presence in emerging markets.

Although mergers among competitors are not unusual, the deal’s highly leveraged financial structure is atypical of transactions of this type. Almost �0 percent of the purchase price was financed through borrowed funds, with the remainder financed largely by a third-party equity investor. Mars’ upfront exposure consisted of paying for closing costs from its cash balances in excess of its operating needs. JPMorgan Chase and Goldman Sachs provided the debt financing for the transaction, $�� billion and $�.� billion, respectively. Berkshire Hathaway, a nontraditional source of high-yield financing, put in an additional $�.� billion in subordinated debt. Typically, such financing would have been provided by investment banks or hedge funds and subsequently repackaged into securities and sold to long-term investors such as pension funds, insurance companies, and foreign investors, but the meltdown in the global credit markets in �00� forced investment banks and hedge funds to withdraw from the high-yield market in an effort to strengthen their balance sheets. Berkshire Hathaway completed the financing of the purchase price by providing $�.� billion in equity financing in exchange for a �.� percent ownership stake in Wrigley.

Things to Think About:�. Why did Wrigley’s share price not rise to the $�0 offer price following the

announcement of the merger? Why did competitor Cadbury’s shares gain �.� percent following the announcement?

�. Speculate as to how the Wrigley family may have been convinced to sell their firm.

�. How did factors external to both firms specifically influence their decision to merge?

�. Would you characterize this transaction as a friendly or hostile takeover? Why was this particular approach taken?

�. Of the motivations for business combinations outlined in this chapter, which do you think were most applicable in this case study?

Answers can be found at: www.elsevierdirect.com/companion.jsp?ISBN=���0���������

23Mergers and Acquisitions Basics� ©�2011�Elsevier�Inc.ISBN:�����0�12��������2�� ��I: �ll ri���s reserve�.����0�12��������2�� ��I: �ll ri���s reserve�.�����I:� �ll�ri���s�reserve�.

CHAPTER

201110.1016/B����0�12��������2.00002�0

What History Tells Us about M&A Performance

�l��ou�����ere�is�li��le�ques�ion���a����e�fu�ure�of�M&��ac�ivi�y�will�con��inue��o�evolve���reflec�in��new��lobal�compe�i�ion�an����e�c�an�in��re�u�la�ory� clima�e��� i��will� con�inue� �o� be� possible� �o� �raw�parallels�wi��� ��e�pas�.�T�ese�insi���s�s�oul���elp�us��o�un�ers�an���ow��o�a�ap����e�s�ruc��ure�an��financin��of�fu�ure�M&�s.

��ains����is�back�rop�����is�c�ap�er��iscusses�mer�er�ac�ivi�y�in��erms�of�cycles���or�waves���w�ic���en���o�mirror�c�an�es�in���e�business�cycle�as�well�as���e�re�ula�ory�environmen��an���ec�nolo�ical�innova�ion.�You�will�learn�w�y� ��ey�occur� an�� jus���ow� impor�an�� i�� is� �o�un�ers�an���ow�mer�er�waves� can�be� an�icipa�e�.�You� also�will� consi�er�w�e��er�M&�s��� �is�ori�cally����ave�pai��off� for� s�are�ol�ers���bon��ol�ers��� an�� socie�y.�Finally���you�will�explore�a�case���a��illus�ra�es��ow���e�marke��base��process�of�crea�ive��es�ruc�ion�paves���e�way�for�new�an��innova�ive�solu�ions��o�con�empo�rary�c�allen�es�an��i�en�ifies���e�impor�an��role�M&�s��ave�in���is�process.

Merger and acquisition Waves

T�e� followin�� sec�ions� �iscuss� ��e� �e�erminan�s� of� M&�� waves��� ��e� six��iscre�e�perio�s�in�w�ic����ey��ave�occurre����an��w�y�i��is�impor�an���o�an�icipa�e�suc��waves.

Why M&A Waves OccurM&�� ac�ivi�y� in� ��e� Uni�e�� S�a�es� �as� �en�e�� �o� clus�er� in� mul�iyear�waves���wi���six�suc��waves�occurrin��since���e�la�e�1��0s.�T�ere�are��wo�compe�in�� explana�ions� for� ��is� p�enomenon.� �ne� ar�ues� ��a�� mer�er�waves�occur�w�en�firms�in�in�us�ries�reac���o�“s�ocks”�in���eir�opera�in��environmen�s��1� suc�� as� from� �ere�ula�ion;� ��e� emer�ence� of� new� �ec��nolo�ies��� �is�ribu�ion� c�annels��� or� subs�i�u�e� pro�uc�s;� or� a� sus�aine�� rise�in�commo�i�y�prices.�T�e�size�an�� len����of� ��e�M&��wave��epen�s� �o�

2

1� Brealey�an��Myers�(200�);�Mar�ynova�an��Renneboo��(200�);�an��Mi�c�ell�an��Mul�erin�(1��6).

Mergers and Acquisitions Basics24

a� lar�e�par��on��ow�many�in�us�ries�are�affec�e��by���ese�s�ocks���as�well�as� ��e�ex�en��of� ��e� impac�.�Some� s�ocks��� suc�� as� ��e�emer�ence�of� ��e�In�erne���� are� pervasive� in� ��eir� impac�;� o��ers� are� more� specific��� suc�� as��ere�ula�ion� of� financial� services� an�� u�ili�ies� or� rapi�ly� escala�in�� com�mo�i�y� prices.� In� response� �o� s�ocks��� firms� wi��in� ��e� in�us�ry� of�en�acquire�ei��er�all�or�par�s�of�o��er�firms.

T�e� secon�� ar�umen�� is� base�� on� ��e� misvalua�ion� i�ea� (�iscusse�� in�C�ap�er�1)�an��su��es�s���a��mana�ers�use�overvalue��s�ock��o�buy���e�asse�s�of�lower�value��firms.�For�M&�s��o�clus�er�in�waves����oes���e�ar�umen����valu�a�ions�of�many�firms�(measure��by���eir�price��o�earnin�s�or�marke���o�book�ra�ios� compare�� �o� o��er� firms)� mus�� increase� a�� ��e� same� �ime.� Mana�ers�w�ose� s�ocks� are� believe�� �o� be� overvalue�� move� concurren�ly� �o� acquire�companies�w�ose�s�ock�prices�are�lesser�value�2�an����reflec�in����e�influence�of�overvalua�ion�����e�me��o��of�paymen��woul��normally�be�s�ock.�

Experience�su��es�s���a����e�“s�ock”�ar�umen��is�a�s�ron�er�one���espe�cially� if� i�� is�mo�ifie�� �o� inclu�e� ��e� effec�s� of� ��e� availabili�y� of� capi�al�in� causin�� an�� sus�ainin��mer�er�waves.�Capi�al� availabili�y� plays� a� cri�i�cal� role� in� �e�erminin�� mer�er� waves.� S�ocks� alone��� wi��ou�� sufficien��liqui�i�y� �o� finance� ��e� �ransac�ions��� will� no�� ini�ia�e� a� wave� of� mer�er�ac�ivi�y.�Moreover���rea�ily�available��� low�cos��capi�al�may�cause�a�sur�e�in�M&��ac�ivi�y�even�if�in�us�ry�s�ocks�are�absen�����an����is�was�par�icularly�impor�an��in���e�mos��recen��M&��boom.

First Wave (1897–1904): Horizontal ConsolidationM&��ac�ivi�y� in� ��is� firs��wave�was� spurre��by�a��rive� for�efficiency��� lax�enforcemen��of���e�S�erman��n�i�rus���c����wes�war��mi�ra�ion���an���ec��nolo�ical�c�an�e.�Mer�ers��urin����is�perio��were�lar�ely��orizon�al�an��resul�e��in�increase��concen�ra�ion�in�primary�me�als��� �ranspor�a�ion���an��minin�.�Lar�e�companies�absorbe��small�ones.�In�1�01���J.�P.�Mor�an�cre�a�e���merica’s� firs��billion��ollar�corpora�ion���U.S.�S�eel—forme��by� ��e�combina�ion�of���5�separa�e�companies�����e�lar�es��of�w�ic��was�Carne�ie�S�eel.����er��ian�s�forme���urin����is�era�inclu�e�S�an�ar���il���Eas�man�Ko�ak����merican�Tobacco���an��General�Elec�ric.�Frau�ulen��financin��an����e�1�0��s�ock�marke��cras��en�e����e�boom.

2� R�o�es�Kropf�an��Viswana��an�(200�);�S�leifer�an��Vis�ny�(200�).�� Numerous�s�u�ies�confirm���a��lon���erm�fluc�ua�ions�in�marke��valua�ions�an����e�number�of�

�akeovers�are�posi�ively�correla�e�.�See��n�ra�e�e��al.�(2001);��n��an��C�en��(2006);��aniel�e��al.�(1���);�an���on��e��al.�(2006).�However���w�e��er��i���valua�ions�con�ribu�e��o��rea�er��akeover�ac�ivi�y�or�increase��M&��ac�ivi�y�boos�s�marke��valua�ions�is�less�clear.

�� Harfor��(2005).

What History Tells Us about M&A Performance 25

Second Wave (1916–1929): Increasing Concentration�c�ivi�y��urin����is�perio��was�a�resul��of���e�en�ry�of���e�Uni�e��S�a�es�in�o�Worl��War�I�an����e�pos�war�economic�boom.�Mer�ers�also��en�e���o�be� �orizon�al� an�� fur��er� increase�� in�us�ry� concen�ra�ion;� for� example���Samuel�Insull�buil��an�empire�of�u�ili�ies�wi���opera�ions�in����s�a�es.�T�e�s�ock�marke�� cras��of� 1�2���� alon��wi���passa�e�of� ��e�Clay�on��n�i�rus���c����a��fur��er��efine��monopolis�ic�prac�ices���brou������is�era��o�a�close.

Third Wave (1965–1969): The Conglomerate EraT�is�perio��of�M&��ac�ivi�y�was�c�arac�erize��by���e�emer�ence�of�finan�cial�en�ineerin��an��con�lomera�ion.���risin��s�ock�marke��an����e�lon��es��perio��of�unin�errup�e���row���in�U.S.��is�ory��o���a���ime�resul�e��in�recor��price��o�earnin�s�(P/E)�ra�ios.�Companies��iven��i���P/E�ra�ios�by�inves�ors�learne���ow��o��row�earnin�s�per�s�are�(EPS)���rou���acqui�si�ion���ra��er���an���rou���reinves�men�.�Companies�wi����i���P/E�ra�ios�woul��of�en�acquire�firms�wi���lower�P/E�ra�ios�an��increase���e�EPS�of���e� combine�� companies��� w�ic�� in� �urn� boos�e�� ��e� s�are� price� of� ��e�combine��companies—so�lon��as���e�P/E�applie���o���e�s�ock�price�of���e�combine�� companies��i��no�� fall� below� ��e�P/E�of� ��e� acquirin�� com�pany� before� ��e� �ransac�ion.�To� main�ain� ��is� pyrami�in�� effec���� ��ou������ar�e��companies��a�� �o��ave�earnin�s��row���ra�es� sufficien�ly�a��rac�ive��o�convince�inves�ors��o�apply���e��i��er�mul�iple�of���e�acquirin��com�pany� �o� ��e� combine�� companies.� In� �ime��� ��e� number� of� �i����row�����rela�ively� low� P/E� companies� �ecline���� as� con�lomera�es� bi�� up� ��eir�P/Es.�T�e��i��er�prices�pai�� for� ��e� �ar�e�s���couple��wi��� ��e� increasin��levera�e�of���e�con�lomera�es���cause����e�“pyrami�s”��o�collapse.

Fourth Wave (1981–1989): The Retrenchment EraT�e�1��0s���a��eca�e���a��saw���e�rise�of���e�corpora�e�rai�er���were�c�ar�ac�erize�� by� ��e� breakup� of�many�major� con�lomera�es� an�� a� prolifera��ion�of�financial�buyers�usin����e��os�ile��akeover�(rarely�use��previously)�an�� ��e� levera�e�� buyou�� (LB�)� as� ��eir� primary� acquisi�ion� s�ra�e�ies.�Mana�emen��buyou�s�an���akeovers�of�U.S.�companies�by�forei�n�acquirers�became�more�common.�Con�lomera�es�be�an��o��ives��unrela�e��acquisi��ions�ma�e�in���e�1�60s�an��early�1��0s;�in�fac����of�acquisi�ions�ma�e�ou��si�e� ��e� acquirer’s� main� line� of� business� be�ween� 1��0� an�� 1��2��� some��60�percen���a��been�sol��by�1���.5�In�1��������e�me�a�railroa��Burlin��on�Nor��ern� spun� off� i�s� ener�y� proper�ies��� Burlin��on� Resources��� for��5� Wassers�ein�(1���).

Mergers and Acquisitions Basics26

$�.2�billion.�T�e�same�year���Mobil��il�sol��re�ailer�Mon��omery�War��for�$�.�� billion.� In� 1������ Paramoun���� formerly� Gulf� an��Wes�ern� In�us�ries���sol��i�s�finance�company����ssocia�es�Firs��Capi�al���for�$�.��billion.

For� ��e� firs�� �ime��� �akeovers� of� U.S.� companies� by� forei�n� firms�excee�e��in�number�an���ollars���e�acquisi�ions�by�U.S.�firms�of�compa�nies� in� Europe��� Cana�a��� an�� ��e� Pacific� Rim� (exclu�in�� Japan).� Forei�n�purc�asers�were�mo�iva�e��by� ��e� size�of� ��e�marke���� limi�e�� res�ric�ions�on� �akeovers��� ��e� sop�is�ica�ion� of�U.S.� �ec�nolo�y��� an�� ��e�weakness� of���e��ollar�a�ains��major�forei�n�currencies.�Forei�n�companies�also��en�e���o� pay� subs�an�ial� premiums� for�U.S.� companies��� because� ��e� s�ren���� of���eir�currencies�lowere����e�effec�ive�cos��of�acquisi�ions.�Moreover���favor�able�accoun�in��prac�ices�allowe��forei�n�buyers��o�wri�e�off��oo�will� in���e�year�in�w�ic��i��occurre����unlike�U.S.�firms���a���a���o�c�ar�e��oo��will� expense� a�ains�� earnin�s� for� many� years.6�T�e� lar�es�� cross�bor�er��eals� in� ��is�perio�� inclu�e� ��e�Beec�am�Group�PLC�(UK)�purc�ase�of���e�Smi��Kline�Beckman�Corpora�ion� for� $16.1�billion� in�1������Bri�is��Pe�roleum�Corpora�ion’s�1����acquisi�ion�of���e�remainin���5�percen��of�S�an�ar���il�Corpora�ion�for�$�.��billion���an��Campeau�Corpora�ion�of�Cana�a’s�1����purc�ase�of�Fe�era�e���epar�men��S�ores�for�$6.5�billion.

T�e� for�unes� of� LB�s� wane�� �urin�� ��e� �eca�e’s� secon�� �alf.� RJR�Nabisco� exemplifie�� ��e� c�allen�es� face�� by� LB�s� �urin�� ��is� perio�.�Ko�lber����Kravis�&�Rober�s�(KKR)�pai��$2�.5�billion�for���e�company�in�1������a�recor��purc�ase�price�a����e��ime.��espi�e��oin��public�in�1��1���RJR�Nabisco�s�ru��le��un�er���e�bur�en�of�i�s�massive��eb��un�il���e�mi��1��0s���w�en�improvin��cas��flow�enable����e�firm��o�pay�off�a�si�nifican��por�ion.����er�LB���ransac�ions�also�fell�on��ar���imes.�Towar����e�en��of���e�1��0s�����e�level�of�mer�er�ac�ivi�y��apere��off�in�line�wi���a�slowin��economy�an��wi�ely�publicize��LB��bankrup�cies.�Moreover�����e�junk�bon��marke���rie��up�as�a�major�source�of�financin��wi�����e��emise�of��rexel�Burn�am�����e�lea�in��un�erwri�er�an��“marke��maker”�for��i���yiel��securi�ies.

6� Goo�will�represen�s���e�excess�of���e�purc�ase�price�pai��by���e�acquirer�for���e�ne��asse�s�acquire��(i.e.���asse�s�purc�ase��revalue���o���eir�curren��marke��values�less�acquire��liabili�ies).�Concep�ually���i��represen�s�in�an�ible�value�suc��as�bran��names�an��o��er�forms�of�in�ellec�ual�proper�y.�Prior��o��ecember�15���2001�����e�value�of��oo�will�on���e�acquirer’s�balance�s�ee���a���o�be�wri��en�off�(i.e.���amor�ize�)�over�as�lon��as��0�years.�T�is�is�no�lon�er�require����bu��i��mus��be�c�ecke��for�impairmen��in���e�wake�of�any�si�nifican��even����a��may�re�uce���e�value�of���e��oo�will��o�less���an�w�a��is�s�own�on���e�acquirer’s�balance�s�ee��(suc��as���e�loss�of�key�cus�omer�con�rac�s�or�pa�en��or�copyri����pro�ec�ion���or�any��iminu�ion�in���e�value�of���e�bran��of�pro�uc�s�acquire��from���e��ar�e��firm).�W�enever���is�occurs�����e�value�of���e��oo�will�mus��be�revise���ownwar���o�reflec����ese�even�s�wi�����e�amoun��of���e��ownwar��revision�c�ar�e��a�ains����e�firm’s�curren��earnin�s.

What History Tells Us about M&A Performance 27

Fifth Wave (1992–2000): The Age of the Strategic Mega-MergerMany�believe����a����e�M&�s��urin����e�1��0s�were� lar�ely�overprice��an��overlevera�e����an��junk�bon��or��i���yiel��financin��was�consi�ere��unlikely� �o� recover� from� ��e� pummelin�� i�� �a�� �aken� a�� ��e� en�� of� ��e��eca�e.�Consequen�ly���many�assume�� ��a�� �akeovers�woul��no�� re�urn� �o���eir�levels�of���e�la�e�1��0s.

�l��ou��� M&�� ac�ivi�y� �i�� �iminis�� �urin�� ��e� 1��0� recession��� ��e�number� of� �ransac�ions� an�� ��e� �ollar� volume� reboun�e�� s�arply� be�in�nin��in�1��2.�T�e�lon�es��economic�expansion�an��s�ock�marke��boom�in�U.S.��is�ory���unin�errup�e��by�recession���was�powere��by�a�combina�ion�of���e�informa�ion��ec�nolo�y�revolu�ion���con�inue���ere�ula�ion���re�uc�ions�in��ra�e�barriers���an����e��lobal��ren���owar��priva�iza�ion.�Bo�����e��ollar�volume�an��number�of� �ransac�ions� con�inue�� �o� se�� recor�s� ��rou��� ��e�en��of���e�1��0s�before�con�rac�in��s�arply�w�en���e�In�erne��bubble�burs����a�recession��i����e�Uni�e��S�a�es�in�2001���an���lobal��row���weakene�.

Sixth Wave (2003–2007): The Rebirth of LeverageU.S.�financial�marke�s��urin����is�six���wave���especially�from�2005���rou���200����were�c�arac�erize��by�an�explosion�of��i��ly�levera�e��buyou�s�an��priva�e� equi�y� inves�men�s� (i.e.��� �akeovers� finance�� by� limi�e�� par�ner�s�ips)�an����e�prolifera�ion�of�complex�securi�ies�colla�eralize��by�pools�of��eb��an��loan�obli�a�ions�of�varyin��levels�of�risk.�Muc��of���e�financin��of� ��ese� �ransac�ions���as�well� as�mor��a�e�backe�� securi�y� issues��� �ook� ��e�form�of�syn�ica�e���eb��(i.e.����eb��purc�ase��by�un�erwri�ers�for�resale��o���e�inves�in��public).

T�e�syn�ica�ion�process��isperses�suc���eb��amon��many��ifferen��inves��ors.�T�e� issuers� of� ��e� �eb�� �isc�ar�e� muc�� of� ��e� responsibili�y� for� ��e�loans� �o�o��ers� (excep��w�ere� inves�ors��ave� recourse� �o� ��e�ori�ina�ors� if��efaul��occurs�wi��in�a�s�ipula�e���ime).�Un�er�suc��circums�ances��� len�ers��ave�an�incen�ive��o�increase���e�volume�of�len�in���o��enera�e�fee�income�by�re�ucin����eir�un�erwri�in��s�an�ar�s��o�accep��riskier� loans.��f�er�suc��loans�are�sol���o�o��ers���loan�ori�ina�ors�are�likely��o�re�uce���eir�moni�orin��of���em.�T�ese�prac�ices���couple��wi���excee�in�ly�low�in�eres��ra�es�ma�e�possible�by�a�worl��awas��in�liqui�i�y���con�ribu�e���o�excessive�len�in��an��encoura�e�� acquirers� �o� overpay� si�nifican�ly� for� �ar�e�� firms.� Ex�ibi�� 2�1�illus�ra�es��ow���ese�fac�ors�sprea��risk���rou��ou����e��lobal�cre�i��marke�s.

Because� i�� is� �ifficul�� �o� �e�ermine� ��e� ul�ima�e� �ol�ers� of� ��e� �eb��af�er�i��is�sol�����eclinin���ome�prices�an��a�rela�ively�few��i��ly�publicize���efaul�s� in�200���ri��ere��concerns�amon��len�ers���a����e�marke��value�of� ��eir� asse�s� was� ac�ually� well� below� ��e� value� lis�e�� on� ��eir� balance��

Mergers and Acquisitions Basics28

s�ee�s.�Subsequen��wri�e��owns�in���e�value�of���ese�asse�s�re�uce��bank�capi�al.�Re�ula�ors�require�banks��o�main�ain�cer�ain�capi�al��o�asse��ra�ios.�To� res�ore� ��ese� ra�ios� �o� a� level� comfor�ably� above� re�ula�ory� require�men�s��� len�ers� res�ric�e�� new� len�in�.� Bank� len�in�� con�inue�� �o� la�����espi�e� effor�s� by� ��e� Fe�eral� Reserve� �o� increase� s�arply� ��e� amoun��of� liqui�i�y� in� ��e� bankin�� sys�em�by� �irec�ly� acquirin�� bank� asse�s� an��expan�in����e��ypes�of�financial�services�firms���a��coul��borrow�from���e�cen�ral�bank���or�by���e�U.S.�Treasury’s��irec��inves�men��in�selec�e��com�mercial� banks� an��o��er� financial� ins�i�u�ions.�T�us��� ��e� repacka�in�� an��sale�of��eb��in�many��ifferen��forms�con�ribu�e���o�ins�abili�y�in���e�finan�cial�marke�s�in�200�.�T�e�limi�a�ions�of�cre�i��availabili�y�affec�e��no��only���e�abili�y�of�priva�e�equi�y�an���e��e�fun�s��o�finance�new�or�refinance�exis�in���ransac�ions���bu��also�limi�e����e�abili�y�of�o��er�businesses��o�fun����eir�normal�opera�ions.�Compoun�e��by� rapi�ly�escala�in��oil�prices� in�200��an����e�firs���alf�of�200������ese�con�i�ions�con�ribu�e���o���e��lobal�economic� slow�own� in� 200�� an�� 200�� an�� ��e� concomi�an�� slump� in�M&���ransac�ions���par�icularly���ose���a��were��i��ly�levera�e�.

Ex�ibi��2�2�provi�es���e��is�orical��a�a�un�erlyin����e��ren�s�in�bo����lobal� an�� U.S.� mer�er� an�� acquisi�ion� ac�ivi�y� in� recen�� years.� M&��ac�ivi�y� worl�wi�e� reac�e�� an� �is�orical� peak� in� 2000� in� �erms� of� bo�����e�number�an���ollar�value�of� �ransac�ions��� followin��sur�in��economic��row���an����e�In�erne��bubble�of���e�la�e�1��0s.��urin��2000�����e��ollar�value� of� �ransac�ions� in� ��e�Uni�e�� S�a�es� accoun�e�� for� nearly� one��alf�of���e��lobal��o�al.�T�e�ensuin��2001�recession���escala�in��concerns�abou���errorism���an����e�subsequen���ecline�in���e�worl�’s�s�ock�marke�s�cause��bo�����e�number�an���ollar�value�of��lobal�an��U.S.��ransac�ions��o��ecline�

EXHIBIT 2-1 Debt-Financed 2003–2007 M&A Boom

Low InterestRates and DecliningRisk AversionDrive Increasing–Sub-Prime Mortgage Lending–LBO Financing & Other Highly Leveraged Transactions

Investment BanksUnderwrite &Repackage–Mortgages–High-Yield Bonds

Banks &Hedge FundsCreate–Collateralized Debt Obligations (CDOs)–Collateralized Loan Obligations (CLOs)

ForeignInvestors

Buy Highest-Rated Debt

HedgeFunds

Buy Lower-Rated Debt

Investment Banks Lend to Hedge Funds

Low InterestRates and DecliningRisk AversionDrive Increasing–Sub-Prime Mortgage Lending–LBO Financing & Other Highly Leveraged Transactions

Investment BanksUnderwrite &Repackage–Mortgages–High-Yield Bonds

Banks &Hedge FundsCreate–Collateralized Debt Obligations (CDOs)–Collateralized Loan Obligations (CLOs)

ForeignInvestors

Buy Highest-Rated Debt

HedgeFunds

Buy Lower-Rated Debt

Investment Banks Lend to Hedge Funds

What History Tells Us about M&A Performance 29

��rou���2002.�By���en�����ou�����con�i�ions�were�in�place�for�a�resur�ence�in�M&��ac�ivi�y���an��by�200����e��ollar�value�an��number�of�announce���lobal�M&���ransac�ions�ou�si�e���e�Uni�e��S�a�es�reac�e��new��i��s�(see�Ex�ibi�s�2���an��2��).�However����lobal�mer�er� ac�ivi�y��roppe��precipi��ously� in� 200���� reflec�in�� a� lack� of� cre�i���� plun�in�� equi�y� marke�s��� an����e�worl�wi�e�financial�crisis.��T�e�number�an���ollar�value�of�U.S.��rans�ac�ions�as�a�percen��of��lobal�M&���eals�con�inue���o��ecline.

Similarities and Differences among Merger Waves�l��ou��� pa��erns� of� �akeover� ac�ivi�y� an�� ��eir� profi�abili�y� vary� si��nifican�ly� across�M&��waves��� ��ere� are� common� elemen�s.�Mer�ers� �ave�

�� �ccor�in���o��ealo�ic���1���0��previously�announce���eals�value��a��$�11�billion�were�cancele��in�200����un�erscorin����e�malaise�affec�in����e��lobal�M&��marke�.��eals�sponsore��by�priva�e�equi�y�firms�an���e��e�fun�s��i��a�five�year�low�worl�wi�e���fallin���1�percen��in�200��from���e�prior�year��o�$1���billion.

EXHIBIT 2-2 Trends in Announced Mergers and Acquisitions (M&As)*

Year Global M&As U.S. M&As U.S. Share of Global M&As

Number $Value (Billions)

Number $Value (Billions)

Number (%)

$Value (%)

1995 22,027   980 3,510 356 15.9 36.31996 23,166 1,146 5,848 495 25.2 43.21997 22,642 1,676 7,800 657 34.5 39.21998 27,256 2,581 7,809 1,192 28.7 46.21999 31,701 3,439 9,278 1,426 29.3 41.52000 37,204 3,497 9,566 1,706 25.7 48.82001 28,828 1,745 8,290 759 28.8 43.52002 26,270 1,207 7,303 441 27.7 36.52003 27,753 1,333 8,131 559 29.3 41.92004 31,467 1,949 9,783 812 31.1 41.72005 33,574 2,775 10,644 1,045 31.7 37.72006 38,602 3,794 10,977 1,563 28.4 41.22007 43,817 4,169 11,296 1,571 25.8 37.72008 39,597 2,936 9,165 986 23.2 33.6

* All valuations include the value of debt assumed by the acquirer.Source: Thompson Reuters and Dealogic.

Mergers and Acquisitions Basics30

�en�e���o�occur��urin��perio�s�of�sus�aine���i���ra�es�of�economic��row�����low�or��eclinin��in�eres��ra�es���an��a�risin��s�ock�marke�.�His�orically���eac��mer�er�wave��as��iffere�� in� �erms�of� a� specific��evelopmen���� suc��as� ��e�emer�ence�of�a�new��ec�nolo�y;�in�us�ry�focus���suc��as�rail���oil���or�financial�

EXHIBIT 2-3 Dollar Value of Transactions: U.S. versus Global M&A*

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

1995 1998 2001 2004 2007

Global M&A,$Billions

U.S. M&A,$Billions

Global Non-U.S., $Billions

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

1995 1998 2001 2004 2007

Global M&A,$Billions

U.S. M&A,$Billions

Global Non-U.S., $Billions

*All valuations include the value of debt assumed by the acquirer.Source: Thompson Reuters and Dealogic.

EXHIBIT 2-4 Number of Transactions: U.S. versus Global M&A*

1995 1998 2001 2004 2007

Global M&A,Thousands

U.S. M&A,Thousands

Global Non-U.S., Thousands

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

1995 1998 2001 2004 2007

Global M&A,Thousands

U.S. M&A,Thousands

Global Non-U.S., Thousands

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

*All valuations include the value of debt assumed by the acquirer.Source: Thompson Reuters and Dealogic.

What History Tells Us about M&A Performance 31

services;� �e�ree�of� re�ula�ion;� an�� �ype�of� �ransac�ion��� suc�� as��orizon�al���ver�ical���con�lomera�e���s�ra�e�ic���or�financial�(�iscusse��in�more��e�ail�la�er�in���is�c�ap�er).�Ex�ibi��2�5�compares���e�six��is�orical�mer�er�waves.

Why It Is Important to Anticipate Merger WavesNo�� surprisin�ly��� ��ere� is� evi�ence� ��a�� ��e� s�ock� marke�� rewar�s� firms���a��see�an��ac��on�promisin��oppor�uni�ies�early�an��punis�es���ose���a��merely� imi�a�e.�T�ose� pursuin�� ��ese� oppor�uni�ies� early� on� pay� lower�prices� for� �ar�e�� firms� ��an� ��e� followers.� �ne� review� of� ���1��� public�companies� ��a��acquire��o��er� firms�be�ween�1����an��200�� foun�� ��a����e� �eals� comple�e���urin�� ��e� firs�� 15�percen�� of� a� consoli�a�ion�wave��ave�s�are�prices���a��ou�perform�si�nifican�ly���e�overall�s�ock�marke��as�well�as���ose��eals���a��follow�muc��la�er�in���e�cycle�w�en���e�purc�ase�price�of��ar�e��firms��en�s��o�escala�e.��Consequen�ly�����ose���a��are�la�e�in�pursuin��acquisi�ion��ar�e�s�are�more�likely��o�overpay.

do Mergers and acquisitions Pay off for shareholders, Bondholders, and society?

T�e� answer� �o� w�e��er� M&�s� pay� off� seems� �o� �epen�� on� w�om�an�� over� w�a�� perio�.� �n� avera�e��� �o�al� s�are�ol�er� �ains� aroun�� ��e�announcemen���a�e�of�an�acquisi�ion�or�mer�er�are�si�nifican�ly�posi�ive;��owever���mos��of���e��ain�accrues��o��ar�e��firm�s�are�ol�ers.�Moreover���in���e���ree��o�five�years�af�er�a��akeover���many�acquirer�firms�ei��er�un�er�perform�compare��wi�����eir�in�us�ry�peers�or��es�roy�s�are�ol�er�value.�I�� is� less�clear�w�e��er���is� sub�par�performance�an��value��es�ruc�ion�is��ue��o���e�acquisi�ion�or��o�o��er�fac�ors.

Researc�ers�use�a�wi�e�varie�y�of�approac�es��o�measure���e�impac��of��akeovers�on�s�are�ol�er�value.��W�a��follows�is�a��iscussion�of���e�resul�s�of���e��wo�mos��common��ypes�of�analyses�of�pre��an��pos�mer�er�re�urns:���e�“even��s�u�y”���a��examines�abnormal�s�ock�re�urns��o���e�s�are�ol�ers��

�� In�an�analysis�of����empirical�s�u�ies�be�ween�1��0�an��2006���Zola�an��Meier�(200�)�i�en�ifie���12��ifferen��approac�es��o�measurin����e�impac��of��akeovers�on�s�are�ol�er�value.��f���ese�s�u�ies�����1�percen��use���e�even��s�u�y�me��o���o�analyze�premer�er�re�urns���an��2��percen��u�ilize��lon���erm�accoun�in��measures��o�analyze�pos�mer�er�re�urns.

�� McNamara�e��al.�(200�).�T�e�s�u�y��efine��a�mer�er�consoli�a�ion�wave�as�a�cycle�in�w�ic����e�peak�year��a��a��rea�er���an�100�percen��increase�from���e�firs��year�of���e�wave���followe��by�a��ecline�in�acquisi�ion�ac�ivi�y�of��rea�er���an�50�percen��from���e�peak�year.�For�some�of���e�12�in�us�ries�s�u�ie����consoli�a�ion�waves�were�as�lon��as�six�years.�T�ere�is�also�evi�ence���a��acquisi�ions�early�in���e�M&��cycle�pro�uce�financial�re�urns�over�50�percen��an����on�avera�e���crea�e�1�.5�percen��more�value�for�acquirer�s�are�ol�ers.�See�Gell�e��al.�(200�).

Mergers and Acquisitions Basics

32

EXHIBIT 2-5 U.S. Historical Merger WavesTime Period Driving Force(s) Type of M&A Activity Key Impact Key Transactions Factors Contributing to

End of Wave

1897–1904 Drive for efficiencyLax antitrust law 

enforcementWestward migrationTechnological 

change

Horizontal consolidation

Increasing concentration:Primary metalsTransportationMining

U.S. SteelStandard OilEastman KodakAmerican TobaccoGeneral Electric

Fraudulent financing1904 stock market crash

1916–1929 Entry into WWIPost–WWI boom

Largely horizontal consolidation

Increased industry concentration

Samuel Insull builds utility empire in 39 states called Middle West Utilities

1929 stock market crashClayton Antitrust Act

1965–1969 Rising stock marketSustained economic 

boom

Growth of conglomerates

Financial engineering and conglomeration

LTVITTLitton IndustriesGulf and WesternNorthwest Industries

Escalating purchase prices

Excessive leverage

1981–1989 Rising stock marketEconomic boomUnderperformance 

of conglomerates

Retrenchment eraRise of hostile 

takeoversCorporate raiders

Break-up of conglomerates

Increased use of junk (unrated) bonds to finance transactions

RJR Nabisco MBOBeecham Group (U.K.) 

buys SmithKline Beckman

Widely publicized bankruptcies

1990 recession

What H

istory Tells Us about M

&A Performance

33

Relative weakness of U.S. dollar

Favorable regulatory environment

Favorable foreign accounting practices

Proliferation of financial buyers using highly leveraged transactions

Increased takeover of U.S. firms by foreign buyers

Campeau of Canada buys Federated Stores

1992–2000 Economic recoveryBooming stock 

marketInternet revolutionLower trade barriersGlobalization

Age of strategic mega-merger

Record levels of transactions in terms of numbers and prices

AOL acquires Time Warner

Vodafone AirTouch acquires Mannesmann

Exxon buys Mobil

Slumping economy and stock market in 2001–02

Escalating terrorism

2003–2007 Low interest ratesRising stock marketBooming global 

economyGlobalizationHigh commodity 

prices

Age of cross-border transactions, horizontal megamergers, and growing influence of private equity investors

Increasing synchronicity among the world’s economies

Mittal acquires Arcelor

P&G buys GilletteVerizon acquires MCIBlackstone buys 

Equity Office Properties

Loss of confidence in global capital markets

Economic slowdown in industrial nations

Mergers and Acquisitions Basics34

of� bo��� bi��ers� an�� �ar�e�s� aroun�� ��e� announcemen�� of� an� offer� (��e�“even�”)� an�� inclu�es� bo��� successful� (i.e.��� comple�e�� �ransac�ions)� an��unsuccessful� �akeovers��� an�� ��e�use�of� accoun�in��measures� �o��au�e� ��e�impac��on�s�are�ol�er�value�af�er���e�mer�er��as�been�comple�e�.

Premerger Returns to ShareholdersPosi�ive� abnormal returns� represen�� �ains� for� s�are�ol�ers��� w�ic�� coul��be�explaine��by�suc��fac�ors�as�improve��efficiency���pricin��power���or��ax�benefi�s.�T�ey�are�abnormal�in���e�sense���a����ey�excee��w�a��an�inves��or�woul��normally�expec���o�earn�for�accep�in��a�cer�ain�level�of�risk.�For�example���if�an�inves�or�can�reasonably�expec���o�earn�a�10�percen��re�urn�on�a�s�ock�bu��ac�ually�earns�25�percen���ue��o�a��akeover�����e�abnormal�or�excess� re�urn� �o� ��e� s�are�ol�er�woul��be�15�percen�.��bnormal� re�urns�are�calcula�e��by�sub�rac�in����e�ac�ual�re�urn�from�a�benc�mark�in�ica��in��inves�ors’�require��re�urns���w�ic��of�en�are�approxima�e��by���e�capi�al�asse��pricin��mo�el�or���e�re�urn�on���e�S&P�500�s�ock�in�ex.��bnormal�re�urns�are�forwar��lookin��in���a��s�are�prices�usually�represen����e�pres�en�� value� of� expec�e�� fu�ure� cas�� flows.�T�erefore��� ��e� lar�e� announce�men��re�urns�coul��reflec��an�icipa�e��fu�ure�syner�ies�resul�in��from���e�combina�ion�of���e��ar�e��an��acquirin��firms.

Ex�ibi��2�6�provi�es�some�empirical�evi�ence�of�abnormal�re�urns��o�bi��ers�an���ar�e�s�aroun��announcemen���a�es.

High Returns for Target Shareholders in Successful and Unsuccessful BidsW�ile�avera�in���0�percen��be�ween�1�62�an��2001���abnormal�re�urns�for��en�er�offers��ave�risen�s�ea�ily�over��ime��10�reflec�in����e�frequen��bi��er�s�ra�e�y�of�offerin��a�subs�an�ial�premium��o�preemp��o��er�po�en�ial�bi���ers� an�� ��e� po�en�ial� for� revisin�� ��e� ini�ial� offer� because� of� compe�in��bi�s.� ���er� con�ribu�in�� fac�ors� inclu�e� ��e� increasin�� sop�is�ica�ion� of��akeover��efenses���as�well�as�fe�eral�an��s�a�e�laws�requirin��bi��ers��o�no�ify��ar�e�� s�are�ol�ers� of� ��eir� in�en�ions� before� comple�in�� ��e� �ransac�ion.�Moreover�����e�abnormal��ains��en���o�be��i��er�for�s�are�ol�ers�of��ar�e��firms���w�ose�financial�performance�is�expec�e���o��e�eriora�e�over���e�lon���erm.11�T�is�may�su��es����a����e�bi��in��firms�see���e��i��es��po�en�ial�for��ain�amon����ose� �ar�e�� firms�w�ose�mana�emen�� is�viewe��as� incompe��en�.�Re�urns�from��os�ile��en�er�offers��ypically�excee����ose�from�frien�ly�

10� B�a�a�����on����Hirs�leifer���an��Noa��(2005).11� G�os��an��Lee�(2000).

What H

istory Tells Us about M

&A Performance

35

EXHIBIT 2-6 Empirical Evidence on Abnormal Returns to Bidders and Targets Around Announcement Dates1

Total Gains from Takeovers2 Target Shareholders Bidder Shareholders

1.  On average, takeovers increasetakeovers increase the combined market value of the merged firms, with target shareholders earning large positive returns and bidding  firm shareholders, on average, showing little or no abnormal return.

2.  The largest gains are realized  at the beginning of a takeover wave.

3.  Takeovers with the largest  losses come during the second half of a takeover wave.

1.  For the two-week period around the announcement date, returns range  from 14–44%.

2.  Average returns vary by period:–1960s: 18–19%–1980s: 32–35%–1990s: 32–45%

3.  Average returns vary by type of bid:–Hostile bids: 32%–Friendly bids: 22%

4.  Returns are higher for all-cash bids  than for all-equity offers.

5.  Target share prices often react as  much as six weeks prior to an announcement reflecting  speculation or insider trading.

1.  For the two-week period around the announcement date, average returns are close to zero when the target is a public firm. Some studies show small positive gains; others show small losses.

2.  Returns can be 2–3% when the target is a private firm as the target’s performance benefits from increased monitoring by the acquiring firm.

3.  In the United States all-equity financed transactions are associated with negative abnormal returns and underperform all-cash bids.

4.  In Europe, all-equity M&As are associated with positive returns (often exceeding all-cash bids), reflecting the greater concentration of ownership and the tendency of blockholders of stock to more closely monitor management.

Source: Adapted from Martynova and Renneboog (2008).1 Results based on 65 studies of successful nonfinancial (friendly and hostile) M&As in the United States, the United Kingdom, and Continental Europe. Studies include horizontal, vertical, and conglomerate mergers, as well as tender offers. The studies also include related and unrelated takeovers; and all-stock, all-cash, and mixed forms of payment involving both public and private firms. Financial returns in these studies usually are computed over a period starting immediately before and ending shortly after the announcement date of the transaction. Moreover, these studies usually assume that share prices fully adjust to reflect anticipated synergies; therefore, they are believed to reflect both the short- and long-term effects of the acquisition.2 Includes the sum of returns to target and acquirer shareholders.

Mergers and Acquisitions Basics36

mer�ers���w�ic��are�c�arac�erize��by�less�con�en�ious�ne�o�ia�e��se��lemen�s�be�ween� ��e� boar�s� an�� mana�emen�� of� ��e� bi��er� an�� ��e� �ar�e�� firm.�Moreover���frien�ly��akeovers�of�en��o�no��receive�compe�in��bi�s.

Unsuccessful� �akeovers�may�also�resul�� in�si�nifican��re�urns� for� �ar�e��company� s�are�ol�ers� aroun�� ��e� announcemen�� �a�e��� bu��muc�� of� ��e��ain��issipa�es� if� ano��er�bi��er��oes�no�� appear.�T�e� imme�ia�e��ain� in��ar�e��s�are�prices�followin��a�mer�er�announcemen���isappears�wi��in�a�year� if� ��e��akeover�a��emp��fails.12�So����o�realize�abnormal�re�urns��� �ar�e��firm�s�are�ol�ers�mus��sell���eir�s�ares�s�or�ly�af�er���e�announcemen��of�a�faile���akeover�a��emp�.

Returns to Acquirer Shareholders May Not Be So DisappointingIn� ��e� a��re�a�e��� re�urns� �o� acquirer� s�are�ol�ers� are� mo�es�� �o� sli���ly�ne�a�ive�for�successful��akeovers���w�e��er���rou����en�er�offers�or�mer��ers.�Bi��er�re�urns��enerally��ave��ecline�� sli���ly�over� �ime���as� ��e�pre�miums�pai��for��ar�e�s��ave�increase�.�Even�if���e�excess�re�urns�are�zero�or�sli���ly�ne�a�ive��� ��ese�re�urns�are�consis�en��wi���re�urns� in�compe�i��ive�marke�s� in�w�ic�� financial� re�urns� are� propor�ional� �o� risk� assume��by���e�avera�e�compe�i�or�in���e�in�us�ry.�For�unsuccessful��akeovers���bi���er�s�are�ol�ers��ave�experience��ne�a�ive�re�urns�in���e�5��o���percen��ran�e��1��per�aps� reflec�in�� inves�ors’� reassessmen��of� ��e�bi��er’s�business�plan�more���an�concerns�abou����e�acquisi�ion.1�

Bi��ers� wi��� low� levera�e� s�ow� a� �en�ency� �o� pay� �i��� purc�ase��premiums.15�No��surprisin�ly���suc��bi��ers�are�in�a�posi�ion��o�pay��i��er�prices���an�more�levera�e��bi��ers.�However�����is��en�ency�may�also�resul��in�suc��bi��ers�overpayin��for��ar�e��firms���w�ic��increases���e��ifficul�y�in�earnin����e�acquirer’s�cos��of�capi�al�on�ne��acquire��asse�s�w�en���ey�are�res�a�e���o�reflec����eir�fair�marke��value.

Focusin��on�a��re�a�e� re�urns� �o�acquirer� s�are�ol�ers�can�by��i��ly�mislea�in�.�T�e� resul�s�can�be��is�or�e��by�a� rela�ively� few� lar�e� �ransac��ions.16�W�e��er� abnormal� re�urns� �o� acquirers� are� posi�ive� or� ne�a�ive�

12� �k�i�be���Bor�e���an��W�y�e�(2000);�Bra�ley����esai���an��Kim�(1���);�an��Sullivan���Jensen���an��Hu�son�(1���).

1�� Bra�ley����esai���an��Kim�(1���).1�� Grinbla���an��Ti�man�(2002).15� Morellec�an��Z��anov�(200�);�Uysal�(2006).16� Moeller�e��al.�(2005).��cquirer�re�urns�aroun���ransac�ion��a�es�were�in���e�a��re�a�e�posi�ive�

�urin����e�1��0s�(aroun��1.5�percen�)���par�icularly��urin����e�1��0–1����perio�.�However���losses�incurre��by�a�rela�ively�few�me�a��ransac�ions�be�ween�1����an��2001�offse��muc��of���e��ains��urin����e�earlier�perio�.

What History Tells Us about M&A Performance 37

varies�wi�����e�c�arac�eris�ics�of���e�acquirer�����e��ar�e����an����e��eal�(�is�cusse��in�more��e�ail�la�er�in���is�c�ap�er).�Fur��er���al��ou���even��s�u�ies��rea��acquisi�ions�as�a� sin�le�even�����ains� from�a� specific�acquisi�ion�of�en��epen��on�subsequen��acquisi�ions�un�er�aken��o�implemen��a�firm’s�busi�ness� s�ra�e�y��1�� an�� because� of� po�en�ial� syner�ies� amon�� ��e� acquire��firms�(e.�.���cos��savin�s�an��cross�sellin��oppor�uni�ies)�����e�success�or�fail�ure�of���ese�acquisi�ions�s�oul��be�evalua�e��in���e�con�ex��of���e�en�ire�s�ra�e�y� an��no�� as� s�an�alone� �ransac�ions.�Finally��� ��ere� is� evi�ence� ��a����e� ini�ial� s�ock�marke�� reac�ion� �o� ��e� announcemen�� of� an� acquisi�ion�of�en�is�biase��or�incomple�e.1�

Postmerger Returns to ShareholdersT�e� objec�ive� of� examinin�� pos�mer�er� accoun�in�� or� o��er� perfor�mance� measures� suc�� as� cas�� flow� an�� opera�in�� profi���� usually� �urin����e� ��ree�� �o� five�year� perio�� followin�� closin���� is� �o� assess� �ow�perfor�mance�c�an�e�.�T�e�evi�ence����owever���is�conflic�in��abou����e�lon���erm�impac�� of� M&�� ac�ivi�y.�W�ere� some� s�u�ies� fin�� a� be��er���an�avera�e�c�ance� ��a��M&�s� crea�e� s�are�ol�er� value��� o��ers� fin�� ��a�� as�many� as�50� �o� �0� percen�� �ave� un�erperforme�� ��eir� in�us�ry� peers� or� faile�� �o�earn���eir�cos��of�capi�al.1��W�a��may�seem�like�a��ubris��riven�inabili�y��of�CE�s�an��boar�s��o�learn�from���e�pas��(because���e�number�an��size�of��ransac�ions�con�inue��o�increase�over��ime)�looks�more�like���e�resul��of��

1�� Barkema�an��Sc�ijven�(200�).�For�example���in�an�effor���o�become���e�na�ion’s�lar�es��consumer�len�er���Bank�of��merica�spen��more���an�$100�billion��o�acquire�cre�i��car��company�MBN��in�2005���mor��a�e�len�er�Coun�rywi�e�in�200����an����e�inves�men��firm/broker�Merrill�Lync��in�200�.

1�� Harrison�e��al.�(2005).�Even��s�u�ies�assume���a��marke�s�are��i��ly�efficien��an��s�are�prices�reflec��all�of���e�public�an��priva�e�informa�ion�available�wi���respec���o���e��ransac�ion.�In�prac�ice���muc��of���e��a�a�provi�e��by���e�seller��o���e�buyer�are�confi�en�ial�an����erefore�lar�ely�unavailable��o���e�public.�Fur��ermore�����e�inves�in��public�of�en�is�unaware�of���e��ar�e�’s�specific�business�plan�a����e��ime�of���e�announcemen����makin��a�comparison�of�w�e��er��o�con�inue��o��ol��or�sell���e��ar�e�’s�s�ock��ifficul�.�Zola�an��Meier�(200�)�no�e����a��s�or���erm�even��s�u�ies�resul�s��o�no��correla�e�wi���any�of���e�o��er�measures�of�M&��performance�because���e�“blip”�in���e�financial�re�urns�of���e�buyer�an��seller�on�or�abou����e�announcemen���a�e�of�en�reflec�s���e�“collec�ive�be�”�by�inves�ors�on���e�probable�success�or�failure�of���e�mer�er.�Suc��be�s�are�of�en�wron����provi�in��evi�ence�con�rary��o���e�of�en�presume��efficiency�of���e�financial�marke�s.

1�� In�a�review�of�26�s�u�ies�of�pos�mer�er�performance��urin����e����o�5�years�af�er���e�mer�er���Mar�ynova�an��Renneboo��(200�)�foun����a��1��s�owe��a��ecline�in�opera�in��re�urns������provi�e��posi�ive�(bu��s�a�is�ically�insi�nifican�)�c�an�es�in�profi�abili�y���an��5�s�owe��a�posi�ive�an��s�a�is�ically�si�nifican��increase�in�profi�abili�y.�T�e��iversi�y�of�conclusions�abou��pos�mer�er�re�urns�may�be���e�resul��of�sample�an���ime�selec�ions���me��o�olo�y�employe��in���e�s�u�ies���or�fac�ors�unrela�e���o���e�mer�er�suc��as�a�slowin��economy�(Barber�an��Lyon���1���;�Fama���1���;�Lyon���Barber���an��Tsai���1���).

Mergers and Acquisitions Basics38

me��o�olo�ical�issues�an����e�failure��o��is�in�uis��amon��al�erna�ive�si�u�a�ions� in�w�ic��M&�s�occur��� lea�in�� �o� an�un�ers�a�emen��of� po�en�ial�re�urns��o�acquirers.20

Specific Characteristics Vary Acquirer ReturnsW�e��er�acquisi�ions�lea���o��ains�on�avera�e�for�acquirer�s�are�ol�ers�is�problema�ic.�However��� ��ere� is� s�ron�� evi�ence� ��a�� abnormal� re�urns� �o�acquirer� s�are�ol�ers� are� lar�ely� si�ua�ional��� varyin�� accor�in�� �o� size� of���e�acquirer�����e�size�of�an���ype�of��ar�e��(i.e.���publicly��ra�e��or�priva�e)���an����e�form�of�paymen��(i.e.���cas��or�s�ock).

Smaller Acquirers Tend to Realize Higher ReturnsT�e� size� of� ��e� acquirer� an�� financial� re�urns� realize�� on� mer�ers� an��acquisi�ions�are�inversely�rela�e����wi���rela�ively�smaller�acquirers���on�aver�a�e���realizin��lar�er�abnormal�re�urns���an�lar�er�acquirers.�W�y?�I��seems��o�be�a�func�ion�of�mana�emen��overconfi�ence�an����e�empire�buil�in���en�encies�of�lar�e�firms.�For���e�20�year�perio��en�in��in�2001���researc��ers� foun�� ��a�� lar�e� firms� �es�roye�� s�are�ol�er� weal����� w�ereas� small�firms�crea�e��weal��.21

Returns Are Often Positive for Private or Subsidiary TargetsU.S.� acquirers� of� priva�e� firms� or� subsi�iaries� of� publicly� �ra�e�� firms�of�en�realize�posi�ive�excess�re�urns�of�1.5��o�2.6�percen�.22��cquirers�are�incline�� �o� pay� less� for� nonpublicly� �ra�e�� companies� �ue� �o� ��e� �iffi�cul�y�of�buyin��priva�e�firms�or�subsi�iaries�of�public�companies.�In�bo���cases��� s�ares�are�no��publicly� �ra�e����an��access� �o� informa�ion� is� limi�e�.�Moreover�����ere�may�be�fewer�bi��ers�for�nonpublicly��ra�e��companies.�Consequen�ly�����ese��ar�e�s�may�be�acquire��a��a��iscoun��from���eir�ac�ual�

20� Presumably�����e�lon�er���e�pos�mer�er�perio��analyze������e��rea�er���e�likeli�oo����a��o��er�fac�ors���w�olly�unrela�e���o���e�mer�er���will�affec��financial�re�urns.�Moreover�����ese�lon�er��erm�s�u�ies�are�no��able��o�compare��ow�well���e�acquirer�woul���ave��one�wi��ou����e�acquisi�ion.

21� Moeller�e��al.�(200�).�Small�firms�are��efine��as���e�smalles��25�percen��of�firms�lis�e��on���e�New�York��S�ock�Exc�an�e�eac��year��urin����a��20�year�perio�.�For�y�six�percen��of�a�sample�of�12��02���ransac�ions�involve��acquisi�ions�of�priva�e�firms����2�percen��involve��acquisi�ions�of�subsi�iaries���an����e�remainin��22�percen��involve��acquisi�ions�of�public�firms.�Re�ar�less�of��ow���ey�were�finance��(i.e.���s�ock�or�cas�)�or�w�e��er���ey�were�public�or�priva�e��ar�e�s���acquisi�ions�ma�e�by�smaller�firms��a��announcemen��re�urns�1.55�percen���i��er���an�a�comparable�acquisi�ion�ma�e�by�a�lar�er�firm.

22� �n��e��al.�(2001);�Fuller�e��al.�(2002);�an��Moeller�e��al.�(2005).�Similar�resul�s�were�foun��in�an�ex�aus�ive�s�u�y�of�U.K.�acquirers�(�raper�an��Pau�yal���2006)�makin��bi�s�for�priva�e�firms�or�subsi�iaries�of�public�firms���w�ere���e�posi�ive�abnormal�re�urns�were�a��ribu�e���o���e�rela�ive�illiqui�i�y�of�suc��businesses.

What History Tells Us about M&A Performance 39

economic�value�(i.e.���cas���enera�ion�po�en�ial).��s�a�consequence�of���is��iscoun����bi��er�s�are�ol�ers�are�able��o�realize�a�lar�er�s�are�of���e�an�ici�pa�e��syner�ies�resul�in��from�combinin����e�acquirer�an���ar�e��firms.

Relatively Small Deals May Generate Higher Returns�vera�e��ar�e��size�appears��o�play�an�impor�an��role�in��e�erminin��finan�cial�re�urns��o�acquirer�s�are�ol�ers.2��Hi����ec��firms�of�en�acquire�small���bu��rela�e�����ar�e��firms��o�fill��aps�in���eir�pro�uc��offerin�s.�Consequen�ly�����e� con�ribu�ion� of� ��ese� acquisi�ions� s�oul�� no�� be� viewe�� in�ivi�u�ally���bu��in��erms�of���eir�impac��on���e�implemen�a�ion�of���e�acquirer’s�overall�business�s�ra�e�y.�Lar�er��eals��en���o�be�more�risky�for�acquirers2��an����as�a�percen�a�e�of���e�acquirin��firms’�equi�y���s�ow�consis�en�ly�lower�pos�mer�er� performance��� possibly� reflec�in�� ��e� c�allen�es� of� in�e�ra�in��lar�e��ar�e��firms�an��realizin��projec�e��syner�ies�on�a��imely�basis.

Un�er�cer�ain�circums�ances�����ou�����lar�er��eals�may�offer�si�nifican��posi�ive� abnormal� ra�es� of� re�urns.� For� ins�ance��� acquirers’� re�urns� from�buyin��pro�uc��lines�an��subsi�iaries�of�o��er�companies��en���o�be��i��er�w�en���e�size�of���e�asse��is�lar�e�rela�ive��o���e�buyer�an��small�rela�ive��o���e� seller.25�Specifically��� in��eals�w�ere� ��e��ives�e��uni�� represen�s�more���an�50�percen��of���e�value�of���e�buyer�bu��less���an�10�percen��of���e�value�of���e�seller���acquirer�re�urns�are���ree��imes���ose�of��eals�in�w�ic����e� �ives�e�� uni�� represen�s� abou�� ��e� same� s�are� of� value� �o� ��e� buyer�an��seller.�T�e�implica�ion� is� ��a��paren�� firms� in�eres�e�� in� fun�in��new�oppor�uni�ies�are�more�likely��o��ives��rela�ively�small�businesses�no���er�mane��o���eir�core�business�s�ra�e�y�a��rela�ively�low�prices��o�raise�capi�al�quickly.�Buyers� are� able� �o� acquire� sizeable�businesses� a�� favorable�prices���increasin����e�likeli�oo����ey�will�be�able��o�earn���eir�cos��of�capi�al.

Cash Deals Often Exceed Equity-Financed DealsMana�ers��en���o�issue�s�ock�w�en���ey�believe�i��is�overvalue�.��ver��ime���inves�ors� learn� �o� �rea�� suc���ecisions�as� si�nals� ��a�� ��e�s�ock� is�overval�ue��an��sell���eir�s�ares�w�en���e�new�equi�y�issue�is�announce����causin����e�firm’s�s�are�price��o��ecline.�T�ere�is�consi�erable�evi�ence���a��bi���in��firms�usin��cas���o�purc�ase���e��ar�e��firm�ex�ibi��be��er�lon���erm��

2�� For���e�10�year�perio��en�in��in�2000����i����ec��companies���avera�in�����percen��annual��o�al�re�urn��o�s�are�ol�ers���acquire���ar�e�s�wi���an�avera�e�size�of�less���an�$�00�million���abou���1�percen��of���e�marke��value�of���e�acquirin��firms�(Frick�an��Torres���2002).

2�� Hackbar���e��al.�(200�).25� Gell�e��al.�(200�).

Mergers and Acquisitions Basics40

performance� ��an� �o� ��ose� usin�� s�ock��� since� inves�ors� an�icipa�e� ��a��s�ock�finance�� mer�ers� un�erperform� precisely� because� inves�ors� �rea��s�ock�financin��as�a�si�nal���a��s�ares�are�overvalue�.26

Usin��s�ock��o�acquire�a�firm�of�en�resul�s�in�announcemen��perio���ains��o� bi��er� s�are�ol�ers� ��a�� �issipa�e�wi��in� ��ree� �o� five� years��� even�w�en���e�acquisi�ion�was�successful.2��T�ese�fin�in�s�imply���a��s�are�ol�ers�sellin��aroun����e�announcemen���a�es�may�realize���e�lar�es���ains�from�ei��er��en��er�offers�or�mer�ers.�Tar�e��s�are�ol�ers�w�o��ol��on�o���e�acquirer’s�s�ock�receive��as�paymen��for���eir�s�ares�may�see���eir��ains��iminis��over��ime.

Some� ar�ue� ��a�� equi�y� overvalua�ion�occurs�w�en� a� firm’s�mana�e�men��canno��expec���o�make�inves�men�s���a��will�sus�ain���e�curren��s�are�price� excep��by� c�ance.2��Consequen�ly���mana�emen��will� be� en�ice�� �o�pursue�lar�er���more�risky�inves�men�s�(suc��as�unrela�e��acquisi�ions)�in�a�vain�a��emp���o�suppor����e�overvalue��s�are�price.�T�ese�ac�ions��es�roy�s�are�ol�er� value� because� ��e� firm� is� unable� �o� earn� i�s� cos�� of� capi�al.�Consequen�ly�����e�lon�er��erm�performance�of���e�combine��firms�suffers�as���e�s�ock�price��eclines��o�i�s�in�us�ry�avera�e�performance.

�bnormal� re�urns� �o� acquirers� are� ne�a�ively� rela�e�� �o� equi�y� offers���bu�� no�� �o� cas�� offers.� However��� ��ere� appears� �o� be� no� �ifference� in�abnormal�re�urns� for�cas��offers� for�public� firms���equi�y�offers� for�public�firms���an��equi�y�offers� for�priva�e� firms�w�en�suc��firms�ex�ibi�� similar�business�specific� risk� (e.�.��� ins�i�u�ional�owners�ip��� �row��� ra�es��� levera�e���pro�uc��offerin�s���e�c.).2�

Successful� acquirers� usin�� s�ock� as� ��e� form� of� paymen�� si�nifican�ly�ou�perform�unsuccessful� a��emp�s� by� a�wi�e�mar�in.�0� I�� seems� ��a�� ��e�rela�ively�be��er�performance�of�successful�s�ock�finance��acquirers�resul�s�from� ��eir� abili�y� �o� use� ��eir� overvalue�� s�ock� �o� buy� ��e� �ar�e�� firm’s�asse�s�rela�ively�inexpensively.�1

2�� Moeller�e��al.�(200�).�0� Savor�an��Lu�(200�).��ver���e�firs��year�����e�mean�abnormal�financial�re�urn�for�acquirers�usin��

s�ock�is�a�ne�a�ive���percen����reac�in��a�ne�a�ive�cumula�ive�1��percen��a����e�en��of���ree�years.�However���acquirers�usin��s�ock�w�o�fail�in���eir��akeover�a��emp�s��o�even�worse���experiencin��ne�a�ive�re�urns�of�21�percen��an���2�percen��af�er�one�year�an����ree�years���respec�ively���followin����eir�abor�e���akeover�a��emp�s.

�1� S�u�ies�of�European�firms�in�ica�e���a��pos�mer�er�re�urns��o�bi��ers�usin��s�ock�of�en�are��i��er���an���ose�usin��cas�.�T�ese�resul�s�may�reflec����e��rea�er�concen�ra�ion�of�owners�ip�in�European�firms���an�in���e�Uni�e��S�a�es�an����e��en�ency�of�lar�e�s�are�ol�ers��o�more�closely�moni�or���e�ac�ions�of�mana�emen��(Mar�ynova�an��Renneboo����200�).

26� Heron�an��Lie�(2002);�Linn�an��Swi�zer�(2001);�Me��inson�e��al.�(200�);�an��Sc�leifer�an��Vis�ny�(200�).

2�� ��rawal�an��Jaffe�(1���);�Black�e��al.�(2000);��eo�un�an��Lipin�(2000);�an��Rau�an��Vermaelen�(1���).

2�� Jensen�(2005).

What History Tells Us about M&A Performance 41

Acquirer Experience May Not Improve Long-Term Performance of Combined CompaniesExperience�is�a�necessary�bu��no��sufficien��con�i�ion�for�successful�acqui�si�ions.�I��con�ribu�es��o�improve��financial�re�urns���i��appears���only�if�i��is�applie���o��ar�e�s�in���e�same�or�similar�in�us�ries���or�in���e�same�or�simi�lar��eo�rap�ic�or�cul�ural�re�ions.�2

�bnormal� re�urns� �o� serial� acquirers� (i.e.��� firms� makin�� numerous�an��frequen��acquisi�ions)��ave��en�e���o��ecline�from�one��ransac�ion��o���e�nex�.���T�is� is� �ypically� a��ribu�e�� �o� ��e�CE��of� ��e� serial� acquirer�becomin��overconfi�en��wi���eac��successive�acquisi�ion.�T�e�CE����en��en�s��o�overes�ima�e���e�value�of�syner�ies�an����e�ease�wi���w�ic����ey�can� be� realize�.� Now� subjec�� �o� �ubris��� ��e� CE�� �en�s� �o� overpay� for�acquisi�ions.��

Bidder Returns Are Good Predictors of Successful TransactionsT�ere� is� evi�ence� ��a�� ��e� ma�ni�u�e� of� abnormal� re�urns� �o� acquirers�aroun����e�announcemen���a�e�is�a��oo��pre�ic�or�of�w�e��er���e�ini�ial�offer� price�will� be� rene�o�ia�e��or� ��a�� ��e� �eal�will� be� cancele�.�5�T�e�acquirer’s� mana�emen�� will� reac�� �o� a� si�nifican�� ne�a�ive� �ecline� in� i�s�s�ock�imme�ia�ely� followin��a�mer�er�announcemen��as� inves�ors��isplay���eir��ispleasure�wi�����e��eal.�Cancella�ion�is�muc��less�likely�if�an�a�ree�men��of�purc�ase�an��sale�was�si�ne��before���e�announcemen�.

Rene�in�� on� a� si�ne�� a�reemen�� can� be� expensive.��f�er� Ge��y� �il�rene�e��on�a�mer�er�a�reemen��wi���Pennzoil�in���e�early�1��0s�in�favor�of�mer�in��wi���Texaco���a�fe�eral�cour��rule����a��Texaco�woul���ave��o�pay�Penzoil�$10�billion�in�compensa�ory��ama�es.

�2� T�is�is���e�conclusion�from�Barkema�an��Sc�ijven�(200�)���w�o�performe��an�ex�ensive�survey�of���e�li�era�ure�on��ow�firms�learn�from�pas��acquisi�ions.

��� Bille���an��Qian�(2006);�Conn�e��al.�(2005);�Fuller�e��al.�(2002);�an��Ismail�(2005).��� T�ese�fin�in�s�are�in�s�arp�con�ras��wi�����e�fin�in�s���a��acquirers��ave��rea��po�en�ial��o�learn�

from���eir�mis�akes���su��es�in����a��serial�acquirers�are�more�likely��o�earn�re�urns�in�excess�of���eir�cos��of�capi�al�(Har�in��an��Rovi����200�).��k�kas�e��al.�(200�)�propose��an�al�erna�ive�explana�ion�for���e�role�of��ubris�in���e��ecline�in�abnormal�acquirer�re�urns�for�serial�acquirers.�If�acquirers�are�learnin��from�prior�acquisi�ions�����ey�s�oul��improve���eir�selec�ion�of���an��abili�y��o���in�e�ra�e��ar�e��firms.�T�erefore�����e�risk�of�eac��successive�acquisi�ion�s�oul���ecline.�If�risk�associa�e��wi�����e�successive�acquisi�ions��eclines�fas�er���an���e�abnormal�re�urn���risk�a�jus�e��acquirer�re�urns�coul��rise.�If�so���CE�s�of��i��ly�acquisi�ive�firms�s�oul��be�willin���o�bi��more�a��ressively�for��ar�e�s�as���e�perceive��risk�associa�e��wi���suc���ar�e�s��eclines.��s�suc����abnormal�re�urns�are�simply��eclinin��in�line�wi�����e�level�of�perceive��risk�for�experience��acquirers.

�5� Luo�(2005)���base��on�a�sample�of�1��5�6��ransac�ions�be�ween�1��5�an��2001.

Mergers and Acquisitions Basics42

Bondholder PayoffsMer�ers�an��acquisi�ions��ave�rela�ively�li��le�impac��on�abnormal�re�urns�ei��er� �o� acquirer� or� �ar�e�� bon��ol�ers��� excep�� in� special� si�ua�ions���6��ue� in�par�� �o� ��e� rela�ions�ip�be�ween� levera�e� an��mana�emen���isci�pline.� Increasin�� levera�e� or� �efaul�� risk� imposes� �iscipline� on� mana�e�men���o�improve�opera�in��performance���w�ereas��ecreasin��levera�e��as���e�opposi�e�effec�.�Moreover����ecreasin�� levera�e�encoura�es�con�rollin��s�are�ol�ers��o�increase�fu�ure�borrowin���o�en�ance�financial�re�urns��o�equi�y.�T�e� impac��may�be�ne�li�ible� even� if� ��e� �ransac�ion� resul�s� in� a�lar�er���less�risky�business.��

Payoffs for SocietySome�observers� ar�ue� ��a��M&�s�are�no���oo�� for� socie�y�because� ��ey�resul��in�increase��concen�ra�ion���an��lar�er�firms�wi���lar�er�marke��s�are�are�in�a�be��er�posi�ion��o�raise�prices���an���ey�woul���ave�been��a����e�mer�er��a��no�� �aken�place.�T�ere� is� li��le�evi�ence����owever��� ��a�� ��is� is���e�case.

Firs���� ��ere� is� no� evi�ence� ��a�� M&�� ac�ivi�y� resul�s� in� increasin��in�us�ry�concen�ra�ion.��l��ou���mer�ers�an��acquisi�ions��ave�con�inue���o� increase� in� number� an�� avera�e� size� �urin�� ��e� pas�� �0� years��� M&��ac�ivi�y��� since�1��0����as�no�� increase�� in�us�ry�concen�ra�ion� in� �erms�of���e�s�are�of�ou�pu��or�value�pro�uce��by���e�lar�es��firms�in���e�in�us�ry���ei��er�in�manufac�urin��or�in���e�overall�economy.��

Fur��er�����e�bulk�of���e�evi�ence�su��es�s���a��M&��ac�ivi�y�resul�s�in�improve��opera�in��efficiencies�an��lower�pro�uc��prices���an�woul���ave�been���e�case�wi��ou����e�mer�er��avin���aken�place.�Gains�in�a��re�a�e�s�are�ol�er�value�are�a��ribu�able�more��o���e�improve��opera�in��efficiency��

�6� Renneboo��an��Szila�yi�(200�).��� T�e�empirical�evi�ence�is�ambi�uous.���s�u�y�by�Bille�����Kin����an��Mauer�(200�)�s�owe��sli���ly�

ne�a�ive�abnormal�re�urns��o�acquirer�bon��ol�ers�re�ar�less�of���e�acquirer’s�bon��ra�in�;���ey�use��a�sample�of���1�U.S.��ransac�ions�be�ween�1����an��1���.�However�����ey�also�foun����a���ar�e��firm��ol�ers�of�below�inves�men���ra�e�bon�s�(i.e.���BBB�)�earn�avera�e�excess�re�urns�of��.��percen��or��i��er�aroun����e�mer�er�announcemen���a�e���w�en���e��ar�e��firm’s�cre�i��ra�in��is�less���an���e�acquirer’s�an��w�en���e�mer�er�is�expec�e���o��ecrease���e��ar�e�’s�risk�or�levera�e.�Maquierira���Me��inson���an��Nail�(1���)�s�owe��posi�ive�excess�re�urns��o�acquirer�bon��ol�ers�of�1.��percen����an��0.5�percen��for��ar�e��bon��ol�ers���bu��only�for�noncon�lomera�e��ransac�ions;���eir�sample�inclu�e��25��U.S.��ransac�ions�from�1�6���o�1��6.��no��er�s�u�y���usin��a�sample�of�225�European��ransac�ions�be�ween�1��5�an��200����foun��small�posi�ive�re�urns��o�acquirer�bon��ol�ers�of�0.56�percen��aroun����e�announcemen���a�e�of���e��ransac�ion�(Renneboo��an��Szila�yi���2006).

��� Carl�on�an��Perloff�(1���).

What History Tells Us about M&A Performance 43

of� ��e� combine�� firms� ��an� �o� increase�� marke�� or� pricin�� power.��� In�fac���� corpora�e� �ransac�ions� seem� �o� resul�� in� an� overall� improvemen�� in�efficiency�by��ransferrin��asse�s�from���ose�w�o�are�no��usin����em�effec��ively��o���ose�w�o�can.�0

Why soMe M&as fail to Meet exPectations

T�e�no�ion� ��a��mos��M&�s� fail� in� some�subs�an�ive�manner� is�no�� sup�por�e��by���e�evi�ence.�In�fac������e�failure�of�an�M&���o�mee��expec�a�ions��epen�s�en�irely�on��ow�you��efine�failure.�T�e�failure�ra�e�is�low�if�failure�is��efine��as� ��e�even�ual� sale�or� liqui�a�ion�of� ��e�business���bu�� is��i��er�if� failure� is��efine��as� ��e� inabili�y� �o�mee��or�excee�� financial�objec�ives.�Mana�ers�are�of�en�very�sa�isfie��wi�����eir�acquisi�ions���so���e�failure�ra�e�is�low�if�failure�is��efine��as�no��ac�ievin��s�ra�e�ic���nonfinancial�objec�ives.�1

�l��ou�����ere�are�many�cases�in�w�ic��acquirers�earn�posi�ive�abnor�mal� financial� re�urns� aroun�� ��e� �ransac�ion� announcemen�� �a�e��� firms�of�en� con�inue� �o� ou�perform� ��eir� peers� in� ��e� years� imme�ia�ely� fol�lowin��closin�;� ��e�avera�e� firm� is� s�ill� earnin��a����or�close� �o��� i�s� cos��of�capi�al—even���ou�����e�avera�e�abnormal�re�urn�for�all�bi��ers��en�s��o�be� abou�� zero.� S�ill��� ��ese� cases�may� s�ill� be� consi�ere�� a� failure� because�acquirers�of�en�promise��o�ac�ieve�financial�re�urns�well�in�excess�of���eir�cos��of�capi�al.

No�sin�le�fac�or�seems�likely��o�be���e�cause�of�M&�s�failin���o�mee��expec�a�ions.�T�ere�are����owever�����ree�explana�ions��o�w�ic����is�is�mos��commonly� a��ribu�e�:� overpayin���� overes�ima�in�� syner�ies��� an�� a� slow�pace�of�in�e�ra�ion.

Overpaying�verpayin��for�a��ar�e��firm�increases���e��ur�les�an�acquirer�mus��over�come��o�earn�i�s�cos��of�capi�al�because���ere�is�li��le�or�no�mar�in�of�error�in� ac�ievin�� an�icipa�e�� syner�ies� on� a� �imely� basis.�2�Consequen�ly��� ��e�

��� �k�i�be���Bor�e���an��W�y�e�(2000);�G�os��(200�);�S�a�rur�(2005);�an��Son��an��Walkin��(2000).�0� See�Maksimovic�an��P�illips�(2001)���an�ex�aus�ive�s�u�y�of�10��0����ransac�ions�be�ween�1����an��

1��2.�1� Brou��ers���van�Has�enbur����an��van��en�Ven�(1���).�2� In�an�ex�aus�ive�s�u�y�of�22��ifferen��papers�examinin��lon��run�pos�mer�er�re�urns�����rawal�

an��Jaffe�(1���)�separa�e��financial�performance�followin��mer�ers�an���os�ile��en�er�offers.�Reviewin��a�number�of�ar�umen�s�purpor�in���o�explain�pos�mer�er�performance�����ey��eeme��mos��convincin����e�ar�umen����a��acquirers��en���o�overpay�for�so�calle���i����row����lamour�companies�base��on���eir�pas��performance.

Mergers and Acquisitions Basics44

pos�mer�er�s�are�price�for�suc��firms�s�oul��un�erperform�broa�er�in�us��ry�avera�es�as�fu�ure��row���slows��o�more�normal�levels.

T�e� le�acy� of� overpayin�� is� lon��las�in�.� By� subs�an�ially� overpayin��for� an� acquisi�ion��� acquirers� con�emn� ��emselves� �o� �avin�� �o� improve�profi�abili�y��rama�ically��o�earn���e�financial�re�urns�require��by�inves�ors�on�a��i��er�ne��asse��base�(inclu�in����e�fair�marke��value�of� ��e��ar�e�’s�ne��asse�s).

Overestimating SynergiesIf� acquirers� �ave� si�nifican�ly� overes�ima�e�� po�en�ial� syner�y��� ��ey� will�be� unable� �o� realize� ��ese� re�urns.�Wi��� so�muc�� overpayin�� in� ��e� la�e�1��0s���many�firms��ave�been�force���o�wri�e�off��oo�will�associa�e��wi���prior� acquisi�ions� or� major� por�ions� of� ��e� acquire�� asse�s.� �s� a� resul��of� ��e��ecline� in� ��e� s�ock�marke�� in�2000� an��2001���many� firms’� s�are�prices�were��ra�in��a�� levels�si�nifican�ly�less���an�book�value.�In�an�eye��poppin��firs��quar�er�2002�wri�e�off���for�ins�ance�����L�effec�ively�a�mi���e����a��i���a��overpai��for�Time�Warner�by�more���an�one��alf;���L�sai��i��woul��re�uce���e�value�of���e��oo�will�associa�e��wi�����e��ransac�ion�by�$60�billion.� In�200����MCI��ook�a�recor��se��in��$�5�billion�wri�e�off�for�acquisi�ions�ma�e�by���e�company�w�en�i��was�name��Worl�Com.

Slow IntegrationIn�e�ra�ion�frequen�ly��urns�ou���o�be�more�c�allen�in����an�an�icipa�e��(��is�is��e�aile��in�C�ap�er�10).�Consequen�ly���payin��less���an�“fair�marke��value”�of�en�enables�acquirers��o�realize�a��rac�ive�financial�re�urns�even�if���ey�are�unable��o�realize�quickly���e�forecas��amoun��of�cos��savin�s�an��revenue.�However���no�ma��er�w�a��is�pai��for���e��ar�e��firm���success�will�be�elusive�if���e�s�ra�e�y�jus�ifyin����e�acquisi�ion�is�severely�flawe�.

long-terM PerforMance is siMilar for M&as, Business alliances, and solo ventures

Even�if�a�subs�an�ial�percen�a�e�of�M&�s�un�erperforme����eir�peers�or�faile�� �o� earn� appropria�e� financial� re�urns��� i�� is� impor�an�� �o� no�e� ��a����ere�is�li��le�compellin��evi�ence���a���row���s�ra�e�ies�un�er�aken�as�an�al�erna�ive� �o�M&�s� fare� any� be��er.� Suc�� al�erna�ives� inclu�e� solo� ven��ures��� in� w�ic�� firms� reinves�� excess� cas�� flows��� an�� business� alliances���inclu�in�� join�� ven�ures��� licensin���� franc�isin���� an��minori�y� inves�men�s.�

What History Tells Us about M&A Performance 45

Failure�ra�es�amon��al�erna�ive�s�ra�e�ies��en���o�be�remarkably�similar��o���ose��ocumen�e��for�M&�s.��

*�*�*M&�� ac�ivi�y��� w�ic�� �as� �en�e�� �o� clus�er� in� ��e� Uni�e�� S�a�es� in��

mul�iyear�waves���seems��o�be��ri��ere��by�in�us�ry�s�ocks���assumin����ere�is�sufficien��cre�i��marke��liqui�i�y��o�finance���e�upsur�e�in��ransac�ions.�Typically��� mer�ers� occur� �urin�� perio�s� of� sus�aine�� �i��� ra�es� of� eco�nomic��row�����low�or��eclinin��in�eres��ra�es���an��a�risin��s�ock�marke�.

�l��ou��� M&�s� clearly� pay� off� for� �ar�e�� company� s�are�ol�ers�aroun�� announcemen���a�es��� s�are�ol�er�weal��� crea�ion� in� ��e� ��ree� �o�five� years� ��a�� follow� closin�� is� less� cer�ain.�T�e� lon�er� ��e� pos�acquisi��ion�perio������e��rea�er���e�likeli�oo����a��o��er�fac�ors�will�affec��perfor�mance.�W�en�mer�ers�fail��o�sa�isfy�expec�a�ions�����e�reason�is�usually���a��syner�ies�were�overes�ima�e����resul�in��in�overpaymen����as�well�as���e�slow�pace�of�pos�mer�er�in�e�ra�ion�an����e�lack�of�a�co�eren��business�s�ra�e�y.

T�e�success�ra�e�for�M&�s�is�very�similar��o�al�erna�ive��row���s�ra�e��ies� ��a��may�be�un�er�aken��� suc�� as� reinves�in�� excess� cas�� flow� in� ��e�firm�(i.e.���solo�ven�ures)�or�business�alliances.

��� Sc�umpe�er�uses�“crea�ive��es�ruc�ion”��o��escribe���e�free�marke��process�by�w�ic��new��ec�nolo�ies�an���ere�ula�ion�crea�e�new�in�us�ries���of�en�a����e�expense�of�exis�in��ones.�In���e�s�or��run�����e�process�of�“crea�ive��es�ruc�ion”�can��ave�a��i��ly��isrup�ive�impac��on�curren��employees�w�ose�skills�are�ma�e�obsole�e���inves�ors�an��business�owners�w�ose�businesses�are�no�lon�er�compe�i�ive���an��communi�ies���a��are�rava�e��by�increasin��unemploymen��an���iminis�e���ax�revenues.�In���e�lon��run�����ou�������e�process��en�s��o�raise�livin��s�an�ar�s�by�boos�in��worker�pro�uc�ivi�y�an��increasin��real�income�an��leisure��ime���s�imula�in��innova�ion���an��expan�in����e�ran�e�of�pro�uc�s�an��services�offere����of�en�a��a�lower�price����o�consumers.�Muc��of���e�c�an�e�spurre��by���e�process�of�“crea�ive��es�ruc�ion”��akes���e�form�of�mer�ers�an��acquisi�ions.�For�more�informa�ion�abou����e�concep��of�“crea�ive��es�ruc�ion��”�see�Sc�umpe�er�(200�).

��� �CNielsen�(2002)�es�ima�e����e�failure�ra�e�for�new�pro�uc��in�ro�uc�ions�a��well�over��0�percen�.�Failure�ra�es�for�alliances�of�all��ypes�excee��60�percen��(Ellis���1��6;�Klein���200�).

A Case in Point: Consolidation in the Telecommunications IndustryThe  blur  of  consolidation  in  the  U.S.  telecommunications  industry  in  recent years  illustrates  dramatically  how  free  market  forces  can  radically  restructure the  competitive  landscape,  spurring  improved  efficiency  and  innovation.  It is  a  process  economic  historian  Joseph  Schumpeter  has  described  as “creative destruction.”44

Mergers and Acquisitions Basics46

In 2005, Verizon acquired MCI. That same year, SBC acquired AT&T and then merged with BellSouth in 2006—later to be renamed AT&T to take advantage of the globally  recognized brand name.  In all, Verizon and SBC spent about $170 billion  in  acquisitions  during  this  two-year  period,  pushing  these  two  firms  to the top of the U.S. telecommunications industry.

Buying their long-distance rivals gave SBC and Verizon instant access to cor-porate customers  that purchase discounted packages of  telecom services, and it came at a lower cost than marketing to these customers and replicating their networks. There are other cost savings that come from eliminating overlapping functions.  Buying  BellSouth  also  gave  the  new  AT&T  full  control  over  Cingular (later  renamed  AT&T  Wireless),  the  biggest  U.S.  mobile  phone  operator.  As  of January 2008, 18 percent of  the U.S. population were still without cell phones, so there is still room for growth that can help offset the decline in the number of “landlines.”

There  is  still  considerable  competition,  particularly  from  nontraditional sources. Many cable companies have been racing to add phone service to their TV and Internet packages. Phone companies are responding with offers of com-bined  cell  phone,  Internet,  and  landline  phone  service.  The  growing  expan-sion  of  new  fiberoptic  networks  is  accelerating  the  pace  at  which TV  services are  being  offered.  Internet  telephony  services  such  as Vonage  give  consumers options  besides  cable  and  telephone  companies’  calling  services.  Local  phone companies are also expected to face increasing competition from wireless call-ing.  In  December  2004,  Sprint  and  Nextel  Communications  merged  to  form  a  wireless  giant  in  a  $35  billion  transaction  aimed  at  competing  directly  with  traditional phone lines.

Changes  in  technology  mean  that  there  will  likely  be  many  more  compa-nies  competing  against  the  phone  companies  than  just  cable  companies. The integration  of  voice  and  data  on  digital  networks  and  the  arrival  of  Internet calling  have  attracted  many  new  competitors  for  phone  companies,  including Microsoft, Sony, Google, and others.

The  implications  of  all  this  consolidation  remain  unclear.  Some  analysts believe fewer providers will  leave business customers with  less  leverage. Cable is an ineffective alternative to phone service for business customers because the U.S. cable  infrastructure was built to offer television service to homes, so cable networks do not reach all commercial areas. Cable companies are often unwill-ing  to  invest  the  capital  required  for  expansion  because  they  cannot  be  clear that  they  will  acquire  the  customer  density  necessary  to  achieve  the  desired financial  returns.  Other  analysts  see  a  continuation  of  very  competitive  price competition  for  consumers  based  on  price. Telecom  companies  are  rushing  to sell consumers bundles of services that include local and long-distance service, cellular service, and Internet access for one monthly fee.

What History Tells Us about M&A Performance 47

These competitive forces are likely to prevent higher prices for local phone service, which  is already eroding at a  rapid rate due to emerging technologies such as Internet calling. In fact, when adjusted for inflation, prices paid by con-sumers and businesses are a fraction of what they were a generation ago.

Things to Think About:1. How have technological and regulatory changes affected competition in the 

telecommunications industry?2. How have technological and regulatory changes affected the rate of innova-

tion and customer choice in the telecom industry?3. The  process  of “creative  destruction”  has  stimulated  substantial  consolida-

tion in the U.S. telecom industry.  Is bigger always better? Why or why not? (Hint: Consider the impact on a firm’s operating efficiency, speed of decision making, creativity, ability to affect product and service pricing, and so on.)

4. To determine the extent to which industry consolidation is likely to lead to higher,  lower,  or  unchanged  product  selling  prices,  you  need  to  consider current  competitors,  potential  competitors,  the  availability  of  substitutes, and customer pricing sensitivity (i.e., elasticity). Explain why.

5. What  factors  motivated Verizon  and  SBC  to  acquire  MCI  and  AT&T,  respec-tively? Discuss these factors in terms of the motives for mergers and acquisi-tions described in Chapter 1.

Answers can be found at: www.elsevierdirect.com/companion.jsp?ISBN=9780123749482

49Mergers and Acquisitions Basics� ©�2011�Elsevier�Inc.ISBN:�����0�12��������2�� ��I: �ll ri���s reserve�.����0�12��������2�� ��I: �ll ri���s reserve�.�����I:� �ll�ri���s�reserve�.

CHAPTER

201110.1016/B����0�12��������2.0000��2

Developing Takeover Strategies and the Impact on Corporate Governance

Hollywoo���rama�izes� ��e�mo�iva�ion� for� corpora�e� �akeovers� as�“exces�sive��ree�.”�T�e�press�of�en�por�rays���em�as�“job��es�royers.”�From�o��er�quar�ers���corpora�e��akeovers�are��aile��as�a�way��o��islo��e�incompe�en��mana�emen�.� S�are�ol�ers�of�en��ail� ��em�as� a� source�of�win�fall� �ains.�T�e�reali�y�is���a��corpora�e��akeovers�may�be�a�li��le�of�all�of���ese���in�s.

��number�of��ac�ics�are�commonly�use���o�acquire�a�company���inclu�in���bear��u�s���proxy�con�es�s���an���os�ile��en�er�offers;���ey�may�be�more�or�less� effec�ive����epen�in��on�circums�ances.�T�e�“corpora�e� �akeover�mar�ke�s”� in�w�ic�� ��ese� �ac�ics� are�employe�� serve� �wo� impor�an�� func�ions�in� a� free�marke�� economy.� Firs���� suc��marke�s� facili�a�e� ��e� alloca�ion� of�resources��o�sec�ors�of���e�economy�in�w�ic����ey�can�be�use��mos��effi�cien�ly.�Secon������ey�serve�as�a�mec�anism�for��isciplinin��un�erperform�in�� corpora�e� mana�ers.�W�en� �os�ile� �akeover� a��emp�s� or� proxy� fi���s�succee��in�replacin��suc��mana�ers�����ey��elp�encoura�e�corpora�e��over�nance�prac�ices���a��promo�e�corpora�e�s�ake�ol�er�ri���s.

Corporate GovernanCe

W�a�� is� corporate governance?�T�e� common� �efini�ion� is� fairly� s�rai����forwar�;� ��e� �erm� refers� broa�ly� �o� ��e� rules� an�� processes� by� w�ic�� a�business� is� con�rolle���� re�ula�e���� or� opera�e�.�T�ere� is��� ��ou����� no� uni�versally�accep�e��goal�for�corpora�e��overnance.�Tra�i�ionally�����e��oal��as�been��o�pro�ec��s�are�ol�er�ri���s.�More�recen�ly��� ��is��oal��as�expan�e���o� encompass� a��i�ional� corpora�e� s�ake�ol�ers��� inclu�in�� cus�omers���employees��� ��e��overnmen���� len�ers���communi�ies��� re�ula�ors��� an�� suppli�ers.�For�our��iscussion��ere���corpora�e��overnance�is�abou��lea�ers�ip�an��accoun�abili�y���an��i��involves�all���ose�fac�ors�in�ernal�an��ex�ernal��o���e�firm���a��in�erac���o�pro�ec����e�ri���s�of�corpora�e�s�ake�ol�ers.

3

Mergers and Acquisitions Basics

50EXHIBIT 3-1 Factors Affecting Corporate Governance External to the Firm

External to the FirmExternal to the Firm

• Board of Directors/Management: –Independence of Board, Audit, and Compensation Committees –Separation of CEO and Chairman Positions• Internal Controls & Incentives Systems: –Financial Reporting –Executive Compensation –Personnel Practices –Succession Planning• Antitakeover Defenses: –Pre-offer –Postoffer• Corporate Culture & Values

Legislation: –Federal & State Securities Laws–Insider Trading Laws–Antitrust Laws

Corporate Takeover Market: –Hostile Takeover Tactics (e.g., Tender Offers, Proxy Contests)

Regulators: –Government Agencies –Public Exchanges (e.g., Listing Requirements)–Standards Setting Boards (e.g., FASB)

External to the Firm

Institutional Activism: –Pension & Mutual Funds–Hedge Funds & Private Equity Investors

Internal to the Firm

External to the Firm

External to the FirmExternal to the Firm

• Board of Directors/Management: –Independence of Board, Audit, and Compensation Committees –Separation of CEO and Chairman Positions• Internal Controls & Incentives Systems: –Financial Reporting –Executive Compensation –Personnel Practices –Succession Planning• Antitakeover Defenses: –Pre-offer –Postoffer• Corporate Culture & Values

Legislation: –Federal & State Securities Laws–Insider Trading Laws–Antitrust Laws

Corporate Takeover Market: –Hostile Takeover Tactics (e.g., Tender Offers, Proxy Contests)

Regulators: –Government Agencies –Public Exchanges (e.g., Listing Requirements)–Standards Setting Boards (e.g., FASB)

External to the Firm

Institutional Activism: –Pension & Mutual Funds–Hedge Funds & Private Equity Investors

Internal to the Firm

Developing Takeover Strategies and the Impact on Corporate Governance 51

Ex�ibi�� ��1� illus�ra�es� ��e� ran�e�of� fac�ors� affec�in�� corpora�e� �over�nance���inclu�in����e�corpora�e��akeover�marke�.

Alternative Models of Corporate GovernanceT�e�ul�ima�e��oal�of� a� successful� corpora�e��overnance� sys�em�s�oul��be��o��ol����ose�in�power�accoun�able�for���eir�ac�ions.�W�ere�capi�al�marke�s�are�liqui����inves�ors��iscipline�ba��mana�ers�by�sellin����eir�s�ares—referre���o�as���e�marke��mo�el�of�corpora�e��overnance.�W�ere�capi�al�marke�s�are�illiqui����ba��mana�ers�are��iscipline��by���ose�ownin��lar�e�blocks�of�s�ock�in���e�firm�or�by���ose�w�ose��e�ree�of�con�rol�is��ispropor�iona�e��o���eir�owners�ip�posi�ion.�T�is�is���e�con�rol�mo�el�of�corpora�e��overnance���an��i��may��evelop���rou�����e�concen�ra�ion�of�s�ares��avin��mul�iple�vo�in��ri���s�(i.e.���so�calle��supervo�in��s�ares)�in���e��an�s�of�a�few�inves�ors.

Internal Factors That Affect Corporate GovernanceCorpora�e��overnance� is� affec�e��by� ��e� in�e�ri�y� an��professionalism�of���e� firm’s� boar��of� �irec�ors��� as�well� as� by� ��e� effec�iveness�of� ��e� firm’s�in�ernal� con�rols� an�� incen�ive� sys�ems��� �akeover� �efenses��� an�� corpora�e�cul�ure�an��values.

Board of Directors/ManagementT�e� boar�� a�vises� ��e� firm’s� CE���� w�o� runs� ��e� �aily� opera�ions��� an��reviews���e�quali�y�of�recommen�a�ions���e�CE��receives�from�o��ers�in�corpora�e�mana�emen�.�T�e�boar��also��ires���fires���an��se�s�CE��compen�sa�ion.�Moreover�����e�boar��is�expec�e���o�oversee�mana�emen����corpora�e�s�ra�e�y���an����e�company’s�financial�repor�s��o�s�are�ol�ers���as�well�as��eal�wi���si�ua�ions�in�w�ic��mana�ers�as�a�en�s�of���e�s�are�ol�er�make��eci�sions� ��a�� are�no�� in� ��e�bes�� in�eres�s�of� s�are�ol�ers� (��is� is� ��e�a�ency�problem��iscusse��in�C�ap�er�1).

Some�boar��members�may�also�be�employees�or�family�members�(mos��of�en�from���e�ex�en�e��family�of���e�firm’s�foun�er)�an����us�subjec���o�po�en�ial�conflic�s�of�in�eres����a��cause���em��o�ac��in�ways�no��necessarily�in�s�ake�ol�ers’�in�eres�s.�T�is��as�le��some�observers��o�ar�ue���a��boar�s�s�oul��be�compose��primarily�of�in�epen�en���irec�ors�an����a���ifferen��in�ivi�uals�s�oul���ol����e�CE��an��boar��c�airman�posi�ions.1

1� Various�researc�ers�(�a�ya�e��al.���2001;�Hermalin���2006;�an��Huson�e��al.���2001)��ave��ocumen�e��a�number�of��ren�s�re�ar�in��boar��composi�ion.�T�e�propor�ion�of�in�epen�en���irec�ors��as�s�ea�ily�increase��in���e�Uni�e��S�a�es�an��in�o��er�coun�ries;�ou�si�e��irec�ors�rose�from�an�avera�e�of��5�percen��in�1�����o�61�percen��in�1���.�Secon������e�use�of�incen�ive�compensa�ion�for�ou�si�e��irec�ors��as�increase��si�nifican�ly.�Some����percen��of�firms�repor�in���o�a�Conference�Boar��

Mergers and Acquisitions Basics52

Internal Controls and Incentive SystemsCompensa�ion�is�an�in�e�ral�par��of���e�incen�ive�sys�ems�in�ernal��o�a�firm���a�� are� use�� �o� mana�e� ��e� firm� in� ��e� manner� ��e� boar�� �eems� mos��appropria�e.�T�is� is� s�ron�ly� influence��by�ex�ernal� fac�ors.�U.S.� �ax� rules�an��accoun�in��s�an�ar�s�sen��mixe��si�nals.��n���e�one��an������e�U.S.��ax�co�e�requires�compensa�ion�above�$1�million��o�be�“performance�base�”�an����erefore��ax��e�uc�ible.�T�is�encoura�es�firms��o�pay�execu�ives�wi���s�ock�op�ions�ra��er���an�wi���cas�.�In�con�ras����firms�are�now�require���o�c�ar�e���e�cos��of�op�ions�a�ains��curren��earnin�s�(in���e�pas������ey�coul���efer�suc��cos�s)���w�ic���as�a��ampenin��effec��on���e�wi�esprea��use�of�op�ions.�Moreover��� ��e� curren�� prac�ice� of� fixe�� s�rike� or� exercise� prices�(i.e.���prices�a��w�ic��op�ion��ol�ers�can�buy�company�s�ock)� for�op�ions�le���o�enormous�profi�s�simply�because���e�overall�s�ock�marke��rose�even���ou���a��iven�firm’s�performance�la��e����e�overall�marke�.

Recen�� �overnmen�� effor�s� �o� cap� CE�� compensa�ion� in� ��ose� firms�receivin�� �axpayer�fun�e�� bailou�s� are� likely� �o� resul�� in� execu�ives� bein��compensa�e��in�kin��(i.e.���receivin��services�pai��by���e�firm)�an��may��is�coura�e���e�mos���alen�e��execu�ives�from�seekin��employmen��in�suc��firms.�T�e�mos���alen�e��mana�ers�s�ill�can�receive�lar�e�compensa�ion�packa�es�in�companies�finance��by�priva�e�equi�y����e��e�fun�s���an��ven�ure�capi�al.

By�elimina�in��suc���ax�rules���boar�s�woul��be�encoura�e���o��esi�n�com�pensa�ion�plans���a��rewar��excep�ional�performance�ra��er���an���e�exploi�a��ion�of��ax�rules.�Fur��ermore���linkin��op�ion�s�rike�prices��o���e�performance�of���e�company’s�s�ock�price�rela�ive��o���e�s�ock�marke��woul��ensure���a��increases�in���e�s�ock�marke���o�no��benefi��mana�ers�w�ose�companies�are�un�erperformin�.��no��er� way� �o� ali�n� corpora�e� mana�ers’� in�eres�s� wi�����ose�of�o��er�s�ake�ol�ers�is�for�mana�ers��o�own�a�si�nifican��por�ion�of���e�firm’s�ou�s�an�in�� s�ock���or� for� ��e�mana�ers’�owners�ip�of� ��e� firm’s� s�ock��o� comprise� a� subs�an�ial� s�are�of� ��eir�personal�weal�����bu�� ��e�percen�a�e�c�an�e�in�suc��owners�ip��as�been�rela�ively�small�over���e��eca�es.2

�n�al�erna�ive� �o�concen�ra�in��owners�ip� in�mana�emen�� is� for�one�or�more� s�are�ol�ers�w�o� are� no��mana�ers� �o� accumula�e� a� si�nifican��block� of� vo�in�� s�ares.� Corpora�ions� �avin�� ou�si�e� s�are�ol�ers� wi���

2� T�e�propor�ion�of�s�ares�owne��by�mana�ers�of�public�firms�in���e�Uni�e��S�a�es��rew�from�an�avera�e�of�12.��percen��in�1��5��o�an�avera�e�of�21.1�percen��in�1����(Economic Report to the President���200����p.��6).

� Survey�use��s�ock�base��compensa�ion�for�ou�si�e��irec�ors�in�1����as�compare���o�only�6�percen��in�1���.�Unfor�una�ely���empirical�s�u�ies��ave�no��consis�en�ly��emons�ra�e����a��suc��proposals�improve�s�are�ol�er�weal���(Economic Report to the President���200����p.��0).

Developing Takeover Strategies and the Impact on Corporate Governance 53

lar�e�blocks�of�s�ock�may�be�easier��o�acquire�����ereby�increasin����e�risk��o�mana�ers���a����ey�will�be�ous�e��for�poor�performance.

Antitakeover Defenses�� firm’s� mana�emen�� an�� boar�� may� employ� �akeover� �efenses� �o� �ain�levera�e� in�ne�o�ia�in��wi��� a�po�en�ial� sui�or��� or� �o� soli�ify� ��e� curren��mana�emen�’s� posi�ion� wi��in� ��e� firm.�T�ere� is� a� ran�e� of� �efensive�ac�ions;���ey�are��e�aile��in�C�ap�er��.

Corporate Culture and Values�l��ou��� in�ernal� sys�ems� an�� con�rols� are� impor�an���� �oo�� �overnance�also� resul�s�w�en� ��e� employee� cul�ure� is� ins�ille��wi��� appropria�e� core�values�an��be�aviors.�Se��in����e�ri�����one�an���irec�ion�comes�from���e�boar��of��irec�ors�an��senior�mana�emen��an����eir�willin�ness��o�be�ave�in� a� manner� consis�en�� wi��� w�a�� ��ey� �eman�� from� o��er� employees.��ne�can�only�specula�e�as��o���e��e�ree��o�w�ic����e�scan�al���a��rocke��Hewle���Packar��(HP)�in�la�e�2006�un�ermine����e�firm’s�in�ernal�cul�ure.�Some� of� HP’s� �op� mana�ers� �a�� sanc�ione�� in�ernal� (an�� ille�al)� spyin��on���e�firm’s�boar��members��o��ain�access��o���eir�priva�e�informa�ion.�I��s�oul��come�as�no�surprise���a��suc��ac�ions��ras�ically�re�uce�employee�confi�ence�in�senior�mana�emen��pronouncemen�s�abou���esire��corpo�ra�e�values�an��be�aviors.

Factors External to the FirmFe�eral� an�� s�a�e� le�isla�ion��� ��e� cour�� sys�em��� re�ula�ors��� ins�i�u�ional�ac�ivis�s��� an�� ��e�corpora�e� �akeover�marke�� all�play�an� impor�an�� role� in�main�ainin���oo��corpora�e��overnance�prac�ices.

Legislation and the Legal SystemIn���e�Uni�e��S�a�es�����e�Securi�ies��c�s�of�1����an��1����form���e�basis�for� mo�ern� securi�ies� le�isla�ion;� ��ese� ac�s� crea�e�� ��e� Securi�ies� an��Exc�an�e� Commission� (SEC)� an�� c�ar�e�� i�� wi��� wri�in�� an�� enforc�in�� securi�ies� re�ula�ions.�T�e� U.S.� Con�ress� �as� since� �ransferre�� some�enforcemen���asks��o�public�s�ock�exc�an�es���suc��as���e�New�York�S�ock�Exc�an�e�(NYSE)���w�ic��opera�e�un�er�SEC�oversi����as�self�re�ula�in��or�aniza�ions.�T�e�SEC�i�self��as��ele�a�e��cer�ain�responsibili�ies�for�se���in�� an�� main�ainin�� accoun�in�� s�an�ar�s� �o� ��e� Financial��ccoun�in��S�an�ar�s�Boar�.�Un�er���e�Sarbanes–�xley��c��of�2002�����e�SEC�is�over�seein����e�Public�Company��ccoun�in���versi����Boar����w�ose�primary�

Mergers and Acquisitions Basics54

�ask� is� �o��evelop���main�ain��� an��enforce� s�an�ar�s� ��a�� �ui�e� au�i�ors� in�moni�orin�� an�� cer�ifyin�� corpora�e� financial� repor�s.�T�e� aim� of� ��e�Sarbanes–�xley��c�� was� �o� ac�ieve� �rea�er� corpora�e� �ransparency� wi���respec�� �o� financial� s�a�emen�s��� bu�� ��e� even�s� of� 200�� an�� 200�� in� ��e�financial�an��real�es�a�e�marke�s�un�erscore��ow�le�isla�ive�solu�ions�of�en�fail��o�ac�ieve���eir�in�en�e��resul�s.�S�a�e�le�isla�ion�also��as�a�si�nifican��impac��on��overnance�prac�ices�by�requirin��corpora�e�c�ar�ers��o��efine���e�responsibili�ies�of�boar�s�an��mana�ers�wi���respec���o�s�are�ol�ers.

RegulatorsT�e�SEC���Fe�eral�Tra�e�Commission� (FTC)��� an���epar�men�� of� Jus�ice�(�oJ)�can��iscipline�firms�wi���inappropria�e��overnance�prac�ices���rou���formal�an��informal�inves�i�a�ions���lawsui�s���an��se��lemen�s.�In�mi��200������e� SEC� approve�� new� lis�in�� s�an�ar�s� ��a�� woul�� pu�� many� lucra�ive���s�ock�base��pay�plans��o�a�s�are�ol�er�vo�e�����us��ivin��inves�ors�in�more���an� 6��200� companies� lis�e�� on� ��e� NYSE��� N�S��Q��� an�� o��er� major�marke�s� si�nifican��con�rol�over�CE��pay�packa�es.�In�January�200���� ��e�SEC� implemen�e�� a��i�ional� �isclosure� requiremen�s� for� CE�� pay� an��perks���a��excee��$10��000�in�value.

Institutional ActivistsPension�fun�s����e��e�fun�s���priva�e�equi�y� inves�ors���an��mu�ual� fun�s��ave�become�increasin�ly�influen�ial�ins�i�u�ions���a��can�affec����e�policies�of�com�panies� in�w�ic�� ��ey� inves�.�C�ap�er�5�explores� ��e��rowin��evi�ence� ��a��ins�i�u�ional�ac�ivism���in�combina�ion�wi���mer�er�an��acquisi�ion�ac�ivi�y����as�become�an�impor�an��fac�or�in��isciplinin��un�erperformin��mana�ers.

the role of M&a in aChievinG Good Corporate GovernanCe

C�an�es� in� corpora�e� con�rol� can� occur� because� of� a� �os�ile� (i.e.��� bi�s�con�es�e��by���e��ar�e�’s�boar��an��mana�emen�)�or�frien�ly��akeover�of�a��ar�e��firm���or�because�of�a�proxy�con�es��ini�ia�e��by��issi�en��s�are�ol��ers.�W�en�a� firm’s� in�ernal�mec�anisms� ��a���overn�mana�emen��con�rol�are�rela�ively�weak�����e�corpora�e��akeover�marke��seems��o�ac��as�a�“cour��of� las�� resor�”� �o� �iscipline� inappropria�e� mana�emen�� be�avior.�� S�ron��in�ernal��overnance�mec�anisms���by�con�ras����lessen���e�role�of�a��akeover���rea��as�a��isciplinary�fac�or.�Moreover�����e��isciplinin��effec��of�a��akeover��

�� Kini���Kracaw���an��Mian�(200�).

Developing Takeover Strategies and the Impact on Corporate Governance 55

��rea��on�a�firm’s�mana�emen��can�be�reinforce��w�en�i��is�paire��wi���a�lar�e�s�are�ol�in��by�an�ins�i�u�ional�inves�or.�

T�ere� are� several� ��eories� ��a�� explain� w�y� mana�ers� may� resis�� a��akeover� a��emp�.�T�e�management entrenchment theory� su��es�s� mana��ers�use� a� varie�y�of� �akeover��efenses� �o� ensure� ��eir� lon�evi�y�wi��� ��e�firm.� Hos�ile� �akeovers��� or� ��e� ��rea�� of� suc�� �akeovers��� �ave� �is�orically�been�useful�for�main�ainin���oo��corpora�e��overnance�by�removin��ba��mana�ers�an��ins�allin��be��er�ones.5�In�ee������ere�is�evi�ence�of�frequen��mana�emen���urnover�even�if�a��akeover�a��emp��is��efea�e��because��ake�over��ar�e�s�are�of�en�poor�financial�performers.6��n�al�erna�ive�viewpoin��is� ��e� shareholder interest theory���w�ic�� su��es�s� ��a��mana�emen�� resis��ance��o�propose���akeovers� is�a��oo��bar�ainin��s�ra�e�y��o� increase� ��e�purc�ase�price��o���e�benefi��of���e��ar�e��firm’s�s�are�ol�ers.�

In� a�proxy contest��� a��issi�en���roup�of� s�are�ol�ers� a��emp�s� �o��ain�represen�a�ion�on�a�firm’s�boar��of��irec�ors�or�c�an�e�mana�emen��pro�posals.��l��ou�����ose���a��a��ress� issues�o��er���an�boar��represen�a�ion��o�no��bin��a� firm’s�boar��of��irec�ors��� ��ere� is�evi�ence� ��a��boar�s�are�becomin�� more� responsive—per�aps� reflec�in�� fallou�� from� ��e� Enron��ype� scan�als� in�2001�an��2002.��Even�unsuccessful�proxy�con�es�s�of�en�lea�� �o�a�c�an�e� in�mana�emen����a� res�ruc�urin��of� ��e� firm���or� inves�or�expec�a�ions���a����e�firm�ul�ima�ely�will�be�acquire�.

the friendly approaCh in the Corporate takeover Market

In� frien�ly� �akeovers��� a� ne�o�ia�e�� se��lemen�� is� possible� wi��ou�� ��e�acquirer� resor�in�� �o�a��ressive� �ac�ics.�T�e�po�en�ial� acquirer� ini�ia�es� an�informal��ialo�ue�wi�����e��ar�e�’s��op�mana�emen����an����e�acquirer�an���ar�e�� reac��a�reemen��on�key� issues�early� in� ��e�process.�Typically��� ��ese�issues�inclu�e���e�lon���erm�business�s�ra�e�y�of���e�combine��firms����ow���ey�will�opera�e�in���e�s�or���erm���an��w�o�will�be�in�key�mana�emen��posi�ions.��f�en���a�standstill agreement�is�ne�o�ia�e��in�w�ic����e�acquirer�a�rees� no�� �o� make� any� fur��er� inves�men�s� in� ��e� �ar�e�’s� s�ock� for� a�

�� Cremers�an��Nair�(2005).5� Morck���S�leifer���an��Vis�ny�(1���b).6� Economic Report to the President�(200����p.��1).�� Franks�an��Mayer�(1��6);�Sc�wer��(2000).�� �ccor�in���o�Er�imur���Ferri���an��S�ubben�(200�)���boar�s�implemen�e���1�percen��of�nonbin�in��

s�are�ol�er�proposals�for�majori�y�vo�in��in�200����versus�only�22�percen��in�1���.���boar��was�more�likely��o�a�op��a�s�are�ol�er�proposal�if�a�compe�i�or��a��a�op�e��a�similar�plan.

Mergers and Acquisitions Basics56

s�ipula�e��perio�.�T�is�compels���e�acquirer��o�pursue���e�acquisi�ion�on�frien�ly��erms�alone���a�� leas�� for� ��e�perio��covere��by���e�a�reemen�.�I��also�permi�s�ne�o�ia�ions��o�procee��wi��ou����e���rea��of�more�a��ressive��ac�ics���suc��as���ose��iscusse��in���e�followin��sec�ions.

the hostile approaCh in the Corporate takeover Market

T�e�1��0s�an��early�1��0s�were�c�arac�erize��by�bli�zkrie��s�yle��akeovers.��ccor�in���o�T�omson�Reu�ers����os�ile��akeovers�of�U.S.�firms�peake��a��abou��1��percen��of�all��akeovers�in���e�1��0s�before��roppin���o�a�low�of�abou����percen��in���e�1��0s.�T�e��ecline�can�be�a��ribu�e��in�par���o���e�soarin��s�ock�marke��in���e�1��0s—�ar�e��s�are�ol�ers�are�more�willin���o�accep���akeover�bi�s�w�en���eir�s�ares�are�overvalue�.�In�a��i�ion���fe�eral�preno�ifica�ion�re�ula�ions��ave�slowe���rama�ically�a�process���a��use���o�be�quicker.�W�en�a� firm�acquires�more� ��an�5�percen��of� ��e� s�ock�of�a�publicly� �ra�e�� firm��� i�� is� require�� �o� file� i�s� in�en�ions�publicly�wi��� ��e�SEC.���number� of� s�a�es� an�� public� s�ock� exc�an�es� also� require� s�are��ol�er�approval�for�cer�ain��ypes�of�offers.�Moreover���mos��lar�e�companies��ave�an�i�akeover��efenses� in�place��� suc��as�poison�pills.�Hos�ile� �akeover�ba��les�are�now�likely��o�las��for�mon��s.

T�ere� are� several� �ypes� of� �os�ile� �akeover� �ac�ics��� inclu�in�� ��e� bear��u����proxy�con�es����an���en�er�offer.

The Bear Hug: Limiting the Target’s OptionsWi��� a� bear hug��� ��e� acquirer� mails� a� le��er� ��a�� inclu�es� an� acquisi�ion�proposal� �o� ��e� �ar�e��company’s�CE��an��boar��of��irec�ors.�T�e� le��er�arrives�wi���no�warnin��an���eman�s�a�rapi���ecision.�T�e�bear��u��usu�ally�involves�a�public�announcemen��as�well.

T�e�aim� is� �o�move� ��e�boar�� �o� a�ne�o�ia�e�� se��lemen�.�T�e�boar��may� be�mo�iva�e�� �o� �o� so� because� of� i�s� fi�uciary� responsibili�y� �o� ��e��ar�e�’s�s�are�ol�ers.��irec�ors�w�o�vo�e�a�ains����e�proposal�may�be�sub�jec���o�lawsui�s�from��ar�e��s�ock�ol�ers.�T�is�is�especially��rue�if���e�offer�is� a�� a� subs�an�ial� premium� �o� ��e� �ar�e�’s� curren�� s�ock� price.��nce� ��e�bi�� is�ma�e�public��� ��e�company� is�effec�ively�“pu�� in�o�play”� (i.e.��� likely��o� a��rac�� a��i�ional� bi��ers).� Ins�i�u�ional� inves�ors� an�� arbi�ra�eurs� a����o� ��e� pressure� by� lobbyin�� ��e� boar�� �o� accep�� ��e� offer.��rbi�ra�eurs�(“arbs”)� are� likely� �o� acquire� ��e� �ar�e�’s� s�ock� an�� �o� sell� ��e� bi��er’s�s�ock� s�or�� in� an�effor�� �o�profi�� from� ��e� an�icipa�e�� rise� in� ��e� �ar�e�’s�

Developing Takeover Strategies and the Impact on Corporate Governance 57

s�are�price�an����e�fall�in���e�acquirer’s�s�are�price.�S�or��sellin��involves��borrowin��s�ock���sellin��i����an��buyin��i��back�a��w�a��is�expec�e���o�be�a�lower�price.�T�e�accumula�ion�of�s�ock�by�arbs�makes�purc�ases�of�blocks�of�s�ock�by���e�bi��er�easier�because���e�arbs�of�en�are�qui�e�willin���o�sell���eir�s�ares.

Proxy Contests in Support of a TakeoverT�ere�are���ree�primary�forms�of���e�proxy contest.�In�one����issi�en��s�are��ol�ers�a��emp���o�win�represen�a�ion�on���e�boar��of��irec�ors.�In�ano��er�����ey� seek� �o� c�an�e� a� firm’s� bylaws� or� force� mana�emen�� �o� �ake� some�par�icular�ac�ion�(e.�.����ivi�en��paymen�s�an��s�are�repurc�ases)�by�ob�ain�in����e�ri�����o�vo�e�on�be�alf�of�o��er�s�are�ol�ers.�Finally���proxy�con�es�s�may�concern�mana�emen��proposals�(e.�.���an�acquisi�ion).�Mos��commonly����issi�en�s�ini�ia�e�a�proxy�fi�����o�remove�mana�emen�����ue��o�poor�cor�pora�e�performance���or�a��esire��o�promo�e�a�specific��ype�of�res�ruc�urin��of���e�firm�(e.�.���sell�or�spin�off�a�business)�or���e�ou�ri����sale�of���e�busi�ness;�or���ey��o�so��o�force�a��is�ribu�ion�of�excess�cas���o�s�are�ol�ers.�

Proxy� fi���s� enable� �issi�en�� s�are�ol�ers� �o� replace� specific� boar��members�or�mana�emen��wi�����ose�more�willin���o�suppor����eir�posi��ions.� By� replacin�� boar�� members��� proxy� con�es�s� can� be� an� effec�ive�means� of� �ainin�� con�rol� wi��ou�� ownin�� 50.1� percen�� of� ��e� vo�in��s�ock���or� ��ey�can�be�use���o�elimina�e��akeover��efenses��� suc��as�poison�pills���as�a�precursor�of�a��en�er�offer.�For�example���Weyer�auser�succee�e��in� placin�� ��ree� �irec�ors� on� rival�Willame��e� In�us�ries’� nine�member�boar��in�2001���an����e�prospec��of�losin��an�a��i�ional���ree�sea�s���e�fol�lowin�� year� ul�ima�ely� brou����Willame��e� �o� ��e� bar�ainin�� �able� an��en�e��Weyer�auser’s�1��mon����akeover�a��emp�.�In�mi��2005���billionaire��Carl� Ica�n� an�� �is� �wo� �issi�en�� nominees� won� sea�s� on� ��e� boar�� of�Blockbus�er�an��ous�e��C�airman�Jo�n��n�ioco.

Ini�ia�in��a�proxy�con�es���o�replace�a�boar��is�cos�ly���w�ic��explains�w�y���ere�are�so�few�con�es�e��boar��elec�ions.10�For���e�official�sla�e�of��irec��ors�nomina�e��by���e�boar����campai�ns�can�be�pai��ou��of�corpora�e�fun�s���bu��s�are�ol�ers�promo�in����eir�own�sla�e�of�can�i�a�es�mus��pay�subs�an��ial�fees��o��ire�proxy�solici�ors���inves�men��bankers���an��a��orneys.��n��op�of���is�����ey�face�o��er�expenses��o�prin��an��mail���e�proxy�s�a�emen��an��place� a�ver�isemen�s.� Li�i�a�ion� expenses� may� also� be� subs�an�ial� an�� can�

����� Faleye�(200�).10� Be�ween�1��6�an��200����an�avera�e�of�12�firms�annually�face��con�es�e��boar��elec�ions�

(Economist,�Sep�ember�16���2006).

Mergers and Acquisitions Basics58

easily�become���e�lar�es��sin�le�cos��in�a��i��ly�con�en�ious�proxy�con�es�.�None��eless���a�successful�proxy�fi����is�a�far�less�expensive�way��o��ain�con��rol�over�a��ar�e����an�a��en�er�offer���w�ic��may�require�purc�asin��a�con��rollin��in�eres��in���e��ar�e��a��a�subs�an�ial�premium.

Implementing a Proxy ContestW�en���e�bi��er� is�also�a� s�are�ol�er� in� ��e� �ar�e�� firm��� ��e�proxy�pro�cess�may�be�in�wi��� ��e�bi��er�a��emp�in���o�call�a� special� s�ock�ol�ers’�mee�in�.��l�erna�ively�����e�bi��er�may�pu��a�proposal��o�replace���e�boar��or�mana�emen��a��a�re�ularly�sc�e�ule��s�ock�ol�ers’�mee�in�.�Before���e�mee�in���� ��e� bi��er� may� open� an� a��ressive� public� rela�ions� campai�n���wi����irec��solici�a�ions�sen���o�s�are�ol�ers�an��full�pa�e�a�ver�isemen�s�in���e�press��o�convince�s�are�ol�ers��o�suppor����e�bi��er’s�proposals.�T�e���ar�e��will�respon��wi���i�s�own�campai�n�an��will��ave�a��is�inc��a�van��a�e�in�bein��able��o��eal��irec�ly�wi���i�s�own�s�are�ol�ers.�T�e�bi��er�may�even��ave��o�sue���e��ar�e��corpora�ion��o��e��a�lis��of�i�s�s�are�ol��ers’�names�an��a��resses.��f�en���s�ares�are��el��in���e�names�of�banks�or�brokera�e��ouses�un�er�“s�ree��names��”�an����ese��eposi�ories��enerally��o�no���ave���e�au��ori�y��o�vo�e�suc��s�ares.

W�en�s�are�ol�ers�receive���e�proxies�����ey�may�c�oose��o�si�n�an��sen����em��irec�ly��o�a��esi�na�e��collec�ion�poin��suc��as�a�brokera�e��ouse�or�bank.�S�are�ol�ers�may�c�an�e���eir�vo�es�un�il� ��ey�are�coun�e�—w�ic��of�en��akes�place�un�er���e�s�ric��supervision�of�inspec�ors��o�ensure�accu�racy.�Bo�����e��ar�e��firm�an��bi��er��enerally��ave���eir�own�proxy�solici��ors�presen���urin����e��abula�ion�process.

Legal Filings in Undertaking Proxy ContestsSEC� re�ula�ions� cover� proxy� solici�a�ions� un�er� Sec�ion� 1�(�)� of� ��e�Securi�ies�Exc�an�e��c��of�1���.��ll�ma�erials��is�ribu�e�� �o� s�are�ol�ers�mus��be�submi��e���o���e�SEC�for�review�a�� leas��10��ays�before���ey�are��is�ribu�e�.�T�e�par�y�a��emp�in���o�solici��proxies�from���e��ar�e�’s�s�are��ol�ers�mus�� file�a�proxy statement� an��Sc�e�ule�1���wi��� ��e�SEC�an��mail�i���o���e��ar�e�’s�s�are�ol�ers;���ese�s�a�emen�s�inclu�e���e��a�e�of���e�s�are�ol�ers���mee�in��a��w�ic��approval�of���e��ransac�ion�is��o�be�solici�e�����e�ails�of���e�mer�er�a�reemen����company�back�roun�s���reasons�for���e�pro�pose��mer�er���an��opinions�of�le�al�an��financial�a�visors.�Proxy�s�a�emen�s�may�be�ob�aine��from���e�companies�involve��an��on���e�SEC’s�websi�e��11�an��are�excellen��sources�of�informa�ion�abou��a�propose���ransac�ion.11� www.sec.�ov

Developing Takeover Strategies and the Impact on Corporate Governance 59

The Impact of Proxy Contests on Shareholder Value�nly�one�fif����o�one���ir��of�all�proxy�fi���s�ac�ually�resul��in�a�c�an�e�in�boar��con�rol.��espi�e���is�low�success�ra�e�����ere�is�some�empirical�evi��ence� ��a��proxy� fi���s� resul�� in�abnormal� re�urns� �o� s�are�ol�ers�of� ��e��ar�e�� company� re�ar�less� of� ��e�ou�come.12�T�e� reasons� for� ��ese� �ains�may� inclu�e� ��e� even�ual� c�an�e� in� mana�emen�� a�� firms� embroile�� in�proxy� fi���s��� ��e� �en�ency� for� new�mana�emen�� �o� res�ruc�ure� ��e� firm���inves�or�expec�a�ions�of�a� fu�ure�c�an�e� in�con�rol��ue��o�M&��ac�ivi�y���an��possible�special�cas��payou�s�for�firms�wi���excess�cas���ol�in�s.

The Hostile Tender Offer��hostile tender offer�is�a��elibera�e�effor���o��o�aroun����e��ar�e�’s�boar��an��mana�emen���o�reac����e��ar�e�’s�s�are�ol�ers��irec�ly�wi���an�offer��o�purc�ase���eir�s�ares.�Unlike�a�mer�er�in�w�ic����e�minori�y�mus��a�ree��o���e��erms�of���e�a�reemen��ne�o�ia�e��by���e�boar��once���e�majori�y�of���e�firm’s�s�are�ol�ers�(i.e.���50.1�percen��or�more)�approve���e�proposal�����e��en�er�offer�specifically�allows�for���e�minori�y�s�are�ol�ers’�approval.�In�a��ra�i�ional�mer�er���minori�y�s�are�ol�ers�are�sai���o�be�frozen�ou��of���eir�posi�ions.�T�is�majori�y�approval�requiremen��is�in�en�e���o�preven��minori�y� s�are�ol�ers� from� s�oppin��a�mer�er�un�il� ��ey�are�pai�� a�pre�mium�over� ��e� purc�ase� price� a�ree�� �o� by� ��e�majori�y.� Followin�� ��e��en�er�offer��� ��e� �ar�e�� firm�becomes�a�par�ially�owne�� subsi�iary�of� ��e�acquirin��company.

�l��ou��� �ar�e�� boar�s�of�en��iscoura�e�unwan�e��bi�s� ini�ially��� ��ey�are�more� likely��o�relen��w�en�a��os�ile� �en�er�offer� is� ini�ia�e�.1��W�ile���ey��ave�become�more�common�in�recen��years����os�ile��akeovers�are�also�rare�ou�si�e���e�Uni�e��S�a�es.

Pre-tender Offer Tactics: Purchasing Target Stock in the Open MarketPo�en�ial� bi��ers� of�en� purc�ase� s�ock� in� a� �ar�e�� before� a� formal� bi�� �o�accumula�e�s�ock�a��a�price� lower���an���e�even�ual�offer�price.�Suc��pur�c�ases�are�normally�kep�� secre�� �o�avoi���rivin��up� ��e�price�an�� increas�in�� ��e� avera�e� price� pai�� for� suc�� s�ares.�T�e� primary� a�van�a�e� �o� ��e��

12� In�s�u�ies�coverin��proxy�con�es�s��urin����e�1��0s���rou�����e�mi��1��0s���abnormal�re�urns�ran�e��from�6��o�1��percen����even�if���e��issi�en��s�are�ol�ers�were�unsuccessful�in���e�proxy�con�es��(�e�n�elo�an���e�n�elo���1���;�Faleye���200�;�an��Mul�erin�an��Poulsen���1���).

1�� In�a�s�u�y�of�1��01���en�er�offers�in���e�Uni�e��S�a�es�be�ween�1�62�an��2001���B�a�a��e��al.��(2005)�foun����a���ar�e��boar�s�resis�e���en�er�offers�abou��one�fif���of���e��ime.�In�a�s�u�y�of�����coun�ries���Rossi�an��Volpin�(200�)�foun����a��only�abou��1�percen��of��5��6�6�M&���ransac�ions�consi�ere��be�ween�1��0�an��2002�were�oppose��by��ar�e��firm�boar�s.

Mergers and Acquisitions Basics60

bi��er�of�accumula�in���ar�e��s�ock�before�an�offer�is���e�po�en�ial�levera�e�ac�ieve��wi�����e�vo�in��ri���s�associa�e��wi�����e�s�ock� i���as�purc�ase�.�T�is� vo�in�� power� is� impor�an�� in� a� proxy� con�es�� �o� remove� �akeover��efenses���win�s�are�ol�er�approval�un�er�s�a�e�an�i�akeover�s�a�u�es���or�elec��members�of���e��ar�e�’s�boar�.�In�a��i�ion�����e�bi��er�can�sell���is�s�ock�la�er�if���e��akeover�a��emp��is�unsuccessful.

�f�er� ��e� bi��er� �as� es�ablis�e�� a� �oe�ol�� owners�ip� posi�ion� in� ��e�vo�in��s�ock�of���e��ar�e����rou���open�marke��purc�ases�����e�bi��er�may�a��emp���o�call�a�special� s�ock�ol�ers’�mee�in��in�an�effor�� �o�replace���e�boar�� of� �irec�ors� or� remove� �akeover� �efenses.�T�e� con�i�ions� un�er�w�ic��suc��a�mee�in��can�be�calle��are��e�ermine��by���e�firm’s�ar�icles�of� incorpora�ion��overne��by� ��e� laws�of� ��e� s�a�e� in�w�ic�� ��e� firm� is�incorpora�e�.1�

Implementing a Tender OfferTen�er�offers�can�be�for�cas����s�ock����eb����or�some�combina�ion�of���e���ree.�Unlike�mer�ers����en�er�offers�frequen�ly�use�cas��as���e�form�of�paymen�.�Securi�ies� �ransac�ions� involve� a� lon�er� perio�� �o� comple�e� ��e� �akeover�because�new�securi�y� issues�mus��be� re�is�ere��wi���an��approve��by� ��e�SEC�an��because�s�a�es��ave���eir�own�securi�y�re�is�ra�ion�requiremen�s.��urin�� ��e� approval�perio���� �ar�e�� firms� are� able� �o�prepare��efenses� an��solici�� o��er� bi�s��� resul�in�� in� a� po�en�ially� �i��er� purc�ase� price� for� ��e��ar�e�.�If���e��en�er�offer�involves�a�s�are�for�s�are�exc�an�e���i��is�referre���o�as�an�exchange offer.�W�e��er�cas��or�securi�ies�����e�offer�is�ma�e��irec�ly��o��ar�e��s�are�ol�ers���is�ex�en�e��for�a�specific�perio����an��may�be�unre�s�ric�e��(any�or�all�offer)�or�res�ric�e���o�a�cer�ain�percen�a�e�or�number�of���e��ar�e�’s�s�ares.

Ten�er� offers� res�ric�e�� �o� purc�asin�� less� ��an� 100� percen�� of� ��e��ar�e�’s� ou�s�an�in�� s�ares� may� be� oversubscribe�.� Because� ��e�Williams��c��of�1�6��requires�equal��rea�men��of�all�s�are�ol�ers��en�erin��s�ares�����e�bi��er�may�ei��er�purc�ase�all�of� ��e��ar�e��s�ock���a�� is� �en�ere��or�purc�ase� only� a� por�ion� of� ��e� �en�ere�� s�ock.� For� example��� if� ��e� bi���er��as�ex�en�e��a��en�er�offer�for��0�percen��of���e��ar�e�’s�ou�s�an�in��s�ares� an���0�percen��of� ��e� �ar�e�’s� s�ock� ac�ually� is� offere���� ��e�bi��er�may�c�oose� �o�prora�e� ��e�purc�ase�of� s�ock�by�buyin��only�6��percen���(i.e.���0.���0.�)�of���e��en�ere��s�ock�from�eac��s�are�ol�er.

1�� ��copy�of�a�firm’s�ar�icles�of�incorpora�ion�can�usually�be�ob�aine��for�a�nominal�fee�from���e��ffice�of���e�Secre�ary�of�S�a�e�of���e�s�a�e�in�w�ic����e�firm�is�incorpora�e�.

Developing Takeover Strategies and the Impact on Corporate Governance 61

If� ��e�bi��er�c�ooses� �o� revise� ��e� �en�er�offer��� ��e�wai�in��perio�� is�au�oma�ically� ex�en�e�.� If� ano��er� bi�� is� ma�e� �o� ��e� �ar�e�� s�are�ol��ers�����e�wai�in��perio��mus��also�be�ex�en�e��by�ano��er�10��ays��o�pro�vi�e�a�equa�e��ime��o�consi�er���e�new�bi�.��nce�ini�ia�e�����en�er�offers�for�publicly��ra�e��firms�are�usually�successful���al��ou�����e�success�ra�e�is�lower�if�i��is�con�es�e�.15

Multitiered OffersT�e�form�of���e�bi��for���e��ar�e��firm�can�be�presen�e���o��ar�e��s�are��ol�ers�ei��er�as�a�one��or��wo��iere��offer.�In�a�one-tier offer�����e�acquirer�announces� ��e� same� offer� �o� all� �ar�e�� s�are�ol�ers��� w�ic�� offers� ��e�po�en�ial� �o� purc�ase� con�rol� of� ��e� �ar�e�� quickly� an�� ��us� �iscoura�e�o��er�po�en�ial�bi��ers�from�a��emp�in���o��isrup����e��ransac�ion.

In� a� two-tiered offer��� ��e� acquirer� offers� �o� buy� a� cer�ain� number� of�s�ares� a��one�price� an��more� s�ares� a�� a� lower�price� a�� a� la�er��a�e.�T�e�form�of�paymen��in���e�secon���ier�may�also�be�less�a��rac�ive���consis�in��of�securi�ies�ra��er���an�cas�.�T�e�in�en��of���e��wo��iere��approac��is��o��ive��ar�e��s�are�ol�ers�an�incen�ive��o��en�er���eir�s�ares�early�in���e�process��o�receive���e��i��er�price.

�nce� ��e�bi��in�� firm�accumula�es�enou��� s�ares� �o��ain�con�rol�of���e� �ar�e�� (usually�50.1�percen�)��� ��e�bi��er�may� ini�ia�e�a� so�calle��back end merger�by�callin��a�special�s�are�ol�ers’�mee�in��seekin��approval�for�a� mer�er� in� w�ic�� minori�y� s�are�ol�ers� are� require�� �o� acce�e� �o� ��e�majori�y� vo�e.��l�erna�ively��� ��e� bi��er� may� opera�e� ��e� �ar�e�� firm� as� a�par�ially� owne�� subsi�iary��� la�er� mer�in�� i�� in�o� a� newly� crea�e�� w�olly�owne��subsi�iary.

Many�s�a�e�s�a�u�es��ave�been�amen�e���o�require�equal��rea�men��for�all��en�erin��s�are�ol�ers�as�par��of��wo��ier�offers.�Many�s�a�es�also��ive��ar�e�� s�are�ol�ers�appraisal rights� ��a�� allow� ��ose�no�� �en�erin�� s�ares�in���e�firs��or�secon���ier��o�ask���e�s�a�e�cour���o��e�ermine�a�“fair�value”�for���e�s�ares.�T�e�appraise��value�for���e�s�ares�may�be�more�or�less���an���e�offer�ma�e�by���e�bi��in��firm.�T�e�minori�y�s�ares�may�be�subjec���o�a�“minori�y��iscoun�”�because���ey�are�wor���less��o���e�bi��er���an���ose�acquire��in���e�process�of��ainin��con�rol.�S�a�e�s�a�u�es�may�also�con�ain�fair�price�provisions�in�w�ic��all��ar�e��s�are�ol�ers���inclu�in����ose�in���e�secon���ier���receive���e�same�price�an��re�emp�ion�ri���s���enablin���ar�e��

15� �ccor�in���o�Mer�ers�a������e�success�ra�e�of��o�al�a��emp�e���en�er�offers�be�ween�1��0�an��2000�was�more���an��0�percen����wi�����e�success�ra�e�for�uncon�es�e��offers�more���an��0�percen��an��for�con�es�e��(i.e.���by���e��ar�e�’s�boar�)�offers�sli���ly�more���an�50�percen�.

Mergers and Acquisitions Basics62

s�are�ol�ers�in���e�secon���ier��o�re�eem���eir�s�ares�a��a�price�similar��o���a��pai��in���e�firs���ier.

�n�acquirer�seekin��a�con�rollin��in�eres��in���e��ar�e��firm�may�ini�i�a�e� a� creeping takeover strategy��� w�ic�� involves� purc�asin�� �ar�e�� vo�in��s�ock�in�rela�ively�small�incremen�s�un�il���e�acquirer��as��aine��effec�ive�con�rol�of���e�firm.�T�is�may�occur�a��less���an�50.1�percen��if���e��ar�e��firm’s�owners�ip�is�wi�ely��isperse�.�If�abou��60�percen��of�a�firm’s�eli�ible�s�are�ol�ers�vo�e�in�elec�ions�for��irec�ors���a�minori�y�ownin��as� li��le�as��5�percen��can�elec��i�s�own�sla�e�of��irec�ors.��cquirers��enerally�will�pay�more�for���e�ini�ial�vo�in��s�ares���an�for�s�ares�acquire��la�er.

T�ere� are� a� number� of� �isa�van�a�es� �o� ownin�� less� ��an� 100� per�cen��of� ��e� �ar�e�’s�vo�in�� s�ock.�T�ey� inclu�e� ��e�po�en�ial� for��issi�en��minori�y�s�are�ol�ers��o��isrup��effor�s��o�implemen��impor�an��mana�e�men���ecisions�����e�cos��incurre��in�provi�in��financial�s�a�emen�s��o�bo���majori�y�an��minori�y�s�are�ol�ers���an��curren��accoun�in��an���ax�rules.��wnin�� less� ��an�50.1�percen��means� ��a�� ��e� �ar�e��canno��be�consoli��a�e�� for� purposes� of� financial� repor�in�� bu�� ins�ea��mus�� be� accoun�e��for� usin�� ��e� equi�y� me��o�.� Because� ��e� equi�y� me��o�� will� inclu�e���e�inves�or’s�s�are�of���e��ar�e�’s�income���i��will�no��c�an�e�consoli�a�e��income;��owever��� ��e� �ar�e�’s� asse�s��� liabili�ies��� revenues��� an�� expenses� are�no�� s�own�on� ��e� inves�or’s� financial� s�a�emen�s.�Consequen�ly��� po�en�ial�increases� in�borrowin��capaci�y� from�s�owin��a� lar�er� asse��or� sales�base�woul��no��be�realize�.�Fur��ermore����ar�e��losses�canno��be�use���o�offse��bi��er��ains�because�consoli�a�ion�for��ax�purposes�requires�ownin���0.1�percen��of���e��ar�e�.

Legal Filings in Undertaking Tender OffersFe�eral�securi�ies�laws�impose�a�number�of�repor�in�����isclosure���an��an�i�frau�� requiremen�s� on� acquirers� ini�ia�in�� �en�er� offers.� �f�er� ��e� �en��er� offer� �as� been�ma�e��� ��e� acquirer� canno�� purc�ase� any� �ar�e�� s�ares�o��er���an���e�number�specifie��in���e��en�er�offer.�Sec�ion�1�(�)�of���e�Williams��c��requires���a��any�in�ivi�ual�or�en�i�y�makin��a��en�er�offer�resul�in��in�ownin��more���an�5�percen��of�any�class�of�equi�y�mus��file�a�Sc�e�ule�1���1�an��all�solici�a�ion�ma�erials�wi�����e�SEC.

After the Tender OfferFollowin�� ��e� �en�er� offer��� ��e� �ar�e�� firm� becomes� a� par�ially� owne��subsi�iary�of� ��e�acquirin��company.�In�some�ins�ances��� ��e� �erms�of� ��e��ransac�ion� may� be� crammed down� or� impose�� on� ��e� minori�y.�T�is� is�

Developing Takeover Strategies and the Impact on Corporate Governance 63

ac�ieve��by� ��e�paren�� firm�mer�in�� ��e�par�ially�owne�� subsi�iary� ��a��resul�e��from���e�failure�of���e��en�er�offer��o��e��subs�an�ially�all�of���e��ar�e��firm’s�s�ares�in�o�a�new�w�olly�owne��subsi�iary.��l�erna�ively�����e�acquirer�may��eci�e�no�� �o�acquire�100�percen��of� ��e� �ar�e�’s� s�ock—in�w�ic�� case� ��e� minori�y� is� subjec�� �o� a� freeze-out� or� squeeze-out� ��a��makes� ��e� remainin�� s�are�ol�ers� �epen�en�� on� ��e� �ecisions� ma�e� by���e�majori�y�s�are�ol�ers.

Advantages of the Hostile Takeover�l��ou����os�ile� �akeovers� �o�ay� are� cer�ainly�more� c�allen�in�� ��an� in���e�pas���� ��ey��ave�cer�ain�a�van�a�es�over� ��e� frien�ly�approac�.��ne� is���a����e�frien�ly�approac��surren�ers���e�elemen��of�surprise.�Even�a�few��ays’�warnin���ives���e��ar�e�’s�mana�emen���ime��o��ake��efensive�ac�ion��o�impe�e���e�ac�ions�of���e�sui�or.�Ne�o�ia�ion�also�raises���e�likeli�oo��of�a�leak�an��a�spike�in���e�price�of���e��ar�e�’s�s�ock�as�arbs�seek��o�profi��from� ��e� sprea�� be�ween� ��e� offer� price� an�� ��e� �ar�e�’s� curren�� s�ock�price.�T�e�specula�ive�increase�in���e��ar�e�’s�s�are�price�can�a����rama�i�cally��o���e�cos��of���e��ransac�ion:���e�ini�ial�offer�by���e�bi��er��enerally�inclu�es�a�premium�over���e��ar�e�’s�curren��s�are�price���an��because���a��premium�usually�is�expresse��as�a�percen�a�e�of���e��ar�e�’s�s�are�price���a�specula�ive�increase�in���e��ar�e��firm’s�curren��s�are�price�will�a����o���e�overall�purc�ase�price�pai��by���e�acquirin��firm.�For���ese�reasons���a�bi���er�may�op��for�a�more��os�ile�approac�.

T�e� early� successes� of� ��e� �os�ile� �en�er� offer� �enera�e�� new��� more�effec�ive� �efenses.�Takeover� �ac�ics� �a�� �o� a�ap�� �o� ��e� prolifera�ion� of�more�formi�able��efenses.�For�example����os�ile��en�er�offers�were�use��in���e�1��0s�in�combina�ion�wi���proxy�con�es�s��o�coerce��ar�e��boar�s�in�o�rescin�in���akeover��efenses.

What Makes the aGGressive approaCh suCCessful?

Successful� �os�ile� �akeovers� �epen�� on� ��e� premium� offere�� �o� �ar�e��s�are�ol�ers;� ��e� boar�’s� composi�ion;� an�� ��e� composi�ion��� sen�imen����an��inves�men���orizon�of���e��ar�e�’s�curren��s�are�ol�ers.����er�fac�ors�inclu�e���e�provisions�of���e��ar�e�’s�bylaws�an����e�po�en�ial�for���e��ar�e���o�implemen��a��i�ional��akeover��efenses.

T�e��ar�e�’s�boar��will�fin��i��more��ifficul���o�rejec��offers�ex�ibi�in��subs�an�ial� premiums� �o� ��e� �ar�e�’s� curren�� s�ock� price.� Concern� abou��i�s� fi�uciary� responsibili�y� an�� possible� s�ock�ol�er� lawsui�s� pu�� pressure�

Mergers and Acquisitions Basics64

on���e��ar�e�’s�boar���o�accep����e�offer.��espi�e���e�pressure�of�an�a��rac��ive�premium�����e�composi�ion�of���e��ar�e�’s�boar��also��rea�ly�influences�w�a����e�boar���oes�an����e��imin��of�i�s��ecisions.���boar���omina�e��by�in�epen�en�� �irec�ors��� nonemployees��� or� family� members� is� more� likely��o�resis��offers�in�an�effor���o�in�uce���e�bi��er��o�raise���e�offer�price�or��o� �ain� �ime� �o� solici�� compe�in�� bi�s� ��an� �o� pro�ec�� i�self� an�� curren��mana�emen�.16

Fur��ermore�����e�final�ou�come�of�a��os�ile��akeover�is��eavily��epen��en��on���e�composi�ion�of���e��ar�e�’s�s�ock�owners�ip����ow�s�ock�ol�ers�feel�abou��mana�emen�’s�performance���an���ow�lon����ey�in�en���o��ol����e�s�ock.�Firms��el��pre�ominan�ly�by�s�or���erm�inves�ors�(i.e.���less���an�four�mon��s)�are�more�likely��o�receive�a�bi��an��ex�ibi��a�lower�avera�e�premium�of�as�muc��as���percen��w�en�acquire����an��researc�ers�specu�la�e���a��firms��el��by�s�or���erm�inves�ors��ave�a�weaker�bar�ainin��posi��ion�wi�����e�bi��er.1��To�assess���ese�fac�ors���an�acquirer�compiles�(�o���e�ex�en��possible)�lis�s�of�s�ock�owners�ip�by�ca�e�ory:�mana�emen����officers���employees���an��ins�i�u�ions�suc��as�pension�an��mu�ual�fun�s.�T�is�infor�ma�ion� can� be� use�� �o� es�ima�e� ��e� �ar�e�’s� float—��e�number� of� s�ares���a��are�ou�s�an�in����no���el��by�block�s�are�ol�ers���an��available�for��ra��in��by���e�public.�T�e�lar�er���e�s�are�of�s�ock��el��by�corpora�e�officers���family�members���an��employees�����e�smaller���e�floa����because���ese��ypes�of�s�are�ol�ers�are�less�likely��o�sell���eir�s�ares.�Floa��is�likely��o�be�lar��es�� for� ��ose�companies� in�w�ic��s�are�ol�ers�are��isappoin�e��wi��� ��e�firm’s�financial�performance.

Finally��� an� as�u�e� bi��er� will� always� analyze� ��e� �ar�e�� firm’s� bylaws�(of�en�easily�accessible���rou���a�firm’s�websi�e)�for�provisions�po�en�ially�a��in���o���e�cos��of�a��akeover.�Suc��provisions�coul��inclu�e�a�s�a��ere��boar���� ��e� inabili�y� �o� remove��irec�ors�wi��ou��cause���or� super�majori�y�vo�in��requiremen�s�for�approval�of�mer�ers.�T�ese�an��o��er�measures�are��e�aile��in�C�ap�er��.

other taCtiCal Considerations

T�e�avera�e� �ime�be�ween� si�nin�� ��e� ini�ial� a�reemen�� an��comple�in��or��ermina�in��an�a�reemen��is�abou��six�mon��s���w�ic���ives�bo���buyer�

16� T�e�s�are�ol�er��ain�from���e�incep�ion�of���e�offer��o�i�s�resolu�ion�is�62.��percen��for��ar�e�s�wi���an�in�epen�en��boar����as�compare��wi����0.��percen��for��ar�e�s�wi��ou��an�in�epen�en��boar��(S�iv�asani���1���).

1�� Gaspara�an��Ma�os�(2005).

Developing Takeover Strategies and the Impact on Corporate Governance 65

an��seller�an�incen�ive��o��ol��up�a��eal��o�rene�o�ia�e���e��erms�base��on�new� informa�ion.�Several� s�ra�e�ies��ave�been��esi�ne�� �o�minimize� ��is�so�calle���ol��up�problem.

To��ei���en���e�c�ance�of�a�successful��akeover�����e�bi��er�will�inclu�e�a�varie�y�of�provisions�in�a�letter of intent�(L�I)��esi�ne���o��iscoura�e���e��ar�e��firm�from�backin��ou��of�any�preliminary�a�reemen�s.�T�e�L�I�is�a�preliminary� a�reemen��be�ween� �wo�companies� in�en�in�� �o�mer�e� ��a��s�ipula�es� major� areas� of� a�reemen�� be�ween� ��e� par�ies��� as� well� as� ��eir�ri���s�an��limi�a�ions.�I��may�con�ain�a�number�of�fea�ures���a��pro�ec����e�buyer;�amon����e�mos��common�is���e�no-shop agreement���w�ic��pro�ibi�s���e��akeover��ar�e��from�seekin��o��er�bi�s�or�makin��public�informa�ion�no��curren�ly�an��rea�ily�available.�Rela�e��a�reemen�s�commi����e��ar�e��firm’s�mana�emen���o�use�i�s�bes��effor�s��o�secure�s�are�ol�er�approval�of���e�bi��er’s�offer.

Con�rac�s�of�en��ran����e��ar�e����e�ri�����o�for�o���e�mer�er�an��pur�sue�an�al�erna�ive�s�ra�e�y�an����e�acquirer���e�ri�����o�wi���raw�from���e�a�reemen�.�However��� ��e� ri���� �o�break� ��e� a�reemen�� is� usually�no�� free.���breakup fee�or�termination fee�is�pai���o���e�ini�ial�bi��er�or��ar�e��if���e��ransac�ion�is�no��comple�e����an��inclu�es�le�al�an��a�visory�expenses���exec�u�ive�mana�emen���ime���an����e�cos�s�associa�e��wi���oppor�uni�ies���a��may��ave�been�los���o���e�bi��er�w�o�was�involve��in��ryin���o�close���is��eal.1��Termina�ion�fees�are�use��more�frequen�ly�on���e��ar�e��si�e���an�on���a��of���e� acquirer�because� �ar�e�s��ave��rea�er� incen�ives� �o�break�con�rac�s� an��seek�o��er�bi��ers.�Suc��fees��en���o�avera�e�abou����percen��of���e�purc�ase�price���an��usin����em�increases���e�probabili�y�of�a��eal�bein��comple�e�.1�

��breakup�fee�pai��by���e�bi��er��o���e��ar�e��firm�is�calle��a�reverse breakup fee���an��suc��fees��ave�become�more�common�in�recen��years�as�buyers��� fin�in�� i�� increasin�ly��ifficul�� �o� finance��ransac�ions����ave�op�e���o� back� ou�� of� si�ne�� a�reemen�s.� P�armaceu�ical� be�emo��� Pfizer’s�200�� a�reemen�� of� purc�ase� an�� sale� �o� buy�Wye��� con�aine�� a� reverse��ermina�ion� fee� in�w�ic��Pfizer� coul��wi���raw� from� ��e� con�rac�� only�if� i�� receive��a�cre�i�� ra�in���own�ra�e�an�� i�s� len�ers� refuse���o�ex�en��loans� base�� on� ��e� �own�ra�e.� Ha�� ��is� �appene���� Pfizer� woul�� �ave�been�le�ally�boun���o�pay�Wye���a�$�.5�billion�paymen��equal��o�an�eye��poppin��6.6�percen��of���e�$6��billion�purc�ase�price.

1�� In�a�sample�of�1��100�s�ock�mer�ers�be�ween�1����an��1������Ho�c�kiss���Qian���an��Son��(200�)�foun��a��ar�e���ermina�ion�or�breakup�fee�inclu�e��in���e�ini�ial�a�reemen��in�55�percen��of�all��eals���w�ereas�in�21�percen��of���e��eals�bo����ar�e��an��acquirer��ermina�ion�fees�were�inclu�e�.

1�� �fficer�(200�).

Mergers and Acquisitions Basics66

T�e� stock lockup��� an� op�ion� �ran�e�� �o� ��e� bi��er� �o� buy� ��e� �ar�e��firm’s�s�ock�a����a��bi��er’s� ini�ial�offer��� is�ano��er�form�of�pro�ec�ion�for���e�bi��er.� I�� is� �ri��ere��w�enever� ��e� �ar�e�� firm�accep�s� a� compe�in��bi�.�Because� ��e� �ar�e��may� c�oose� �o� sell� �o� a� �i��er� bi��er��� ��e� s�ock�lockup� arran�emen�� usually� ensures� ��a�� ��e� ini�ial� bi��er� will� make�a� profi�� on� i�s� purc�ase� of� ��e� �ar�e�’s� s�ock.�T�e� ini�ial� bi��er� also�may�require���a����e�seller�a�ree��o�a�crown jewels lockup,�in�w�ic����e�ini�ial�bi��er��as�an�op�ion��o�buy�impor�an��s�ra�e�ic�asse�s�of���e�seller��� if� ��e�seller�c�ooses��o�sell��o�ano��er�par�y.�Tar�e��firms�may�use�lockup�op�ions��o�en�ance���eir�bar�ainin��power�in��ealin��wi���a�bi��in��firm.20

developinG a BiddinG or takeover strateGy

T�e��ac�ics� ��a��may�be�use�� in��evelopin��a�bi��in�� s�ra�e�y� s�oul��be�viewe��as�a� series�of��ecision�poin�s���wi���objec�ives�an��op�ions�usually�well� �efine�� an�� un�ers�oo�� before� a� �akeover� a��emp�� is� ini�ia�e�.� Pre�offer�plannin��s�oul��involve�a�review�of���e��ar�e�’s�curren���efenses���an�assessmen��of���e��efenses���a��coul��be�pu��in�place�by���e��ar�e��af�er�an�offer� is�ma�e��� an�� ��e� size�of� ��e� floa�� associa�e��wi��� ��e� �ar�e�’s� s�ock.�Poor�plannin��can�resul��in�poor�bi��in����w�ic��can�be�cos�ly��o�CE�s—��ey�may�lose���eir�jobs.21

Common�bi��in�� s�ra�e�y� objec�ives� inclu�e�winnin�� con�rol� of� ��e��ar�e���� minimizin�� ��e� con�rol� premium��� minimizin�� �ransac�ion� cos�s���an�� facili�a�in��pos�acquisi�ion� in�e�ra�ion.� If�minimizin�� ��e� cos��of� ��e�purc�ase�(i.e.��� ��e�price�pai���o�purc�ase���e��ar�e�� firm)�an���ransac�ion�cos�s���w�ile�maximizin�� coopera�ion�be�ween� ��e� �wo�par�ies��� is� consi��ere�� cri�ical��� ��e� bi��er� may� c�oose� ��e�“frien�ly”� approac���� w�ic�� �as���e� a�van�a�e� of� �enerally� bein�� less� cos�ly� ��an� more� a��ressive� �ac�ics�an�� minimizes� ��e� loss� of� key� personnel��� cus�omers��� an�� suppliers� �ur�in�� ��e� fi���� for� con�rol� of� ��e� �ar�e�.� Frien�ly� �akeovers� avoi�� an� auc��ion�environmen����w�ic��may�raise� ��e��ar�e�’s�purc�ase�price.�Moreover���frien�ly�acquisi�ions�facili�a�e�premer�er�in�e�ra�ion�plannin��an��increase�

21� Le�n�an��Z�ao�(2006)���for�a�sample�of��1��acquisi�ions�be�ween�1��0�an��1������foun����a�����percen��of�acquirin��firm�CE�s�were�replace��wi��in�five�years.�Moreover����op�execu�ives�are�more�likely��o�be�replace��a��firms���a���ave�ma�e�poor�acquisi�ions�some�ime��urin����e�previous�five�years.

20� Burc��(2001).

Developing Takeover Strategies and the Impact on Corporate Governance 67

��e� likeli�oo�� ��a�� ��e� combine�� businesses� will� be� quickly� in�e�ra�e���followin��closin�.

�s� �escribe�� earlier��� ��e� primary� risk�of� ��e� frien�ly� approac�� is� ��e�loss�of�surprise.�If���e��ar�e��is�unwillin���o�reac��a�ne�o�ia�e��se��lemen������e�acquirer�is�face��wi�����e�c�oice�of�aban�onin����e�effor��or�resor�in���o�more�a��ressive��ac�ics.�Suc���ac�ics�are�likely��o�be�less�effec�ive�because�of���e�ex�ra��ime���ey��ive���e��ar�e�’s�mana�emen���o�pu��a��i�ional��ake�over� �efenses� in� place.� In� reali�y��� ��e� risk� of� loss� of� surprise�may�no�� be�very��rea��because�of���e�preno�ifica�ion�requiremen�s�of�curren��U.S.�law.

T�e� bi��er� ini�ia�es� con�ac�� casually� ��rou��� an� in�erme�iary� or���rou���a�more�formal�inquiry�(see�Ex�ibi����2���rea�in��from�lef���o�ri���).�If� ��e� �ar�e�’s�mana�emen�� an��boar�� rejec�� ��e�bi��er’s� ini�ial�offer��� ��e�bi��er’s� op�ions� un�er� ��e� frien�ly� approac�� are� ei��er� �o�walk� away�or�a�op��more�a��ressive��ac�ics.�In���e�la��er�case�����e�bi��er�may�un�er�ake�a�simple�bear��u�����opin����a��pressure�from�lar�e�ins�i�u�ional�s�are�ol��ers�an��arbs�will�nu��e���e��ar�e���owar��a�ne�o�ia�e��se��lemen�.

If� ��e� bear� �u�� fails� �o� convince� ��e� �ar�e�’s�mana�emen�� �o� ne�o�i�a�e�����e�bi��er�may�c�oose��o�buy�s�ock�in���e�open�marke�.�T�is�is�mos��effec�ive�w�en� owners�ip� in� ��e� �ar�e�� is� concen�ra�e�� amon�� rela�ively�few�s�are�ol�ers.�T�e�bi��er�may�accumula�e�a�sufficien��number�of�vo��in��ri���s��o�call�a�special�s�ock�ol�ers’�mee�in��if�a�proxy�fi����is��eeme��necessary��o�c�an�e�boar��members�or��ismember���e��ar�e�’s��efenses.

If� ��e� �ar�e�’s� �efenses� are� viewe�� as� rela�ively� weak��� ��e� bi��er� may�for�o� a�proxy�con�es�� an�� ini�ia�e� a� �en�er�offer� for� ��e� �ar�e�’s� s�ock.� If���e� �ar�e�’s� �efenses� appear� formi�able��� �owever��� ��e� bi��er� may� imple�men��a�proxy�con�es��an��a��en�er�offer�concurren�ly.�T�a�����owever��� is�a�very�expensive�s�ra�e�y.�Ten�er�offers�are�cos�ly���because���ey�are�offers��o�buy�up��o�100�percen��of���e��ar�e�’s�ou�s�an�in��s�ock�a��a�si�nifican��pre�mium.���proxy�fi������al��ou���less�expensive���is�s�ill�cos�ly���involvin��all���e�fees��escribe��earlier—inclu�in��for�ex�ensive�li�i�a�ion���w�ic��is�likely.

Li�i�a�ion�is�a�common��ac�ic�use���o�pressure���e��ar�e��boar���o�relen���o���e�bi��er’s�proposal�or�remove��efenses.�I��is�mos��effec�ive�if���e�firm’s��efenses�appear��o�be�especially�onerous.�T�e�bi��er�may�ini�ia�e�li�i�a�ion���a�� accuses� ��e� �ar�e�’s� boar�� of� no�� �ivin�� ��e� bi��er’s� offer� sufficien��review���or�may�ar�ue���a����e��ar�e�’s��efenses�are�no��in���e�bes��in�eres�s�of���e��ar�e�’s�s�are�ol�ers�an��serve�only��o�en�renc��senior�mana�emen�.�In�suc��a�case�����e�acquirer�will�alle�e���a����e�boar��is�viola�in��i�s�fi�u�ciary�responsibili�y��o���e��ar�e��s�are�ol�ers.

Mergers and Acquisitions Basics

68

EXHIBIT 3-2 Alternative Takeover Tactics

.Bidder Chooses Option A, B, C, D, E, or

Some Combination

If Yes Target Board’s Response If No Target Board’s Response

If Yes If No, Initiate

Proxy FightOpen MarketPurchases1

TenderOffer2

Tender Offer &Proxy Fight3

Target Response

If Yes If No

Bidder Adopts Friendly Approach toTarget’s Board

Bidder Adopts more Aggressive Approach toTarget’s Board

Bear Hug (A)

Open Mkt.Purchase (C)

Tender Offer(D)

Proxy Fight(B)

Initial Query/Casual Pass

Litigation(E)

Proceed toNegotiatedSettlement

Walk Away Proceed toNegotiatedSettlement

Rescind Tender Offer & Proceedto Negotiated Settlement

ImplementTender Offer

Bidder Chooses Option A, B, C, D, E, orSome Combination

If Yes Target Board’s Response If No Target Board’s Response

If Yes If No, Initiate

Proxy FightOpen MarketPurchases1

TenderOffer2

Tender Offer &Proxy Fight3

Target Response

If Yes If No

Bidder Adopts Friendly Approach toTarget’s Board

Bidder Adopts more Aggressive Approach toTarget’s Board

Bear Hug (A)

Open Mkt.Purchase (C)

Tender Offer(D)

Proxy Fight(B)

Initial Query/Casual Pass

Litigation(E)

Proceed toNegotiatedSettlement

Walk Away Proceed toNegotiatedSettlement

Rescind Tender Offer & Proceedto Negotiated Settlement

ImplementTender Offer

Developing Takeover Strategies and the Impact on Corporate Governance 69

EXHIBIT 3-3 Advantages and Disadvantages of Alternative Takeover Tactics

Common Bidder Strategy Objectives:l Gain control of target firml Minimize the size of the control premiuml Minimize transaction costsl Facilitate postacquisition integration

Tactics Advantages Disadvantages

Casual Pass (i.e., informal inquiry)

l May learn target is receptive to offer

l Gives advance warning

Bear Hug (i.e., letter to target board forcefully proposing takeover)

l Raises pressure on target to negotiate a deal

l Gives advance warning

Open-Market Purchases (i.e., acquirer buys target shares on public markets)

l May lower cost of transaction

l Creates profit if target agrees to buy back bidder’s toehold position (i.e., greenmail)

l May discourage other bidders

l Can result in a less-than-controlling interest

l Limits on amount can purchase without disclosure

l Some shareholders could hold out for higher price

l Could suffer losses if takeover attempt fails

Proxy Contest (i.e., effort to obtain target shareholder support to change target board)

l Less expensive than tender offer

l May obviate need for tender offer

l Relatively low probability of success if target stock widely held

l Adds to transaction costsTender Offer (i.e.,

direct offer to target shareholders to buy shares)

l Pressures target shareholders to sell stock

l Bidder not bound to purchase tendered shares unless desired number of shares tendered

l Tends to be most expensive tactic

l Disruptive to postclosing integration due to potential loss of key target management, customers, and suppliers

Litigation (i.e., lawsuits accusing target board of improper conduct)

l Puts pressure on target board

l Expense

Mergers and Acquisitions Basics70

Ex�ibi������summarizes�common�bi��er�objec�ives�an����e�a�van�a�es�an���isa�van�a�es�of���e�various��ac�ics���a��may�be�employe���o�ac�ieve���ese�objec�ives.

*�*�*In�a�free�marke��economy�����e�corpora�e��akeover�marke��in�w�ic���ake�

over� �ac�ics� an���efenses� are� employe�� facili�a�es� ��e� alloca�ion�of� resources�an�� �isciplines� un�erperformin�� mana�ers.�T�is� marke���� alon�� wi��� fe�eral�an��s�a�e�le�isla�ion�����e�cour�s���re�ula�ors���an��ins�i�u�ional�ac�ivism����elp�pro�mo�e��oo��corpora�e��overnance�prac�ices���a��pro�ec��s�ake�ol�er�in�eres�s.

A Case in Point: Mittal Acquires Arcelor in a Battle of Global TitansEnding five months of maneuvering, Arcelor—created in 2001 by a combination of steel companies in Spain, France, and Luxembourg—agreed on June 26, 2006, to be acquired by larger rival Mittal Steel Co. for $33.8 billion in cash and stock. Mittal is headquartered in the Netherlands and has plants outside Europe where labor costs are lower. Mittal acquired Arcelor to accelerate steel industry consoli-dation and reduce industry overcapacity. The combined firms could have more leverage in setting prices and negotiating contracts with major customers such as auto and appliance manufacturers and suppliers such as iron ore and coal ven-dors; in addition, they could eventually realize $1 billion annually in pretax cost savings.

The takeover battle was one of the most acrimonious in recent European Union history. It shows how far a firm can go in an attempt to halt an unwanted takeover.

Mittal first tried to consummate a friendly merger but was rebuffed by Arcelor’s president. Then, in January 2006, Mittal launched a tender offer, mostly of stock and cash, for all of Arcelor’s outstanding equity at a 27 percent premium over the share price at the time. Arcelor’s management, European trade unions (fearing job losses), and government officials reacted swiftly and furiously.

Arcelor’s president then undertook one of the most aggressive takeover defenses in recent corporate history. Early that February, Arcelor doubled its div-idend and announced plans to buy back about $8.75 billion in stock at a price well above the then-current market price for Arcelor stock—aimed at motivat-ing Arcelor shareholders not to tender their shares to Mittal. Arcelor also backed an unsuccessful move to change the law to require Mittal to pay in cash.

To counter these moves, Mittal Steel announced that if it received more than one-half of the Arcelor shares submitted in the initial tender offer, it would hold a second tender offer for the remaining shares at a slightly lower price.

Developing Takeover Strategies and the Impact on Corporate Governance 71

Mittal pointed out that it could acquire the remaining shares through a merger or corporate reorganization. This rhetoric sought to encourage Arcelor sharehold-ers to tender their shares during the first offer.

A host of other defensive steps were then taken. In April, Arcelor com-pleted a deal initiated in 2005 to buy Canadian steelmaker Dofasco for $5 billion and then set up a special Dutch trust to prevent Mittal from getting access to the asset, which Mittal was proposing to sell to raise money and avoid North American antitrust concerns. Mittal immediately sued to test the legality of this tactic. Arcelor also cut a deal to exchange a 32 percent stake in Arcelor for the 90 percent stake held by a Mr. Alexei Mordashov in the Russian steelmaker OAO Severstahl and then scheduled an unusual vote that created very tough condi-tions for Arcelor shareholders to prevent the deal from being completed. Some major Arcelor shareholders balked, and the Arcelor board was pressured to at least agree to talk to Mittal. When Arcelor first demanded and received an intri-cate business plan from Mittal, Arcelor still refused to talk.

In late May, Mittal raised its bid by 34 percent and said that if the bid suc-ceeded, Mittal would eliminate its two-tiered share structure, which gave the Mittal family shares 10 times the voting rights of other shareholders. The Arcelor board rejected Mittal’s sweetened bid and repeated its support of the Severstahl deal. Shareholder anger continued as many investors said they would reject the share buyback, some because it would increase Mordashov’s ultimate stake in Arcelor to 38 percent by reducing the number of outstanding Arcelor shares—and thus give Mordashov “effective control” of the company under the law of most European countries.

Arcelor canceled a scheduled June 21 shareholder vote on the buyback and then—despite Mordashov’s efforts to enhance his bid—the Arcelor board asked him and Mittal to submit final bids by June 25.

Finally, Arcelor agreed to Mittal’s final bid. The new offer was $15.70 in cash and 1.0833 Mittal shares for each Arcelor share, valued at $50.54 per Arcelor share, up from Mittal’s initial bid in January 2006 of $35.26. This final offer rep-resented an unprecedented 93 percent premium over Arcelor’s share price of $26.25 immediately before Mittal’s initial bid. Lakshmi Mittal would control 43.5 percent of the combined firm’s stock, and Mordashov would receive a $175 million breakup fee for Arcelor’s failure to complete its agreement with him. Finally, Mittal agreed not to make any layoffs beyond what Arcelor already had planned.

Things to Think About:1. Identify the takeover tactics employed by Mittal and explain why each was

used.2. Identify the takeover defenses employed by Arcelor and explain why each

was used.

Mergers and Acquisitions Basics72

3. Using the Arcelor/Mittal example, discuss the arguments for and against encouraging hostile corporate takeovers.

4. Was Arcelor’s board and management acting to protect their own positions (i.e., the management entrenchment theory) or in the best interests of the shareholders (i.e., the shareholder interests theory)? Explain your answer.

5. In an attempt to counter Mittal’s hostile tender offer, Arcelor offered to increase its dividend and to buy back shares from current shareholders. In doing so, it hoped to discourage Arcelor shareholders from tendering their shares to Mittal. Explain how you, as an Arcelor shareholder, would decide whether to tender your shares to Mittal or support Arcelor’s management.

Answers can be found at: www.elsevierdirect.com/companion.jsp?ISBN=9780123749482

73Mergers and Acquisitions Basics� ©�2011�Elsevier�Inc.ISBN:�����0�12��������2�� ��I: �ll ri���s reserve�.����0�12��������2�� ��I: �ll ri���s reserve�.�����I:� �ll�ri���s�reserve�.

CHAPTER

201110.1016/B����0�12��������2.0000���

Common Takeover Defenses

You�learne��in�C�ap�er���abou����e��ac�ics�acquirers�commonly�use��o��ain�a�con�rollin��in�eres��in�a��ar�e��firm.�T�is�c�ap�er�focuses�on���e��efense.

Takeover defenses�are�impe�imen�s��o�po�en�ial�bi��ers�an��are��esi�ne��ei��er��o�slow��own�an�unwan�e��offer�or�force�a�sui�or��o�raise���e�bi���o��e����e��ar�e�’s�boar���o�rescin����e��efense.�Some�observers�ar�ue���a����ese��efenses�are�mean���o��iscoura�e�unwan�e���akeovers�so��ar�e��mana�emen��can��ol��on��o��i���salaries�an��perks.����ers�con�en����a����ese��efenses�of�en�benefi��s�are�ol�ers�by�forcin��bi��ers��o�raise���eir�offer�prices.

Takeover��efenses�are��esi�ne��ei��er��o�slow���e��akeover�process�an���ive���e��ar�e��firm�a�c�ance��o�s�ren���en�i�s�exis�in���efense�or�pu��new�ones�in�place���or�raise���e��o�al�cos���o���e�acquirers�of��akin��over���e��ar�e�.�T�ey�can�be��roupe��in��wo�ca�e�ories:���ose�pu��in�place�before�receivin��an�offer�an����ose�implemen�e��af�er�receip��of�an�offer.�Ex�ibi����1�s�ows���e�mos�� commonly� use�� pre�� an�� pos��offer� �efenses;� public� companies�use���on�avera�e�����ree�of���ese�w�en�confron�e��wi���a��akeover�a��emp�.1��s�you�will�learn�in���is�c�ap�er�����ey�are�effec�ive��o�varyin���e�rees.

T�e�bes���efense�a�ains��unwan�e��sui�ors�may�be�a�vance�plannin��an��a� s�ron�� financial� performance.� Lar�e� public� companies� rou�inely� review���eir� �akeover� �efenses.� Many� companies� �ave� “s�ock� wa�c�”� pro�rams�in�place� ��a�� are� in�en�e�� �o� i�en�ify� s�ock� accumula�ions���or� s�ock�price�movemen�s� ��a�� reflec�� an� impen�in�� �akeover� a��emp�.� Suc�� pro�rams��rack��ra�in��pa��erns�in�a�company’s�s�ock.�Companies�require���eir�s�ock��ransfer�a�en���o�provi�e�up��o��a�e�an��accura�e�s�ock��ransfer�s�ee�s�an���o� repor�� any� unusual� movemen�s� in� s�ock� �ransfer� ac�ivi�y.� S�ock� wa�c��pro�rams�rou�inely�review�SEC�recor�s�for�any�Sc�e�ule�1���filin�s���w�ic��are�require��w�en�a�firm�buys�more���an�5�percen��of�ano��er�firm’s�s�ock.

Pre-Offer Defenses

Pre�offer� �efenses� are� use�� �o� preven�� a� su��en��� unexpec�e�� �os�ile� bi��from� �ainin�� con�rol� of� ��e� company� before� mana�emen�� �as� �ime� �o�

4

1� Fiel��an��Karpoff�(2000).

Mergers and Acquisitions Basics74

EXHIBIT 4-1 Alternative Pre-offer and Post-offer Takeover Defenses

Pre-offer Defenses Post-offer Defenses

Poison Pills*:Flip-Over Rights PlansFlip-In Rights Plans

Greenmail (Bidder’s investment purchased at a premium to what it paid as inducement to refrain from any further activity)

Shark Repellants (Implemented by changing bylaws or charter):Strengthening the Board’s

DefensesStaggered or Classified Board

ElectionsCumulative Voting Rights“For Cause” Provisions

Limiting Shareholder ActionsCalling Special MeetingsConsent SolicitationsAdvance Notice ProvisionsSuper-Majority Rules

Other Shark RepellentsAntigreenmail Provisions

(Discourages target’s use of greenmail as a takeover tactic)

Fair Price ProvisionsSupervoting StockReincorporation

Standstill Agreements (Often used in conjunction with an agreement to buy bidder’s investment)

Golden Parachutes Pac-Man DefenseWhite Knights and White SquiresEmployee Stock Ownership PlansLeveraged RecapitalizationShare Repurchase or Buyback

PlansCorporate RestructuringLitigation

*Although many different types of poison pills are used, only the most common forms are discussed in this text. Note also that the distinction between pre- and post-offer defenses is becoming murky as increasingly poison pill plans are put in place immediately following the announcement of a bid. Pills can be adopted without a shareholder vote because they are issued as a dividend and the board has the exclusive authority to issue dividends.

Common Takeover Defenses 75

assess���eir�op�ions�properly.�If� ��e�pre�offer��efenses�succee��in��elayin����e�c�an�e�in�con�rol�����e��ar�e��firm��as��ime��o�erec��a��i�ional��efenses�af�er���e�unsolici�e��offer�is�receive�.

Pre�offer��efenses��enerally�fall�in�o���ree�ca�e�ories:�poison�pills���s�ark�repellen�s���an���ol�en�parac�u�es.�T�e�sop�is�ica�ion�of�suc��measures��as�increase���rama�ically�since�1��0���keepin���empo�wi�����e��rowin��effec��iveness�of��akeover��ac�ics.

Poison PillsT�e�popular�press�uses���e��erm�“poison�pill”��o��escribe�a�ran�e�of�pro��ec�ions�a�ains��unsolici�e���en�er�offers.� In�prac�ice����owever��� ��e�poison pill�is�a�very�specific��ype�of�an�i�akeover��efense.

�f�en�referre���o�as�s�are�ol�er�ri���s�plans���poison�pills�are�a�new�class�of�securi�ies�issue��by�a�company��o�i�s�s�are�ol�ers.�Because�pills�are�issue��as�a��ivi�en��an����e�boar���as���e�exclusive�au��ori�y��o�issue��ivi�en�s���a�pill� can�of�en�be� a�op�e��wi��ou�� a� s�are�ol�er�vo�e� (unless� ��e� firm’s�bylaws� limi�� suc�� ac�ion).�Consequen�ly��� poison� pills� can� be� a�op�e�� no��only�before�bu��also�af�er���e�onse��of�a��os�ile�bi����w�ic��means���a��even�a�company���a���oes�no���ave�a�poison�pill�in�place�can�be�re�ar�e��as��av�in��a�“s�a�ow�poison�pill”���a��coul��be�use��in���e�even��of�a��os�ile�bi�.2

Poison�pill�securi�ies��ave�no�value�unless�an�inves�or�acquires�a�specific�percen�a�e�(of�en�as� low�as�10�percen�)�of���e��ar�e��firm’s�vo�in��s�ock.�If���is���res�ol��percen�a�e�is�excee�e��an����e�pill�is�a�so�calle��flip-in poison pill�����e�poison�pill�securi�ies�are�ac�iva�e��an���ypically�allow�exis�in���ar�e��s�are�ol�ers��o�purc�ase�a��i�ional�s�ares�of���e��ar�e��firm’s�common�s�ock�a��a��iscoun��from���e�curren��marke��price.��l�erna�ively���if���e�pill�is�a�flip-over poison pill���exis�in��s�are�ol�ers�may�purc�ase�a��i�ional�s�ares�of���e�acquirer�or�survivin��firm’s�common�s�ares�(i.e.�����e�s�ares�of���e�combine��companies)���also�a��a��iscoun�.

Tri��erin����e�flip�in�pill�increases���e�acquirer’s�cos��of���e��ransac�ion�by� increasin�� ��e�number�of� �ar�e�� s�ares� ��a��nee�� �o�be�purc�ase�� for�cas��in�a�cas��for�s�are�exc�an�e�or���e�number�of�new�s�ares���a��mus��be�issue��by���e�acquirer�in�a�s�are�for�s�are�exc�an�e.�In�a�cas��for�s�are�exc�an�e��� ��e� c�an�e� in� ��e� acquirer’s� cas�� ou�lay� will� �epen�� on� ��e�number�of��ar�e��s�are�ol�ers�exercisin����eir�ri�����o�buy�a��i�ional��ar��e��s�ares.�For�example���if���e�number�of��ar�e��s�ares�ou�s�an�in���ouble��an����e�price�per�s�are�offere��by���e�acquirer�remaine��unc�an�e������e�

2� Coa�es�(2000).��ccor�in���o�s�arkrepellen�.com���almos��one�four���of�firs���ime�pill�a�op�ions�in�200��were�implemen�e��w�en���e�firm�was�“in�play.”��T�is�compares��o�abou����percen��of�all�firs���ime�pill�a�op�ions�in�2002.

Mergers and Acquisitions Basics76

amoun�� of� cas�� require�� �o� buy� all� or� a� specific� por�ion� of� ��e� �ar�e�’s�s�ares�woul���ouble.�In�a�s�are�for�s�are�exc�an�e�����e�increase��number�of�acquirer�s�ares�issue��imposes�a�cos��on�acquirer�s�are�ol�ers�by��ilu��in����eir�owners�ip�posi�ion.�News�Corp.�was�usin����e�flip�in�poison�pill�w�en� ��e� firm� announce��on�November� ���� 200���� ��a�� i��woul�� �ive� i�s�s�are�ol�ers� ��e� ri���� �o�buy�one� s�are�a���alf�price� for�eac�� s�are� ��ey�own� in� ��e�even�� any�par�y� seeks� �o�buy�a�15�percen�� s�ake� in� ��e� firm.�T�e�pill�woul��exclu�e���e�purc�aser�of���e�15�percen��s�ake.

Ex�ibi�� ��2� illus�ra�es� ��e� �ilu�ion� of� ��e� acquirer’s� s�are�ol�ers� own�ers�ip� posi�ion� resul�in�� from� a� poison� pill� in� a� s�are�for�s�are� exc�an�e�offer.��ssume� ��e� acquirer� �as� 1� million� s�ares� curren�ly� ou�s�an�in�� an���as� a�ree�� �o� acquire� ��e� 1� million� s�ares� of� �ar�e�� s�ock� ou�s�an�in�� by�exc�an�in�� one� s�are� of� acquirer� s�ock� for� eac�� s�are� of� �ar�e�� s�ock.�To�comple�e� ��e� �ransac�ion��� ��e� acquirer�mus�� issue� 1�million� s�ares� of� new�s�ock���wi�����e��ar�e�’s�s�ock�bein��cancele�.�T�e��o�al�number�of�s�ares�ou��s�an�in��for���e�new�company�woul��be�2�million�s�ares�(i.e.���1�million�of�exis�in��acquirer�s�ock�plus�1�million�in�newly�issue��s�ares).�Tar�e��company�an�� acquirer� s�are�ol�ers�woul��eac��own�one��alf�of� ��e�new�company.�However��� if� �ar�e�� company� s�are�ol�ers�were� able� �o�buy�1�million�new�s�ares�of��ar�e��s�ock�a��a�nominal�price�because�of�a�flip�in�pill�����e�number�of�s�ares���a��now�mus��be�acquire��woul���o�al�2�million.�T�e��o�al�number�of�s�ares�of���e�new�company�woul��be���million���of�w�ic���ar�e��company�s�are�ol�ers�woul��own��wo���ir�s�an��acquirer�s�are�ol�ers�one���ir�.

No�e� ��a�� a� flip�in� or� flip�over� pill� �as� ��e� same� �ilu�ive� effec�� on�acquirer� s�are�ol�ers.�Wi��� ��e� flip�in� pill��� �ar�e�� s�are�ol�ers� purc�ase���1� million� new� s�ares� of� �ar�e�� s�ock��� w�ereas� for� a� flip�over� pill� ��ey�bou����1�million�new�s�ares�of���e�acquirer’s�or�survivin��firm’s�s�ares.�In�ei��er�case�����e�acquirer��a���o�issue�1�million�new�s�ares.

Proponen�s� of� ��e� pill� �efense� ar�ue� ��a�� i�� preven�s� a� rai�er� from�acquirin��a�subs�an�ial�por�ion�of���e�firm’s�s�ock�wi��ou��boar��permis�sion.�Because���e�boar���enerally��as���e�power��o�rescin����e�pill���bi��ers�are�compelle���o�ne�o�ia�e�wi�����e��ar�e�’s�boar����w�ic��coul��resul�� in�a��i��er�offer�price.�Pill��efenses�may�be�mos��effec�ive�w�en�use��wi���s�a��ere��boar���efenses�in�w�ic��a�rai�er�woul��be�unable��o�remove���e�pill�wi��ou��winnin���wo�successive�elec�ions;���is�increases���e�likeli�oo��of� remainin�� in�epen�en�.�� �e�rac�ors� ar�ue� ��a�� pill� �efenses� simply��

�� �ccor�in���o�Bebc�uk�e��al.�(2002)�����e�likeli�oo��of�remainin��in�epen�en��rises�from�����o�61�percen��wi���suc��a�combina�ion�of��efenses���an����e�probabili�y���a����e�firs��bi��er�will�be�successful��rops�from�����o�1��percen�.

Comm

on Takeover Defenses

77

EXHIBIT 4-2 Acquirer Shareholder Dilution Due to Poison PillFlip-In Pill Defense2 New Company Shares Outstanding1 Ownership Distribution in New Company (%)

Without Pill With Pill Without Pill With Pill

Target Firm ShareholdersShares Currently Outstanding

Total Shares Outstanding1,000,000 2,000,000 50 673

1,000,000 2,000,000Acquiring Firm Shareholders

Shares Currently OutstandingNew Shares Issued

Total Shares Outstanding

1,000,000 1,000,0001,000,000 2,000,000 50 332,000,000 3,000,000

Flip-Over Pill Defense4

Target Firm ShareholdersShares Currently Outstanding

Total Shares Outstanding1,000,000 1,000,000 50 671,000,000 1,000,000

Acquiring Firm ShareholdersShares Currently OutstandingNew Shares Issued

Total Shares Outstanding

1,000,000 1,000,000 50 331,000,000 2,000,0002,000,000 3,000,000

1 Acquirer agrees to exchange one share of acquirer stock for each share of target stock. The target shares outstanding are canceled.2 Poison pill provisions enable target shareholders to buy one share of target stock for each share they own at a nominal price.3 2,000,000/3,000,000.4 One million new shares must be issued to target shareholders exercising their right to buy shares in the surviving or new company at a nominal price.

Mergers and Acquisitions Basics78

serve��o�en�renc��mana�emen��an��encoura�e��isaffec�e��s�are�ol�ers��o�li�i�a�e.

In�recen��years���boar�s��ave�been�un�er�pressure��o�require�s�are�ol�er�approval�of�all�ri���s�plans�an��rescin��exis�in��pill��efenses.

Shark RepellentsShark repellents�are�specific��ypes�of��akeover��efenses�ac�ieve��by�amen��in��ei��er�a�corporate charter�or���e�corporate bylaws.�T�e�corpora�e�c�ar��er��ives� ��e�corpora�ion� i�s� le�al�exis�ence�an��comprises� ��e�articles of incorporation,�a��ocumen��file��wi���a�s�a�e��overnmen��by���e�foun�ers�of� a� corpora�ion��� an�� a� certificate of incorporation,� a� �ocumen�� receive��from���e�s�a�e�af�er���e�ar�icles��ave�been�approve�.�T�e�c�ar�er�i�en�ifies���e�corpora�ion’s�name���purpose���number�of�au��orize��s�ares���an��number�an�� i�en�i�y�of� �irec�ors.�T�e� corpora�ion’s� powers� ��us� �erive� from� ��e�laws�of���e�s�a�e�an��from���e�provisions�of���e�c�ar�er.�Rules��overnin����e�in�ernal�mana�emen��of���e�corpora�ion�are��escribe��in���e�corpora��ion’s�bylaws���w�ic��are��e�ermine��by���e�corpora�ion’s�foun�ers.

S�ark� repellen�s� are� pu�� in� place� lar�ely� �o� reinforce� ��e� abili�y� of� a�firm’s�boar��of��irec�ors� �o� re�ain� con�rol.�T�ey�pre�a�e�poison�pills� as� a��efense��� an�� ��eir� success� in� slowin�� �own� �akeovers� an�� makin�� ��em�more�expensive��as�been�mixe�—w�ic���� in�fac����par�ly�explains�w�y���e�poison�pill�an��o��er�more�crea�ive��efenses�were��evelope�.

To�ay���s�ark�repellen�s��ave�lar�ely�become�supplemen�s��o�poison�pill��efenses.�T�eir�primary�role�is��o�make�i��more��ifficul���o��ain�con�rol�of���e�boar����rou���a�proxy�fi����a��an�annual�or�special�mee�in�.�In�prac��ice��� s�ark� repellen�s� as��escribe���ere� require� amen�men�s� �o� ��e� firm’s�c�ar�er��� w�ic�� necessi�a�e� a� s�are�ol�er� vo�e.��l��ou��� ��ere� are� many�varia�ions� of� s�ark� repellen�s��� ��e� mos�� �ypical� are� s�a��ere�� boar�� elec��ions��� res�ric�ions�on� s�are�ol�er�ac�ions��� an�i�reenmail�provisions��� super�vo�in���� an�� �eb��base�� �efenses.� Ex�ibi�� ���� summarizes� ��e� primary�a�van�a�es� an�� �isa�van�a�es� of� eac�� �ype� of� s�ark� repellen�� �efense� in���ree�ca�e�ories:���ose���a��s�ren���en���e�boar�’s��efenses�����ose���a��limi��s�are�ol�er� ac�ions��� an�� all� o��ers.�T�e� ex�ibi�� also� inclu�es� poison�pills�an���ol�en�parac�u�es�(�e�aile��la�er�in���is�c�ap�er).

Strengthening the Board’s Defenses��staggered board election�or�classified board election�involves��ivi�in����e�firm’s��irec�ors�in�o�a�number�of��ifferen��classes.��nly�one�class�is�up�for�reelec�ion�eac��year.�For�example���a�12�member�boar��may��ave��irec�ors�

Common Takeover Defenses 79

EXHIBIT 4-3 Advantages and Disadvantages of Pre-offer Takeover Defenses: Poison Pills, Shark Repellents, and Golden Parachutes

Type of Defense Advantages for Target Firm

Disadvantages for Target Firm

Poison Pills: Raising the Cost of Acquisition

Flip-Over Pills (Rights to buy stock in the acquirer, activated with 100% change in ownership)

Dilutes ownership position of current acquirer shareholders

Rights redeemable by buying them back from shareholders at nominal price

Ineffective in preventing acquisition of ,100% of target (Bidders(Bidders could buy controlling interest only and buy remainder after rights expire)

Subject to hostile tender contingent on target board’s redemption of pill

Makes issuer less attractive to white knights

Flip-In Pills (Rights to buy stock in the target, activated when acquirer purchases ,100% change in ownership)

Dilutes target stock regardless of amount purchased by potential acquirer

Discriminatory as not given to investor who activated the rights

Rights redeemable at any point prior to triggering event

Not permissible in some states due to discriminatory nature

No poison pill provides any protection against proxy contests

Shark Repellents: Strengthening the Board’s Defenses

Staggered or Classified Boards

Delays assumption of control by a majority shareholder

May be circumvented by increasing size of board, unless prevented by charter or bylaws

Cumulative Voting Delays assumption of control by a majority shareholder

Gives dissident shareholder a board seat and access to confidential information

(Continued)

Mergers and Acquisitions Basics80

EXHIBIT 4-3 (Continued)

Type of Defense Advantages for Target Firm

Disadvantages for Target Firm

Shark Repellents: Strengthening the Board’s Defenses

Limitations on When Shareholders Can Remove Directors

“For cause” provisions narrow range of reasons for removal

Can be circumvented unless supported by a super-majority requirement for repeal

Shark Repellents: Limiting Shareholder Actions

Limitations on Calling Special MeetingsMeetings

Limits ability to use special meetings to add board seats and remove or elect new members

States may require a special meeting if a certain percentage of shareholders request a meeting

Limiting Consent Solicitations

Limits ability of dissident shareholders to expedite a proxy contest process

May be subject to court challenge

Advance Notice Provisions

Gives board time to select its own slate of candidates and to decide an appropriate response

May be subject to court challenge

Super-Majority Provisions

May be applied selectively to events such as hostile takeovers

Can be circumvented unless a super-majority of shareholders are required to change the provision

Other Shark Repellents

Antigreenmail Provision Eliminates profit opportunity for raiders

Eliminates greenmail as a takeover defense

Fair Price Provisions Increases the cost of a two-tiered tender offer

Raises the cost to a white knight, unless waived by typically 95% of shareholders

(Continued)

Common Takeover Defenses 81

�ivi�e��in�o�four�classes���wi���eac���irec�or�elec�e��for�a�four�year�perio�.�In���e�firs��year�����e���ree��irec�ors�in�w�a��mi����be�calle��“Class�1”�are�up�for�elec�ion;�in���e�secon��year���“Class�2”��irec�ors�are�up�for�elec�ion;�an��so�on.�T�is�means���a��an�insur�en��s�ock�ol�er���even�one�w�o��ol�s���e�majori�y�of���e�s�ock���woul���ave��o�wai��for���ree�elec�ion�cycles��o��ain� con�rol� of� ��e� boar�.�Moreover��� ��e� size� of� ��e� boar�� is� limi�e�� by���e�firm’s�bylaws��o�preclu�e���e�insur�en��s�ock�ol�er�from�a��in��boar��sea�s� �o� �ake�con�rol�of� ��e�boar�.�T�e� �ar�e��may��ave� �o�acce�e� �o� ��e�majori�y�s�ock�ol�er’s��eman�s�because�of�li�i�a�ion�ini�ia�e��by��issi�en��s�are�ol�er��roups.�T�e�likeli�oo��of�li�i�a�ion�is��i��es����an��pressure�on�

Other Shark Repellents

Supervoting Stock Concentrates control by giving “friendly” shareholders more voting power than others

Difficult to implement because requires shareholder approval and only useful when voting power can be given to promanagement shareholders

Reincorporation Takes advantage of most favorable state antitakeover statutes

Requires shareholder approval; time consuming to implement unless subsidiary established before takeover solicitation

Golden Parachutes* Emboldens target management to negotiate for a higher premium and raises the cost of a takeover to the hostile bidder

Negative public perception; makes termination of top management expensive; cost not tax deductible

* Generally not considered a shark repellent but included in this table because they are usually put in place before a bid is made for the firm.

EXHIBIT 4-3 (Continued)

Type of Defense Advantages for Target Firm

Disadvantages for Target Firm

Mergers and Acquisitions Basics82

��e�boar��is��rea�es����w�enever���e�offer�price�for���e��ar�e��is�subs�an�ially�above���e��ar�e��firm’s�curren��s�are�price.�S�a��ere��boar�s�can�be�effec��ive�in��elpin��a��ar�e���o�war��off�a��os�ile��akeover�a��emp�.�

Some� firms��ave� common� s�ock� carryin�� cumulative voting rights� �o�maximize� minori�y� represen�a�ion.� Cumula�ive� vo�in�� in� ��e� elec�ion� of��irec�ors�means�eac��s�are�ol�er�is�en�i�le���o�as�many�vo�es�as�s�all�equal���e�number�of�s�ares���e�s�are�ol�er�owns���mul�iplie��by���e�number�of��irec�ors��o�be�elec�e�.�Fur��ermore�����e�s�are�ol�er�may�cas��all�of���ese�vo�es�for�a�sin�le�can�i�a�e�or�for�any��wo�or�more�can�i�a�es.

��ain� usin�� ��e� example� of� a� 12�member� boar���� a� s�are�ol�er� w�o��as�100�s�ares�of�s�ock��as��00�vo�es�for���ree�open�sea�s�for�Class�1��irec��ors.�T�e�s�are�ol�er�may�cumula�e�vo�es�an��cas����em�for�a�specific�can��i�a�e.����issi�en��s�ock�ol�er�may�c�oose���is�approac���o�ob�ain�a�sin�le�sea��on���e�boar���o��ain�access��o�useful�informa�ion���a��is�no��o��erwise�rea�ily�available.�For cause provisions�specify���e�con�i�ions�for�removin��a�member�of� ��e� boar��of� �irec�ors��� narrowin�� ��e� ran�e�of� permissible�reasons�an�� limi�in����e� flexibili�y�of��issi�en��s�are�ol�ers� in�con�es�in��boar��sea�s.

Limiting Shareholder ActionsT�e�boar��can�also�reinforce�i�s�con�rol�by�res�ric�in����e�abili�y�of�s�are��ol�ers� �o� �ain� con�rol� of� ��e� firm� by� bypassin�� ��e� boar�� al�o�e��er.�Limi�s�can�be�se��on�s�are�ol�ers’�abili�y��o�call�special�mee�in�s���en�a�e�in�consen��solici�a�ions���an��use�super�majori�y�rules�(explaine��la�er).�Firms�frequen�ly�rely�on���e�con�i�ions�un�er�w�ic���irec�ors�can�be�remove��(i.e.��� ��e�“for� cause”� provision� �iscusse�� earlier)� an�� a� limi�a�ion� on� ��e�number�of�boar��sea�s�as��efine��in���e�firm’s�bylaws�or�c�ar�er.

In�some�s�a�es���s�are�ol�ers�may��ake�ac�ion—wi��ou��a�special�s�are��ol�ers’� mee�in�—�o� a��� �o� ��e� number� of� sea�s� on� ��e� boar���� remove�specific� boar�� members��� or� elec�� new� members.�T�ese� s�a�es� allow� �issi��en��s�are�ol�ers��o�ob�ain�s�are�ol�er�suppor��for���eir�proposals�simply�by�ob�ainin����e�wri��en�consen��of�s�are�ol�ers�un�er�w�a��is�known�as�consent solicitation���a�process���a��s�ill�mus��abi�e�by���e��isclosure�require�men�s� applicable� �o� proxy� con�es�s� (see� C�ap�er� �).�T�e� process� circum�ven�s��elays�in�eren��in�se��in��up�a�mee�in���o�con�uc��a�s�ock�ol�er�vo�e.

T�ere�is�an�impor�an���ifference�be�ween�a�consen��solici�a�ion�an��a�proxy�con�es�.�W�ereas���e�winnin��vo�e�in�a�proxy�fi����is��e�ermine��as�

�� Bebc�uk���Coa�es���an��Subramanian�(2002���200�).

Common Takeover Defenses 83

a�percen�a�e�of���e�number�of�vo�es�ac�ually�cas��(unless�majori�y�vo�in���rules�are�in�place���w�ic��require���e�coun�in��of�vo�es�wi���el�)�����e�win�nin�� vo�e� in� a� consen�� solici�a�ion� is� �e�ermine�� as� a� percen�a�e� of� ��e�number�of�s�ares�ou�s�an�in�.����issi�en��s�are�ol�er�may�����erefore���fin��i�� easier� �o�win�by� ini�ia�in�� a� proxy� con�es�� because�many� s�are�ol�ers�simply��o�no��vo�e.

Companies� �ave� a��emp�e�� �o� limi�� s�are�ol�ers’� abili�y� �o� use� ��is�proce�ure�by� amen�in��c�ar�ers�or�bylaws.�Bylaw�amen�men�s�may�no��require�s�are�ol�er�approval.�However�����e�cour�s�frequen�ly��ave�frowne��upon�ac�ions���a��res�ric��s�are�ol�er�ri���s�wi��ou��s�are�ol�er�approval.

Corpora�e� bylaws� may� inclu�e� advance notice provisions� ��a�� require�s�are�ol�er� proposals� an�� boar�� nomina�ions� be� announce�� well� in�a�vance��� some�imes� as� lon�� as� �wo� mon��s��� of� an� ac�ual� vo�e.�T�is� buys��ime� for� ��e� �ar�e�’s� mana�emen�.� Super-majority rules� require� a� �i��er�level�of�approval���an�is�s�an�ar���o�amen����e�c�ar�er�or�for�cer�ain��ypes�of� �ransac�ions��� suc�� as� a�mer�er� or� acquisi�ion.� Suc�� rules� are� �ri��ere��w�en� an�“in�eres�e�� par�y”� acquires� a� specific� percen�a�e� of� ��e� owner�s�ip�s�ares�(e.�.���5��o�10�percen�).�Super�majori�y�rules�may�require���a��as�muc��as��0�percen��of���e�s�are�ol�ers�mus��approve�a�propose��mer�er�or� a� simple� majori�y� of� all� s�are�ol�ers� excep�� ��e� “in�eres�e�� par�y.”�Super�majori�y�rules�of�en�inclu�e�escape clauses� ��a��allow���e�boar���o�waive� ��e� requiremen�.�For�example��� super�majori�y� rules�may�no��apply��o�mer�ers�approve��by���e�boar�.

Other Pre-offer DefensesIn�a��i�ion��o�poison�pills�����ere�are�some�o��er�pre�offer��efenses���inclu��in��an�i�reenmail���fair�price�provisions���supervo�in��s�ock���reincorpora�ion���an���ol�en�parac�u�es.

Antigreenmail Provisions�urin����e�1��0s���many�rai�ers�profi�e��by��akin��an�equi�y�posi�ion�in�a��ar�e��firm�����rea�enin���akeover���an��subsequen�ly�sellin����eir�owners�ip�posi�ion�back��o���e��ar�e��firm�a��a�premium�over�w�a����ey�pai��for���e��ar�e�’s� s�ares.�T�e� prac�ice� was� �ubbe�� greenmail—a� neolo�ism� �erive��from�blackmail�an��greenback.�In�response���many�corpora�ions�a�op�e��c�ar��er� amen�men�s� calle�� antigreenmail provisions� ��a�� res�ric�� ��e� firm’s�abili�y� �o�repurc�ase�s�ares�a��a�premium.�By�removin����e� incen�ive� for��reenmail���companies�believe����ey�were�makin����emselves�less�a��rac�ive�as�po�en�ial��akeover��ar�e�s.

Mergers and Acquisitions Basics84

Fair Price ProvisionsRequiremen�s� ��a�� any� acquirer� pay�minori�y� s�are�ol�ers� a�� leas�� a� fair�marke��price�for���eir�s�ock�are�calle�� fair price provisions.�T�e�fair�mar�ke��price�may�be�expresse��as� some��is�orical�mul�iple�of� ��e�company’s�earnin�s�or�as�a�specific�price�equal��o���e�maximum�price�pai��w�en���e�buyer�acquire��s�ares�in���e�company.�Fair�price�provisions�are�mos��effec��ive�w�en���e��ar�e��firm�is�subjec���o�a��wo��iere���en�er�offer.�T�e�fair�price� provision� forces� ��e� bi��er� �o� pay� �ar�e�� s�are�ol�ers���w�o� �en�er���eir� s�ock� in� ��e� secon���ier��� ��e� same��erms�offere�� �o� ��ose� �en�erin����eir�s�ock�in���e�firs�� �ier.�Mos��fair�price�provisions��o�no��apply�if� ��e�propose���akeover�is�approve��by���e��ar�e��firm’s�boar��of��irec�ors�or�if���e� bi��er� ob�ains� a� specifie�� super�majori�y� level� of� approval� from� ��e��ar�e�’s�s�are�ol�ers.

Supervoting Stock��firm�may�crea�e�more���an�one�class�of�s�ock�for�many�reasons���inclu��in��separa�in����e�performance�of�in�ivi�ual�opera�in��subsi�iaries���com�pensa�in��subsi�iary�opera�in��mana�emen����main�ainin��con�rol�wi�����e�foun�ers��� an�� preven�in�� �os�ile� �akeovers.��s� a� �akeover� �efense��� a� firm�may�un�er�ake�a�dual class recapitalization�wi�����e�objec�ive�of�concen��ra�in��s�ock�wi�����e��rea�es��vo�in��ri���s�in���e��an�s�of���ose�w�o�are�mos�� likely� �o� suppor��mana�emen�.��ne� class� of� s�ock�may��ave� 10� �o�100��imes���e�vo�in��ri���s�of�ano��er�class�of�s�ock.�Suc��s�ock�is�calle��supervoting stock.

Supervo�in��s�ock�is�issue���o�all�s�are�ol�ers�alon��wi�����e�ri�����o�exc�an�e�i��for�or�inary�s�ock.�Mos��s�are�ol�ers�are�likely��o�exc�an�e�i�� for�or�inary� s�ock�because� ��e� s�ock�wi��� ��e�mul�iple� vo�in�� ri���s�usually��as�a�limi�e��resale�marke��an��pays�a�lower��ivi�en����an�o��er��ypes� of� vo�in�� s�ock� ��e� corpora�ion� issues.� Typically��� mana�emen��re�ains���e�special�s�ock���w�ic��effec�ively�increases���e�vo�in��con�rol�of���e�corpora�ion� in� ��e��an�s�of�mana�emen�.�For�example���For�’s��ual�class�or�supervo�in��s�ares�enable���e�For��family��o�con�rol��0�percen��of���e�vo�in��power�w�ile�ownin��only���percen��of���e��o�al�equi�y�of���e�company.

Un�er� ��e� vo�in�� ri���s� policies� of� ��e� SEC� an�� major� public�exc�an�es���U.S.�firms�are�allowe���o�lis���ual�class�s�ares.��nce�suc��s�ares�are�lis�e�����owever���firms�canno��re�uce���e�vo�in��ri���s�of�exis�in��s�ares�or�issue�a�new�class�of�superior�vo�in��s�ares.�Several��un�re��U.S.�com�panies� issue��ual�class� s�ares��� inclu�in����e�New�York�Times����ow�Jones���

Common Takeover Defenses 85

��e�Was�in��on�Pos����Coors���Tyson�Foo�s�����elp�ia���Comcas����Viacom���an��Goo�le.�S�ill���suc��s�ares�are�far�more�common�in�o��er�coun�ries.5

ReincorporationIn� some� ins�ances��� a� po�en�ial� �ar�e�� firm� may� c�an�e� ��e� s�a�e� wi��in�w�ic�� i�� is� incorpora�e�� �o� one� w�ere� ��e� laws� are� more� favorable� for�implemen�in�� �akeover��efenses.�T�is� is� �one�by� crea�in�� a� subsi�iary� in���e�new�s�a�e���in�o�w�ic����e�paren��is�mer�e��a��a�la�er��a�e.

Several�fac�ors�nee���o�be�consi�ere��in�selec�in��a�s�a�e�for�suc��rein-corporation���inclu�in���ow���e�s�a�e’s�cour�s��ave�rule��in�lawsui�s�alle�in��breac��of�corpora�e��irec�or�fi�uciary�responsibili�y�in��akeover�si�ua�ions���as�well�as� ��e�s�a�e’s� laws�per�ainin���o�poison�pills��� s�a��ere��boar�s���an���os�ile��en�er�offers.�Reincorpora�ion�requires�s�are�ol�er�approval.

Golden Parachutes�n�employee�severance�arran�emen����a��is��ri��ere��w�enever�a�c�an�e�in� con�rol� �akes� place� is� calle�� a� golden parachute.��� c�an�e� in� con�rol�usually� is��efine��as�any� �ime�an� inves�or�accumula�es�more� ��an�a� fixe��percen�a�e� of� ��e� corpora�ion’s� vo�in�� s�ock.��� �ol�en� parac�u�e� �ypi�cally� covers� only� a� few��ozen� employees���w�o� are� �ermina�e�� followin����e� c�an�e� in� con�rol� an�� �o� w�om� ��e� company� is� obli�a�e�� �o� make�a� lump�sum�paymen�.�T�ey�are��esi�ne�� �o�raise� ��e�bi��er’s�cos��of� ��e�acquisi�ion� by� crea�in�� a� cos�� for� re�ainin�� mana�emen���� ra��er� ��an� �o��ain� �ime� for� ��e� �ar�e�� boar�.� Suc�� severance� packa�es� may� serve� ��e�in�eres�s� of� s�are�ol�ers� by�makin�� senior�mana�emen��more�willin�� �o�accep��an�acquisi�ion.

T�e�Tax� Reform��c�� of� 1��6� impose�� s�iff� penal�ies� on� ��ese� �ypes�of�plans� if� ��ey�crea�e�w�a�� is��eeme��an�excessive�paymen�—��ose� ��a��excee�� ��ree� �imes� ��e� employee’s� avera�e� pay� over� ��e� previous� five�years—an�� �rea�s� ��em� as� income� an�� �ence� no�� �ax� �e�uc�ible� by� ��e�payin��corpora�ion.�T�e�employee�receivin����e�parac�u�e�paymen��mus��pay�a�20�percen��surc�ar�e�in�a��i�ion��o���e�normal��ax��ue�on���e�para�c�u�e�paymen�.

5� Researc��by�Gompers���Is�ii���an��Me�rick�(2010)�su��es�s���a��firms�wi����ual�class�s�ares�of�en�un�erperform�in���e�overall�s�ock�marke�.�T�is�may�resul��from�effor�s��o�en�renc��con�rollin��s�are�ol�ers�by�erec�in��excessive��akeover��efenses�an��policies���a��are�no��in���e�bes��in�eres�s�of�noncon�rollin��s�are�ol�ers���suc��as�excessive�compensa�ion�for�key�mana�ers�an��boar��members.�Moreover���suc��firms�of�en��ave�excessive�levera�e��ue��o�an�unwillin�ness��o�raise�a��i�ional�fun�s�by�sellin��s�ares���a��coul���ilu�e���e�con�rollin��s�are�ol�ers.

Mergers and Acquisitions Basics86

POst-Offer Defenses

�f�er� an� unwan�e�� sui�or� �as� approac�e�� a� firm��� various� a��i�ional��efenses�can�be�in�ro�uce�.�T�ey�inclu�e��reenmail��o��issua�e���e�bi��er��from� con�inuin�� ��e� pursui�;� �efenses� �esi�ne�� �o� make� ��e� �ar�e�� less�a��rac�ive��� suc�� as� res�ruc�urin�� an�� recapi�aliza�ion� s�ra�e�ies;� an�� effor�s��o�place�an�increasin��s�are�of���e�company’s�owners�ip�in�frien�ly��an�s�by�es�ablis�in��employee stock ownership plans�(ES�Ps)�or�seekin��w�i�e�kni���s.�Ex�ibi������summarizes���e�primary�a�van�a�es�an���isa�van�a�es�of���ese�pos��offer��efenses.

GreenmailGreenmail� (in�ro�uce�� earlier)� is� ��e� prac�ice� of� payin�� a� po�en�ial�acquirer��o�leave�you�alone.�I��consis�s�of�a�paymen���o�buy�back�s�ares�a��a� premium�price� in� exc�an�e� for� ��e� acquirer’s� a�reemen�� no�� �o� com�mence� a� �os�ile� �akeover.� In� exc�an�e� for� ��e� paymen���� ��e� po�en�ial�acquirer� is� require�� �o� si�n� a� standstill agreement���w�ic�� �ypically� speci�fies� ��e� amoun��of� s�ock��� if� any��� ��e� inves�or� can�own��� ��e�circums�ances�un�er�w�ic�� ��e� rai�er� can� sell� s�ock�curren�ly�owne���� an�� ��e� �erm�of���e�a�reemen�.

Cour�s�view��reenmail� as��iscrimina�ory�because�no��all� s�are�ol�ers�are�offere�� ��e�oppor�uni�y� �o� sell� ��eir� s�ock�back� �o� ��e� �ar�e�� firm�a��an�above�marke��price.�Never��eless���cour�s�in�some�s�a�es�(e.�.����elaware)��ave�foun��i���o�be�an�appropria�e�response�if��one�for�vali��business�rea�sons.�Cour�s�in�o��er�s�a�es�(e.�.���California)��ave�favore��s�are�ol�er�law�sui�s�con�en�in����a���reenmail�breac�es�fi�uciary�responsibili�y.6

White Knights���ar�e��company�seekin���o�avoi��bein���aken�over�by�a�specific�bi��er�may��ry��o�be�acquire��by�a�white knight—ano��er�firm�viewe��as�a�more�appropria�e�sui�or.�To�comple�e�suc��a��ransac�ion�����e�w�i�e�kni����mus��be� willin�� �o� acquire� ��e� �ar�e�� on� �erms� more� favorable� ��an� ��ose� of�o��er�bi��ers.�T�is��oes�no��necessarily�mean�a��a��i��er�price;���e�more�favorable� �erms�may�be� ��e�willin�ness�of� ��e�w�i�e�kni���� �o�allow���e��ar�e�� firm’s� mana�emen�� �o� remain� in� place� �o� con�inue� pursuin�� ��e�firm’s�curren��s�ra�e�y.

Fearin�� ��a�� a� bi��in�� war� mi���� ensue��� ��e� w�i�e� kni���� of�en��eman�s� some� pro�ec�ion� in� ��e� form� of� a� lockup.�T�is� may� involve� �iv�in�� ��e� w�i�e� kni���� op�ions� �o� buy� s�ock� in� ��e� �ar�e�� ��a�� �as� no�� ye��

6� Wassers�ein�(1������pp.��1�–�20).

Comm

on Takeover Defenses

87

EXHIBIT 4-4 Advantages and Disadvantages of Post-offer Takeover DefensesType of Defense Advantages for Target Firm Disadvantages for Target Firm

Greenmail Encourages raider to go away (usually accompanied by a standstill agreement).

Reduces risk to raider of losing money on a takeover attempt; unfairly discriminates against nonparticipating shareholders; often generates litigation; and triggers unfavorable tax consequences and negative public image.

Standstill Agreement

Prevents raider from returning for a specific time period.

Increases amount of greenmail paid to get raider to sign standstill; provides only temporary reprieve.

White Knights May be a preferable to the hostile bidder. Involves loss of target’s independence.ESOPs Alternative to white knight and highly effective

if used in conjunction with certain states’ antitakeover laws.

Employee support not guaranteed. ESOP cannot overpay for stock because transaction could be disallowed by federal law.

Recapitalizations Makes target less attractive to bidder and may increase target shareholder value if incumbent management motivated to improve performance.

Increased leverage reduces target’s borrowing capacity.

Share Buyback Plans

Reduces number of target shares available for purchase by bidder, arbs, and others who may sell to bidder.

Securities laws limit ability to self-tender without SEC filing once hostile tender under way. A reduction in the shares outstanding may facilitate bidder’s gaining control.

Corporate Restructuring

Going private may be an attractive alternative to bidder’s offer for target shareholders and for incumbent management.

Going private, sale of attractive assets, making defensive acquisitions, or liquidation may reduce target’s shareholder value versus bidder’s offer.

Litigation May buy time for target to build defenses and increases takeover cost to the bidder.

May have negative impact on target shareholder returns.

Mergers and Acquisitions Basics88

been� issue�� a�� a� fixe�� price� or� �o� acquire� specific� �ar�e�� asse�s� a�� a� fair�price.� Suc�� lockups� usually� make� ��e� �ar�e�� less� a��rac�ive� �o� o��er� bi��ers.��If�a�bi��in��war��oes�ensue�����e�w�i�e�kni����may�exercise���e�s�ock�op�ions�an�� sell� ��e� s�ares� a�� a� profi�� �o� ��e� acquirin�� company.�German��ru�� an��c�emical�firm�Bayer��G’s�w�i�e�kni����bi��for�Sc�erin���G�in�2006�(w�ic��was� recommen�e��by� ��e�Sc�erin��boar�)�was��esi�ne�� �o� �rump�a��os�ile�offer�from�a�German�rival���Merck�KGaS—an��succee�e��in�repellin��Merck.

Employee Stock Ownership PlansES�Ps�are� �rus�s� ��a���ol��a� firm’s� s�ock�as� an� inves�men�� for� i�s�employ�ees’�re�iremen��pro�ram.�T�ey�can�be�es�ablis�e��quickly���wi�����e�company�ei��er� issuin�� s�ares� �irec�ly� �o� ��e� ES�P� or� �avin�� an� ES�P� purc�ase�s�ares�on���e�open�marke�.�T�e�s�ock��el��by�an�ES�P�is�likely��o�be�vo�e��in�suppor��of�mana�emen��in���e�even��of�a��os�ile��akeover�a��emp�.

Leveraged Recapitalization��company�may�recapi�alize�by�assumin��subs�an�ial�amoun�s�of�new��eb����w�ic��is�use��ei��er��o�buy�back�s�ock�or�finance�a��ivi�en��paymen���o�s�are�ol�ers.�T�e�a��i�ional��eb��re�uces���e�company’s�borrowin��capac�i�y�an��leaves�i��in�a��i��ly�levera�e��posi�ion���w�ic��makes�i��a�less�a��rac��ive��ar�e���o�a�bi��er���a��may��ave�wan�e���o�use���a��capaci�y��o��elp�finance�a��akeover.�Moreover�����e�paymen��of�a��ivi�en��or�a�s�ock�buy�back�may�persua�e�s�are�ol�ers� �o�suppor�� ��e��ar�e�’s�mana�emen�� in�a�proxy�con�es��or��os�ile��en�er�offer.

W�e��er���e�recapi�aliza�ion�ac�ually�weakens���e��ar�e��firm�over���e�lon�� �erm��epen�s�on� i�s� impac��on�s�are�ol�er�value.�S�are�ol�ers�will�benefi��from���e�receip��of�a��ivi�en��or�from�capi�al��ains�resul�in��from�a� s�ock� repurc�ase.�Fur��ermore��� ��e� increase���eb�� service� requiremen�s�of� ��e�a��i�ional��eb��will� s�el�er�a� subs�an�ial�amoun��of� ��e� firm’s� �ax�able� income� an��may� encoura�e�mana�emen�� �o�be�more� conscien�ious�abou�� improvin�� ��e� firm’s�performance.�T�us��� ��e�combina�ion�of� ��ese�fac�ors�may�resul��in�curren��s�are�ol�ers�benefi�in��more�from���is��ake�over��efense���an�from�a��os�ile��akeover�of���e�firm.�T�e�primary��iffer�ences�be�ween�a�leveraged recapitalization�an��a�levera�e��buyou��are���a����e�firm�remains�a�public�company�an����a��mana�emen���oes�no���ake�a�si�nifican��equi�y�s�ake�in���e�firm.

Recapi�aliza�ion�may� require� s�are�ol�er� approval��� �epen�in�� on� ��e�company’s�c�ar�er�an����e�laws�of���e�s�a�e�in�w�ic��i��is�incorpora�e�.

Common Takeover Defenses 89

Share Repurchase or Buyback PlansFirms�repurc�ase�s�ares��o�rewar��s�are�ol�ers���si�nal�un�ervalua�ion���fun��ES�Ps��� a�jus�� capi�al� s�ruc�ure��� an�� �efen�� a�ains�� unwan�e�� �akeovers.��T�ese� repurc�ases� can� be� execu�e�� ei��er� ��rou��� a� �en�er� offer� or� by��irec��purc�ases�of�s�ares�in�public�marke�s.

W�en�use��as�an�an�i�akeover��ac�ic���s�are�repurc�ase�or�buyback�plans�aim��o�re�uce���e�number�of�s�ares���a��coul��be�purc�ase��by���e�po�en��ial� acquirer� or� by� arbi�ra�eurs� w�o� will� sell� �o� ��e� �i��es�� bi��er.�T�is��ac�ic� reflec�s� ��e� belief� ��a�� w�en� a� firm� ini�ia�es� a� �en�er� offer� (i.e.��� a�self��en�er)� for� a� por�ion� of� i�s� own� s�ares��� ��e� s�are�ol�ers� w�o� offer���eir�s�ares�for�sale�are���ose�mos��suscep�ible��o�a��en�er�offer�by�a��os��ile� bi��er.�T�is� leaves� ��e� �ar�e�� firm’s� s�ares� concen�ra�e�� in� ��e��an�s�of� s�are�ol�ers�w�o� are� less� likely� �o� sell��� ��ereby� re�ucin�� floa�.� So��� for�a��os�ile� �en�er�offer� �o� succee�� in�purc�asin�� ��e� remainin�� s�ares��� ��e�premium�offere��woul���ave��o�be��i��er.�T�e�resul�in���i��er�premium�mi���� �iscoura�e� some� prospec�ive� bi��ers.��� s�are� buyback� may� work�well�in�combina�ion�wi���a�self��en�er�by�allowin����e�firm��o�buy�s�ares�(per�aps�a��a�somew�a���i��er�price)�in�a��i�ion��o���ose��en�ere���o���e�firm.�T�ere�is�consi�erable�evi�ence���a��buyback�s�ra�e�ies�are�an�effec�ive��e�erren�.�

T�e� repurc�ase� �ac�ic� may��� �owever��� be� subjec�� �o� ��e�“law� of� unin��en�e��consequences.”�Re�ucin����e�number�of�s�ares�on���e�open�mar�ke�� makes� i�� easier� for� ��e� buyer� �o� �ain� con�rol� because� fewer� s�ares��ave��o�be�purc�ase���o�ac�ieve�50.1�percen��of���e��ar�e�’s�vo�in��s�ares.�Moreover��� self��en�ers� may� ac�ually� a��rac�� po�en�ial� bi��ers� if� ��ey� are�seen�as�a��arbin�er�of�improvin���ar�e��company�cas��flows.

Fe�eral�securi�ies�law�pro�ibi�s�purc�ase�by�an�issuer�of�i�s�own�s�ares��urin��a��os�ile��en�er�offer�for�i�s�s�ares.��n�excep�ion�is�ma�e�if���e�firm�files� a� s�a�emen�� wi��� ��e� SEC� �isclosin�� ��e� i�en�i�y� of� ��e� purc�aser���s�ock�exc�an�es���a��will�be�use��for���e�purc�ase�����e�in�en��of���e�pur�c�ase���an����e�in�en�e���isposi�ion�of���e�s�ares.

Corporate RestructuringRes�ruc�urin��may� involve� �akin�� ��e� company� priva�e��� sellin�� a��rac�ive�asse�s��� un�er�akin�� a�major� acquisi�ion���or� even� liqui�a�in�� ��e� company.�

�� Po�en�ial�acquirers�are�less�likely��o�pursue�firms�wi���subs�an�ial�excess�cas����w�ic��coul��be�use���o�a�op���i��ly�a��ressive�s�are�repurc�ase�pro�rams�(Faleye���200�;�Harfor����1���;�Pinkowi�z���2002).

�� �ccor�in���o�Bille���an��Xue�(200�)���firms�frequen�ly�increase���eir�s�are�repurc�ase�ac�ivi�ies�w�en�confron�e��wi���an�imminen���akeover���rea�.

Mergers and Acquisitions Basics90

“Goin��priva�e”��ypically�involves���e�mana�emen���eam’s�purc�ase�of���e�bulk�of�a�firm’s�s�ares.�T�is�may�crea�e�a�win–win�si�ua�ion�for�s�are�ol��ers���w�o�receive�a�premium�for���eir�s�ock�an��mana�emen����w�ic��re�ains�con�rol.�To�avoi��lawsui�s�����e�company�mus��pay�a�price���a��represen�s�a�subs�an�ial�premium��o���e�curren��marke��price.

�l�erna�ively��� ��e� �ar�e�� may� make� i�self� less� a��rac�ive� by� �ives�in��asse�s���e�bi��er�wan�s.�T�e�cas��procee�s�of�suc��sales�coul��fun��o��er��efenses���suc��as�s�are�buybacks�or�paymen��of�a�special�s�ock�ol�er��ivi��en�.��� �ar�e�� company� also� may� un�er�ake� a� so�calle�� defensive acqui-sition� �o��raw��own�any�excess� cas��balances� an�� �o�ex�aus�� i�s� curren��borrowin��capaci�y.���firm�may�c�oose��o�liqui�a�e���e�company���pay�off�ou�s�an�in��obli�a�ions��o�cre�i�ors���an���is�ribu�e���e�remainin��procee�s��o�s�are�ol�ers�as�a�liquidating dividend.�T�is��ac�ic�makes�sense�only�if���e�liqui�a�in���ivi�en�� excee�s�w�a�� ��e� s�are�ol�ers�woul���ave� receive��from���e�bi��er.

LitigationTakeover�li�i�a�ion�of�en�inclu�es�an�i�rus��concerns���alle�e��viola�ions�of�fe�eral� securi�ies� laws��� ina�equa�e��isclosure�by���e�bi��er�as�require��by���e�Williams��c�� of� 1�6���� an�� alle�e�� frau�ulen�� be�avior.�Tar�e�s� of�en�seek�a�cour�� injunc�ion��o�s�op���e��akeover�a��emp����a�� leas���emporarily���un�il� ��e� cour�� �as� �eci�e�� ��e� meri�s� of� ��e� alle�a�ions.� By� preven�in����e�po�en�ial�acquirer�from�acquirin��more�s�ock�����e��ar�e��firm�is�buyin���ime��o�erec��a��i�ional��akeover��efenses.

In� mi��200�����n�euser�Busc�� file�� a� lawsui�� in� fe�eral� cour�� in� an�effor�� �o� s�op� i�s� sui�or��� InBev��� from� a��emp�in�� �o� replace� i�s� boar�� of��irec�ors.�T�e�sui��alle�e����a��InBev��a��ma�e�numerous�“false�an��mis�lea�in�� s�a�emen�s”� in� �ou�in�� i�s� financin�� as� fully� commi��e���� because���e� commi�men�s� ��a�� i�� �a�� receive�� from� len�ers� were� full� of� con�i��ions�allowin�� ��em��o�walk�away.�Ul�ima�ely��n�euser�Busc��a�ree�� �o�be�acquire��by�InBev.

the ImPact Of takeOver Defenses On sharehOlDer anD BOnDhOlDer value

In� C�ap�er� 2��� you� learne�� abou�� ��e� �rama�ic� increase� since� ��e� 1�60s�in� ��e� abnormal� re�urns—�o�more� ��an� �0� percen���� on� avera�e—�o� �ar��e��s�are�ol�ers�aroun����e��ime�of�a��os�ile��en�er�offer�announcemen�.�Meanw�ile��� abnormal� re�urns� �o� acquirer� s�are�ol�ers� �ave� �e�eriora�e��

Common Takeover Defenses 91

from� mar�inally� posi�ive� �o� sli���ly� ne�a�ive.� �bnormal� re�urns� �o� �ar��e��s�are�ol�ers�in�frien�ly��akeovers��ave�remaine��a��abou��20�percen�.�W�a�� �as� spurre�� ��is� increase� in� �ar�e�� company� s�are�ol�er� re�urns�w�en��os�ile�bi�s�are�a��work?�I��coul��be�po�en�ial�improvemen�s�in�effi�ciency��� �ax� savin�s��� or� marke�� power.� However��� if� any� of� ��ese� were� ��e�explana�ion���we�woul�� be� ri���� �o� expec�� abnormal� re�urns� for�mer�ers��o�s�ow�a�correspon�in�ly�lar�e�increase�over��ime—w�ic����ey��ave�no�.�Consequen�ly�����e�explana�ion�mus��lie�elsew�ere.

I�� is� probably� more� ��an� coinci�en�al� ��a�� ��e� increase� in� abnormal�re�urns� be�an� wi��� ��e� in�ro�uc�ion� of� ��e� 1�6��Wallace��c�� preno�ifi�ca�ion�perio����w�ic��provi�es� a� respi�e� for� �ar�e�� firms� �o�erec�� �akeover��efenses� an�� searc�� for� o��er� po�en�ial� bi��ers.�Takeover� �efenses� suc��as� poison� pills��� al��ou��� unlikely� �o� preven�� a� �akeover��� can� a��� si�nifi�can�ly� �o� ��e� overall� purc�ase� price.�T�e� purc�ase� price� can� be� boos�e��even� fur��er� by� any� auc�ion� ��a�� mi���� �ake� place��� as� ��e� ini�ial� bi���er�loses�precious��ime�in��ryin���o�overcome���e�myria��of��efenses���e��ar�e��may�be� employin�.�T�us��� ��e� increasin�� sop�is�ica�ion�of� �akeover��efenses�since�1��0�woul��seem��o�be�a��i��ly�plausible�explana�ion—a��leas�� in�ui�ively—for� ��e� sus�aine�� increase� in�abnormal� re�urns� �o� �ar�e���s�are�ol�ers�followin����e�announcemen��of�a��os�ile��en�er�offer.

Experience Shows Mixed ResultsUnfor�una�ely�����e�in�ui�ive�ar�umen����a��experience�s�ows�resul�s�is��if�ficul���o�subs�an�ia�e.�Some�empirical�evi�ence�seems��o�su��es����a���ake�over��efenses�in��eneral��ave�vir�ually�no�s�a�is�ically�si�nifican��impac��on�s�are�ol�er�re�urns.�����er�evi�ence�poin�s��o�poison�pills��avin��a�posi��ive�impac�.10�S�u�ies���a��fin��a�posi�ive�re�urn�seem��o�suppor����e�i�ea���a��incumben��mana�emen��ac�s�in���e�bes��in�eres�s�of�s�are�ol�ers�(��e�s�are�ol�er� in�eres�s� ��eory)��� w�ereas� ��ose� s�u�ies� ��a�� fin�� a� ne�a�ive�

��� �e�n�elo�an��Rice�(1���)�an��Linn�an��McConnell�(1���)�bo���foun��no�s�a�is�ically�si�nifican��ne�a�ive�resul�s.�Karpoff�an��Walklin��(1��6)�foun����a��s�are�ol�er�effor�s��o�remove��akeover��efenses��a��no�si�nifican��impac��on�s�are�ol�er�re�urns���su��es�in����a��suc��effor�s�were�viewe��by�inves�ors�as�lar�ely�inconsequen�ial.�Fiel��an��Karpoff�(2002)���in�a�s�u�y�of�1��01��ini�ial�public�offerin�s�be�ween�1����an��1��2���foun����a���akeover��efenses��a��no�impac��on���e��akeover�premiums�of���ose�firms�acquire��af�er���e�IP�.

10� Commen��an��Sc�wer��(1��5)�foun����a��poison�pills�woul���ave�a�posi�ive�impac��on�s�are�ol�er�re�urns�if���eir�a��i�ion�by���e��ar�e��were�viewe��by�inves�ors�as�a�si�nal���a��a��akeover�was�imminen����or���a����e�firm’s�mana�emen��woul��use�suc��a��efense��o�improve���e�purc�ase��price��urin��ne�o�ia�ion.�T�e�exis�ence�of�poison�pills�of�en�requires���e�bi��er��o�raise�i�s�bi���or��o�c�an�e���e�composi�ion�of�i�s�bi���o�an�all�cas��offer��o�pu����e��ar�e�’s�boar��un�er��pressure��o��isman�le�i�s�pill��efenses.�Timin��also�is�impor�an�.�For�example���w�enever�a�mer�er�

Mergers and Acquisitions Basics92

re�urn� seem� �o� suppor�� ��e� no�ion� ��a�� incumben�� mana�emen�� ac�s� in�i�s�own�in�eres�s�(��e�mana�emen��en�renc�men����eory).��verall����espi�e�mul�iple�s�u�ies�����e�researc��is�lar�ely�con�ra�ic�ory.11

More�recen��researc���as�s�if�e��some�of���e�conclusions���a��mi����be��rawn.

Takeover Defenses May Destroy Shareholder Value�espi�e���e�lar�ely�mixe��resul�s�from�earlier�s�u�ies���more�recen��researc��su��es�s���a���akeover��efenses�may�ac�ually��es�roy�s�are�ol�er�value.�For�ins�ance��� ��e� crea�ion� of� a� �e�aile��“mana�emen�� en�renc�men�� in�ex”�reveale����a��firms�a��w�ic��mana�emen�’s�in�eres�s�are�more�ali�ne��wi�����ose�of� ��e�s�are�ol�ers��ave� lar�er�abnormal�re�urns���an�firms�wi���a��i���en�renc�men�� in�ex.12��no��er� lar�e� s�u�y�provi�es� a��i�ional� evi��ence�of���e��es�ruc�ive�effec��of��akeover��efenses���fin�in����a��mana�ers�a��firms�pro�ec�e��by��akeover��efenses�are�less�subjec���o���e��isciplinary�power�of���e�marke��for�corpora�e�con�rol�an��are�more�likely��o�en�a�e�in�“empire�buil�in�”�acquisi�ions���a���es�roy�s�are�ol�er�value.1�

W�en� firms� move� imme�ia�ely� from� s�a��ere�� boar�� elec�ions� �o�annual� elec�ions� of� �irec�ors��� ��ey� experience� a� cumula�ive� abnormal�re�urn� of� 1.�2� percen���� reflec�in�� inves�or� expec�a�ions� ��a�� ��e� firm� is�

� announcemen��coinci�e��wi�����e�announcemen��of�a�poison�pill���abnormal�re�urns��o��ar�e��s�are�ol�ers�increase��by����o���percen�.���number�of�s�u�ies�su��es����a��inves�ors�will�reac��posi�ively��o���e�announcemen��of���e�a�op�ion�of��akeover��efenses���if���e�firm’s�mana�emen��in�eres�s�are�viewe��as�ali�ne��wi�����ose�of���e�s�are�ol�ers���an��ne�a�ively���if�mana�emen��is�viewe��as�seekin���o�en�renc��i�self�(Boyle�e��al.���1���;�Malekza�e��e��al.���1���;�an��McWilliams���1���).

11� Commen��an��Sc�wer��(1��5)�provi�e�a�compre�ensive�review�of�previous�s�u�ies���inclu�in��Jarrell�an��Poulsen�(1���)���Mala�es�a�an��Walklin��(1���)���Ryn�aer��(1���)���Karpoff�an��Mala�es�a�(1���)���an��Romano�(1���).�From���ese�s�u�ies�����e�au��ors�foun����a��mos���akeover��efenses���suc��as�s�a��ere��boar�s���super�majori�y�provisions���fairprice�provisions���reincorpora�ion���an���ual�capi�aliza�ion�resul�e��in�a�sli���ly�ne�a�ive��ecline�in�s�are�ol�er�re�urns�of�abou��0.5�percen�.

12� Bebc�uk�e��al.�(2005)�crea�e��a�mana�emen��en�renc�men��in�ex�in�an�effor���o�assess�w�ic��of�2��provisions��racke��by���e�Inves�or�Responsibili�y�Researc��Cen�er�(IRRC)��a����e��rea�es��impac��on�s�are�ol�er�value.�T�e�in�ex���w�ic��is�ne�a�ively�correla�e��wi���firm�value�be�ween�1��0�an��200����comprises�s�a��ere��boar�s���limi�s��o�s�are�ol�er�bylaw�amen�men�s���super�majori�y�requiremen�s�for�mer�ers���super�majori�y�requiremen�s�for�c�ar�er�amen�men�s���poison�pills���an���ol�en�parac�u�es.�No�correla�ion�be�ween�firm�value�an��1��o��er�IRRC�provisions��urin����e�sample�perio��was�foun�.�T�e�researc�ers�no�e����a����e�mere�exis�ence�of�correla�ion��oes�no��necessarily�mean���a����ese��akeover��efenses�cause�a�re�uc�ion�in���e�value�of���e�firm.�T�e�correla�ion�coul��reflec����e��en�ency�of�un�erperformin��firms���a��are�likely��o�be��akeover��ar�e�s��o�a�op���akeover��efenses.�T�ese�resul�s�suppor�e����e�fin�in�s�of�an�earlier�s�u�y�by�Bebc�uk���Co�en���an��Ferrell�(2005)���w�ic��use��a�s�or�er��ime�perio�.

1�� Masulis�e��al.�(200�)���a�s�u�y�of��������comple�e��acquisi�ions�be�ween�1��0�an��200�.

Common Takeover Defenses 93

more�likely��o�be�subjec���o�a��akeover.��f�en���suc��firms�come�un�er�con�si�erable�pressure�from�ac�ivis��s�are�ol�ers—an����e�presence�of�a��rea�er�propor�ion�of�in�epen�en���irec�ors�means���a����ese�firms�are�of�en�more�willin���o�submi���o���e��eman�s�of���ose�ac�ivis�s.1�

Takeover Defenses May Benefit Initial Public OfferingsEven��s�u�ies�(a�researc��approac��in�ro�uce��in�C�ap�er�2)�examine�only��ow��akeover��efenses�affec��s�are�ol�er�weal���af�er���e�corpora�ion��as�been� forme���� s�are�ol�ers� �ave� purc�ase�� i�s� s�ock��� an�� af�er� employees�an��mana�ers��ave�been��ire�.� I��may�be� ��e�case��� ��ou����� ��a�� �akeover��efenses�crea�e�si�nifican��firm�value�a����e�very�poin����e�firm�is�forme�.�Consequen�ly��� �o� evalua�e� fully� ��e� impac�� of� �akeover� �efenses� on� firm�value� requires� �ivin�� consi�era�ion� bo��� �o� ��e� po�en�ially� beneficial�effec�s�before���e�even��of�a��akeover�a��emp��an����e�po�en�ially��es�ruc��ive�effec�s�on�firm�value�af�er���e�announcemen�.

Takeover� �efenses� may� a��� �o� firm� value� before� a� �akeover� a��emp��if� ��ey��elp� ��e� firm� a��rac���� re�ain��� an��mo�iva�e� effec�ive�mana�ers� an��employees.�Fur��ermore���suc���efenses��ive���e�new�firm��ime��o�imple�men��i�s�business�plan�fully�an��inves�� in�up�ra�in����e�skills�of�employ�ees.15�T�ere� is� also� evi�ence� ��a�� inves�ors� may� prefer� ��e� a�op�ion� of��akeover��efenses��urin����e�early�s�a�es�of�a�firm’s��evelopmen�.16

Takeover Defenses May Benefit BondholdersCompanies�wi���limi�e���akeover��efenses�are�of�en�vulnerable��o��os�ile��akeovers���w�ic��may��ur��bon��ol�ers.1���l��ou�����e�increase��po�en��ial� for� �akeover� may� benefi�� s�are�ol�er� inves�ors��� exis�in�� bon��ol�ers�s�an���o�lose�if���e��akeover�resul�s�in�a�si�nifican��increase�in�levera�e.�T�is�is� �ypical�of�a� levera�e��buyou�.�Hi��er� levera�e�can�re�uce���e�value�of�curren��ou�s�an�in���eb��by�increasin����e�po�en�ial�for�fu�ure�bankrup�cy.

*�*�*

T�e� rapi�i�y� of� even�s� once� a� �akeover� is� un�erway� may� make� an�effec�ive� �efense� impossible� unless� cer�ain� �efenses� are� alrea�y� in� place.�

1�� Guo�e��al.�(200�).15� S�ou��(2002).16� T�is�is�su��es�e��by���e�fin�in��of�Coa�es�(2001)���a����e�percen�a�e�of�IP��firms�wi���s�a��ere��

boar�s�in���eir�c�ar�ers�a����e��ime�of���e�ini�ial�public�offerin��rose�from����percen��in���e�early�1��0s��o��2�percen��in�1���.

1�� Cremers�e��al.�(200�).

Mergers and Acquisitions Basics94

�� pre�offer� s�ra�e�y� involves� buil�in�� �efenses� ��a�� are� a�equa�e� �o� ��e��ask�of�slowin���own�a�bi��er��o��ive���e��ar�e��company’s�mana�emen��an�� boar�� �ime� �o� assess� ��e� si�ua�ion� an�� �o� �eci�e� on� an� appropria�e�response��o�an�offer.���company’s�s�ra�e�y�s�oul��never�be��o��ry��o�buil��insurmoun�able��efenses.�Cour�s�will��isallow��efenses� ��a�� appear� �o�be��esi�ne��only��o�en�renc����e�firm’s�mana�emen�.

T�e� recen�� �ren�� s�ows� U.S.� corpora�ions� lar�ely� �isman�lin�� ��eir��akeover��efenses;���a��is���e�evi�ence�from���e�five�years�en�in��in�200�.1��T�e��ren��be�an�wi���lar�e�capi�aliza�ion�firms���w�ere�i����en�slowe����bu��i��sprea���o�smaller�firms�as�well���w�ere�i��accelera�e�.�Es�ima�es�for�200��su��es����a����e��ren��for�lar�er�companies��as�be�un��o��row�a�ain���w�ile���e��ren��for�smaller�companies�remains�unc�an�e�.1�

1�� �ccor�in���o�s�arkrepellen�.ne����1���00�U.S.�firms��a��poison�pills�in�place�a����e�en��of�200�.�T�is�compares��o�2��200�firms�wi���poison�pills�a����e�en��of�2002.�T�e�percen�a�e�of�S&P�500�firms�wi���poison�pills�in�place�fell�below��0�percen����as�compare���o�60�percen��in�2002.�T�e��ecline�in�overall��akeover��efenses�resul�e��primarily�from���e�removal�of�poison�pills�an����e�swi�c���o�annually�elec�e��boar�s�from�a�s�a��ere��boar��sys�em.

1�� Fac�Se��Mer�er�Me�rics�repor�e����a����in�response��o��epresse��equi�y�prices����os�ile��akeover�ac�ivi�y�sur�e��upwar����comprisin��as�muc��as�one�fif���of�U.S.��eals�announce��in�200�.�In�an�effor���o�war��off��akeovers���5��U.S.�firms�a�op�e����eir�firs��pills���20�percen��more���an�in�200�.��f���ese���one�four���were�“in�play”�a�op�ions�un�er�aken�in�response��o�an�unwan�e���akeover�a��emp�.

A Case in Point: Verizon Acquires MCIMany parties showed an interest in acquiring the global telecommunications company MCI. How it played out illustrates the dynamics of a real transaction, employing many of the takeover tactics you learned about in Chapter 3 and some of the defenses you’ve learned about in this chapter also put to use to achieve a higher purchase price.

In the end, there were two major players. One was Qwest, which saw the acquisition as a way to ease its huge $17.3 billion debt burden (more than twice its stock market value), because the debt would be supported by the combined company with a much larger revenue and asset base; plus, the deal would also give the firm access to new business customers and opportunities to cut costs. The other was Verizon Communications, created through the merger of Bell Atlantic and GTE in 2000 and now the largest telecommunications provider in the United States. Merging with MCI would make it more efficient for Verizon to provide a broader range of services, give the firm access to MCI’s business cus-tomer base, accelerate new product development using MCI’s fiber-optic net-work infrastructure, and create substantial cost savings. By mid-2004, MCI had

Common Takeover Defenses 95

received several expressions of interest from both firms about potential strategic relationships.

In July of that year, Qwest and MCI entered into a confidentiality agree-ment and proceeded to perform a more detailed due diligence. As the MCI board evaluated its strategic options—including Qwest’s proposal for a share-for-share merger following a one-time cash dividend to MCI shareholders from MCI’s cash in excess of its required operating balances—Verizon’s chairman/CEO also inquired about a potential takeover. The MCI board directed management to advise Qwest that MCI was not prepared to move forward with a potential transaction. This set the stage for what would become Qwest’s laboriously long and ultimately unsuccessful pursuit of MCI—during which the firm would be rejected by MCI four times.

After assessing its strategic alternatives, including the option to remain a standalone company, MCI’s board concluded merging with Verizon best served MCI’s stockholders. Verizon’s bid of $26.00 per share represented a 41.5 percent premium over the closing price of MCI’s common stock on January 26, 2005, and included “price protection” in the form of a collar. Furthermore, the merger agreement would allow MCI to declare a special $5.60 dividend after the firm’s shareholders approved the deal. MCI’s board also considered the additional value its stockholders would realize from a merger that was expected to be a tax-free reorganization: only the cash portion of the purchase price would be taxable, with the payment of taxes on any gains from the receipt of Verizon stock deferred until MCI shareholders chose to sell their shares. The final factor in favor of Verizon was that a large number of MCI’s most important business customers had indicated their preference of Verizon over Qwest.

The sequence of events reveals a great deal about Verizon’s possible bidding strategy, beginning with the firm’s assumptions about how to approach its tar-get. Certainly, Verizon’s interests would be best served through a friendly take-over of MCI, especially given the challenges of integrating these two complex businesses. The special dividend payable by the target firm to its shareholders (contingent on their approval of the deal), part of Verizon’s approach, encour-aged shareholder approval.

At first, Verizon seems to have based its bidding strategy on the low end of the price range it was willing to offer MCI—evidenced by the modest 3 percent premium over the first Qwest bid. There was a lot of consolidation going on at the time in the telecommunications industry, and competitors were in a weak financial position, so Verizon may have seen no need at first to share more than a little of the potential synergy with MCI shareholders. A bidding war, given the circumstances, seemed unlikely; and Qwest appeared unable to finance a sub-stantial all-cash offer due to its excessive debt burden, and its stock appeared to have little appreciation potential because of ongoing operating losses. Perhaps

Mergers and Acquisitions Basics96

stunned by the persistence with which Qwest pursued MCI, Verizon believed that its combination of cash and stock would ultimately be more attractive to MCI investors than Qwest’s primarily all-cash offer, due to the partial tax-free nature of the bid.

Throughout the bidding process, many hedge funds—which had acquired significant positions in MCI stock because of the company’s potential for merger—criticized MCI’s board publicly for accepting the initial Verizon bid. MCI’s largest shareholder, Mexican telecom magnate Carlos Slim Helu, was par-ticularly public and vocal about the MCI board’s failure to get full value for the firm’s shares. Pressure from hedge funds and other dissident MCI shareholders may have triggered a shareholder lawsuit to void the February 14, 2005, merger agreement signed with Verizon.

Expecting a possible proxy fight, Verizon chose to negotiate with Slim and ultimately acquired his 13.7 percent stake in MCI that April. Still, Verizon’s total stake in MCI remained below the 15 percent ownership level that would trigger the MCI rights plan.

About 70 percent ($1.4 billion) of the cash portion of Verizon’s proposed pur-chase price was represented by the special MCI dividend mentioned previously. Verizon’s management argued that the deal would cost their shareholders only $7.05 billion (i.e., the $8.45 billion purchase price less the MCI special dividend). The promise of the special dividend persuaded MCI shareholders to approve the deal, but the $1.4 billion special dividend reduced MCI’s cash in excess of what was required to meet its normal operating cash requirements.

Qwest consistently attempted to outmaneuver Verizon by establishing a significant premium between its bid and Verizon’s, often as much as 25 percent. Qwest realized that its current level of debt would preclude it from significantly increasing the cash portion of the bid, so the company had to rely on the pre-mium to attract enough investor interest, particularly among hedge funds, to pressure the MCI board to accept the higher bid. But Qwest was never able to convince enough investors that its stock would not simply lose value when more shares were issued to consummate the stock and cash transaction. Qwest could have initiated a tender or exchange offer directly to MCI shareholders proposing to purchase or exchange their shares without going through the merger process. The tender process requires lengthy regulatory approval. However, if Qwest initi-ated a tender offer, it could trigger MCI’s poison pill. Alternatively, a proxy con-test might have been preferable because Qwest already had a bid on the table and the contest would enable Qwest to lobby MCI shareholders to vote against the Verizon bid. This strategy would have avoided triggering the poison pill.

Ultimately, Qwest was forced to capitulate simply because it did not have the financial wherewithal to increase the $9.9 billion bid. It could not borrow any more because of its excessive leverage. Additional stock would have contributed to earnings dilution and caused the firm’s share price to fall.

Common Takeover Defenses 97

This case also illustrates some governance issues you read about in Chapter 3. For instance, it is unusual for a board to turn down a higher bid, especially when the competing bid is 17 percent higher. In accepting the Verizon bid, MCI stated that a number of its large business customers had expressed the prefer-ence for Verizon noted earlier, and even noted concerns from these customers that acquisition by Qwest posed a significant risk. The MCI board’s acceptance of the lower Verizon bid could serve as a test case of how well MCI directors were conducting their fiduciary responsibilities. The central issue is how far boards can go in rejecting a higher offer in favor of one they believe will provide longer-term stability for the firm’s stakeholders.

The bidding war over MCI between Verizon and Qwest shows how forces beyond the company can force management and boards to modify their deci-sions. It featured an almost daily exchange between the bidders and highlighted the powerful role of hedge funds and arbitrageurs, who owned a majority of MCI shares and pushed the company to extract two higher bids from Verizon.

Things to Think About:1. Discuss how changing industry conditions have encouraged consolidation

within the telecommunications industry.2. What alternative strategies could Verizon, Qwest, and MCI have pursued?

Was the decision to acquire MCI the best alternative for Verizon? Explain your answer.

3. Who are the winners and losers in the Verizon/MCI merger? Be specific.4. What takeover tactics did Verizon employ or threaten to employ? What tac-

tics did Qwest employ or threaten to employ? Be specific.5. What specific takeover defenses did MCI employ? Be specific.

Answers can be found at: www.elsevierdirect.com/companion.jsp?ISBN=9780123749482

99Mergers and Acquisitions Basics� ©�2011�Elsevier�Inc.ISBN:�����0�12��������2�� ��I: �ll ri���s reserve�.����0�12��������2�� ��I: �ll ri���s reserve�.�����I:� �ll�ri���s�reserve�.

CHAPTER

201110.1016/B����0�12��������2.00005�6

Key Players in Mergers and Acquisitions

You� learne�� in� previous� c�ap�ers� abou�� ��e� mo�ives� for� mer�ers� an��acquisi�ions�����e�fac�ors���a��affec��M&��performance���an��common��ake�over��ac�ics�an���efenses.�In���is�c�ap�er�you�will�learn�in��e�ail�abou����e�numerous� players�w�o�make�mer�ers� an�� acquisi�ions� �appen.�W�a�� are���eir�roles?�T�eir�responsibili�ies?

Providers of sPecialized services

T�e� firs�� ca�e�ory� of� key� players� inclu�es� ��e� firms� an�� in�ivi�uals� ��a��provi�e�specialize��services��urin��mer�ers�an��acquisi�ions.�T�ey�inclu�e�inves�men�� banks��� lawyers��� accoun�an�s��� proxy� solici�ors��� an�� public� rela��ions�personnel.�Eac���roup�is��iscusse��in���e�followin��sec�ions.

Investment Banks�mi�� ��e� �urmoil� of� ��e� 200�� cre�i�� crisis��� ��e� �ra�i�ional� mo�el� of� ��e�me�a�in�epen�en�� investment bank� as� a� �i��ly� levera�e���� lar�ely� unre�u�la�e���� innova�ive� securi�ies� un�erwri�er� an�� M&�� a�visor� floun�ere�.�Le�man�Bro��ers�was�liqui�a�e����an��Bear�S�earns�an��Merrill�Lync��were�acquire�� by� commercial� banks� JPMor�an� C�ase� an�� Bank� of� �merica���respec�ively.�In�an�effor���o�a��rac��re�ail��eposi�s�an���o�borrow�from���e�U.S.�Fe�eral�Reserve�Sys�em� (��e�“Fe�”)���Gol�man�Sac�s� an��Mor�an�S�anley�conver�e���o�commercial�bank��ol�in��companies�subjec���o�Fe��re�ula�ion.

�l��ou�����e�era�of���e���rivin��in�epen�en��inves�men��bankin��be�e�mo���may�be�over�����e�financial�marke�s�will�con�inue��o�require�inves�men��bankin�� services.�Tra�i�ional� inves�men�� bankin�� ac�ivi�ies� will� con�inue��o�be�in��eman�.�T�ey�inclu�e�provi�in��s�ra�e�ic�an���ac�ical�a�vice�an��acquisi�ion�oppor�uni�ies;�screenin��po�en�ial�buyers�an��sellers;�makin��ini��ial�con�ac��wi���a�seller�or�buyer;�an��provi�in��ne�o�ia�ion�suppor����valua��ion���an���eal�s�ruc�urin���ui�ance.��lon��wi�����ese��ra�i�ional�inves�men��bankin�� func�ions��� ��e� lar�e� “universal� banks”� (e.�.��� Bank� of� �merica/Merrill� Lync�)�will�main�ain� subs�an�ial� broker–�ealer� opera�ions��� servin��

5

Mergers and Acquisitions Basics100

w�olesale� an�� re�ail� clien�s� in� brokera�e� an�� a�visory� capaci�ies� �o� assis��wi�����e�complexi�y�an��of�en��u�e�financin��requiremen�s�of���e�me�a��ransac�ions.� Inves�men��banks� also�of�en�provi�e� lar�e��a�abases�of� recen���ransac�ions���w�ic��are�cri�ical�in�valuin��po�en�ial��ar�e��companies.

Inves�men�� bankers� �erive� si�nifican�� income� from� wri�in�� so�calle��fairness� opinion� le��ers—wri��en� an�� si�ne�� ��ir��par�y� asser�ions� ��a��cer�ify� ��e� appropria�eness� of� ��e� price� of� a� propose�� �eal� involvin�� a��en�er� offer��� mer�er��� asse�� sale��� or� levera�e�� buyou�.� Suc�� le��ers� �iscuss���e�price�an���erms�of���e��eal�in���e�con�ex��of�comparable��ransac�ions.����ypical� fairness�opinion�provi�es�a�ran�e�of�“fair”�prices���wi�����e�pre�sump�ion���a����e�ac�ual��eal�price�s�oul��fall�wi��in���a��ran�e.��l��ou���suc��opinions�are�in�en�e���o�inform�inves�ors��� ��ey�of�en�are��evelope��as�le�al�pro�ec�ion�for�members�of���e�boar�s�of��irec�ors�a�ains��possible�s�are�ol�er�c�allen�es�of���eir��ecisions.1

T�e�size�of���e��ransac�ion�will�likely��e�ermine���e�size�of���e�inves��men��bank���a��can�be�use��as�an�a�visor.�T�e�lar�es��inves�men��banks�are�unlikely� �o� consi�er� any� �ransac�ion� value�� a�� less� ��an� $100�million.� In�selec�in��an� inves�men��bank�as�a� �ransac�ion�a�visor��� ��e�avera�e�ma�ni��u�e�of���e�abnormal�re�urns�on���e�announcemen���a�es�for���ose��eals�for�w�ic����ey�serve�as�an�a�visor�is�far�more�impor�an����an���e�inves��men��bank’s� size�or�marke�� s�are.2� In�o��er�wor�s��� resul�s�coun�.�Smaller���more� focuse���� bou�ique� a�visors� may� be� able� �o� �enera�e� subs�an�ially��i��er�re�urns�for���eir�clien�s���an���e�me�a�inves�men��banks�because�of�proprie�ary�in�us�ry�knowle��e�an��rela�ions�ips.

T�e�lar�e�inves�men��banks�are�more�likely��o�be�able��o�assis��in�fun��in��lar�e��ransac�ions�because�of���eir�curren��rela�ions�ips�wi���ins�i�u�ional�len�ers� an��broker��is�ribu�ion�ne�works.� In� lar�e� �ransac�ions��� a��roup�of�inves�men��banks���also� referre�� �o�as�a� syndicate��� a�rees� �o�purc�ase�a�new�issue�of�securi�ies�(e.�.����eb����preferre����or�common�s�ock)�from���e�acquir�in��company�for�sale��o���e�inves�in��public.�T�e�banks�wi��in���e�syn�ica�e���a�� are�un�erwri�in��or�purc�asin�� ��e� issue� are�of�en��ifferen�� from� ��e�banks� sellin�� ��e� issue��� a� �roup� ��a��of�en� comprises� ��ose� firms�wi��� ��e�bes��broker��is�ribu�ion�ne�works.��f�er�re�is�erin��wi�����e�Securi�ies�an��

1� T�ere�are�some�problems�associa�e��wi���fairness�opinions.�T�ey�inclu�e���e�po�en�ial�conflic�s�of�in�eres��wi���inves�men��banks���a���enera�e�lar�e�fees.�In�many�cases�����e�inves�men��bank���a��brin�s���e��eal��o�a�po�en�ial�acquirer�is���e�same�one���a��wri�es���e�fairness�opinion.�Moreover�����ese�le��ers�are�of�en�ou��of��a�e�by���e��ime�s�are�ol�ers�vo�e�on���e��eal�����ey��o�no��a��ress�w�e��er���e�firm�coul���ave��o��en�a�be��er��eal���an����e�overly�broa��ran�e�of�values��iven�in�suc��le��ers�re�uces���eir�relevance.�Cour�s�a�ree���a����because���e�opinions�are�wri��en�for�boar�s�of��irec�ors�����e�inves�men��bankers��ave�no�obli�a�ion��o���e�s�are�ol�ers�(Henry���November�2����200�).

2� Bao�an��E�mans�(200�).

Key Players in Mergers and Acquisitions 101

Exc�an�e�Commission�(SEC)���suc��securi�ies�may�be�offere���o���e�inves��in��public� as� an� initial public offering� (IP�)��� a�� a� price� a�ree��on�by� ��e�issuer�an����e�inves�men��bankin���roup.�IP�s�may�be�precursors��o�M&�s:�a�paren��firm�may�issue�a�por�ion�of���e�s�ock�in�a�w�olly�owne��subsi�iary��o��e�ermine� i�s�value� in�an�icipa�ion�of� sellin�� ��e�en�ire� subsi�iary�or�of�enablin�� ��e� subsi�iary� �o�use� ��e�publicly� �ra�e�� s�ares� �o�make� acquisi��ions.�Securi�y�issues�may�avoi����e�public�marke�s�an��be�priva�ely�place��wi���ins�i�u�ional�inves�ors���suc��as�pension�fun�s�an��insurance�companies.�

Inves�men�� banks� c�ar�e� an� a�visory� fee� ��a�� �enerally� varies� wi�����e� size�of� ��e� �ransac�ion.��f�en� con�in�en��on� comple�ion�of� ��e��eal�����e� fee�may�run�abou��1� �o�2�percen��of� ��e�value�of� ��e� �ransac�ion;� in�some�cases�����e�fee�may�excee����is�amoun��if���e�a�visors�ac�ieve�cer�ain�incen�ive��oals.�Fairness�opinion�fees�of�en�amoun���o�abou��one�four���of���e��o�al�a�visory�fee�pai��on�a��ransac�ion����an���ypically�are�pai��re�ar��less�of�w�e��er���e��eal�is�consumma�e�.

LawyersLawyers�play�a�pervasive� role� in�mos��M&���ransac�ions.5�T�ey�are� in�i�ma�ely�involve��in�s�ruc�urin����e��eal���evalua�in��risk���ne�o�ia�in��many�of� ��e� �ax� an�� financial� �erms� an�� con�i�ions� (base�� on� inpu�� receive��from�accoun�an�s;�see�followin���iscussion)���arran�in��financin����an��coor��ina�in�� ��e� �imin�� an�� sequence�of� even�s� �o� comple�e� ��e� �ransac�ion.�Specific� �asks� inclu�e� �raf�in�� an�� reviewin�� ��e� a�reemen�� of� purc�ase�an�� sale� an��o��er� �ransac�ion�rela�e���ocumen�a�ion��� provi�in��opinion�of�counsel�le��ers��o���e�len�er���an���efinin���ue��ili�ence�ac�ivi�ies.

T�e� le�al� framework� surroun�in�� a� �ypical� lar�e� �ransac�ion� �as�become� so� complex� ��a��no�one� in�ivi�ual� can��ave� sufficien�� exper�ise��o�a��ress�all���e�issues.�For���ese�complica�e���ransac�ions���le�al��eams�can�consis��of�more���an�a��ozen�a��orneys���eac��brin�in��specialize��exper�ise�in�a��iven�aspec��of���e�law�suc��as�M&�s���corpora�e����ax���employee�bene�fi�s���real�es�a�e���an�i�rus����securi�ies���environmen�al���an��in�ellec�ual�proper�y.�In�a��os�ile� �ransac�ion��� ��e� �eam�may��row��o� inclu�e� li�i�a�ion�exper�s.�In�rela�ively�small�priva�e��ransac�ions���lawyers�play�an�ac�ive�role�in�preac�quisi�ion�plannin���� inclu�in��es�a�e�plannin��for� in�ivi�uals�or� for� family��

�� Unlike�public�offerin�s���priva�e�placemen�s��o�no���ave��o�be�re�is�ere��wi�����e�SEC�if���e�securi�ies�are�purc�ase��for�inves�men��ra��er���an�for�resale.

�� Sweeney�(1���).5� Lea�in��M&��law�firms���in��erms�of���eir�s�are�of���e��ollar�value�of��ransac�ions���inclu�e���a����e�

�ime�of���is�wri�in����Wac��ell�Lip�on�Rosen�&�Ka�z���Simpson�T�ac�er�&�Bar�le�����Ska��en��rps�Sla�e�Mea��er�&�Flom���Sullivan�&�Cromwell���an���avis�Polk�&�War�well.

Mergers and Acquisitions Basics102

owne�� firms��� �ax� plannin���� an�� workin�� wi��� mana�emen�� an�� o��er�company�a�visors��o��elp�be��er�posi�ion�a�clien��for�a�sale.

Accountants�ccoun�an�s6�provi�e�a�vice�on� ��e� financial� s�ruc�ure���perform�financial��ue��ili�ence���an���elp�crea�e���e�mos��appropria�e��ax�s�ruc�ure�of�a��eal.����ransac�ion�can�be�s�ruc�ure��in�many�ways���eac��s�ruc�ure��avin���if�feren�� �ax� implica�ions� for� ��e� par�ies� involve�.� Because� ��ere� is� of�en� a�conflic��in���e��ax�a�van�a�es�associa�e��wi�����e�sales�a�reemen��from���e�buyer’s�an��seller’s�perspec�ive�����e�accoun�an��mus��un�ers�an��bo���poin�s�of�view�an��fin��a�mec�anism�w�ereby�bo���par�ies�benefi�.�Income��ax���capi�al��ains���sales��ax���an��some�imes��if��an��es�a�e��axes�are�all�a��play�in�ne�o�ia�in��a�mer�er�or�acquisi�ion.�T�e�accoun�an�’s�inpu��in���is�re�ar��will� affec���ow� ��e� �ransac�ion� is� s�ruc�ure�� an����ul�ima�ely��� ��e� af�er��ax�amoun��eac��par�y�will�pay�or�receive�in���e��eal.

In�a��i�ion��o��ax�consi�era�ions���accoun�an�s�prepare�financial�s�a�emen�s�an��perform� au�i�s.�Many� a�reemen�s� require� ��a�� ��e� books� an�� recor�s�of���e�acquire��en�i�y�be�prepare��in�accor�ance�wi���Generally��ccep�e���ccoun�in��Principles�(G��P)���so�accoun�an�s�mus��be�in�ima�ely�familiar�wi�����ose�principles��o�assure���a����ey��ave�been�applie��appropria�ely.�In�performin���ue��ili�ence���accoun�an�s�also�perform���e�role�of�au�i�ors�by�reviewin����e��ar�e�’s�financial�s�a�emen�s�an��opera�ions���rou���a�series�of�onsi�e�visi�s�an��in�erviews�wi���senior�an��mi��le�level�mana�ers.

T�e� roles� of� ��e� lawyer� an�� accoun�an�� may� blur� �epen�in�� on� ��e�size�an��complexi�y�of���e��ransac�ion.�Sop�is�ica�e��law�firms�wi���expe�rience�in�mer�ers�an��acquisi�ions�usually��ave���e�capaci�y��o�assis��wi�����e��ax�analysis.�Fur��ermore���lawyers�are�of�en�require���o�review�finan�cial�s�a�emen�s�for�compliance�wi���prevailin��securi�ies�laws.�I��is��elpful���especially�w�en���ere�can�be�an�overlap�of�responsibili�ies����o��efine�clearly�w�ic��professional�will�be�responsible�for�w�ic���asks.

Proxy SolicitorsProxy� con�es�s��� �iscusse�� in� �e�ail� in� C�ap�er� ���� are� a��emp�s� �o� c�an�e�mana�emen��con�rol�or�policies�of�a�company�by��ainin����e�ri�����o�cas��

6� �����is�wri�in������e�accoun�in��in�us�ry�is��omina�e��by���e��roup�of�firms�calle����e�“Bi��Four”:�Erns��&�Youn����Pricewa�er�ouseCoopers���KPMG���an���eloi��e�&�Touc�e.�Lar�e�re�ional�firms�(e.�.���Gran��T�orn�on�an��B���Sei�man)�likely��ave�some�na�ional�an��possibly�some�in�erna�ional�clien�s���bu����ey�are�lar�ely��ie���o�specific�re�ional�accoun�s.�Local�accoun�in��firms�opera�e�in�a�number�of�ci�ies�an���en���o�focus�on�small�businesses�an��in�ivi�uals.

Key Players in Mergers and Acquisitions 103

vo�es� on� be�alf� of� o��er� s�are�ol�ers.� In� con�es�s� for� ��e� con�rol� of� ��e�boar��of��irec�ors�of�a��ar�e��company���i��can�be��ifficul���o�compile�mailin��lis�s�of�s�ock�ol�ers’�a��resses.�T�e�acquirin��firm�or��issi�en��s�are�ol�ers��ire�a�proxy� solici�or�� �o�ob�ain� ��ese�a��resses.�T�e� �ar�e�’s�mana�emen��may�also��ire�proxy�solici�ors��o��esi�n�s�ra�e�ies�for�e�uca�in��s�are�ol�ers�an��communica�in��w�y���ey�s�oul��follow���e�boar�’s�recommen�a�ions.�Suc��s�ra�e�ies�will�inclu�e�a��e�aile��analysis�of���e�s�are�ol�er�base�an��vo�e�projec�ions��esi�ne���o��elp��e�ermine���e�ou�come�of���e�campai�n.

Public Relations FirmsCommunica�in�� a� consis�en�� posi�ion� �urin�� a� �akeover� a��emp�� is� vi�al.�Inconsis�en��messa�es�re�uce���e�cre�ibili�y�of���e�par�ies�involve�.�From���e�viewpoin��of���e�acquirin��company�in�a��os�ile��akeover�a��emp������e�mes�sa�e��o���e�s�are�ol�ers�mus��be���a��i�s�plans�for���e�company�will�increase�s�are�ol�er� value� more� ��an� ��e� plans� of� incumben�� mana�emen�.� �f�en�����e��ar�e��company’s�mana�emen��will��ire�a�priva�e�inves�i�a�or���o��evelop��e�aile��financial��a�a�on���e�acquirin��company�an���o�back�roun��c�ecks�on�key�personnel��� la�er�usin�� ��a�� informa�ion� in� ��e�public� rela�ions�cam�pai�n�in�an�effor���o��iscre�i��publicly���e�mana�emen��of���e�acquirin��firm.

institutional investors and lenders

Ins�i�u�ional� inves�ors� an�� len�ers� are� or�aniza�ions� ��a�� pool� lar�e� sums�of�money��o�inves��in�or�len���o�companies���an��are�an�impor�an��source�of�M&��financin�.�Commercial�banks���one� �ype�of� ins�i�u�ional� inves�or����ave�always�playe��an�impor�an��role� in�provi�in��bo���s�or���an��lon���erm� financin����of�en�backe��by� ��e�asse�s�of� ��e� �ar�e�� firm.��ver� �ime����owever��� o��er� �ypes� of� ins�i�u�ional� inves�ors� �ave� become� increasin�ly�impor�an��as�sources�of�financin��for�corpora�e��akeovers.

Commercial BanksTra�i�ionally�����e�mo�el�of�a�commercial�bank�is�one���a��accep�s�c�eckin����savin�s��� an��money�marke�� accoun�s� an�� len�s� ��ese� fun�s� �o�borrowers.��f�er� ��e�Grea���epression��� ��e�U.S.�Con�ress� require�� ��a�� commercial�banks� en�a�e� only� in� ��ose� �ra�i�ional� bankin�� ac�ivi�ies;� ��ey� were� no��permi��e���o�en�a�e�in�inves�men��bankin��ac�ivi�ies.

�� Geor�eson�&�Company�an���.�F.�Kin��&�Company�are��wo�major�proxy�solici�or�firms.�� T�ere�are�many�priva�e�inves�i�a�ors���bu��Kroll��ssocia�es�is�by�far���e�lar�es��suc��firm���a��

frequen�ly�services��ar�e��mana�emen�.

Mergers and Acquisitions Basics104

T�e�commercial�bank�makes�a�profi��equal��o���e��ifference�be�ween�w�a��i��pays�on��eposi�s�an����e�cos��of�o��er�borrowe��fun�s�an��w�a��i��receives�in�makin����e�loans.�T�is�mo�el��as�evolve��in�o�one�in�w�ic��banks�curren�ly� sell�many�of� ��e� loans� ��ey�ori�ina�e� �o�o��er�players� in���e� financial� sys�em� for�w�om�buyin���� sellin���� an��collec�in��on� loans� is���eir�primary�business.�Commercial�banks�also��erive�an� increasin��s�are�of� ��eir�profi�s� from� fees�c�ar�e�� for�various� �ypes�of� services�offere�� �o��eposi�ors.

C�an�es�ma�e� �o� ��e� law� in�1����now�permi�� commercial� banks� �o�en�a�e� in� inves�men�� bankin�� ac�ivi�ies.� However��� ��e� recen�� �urmoil� in���e��lobal�cre�i��marke�s�may�resul��in�res�ric�ions�on�suc��ac�ivi�ies�in���e�fu�ure.

Insurance Companies�n�insurance�company�offers��o�mi�i�a�e�risk�for�i�s�cus�omers�in�exc�an�e�for� a� fee�or� insurance�premium.�T�e�main� source�of�profi�� for� insurance�companies�is���e�sale�of� insurance�pro�uc�s�(if� ��ey�are�able��o�price�risk�a�equa�ely)���bu����ey�also�make�money�by�inves�in��premium�income���a��is�no��bein��pai��ou���o�cus�omers��o�cover� losses.�Insurers� inves��premi�ums�as� soon�as� ��ey�are�collec�e��an��con�inue��o�earn�in�eres��on���em�un�il�claims�are�pai��ou�.

Pension FundsEmployers�es�ablis��pension�fun�s��o�facili�a�e�an��or�anize���e�inves�men��of� re�iremen�� fun�s� con�ribu�e�� by� ��e� employer� an�� employees.�T�ese�fun�s�are�asse��pools�in�en�e���o��enera�e�s�able�income��row���over���e�lon�� �erm� �o�provi�e�pensions� for� employees�w�en� ��ey� re�ire.�Typically���pension� fun�s� are�mana�e��by� a� financial� a�visory� service� for� ��e� com�pany� an�� i�s� employees��� al��ou��� some� lar�er� corpora�ions�opera�e� ��eir�pension�fun�s�in��ouse.

Pension� fun�s� con�rol� rela�ively� lar�e� amoun�s� of� capi�al� an�� are� ��e�lar�es�� ins�i�u�ional� inves�ors� in� many� coun�ries.� �s� lar�e� ins�i�u�ional�inves�ors�����ey�are�impor�an��s�are�ol�ers�of�bo���publicly�lis�e��an��pri�va�e�companies.

Mutual FundsMu�ual� fun�s�are�pools�of�money�professionally�mana�e�� for� ��e�benefi��of� inves�ors.�T�ey�may� focus�on� s�ocks���bon�s���cas����or�a�combina�ion�of�

Key Players in Mergers and Acquisitions 105

��ese�asse��classes.���mu�ual� fun�’s�por�folio� is� s�ruc�ure��an��main�aine���o�ma�c����e� inves�men��objec�ives� s�a�e�� in� i�s�prospec�us.�Mu�ual� fun�s�can�influence�corpora�e�policies�by�exercisin����e�vo�in��ri���s�associa�e��wi�����eir�s�ock�ol�in�s.

Hedge and Private Equity FundsPriva�e�equi�y�fun�s�an��hedge funds�usually�are�limi�e��par�ners�ips�(for�U.S.�inves�ors)�or�offs�ore�inves�men��corpora�ions�(for�non�U.S.�or��ax�exemp�� inves�ors)� in� w�ic�� ��e� �eneral� par�ner� �as� ma�e� a� subs�an�ial�personal�inves�men�.��T�is�s�ruc�ure�allows���e��eneral�par�ner��o�ac�ieve�ex�ensive�con�rol�over���e�fun�s��e�or�s�e�mana�es���subjec���o�rela�ively�few� le�al� res�ric�ions.� ���er� c�arac�eris�ics� of� par�ners�ips� ��a�� make���em� a��rac�ive� inclu�e� favorable� �ax� benefi�s��� a� fini�e� life��� an�� inves�or�liabili�y�limi�e���o���e�amoun��of���eir�inves�men�.�Ins�i�u�ional�inves�ors�suc�� as� pension� fun�s��� en�owmen�s��� insurance� companies��� an�� priva�e�banks���as�well�as�in�ivi�uals�wi����i���ne��wor������ypically�inves��in���ese��ypes�of�fun�s.�W�en�a�par�ners�ip��as�reac�e��i�s��ar�e��size�����e�par�ner�s�ip�closes��o�fur��er�inves�men����w�e��er�from�new�or�exis�in��inves�ors.

��� ��e� en�� of� 200���� ��ere� were� approxima�ely� ���000� �e��e� fun�s�worl�wi�e�mana�in��$1.���rillion.10�T�is�compares��o�some����000�priva�e�equi�y�fun�s�wi���abou��$500�billion�un�er�mana�emen�.�T�ese�numbers�are�likely��o�s�rink��rama�ically�by���e�en��of�2010��ue��o���e�cre�i��mel���own�an���lobal�economic�slow�own�in�200��an��200�.11

He��e�fun�s�an��priva�e�equi�y�fun�s�are��is�in�uis�e��by���eir�inves��men�� s�ra�e�ies��� lockup� perio�s� (i.e.��� ��e� len���� of� �ime� inves�ors� are�require���o�commi��fun�s)���an����e�liqui�i�y�of���eir�por�folios.�He��e�fun��inves�men�� s�ra�e�ies� inclu�e� �ra�in�� a� varie�y�of� financial� ins�rumen�s—��eb���� equi�y��� op�ions��� fu�ures��� an�� forei�n� currencies—as� well� as� �i��er�risk� s�ra�e�ies� suc�� as� corpora�e� res�ruc�urin�s� (e.�.��� LB�s)� an�� cre�i���eriva�ives� (e.�.��� cre�i�� �efaul�� swaps��� w�ic�� involve� insurin�� ��e� bor�rower�a�ains��po�en�ial�issuer��efaul�).�He��e�fun��inves�ors��ypically�fin��i��easier��o�wi���raw���eir�money���an���ose�w�o�inves��in�priva�e�equi�y�fun�s���because� ��ey�are� subjec�� �o�muc�� s�or�er� lockup�perio�s.�Because��e��e� fun�s� nee�� �o� main�ain� liqui�i�y� �o� sa�isfy� inves�or� wi���rawals����

��� For�an�ex�aus�ive��iscussion�of��e��e�fun��inves�in����see�S�efanini�(2006).10� T�omson�Reu�ers�Lipper/T�SS��sse��Flow�repor�.11� ��survey�by�He��e�Fun��Researc��in�ica�es���a���e��e�fun��asse�s�un�er�mana�emen��fell��o�

abou��$1.���rillion�by���e�en��of�200����reflec�in��a�combina�ion�of�losses�on�inves�e��asse�s�an��re�emp�ions.�T�is�is�abou����e�same�amoun��of�asse�s�un�er�mana�emen��a����e�en��of�2006.

Mergers and Acquisitions Basics106

��ey� focus�on� inves�men�s� ��a�� can�be�conver�e�� �o�cas�� rela�ively�easily���suc��as�compara�ively�small�inves�men�s�in�companies.��no��er�way��e��e�fun�s�main�ain�sufficien��liqui�i�y��o�sa�isfy�inves�or�wi���rawals�is��o�sell���eir�inves�men�s�af�er�six��o�1��mon��s���wi���lockup�perio�s�for�par�ners�ran�in��from�one��o���ree�years.

In� con�ras���� priva�e� equi�y� fun�� mana�ers� of�en� make� �i��ly� ill�iqui�� inves�men�s� in� nonpublicly� lis�e�� securi�ies� of� priva�e� companies.�Inves�men�s� of�en� are� ma�e� �urin�� ��e� firs�� �wo� or� ��ree� years� of� ��e�fun����an����ese�inves�men�s�are�main�aine��for�five��o�seven�years—�urin���w�ic�� �ime� ��ere� are� few� new� inves�men�s.� Suc�� fun�s� inves�� in� IP�s���LB�s���an��corpora�e�res�ruc�urin�s���an��a��emp���o�con�rol�risk�by�becom�in�� more� ac�ively� involve�� in� mana�in�� ��e� firm� in� w�ic�� ��ey� �ave�inves�e�.�Priva�e�equi�y�fun��par�ners�ips�usually�las��abou��10�years���af�er�w�ic��cas��or�s�ares�in�companies�wi��in���e�por�folio�are��is�ribu�e�.

In���e�pas����one�coul���eneralize�by�sayin����a���e��e�fun�s�are��ra��ers���w�ereas�priva�e�equi�y� fun�s� are�more� likely� �o�be� lon���erm� inves��ors.�T�is��is�inc�ion��as�blurre��in�recen��years�as��e��e�fun�s��ave��aken�more�ac�ive�roles�in�acquirin��en�ire�companies.12�T�e�blurrin��of���e��if�ferences�be�ween��e��e�an��priva�e�equi�y� fun�s� reflec�s� increase��com�pe�i�ion��ue��o���e��row���in���e�number�of�fun�s�an����e��u�e�infusion�of�capi�al���a��occurre��be�ween�2005�an��mi��200����makin��i��more��if�ficul��for�fun��mana�ers��o��enera�e�superior�re�urns.

Like�mu�ual� fun�s����e��e�an��priva�e�equi�y� fun�s�receive�a�mana�e�men�� fee� from� par�icipa�in�� inves�ors��� avera�in�� abou�� 2� percen�� of� ��e�asse�s�un�er�mana�emen�.�He��e�fun�s�mana�ers�also�receive�“carrie��in�er�es�”�of�20�percen��of�any�profi�s�realize��from���e�sale�of�por�folio�compa�nies� before� any� monies� are� �is�ribu�e�� �o� inves�ors.� Fur��ermore��� �e��e�fun�s�an��priva�e�equi�y�inves�ors��ypically�receive�fees�from���eir�por�fo�lio�companies�for�comple�in���ransac�ions���arran�in��financin����performin����ue��ili�ence��� an�� for�moni�orin��business�performance�w�ile� ��e�com�pany�is�in���e�fun�’s�por�folio.1�

12� For�example�����e��e��e�fun��Hi��fiel�s�Capi�al�Mana�emen����w�ic��owne����percen��of�Circui��Ci�y���ma�e�a�bi���o�buy���e�en�ire�company�in�2005.�T�a��same�year����e��e�fun��mana�er�E�war��Lamper����af�er�buyin��a�lar�e�s�ake�in�Kmar����en�ineere��an�$11�billion��akeover�of�Sears.�T�e�Blacks�one�Group�(a�priva�e�equi�y�firm)�an��Lion�Capi�al�(a��e��e�fun�)�ban�e���o�e��er��o�purc�ase���e�European�bevera�e��ivision�of�Ca�bury�Sc�weppes�in�early�2006.�Blacks�one�also�ac�e��like�a��e��e�fun����a��same�year�wi���i�s�purc�ase�of�a��.5�percen��s�ake�in��eu�sc�e�Telekom.��ccor�in���o��ealo�ic����e��e�fun�s�accoun�e��for�a��leas��50�levera�e��buyou�s�in�2006.

1�� Kaplan�an��Sc�oar�(2005)�foun��li��le�evi�ence���a��priva�e�equi�y�fun�s�on�avera�e�ou�perform���e�overall�s�ock�marke��w�en���eir�fees�are��aken�in�o�accoun�.�In�con�ras�����e��e�fun�s��ave��en�e���o�ou�perform���e�overall�marke��by�1��o�2�percen�a�e�poin�s���even�af�er�fees�are�consi�ere����

Key Players in Mergers and Acquisitions 107

T�e�200�–200��perio��prove���o�be��ransforma�ional�for�bo����e��e�fun�s�an��priva�e�equi�y�inves�ors���an��200��was���e�wors��year�in��erms�of�performance�an��re�emp�ions�since�1���—�espi�e���e�promise�by��e��e�fun�s� �o�make�money� in�ba��years� as�well� as��oo�.1�� I�� is� clear� ��a�� ��e��i���enin�� of� cre�i�� con�i�ions� an�� ��e� erosion� of� asse�s� un�er� mana�e�men���as�cause��a� si�nifican�� re�renc�men��of� ��eir� inves�men��ac�ivi�ies.�He��e�fun�s�an��priva�e�equi�y�firms�en�a�e��in��is�resse���eb��exc�an�es��o�save�some�of���e�overlevera�e��companies�in���eir�inves�men��por�folios�from��oin��in�o�bankrup�cy.15

He��e�fun�s�an��priva�e�equi�y�companies�are�likely��o�be�more��rans�paren��an���o�lower�mana�emen��fees��o�a��rac��new�inves�ors.�Specula�ion���a�� ��ey� will� �iminis�� in� impor�ance� as� financin�� sources��� ��ou����� is��i��ly�prema�ure.��s�marke�s�re�urn��o���eir�normal�func�ionin������ere�will�con�inue��o�be�a�nee��for�inves�or��roups��o�finance�inves�men�s���a��may�no��be�permissible�un�er���e�c�ar�ers�of�many�pension�an��mu�ual�fun�s.��l�erna�ive�fun�in��sources�are�cri�ical�for�a�vibran���rowin��economy��o�s�imula�e�job��row���an��innova�ion.16�T�e�U.S.��overnmen�’s�bank�rescue�plan�in�200��is�reco�ni�ion�of���e�impor�ance�of�suc��priva�e�capi�al.1�

1�� �ccor�in���o�a�survey�by���e�consul�in��firm�Hennessee�Group�����e�avera�e�fun��los��1��percen��in�200����markin��200����e�in�us�ry’s�firs��full�year�loss�since�2002�w�en���e�avera�e�fun��slippe��2.��percen�.�T�e�losses�were�wi�esprea����wi���abou���0�percen��of�fun�s�respon�in���o���e�survey�in�ica�in��losses.

15� T�a��is���exc�an�in���is�resse���eb��for�new��eb��from�len�ers�un�er�more�favorable��erms.�Increasin�ly����e��e�an��priva�e�equi�y�firms��ave�inves�e��in���e��is�resse���eb��of�o��er�firms�purc�ase��a��pennies�on���e��ollar.

16� In�a�s�u�y�of�mana�emen��prac�ices�a�����000�companies�be�ween�1��0�an��2005����nura��a�Gurun��of���e�Worl��Forum�an��Jos��Lerner�of�Harvar��Business�Sc�ool�conclu�e����a��priva�e�equi�y�firms�are�be��er���an�comparable�firms�a��makin����e��ifficul��c�oices�of�res�ruc�urin��an��s�u��in���own�poorly�performin��opera�ions�in��imes�of�economic��own�urn.�In���e��wo�years�af�er�companies�were�acquire��by�priva�e�equi�y�����eir�pro�uc�ivi�y�increase��by���percen����compare���o���percen��for�similar�firms.�Two���ir�s�of�priva�e�equi�y’s�superior�performance�is�a��ribu�able��o�improvemen��in�exis�in��opera�ions���an����e�remain�er�from�closin��poorly�performin��opera�ions�(Gurun��an��Lerner���200�).

1�� T�e�Financial�S�abili�y��c��of�200��s�ipula�e��a�public–priva�e�par�ners�ip�in�w�ic��a�combina�ion�of��overnmen��fun�s�an��priva�e�inves�men��woul��be�use���o�purc�ase�up��o�$1��rillion�of�

� al��ou�����e��ifference�varies�wi�����e��ime�perio��selec�e��(T�e��eal���2006).�Moreover����e��e�fun��re�urns�appeare���o�be�less�risky���an���e�overall�marke����as�measure��by���e�s�an�ar���evia�ion�of���eir�re�urns.�T�ese��a�a�may�be�problema�ic�because��e��e�fun��financial�re�urns�are�self�repor�e��an��no��subjec���o�public�au�i�.�Fur��ermore���suc��re�urns�coul��be�upwar��biase���ue��o���e�failure��o�repor��poorly�performin��fun�s.�Me�rick�an��Yasu�a�(200�)�foun����a����for�a�sample�of�2���LB��fun�s�from�1��2��o�2006�����e�avera�e�priva�e�equi�y�fun��collec�e��abou��$10.�5�in�mana�emen��fees�for�every�$100.00�un�er�mana�emen����as�compare���o�$5.�1�for�every�$100.00�un�er�mana�emen����a��came�from�carrie��in�eres�.�Consequen�ly���abou���wo���ir�s�of�fun��income�comes�from�fees.

Mergers and Acquisitions Basics108

In�any�even�����e��e�fun�s�are�likely��o�be�subjec���o�more�re�ula�ion�in���e�fu�ure���suc��as�a�requiremen����a����ey�re�is�er�wi�����e�Securi�ies�an��Exc�an�e�Commission�(�o�ay���many��e��e�fun�s��o���is���bu��only�volun��arily)�an��main�ain�lar�er�capi�al�reserves.

Sovereign Wealth FundsSoverei�n� weal��� fun�s� (SWFs)� are� �overnmen��backe�� or� �sponsore��inves�men��fun�s�w�ose�primary�func�ion�is��o�inves��accumula�e��reserves�of� forei�n� currencies� an�� earn� a� profi�.� Coun�ries� ��a�� �a�� accumula�e���u�e� quan�i�ies� of� U.S.� �ollars� woul���� ��rou��� suc�� fun�s��� reinves�� ��e�money� in� U.S.�Treasury� securi�ies.�T�ey� �ave� been� aroun�� for� years��1��an��collec�ively�con�rol� almos��$�� �rillion� in�asse�s.�Recen�ly��� ��ese� fun�s��ave�be�un��o��row�an��are�increasin�ly��akin��equi�y�posi�ions�in�forei�n�firms���makin���i���profile�inves�men�s�in�public�companies.

For���e�mos��par������e�soverei�n�fun�s�appear��o�be�lon���erm���sop�is��ica�e��inves�ors.�Havin��inves�e��more���an�$�0�billion�in�UBS���Mor�an�S�anley��� Merrill� Lync���� an�� Ci�i�roup� �urin�� 200���� ��e� fun�s� of�en� are�a��rac�e�� by� marquee� bran�s.� Moreover��� ��ey� �ave� ��us� far� no�� �emon�s�ra�e��a��esire� �o� seek�con�rollin�� in�eres�s.�However��� ��e��isarray� in� ��e��lobal� capi�al� marke�s� in� 200�� an�� 200���� an�� ��e� resul�in�� sli�e� in� ��e�value� of� ��eir� inves�men�s��� �as� cause�� many� suc�� fun�s� �o� re�renc�� by�inves�in��more�in��overnmen��securi�ies���an�in�in�ivi�ual�firms.

Venture Capital FirmsVen�ure� capi�alis�s� (VCs)� are� a� si�nifican�� source� of� fun�s� for� financin��bo���s�ar�ups�an��acquisi�ions�an��are�some�imes�willin���o�len��w�en���e�more��ra�i�ional�sources���suc��as�banks���insurance�companies���an��pension�fun�s���are�unwillin��because�of�perceive��risk.�Represen�in��priva�e�equi�y�capi�al����ypically�from�ins�i�u�ional�inves�ors�an��in�ivi�uals�wi����i���ne��wor�����VC�firms�i�en�ify�an��screen�oppor�uni�ies����ransac��an��close��eals���moni�or�performance���an��provi�e�a�vice���a��in��value�by�provi�in��man�a�erial� an�� �ec�nical� exper�ise� in� a��i�ion� �o� ��eir� capi�al� con�ribu�ions.�VC� firms� �ypically� provi�e� capi�al� �o� early�s�a�e��� �i���po�en�ial��� �row���

1�� T�e�ol�es��SWF���Kuwai��Inves�men���u��ori�y���be�an�in�1�5�.��bu���abi�Inves�men���u��ori�y�(��I�)�an��Temasek�Hol�in�s�of�Sin�apore��ave�been�aroun��for�more���an��0�years.

� so�calle���oxic�bank�asse�s.�T�e�objec�ive�was��o�injec��a��i�ional�liqui�i�y�in�o���e�banks�an��enable���em��o�au�men����eir�capi�al�base.�He��e�fun�s�an��priva�e�equi�y�inves�ors�un�er���e�pro�ram�were�liable�for�losses���ey�mi����incur�in�excess�of�5�percen���o�16�percen��of���eir�ac�ual�inves�men�����epen�in��on���e��ype�of�asse��backe��securi�y���ey�acquire�.

Key Players in Mergers and Acquisitions 109

companies�wi�����e�expec�a�ion�of��enera�in��a�re�urn���rou���an�even��ual�IP��or�sale��o�a�s�ra�e�ic�inves�or.�Inves�men�s��enerally�are�ma�e�in�cas��in�exc�an�e�for�s�ares�in�a�company���an��VCs�usually��eman��a�lar�e�equi�y� posi�ion� in� ��e� firm� in� exc�an�e� for� payin�� a� rela�ively� low�per�s�are�price.1�

Angel Investors�n�el� inves�ors� are� weal��y� in�ivi�uals� w�o� of�en� ban�� �o�e��er� in�“inves�men��clubs”�or� loose�ne�works.�T�eir�objec�ive� is� �o��enera�e��eal�flow��� pool� money��� an�� s�are� exper�ise.� Some� an�el� �roups� imi�a�e� pro�fessional� inves�men�� fun�s��� some� affilia�e� wi��� universi�ies��� w�ereas� o���ers�en�a�e�in�for�profi��p�ilan��ropy.��n�el�inves�ors�of�en�expec��annual�avera�e�re�urns�of�abou��2��percen�.20

activist investors

Ins�i�u�ional�ac�ivism�(in�ro�uce��in�C�ap�er��)��as�become�an�impor�an��fac�or�in�mer�ers�an��acquisi�ions.�Ins�i�u�ions�of�en�play���e�role�of�ac�iv�is�� inves�ors� �o�affec�� ��e�policies�of�companies� in�w�ic�� ��ey� inves��an��especially��o��iscipline�corpora�e�mana�emen�.

Mutual Funds and Pension FundsIns�i�u�ional�owners�ip�of�public�firms�increase��subs�an�ially�over���e�pas��few� �eca�es.21��l��ou��� re�ula�ions� res�ric�� ��e� abili�y� of� ins�i�u�ions� �o��iscipline�corpora�e�mana�emen����ins�i�u�ional�inves�ors�wi����u�e�por�fo�lios�can�be�very�effec�ive�in��eman�in���overnance�c�an�es.22

1�� General�par�ners�of�ven�ure�capi�al�firms�receive�a�2��o���percen��fee�an��15��o�25�percen��of�any�capi�al��ains�from�ini�ial�public�offerin�s�an��mer�ers.�T�e�remainin���5��o��5�percen��of�capi�al��ains���plus�a�re�urn�of�principal����oes�back��o�inves�ors�in���e�VC�fun��(By�rave�an��Timmons���1��2).��nly�2��o���percen��of���e�firms�con�ac�in��VC�firms�ac�ually�receive�fun�in��(Vac�on���1���).

20� However�����e�variabili�y�of�suc��re�urns�can�be�subs�an�ial.�In���eir�s�u�y�of�1��1���“exi�s”�be�ween�1��0�an��200����rou���mer�ers���acquisi�ions���ini�ial�public�offerin�s���reor�aniza�ions���an��liqui�a�ions���Wil�bank�an��Boeker�(200�)�foun����a����percen��of���e�sample��a��re�urns�10��imes���eir�ori�inal�inves�men�s���an�����percen���i��no��make�back���eir�ini�ial�inves�men�.

21� T�e�percen��of�equi�y��el��by�ins�i�u�ions�was���.1�percen��in�2001���compare���o��1�percen��in�1��0�(Federal Reserve Bulletin����ecember�200����p.���).

22� T�e�Inves�men��Company��c��of�1��0�res�ric�s���e�abili�y�of�ins�i�u�ions��o��iscipline�corpora�e�mana�emen�.�For�example���mu�ual�fun�s����o�ac�ieve��iversifica�ion���are�limi�e��in���e�amoun����ey�can�inves��in�any�one�firm’s�ou�s�an�in��s�ock.�S�a�e�re�ula�ions�of�en�res�ric����e�s�are�of�a�life�insurance�or�proper�y�casual�y�company’s�asse�s���a��can�be�inves�e��in�s�ock��o�as�li��le�as�2�percen�.

Mergers and Acquisitions Basics110

In� ��e� 1��0s��� pension� fun�s��� mu�ual� fun�s��� an�� insurance� firms� were�of�en�passive�inves�ors���s�owin��li��le�in�eres��in�ma��ers�of�corpora�e��ov�ernance.� Pension� fun�s� became�more� forceful� in� ��e� 1��0s��� an�� ��ere� is�fur��er�evi�ence� ��a�� ins�i�u�ions�are� �akin�� increasin�ly�a��ressive� s�an�s�a�ains�� mana�emen�.� For� ins�ance���TI��–CREF—��e� New�York–base��inves�men�� company� ��a�� mana�es� pension� plans� for� �eac�ers��� colle�es���universi�ies��� an�� researc�� ins�i�u�ions—believes� i�� �as� a� responsibili�y� �o�pus�� for�be��er�corpora�e��overnance�an��be��er� s�ock�performance.�T�e�Louisiana�Teac�ers�Re�iremen��Sys�em�brou���� le�al�pressure� �o�bear�on�Siebel� Sys�ems� Inc.��� resul�in�� in� a� se��lemen�� in�mi��200�� in�w�ic�� ��e�sof�ware� company� a�ree�� �o� make� c�an�es� in� i�s� boar�� an�� �o� �isclose��ow� i�� se�s�execu�ive�compensa�ion���w�ic���a��been�cri�icize��as�exces�sive.�In�a�case�brou����a�ains��some�officers�an���irec�ors�of�Sprin��Corp.�in�200��by�labor�unions�an��pension�fun�s���Sprin��se��le��by�a�reein���o��overnance�c�an�es���a��require�a�� leas���wo���ir�s�of� i�s�boar��members��o�be�in�epen�en�.

Mu�ual� fun�s�are� increasin�ly�c�allen�in��mana�emen��on�suc���o��bu��on�issues�as�an�i�akeover��efenses���lavis��severance�benefi�s�for�CE�s���an�� employee� s�ock� op�ion� accoun�in�.� Vo�in�� a�ains�� mana�emen������ou����� can� be� problema�ic� because� some� mu�ual� fun�s� mana�e� re�ire�men��plans�an����increasin�ly���provi�e�a��os��of�ou�sourcin��services—from�payroll� �o� �eal��� benefi�s—for� ��eir� business� clien�s.� Mu�ual� fun�s� may�own� s�ock���on�be�alf�of� in�ivi�ual�or� ins�i�u�ional� clien�s��� in� ��ese� same�firms.2�

Pressure�from�ins�i�u�ional�ac�ivis�s�may�accoun��for���e��eneral��ecline�in���e�number�of�execu�ives�servin��as�bo���boar��c�airman�an��CE��of�companies.2��Some�imes���CE�s�c�oose� �o�ne�o�ia�e�wi��� ac�ivis�s� ra��er���an�face�a�s�ow�own�a��an�annual�s�are�ol�ers�mee�in�.��c�ivis�s�are�also�fin�in����a����ey�may�avoi����e�expense�of�a�full�blown�proxy�fi����simply�by���rea�enin���o�vo�e�in�cer�ain�ways�on�suppor�in��a�CE��or�a�mana�e�men��proposal.�T�is�many�mean�a�“no”�vo�e��� al��ou��� in� some� ins�ances���e� only� op�ions� are� �o� vo�e� in� ��e� affirma�ive� or� abs�ain.��bs�ainin�� is�

2�� ��s�u�y�of���e�2��lar�es��mu�ual�fun�s�in���e�Uni�e��S�a�es�in�ica�e����a����in�200�����merican�Fun�s���T.�Rowe�Price���an��Van�uar��vo�e��a�ains��mana�emen��an��for�key�s�are�ol�er�proposals��0���61���an��51�percen��of���e��ime���respec�ively—s�arply��i��er���an�in�200�.�However���in�us�ry�lea�er�Fi�eli�y�vo�e��a�ains��mana�emen��only����percen��of���e��ime�(�avis�an��Kim���200�;�Farza����2006).

2�� Brickley���Coles���an��Jarrell�(1���);�Goyal�an��Park�(2002).�T�e�number�of�execu�ives�servin��in�bo���posi�ions�of���eir�companies��ecline��from�abou���1�percen���urin����e�1��0s��o�5��percen���urin����e�1��0s�(Kini���Kracaw���an��Mian���200�).

Key Players in Mergers and Acquisitions 111

a�way� �o� in�ica�e� �issa�isfac�ion�wi��� a�CE��or� a� firm’s� policy�wi��ou��jeopar�izin��fu�ure�un�erwri�in��or�M&��business�for���e�ins�i�u�ion.25

I�� s�oul�� be� no�e���� ��ou����� ��a�� ins�i�u�ional� inves�or� ac�ivism� by�mu�ual�fun�s�an��pension�fun�s��as�of�en�faile���o�ac�ieve�si�nifican��ben�efi�s�for�s�are�ol�ers.26

Hedge Funds and Private Equity FirmsIn�recen��years����e��e�fun�s�an��priva�e�equi�y�inves�ors��ave�increasin�ly�playe�� ��e� role� of� ac�ivis�� inves�ors��� an��wi���muc�� �rea�er� success� ��an�o��er� ins�i�u�ional� inves�ors.�For� ins�ance���New�York–base��Kni����Vinke��sse��Mana�emen��le��a�s�are�ol�er�revol��in�2006���a��promp�e����e�$�.6�billion�sale�of���e�un�erperformin���u�c��con�lomera�e�VNU��o�a��roup�of�priva�e�equi�y�inves�ors.�In�200����Trian—a�U.S.��e��e�fun�—compelle��sof�� �rink� an��can�y��ian��Ca�bury�Sc�weppes� �o� spli�� ��e� firm� in� �wo�af�er�Trian� �ook� a� �� percen�� owners�ip� posi�ion� an�� ��rea�ene�� a� proxy�con�es�.

�c�ivis���e��e�fun�s�are�successful�(or�par�ially�so)�abou���wo���ir�s�of���e��ime�in���eir�effor�s��o�c�an�e�a�firm’s�s�ra�e�ic���opera�ional���or�finan�cial� s�ra�e�ies.�T�ey� sel�om� seek� con�rol� (wi��� owners�ip� s�akes� avera��in��abou����percen�)�an��are�mos��of�en�nonconfron�a�ional.�He��e�fun��ac�ivis�s� �en�� �o� rely� on� coopera�ion� from� mana�emen�� or� from� o��er�s�are�ol�ers� �o� promo�e� ��eir� a�en�as.� Researc�� s�ows� ��a�� ��ere� is� an�approxima�e���percen��abnormal�re�urn�aroun����e��a�e�of���e�announce�men����a����e��e��e�fun��is�ini�ia�in��some�form�of�ac�ion.2�

T�e�rela�ive�success�of��e��e�fun�s�as�ac�ivis�s�can�be�a��ribu�e���o���e�fac����a����eir�mana�ers���w�o�mana�e�lar�e�pools�of�rela�ively�unre�ula�e��capi�al��� are� �i��ly� mo�iva�e�� by� ��e� prospec�� of� financial� �ain.� Because��e��e� fun�s� are� no�� subjec�� �o� ��e� same� re�ula�ions� �overnin�� mu�ual�fun�s� an��pension� fun�s��� ��ey�can��ol���i��ly�concen�ra�e��posi�ions� in�small�numbers�of�firms.�Moreover����e��e�fun�s�are�no��limi�e��by���e�same�conflic�s� of� in�eres�s� ��a�� afflic��mu�ual� fun�s� an�� pension� fun�s� because�

25� In�an�unprece�en�e��expression�of�no�confi�ence�in�early�200�������percen��of���e�vo�es�cas��were�oppose���o�Mic�ael�Eisner�con�inuin��as�c�airman�an��CE��of��isney.�Even���ou���Eisner�won�a�majori�y�of���e�vo�es�����e��isney�boar��vo�e���o�s�rip��im�of��is�role�as�c�airman.�La�er���a��year���Eisner�announce����a���e�woul��re�ire�w�en��is�con�rac��expire��in�2006.

26� Black�(1���);�Gillan�an��S�arks�(200�);�Karpoff�(2001);�an��Romano�(2001).2�� Brav�e��al.�(2006).�T�e�au��ors�ar�ue���a��ac�ivis���e��e�fun�s�occupy�a�mi��le��roun��be�ween�

in�ernal�moni�orin��by�lar�e�s�are�ol�ers�an��ex�ernal�moni�orin��by�corpora�e�rai�ers.�Cliffor��(200�)�an��Klein�e��al.�(200�)�also�foun����a���e��e�fun��ac�ivism�can��enera�e�si�nifican��abnormal�financial�re�urns��o�s�are�ol�ers.

Mergers and Acquisitions Basics112

��ey��ave�few�financial��ies��o���e�mana�emen��of���e�firms�w�ose�s�ares���ey�own�an����unlike�mu�ual�fun�s����o�no���ave�o��er�business�suc��as�cli�en�s�services�a��risk.

He��e� fun�s� as� ac�ivis�� inves�ors� �en�� �o��ave� ��e��rea�es�� impac��on�financial� re�urns� �o� s�are�ol�ers� w�en� ��ey� pro�� mana�emen�� �o� pu�� a�company�up�for�sale.�However�����eir�impac��rapi�ly��issipa�es�if���e�sale�of���e�company� is�unsuccessful.2��Firms�once� �ar�e�e��by�ac�ivis�s� are�more�likely��o�be�acquire�.

A General Point about Activist InvestorsI��s�oul��be�no�e����a��even�if�s�are�ol�ers�vo�e�overw�elmin�ly�in�favor�of� specific� resolu�ions� �o�amen��a� firm’s�c�ar�er���boar�s�nee��no�� imple�men����ese�resolu�ions�because�mos��are�only�a�visory.�Mana�ers�nee���o�be� able� �o� mana�e� ��e� business� wi��ou�� si�nifican�� ou�si�e� in�erference�from� sin�le�a�en�a� �issi�en�� s�are�ol�ers.� I�� is� analo�ous� �o� ��e� �is�inc��ion�be�ween�pure��emocracy���in�w�ic��everyone��as�a�vo�e�in�c�an�in��a�law���an��a�represen�a�ive��emocracy���in�w�ic��only�elec�e��represen�a�ives�vo�e�on�new�le�isla�ion.�Reflec�in����is��is�inc�ion���s�are�ol�er�proposals��en���o�be�nonbin�in��because�in�many�s�a�es���inclu�in���elaware���i��is���e�firm’s�boar��represen�in����e�s�are�ol�ers���an��no����e�s�are�ol�ers���em�selves�����a��mus��ini�ia�e�c�ar�er�amen�men�s.

M&a arbitrageurs

W�en�a�bi��is�ma�e�for�a��ar�e��company�����e��ar�e��company’s�s�ock�price�of�en��ra�es�a��a�small��iscoun���o���e�ac�ual�bi�—reflec�in����e�risk���a����e�offer�may�no�� be� accep�e�.�Mer�er� arbi�ra�e� refers� �o� an� inves�men��s�ra�e�y� ��a�� a��emp�s� �o� profi�� from� ��is� sprea�.� Arbitrageurs� (arbs)� buy���e�s�ock�an��make�a�profi��on���e��ifference�be�ween���e�bi��price�an����e�curren��s�ock�price�if���e��eal�is�consumma�e�.�He��e�fun��mana�ers�of�en�play���e�role�of�arbs.

�rbs�may�accumula�e�a�subs�an�ial�percen�a�e�of���e�s�ock��el��ou�si�e�ins�i�u�ions�so���ey�can�be�in�a�posi�ion��o�influence���e�ou�come�of���e��akeover� a��emp�.� For� example��� if� o��er�offers� for� ��e� �ar�e�� firm� appear���arbs�promo�e���eir�posi�ions��irec�ly��o�mana�ers�an��ins�i�u�ional�inves�ors��

2�� Greenwoo��an��Sc�or�(200�)�foun����a��un�er�suc��circums�ances�����ere�is�li��le�c�an�e�in���e�firm’s�s�are�price�or�financial�performance��urin����e�1��mon��s�followin����e�sale�of���e�company���even�if���e�firm�follows���e�ac�ivis�’s�recommen�a�ions�an��buys�back�s�ares�or�a��s�new��irec�ors.

Key Players in Mergers and Acquisitions 113

wi���p�one�calls�an����rou���leaks��o���e�financial�press.�T�eir�in�en��is��o�sell���eir�s�ares��o���e��i��es��bi��er.

�cquirers�involve��in�a��os�ile��akeover�a��emp��of�en�encoura�e��e��e�fun�s��o�buy�as�muc���ar�e��s�ock�as�possible�wi�����e�objec�ive�of��ainin��con�rol�of� ��e� �ar�e�� la�er�by�buyin�� ��e� s�ock� from� ��e��e��e� fun�s.� In�2006���for�ins�ance����e��e�fun�s�ac�e��as�arbi�ra�eurs�an��were���e��eci�in��fac�or�in���e�ba��le�over�Swe�is��insurance�company�Skan�ia��B.�Skan�ia�oppose��a� �akeover�bi��by��l��Mu�ual�PLC���bu���l��Mu�ual�even�ually��aine��con�rol�of�Skan�ia�because�enou����e��e�fun�s�purc�ase��Skan�ia�s�ares�an��sol����eir�s�ock��o��l��Mu�ual.

�rbs�moni�or�rumors�an��s�ock�price�movemen�s��o��e�ermine�w�e��er�inves�ors� are� accumula�in�� a� par�icular� s�ock��� seekin�� �o� i�en�ify� a� �ar�e��before� ��e� po�en�ial� acquirer� is� require�� by� law� �o� announce� i�s� in�en��ions.�S�u�ies� s�ow���a�� ��e�price�of�a� �ar�e��company’s� s�ock�of�en� s�ar�s��o� rise� in�a�vance�of� ��e�announcemen��of� a� �akeover�a��emp���� ��e� resul��of�arb�ac�ivi�y�(an����possibly���insi�er��ra�in�).2��If�one�firm�in�an�in�us�ry�is�acquire����i��is�commonplace�for���e�s�are�prices�of�o��er�firms�in���e�same�in�us�ry� �o� increase� because� ��ose� firms� are� viewe�� as� po�en�ial� �akeover��ar�e�s.

�rbs�also�provi�e�marke��liqui�i�y�(i.e.�����e�ease�wi���w�ic��a�securi�y�can�be�bou����or�sol��wi��ou��affec�in��i�s�curren��marke��price)��urin���ransac��ions.�In�a�cas��finance��mer�er�����e�mer�er�arbi�ra�eur�seekin���o�buy���e��ar�e��firm’s�s�ares�provi�es�liqui�i�y��o���e��ar�e�’s�s�are�ol�ers���a��wan���o�sell�on���e�announcemen���ay�or�s�or�ly���ereaf�er.��rbi�ra�eurs�may�ac�ually�re�uce�liqui�i�y�for���e�acquirer’s�s�ock�in�a�s�ock�for�s�ock�mer�er�because���ey�imme�ia�ely�“s�or�”���e�acquirer�s�ares�(i.e.���sell�borrowe��s�ares—payin���in�eres���o���e�s�are�owner�base��on���e�value�of���e�s�ares�w�en�borrowe�—��opin�� �o� buy� ��em� back� a�� a� lower� price).�T�e� �ownwar�� pressure� ��a��wi�esprea��arb�s�or��sellin��pu�s�on���e�acquirer’s�s�are�price�a����e��ime���e��ransac�ion�is�announce��makes�i���ifficul��for�o��ers��o�sell�wi��ou��incur�rin��a�loss�from���e�premer�er�announcemen��price.�Mer�er�arbi�ra�e�s�or��sellin��may�accoun��for�abou��one��alf�of���e��ownwar��pressure�on�acquirer�s�are�prices�aroun����e�announcemen��of�a�s�ock�finance��mer�er.�0�Mer�er�arbi�ra�e�also��as���e�po�en�ial��o�be��i��ly�profi�able.�1

2�� �scio�lu���McInis����an��Woo��(2002).�0� Mi�c�ell���Pulvino���an��S�affor��(200�).�1� ��number�of�s�u�ies�fin����a��suc��arbi�ra�e��enera�es�financial�re�urns�ran�in��from��.5�percen��

�o�more���an�100�percen��in�excess�of�w�a��woul��be�consi�ere��normal�in�a��i��ly�compe�i�ive�marke��(Jin�ra�an��Walklin����1���;�Karolyi�an��S�annon���1���;�an��Mi�c�ell�an��Pulvino���2001).

Mergers and Acquisitions Basics114

M&�� price� sprea�s� in�ica�e� �ow� arbs� evalua�e� ��e� likeli�oo�� ��a�� a�propose���eal� is� ac�ually��oin�� �o��appen.�Ex�ibi��5�1��isplays� ��e� arbi��ra�e� sprea�� for� selec�e�� announce�� mer�ers� an�� acquisi�ions� in� 200��an�� 200�� involvin�� U.S.� companies.� T�e� sprea�s� represen�� ��e� �iffer�ence�be�ween� ��e�offer�price� an�� ��e� s�are�price� imme�ia�ely� followin����e� announcemen�� as� a�percen��of� ��e�curren�� s�are�price.��� small�posi��ive�sprea��in�ica�es���e�belief���a����e��eal�is�almos��cer�ain��o��ake�place���w�ereas� a� ne�a�ive� sprea�� in�ica�es� ��a�� ei��er� ��e� curren�� bi��er� or�ano��er�bi��er�is�expec�e���o�raise���e�offer�price.

regulators

Re�ula�ions� ��a�� affec�� mer�er� an�� acquisi�ion� ac�ivi�y� exis�� a�� all� levels�of� �overnmen�.� Some� are� �eneral:� ��ey� affec�� all� firms��� an�� involve� fe��eral� securi�y��� an�i�rus���� environmen�al��� racke�eerin���� an�� employee� ben�efi�s� laws.����ers�are�in�us�ry�specific.�Public�u�ili�ies��� insurance���bankin����broa�cas�in���� �elecommunica�ions����efense�con�rac�in����an���ranspor�a�ion�are�examples�of�specific�in�us�ries�subjec���o�subs�an�ial�re�ula�ion.�M&��ac�ivi�ies� in���ese� in�us�ries�of�en�require��overnmen��approvals� �o��rans�fer� �overnmen���ran�e�� licenses��� permi�s��� an�� franc�ises.� S�a�e� an�i�ake�over�s�a�u�es�place�limi�a�ions�on��ow�an��w�en�a��os�ile��akeover�may�be�implemen�e�.�Moreover���approval�a��bo�����e�s�a�e�an��fe�eral� levels�may�

EXHIBIT 5-1 U.S. Merger and Acquisition Price SpreadsAcquirer Target Value of Deal

($Billions)Price Per Share

Bid Price Spread (%)

Pfizer Inc. Wyeth $66.8 $47.62 9.7Roche Holdings Genentech $36.5 $86.50 4.22Dow Chemical Rohm and Haas $15.2 $78.00 38.05NRG Energy Calpine $10.9 $13.40 63.26Exelon Corp. NRG Energy $6.2 $28.04 11.7CenturyTel Inc. Embarq Corp. $5.7 $38.02 3.2Consortium Post Properties $2.1 $47.00 291.01CF Industries Terra Industries $1.9 $23.14 2.22

Abbott Labs Advanced Medical $1.4 $22.00 0.55

Source: Reuters.

Key Players in Mergers and Acquisitions 115

be� require�� for��eals� in�cer�ain� in�us�ries.�Cross�bor�er� �ransac�ions�may�be�even�more�complica�e��because�i��may�be�necessary��o�ob�ain�approval�from�re�ula�ory�au��ori�ies�in�all�coun�ries�in�w�ic����e�acquirer�an���ar��e��companies��o�business.

Ex�ibi��5�2�summarizes���e�various�laws�affec�in��M&��ac�ivi�y�in���e�Uni�e��S�a�es.

EXHIBIT 5-2 Laws Affecting M&ALaw Intent

Federal Securities Laws

Securities Act (1933) Prevents the public offering of securities without a registration statement; defines minimum data requirements and noncompliance penalties

Securities Exchange Act (1934)

Established the Securities and Exchange Commission (SEC) to regulate securities trading. Empowers Securities and Exchange Commission (SEC) to revoke registration of a security if issuer is in violation of any provision of the 1934 act

Section 13 Defines content and frequency of, as well as events triggering, SEC filings

Section 14 Defines disclosure requirements for proxy solicitationSection 16(a) Defines what insider trading is and who is an insiderSection 16(b) Defines investor rights with respect to insider trading

Williams Act (1968) Regulates tender offersSection 13(d) Defines disclosure requirements

Sarbanes-Oxley Act (2002)

Initiates extensive reform of regulations governing financial disclosure, governance, auditing standards, analyst reports, and insider trading

Federal Antitrust Laws

Sherman Act (1890) Made “restraint of trade” illegal. Establishes criminal penalties for behaviors that unreasonably limit competition

Section 1 Makes mergers creating monopolies or “unreasonable” market control illegal

Section 2 Applies to firms already dominant in their served markets to prevent them from “unfairly” restraining trade

(Continued)

Mergers and Acquisitions Basics116

EXHIBIT 5-2 (Continued)

Law Intent

Federal Antitrust Laws

Clayton Act (1914) Outlawed certain practices not prohibited by the Sherman Act such as price discrimination, exclusive contracts, and tie-in contracts and created civil penalties for illegally restraining trade; also established law governing mergers

Celler–Kefauver Act of 1950

Amended Clayton Act to cover asset as well as stock purchases

Federal Trade Commission Act (1914)

Established a federal antitrust enforcement agency; made it illegal to engage in deceptive business practices.

Hart–Scott–Rodino Antitrust Improvement Act (1976)

Requires waiting period before a transaction can be completed and sets regulatory data submission requirements

Title I Defines what must be filedTitle II Defines who must file and whenTitle III Enables state attorneys general to file triple damage

suits on behalf of injured parties

Other Legislation Affecting M&A

State Antitakeover Laws

Define conditions under which a change in corporate ownership can take place; may differ by state

State Antitrust Laws Similar to federal antitrust laws; states may sue to block mergers, even if the mergers are not challenged by federal regulators

Exon-Florio Amendment to the Defense Protection Act of 1950

Establishes authority of the Committee on Foreign Investment in the United States (CFIUS) to review the impact of foreign direct investment (including M&A) on national security

Industry-Specific Regulations

Banking, communications, railroads, defense, insurance, and public utilities

Environmental Laws (federal and state)

Define disclosure requirements

Labor and Benefit Laws (federal and state)

Define disclosure requirements

Applicable Foreign Laws

Cross-border transactions subject to jurisdictions of countries in which the bidder and target firms have operations

Key Players in Mergers and Acquisitions 117

Securities and Exchange CommissionW�enever�ei��er� ��e�acquirin��or� ��e� �ar�e��company� is�publicly� �ra�e������e�firms�are�subjec���o���e�subs�an�ial�repor�in��requiremen�s�of���e�cur�ren�� fe�eral� securi�ies� laws� a�minis�ere�� by� ��e� Securi�ies� an��Exc�an�e�Commission.�Passe��in���e�early�1��0s��� ��ese� laws�were�a��irec��resul��of���e�loss�of�confi�ence�in���e�securi�ies�marke�s�followin����e�cras��of���e�s�ock�marke��in�1�2�.

T�e� Securi�ies��c�� of� 1���� requires� ��a�� all� securi�ies� offere�� �o� ��e�public�mus�� be� re�is�ere��wi��� ��e� SEC.�Re�is�ra�ion� requires��� bu�� �oes�no���uaran�ee�����a����e�fac�s�represen�e��in���e�re�is�ra�ion�s�a�emen��an��prospec�uses� are� accura�e.� However��� ��e� law� makes� provi�in�� inaccura�e�or�mislea�in��s�a�emen�s�in���e�sale�of�securi�ies��o���e�public�punis�able�wi��� a� fine��� imprisonmen����or�bo��.�T�e� re�is�ra�ion�process� requires� ��e��escrip�ion�of���e�company’s�proper�ies�an��business���a��escrip�ion�of���e�securi�ies��� informa�ion�abou��mana�emen����an��financial�s�a�emen�s�cer�i�fie��by�public� accoun�an�s.� Sec�ion���of� ��e� law�permi�s� ��e� re�is�ra�ion�s�a�emen�� �o� au�oma�ically�become�effec�ive�20��ays� af�er� i�� is� file��wi�����e�SEC.�However�����e�SEC�may��elay�or�s�op���e�process�by�reques�in��a��i�ional�informa�ion.

T�e�Securi�ies�Exc�an�e��c��of�1����ex�en�s��isclosure�requiremen�s�s�ipula�e�� un�er� ��e� earlier� ac���� coverin�� new� issues� �o� inclu�e� securi��ies� alrea�y� �ra�in�� on� ��e� na�ional� exc�an�es.� In� 1�6���� covera�e� was�expan�e�� �o� inclu�e� securi�ies� �ra�e�� on� ��e� over���e�coun�er� (�TC)�Marke�.� Moreover��� ��e� ac�� pro�ibi�s� brokera�e� firms� workin�� wi��� a�company�an��o��ers�rela�e���o���e�securi�ies��ransac�ion�from�en�a�in��in�frau�ulen��an��unfair�be�avior���suc��as�insi�er��ra�in�.�T�e�ac��also�covers�proxy�solici�a�ions�(i.e.���mailin�s��o�s�are�ol�ers�reques�in����eir�vo�e�on�a� par�icular� issue)� by� a� company� or� s�are�ol�ers��� inclu�in�� w�en� con��rol�of���e�boar��an��mana�emen��is�involve����an��requires���e��isclosure�of���e�names�an��in�eres�s�of�all�par�icipan�s� in���e�proxy�con�es�.�Proxy�ma�erials�mus��be�file��in�a�vance�of���eir��is�ribu�ion��o�ensure���a����ey�are�in�compliance�wi����isclosure�requiremen�s.�If���e��ransac�ion�involves���e�s�are�ol�er�approval�of�ei��er���e�acquirer�or��ar�e��firm���any�ma�eri�als��is�ribu�e���o�s�are�ol�ers�mus��conform��o���e�SEC’s�rules�for�proxy�ma�erials.

Passe�� in� 1�6���� ��e�Williams� �c��2� is� a� se�� of� amen�men�s� �o� ��e�Securi�ies�Exc�an�e��c��of�1���.�I�s�in�en��was��o�pro�ec���ar�e��firm�s�are��ol�ers� from� li���nin��fas�� �akeovers� in� w�ic�� ��ey� woul�� �ave� nei��er��

�2� Sec�ions�1�(�)�an��1�(�)�of���e�Williams��c��are���e�mos��relevan���o�M&�s.

Mergers and Acquisitions Basics118

sufficien�� informa�ion� nor� �ime� �o� make� an� a�equa�e� assessmen�� of� ��e�value� of� an� acquirer’s� offer.�T�is� pro�ec�ion� was� ac�ieve�� by� requirin��more��isclosure�by���e�bi��in��company���es�ablis�in��a�minimum�perio���urin��w�ic��a��en�er�offer�mus��remain�open���an��au��orizin���ar�e�s��o�sue�bi��in�� firms.�T�e��isclosure�requiremen�s�of� ��e�Williams��c��apply��o�anyone�askin��s�are�ol�ers��o�accep��or�rejec��a��akeover�bi����inclu�in����e��ar�e�.

T�e�preno�ifica�ion�proce�ures�ou�line�� in� ��e�Williams��c��mus��be�followe���ili�en�ly.�T�e�ac��requiremen�s�apply��o�all��ypes�of��en�er�offers���inclu�in����ose�ne�o�ia�e��wi�����e��ar�e��firm�(i.e.���ne�o�ia�e��or�frien�ly��en�er�offers)�����ose�un�er�aken�by�a�firm��o�repurc�ase�i�s�own�s�ock�(i.e.���self��en�er� offers)��� an�� ��ose� ��a�� are� unwan�e�� by� ��e� �ar�e�� firm� (i.e.����os�ile��en�er�offers).

Federal Trade Commission and Department of JusticeFe�eral�antitrust laws�exis���o�preven��in�ivi�ual�corpora�ions�from�assum�in��a�level�of�marke��power���a��makes���em�able��o�limi����eir�ou�pu��an��raise�prices�wi��ou��concern�for�any�si�nifican��compe�i�or�reac�ion.�T�e��epar�men�� of� Jus�ice� (�oJ)� an�� ��e� Fe�eral�Tra�e� Commission� (FTC)��ave�primary�responsibili�y�for�enforcin����ese�laws.�T�e�FTC�was�es�ab�lis�e��in���e�Fe�eral�Tra�e�Commission��c��of�1�1��wi�����e�specific�pur�pose�of�enforcin��prece�in��an�i�rus�� laws�suc��as� ��e�S�erman���Clay�on���an��Fe�eral�Tra�e�Commission��c�s.

Passe��in�1��0�����e�S�erman��n�i�rus���c��remains���e�mos��impor�an��source�of� an�i�rus�� law� �o�ay.�T�e�ac���efines�broa��con�i�ions� an�� rem�e�ies�for�suc��firms���a��are��eeme���o�be�in�viola�ion�of�curren��an�i�rus��laws��� an�� applies� �o� all� �ransac�ions� an�� businesses� involve�� in� in�ers�a�e�commerce�or���if���e�ac�ivi�ies�are�local���all��ransac�ions�an��business�“affec��in�”�in�ers�a�e�commerce.�I��makes�ille�al�all�con�rac�s���combina�ions���an��conspiracies���a��‘‘unreasonably’’�res�rain��ra�e.�T�ey�inclu�e�a�reemen�s��o�fix�prices���ri��bi�s���alloca�e�cus�omers�amon��compe�i�ors���or�monopolize�any�par��of�in�ers�a�e�commerce.�Sec�ion�I�of���e�ac��pro�ibi�s�new�busi�ness�combina�ions���a��resul��in�monopolies�or�in�a�si�nifican��concen�ra��ion�of�pricin��power�in�a�sin�le�firm.�Sec�ion�II�applies��o�firms�alrea�y��ominan��in���eir��ar�e�e��marke�s.

T�e� Clay�on� �n�i�rus�� �c�� was� enac�e�� in� 1�1�� �o� s�ren���en� ��e�S�erman��n�i�rus���c�.�I��ou�laws�cer�ain�prac�ices�no��pro�ibi�e��by���e�S�erman��c��an���elps���e��overnmen��s�op�a�monopoly�before�i���evel�ops.� Sec�ion�5�of� ��e� ac��makes�price��iscrimina�ion�be�ween� cus�omers��

Key Players in Mergers and Acquisitions 119

ille�al��� unless� i�� can� be� jus�ifie�� by� cos�� savin�s� associa�e�� wi��� bulk��purc�ases.� Tyin�� of� con�rac�s—in� w�ic�� a� firm� refuses� �o� sell� cer�ain�impor�an��pro�uc�s��o�a�cus�omer�unless���e�cus�omer�a�rees��o�buy�o��er�pro�uc�s� from� ��e� firm—also� is� pro�ibi�e�.� Sec�ion� �� pro�ibi�s� mer�ers�an��acquisi�ions���a��may�subs�an�ially�lessen�compe�i�ion�or��en���o�cre�a�e�a�monopoly���an��also�makes�i��ille�al�for�one�company��o�purc�ase���e�s�ock�of�ano��er�company�if���eir�combina�ion�resul�s�in�re�uce��compe��i�ion� wi��in� ��e� in�us�ry.� In�erlockin�� �irec�ora�es� also� are� ma�e� ille�al�w�en���e��irec�ors�are�on���e�boar�s�of�compe�in��firms.

Unlike� ��e� S�erman� �c���� w�ic�� con�ains� criminal� penal�ies��� ��e�Clay�on��c��is�a�civil�s�a�u�e.�T�e�Clay�on��c��allows�priva�e�par�ies�injure��by���e�an�i�rus��viola�ion��o�sue�in�fe�eral�cour��for���ree��imes���eir�ac�ual��ama�es.�S�a�e�a��orneys��eneral�also�may�brin��civil� sui�s.� If� ��e�plain�iff�wins���cos�s�mus��be�borne�by���e�par�y�viola�in��prevailin��an�i�rus��law���in�a��i�ion��o���e�criminal�penal�ies�impose��un�er���e�S�erman��c�.

�cquirers� soon� learne�� �ow� �o� circumven�� ��e� ori�inal� 1�1�� s�a��u�es�of���e�Clay�on��c����a��applie���o���e�purc�ase�of�s�ock.�T�ey�simply�woul�� acquire� ��e� asse�s� of� a� �ar�e�� firm��� ra��er� ��an� ��e� s�ock.� So��� ��e�Celler�Kefauver��c��of�1�50�amen�e����e�Clay�on��c�� �o��ive� ��e�FTC���e�power��o�pro�ibi��asse����as�well�as�s�ock���purc�ases.�T�e�FTC�also�may�block�mer�ers� if� i��believes� ��a�� ��e�combina�ion�will� resul�� in� increase��marke��concen�ra�ion�(i.e.��� fewer�firms��avin��increase��marke��s�ares)�as�measure��by���e�sales�of���e�lar�es��firms.

�l��ou�����e�1�6��Wallace��c�� requires�preno�ifica�ion�un�er�cer�ain�con�i�ions� for� s�ock� �ransac�ions��� ��e�1��6�Har�–Sco��–Ro�ino��n�i�rus��Improvemen�s��c�� (HSR)�was� passe�� �o� require� preno�ifica�ion� for� asse��acquisi�ions.��cquisi�ions�involvin��companies�of�a�cer�ain�size�canno��be�comple�e��un�il�cer�ain�informa�ion�is�supplie���o���e�fe�eral��overnmen��an��un�il� a� specifie��wai�in��perio���as�elapse�.�T�e�premer�er�no�ifica��ion�allows���e�FTC�an����e��oJ�sufficien���ime��o�c�allen�e�acquisi�ions�believe���o�be�an�icompe�i�ive�before���ey�are�comple�e�.��f�er���e�mer�er��as��aken�place���breakin��i��up�can�be�excee�in�ly��ifficul�.

Other RegulatorsIn�a��i�ion��o���e�SEC����oJ���an����e�FTC���various�o��er�a�encies�moni��or� ac�ivi�ies� in� cer�ain� in�us�ries��� suc�� as� commercial� bankin���� railroa�s����efense���an��cable�TV.�In�eac��in�us�ry�����e�a�ency��ypically�is�responsible�bo���for���e�approval�of�M&�s�an��subsequen��oversi���.�Mer�ers�in���ese�in�us�ries�of�en� �ake�muc�� lon�er� �o�comple�e�because�of� ��e�a��i�ional��

Mergers and Acquisitions Basics120

filin��requiremen�s.����ili�en��buyer�also�mus��ensure���a����e��ar�e��is�in�compliance�wi�����e�labyrin���of�labor�an��benefi��laws.�T�ese�laws��overn�areas� suc��as�employmen���iscrimina�ion��� immi�ra�ion� law���sexual��arass�men����a�e��iscrimina�ion����ru���es�in����an��wa�e�an���our�laws.�Labor�an��benefi�� laws� inclu�e� ��e� Family� an�� Me�ical� Leave��c���� ��e��mericans�wi��� �isabili�ies� �c���� an�� ��e� Worker� ��jus�men�� an�� Re�rainin��No�ifica�ion��c��(W�RN).�W�RN��overns�no�ifica�ion�before�plan��clos�in�s�an��requiremen�s��o�re�rain�workers.

*�*�*

T�e�numerous�par�icipan�s�in���e�M&��process�play�a�varie�y�of�roles.�Some� provi�e� specialize�� services.� ���ers� are� inves�ors� of� various� sor�s���some�imes� represen�in�� in�ivi�uals� an�� o��er� �imes� represen�in�� �u�e�pools�of�inves�ors�w�o��ave�combine����eir�capi�al.�Some�serve�as�fun�in��sources�specifically�for�M&��ac�ivi�y.�S�ill�o��ers�re�ula�e���e�process.

A Case in Point: Blackstone Outmaneuvers Vornado to Buy Equity Office PropertiesThe sale and subsequent dismemberment of Equity Office Properties (EOP) illustrates the excesses of the commercial real estate boom in recent years. The story underscores the importance of timing and raises questions about how seemingly sophisticated institutional investors and lenders could be induced to make such poor investment decisions, while regulators appeared to ignore the “handwriting on the wall.” And, from a purely tactical perspective, the EOP case shows how the form of payment can be used as a key component of a takeover strategy.

EOP was established in 1976 by Sam Zell, a veteran property investor known for his ability to acquire distressed properties. Over three decades, he had amassed a portfolio of 573 properties. The Blackstone Group, one of the largest U.S. private equity buyout firms, first entered the commercial real estate market in 2005—part of a wave of capital flowing into that market from private equity investors. Vornado Realty Trust, a publicly traded real estate investment trust, had a long-standing reputation for savvy investing in the commercial real estate market. These were the players in our story.

After EOP’s management came under fire from investors for failing to sell properties fast enough and distribute the proceeds to shareholders, EOP signed a definitive agreement to be acquired by Blackstone for $48.50 per share in cash in November 2006, subject to approval by EOP’s shareholders. Vornado bid $52.00 per share—60 percent in cash and the remainder in Vornado

Key Players in Mergers and Acquisitions 121

stock. The Vornado bid reflected a view that EOP’s breakup value exceeded Blackstone’s offer.

Blackstone countered with a bid of $54 per share, if EOP would raise the breakup fee from $200 million to $500 million. Ostensibly designed to com-pensate Blackstone for expenses incurred in its takeover attempt, the breakup fee also raised the cost of acquiring EOP by another bidder, which, as the new owner, would actually pay the fee. Within a week, Vornado responded with a bid valued at $56 per share. Still, EOP continued to favor Blackstone’s offer; the value was more certain because it could take three to four months before Vornado could get approval from its shareholders. What if Vornado’s stock declined in the interim or shareholders nixed the deal?

Reluctant to raise its offer price again, Vornado agreed to increase the cash portion of the purchase price and pay shareholders the cash more quickly than in its initial offer. However, Vornado did not offer to pay EOP shareholders a fee if Vornado’s shareholders did not approve the deal.

The next day, Blackstone increased its bid to $55.25 and eventually—at Zell’s behest—to $55.50, in exchange for another increase in the breakup fee, this time to $720 million. Vornado’s failure to counter gave Blackstone the win. On that news, Vornado’s stock jumped by 5.8 percent, and EOP’s fell by 1 percent to just below Blackstone’s final offer price. On February 8, 2007, Blackstone Group closed the purchase of EOP for $39 billion, consisting of about $23 billion in cash and $16 billion in assumed debt.

Blackstone’s strategy had been to sign contracts to presell selected EOP properties contingent on its closing of the deal with Sam Zell. This resulted in buyers purchasing buildings at what, in retrospect, were highly inflated prices. Fueled by historically low interest rates permitted by the U.S. Federal Reserve System, lenders were willing to finance the deals, lending up to 90 percent or more of the purchase price, because they were betting that rents, and therefore values, would continue to climb. Investment banks, including Morgan Stanley, Wachovia, Goldman Sachs, Bear Stearns, and Lehman Brothers collected fees for packaging the deals and selling the loans as securities to eager investors.

In fact, rental rates in most major urban markets collapsed in 2008 and 2009 as vacancy rates soared. With credit extremely tight, the ability to refinance these properties proved almost impossible. Building owners began to default on loans as they came due. What had begun in late 2007 as a recession centered largely in the residential housing market soon spread to other areas, including the commercial and office building markets. Both Sam Zell and the Blackstone Group were huge winners, although the value of the 105 properties Blackstone retained has fallen substantially.

Once again, timing proves to be the deciding factor in determining winners and losers in these types of M&A transactions.

Mergers and Acquisitions Basics122

Things to Think About:1. Despite having a signed purchase agreement with Blackstone, Vornado bid

$52 per share (60 percent cash and remainder in Vornado stock) and eventu-ally $56 per share. What was the motivation for the Vornado bid and its cash and stock composition?

2. What was EOP’s response to the higher Vornado bids and why?3. Describe Blackstone’s negotiating strategy with EOP to counter Vornado

bids.4. What could Vornado have done to assuage EOP’s concerns about the value

of its stock?5. Why did Blackstone have a huge incentive to close the deal?

Answers can be found at: www.elsevierdirect.com/companion.jsp?ISBN=9780123749482

123Mergers and Acquisitions Basics� ©�2011�Elsevier�Inc.ISBN:�����0�12��������2�� ��I: �ll ri���s reserve�.����0�12��������2�� ��I: �ll ri���s reserve�.�����I:� �ll�ri���s�reserve�.

CHAPTER

201110.1016/B����0�12��������2.00006��

Developing the Business Plan as the Initial Phase of the Merger and Acquisition Process

��poorly��esi�ne��or�inappropria�e�business�s�ra�e�y�is�amon����e�reasons�mos��frequen�ly��iven�w�en�mer�ers�an��acquisi�ions�fail��o�sa�isfy�expec��a�ions.�Too�of�en�����e�overarc�in��role�plannin��s�oul���ake�in�concep�u�alizin��an��implemen�in��business�combina�ions�is�i�nore�.

Many�companies� view�mer�ers� an�� acquisi�ions� as� a�business� �row���s�ra�e�y�in�an��of���emselves.�Here���in�accor��wi�����e�view�of�successful�acquirers��1�M&�s�are�consi�ere��a�means�of�implemen�in��a�business�s�ra��e�y.��l��ou���firms�may�accelera�e�overall��row���in���e�s�or��run���rou���acquisi�ion�����e��i��er��row���ra�e�of�en�is�no��sus�ainable�wi��ou��a�busi�ness�plan—w�ic��also�serves�as�a�roa�map�for�i�en�ifyin��a��i�ional�acqui�si�ions� �o� fuel� fu�ure� �row��.� Moreover��� ��e� business� plan� facili�a�es� ��e�in�e�ra�ion�of���e�acquire��firms�an����e�realiza�ion�of�syner�y.

�� soun�� business� plan� s�oul�� be� viewe�� as� a� necessary��� bu�� no�� suf�ficien����con�i�ion�for�ac�ievin��a�company’s�vision�an��objec�ives.�Bank�of��merica’s�vision�of�becomin����e�number�one�financial�services�provi�er�in�i�s��omes�ic�marke���rove���e�firm’s�business�s�ra�e�y���w�ic��focuse��on�broa�enin��i�s�pro�uc��offerin�s�an��expan�in��i�s��eo�rap�ic�covera�e�in���e�Uni�e��S�a�es.�T�is�s�ra�e�y�was�implemen�e��by�makin��oppor�unis�ic�acquisi�ions��� inclu�in���rouble��resi�en�ial�mor��a�e�len�er�Coun�rywi�e�in� 200�� an�� financially� ailin�� brokera�e� an�� inves�men�� bank� Merrill�Lync��in�200�.�Bank�of��merica’s�failure��o�perform�proper��ue��ili�ence�in�makin����ese�acquisi�ions����owever���may�ul�ima�ely�mean���a����ey�fail��o�mee��expec�a�ions.��lrea�y�����ey��ave�severely�ero�e��Bank�of��merica’s�marke��value.�Even���e�bes��lai��plans�canno��save�an�acquirer�from�a�poor�execu�ion�of�i�s�business�s�ra�e�y.

To�un�ers�an����e�role�of�plannin��in���e�M&��process���you�nee���o�un�ers�an����e�purpose�of���e�acquirin��firm’s�mission�an��s�ra�e�y.�Here���you� will� be� in�ro�uce�� �o� a� plannin��base�� approac�� �o� mer�ers� an��

6

1� Pal�er�an��Srinivasan�(2006).

Mergers and Acquisitions Basics124

acquisi�ions��� comprisin�� an� in�e�ra�e�� process� of� 10� in�errela�e�� p�ases.�T�is�c�ap�er�focuses�on���e�ini�ial�p�ase—buil�in����e�business�plan—an��on��ools�commonly�use���o�evalua�e����isplay���an��communica�e�informa�ion��o�key�cons�i�uencies�bo���insi�e�(e.�.���boar��of��irec�ors�an��mana�emen�)�an�� ou�si�e� (e.�.��� len�ers� an�� s�ock�ol�ers)� ��e� corpora�ion.� Subsequen��c�ap�ers��e�ail���e�remainin��p�ases�of���e�M&��process.

T�e�plannin��concep�s��escribe���ere�are�lar�ely�prescrip�ive�in�na�ure:���ey� recommen�� cer�ain� s�ra�e�ies� base�� on� ��e� resul�s� �enera�e�� by�applyin�� specific� �ools� (e.�.��� experience� curves)� an�� answerin�� c�ecklis�s�of�relevan��ques�ions.��l��ou�����ese��ools�in�ro�uce�some��e�ree�of�ri�or��o�s�ra�e�ic�plannin������eir�applica�ion�s�oul��no��be�viewe��as�a�comple��ion�of���e�plannin��process.�Business�plans�mus��be�up�a�e��frequen�ly��o�accoun��for�c�an�es�in���e�firm’s�opera�in��environmen��an��i�s�compe�i��ive�posi�ion�wi��in���a��environmen�.�In�ee����business�plannin��is�no��an�even����bu��an�evolvin��process.2

A PlAnning-BAsed APProAch to Mergers And Acquisitions

T�e�acquisi�ion�process�envisione���ere�can�be�separa�e��in�o��wo�s�a�es.�T�e�planning�s�a�e�comprises��evelopin��business�an��acquisi�ion�plans.�T�e�imple-mentation�s�a�e�inclu�es�searc�in����screenin����con�ac�in����e��ar�e����ne�o�ia��in����in�e�ra�ion�plannin����closin����in�e�ra�in����an��evalua�in����e�acquisi�ion.

Key Business Planning Concepts��plannin��base��acquisi�ion�process�comprises�bo���a�business�plan�an��a�mer�er/acquisi�ion�plan���w�ic���rive�all�subsequen��p�ases�of���e�acquisi��ion�process.�T�e�business plan�ar�icula�es�a�mission�or�vision�for���e�firm�an��a�business strategy�for�realizin����a��mission�for�all�of���e�firm’s�s�ake��ol�ers.�Stakeholders�are�cons�i�uen���roups�suc��as�cus�omers���s�are�ol��ers���employees���suppliers���len�ers���re�ula�ors���an��communi�ies.�T�e�business�s�ra�e�y�is�orien�e���o���e�lon���erm�an��usually�cu�s�across�or�aniza�ional�lines��o�affec��many��ifferen��func�ional�areas.�Typically���i��is�broa�ly��efine��an��provi�es�rela�ively�li��le��e�ail.

Wi��� respec�� �o� business� s�ra�e�y��� i�� can� be� impor�an�� �o� �is�in�uis��be�ween���e�corpora�e�level�an����e�business�level.�Corporate-level strategies��are�se��by���e�mana�emen��of�a��iversifie��or�mul�ipro�uc��firm�an���en�erally� cross� business� uni�� or�aniza�ional� lines.�T�ey� en�ail� �ecisions� abou��

2� For�a�more��e�aile���iscussion�of�business�plannin����see��eusen�e��al.�(200�);�Hun�er�an��W�eeler�(200�);�an��T�ompson�(200�).

Developing the Business Plan as the Initial Phase of the Merger and Acquisition Process 125

financin����e��row���of�cer�ain�businesses���opera�in��o��ers��o��enera�e�cas�����ives�in�� some� uni�s��� or� pursuin�� �iversifica�ion.� Business-level strategies��are�se��by���e�mana�emen��of�a�specific�opera�in��uni��wi��in���e�corpora�e�or�aniza�ional�s�ruc�ure�an��may�involve���a��uni��a��emp�in���o�ac�ieve�a�low�cos��posi�ion�in���e�marke�s�i��serves����ifferen�ia�in��i�s�pro�uc��offer�in����or�narrowin��i�s�opera�ional�focus��o�a�specific�marke��nic�e.

T�e� implementation strategy� refers� �o� ��e� way� in� w�ic�� ��e� firm�c�ooses� �o� execu�e� ��e� business� s�ra�e�y.� I�� is� usually� far� more� �e�aile����an� ��e� business� s�ra�e�y.�T�e� merger/acquisition plan� is� a� specific� �ype�of� implemen�a�ion� s�ra�e�y� an���escribes� in��e�ail� ��e�mo�iva�ion� for� ��e�acquisi�ion� an�� �ow� an�� w�en� i�� will� be� ac�ieve�.� Functional strategies��escribe�in��e�ail��ow�eac��major�func�ion�wi��in���e�firm�(e.�.���manufac��urin����marke�in����an���uman�resources)�will�suppor����e�business�s�ra�e�y.�Contingency plans�are�ac�ions���a��are��aken�as�an�al�erna�ive��o���e�firm’s�curren��business�s�ra�e�y.�T�e�selec�ion�of�w�ic��al�erna�ive�ac�ion��o�pur�sue� may� be� con�in�en�� on� cer�ain� even�s� calle�� �ri��er� poin�s� occurrin��(e.�.���failure��o�realize�revenue��ar�e�s�or�cos��savin�s)���a��w�ic��poin��a�firm�faces�a�number�of�al�erna�ives�some�imes�referre���o�as�real�op�ions.�T�ese�op�ions�inclu�e�aban�onin�����elayin����or�accelera�in��an�inves�men��s�ra�e�y.�Unlike���e�s�ra�e�ic�op�ions��iscusse��la�er�in���is�c�ap�er���real�op�ions�are��ecisions���a��can�be�ma�e�after�a�business�s�ra�e�y��as�been�implemen�e�.

the Acquisition Process

�n�acquisi�ion�process� can�be� ��ou����of� as� a� series�of� lar�ely� in�epen��en�� even�s� culmina�in�� in� ��e� �ransfer� of� owners�ip� from� ��e� seller� �o���e� buyer.�T�is� process� facili�a�es� ��e� communica�ion� an�� un�ers�an�in��require�� �o� comple�e� ��e� �ransac�ion.�T�inkin�� of� M&�s� as� a� �ransac��ion��es�e��process���w�ile�no��ensurin��success���increases���e�likeli�oo��of�mee�in��or�excee�in��expec�a�ions.

Good Planning Expedites Sound Decision MakingSome�in�ivi�uals� s�u��er�a�� ��e���ou����of� followin��a� s�ruc�ure��process�because���ey�believe�i��may��elay�respon�in���o�oppor�uni�ies���bo���an�ici�pa�e�� an�� unan�icipa�e�.��n�icipa�e�� oppor�uni�ies� are� ��ose� i�en�ifie�� as�a� resul��of� ��e�business�plannin��process:�un�ers�an�in�� ��e� firm’s�ex�ernal�opera�in�� environmen���� assessin�� in�ernal� resources��� reviewin�� a� ran�e� of��reasonable�op�ions���an��ar�icula�in��a�clear�vision�of���e�fu�ure�of���e�business�an��a�realis�ic�s�ra�e�y�for�ac�ievin����a��vision.��Unan�icipa�e��oppor�uni�ies��� Hill�an��Jones�(2001).

Mergers and Acquisitions Basics126

may�emer�e�as�new�informa�ion�becomes�available.�Havin��a�well��esi�ne��business�plan��oes�no���elay�pursuin��oppor�uni�ies;�ra��er���i��provi�es�a�way��o�evalua�e���e�oppor�uni�ies���rapi�ly�and�subs�an�ively.��ecisions�ma�e�in���e�con�ex��of�a�business�plan�are�ma�e�wi��� ��e�confi�ence� ��a��comes� from�alrea�y��avin��aske��an��answere����e��ifficul��ques�ions.

Mergers and Acquisitions Are a Process, Not an EventEx�ibi��6�1�illus�ra�es���e�10�p�ases�of���e�acquisi�ion�process��escribe��in���is�an��subsequen��c�ap�ers.�T�ese�p�ases�fall�in�o��wo��is�inc��se�s�of�ac�iv�i�ies:�pre��an��pos�purc�ase��ecision�ac�ivi�ies.�T�ey�are�summarize���ere:

Phase 1:�Business�Plan—�evelop�a�s�ra�e�ic�plan�for���e�en�ire�business.Phase 2:��cquisi�ion�Plan—�evelop�an�acquisi�ion�plan�suppor�in����e�business�plan.Phase 3:�Searc�—�c�ively�searc��for�acquisi�ion�can�i�a�es.Phase 4:�Screen—Screen�an��priori�ize�po�en�ial�can�i�a�es.

EXHIBIT 6-1 The Acquisition Process Flow DiagramPhases

1. Business Plan

2. Acquisition Plan

3. Search

4. Screen

5. First Contact

6. Negotiation Refine Structure Perform Develop Decision:(Purchase Valuation Deal Due Financing Close orDecision) Diligence Plan Walk Away

7. Integration Plan

8. Closing Postpurchase Decision Activities

9. Integration

10. Evaluation

Prepurchase Decision Activities

Developing the Business Plan as the Initial Phase of the Merger and Acquisition Process 127

Phase 5:�Firs��Con�ac�—Ini�ia�e�con�ac��wi�����e��ar�e�.Phase 6:�Ne�o�ia�ion—Refine�valua�ion���s�ruc�ure�a��eal���perform��ue��ili�ence���an���evelop�a�financin��plan.Phase 7:�In�e�ra�ion�Plan—�evelop�a�plan�for�in�e�ra�in����e�acquire��business.Phase 8:�Closin�—�b�ain�necessary�approvals���resolve�pos�closin��issues����an��execu�e���e�closin�.Phase 9:�In�e�ra�ion—Implemen��pos�closin��in�e�ra�ion.Phase 10:�Evalua�ion—Con�uc��pos�closin��evalua�ion�of���e�acquisi�ion.Ne�o�ia�ion���wi���i�s�four�lar�ely�concurren��an��in�errela�e��ac�ivi�ies���

is���e�crucial�p�ase�of���e�acquisi�ion�process.�T�e��ecision��o�purc�ase�or�walk� away� is� �e�ermine�� as� a� resul�� of� con�inuous� i�era�ion� ��rou��� ��e�four�ac�ivi�ies�comprisin����e�ne�o�ia�ion�p�ase.��ssumin����e��ransac�ion�is�ul�ima�ely�comple�e������e�ac�ual�price�pai��for���e��ar�e��is��e�ermine���urin�� ��e� ne�o�ia�ion� p�ase.�T�e� p�ases� of� ��e� acquisi�ion� process� are�summarize��in���e�followin��sec�ion.

Building the Business PlAn

��well��esi�ne��business�plan�resul�s�from�ei����key�ac�ivi�ies���summarize���ere.� In�prac�ice��� ��e�process�of��evelopin��a�business�plan�can�be� facili��a�e��by�a��ressin��a�number�of��e�aile��ques�ions�correspon�in���o�eac��of���ese�ac�ivi�ies.�

T�e�firs��ac�ivi�y�is���e�external analysis��o��e�ermine�w�ere��o�compe�e—���a�� is���w�ic��in�us�ry�or�marke�(s)—an���ow��o�compe�e—��a�� is����ow���e�firm�can�mos��effec�ively�compe�e�in�i�s�c�osen�marke�(s).�T�is�ac�ivi�y�is�followe��by���e�internal analysis,�or�self�assessmen����of���e�firm’s�s�ren���s�an��weaknesses�rela�ive��o�i�s�compe�i�ion.�T�e�combina�ion�of���ese��wo�ac�ivi�ies—��e� ex�ernal� an�� in�ernal� analyses—is� of�en� calle�� SWOT analysis� because� i�� �e�ermines� ��e� s�ren���s��� weaknesses��� oppor�uni�ies���an��t�rea�s�of�a�business.�W�en���is�ex�aus�ive�analysis�is�comple�e����man�a�emen���as�a�clearer�un�ers�an�in��of�emer�in��oppor�uni�ies�an����rea�s��o� ��e� firm� an��of� ��e� firm’s� primary� in�ernal� s�ren���s� an��weaknesses.�Informa�ion� �leane�� from� ��e� ex�ernal� an�� in�ernal� analyses� �rives� ��e��evelopmen��of� business��� implemen�a�ion��� an�� func�ional� s�ra�e�ies.�Eac��level�of�s�ra�e�y�involves�an�increase��level�of��e�ail.

�� Ex�ensive�c�ecklis�s�can�be�foun��in�Por�er�(1��5)�an��S�ryker�(1��6).��nswerin����ese��ypes�of�ques�ions�requires��a��erin��subs�an�ial�economic���in�us�ry���an��marke��informa�ion.

Mergers and Acquisitions Basics128

T�e� ��ir�� ac�ivi�y� is� �o� �efine� a� mission statement� ��a�� summarizes�w�ere� an�� �ow� ��e� firm� �as� c�osen� �o� compe�e��� base�� on� ��e� ex�er�nal� analysis��� as� well� as� mana�emen�’s� basic� opera�in�� beliefs� an�� values.�Four�����objectives� are� se���� an��quan�i�a�ive�measures�of� financial� an��non�financial� performance� are� �evelope�.�Havin�� comple�e�� ��ese� s�eps��� ��e�firm� is� rea�y� �o� select a business strategy� ��a�� is�mos�� likely� �o�ac�ieve� ��e�objec�ives� in� an� accep�able� perio���� subjec�� �o� cons�rain�s� i�en�ifie�� in����e� self�assessmen�.�T�e� business� s�ra�e�y� �efines��� in� �eneral� �erms��� �ow���e�business�in�en�s��o�compe�e�(i.e.�����rou���cos��lea�ers�ip����ifferen�ia��ion���or�increase��focus).

Nex���� an� implementation strategy� is� selec�e�� ��a�� ar�icula�es� ��e� bes��way� �o� implemen�� ��e� business� s�ra�e�y� from� amon�� a� ran�e� of� reason�able�op�ions.�I��may�be���a����e�firm�op�s��o�ac��on�i�s�own���par�ner�wi���o��ers��� or� acquire/mer�e�wi��� ano��er� firm.�T�is� ac�ivi�y� is� followe�� by��evelopmen�� of� a� functional strategy� ��a�� �efines� ��e� roles��� responsibili�ies���an��resource�requiremen�s�of�eac��major� func�ional�area�wi��in���e�firm�nee�e�� �o� suppor�� ��e�business� s�ra�e�y.�Func�ional� s�ra�e�ies�of�en�en�ail�se��in��objec�ives�an��performance�miles�ones�for�eac��employee�suppor��in����e�implemen�a�ion�s�ra�e�y.

T�e� final� s�ep� is� �o�es�ablis�� strategic controls� �o�moni�or�ac�ual�perfor�mance��o�plan���implemen��incen�ive�sys�ems���an���ake�correc�ive�ac�ions�as�necessary.�T�ese�con�rols�are�pu��in�place��o��ei���en���e�prospec����a����e�firm’s vision�� objec�ives�� an� s�ra�e�ies will be realize� on sc�e�ule. T�ey’s�vision���objec�ives��� an�� s�ra�e�ies�will�be� realize��on� sc�e�ule.�T�ey�may� involve�es�ablis�in��bonus�plans� an��o��er� incen�ive�mec�anisms� �o�mo�iva�e�all�employees��o�ac�ieve���eir� in�ivi�ual�objec�ives�on�or�a�ea��of�sc�e�ule.�Sys�ems�are�also�pu��in�place��o��rack���e�firm’s�ac�ual�perfor�mance� �o�plan.�Si�nifican���evia�ions� from���e� implemen�a�ion�plan�may�require�swi�c�in���o�con�in�ency�plans.

Le�’s�look�a��eac��of���ese�s�eps�in��rea�er��e�ail.

externAl AnAlysis

T�e� external analysis� involves� ��e� �evelopmen�� of� an� in��ep��� un�er�s�an�in�� of� ��e� business’s� cus�omers� an�� ��eir� nee�s��� un�erlyin�� marke���ynamics� or� fac�ors� �e�erminin�� profi�abili�y��� an�� emer�in�� �ren�s� ��a��affec�� cus�omer� nee�s� an�� marke�� �ynamics.�T�is� analysis� be�ins� wi���answerin���wo�basic�ques�ions:�w�ere�an���ow��o�compe�e.�T�e�primary�ou�pu�� of� ��e� ex�ernal� analysis� is� ��e� i�en�ifica�ion�of� impor�an�� �row���oppor�uni�ies�an��compe�i�ive���rea�s.

Developing the Business Plan as the Initial Phase of the Merger and Acquisition Process 129

Determining Where to CompeteT�ere�is�no�more�impor�an��ac�ivi�y�in�buil�in��a�business�plan���an��eci��in�� w�ere� a� firm� s�oul�� compe�e.� I�� be�ins� wi��� i�en�ifyin�� ��e� firm’s�curren��an��po�en�ial�cus�omers�an����eir�primary�nee�s���an��is�base��on���e�process�of�marke��se�men�a�ion���w�ic��involves�i�en�ifyin��cus�omers�wi���common�c�arac�eris�ics�an��nee�s.

W�e��er�ma�e�up�of�in�ivi�ual�consumers�or�o��er�firms���a�collec�ion�of�cus�omers�comprises�a�market.���collec�ion�of�marke�s�is�sai���o�com�prise�an�industry—for�example�����e�au�omo�ive�in�us�ry���w�ic��comprises���e�new�an��use��car�marke�s�as�well�as� ��e�af�ermarke�� for�replacemen��par�s.�Marke�s�may�be�fur��er�sub�ivi�e��by�examinin��cars�by�makes�an��mo�el�years.�T�e�au�omo�ive�marke��coul��also�be��efine��re�ionally�(e.�.���New�En�lan����Nor����merica���Europe)���or�by�coun�ry.�Eac��sub�ivision���w�e��er�by�pro�uc��or��eo�rap�ic�area����efines�a�new�marke��wi��in���e�au�omo�ive�in�us�ry.

����ree�s�ep�process�is�use���o�i�en�ify�a��ar�e��marke�.�Firs������e�firm�es�ablis�es� evalua�ion� cri�eria� �o� �is�in�uis�� ��e� a��rac�iveness� of� mul�i�ple� po�en�ial� �ar�e�� marke�s.�T�ese� cri�eria� may� inclu�e� marke�� size� an���row��� ra�e��� profi�abili�y��� cyclicali�y��� ��e� price� sensi�ivi�y� of� cus�omers���amoun��of�re�ula�ion����e�ree�of�unioniza�ion���an��en�ry�an��exi��barriers.�T�e� secon�� s�ep� is� �o� sub�ivi�e� in�us�ries� an�� ��e�marke�s�wi��in� ��ese�in�us�ries�repea�e�ly�an��analyze���e�overall�a��rac�iveness�of���ese�marke�s�in��erms�of���e�evalua�ion�cri�eria.�For�eac��marke����eac��cri�erion�is��iven�a�numerical�wei����(some�even�a��zero)�reflec�in����e�firm’s�percep�ion�of�i�s� rela�ive� impor�ance� as� applie�� �o� ��a��marke�.�Hi��er� numbers� imply��rea�er� perceive�� impor�ance.�T�e�marke�s� are� ��en� ranke�� from�1� �o� 5�accor�in���o���e�evalua�ion�cri�eria���wi���5�in�ica�in����a����e�firm�fin�s�a�marke���o�be��i��ly�favorable�in��erms�of�a�specific�cri�erion.�In���e���ir��s�ep���a�wei���e��avera�e�score�is�calcula�e��for�eac��marke����an����e�mar�ke�s�are�ranke��accor�in���o���eir�respec�ive�scores.

Determining How to Compete�e�erminin���ow��o�compe�e�requires�a�clear�un�ers�an�in��of���e�fac�ors�cri�ical� for� successfully� compe�in�� in� ��e� �ar�e�e��marke�.�T�is�ou�war��lookin��analysis�applies��o���e�primary�fac�ors��overnin����e�firm’s�ex�er�nal�environmen�.�Un�ers�an�in��marke���ynamics�an��knowin����e�areas�in�w�ic����e�firm�mus��excel�in�comparison��o���e�compe�i�ion�is�crucial�if���e�firm�is��o�compe�e�effec�ively�in�i�s�c�osen�marke�.

Mergers and Acquisitions Basics130

Marke��profilin��en�ails�collec�in��sufficien���a�a��o�assess�an��c�arac��erize�accura�ely�a�firm’s�compe�i�ive�environmen��wi��in�i�s�c�osen�mar�ke�s.� Usin�� Mic�ael� Por�er’s� well�known�“Five� Forces”� framework� (also�known�as���e�Por�er�or�Mo�ifie��Por�er�framework)�����e�marke��or�in�us��ry�environmen��can�be��escribe��in��erms�of�compe�i�ive��ynamics�suc��as���e�firm’s�cus�omers���suppliers���curren��compe�i�ors���po�en�ial�compe�i��ors���an��pro�uc��or�service�subs�i�u�es.5�T�e���ree�po�en�ial��e�erminan�s�of���e�in�ensi�y�of�compe�i�ion�in�an�in�us�ry�inclu�e�compe�i�ion�amon��exis�in�� firms��� ��e� ��rea��of�en�ry�of�new�firms���an�� ��e� ��rea��of� subs�i��u�e�pro�uc�s�or�services.��l��ou�����e��e�ree�of�compe�i�ion��e�ermines�w�e��er���ere�is�po�en�ial��o�earn�abnormal�profi�s�(i.e.�����ose�in�excess�of�w�a��woul��be�expec�e��for���e��e�ree�of�assume��risk)�����e�ac�ual�profi�s�or�cas��flow�is� influence��by���e�rela�ive�bar�ainin��power�of���e�in�us��ry’s�cus�omers�an��suppliers.

T�is�framework�may�be�mo�ifie���o�inclu�e�o��er�fac�ors���a���e�er�mine� ac�ual� in�us�ry� profi�abili�y� an�� cas�� flow��� suc�� as� ��e� severi�y� of��overnmen�� re�ula�ion� or� ��e� impac�� of� �lobal� influences� suc�� as� fluc��ua�in��exc�an�e� ra�es.�Labor� cos�s�may� also�be� inclu�e�.��l��ou��� ��ey�represen�� a� rela�ively� small�percen�a�e�of� �o�al�expenses� in�many�areas�of�manufac�urin������ey�frequen�ly�cons�i�u�e���e�lar�es��expense�in���e�non�manufac�urin��sec�or.�T�e�analysis�s�oul��also�inclu�e�fac�ors�suc��as���e�bar�ainin��power�of�labor.

Ex�ibi�� 6�2� brin�s� �o�e��er� ��ese� compe�i�ive� �ynamics.� T�e� �a�a�require���o�analyze�in�us�ry�compe�i�ive��ynamics�inclu�e��ypes�of�pro��uc�s�an��services;�marke��s�are�(in��erms�of��ollars�an��uni�s);�pricin��me��rics;� sellin�� an���is�ribu�ion� c�annels� an�� associa�e�� cos�s;� �ype��� loca�ion���an��a�e�of�pro�uc�ion�facili�ies;�pro�uc��quali�y�me�rics;�cus�omer�service�me�rics;�compensa�ion�by�major�labor�ca�e�ory;�researc��an���evelopmen��(R&�)�expen�i�ures;� supplier�performance�me�rics;� an�� financial�perfor�mance�(in��erms�of��row���an��profi�abili�y).�T�ese��a�a�mus��be�collec�e��on�all�si�nifican��compe�i�ors�in���e�firm’s�c�osen�marke�s.

Determinants of the Intensity of Industry CompetitionT�e�overall�in�ensi�y�of�in�us�ry�compe�i�ion�is�a�func�ion�of��ifferen��fac��ors� in� several� ca�e�ories.� In�us�ry� �row��� ra�e��� in�us�ry� concen�ra�ion����e�ree�of��ifferen�ia�ion�an�� swi�c�in��cos�s��� scale� an�� scope�economies���excess� capaci�y��� an�� exi�� barriers� all� affec�� ��e� in�ensi�y� of� compe�i�ion�

5� Por�er�(1��5).

Developing the Business Plan as the Initial Phase of the Merger and Acquisition Process 131

amon�� curren�� in�us�ry� compe�i�ors��� ��e� firs�� ca�e�ory.� If� an� in�us�ry�is� �rowin�� rapi�ly��� exis�in�� firms� �ave� less� nee�� �o� compe�e� for� marke��s�are.� If� an� in�us�ry� is� �i��ly� concen�ra�e���� firms� can� more� easily� coor��ina�e� ��eir� pricin�� ac�ivi�ies;� in� con�ras���� ��is� ac�ivi�y� is� more� �ifficul��in� a� �i��ly� fra�men�e�� in�us�ry� in�w�ic�� price� compe�i�ion� is� likely� �o�

EXHIBIT 6-2 Defining Market/Industry Competitive Dynamics (Adapted from Palepu, Healy, and Bernard, 2004, p. 2-2)

Determinants of the Intensity of Industry Competition

Determinants of Actual Profits and Cash Flow

Competition Among Existing Firms Affected By:Industry Growth RateIndustry ConcentrationSwitching CostsScale/Scope EconomiesExcess CapacityExit Barriers

Potential for New Entrants Affected By:Scale/Scope EconomiesFirst Mover AdvantageLegal Barriers (e.g.,

Patents)Limited Access to

Distribution ChannelsProduct DifferentiationCurrent Competitor

Retaliation

Potential for Substitute Products Affected By:Relative PricesRelative PerformanceRelative QualityRelative ServiceWillingness of

Customers to Switch

Bargaining Power of Customers Affected By:Buying CriteriaPrice Sensitivity Switching CostsNumber and Average

Size of BuyersAvailability of

Substitutes

Bargaining Power of Suppliers (Incl. Material, Service, and Capital) Affected By:Switching CostsDifferentiationNumber and Average

Size of SuppliersAvailability of

Substitutes

Bargaining Power of Labor Force Affected By:Degree of UnionizationManagement/Labor

HarmonyAvailability of Critical

Skills

Degree of Government Regulation Affected By:Industry ConcentrationPotential for Natural

MonopolyPotential Risk to the

PublicImportance to National

Defense

Global Exposure Affected By:Dependence on Foreign

SalesExtent of Foreign

OperationsExchange Rate

VolatilityPolitical Risk

Industry Profitability/Cash Flow

Mergers and Acquisitions Basics132

be�very� in�ense.� If� ��e�cos��of� swi�c�in�� from�one� supplier� �o� ano��er� is�minimal�because�of� low�perceive���ifferen�ia�ion���cus�omers�are� likely� �o�swi�c��base��on�rela�ively�small��ifferences�in�price.�In�in�us�ries�in�w�ic��pro�uc�ion�volume�is�impor�an����companies�may�compe�e�a��ressively�for�marke�� s�are� �o� realize� economies�of� scale.�Moreover��� firms� in� in�us�ries�ex�ibi�in�� subs�an�ial� excess� capaci�y� of�en� re�uce� prices� �o� fill� unuse��capaci�y.�Finally���compe�i�ion�may�be�in�ensifie��in�in�us�ries�in�w�ic��i��is��ifficul��for�firms��o�exi���ue��o��i���exi��barriers���suc��as�lar�e�unfun�e��pension�liabili�ies�an��sin�le�purpose�asse�s.

T�e�secon��ca�e�ory� is� ��e�po�en�ial� for�new�en�ran�s.�Curren��com�pe�i�ors� wi��in� an� in�us�ry� c�arac�erize�� by� low� barriers� �o� en�ry� �ave�limi�e�� pricin�� power.����emp�s� �o� raise� prices� resul�in�� in� abnormally�lar�e� profi�s� will� a��rac�� new� compe�i�ors��� ��ereby� a��in�� �o� ��e� in�us��ry’s� pro�uc�ive� capaci�y.� In� con�ras���� �i��� en�ry� barriers�may� �ive� exis��in��compe�i�ors�si�nifican��pricin��power.�Barriers��o�new�en�ran�s�inclu�e�si�ua�ions�in�w�ic����e�lar�e�scale�opera�ions�of�exis�in��compe�i�ors��ive���em�a�po�en�ial�cos��a�van�a�e��ue��o�economies�of�scale.�New�en�ran�s�may�en�er�only� if� ��ey�are�willin�� �o� inves�� in� subs�an�ial�a��i�ional�new�capaci�y.�T�e�“firs��mover�a�van�a�e”—��a�� is���bein��an�early�compe�i�or�in�an�in�us�ry—may�also�crea�e�en�ry�barriers�because�firs��movers�ac�ieve�wi�esprea��bran��reco�ni�ion���es�ablis��in�us�ry�s�an�ar�s���an�/or��evelop�exclusive� rela�ions�ips� wi��� key� suppliers� an�� �is�ribu�ors.� Finally��� le�al�cons�rain�s��� suc��as�copyri���s�an��pa�en�s���may� in�ibi�� ��e�en�ry�of�new�firms.

Examples�of�new�en�ran�s�aboun�.��mazon.com�sells� ��e�same�books�an�� C�s� available� a�� �ra�i�ional� brick�an��mor�ar� s�ores��� bu�� online.�In�erne��base���ec�nolo�ies�are�alrea�y�an�enormous���rea���o�cable��ele�vision���an��new�en�ran�s��T&T�an��Verizon—bo����elep�one��ian�s—are�usin�� ��ese� �ec�nolo�ies� �o�offer� consumers� a�varie�y�of�movies� an��TV�s�ows� ��a�� coul�� be� wa�c�e�� a�� any� �ime.� Meanw�ile��� pro�ram� own�ers� suc�� as�ESPN�are�workin��wi��� consumer� elec�ronics�manufac�urers��o� �evelop� a� box� ��a�� si�s� on� �op� of� a� �elevision� an�� provi�es� access� �o�colle�e� foo�ball� �ames� no�� available� on� cable� or� sa�elli�e.�Users� of��pple�Compu�er’s�iPo��can�wa�c��s�ows�from��isney’s��BC�uni�.

T�ese�examples�of�new�en�ran�s�also�apply��o���e���ir��ca�e�ory���w�ic��is� ��e� po�en�ial� for� subs�i�u�e� pro�uc�s� an�� services.�T�e� sellin�� price� of�one� pro�uc�� compare�� �o� a� close� subs�i�u�e—calle�� ��e� rela�ive� price—�e�ermines���e���rea��of�subs�i�u�ion���alon��wi�����e�performance�of�com�pe�in��pro�uc�s���perceive��quali�y���an����e�willin�ness�of���e�cus�omer��o�

Developing the Business Plan as the Initial Phase of the Merger and Acquisition Process 133

swi�c�.�Po�en�ial� subs�i�u�es� inclu�e� ��ose� ��a�� are� subs�an�ially� similar� �o�exis�in��pro�uc�s�an�� ��ose�performin�� ��e� same� func�ion—for�example���an�MP��ra��er���an�a�C����a�Kin�le�wireless�rea�in���evice�ra��er���an�a�book���or�even�a�paperless�airline��icke�.����er�examples�inclu�e�e�mail�an��faxes�as�subs�i�u�es�for�le��ers.

Determinants of Actual Profits and Cash FlowT�e� bar�ainin�� power� of� cus�omers��� suppliers��� an�� ��e� labor� force� are�impor�an�� fac�ors� ��a�� affec�� profi�s� an�� cas�� flow.� ���ers� inclu�e� ��e��e�ree� of� �overnmen�� re�ula�ion� an�� �lobal� exposure.�T�e� rela�ive� bar��ainin�� power� of� buyers� �epen�s� on� ��eir� primary� buyin�� cri�eria� (i.e.���price���quali�y/reliabili�y���service���convenience���or�some�combina�ion)���price�sensi�ivi�y� or� elas�ici�y��� swi�c�in�� cos�s��� an�� ��eir� number� an�� size� com�pare���o���e�number�an��size�of�suppliers.�For�example���a�cus�omer�w�ose�primary�cri�eria�for�makin��a�purc�ase�are�pro�uc��quali�y�an��reliabili�y�may�be�willin�� �o�pay�a�premium�for�a�Toyo�a�because� i�� is�perceive���o��ave��i��er�rela�ive�quali�y.�Cus�omers�are�more�likely��o�be��i��ly�price�sensi�ive� in� in�us�ries� c�arac�erize�� by� lar�ely� un�ifferen�ia�e�� pro�uc�s�an��low�swi�c�in��cos�s.�Finally���buyers�are�likely��o��ave�consi�erable�bar��ainin�� power�w�en� ��ere� are� rela�ively� few� lar�e� buyers� rela�ive� �o� ��e�number�of�suppliers.

T�e�rela�ive�levera�e�of�suppliers�reflec�s���e�ease�wi���w�ic��cus�omers�can�swi�c��suppliers���perceive���ifferen�ia�ion�����eir�number���an���ow�cri�i�cal� ��ey�are��o���e�cus�omer.�Swi�c�in��cos�s�are��i��es��w�en�cus�omers�mus��pay�penal�ies��o�exi��lon���erm�supply�con�rac�s�or�w�en�new�suppli�ers�woul���ave��o�un�er�o�an�in�ensive�learnin��process��o�mee����e�cus��omers’�requiremen�s.�Moreover���reliance�on�a�sin�le�or�a�small�number�of�suppliers�s�if�s�pricin��power�from���e�buyer��o���e�seller.�Examples�inclu�e�In�el’s��lobal��ominance�of� ��e�microc�ip�marke�� an��Microsof�’s�worl��wi�e�supremacy�in���e�marke��for�personal�compu�er�opera�in��sys�ems.

Work� s�oppa�es� crea�e� oppor�uni�ies� for� compe�i�ors� �o� �ain� marke��s�are.�Cus�omers�are�force���o�sa�isfy���eir�pro�uc��an��service�nee�s�else�w�ere.��l��ou�����e�loss�of�cus�omers�may�be��emporary���i��may�become�permanen��if� ��e�cus�omers�fin����a��ano��er�firm’s�pro�uc��or�service�is�superior.� Frequen�� work� s�oppa�es� also� may� �ave� lon���erm� impac�s� on�pro�uc�ivi�y�an��pro�uc�ion�cos�s�as�a�resul��of�a�less�mo�iva�e��labor�force�an�� increase�� labor� �urnover.�Hi��� �urnover�can�con�ribu�e� �o�escala�in��opera�in��expenses�as�firms�incur�subs�an�ial�searc��an��re�rainin��expenses��o�fill�posi�ions.

Mergers and Acquisitions Basics134

Governmen�s�may�c�oose� �o�re�ula�e� in�us�ries� ��a��are��eavily�con�cen�ra�e���� are� na�ural� monopolies� (e.�.��� elec�ric� u�ili�ies)��� or� provi�e� a�po�en�ial� risk� �o� ��e� public.� Re�ula�ory� compliance� a��s� si�nifican�ly��o� an� in�us�ry’s� opera�in�� cos�s.�Re�ula�ions� also� crea�e� barriers� �o� bo���en�erin��an��exi�in��an�in�us�ry.�T�e��overnmen��may�c�oose��o�re�ula�e��eavily� concen�ra�e�� in�us�ries� �o�minimize� an�icompe�i�ive�prac�ices���or���ose�suc��as�u�ili�ies�in�w�ic����e�economics�jus�ify�rela�ively�few�com�pe�i�ors.�Companies�wis�in���o�en�er���e�p�armaceu�ical�in�us�ry�mus��be�able� �o�pro�uce�an�� �es��new��ru�s� ��a�� sa�isfy� ��e�U.S.�Foo��an���ru����minis�ra�ion.� Companies� wi��� lar�e� unfun�e�� or� un�erfun�e�� pen�sion�liabili�ies�may�fin��exi�in��an�in�us�ry�impossible�un�il���ey��ave�me����eir� pension� obli�a�ions� �o� ��e� sa�isfac�ion� of� ��e� U.S.� Pension� Benefi��Guaran�y�Corpora�ion.

Global� exposure� is� ��e� ex�en�� �o� w�ic�� par�icipa�ion� in� an� in�us�ry�necessi�a�es� �avin�� a� mul�ina�ional� presence.� For� example��� ��e� au�omo��ive�in�us�ry�is�wi�ely�viewe��as�a��lobal�in�us�ry�in�w�ic��par�icipa�ion�requires��avin��assembly�plan�s� an���is�ribu�ion�ne�works� in�major�mar�ke�s� ��rou��ou�� ��e� worl�.��s� ��e� major� au�o� assemblers� move� abroa������ey� nee�� ��eir� par�s� suppliers� �o� buil�� nearby� facili�ies� �o� ensure�“jus���in��ime’’� �elivery.� Global� exposure� in�ro�uces� ��e� firm� �o� si�nifican���currency�risk���as�well�as�poli�ical�risk���a��coul��resul��in���e�confisca�ion�of���e�firm’s�proper�ies.

internAl AnAlysis

T�e� primary� ou�pu�� of� internal analysis� is� �o� �e�ermine� ��e� firm’s�s�ren���s�an��weaknesses.�W�a��are���ey�as�compare���o���e�compe�i�ion?�Can���e�firm’s�cri�ical�s�ren���s�be�easily��uplica�e��an��surpasse��by���e�compe�i�ion?� Can� ��ey� be� use�� �o� �ain� a�van�a�e� in� ��e� firm’s� c�osen�marke�?�Can�compe�i�ors�exploi�� ��e� firm’s�key�weaknesses?�T�ese�ques��ions�mus��be�answere��as�objec�ively�as�possible�for���e�informa�ion��o�be�useful�in�formula�in��a�viable�s�ra�e�y.

Ul�ima�ely���compe�in��successfully�means��oin��a�be��er�job���an�com�pe�i�ors� of� sa�isfyin�� ��e� nee�s� of� ��e� firm’s� �ar�e�e�� cus�omers.��� self�assessmen�� i�en�ifies� ��ose� s�ren���s� or� compe�encies—so�calle�� success factors—necessary��o�compe�e�successfully�in���e�firm’s�c�osen�or��ar�e�e��marke�.�T�ese� fac�ors� may� inclu�e� �i��� marke�� s�are� compare�� �o� ��e�compe�i�ion��� pro�uc�� line� brea������ cos��effec�ive� sales� �is�ribu�ion� c�an�nels���a�e�an���eo�rap�ic�loca�ion�of�pro�uc�ion�facili�ies���rela�ive�pro�uc��

Developing the Business Plan as the Initial Phase of the Merger and Acquisition Process 135

quali�y���price�compe�i�iveness���R&��effec�iveness���cus�omer�service�effec��iveness���corpora�e�cul�ure���an��profi�abili�y.

Recall� ��a����e�combina�ion�of���e�ex�ernal�an��in�ernal�analyses� jus���e�aile�� can� be� �one� as� a� SW�T� analysis;� i�� �e�ermines� ��e� s�ren���s���weaknesses���oppor�uni�ies���an����rea�s�of�a�business.�Ex�ibi��6���illus�ra�es�a� �ypo��e�ical� SW�T� analysis��� in� ��is� case� for��mazon.com.� I�� su��es�s���a���mazon.com�sees�becomin��an�online��epar�men��s�ore�as�i�s��rea��es�� oppor�uni�y��� w�ile� i�s� �rea�es�� ��rea�� is� ��e� �rowin�� online� presence�of� sop�is�ica�e�� compe�i�ors.�T�e� SW�T� analysis� ��en� summarizes� �ow��mazon.com� mi���� perceive� i�s� major� s�ren���s� an�� weaknesses� in� ��e�con�ex��of���is�oppor�uni�y�an����rea�.�T�is�is���e�sor��of�informa�ion���a��allows�mana�emen���o�se��a��irec�ion�in��erms�of�w�ere�an���ow���e�firm�in�en�s��o�compe�e���w�ic��is���en�communica�e���o���e�firm’s�s�ake�ol�ers��

EXHIBIT 6-3 Hypothetical Amazon.com SWOT MatrixOpportunity Threat

To be perceived by shoppers as the preferred online “department store” and thus exploit accelerating online retail sales.

Walmart, Best Buy, Costco, etc., are increasing their online presence.

Strengths l Brand recognitionl Convenient online order-entry

systeml Information technology

infrastructurel Fulfillment infrastructure for

selected products (e.g., books)

l Extensive experience in online marketing, advertising, and fulfillment (i.e., satisfying customer orders)

Weaknesses l Inadequate warehousing and inventory management systems to support rapid sales growth

l Limited experience in merchandising non-core retail products (e.g., pharmaceuticals, sporting goods)

l Limited financial resources

l Substantially smaller retail sales volume limits ability to exploit purchase economies

l Limited financial resources

l Limited name recognition in selected markets (e.g., consumer electronics)

l Retail management depth

Mergers and Acquisitions Basics136

in���e�form�of�a�mission/vision�s�a�emen��an��a�se��of�quan�ifiable�finan�cial�an��nonfinancial�objec�ives.

defining the Mission stAteMent

���a�minimum���a�corpora�e�mission�s�a�emen�� seeks� �o��escribe� ��e�cor�pora�ion’s�purpose�for�bein��an��w�ere���e�corpora�ion��opes��o��o.�T�e�mission� s�a�emen�� s�oul�� no�� be� so� �eneral� as� �o� provi�e� li��le� prac�ical��irec�ion.����oo��mission�s�a�emen��s�oul��inclu�e�references��o���e�firm’s��ar�e�e�� marke�s��� w�ic�� s�oul�� reflec�� ��e� fi�� be�ween� ��e� corpora�ion’s�primary� s�ren���s� an�� compe�encies��� an�� i�s� abili�y� �o� sa�isfy� cus�omer�nee�s� be��er� ��an� ��e� compe�i�ion.� I�� s�oul�� �efine� ��e� pro�uc�� or� ser�vice�offerin����rela�ively�broa�ly��o�allow�for���e�in�ro�uc�ion�of�new�pro��uc�s���a��mi����be��erive��from���e�firm’s�core�compe�encies.��is�ribu�ion�c�annels—�ow� ��e� firm� c�ooses� �o� �is�ribu�e� i�s� pro�uc�s—s�oul�� be�i�en�ifie����as�s�oul����e�cus�omers��ar�e�e��by���e�firm’s�pro�uc�s�an��ser�vices.�T�e�mission�s�a�emen��s�oul��s�a�e�mana�emen��beliefs�wi���respec���o���e�firm’s�primary�s�ake�ol�ers;���ese�beliefs�es�ablis����e�un�erpinnin�s�of��ow���e�firm�in�en�s��o�be�ave��owar����ose�s�ake�ol�ers.

Setting Strategic or Long-Term Business ObjectivesW�a�� is� �o� be� accomplis�e��wi��in� a� specific� perio�—��a�� is� a� business�objec�ive.��� �oo�� objec�ive� is� measurable� an�� �as� a� se�� �ime� frame� in�w�ic���o�be�realize�.�Typical�corpora�e�objec�ives�inclu�e�revenue��row���ra�es���minimum�accep�able�financial�re�urns���an��marke��s�are;���ese�objec��ives�an��several�o��ers�are��iscusse��in�more��e�ail� in���e�followin��sec��ions.����oo��objec�ive�mi����s�a�e���a����e�firm�seeks��o�increase�revenue�from���e�curren��$1�billion��o�$5�billion�by�a��iven�year.���poorly�wri���en�objec�ive�woul�� simply� s�a�e� ��a�� ��e� firm� seeks� �o� increase� revenue�subs�an�ially.

Common Business ObjectivesCorpora�ions� �ypically� a�op�� a� number� of� common� business� objec�ives.�For�ins�ance�����e�firm�may�seek��o�ac�ieve�a�ra�e�of�return���a��will�equal�or�excee����e�re�urn�require��by�i�s�s�are�ol�ers�(cos��of�equi�y)���len�ers�(cos��of��eb�)���or���e�combina�ion�of���e��wo�(cos��of�capi�al)�by�a��iven�year.�T�e� firm� may� se�� a� size� objec�ive��� seekin�� �o� ac�ieve� some� cri�ical�mass��efine�� in� �erms�of� sales�volume��o�realize�economies�of� scale�by�a��iven�year.

Developing the Business Plan as the Initial Phase of the Merger and Acquisition Process 137

Several�common�objec�ives�rela�e��o�growth.��ccoun�in��rela�e���row���objec�ives� inclu�e� seekin�� �o��row�earnin�s�per� s�are� (EPS)��� revenue���or�asse�s�a��a�specific�ra�e�of��row���per�year.�Valua�ion�rela�e���row���objec��ives� may� be� expresse�� in� �erms� of� ��e� firm’s� common� s�ock� price� per�s�are��ivi�e��by�earnin�s�per�s�are���book�value���cas��flow���or�revenue.

Diversification�objec�ives�are���ose�w�ere���e�firm��esires��o�sell�curren��pro�uc�s�in�new�marke�s���new�pro�uc�s�in�curren��marke�s���or�new�pro��uc�s�in�new�marke�s.�For�example�����e�firm�may�se��an�objec�ive��o��erive�25�percen��of�i�s�revenue�from�new�pro�uc�s�by�a��iven�year.

I��is�also�common�for�firms��o�se��flexibility�objec�ives���aimin���o�possess�pro�uc�ion�facili�ies�an���is�ribu�ion�capabili�ies���a��can�be�s�if�e��rapi�ly��o�exploi��new�oppor�uni�ies�as� ��ey�arise.�For�example��� ��e�major�au�o�mo�ive�companies��ave�increasin�ly�s�an�ar�ize��par�s�across�car�an���ruck�pla�forms��o�re�uce���e��ime�require���o� in�ro�uce�new�pro�uc�s����ivin����em��rea�er�flexibili�y��o�facili�a�e�a�s�if��in�pro�uc�ion�from�one�re�ion��o�ano��er.

Technology� objec�ives� are� also� common.�T�e� firm� �esires� �o� possess�capabili�ies�in�core�or�rapi�ly�a�vancin���ec�nolo�ies.�Microc�ip�an��sof��ware�manufac�urers��� as�well� as��efense�con�rac�ors��� are��oo��examples�of�in�us�ries�in�w�ic��keepin��curren��wi�����an��even��e��in��a�ea��of���new��ec�nolo�ies�is�a�prerequisi�e�for�survival.

selecting the APProPriAte corPorAte, Business, And iMPleMentAtion strAtegies

Eac��level�of�s�ra�e�y�serves�a�specific�purpose.�Implemen�a�ion�s�ra�e�ies���necessarily� more� �e�aile�� ��an� corpora�e�level� s�ra�e�ies��� provi�e� �eneral��ui�ance�for�a�firm’s�business�uni�s.

Corporate-Level StrategiesCorpora�e�level� s�ra�e�ies� are� a�op�e�� a�� ��e� corpora�e�or��ol�in�� com�pany�level�an��may�inclu�e�all�or�some�of���e�business�uni�s�ei��er�w�olly�or�par�ially�owne��by���e�corpora�ion.���growth strategy�en�ails�a�focus�on�accelera�in����e�firm’s�consoli�a�e��revenue���profi����an��cas��flow��row��.�T�is�s�ra�e�y�may�be�implemen�e��in�many��ifferen��ways���as��iscusse��la�er�in���is�c�ap�er.���diversification strategy�involves�a��ecision�a����e�corpora�e��level��o�en�er�new�businesses.�T�ese�businesses�may�be�rela�e��or�comple�ely�unrela�e�� �o� ��e� corpora�ion’s� exis�in�� business� por�folio.��n� operational restructuring�s�ra�e�y���some�imes�calle��a��urnaroun��or��efensive�s�ra�e�y����

Mergers and Acquisitions Basics138

usually� refers� �o� sellin�� companies� or� pro�uc�� lines� ou�ri���� or� in� par�����ownsizin��by�closin��unprofi�able�or�nons�ra�e�ic�facili�ies���ob�ainin��pro��ec�ion�from�cre�i�ors�in�bankrup�cy�cour����or�liqui�a�in��asse�s.���financial restructuring� s�ra�e�y� �escribes� ac�ions� by� ��e� firm� �o� c�an�e� i�s� �o�al��eb�� an�� equi�y� s�ruc�ure.�T�e� mo�iva�ion� for� ��is� s�ra�e�y� may� be� be���er�u�iliza�ion�of�excess�corpora�e�cas��balances���rou���s�are�repurc�ase��pro�rams��� re�ucin�� ��e� firm’s� cos�� of� capi�al� by� increasin�� levera�e��� or�increasin��mana�emen�’s�con�rol�by�acquirin��a�company’s�s�ares���rou���a�mana�emen��buyou�.

Business-Level Strategies��firm�s�oul��c�oose� i�s�business� s�ra�e�y�from�amon����e�ran�e�of�rea�sonable� al�erna�ives� ��a�� enables� i�� �o� ac�ieve� i�s� s�a�e�� objec�ives� in� an�accep�able� perio���� subjec�� �o� resource� cons�rain�s.�T�ey� inclu�e� limi�a��ions�on� ��e� availabili�y�of�mana�emen�� �alen�� an�� fun�s.�Gainin�� access��o��i��ly�compe�en��mana�emen���alen��is�frequen�ly���e�more��ifficul��of���e��wo��o�overcome.

Business� s�ra�e�ies� fall� in�o�one�of� four�basic�ca�e�ories:�price�or�cos��lea�ers�ip��� pro�uc�� �ifferen�ia�ion��� focus� or� nic�e� s�ra�e�ies��� or� �ybri��s�ra�e�ies.

Price or Cost LeadershipT�e� price� or� cost leadership� s�ra�e�y� reflec�s� ��e� influence� of� a� series� of��ools��� inclu�in�� ��e� experience� curve� an�� pro�uc�� life� cycle��� in�ro�uce��an��popularize��by���e�Bos�on�Consul�in��Group�(BCG).6�T�is�s�ra�e�y�is��esi�ne���o�make�a�firm���e�cos��lea�er�in�i�s�marke��by�cons�ruc�in��effi�cien��pro�uc�ion�facili�ies����i���ly�con�rollin��over�ea��expense���an��elimi�na�in��mar�inally�profi�able�cus�omer�accoun�s.

T�e�experience curve�pos�ula�es���a��as���e�cumula�ive��is�orical�volume�of�a�firm’s�ou�pu��increases���cos��per�uni��of�ou�pu���ecreases��eome�rically�as� ��e�firm�becomes�more�efficien�� in�pro�ucin����a��pro�uc�.�T�erefore�����e� firm�wi�����e� lar�es���is�orical�ou�pu��s�oul��also�be���e� lowes��cos��pro�ucer.�T�is�implies���a����e�firm�s�oul��en�er�marke�s�as�early�as�pos�sible�an��re�uce�pro�uc��prices�a��ressively��o�maximize�marke��s�are.

T�e� applicabili�y� of� ��e� experience� curve� varies� across� in�us�ries.� I��seems��o�work�bes��for�lar�ely�commo�i�y��ype�in�us�ries�in�w�ic��scale�economies�can�lea���o�subs�an�ial�re�uc�ions�in�per�uni��pro�uc�ion�cos�s���

6� Bos�on�Consul�in��Group�(1��5).

Developing the Business Plan as the Initial Phase of the Merger and Acquisition Process 139

suc��as�PC�or�cellp�one��an�se��manufac�urin�.�T�e�s�ra�e�y�of�con�inu�ously��rivin���own�pro�uc�ion�cos�s�may�make�mos��sense�for���e�exis�in��in�us�ry�marke��s�are�lea�er.�If���e�lea�er�alrea�y��as�a�cos��a�van�a�e�over�i�s� compe�i�ors� because�of� i�s� si�nifican�ly� lar�er�marke�� s�are��� i��may�be�able��o�improve�i�s�cos��a�van�a�e�by�pursuin��marke��s�are�more�a��res�sively� ��rou��� price� cu��in�.�T�is� s�ra�e�y�may� be� �es�ruc�ive� if� pursue��concurren�ly�by�a�number�of� firms�wi���approxima�ely� ��e� same�marke��s�are�in�an�in�us�ry�w�ose�cus�omers�see�no�measurable��ifferences�in���e�pro�uc�s�or�services�offere��by���e�various�compe�i�ors.�T�erefore���repe��i�ive� price� cu��in�� by� firms� wi��in� ��e� in�us�ry� is� likely� �o� �rive� �own�profi�abili�y�for�all�firms�in���e�in�us�ry.

BCG’s�secon��major�con�ribu�ion�is���e�product life cycle���w�ic��c�ar�ac�erizes�a�pro�uc�’s�evolu�ion�in�four�s�a�es:�embryonic����row�����ma�uri�y���an���ecline.�S�ron��sales��row���an��low�barriers��o�en�ry�c�arac�erize���e�firs�� �wo� s�a�es.��ver� �ime����owever��� en�ry�becomes�more�cos�ly� as� early�en�ran�s� in�o� ��e�marke�� accumula�e�marke�� s�are� an�� experience� lower�per�uni��pro�uc�ion�cos�s�as�a�resul��of���e�effec�s�of���e�experience�curve.�New�en�ran�s��ave�subs�an�ially�poorer�cos��posi�ions���anks��o���eir�small�marke��s�ares�compare��wi���earlier�en�ran�s���an��canno��ca�c��up��o���e�marke�� lea�ers� as� overall� marke�� �row��� slows.� �urin�� ��e� la�er� p�ases�c�arac�erize�� by� slow� marke�� �row����� fallin�� pro�uc�� prices� force� mar��inal�firms�an��unprofi�able�firms�ou��of���e�marke��or��o�consoli�a�e�wi���o��er�firms.

Mana�emen�� can� ob�ain� insi���� in�o� ��e� firm’s� probable� fu�ure� cas��requiremen�s� an���� in� �urn��� i�s� value��� by� �e�erminin�� i�s� posi�ion� in� i�s�in�us�ry’s�pro�uc�� life�cycle.��urin�� ��e��i����row���p�ase��� firms� in� ��e�in�us�ry� normally� �ave� �i��� inves�men�� requiremen�s� associa�e�� wi���capaci�y� expansion� an�� increasin��workin��capi�al�nee�s.��pera�in�� cas��flow�is�normally�ne�a�ive.��urin����e�ma�ure�an���eclinin���row���p�ases���inves�men��requiremen�s�are�lower�an��cas��flow�becomes�posi�ive.

�l��ou��� ��e� p�ases� of� ��e� pro�uc�� life� cycle� provi�e� insi���s� in�o�curren�� an�� fu�ure� cas�� requiremen�s� for� bo��� ��e� acquirin�� an�� �ar�e��companies����e�erminin����e�approxima�e�len����of�eac��p�ase�can�be�c�al�len�in�.�T�e�in�ro�uc�ion�of�si�nifican��pro�uc��innova�ion�can�reinvi�o�ra�e� in�us�ry��row���an��ex�en����e� len����of���e�curren���row���p�ase.�T�is�is�par�icularly��rue�in�in�us�ries�suc��as�microc�ip���PC���an��cellular.

In� a��i�ion� �o� i�s� applicabili�y� �o� valuin�� ��e� firm��� ��e� pro�uc�� life�cycle�also�can�be�useful�in�selec�in����e�firm’s�business�s�ra�e�y.�In���e�early�s�a�es�of���e�pro�uc��life�cycle�����e�in�us�ry��en�s��o�be��i��ly�fra�men�e����

Mergers and Acquisitions Basics140

wi��� many� par�icipan�s� �avin�� very� small� marke�� s�ares.� �f�en��� firms� in���e�early�s�a�es�a�op��a�nic�e�s�ra�e�y�in�w�ic����ey�focus���eir�marke�in��effor�s�on�a�rela�ively�small�an���omo�eneous�cus�omer��roup.�If�econo�mies�of� scale�are�possible��� ��e� in�us�ry�will�be�in� �o�consoli�a�e�as� firms�a��ressively�pursue�cos��lea�ers�ip�s�ra�e�ies.�T�a��was���e�si�ua�ion�w�en���in�2005���Mi��al�S�eel� announce��a�$�.5�billion��eal� �o�buy� In�erna�ional�S�eel� Group� (ISG)��� a� collec�ion� of� five� once�bankrup�� s�eel� companies�consoli�a�e��by�U.S.�workou��specialis��Wilbur�Ross.�T�e��ransac�ion�ma�e�Mi��al���e�lar�es��s�eel�pro�ucer�in���e�worl�.�In�a�crea�ive�applica�ion�of�a�cos��lea�ers�ip�s�ra�e�y���Mi��al��as�opera�e��i�s�ei����U.S.�mills�(ISG�an����ree� o��ers� i�� alrea�y� owne�)—clus�ere�� aroun�� ��e� Grea�� Lakes—�o�ac�ieve�“re�ional”�economies�of�scale.�By�runnin����e�facili�ies�as�a�sin�le�uni������e�firm��opes��o�ex�rac��be��er��erms�from�iron�ore���coal���an��elec��rici�y�suppliers.�Moreover���Mi��al��opes��o��ain�be��er�pricin��power�wi�����e�in�ivi�ual�plan�s�no�lon�er�compe�in��wi���eac��o��er.

Product Differentiation�ifferen�ia�ion� encompasses� a� ran�e� of� s�ra�e�ies� in� w�ic�� ��e� pro�uc��offere��is�perceive��by�cus�omers��o�be�sli���ly��ifferen��from�o��er�pro��uc��offerin�s� in� ��e�marke�place.�Bran�� ima�e� is�one�way� �o� accomplis��differentiation.��no��er� is� �o�offer�cus�omers�a� ran�e�of� fea�ures�or� func��ions.�For�example���many�banks�issue�Mas�erCar��or�Visa�cre�i��car�s���bu��eac��bank��ries� �o��ifferen�ia�e� i�s�car��by�offerin��a��i��er�cre�i�� line���a�lower�in�eres��ra�e�or�annual�fee���or�awar�s�pro�rams.�Sof�ware�companies�jus�ify�c�ar�in��for�up�ra�es�base��on�a��e��fea�ures��o�wor��processin���or� sprea�s�ee�� pro�rams� ��a�� are� no�� foun�� on� compe�in�� packa�es.�En�ancin���ec�nolo�y�is�a�s�ron���ifferen�ia�or;��pple�Compu�er��as�use��innova�ive� �ec�nolo�y� �o� s�ay� a�ea�� of� compe�i�ors� sellin�� MP�� players���mos�� recen�ly� wi��� ��e� vi�eo� capabili�ies� of� i�s� newer� iPo�s.� Provi�in��al�erna�ive��is�ribu�ion�c�annels�is�ano��er�way��o��ifferen�ia�e;�for�exam�ple��� enablin�� cus�omers� �o� �ownloa�� pro�uc�s� from� online� si�es.� ���er�firms� compe�e� on� ��e� basis� of� consis�en�� pro�uc�� quali�y��� by� provi��in�� excellen�� service��� or� by� offerin�� cus�omers� ou�s�an�in�� convenience.��mazom.com��� for� ins�ance��� offers� consumers� ��e� oppor�uni�y� �o� buy�books�an��o��er�pro�uc�s�w�enever�an��from�w�erever���ey�c�oose.

Focus or Niche StrategiesFirms�a�op�in��focus�or�nic�e�s�ra�e�ies��en���o�concen�ra�e���eir�effor�s�by� sellin�� a� few� pro�uc�s� or� services� �o� a� sin�le� marke���� an�� compe�e��

Developing the Business Plan as the Initial Phase of the Merger and Acquisition Process 141

primarily� by� un�ers�an�in�� ��eir� cus�omers’� nee�s� be��er� ��an� �oes� ��e�compe�i�ion.�In���e�focus strategy�����e�firm�seeks��o�carve�a�specific�nic�e�wi��� respec�� �o� a� cer�ain� �roup�of� cus�omers��� a� narrow��eo�rap�ic� area���or�a�par�icular�use�of�a�pro�uc�.�Examples�inclu�e���e�major�airlines���air�plane� manufac�urers� (e.�.��� Boein�)��� an�� major� �efense� con�rac�ors� (e.�.���Lock�ee��Mar�in).

Hybrid StrategiesHybri��s�ra�e�ies�involve�some�combina�ion�of���e���ree�s�ra�e�ies�jus���is�cusse��(see�Ex�ibi��6��).�For�example���Coca�Cola�pursues�bo���a��ifferen��ia�e��an���i��ly�marke��focuse��s�ra�e�y.�T�e�company��erives���e�bulk�of�i�s�revenues�by�focusin��on���e�worl�wi�e�sof���rink�marke����an��i�s�main�pro�uc��is��ifferen�ia�e��in���a��consumers�perceive�i���o��ave�a��is�inc�ly�refres�in�� �as�e.� Fas��foo�� in�us�ry� �ian�� Mc�onal�’s� pursues� a� similarly�focuse��ye���ifferen�ia�e��s�ra�e�y���compe�in��on���e�basis�of�provi�in��fas��foo��of�a�consis�en��quali�y�in�a�clean���comfor�able�environmen�.

Implementation Strategies�f�er�a�firm��as��e�ermine����e�appropria�e�business�s�ra�e�y���i��mus���urn�i�s�a��en�ion��o��eci�in����e�bes��means�of�implemen�a�ion.�T�is��ecision�involves� selec�in�� ��e� ri���� op�ion� from� a� ran�e� of� reasonable� op�ions.�Generally���a�firm��as�five�c�oices:�implemen����e�s�ra�e�y�base��solely�on�in�ernal�resources—��e�solo�ven�ure����o�i��alone���or�buil��approac�;�par��ner�wi���o��ers;�inves�;�acquire;�or�swap�asse�s.�Eac��op�ion��as�si�nifican�ly��ifferen��implica�ions.�Ex�ibi��6�5�compares���e�a�van�a�es�an���isa�van��a�es�of���ese�op�ions.

In���eory�����e��ecision��o�c�oose�amon��al�erna�ive�op�ions�s�oul��be�ma�e�base��on� ��e��iscoun�in��of� ��e�projec�e��cas��flow�s�ream��o� ��e�firm�resul�in��from�eac��op�ion.�In�prac�ice�����ere�are�many�o��er�consi��era�ions�a��work.

EXHIBIT 6-4 Hybrid StrategiesCost Leadership Product Differentiation

Niche/Focus approach Cisco Systems/WD-40 Coca-Cola/McDonald’sMultimarket approach Walmart/Oracle America Online/Microsoft

Mergers and Acquisitions Basics142

The Role of Intangible Factors�l��ou���financial�analyses�are�con�uc�e���o�evalua�e� ��e�various� imple�men�a�ion�s�ra�e�y�op�ions���ul�ima�ely���e�c�oice�may��epen��on�unquan��ifiable�fac�ors�suc��as���e�senior�mana�er’s�risk�profile���pa�ience���an��e�o.�T�e� �e�ree� of� con�rol� offere�� by� ��e� various� al�erna�ives� is� of�en� ��e�cen�ral� issue� confron�e�� by� senior� mana�emen�� as� ��is� c�oice� is� ma�e.��l��ou�����e�solo�ven�ure�an��acquisi�ion�op�ions�offer���e��i��es���e�ree�of� con�rol��� ��ey� can� be� ��e� mos�� expensive��� al��ou��� for� very� �ifferen��reasons.�Typically��� a�buil�� s�ra�e�y�will� �ake�consi�erably� lon�er� �o� realize�key�s�ra�e�ic�objec�ives���an��i��may��ave�a�si�nifican�ly�lower�curren��value���an� ��e� al�erna�ives—�epen�in�� on� ��e� ma�ni�u�e� an�� �imin�� of� cas��

EXHIBIT 6-5 Implementation Strategies: Solo Venture, Partner, Invest, Acquire, or Asset Swap

Basic Options Advantages Disadvantages

Solo venture or build (organic growth)

– Control – Capital/expense requirements

– SpeedPartner (shared growth/

shared control)– Marketing/

distribution alliance– Joint venture– License– Franchise

– Limits capital and expense investment requirements

– May be precursor to acquisition

– Lack of or limited control– Potential for diverging

objectives– Potential for creating a

competitor

Invest (e.g., minority investments in other firms)

– Limits initial capital/expense requirements

– High risk of failure– Lack of control– Time

Acquire or merge – Speed– Control

– Capital/expense requirements

– Potential earnings dilution

Swap assets – Limits use of cash– No earnings dilution– Limits tax liability if

basis in assets swapped remains unchanged

– Finding willing parties– Reaching agreement on

assets to be exchanged

Developing the Business Plan as the Initial Phase of the Merger and Acquisition Process 143

flows��enera�e��from���e�inves�men�s.�Gainin��con�rol���rou���acquisi�ion�can�also�be�very�expensive�because�of���e�subs�an�ial�premium���e�acquirer�normally��as��o�pay��o��ain�a�con�rollin��in�eres��in�ano��er�company.

T�e� join�� ven�ure�may� be� a� prac�ical� al�erna�ive� �o� ei��er� a� buil�� or�acquire�s�ra�e�y;�i���ives�a�firm�access��o�skills���pro�uc���is�ribu�ion�c�an�nels��� proprie�ary� processes��� an�� pa�en�s� a�� a� lower� ini�ial� expense� ��an�mi����o��erwise�be�require�.�T�e�join��ven�ure�is�frequen�ly�a�precursor��o�an�acquisi�ion���because�i���ives�bo���par�ies��ime��o�assess���e�compa�ibili�y�of���eir�respec�ive�corpora�e�cul�ures�an��s�ra�e�ic�objec�ives.

�sse�� swaps�may�be�an�a��rac�ive�al�erna�ive� �o� ��e�o��er�op�ions���bu��in�mos�� in�us�ries� ��ey�are��enerally�very��ifficul�� �o�es�ablis��unless� ��e�p�ysical� c�arac�eris�ics� an��use�of� ��e� asse�s� are� subs�an�ially� similar.�T�e�prac�ice�is�rela�ively�common�in���e�commercial�an��in�us�rial�real�es�a�e�in�us�ry.�Firms�in���e�cable�in�us�ry�also�use�asse��swaps��o�ac�ieve�s�ra�e��ic�objec�ives.� In� recen��years���cable�companies��ave�been� swappin��cus��omers��o�allow�a�sin�le�company��o��omina�e�a�specific��eo�rap�ic�area�an��realize���e�full�benefi�s�of�economies�of�scale.�

functionAl strAtegies

Func�ional� s�ra�e�ies� focus�on�s�or���erm�resul�s�an���enerally�are��evel�ope�� by� func�ional� areas;� ��ey� also� �en�� �o� be� very� �e�aile�� an�� �i��ly�s�ruc�ure�.�T�ese� s�ra�e�ies� resul�� in� a� series�of� concre�e� ac�ions� for� eac��func�ion�or�business��roup����epen�in��on� ��e�company’s�or�aniza�ion.� I��is� common� �o� see� separa�e� plans� wi��� specific� �oals� an�� ac�ions� for� ��e�marke�in���� manufac�urin���� R&���� en�ineerin���� an�� financial� an�� �uman�resources� func�ions.� Func�ional� s�ra�e�ies� s�oul�� inclu�e� clearly� �efine��objec�ives��� ac�ions��� �ime�ables� for� ac�ievin�� ��ose� ac�ions��� an�� resources�require�;���ey�also�s�oul��i�en�ify���e�in�ivi�ual�responsible�for�ensurin����a����e�ac�ions�are�comple�e��on��ime�an��wi��in�bu��e�.

Specific�func�ional�s�ra�e�ies�mi����rea��as�follows:l� Se�� up� a� pro�uc�� �is�ribu�ion� ne�work� in� ��e� nor��eas�ern� Uni�e��

S�a�es� capable� of� �an�lin�� a�minimum�of� 1�million� uni�s� of� pro�uc��

�� T�ere�are�many�o��er�examples�of�asse��swaps.�In�2005���Ci�i�roup�exc�an�e��i�s�fun��mana�emen��business�for�Le���Mason’s�brokera�e�an��capi�al�marke�s�businesses���wi�����e��ifference�in���e�valua�ion�of���e�businesses�pai��in�cas��an��s�ock.�Similarly���Royal��u�c��S�ell�an��Russia’s�Gazprom�reac�e��a��eal��o�swap�major�na�ural��as–pro�ucin��proper�ies�in�la�e�2005.�In�200����Bri�is��Pe�roleum�swappe���alf�of�i�s�s�ake�in�i�s�Tole�o�����io���oil�refinery�for��alf�of�Husky�Ener�y’s�posi�ion�in���e�Sunrise�oil�san�s�fiel��in��lber�a���Cana�a.

Mergers and Acquisitions Basics144

annually� by� 12/�1/20XX.� (In�ivi�ual� responsible:� �liver�Tran;� es�i�ma�e��bu��e�:�$5�million.)

l� �evelop� an�� execu�e� an� a�ver�isin�� campai�n� �o� suppor�� ��e� sales�effor�� in� ��e�nor��eas�ern�Uni�e��S�a�es�by�10/�1/20XX.� (In�ivi�ual�responsible:�Maria�Gomez;�es�ima�e��bu��e�:�$0.5�million.)

l� Hire� a� lo�is�ics� mana�er� �o� a�minis�er� ��e� �is�ribu�ion� ne�work� by��/15/20XX.� (In�ivi�ual� responsible:� Pa�rick� Pe��y;� es�ima�e�� bu��e�:�$150��000.)

l� �cquire�a�manufac�urin��company�wi���sufficien��capaci�y��o�mee����e�projec�e���eman��for���e�nex����ree�years�by�6/�0/20XX�a��a�purc�ase�price�no���o�excee��$250�million.�(In�ivi�ual�responsible:�C�an��Lee.)Per�aps� an� applica�ion� sof�ware� company� is� �ar�e�in�� ��e� cre�i�� car��

in�us�ry.�Here�is�an�example�of��ow���e�company’s�business�mission���busi�ness�s�ra�e�y���implemen�a�ion�s�ra�e�y���an��func�ional�s�ra�e�ies�are�rela�e�.l� Mission:�To�be�reco�nize��by�our�cus�omers�as���e�lea�er�in�provi�in��

accura�e����i���spee�����i���volume��ransac�ional�sof�ware�for�processin��cre�i��car��remi��ances�by�20XX.

l� Business Strategy:�Up�ra�e�our�curren��sof�ware�by�a��in����e�necessary�fea�ures�an��func�ions��o��ifferen�ia�e�our�pro�uc��an��service�offerin��from�our�primary�compe�i�ors�an��sa�isfy�projec�e��cus�omer�require�men�s���rou���20XX.

l� Implementation Strategy:�Purc�ase�a�sof�ware�company���a��a�price�no���o�excee�� $�00� million��� capable� of� �evelopin��“s�a�e�of���e�ar�’’� remi���ance� processin�� sof�ware� by� 12/21/20XX.� (In�ivi�ual� responsible:��onal��S�uckee.)� (No�e� ��a�� ��is� assumes� ��e� firm��as� comple�e�� an�analysis� of� available�op�ions��� inclu�in�� in�ernal� �evelopmen���� collabo�ra�in����licensin����or�acquisi�ion.)

l� Functional Strategies to Support Implementation Strategy:l� Researc�� &� �evelopmen�:� I�en�ify� an�� �evelop� new� applica�ions�

for�remi��ance�processin��sof�ware.l� Marke�in��&�Sales:��ssess� impac��of�new�pro�uc��offerin��on�rev�

enue��enera�e��from�curren��an��new�cus�omers.l� Human�Resources:��e�ermine�appropria�e�s�affin��requiremen�s��o�

suppor��our�combine��firms.l� Finance:�I�en�ify�an��quan�ify�po�en�ial�cos��savin�s��enera�e��from�

improve��pro�uc�ivi�y���as�a�resul��of�replacin��exis�in��sof�ware�wi�����e�newly�acquire��sof�ware���an��from���e�elimina�ion�of��uplica�e�personnel�in�our�combine��companies.�Evalua�e���e�impac��of���e�acquisi�ion�on�our�combine��companies’�financial�s�a�emen�s.

Developing the Business Plan as the Initial Phase of the Merger and Acquisition Process 145

l� Le�al:�Ensure���a��all��ar�e��company�cus�omers��ave�vali��con�rac�s�an����a����ese�con�rac�s�are��ransferable��o�us�wi��ou��penal�y.��lso���ensure���a��we�will��ave�exclusive�an��unlimi�e��ri���s��o�use���e�remi��ance�processin��sof�ware.

l� Tax:��ssess���e��ax�impac��of���e�acquisi�ion�on�our�cas��flow.

strAtegic controls

S�ra�e�ic�con�rols�inclu�e�bo���incen�ive�an��moni�orin��sys�ems.�Incentive systems� inclu�e� bonus��� profi�� s�arin���� or� o��er� performance�base�� pay�men�s�ma�e��o�mo�iva�e�bo���acquirer�an���ar�e��company�employees��o�work��o�implemen����e�business�s�ra�e�y�for���e�combine��firms.�Typically�����ese� con�rols�woul���ave�been�a�ree�� �o��urin��ne�o�ia�ion.� Incen�ives�of�en� inclu�e� retention bonuses� for� key� employees� of� ��e� �ar�e�� firm� if���ey�remain�wi�����e�combine��companies�for�a�specific�perio��followin��comple�ion�of���e��ransac�ion.

Monitoring systems�are� implemen�e�� �o� �rack� ��e�ac�ual�performance�of� ��e� combine�� firms� a�ains�� ��e� business� plan.�T�ey� may� be� accoun��in��base��an��moni�or�financial�measures�suc��as�revenue���profi�s���an��cas��flow���or���ey�may�be�ac�ivi�y�base��an��moni�or�variables���a���rive�finan�cial�performance.�T�ese�variables�inclu�e�cus�omer�re�en�ion���avera�e�rev�enue�per�cus�omer���employee��urnover���an��revenue�per�employee.

the Business PlAn As A coMMunicAtion docuMent

T�e�necessary�ou�pu��of���e�plannin��process�is�a��ocumen����a��commu�nica�es�effec�ively�wi���key��ecision�makers�an��s�ake�ol�ers.����oo��busi�ness�plan�s�oul��be�s�or����focuse����an��well��ocumen�e�.�T�ere�are�many�ways� �o��evelop� suc�� a� �ocumen�.�Ex�ibi�� 6�6�ou�lines� ��e�key� fea�ures���a��s�oul��be�a��resse��in�a��oo��business�plan—one���a��is�so�well�rea�sone��an��compellin����a���ecision�makers�accep��i�s�recommen�a�ions.

T�e� execu�ive� summary� may� be� ��e� mos�� impor�an�� an�� �ifficul��piece�of� ��e�business�plan� �o�wri�e.� I��mus�� communica�e� succinc�ly� an��compellin�ly� w�a�� is� bein�� propose���� w�y� i�� is� bein�� propose���� �ow� i��is� �o�be�ac�ieve���� an��by�w�en.� I��mus�� also� i�en�ify� ��e�major� resource�requiremen�s�an��risks�associa�e��wi�����e�cri�ical�assump�ions�un�erlyin����e�plan.�T�e�execu�ive�summary�is�of�en���e�firs��an��only�por�ion�of���e�business�plan� ��a�� is� rea��by� a� �ime�cons�raine��CE���� len�er���or�ven�ure�capi�alis�.��s� suc���� i��may� represen�� ��e� firs�� an�� las�� c�ance� �o� ca�c�� ��e�a��en�ion�of���e�key��ecision�maker.

Mergers and Acquisitions Basics146

EXHIBIT 6-6 Key Features of a Typical Business Unit-Level Business Plan

1. Executive summary: In 1–2 pages, describe what you are proposing to do, why, how it will be accomplished, by what date, critical assumptions, risks, and major resource requirements.

2. Industry/market definition: Define the industry/market in which the firm competes in terms of size, growth rate, product offering, and other pertinent characteristics.

3. External analysis: Describe industry/market competitive dynamics in terms of the factors affecting customers, competitors, potential entrants, product/ service substitutes, and suppliers and how they interact to determine profitability and cash flow (e.g., Porter or Modified Porter Framework, also known as the Five Forces). Discuss major opportunities and threats that exist because of the industry’s competitive dynamics. This information should be used to develop the assumptions underlying revenue and cost projections in building financial statements.

4. Internal analysis: Describe the company’s strengths and weaknesses and how they compare with the competition. Identify which of these strengths and weaknesses are important to the firm’s targeted customers and explain why. These data can be used to develop cost and revenue assumptions underlying the projected financial statements for the business.

5. Business mission/vision statement: Describe the purpose of the corpora-tion, what it intends to achieve, and how it wishes to be perceived by its stakeholders. For example, an automotive parts manufacturer may envision itself as being perceived, by decade’s end, as the leading supplier of high- quality components worldwide by its customers and as fair and honest by its employees, the communities in which it operates, and its suppliers.

6. Quantified strategic objectives (including completion dates): Indicate both financial goals (e.g., rates of return, sales, cash flow, share price) and nonfi-nancial goals (e.g., market share; being perceived by customers or investors as number one in the targeted market in terms of market share, product quality, price, innovation).

7. Business strategy: Identify how the mission and objectives will be achieved (e.g., become a cost leader, adopt a differentiation strategy, focus on a spe-cific market segment, or some combination of these strategies). Show how the chosen business strategy satisfies a key customer need or builds on a major strength of the firm. (For example, a firm whose targeted customers are highly price sensitive may pursue a cost leadership strategy to enable it to lower selling prices and to increase market share and profitability. Alternatively, a firm with a well-established brand name may choose to

(Continued)

Developing the Business Plan as the Initial Phase of the Merger and Acquisition Process 147

Suppor�in���ocumen�a�ion�s�oul��be�referre�� �o� in� ��e�business�plan��ex��bu��presen�e��in�appen�ices.

*�*�*

T�e� success� of� an� acquisi�ion� is� frequen�ly� �epen�en�� on� ��e� focus���un�ers�an�in���� an���iscipline� in�eren�� in� a� ��orou��� an��viable�business�plan� ��a�� a��resses� four� overarc�in�� ques�ions:�W�ere� s�oul�� ��e� firm�compe�e?�How�s�oul����e� firm�compe�e?�How�can���e� firm�sa�isfy�cus��omer�nee�s�be��er���an���e�compe�i�ion?�W�y�is���e�c�osen�s�ra�e�y�pref�erable��o�o��er�reasonable�op�ions?

EXHIBIT 6-6 (Continued) pursue a differentiation strategy by adding features to its product that are

perceived by its customers as valuable.) 8. Implementation strategy: From a range of reasonable options (i.e., solo

venture or “go it alone” strategy; partner via a joint venture or less formal business alliance, license, or minority investment; or acquire/merge), indi-cate which option would enable the firm to best implement its chosen business strategy. State why the chosen implementation strategy is supe-rior to other options. (For example, an acquisition strategy may be appro-priate if the perceived “window of opportunity” is believed to be brief. Alternatively, a solo venture may be preferable if there are few attractive acquisition opportunities or if the firm believes that it has the necessary resources to develop the needed processes or technologies.)

9. Functional tactical strategies: Identify plans and resources required by major functional areas, including manufacturing, engineering, sales and marketing, research and development, finance, legal, and human resources.

10. Business plan financials and valuation: Provide projected five-year income, balance sheet, and cash flow statements for the firm and estimate the firm’s value based on the projected cash flows. State key forecast assumptions underlying the projected financials and valuation.

11. Risk assessment: Evaluate the potential impact on valuation by changing selected key assumptions one at a time. Briefly identify contingency plans (i.e., alternative ways of achieving the firm’s mission/objectives) that would be undertaken if critical assumptions prove inaccurate. Identify specific events that would cause the firm to pursue a contingency plan. Such “trigger points” could include deviations in revenue growth of more than x percent or the failure to acquire or develop a needed technology within a specific period.

Mergers and Acquisitions Basics148

�n�acquisi�ion�is�only�one�of�many�op�ions�available�for�implemen�in��a�business�s�ra�e�y.�T�e��ecision��o�pursue�an�acquisi�ion�of�en�res�s�on���e��esire��o�ac�ieve�con�rol�an��a�percep�ion���a����e�acquisi�ion�will�resul��in�ac�ievin����e��esire��objec�ives�more�rapi�ly���an�o��er�op�ions.��ll��oo�of�en���firms�pay�far��oo�muc��for�con�rol.��l�erna�ive�op�ions�may�prove��o�be�less�risky.���firm�may�c�oose��o�implemen��w�a��amoun�s��o�a�p�ase��acquisi�ion� by� firs�� en�erin�� in�o� a� join�� ven�ure� wi��� ano��er� company�before�acquirin��i��a��a�la�er��a�e.

�nce�a�firm��as��eci�e����a��an�acquisi�ion�is�cri�ical��o�realizin����e�s�ra�e�ic��irec�ion��efine��in���e�business�plan���a�mer�er/acquisi�ion�plan�s�oul��be��evelope�.�T�a��is���e�subjec��of���e�nex��c�ap�er.

A Case in Point: Nokia Moves to Establish Industry StandardsThe ultimate success or failure of any transaction to satisfy expectations often is heavily dependent on the answer to a simple question. Was the justification for buying the target firm based on a sound business strategy? A bad strategy may be bold, innovative, or precedent setting, but it is still a bad strategy.

In a bold move reminiscent of the rollout of Linux, the Finnish phone hand-set manufacturer Nokia announced in mid-2008 that it had reached an agree-ment to acquire Symbian, its supplier of smartphone operating system software. When the transaction was completed, Symbian supplied 56 percent of the oper-ating system software for smartphones.

In its vision for the future, Nokia seems to be positioning itself as the pre-mier supplier of online services to the smartphone market, hoping to estab-lish an industry standard based on the Symbian software to use as a platform. Such services could include online music and photo sharing. By providing the Symbian code at no cost, Nokia hopes that more independent software devel-opers will make their service offering compatible with the Symbian system. Microsoft is likely to be hurt by these developments because it charges royalties to use its software.

Nokia’s business strategy or model is to dominate the smartphone market with handsets that rely on the Symbian operating system—a strategy that relies heavily on the company’s ability to grow its base of customers who use Nokia-supplied handsets capable of downloading online services. The firm hopes to move from more expensive niche products, such as its N series handsets, to less-expensive, mass-market products. Nokia hopes to exploit economies of scale by spreading any fixed cost associated with online services over an expanding cus-tomer base. Such fixed expenses could include a requirement by content serv-ice providers that Nokia pay a minimum level of royalties in addition to royalties

Developing the Business Plan as the Initial Phase of the Merger and Acquisition Process 149

that vary with usage. Similarly, the development cost incurred by service provid-ers can be defrayed by selling to a growing customer base.

At present, many handsets that are in wide use employ proprietary operat-ing software, which makes it difficult to provide online services. Nokia’s imple-mentation strategy is to acquire the leading supplier of handset operating systems and to subsequently give away the Symbian software free.

The opportunity has not been lost on Nokia competitors. Google is backing an operating system called Android to create a Web-friendly software platform, and at this writing has rolled out several Android-based phones, including the Motorola Droid series offered by Verizon. The LiMo Foundation has garnered widespread support for using Linux software for mobile phones. The widespread popularity of Apple’s iPhone has captured the imagination of many independ-ent software developers targeting the smartphone as a conduit for distributing online services to consumers.

The success or failure of Nokia’s vision, business strategy, and implementa-tion strategy will depend on whether Symbian can do a better job of recruiting other handset makers, service providers, and consumers than Nokia’s competi-tors. Nokia may have been too optimistic because its success in establishing an industry operating system standard depends on its ability to enlist the support of other manufacturers of handsets who may be understandably reluctant to do anything that would strengthen a competitor. One projection is that Nokia’s share of the smartphone operating system market will decline to 45 percent in 2012, with Google’s then accounting for 18 percent.8 Many smartphone manu-facturers already are hedging their bets. For example, although Motorola and NTT DoCoMo will serve on the Symbian board, they also are involved in various ways with LiMo and Android.

Things to Think About:1. What are the key assumptions implicit in Nokia’s business strategy, and are

they reasonable?2. What are the key assumptions implicit in Nokia’s implementation strategy,

and are they reasonable?3. How does Nokia intend to make money as a result of these strategies? Be

specific.4. How are Nokia’s competitors reacting to its strategy? Why?5. What options does Nokia have if its strategy is unsuccessful? Be specific.

Answers can be found at: www.elsevierdirect.com/companion.jsp?ISBN=9780123749482

�� Gar�ner���Inc.

151Mergers and Acquisitions Basics� ©�2011�Elsevier�Inc.ISBN:�����0�12��������2�� ��I: �ll ri���s reserve�.����0�12��������2�� ��I: �ll ri���s reserve�.�����I:� �ll�ri���s�reserve�.

CHAPTER

201110.1016/B����0�12��������2.0000��X

The Role of the Acquisition Plan, Finding a Target, and Making First Contact

C�ap�er�6��iscusse��in�some��e�ail���e�role�of�a�firm’s�business�plan�in�pro�vi�in��a�mission�or��irec�ion���measurable�financial�an��nonfinancial�objec��ives��o�measure�pro�ress���an����e�business�s�ra�e�y�for�realizin����e�firm’s�mission�an��objec�ives.�If�a�firm��eci�es��o�execu�e�i�s�s�ra�e�y���rou���an�acquisi�ion���i��will�nee��an�acquisi�ion�plan.�Here���you�will�learn���e�s�eps�of� ��e�acquisi�ion�plannin��process��� inclu�in���e�aile��componen�s�of�an�acquisi�ion�plan����ow��o�con�uc��an�effec�ive�searc��process���an���ow��o�make�ini�ial�con�ac��wi���a�po�en�ial��ar�e��firm.�(No�e���a��if���e�imple�men�a�ion� of� ��e� firm’s� business� s�ra�e�y� require�� some� o��er� business�combina�ion���suc��as�a�join��ven�ure�or�business�alliance�����e�same�lo�ic�of���e�acquisi�ion�plannin��process��escribe���ere�woul��apply.)

T�e�acquisi�ion�plan�is�a�specific��ype�of�implemen�a�ion�s�ra�e�y���a��focuses�on��ac�ical�or�s�or���erm�issues�ra��er���an�s�ra�e�ic�or�lon�er��erm�issues.�I��inclu�es�mana�emen��objec�ives���a�resource�assessmen����a�marke��analysis��� senior� mana�emen�’s� preferences� re�ar�in�� mana�emen�� of� ��e�acquisi�ion�process���a��ime�able���an����e�name�of���e�in�ivi�ual�responsible�for� makin�� i�� all� �appen.�T�ese� an�� ��e� cri�eria� �o� use� w�en� searc�in��acquisi�ion� �ar�e�s� are� co�ifie�� in� ��e� firs�� par�� of� ��e� plannin�� process;�af�er�a��ar�e���as�been�i�en�ifie������ere�are�several�a��i�ional�s�eps���inclu��in�� con�ac�in�� ��e� �ar�e���� �evelopin�� a� ne�o�ia�ion� s�ra�e�y��� �e�erminin����e�ini�ial�offer�price���an���evelopin��bo���financin��an��in�e�ra�ion�plans.�Ex�ibi����1�illus�ra�es���e�en�ire�process.

�evelopmen�� of� ��e� acquisi�ion� plan� s�oul�� be� �irec�e�� by� ��e�“�eal�owner”—�ypically�a��i���performin��mana�er�accoun�able�for���e�specific�acquisi�ion.�Senior�mana�emen��s�oul����very�early� in���e�process���appoin����e��eal�owner��o���is�full��or�par���ime�posi�ion.�I��can�be�someone�in���e�firm’s�business��evelopmen��uni���� for�example���or�a�member�of� ��e� firm’s�business��evelopmen���eam�wi���subs�an�ial��eal�makin��experience.��f�en���i��is���e�in�ivi�ual�w�o�will�be�responsible�for���e�opera�ion�an��in�e�ra��ion�of���e��ar�e����wi���an�experience���ealmaker�playin��a�suppor�in��role.

7

Mergers and Acquisitions Basics152

Pre-target Selection

T�e� firs�� s�eps� in� ��e� acquisi�ion� plannin�� process� involve� co�ifyin�� ��e�plan�elemen�s���a��are�necessary�before���e�searc��for�an�acquisi�ion��ar�e��can�be�in.

Plan ObjectivesT�e�acquisi�ion�plan’s�s�a�e��objec�ives�s�oul��be�comple�ely�consis�en��wi�����e� firm’s� s�ra�e�ic� objec�ives.� Financial� an�� nonfinancial� objec�ives� alike�s�oul��suppor��realiza�ion�of���e�business�plan�objec�ives.�Moreover���as�is��rue�wi���business�plan�objec�ives�����e�acquisi�ion�plan�objec�ives�s�oul��be�quan��ifie��an��inclu�e�a��a�e�w�en�suc��objec�ives�are�expec�e���o�be�realize�.

Financial� objec�ives� in� ��e� acquisi�ion� plan� coul�� inclu�e� �ar�e�s� for� a�minimum� ra�e�of� re�urn�or�opera�in��profi���� revenue��� an�� cas�� flow� �o�be�ac�ieve��wi��in�a�specifie��perio�.�Minimum�or�require��ra�es�of�re�urn��ar��e�s� may� be� subs�an�ially� �i��er� ��an� ��ose� specifie�� in� ��e� business� plan���w�ic��rela�e� �o� ��e�require��re�urn� �o� s�are�ol�ers�or� �o� �o�al�capi�al� (i.e.����eb��plus�equi�y).�T�e�require��re�urn�for���e�acquisi�ion�may�reflec��a�sub�s�an�ially� �i��er� level� of� risk� as� a� resul�� of� ��e� perceive�� variabili�y� of� ��e�amoun��an���imin��of���e�expec�e��cas��flows�resul�in��from���e�acquisi�ion.

EXHIBIT 7-1 Acquisition Planning Steps

Step1: Develop plan objectives

Step 2: Establish timetable for completing the transaction

Step 3: Evaluate acquirer resources and capabilities

Step 4: Determine management preferences

Step 5: Develop search plan

Step 6: Develop negotiation strategy

Step 7: Determine initial offer price

Step 8: Develop financing plan

Step 9: Develop integration plan

Post-Target Selection

Pre-Target Selection

The Role of the Acquisition Plan, Finding a Target, and Making First Contact 153

Nonfinancial�objec�ives�a��ress� ��e�mo�iva�ions� for�makin�� ��e�acquisi��ion� ��a�� suppor�� ��e�ac�ievemen��of� ��e� financial� re�urns� s�ipula�e�� in� ��e�business�plan.�T�ey�coul��inclu�e�ob�ainin��ri���s��o�specific�pro�uc�s���pa��en�s��� copyri���s��� or� bran�� names;� provi�in�� �row��� oppor�uni�ies� in� ��e�same�or� rela�e��marke�s;��evelopin��new��is�ribu�ion�c�annels� in� ��e� same�or� rela�e��marke�s;� ob�ainin�� a��i�ional� pro�uc�ion� capaci�y� in� s�ra�e�ically�loca�e��facili�ies;�a��in��R&��capabili�ies;�an��acquirin��access��o�proprie�ary��ec�nolo�ies���processes���an��skills.1�Because���ese�objec�ives�i�en�ify���e�fac��ors���a��ul�ima�ely��e�ermine�w�e��er�a�firm�will�ac�ieve�i�s��esire��financial�re�urns�����ey�may�provi�e�subs�an�ially�more��ui�ance���an�financial��ar�e�s.

Ex�ibi����2�illus�ra�es��ow���ese�an��o��er�acquisi�ion�plan�objec�ives�can�be�linke��wi���business�plan�objec�ives.�No�e���a��bo���business�an��acquisi��ion�plan�objec�ives�are�quan�ifie��an���ave�associa�e��comple�ion��a�es.

1� �ePamp�ilis�(2001).

EXHIBIT 7-2 Examples of Linkages between Business and Acquisition Plan Objectives

Business Plan Objective Acquisition Plan Objective

Financial: The firm will Achieve rates of return that will

equal or exceed its cost of equity or capital by 20XX.

Maintain a debt/total capital ratio of x%.

Financial returns: The target firm should have

A minimum return on assets of x%. A debt/total capital ratio y%. Unencumbered assets of $z million. Cash flow in excess of operating

requirements of $x million.Size: The firm will Be the number-one or -two market

share leader by 20XX. Achieve revenue of $x million by 20XX.

Size: The target firm should have at least $x million in revenue.revenue.

Growth: The firm will achieve through 20XX annual average

Revenue growth of x%. Earnings per share growth of y%. Operating cash-flow growth of z%.

Growth: The target firm should Have annual revenue, earnings, and

operating cash-flow growth of at least x%, y%, and z%.

Provide new products and markets. Possess excess annual production

capacity of x million units.Diversification: The firm will reduce

earnings variability by x%.Diversification: The target firm’s earnings

should be largely uncorrelated with the acquirer’s earnings.

(Continued)

Mergers and Acquisitions Basics154

Resource/Capability EvaluationEarly�in���e�acquisi�ion�process���i��is�impor�an���o��e�ermine���e�maximum�amoun��of� ��e� firm’s�available�resources� senior�mana�emen��will�commi���o�a�mer�er�or�acquisi�ion.�T�is�informa�ion�is�use��w�en���e�firm��evel�ops��ar�e��selec�ion�cri�eria�before�un�er�akin��a�searc��for��ar�e��firms.

Financial� resources� po�en�ially� available� �o� ��e� acquirer� inclu�e� ��ose�provi�e��by�in�ernally��enera�e��cas��flow�in�excess�of�normal�opera�in��requiremen�s���plus�fun�s�from���e�equi�y�an���eb��marke�s.�In�cases�w�ere���e��ar�e��firm�is�known�����e�po�en�ial�financin��pool�inclu�es�fun�s�pro�vi�e��by� ��e� in�ernal�cas�� flow�of� ��e�combine��companies� in�excess�of�normal� opera�in�� requiremen�s��� ��e� capaci�y� of� ��e� combine�� firms� �o�issue�equi�y�or� increase� levera�e���an����e�procee�s� from�sellin��asse�s�no��require��for�implemen�in����e�acquirer’s�business�plan.

Financial���eory�su��es�s���a��an�acquirin��firm�will�always�be�able��o�a��rac��sufficien��fun�in��for�an�acquisi�ion�if�i��can��emons�ra�e���a��i��can�

Flexibility: The firm will achieve flexibility in manufacturing and design.

Flexibility: The target firm should use flexible manufacturing techniques.

Technology: The firm will be recognized by its customers as the industry’s technology leader.

Technology: The target firm should possess important patents, copyrights, and other forms of intellectual property.

Quality: The firm will be recognized by its customers as the industry’s quality leader.

Quality: The target firm’s product defects must be x per million units manufactured.

Service: The firm will be recognized by its customers as the industry’s service leader.

Warranty record: The target firm’s customer claims per million units sold should be not greater than x.

Cost: The firm will be recognized by its customers as the industry’s low-cost provider.

Labor costs: The target firm should be nonunion and not subject to significant government regulation.

Innovation: The firm will be recognized by its customers as the industry’s innovation leader.

R&D capabilities: The target firm should have introduced at least x new products in the last 18 months.

Business Plan Objective Acquisition Plan Objective

EXHIBIT 7-2 (Continued)

The Role of the Acquisition Plan, Finding a Target, and Making First Contact 155

earn�i�s�cos��of�capi�al.�In�prac�ice���senior�mana�emen�’s�risk��olerance�plays�an�impor�an��role�in��e�erminin��w�a����e�acquirer�believes�i��can�affor���o� spen�� on� a�mer�er� or� acquisi�ion.�Consequen�ly��� risk�averse� mana�e�men��may�be�incline���o�commi��only�a�small�por�ion�of���e��o�al�financial�resources�po�en�ially�available��o���e�firm.

T�ree�basic��ypes�of�risk�confron��senior�mana�emen��consi�erin��an�acquisi�ion�an��affec���ow�mana�emen��feels�abou����e�affor�abili�y�of�an�acquisi�ion�oppor�uni�y.�How���ese�risks�are�perceive��will��e�ermine��ow�muc��of�po�en�ial�available�resources�mana�emen��will�be�willin���o�com�mi���o�makin��an�acquisi�ion.

Operating risk� a��resses� ��e� abili�y� of� ��e� buyer� �o� mana�e� ��e�acquire�� company.� Generally��� i�� is� perceive�� �o� be� �i��er� for� M&�s� in�marke�s�unrela�e���o���e�acquirer’s�core�business.�T�e�limi�e��un�ers�an��in��of�mana�ers�in���e�acquirin��company�of���e�compe�i�ive��ynamics�of���e�new�marke��an����e�inner�workin�s�of���e��ar�e��firm�may�ne�a�ively�affec�� ��e� pos�mer�er� in�e�ra�ion� effor�� as� well� as� ��e� on�oin�� mana�e�men��of���e�combine��companies.

Financial risk�refers��o���e�buyer’s�willin�ness�an��abili�y��o�levera�e�a��ransac�ion���as�well�as���e�willin�ness�of�s�are�ol�ers��o�accep���ilu�ion�of�near��erm�earnin�s�per� s�are� (EPS).�To�re�ain�a� specific�cre�i�� ra�in���� ��e�acquirin�� company� mus�� main�ain� cer�ain� levels� of� financial� ra�ios� suc��as��eb���o��o�al�capi�al�an��in�eres��covera�e�(i.e.���earnin�s�before�in�eres��an���axes��ivi�e��by�in�eres��expense).���firm’s�incremen�al��eb��capaci�y�can�be�approxima�e��by�comparin����e�relevan��financial�ra�ios��o���ose�of�comparable�firms�in���e�same�in�us�ry���a��are�ra�e��by���e�cre�i��ra�in��a�encies.�T�e��ifference�represen�s� ��e�amoun����e�firm��� in���eory���coul��borrow� wi��ou�� jeopar�izin�� i�s� curren�� cre�i�� ra�in�.2� Senior� mana�e�men��coul��also��ain�insi����in�o��ow�muc��EPS��ilu�ion�equi�y�inves�ors�may�be�willin�� �o� �olera�e� ��rou��� informal��iscussions�wi���Wall�S�ree��analys�s�an��an�examina�ion�of�comparable��ransac�ions�finance��by�issu�in��s�ock.

Overpayment risk� involves� ��e� �ilu�ion� of� EPS� or� a� re�uc�ion� in� i�s��row��� ra�e� resul�in�� from�payin�� si�nifican�ly�more� ��an� ��e� economic�

2� For�example���suppose���e�combine��acquirer�an���ar�e��firms’�in�eres��covera�e�ra�io�is���an����e�combine��firms’��eb���o��o�al�capi�al�ra�io�is�0.25.��ssume�fur��er���a��o��er�firms�wi��in���e�same�in�us�ry�wi���comparable�in�eres��covera�e�ra�ios��ave��eb���o��o�al�capi�al�ra�ios�of�0.5.�Consequen�ly�����e�combine��acquirer�an���ar�e��firms�coul��increase�borrowin��wi��ou��jeopar�izin����eir�combine��cre�i��ra�in��un�il���eir��eb���o��o�al�capi�al�ra�io�equals�0.5.

Mergers and Acquisitions Basics156

value� of� ��e� acquire�� company.�T�e� effec�s� of� overpaymen�� on� earnin�s��ilu�ion�can�las��for�years.�

Management PreferencesSenior� mana�emen�’s� preferences� for� con�uc�in�� ��e� acquisi�ion� process�are�usually�expresse��in��erms�of�boun�aries�or� limi�s.�To�ensure���a����e�process�is�mana�e��in�a�manner�consis�en��wi���mana�emen�’s�risk��oler�ance�an��biases���mana�emen��mus��provi�e��ui�ance��o���ose�responsible�for� fin�in�� an�� valuin�� ��e� �ar�e���� as�well� as� ne�o�ia�in�� ��e� �ransac�ion.�Subs�an�ial�upfron��par�icipa�ion�by�mana�emen��will��elp��rama�ically�in���e� successful� implemen�a�ion� of� ��e� acquisi�ion� process.� Unfor�una�ely���senior�mana�emen�� frequen�ly� avoi�s�provi�in�� si�nifican�� inpu��early� in���e� process.�T�is� inevi�ably� lea�s� �o� miscommunica�ion��� confusion��� an��poor�execu�ion�la�er�in���e�process.

Ex�ibi������provi�es�examples�of���e�more�common��ypes�of�mana�e�men���ui�ance���a��mi����be�foun��in�an�acquisi�ion�plan.

TimetableT�e� final� componen�� of� a� properly� cons�ruc�e�� acquisi�ion� plan� is� a�sc�e�ule���a��reco�nizes�all�of� ��e�key�even�s���a��mus���ake�place�in���e�acquisi�ion� process.� Eac�� even�� s�oul�� �ave� be�innin�� an�� en�in�� �a�es�an��miles�ones�alon����e�way���an��s�oul�� i�en�ify�w�o�is� responsible� for�ensurin�� ��a��eac��miles�one� is� ac�ieve�.�T�e� �ime�able�of�even�s� s�oul��be� a��ressive�bu�� realis�ic.�T�e� �ime�able� s�oul��be� sufficien�ly� a��ressive��o�mo�iva�e�all� involve���o�work�as�expe�i�iously�as�possible� �o�mee�� ��e�plan’s�mana�emen��objec�ives���w�ile�also�avoi�in��overop�imism���a��may��emo�iva�e�in�ivi�uals�if�uncon�rollable�circums�ances��elay�reac�in��cer��ain�miles�ones.

Searching for Potential Acquisition TargetsIn� ��e�pre��ar�e�� selec�ion�p�ase�of�acquisi�ion�plannin���� ��e� firs�� s�ep� in�searc�in�� for� po�en�ial� acquisi�ion� can�i�a�es� is� �o� es�ablis�� a� rela�ively�

�� To�illus�ra�e���e�effec�s�of�overpaymen��risk���assume���e�acquirin��company’s�s�are�ol�ers�are�sa�isfie��wi�����e�company’s�projec�e��annual�avera�e�increase�in�EPS�of�20�percen��annually�for���e�nex��five�years.�T�e�company�announces�i��will�be�acquirin��ano��er�company�an����a��a�series�of�“res�ruc�urin�”�expenses�will�slow�EPS��row���in���e�comin��year��o�10�percen�.�However���mana�emen��ar�ues���a����e�savin�s�resul�in��from�combinin����e��wo�companies�will�raise���e�combine��companies’�EPS��row���ra�e��o��0�percen��in���e�secon����rou���fif���year�of���e�forecas�.�T�e�risks�are���a����e�savin�s�canno��be�realize��in���e��ime�assume��by�mana�emen��an����e�slow�own�in�earnin�s�ex�en�s�well�beyon����e�firs��year.

The Role of the Acquisition Plan, Finding a Target, and Making First Contact 157

small� number� of� primary� screenin�� or� selec�ion� cri�eria.� T�ese� cri�e�ria� s�oul�� inclu�e� ��e� in�us�ry�an�� size�of� ��e� �ransac�ion���w�ic�� is�bes���efine��in��erms�of���e�maximum�purc�ase�price�a�firm�is�willin���o�pay.�T�is� can�be�expresse��as� a�maximum�price��o�earnin�s���book���cas�� flow���or�revenue�ra�io���or�a�maximum�purc�ase�price�s�a�e��in��erms�of��ollars.�I��also�may�be�appropria�e��o�a���a��eo�rap�ic�res�ric�ion��o���e�selec�ion�cri�eria.

Consi�er� a� priva�e� acu�e�care� �ospi�al� �ol�in�� company� ��a�� wan�s��o�buy� a� skille��nursin�� facili�y�wi��in�50�miles�of� i�s� lar�es���ospi�al� in��lle��eny�Coun�y���Pennsylvania.�Mana�emen��believes�i��canno��affor���o�pay� more� ��an� $�5� million� for� ��e� facili�y.� I�s� primary� selec�ion� cri�eria�coul�� inclu�e�an� in�us�ry� (skille��nursin�)��� loca�ion�(�lle��eny�Coun�y)���an�� maximum� price� (5� �imes� cas�� flow� no�� �o� excee�� $�5� million).��Similarly��� a� Texas�base�� manufac�urer� of� pa�io� furni�ure� wi��� manu�fac�urin�� opera�ions� in� ��e� sou��wes�ern� Uni�e�� S�a�es� seeks� �o� expan��i�s� sales� in� California.�T�e� company� �eci�es� �o� seek� a� pa�io� furni�ure��

EXHIBIT 7-3 Examples of Management Guidance Provided to Acquisition Teams

1. Determining the criteria used to evaluate prospective candidates (e.g., size, price range, current profitability, growth rate, geographic location, and cul-tural compatibility).

2. Specifying acceptable methods for finding candidates (e.g., soliciting board members; analyzing competitors; and contacting brokers, investment bankers, lenders, law firms, and the trade press).

3. Establishing roles and responsibilities of the acquisition team, including the use of outside consultants, and defining the team’s budget.

4. Identifying acceptable sources of financing (e.g., equity issues, bank loans, unsecured bonds, seller financing, or asset sales).

5. Establishing preferences for an asset or stock purchase and form of pay-ment (cash, stock, or debt).

6. Setting a level of tolerance for goodwill. 7. Indicating the degree of openness to partial rather than full ownership. 8. Specifying willingness to launch an unfriendly takeover. 9. Setting affordability limits (which can be expressed as a maximum price to

after-tax earnings, earnings before interest and taxes, or cash flow multiple or maximum dollar amount).

10. Indicating any desire for related or unrelated acquisitions.

Mergers and Acquisitions Basics158

manufac�urer���a��i��can�purc�ase�for�no�more���an�$100�million.�I�s�pri�mary� selec�ion� cri�eria� coul�� inclu�e� an� in�us�ry� (ou��oor� furni�ure)��� a�loca�ion�(California����rizona���an��Neva�a)���an��a�maximum�purc�ase�price�(15��imes�af�er��ax�earnin�s�no���o�excee��$100�million).

T�e� secon�� pre��ar�e�� selec�ion� s�ep� is� �o� �evelop� a� searc�� s�ra�e�y���a�� employs� ��e� selec�ion� cri�eria.�T�is� s�ra�e�y� �ypically� involves� usin��compu�erize���a�abases�an���irec�ory�services�suc��as��isclosure����un�&�Bra�s�ree�’s�Million Dollar Database���S�an�ar��&�Poor’s�Corporate Register�an��Capital IQ,�or�T�omas’�Register��o�i�en�ify�qualifie��can�i�a�es.�Firms�also�may�query���eir�law���bankin����an��accoun�in��firms��o�i�en�ify�o��er�can��i�a�es.�Inves�men��banks���brokers���an��levera�e��buyou��firms�are�also�fer��ile�sources�of�po�en�ial�can�i�a�es���al��ou�����ey�are�likely��o�require�an�a�visory�or�fin�er’s�fee.

T�e�In�erne��makes�researc��muc��easier���an�in���e�pas�;��o�ay���ana�lys�s� �ave� muc�� more� informa�ion� a�� ��eir� fin�er�ips� ��an� ever� before.�Suc�� services� as�Goo�le� Finance���Ya�oo!� Finance���Hoover’s��� or� E�G�R��nline� enable� researc�ers� �o� �a��er� �a�a� quickly� abou�� compe�i�ors� an��cus�omers.�T�ese�si�es�provi�e�easy�access��o�a�varie�y�of�public��ocumen�s�file��wi�����e�Securi�ies�an��Exc�an�e�Commission.

If�confi�en�iali�y�is�no��an�issue���a�firm�may�seek��o�a�ver�ise�i�s�in�er�es��in�acquirin��a�par�icular��ype�of�firm�in�The Wall Street Journal�or��ra�e�press.��l��ou�����is��ac�ic�is�likely��o��enera�e�subs�an�ial�in�eres����i��is�less�likely� �o��enera�e��i���quali�y�prospec�s.�Ra��er��� ��ere� are� likely� �o�be�a�lo��of� responses� from���ose� in�eres�e�� in��e��in��a� free�valua�ion�of� ��eir�own� company��� brokers� claimin�� ��eir� clien�s� fi�� ��e� buyer’s� cri�eria� as� a�ruse��o�convince�you���a��you�nee����e�broker’s�services����an��o��er�was�es�of��ime.

Fin�in�� reliable� informa�ion� abou�� priva�ely� owne�� firms� is� a� major�problem.�Sources�suc��as��un�&�Bra�s�ree��or�Experian�may�provi�e�only�fra�men�ary��a�a.�Publicly�available�informa�ion�may�offer�a��i�ional��e�ail.�For�example���surveys�by��ra�e�associa�ions�or���e�U.S.�Census�Bureau�of�en�inclu�e�in�us�ry�specific�avera�e�sales�per�employee.���priva�e�firm’s�sales�can� be� es�ima�e�� by� mul�iplyin�� ��is� fi�ure� by� an� es�ima�e� of� ��e� firm’s�workforce���w�ic��may�be�ob�aine��by�searc�in����e�firm’s�pro�uc��li�era��ure���websi�e���or��ra�e�s�ow�speec�es���or�even�by�coun�in����e�number�of�cars�in���e�parkin��lo�.

�� I��is�impor�an���o�respon��in�wri�in��if�you�receive�a�solici�a�ion�from�a�broker�or�fin�er���par�icularly�if�you�rejec����ese�services.�If���a��a�la�er��a�e���you�acquire���e�firm���a����e�broker�or�fin�er�claims��o��ave�represen�e�����e�or�s�e�may�sue�your�firm�for�compensa�ion.

The Role of the Acquisition Plan, Finding a Target, and Making First Contact 159

Increasin�ly���companies—even�mi��size�firms—are�movin��inves�men��bankin��“in��ouse.”�Ra��er� ��an�use�brokers�or� so�calle�� fin�ers5�as�par��of� ��eir� acquisi�ion� process��� ��ey� are� i�en�ifyin�� po�en�ial� �ar�e�s��� �oin��valua�ion���an��performin���ue��ili�ence�on���eir�own.�T�is�reflec�s�effor�s���o�save�on�inves�men��bankin��fees���w�ic��can�easily�be�more���an�$5�million��plus�expenses�on�a�$500�million��ransac�ion.6

Screening the Initial Search ResultsT�e� screenin��process� is� a� refinemen��of� ��e� searc��process.� I��be�ins�by�prunin�� ��e� ini�ial� lis�� of� po�en�ial� can�i�a�es� crea�e�� usin�� ��e� primary�cri�eria��iscusse��earlier.�Because�rela�ively� few�primary�cri�eria�are�use������e�ini�ial� lis��may�be�len���y.�I��can�be�s�or�ene��usin��secon�ary�selec��ion�cri�eria���bu��care�s�oul��be��aken��o�limi����e�number�of���ese�cri�eria.��n�excessively�lon��lis��of�selec�ion�cri�eria�will�severely�limi����e�number�of�can�i�a�es���a��pass���e�screenin��process.

Secon�ary� selec�ion� cri�eria� may� inclu�e� a� specific� marke�� se�men��wi��in� ��e� in�us�ry� i�en�ifie�� as� a� primary� selec�ion� cri�erion���or� a� spe�cific�pro�uc��line�wi��in�a�marke��se�men�.����er�cri�eria�may�inclu�e���e�firm’s�profi�abili�y����e�ree�of�levera�e���an��marke��s�are.�Cul�ural�compa��ibili�y�also�s�oul��be�consi�ere��as�an�impor�an��screenin��cri�erion.�T�e�selec�ion�cri�eria�s�oul��be�quan�ifiable���w�enever�possible.

Market SegmentT�e� searc�� process� involve�� ��e� specifica�ion� of� ��e� �ar�e�� in�us�ry� an��per�aps�resul�e��in�a�len���y�lis��of�acquisi�ion�can�i�a�es.�T�e�lis��can�be�

5� ��broker��as�a�fi�uciary�responsibili�y��o�ei��er���e�po�en�ial�buyer�or�seller�an��is�no��permi��e���o�represen��bo���par�ies.�Compensa�ion�is�pai��by���e�clien���o���e�broker.�Some�s�a�es�license�brokers.����fin�er�is�someone�w�o�in�ro�uces�bo���par�ies�bu��represen�s�nei��er�par�y.�T�e�fin�er��as�no�fi�uciary�responsibili�y��o�ei��er�par�y�an��is�compensa�e��ei��er�by�one�or�bo���par�ies.�Generally���fin�ers�are�no��license�.�(I��can�be�c�allen�in���o��e�ermine�w�e��er�an�a�en��is�a�broker�or�a�fin�er;�cour�s�of�en�i�en�ify�a�fin�er�as�a�broker�if���e�fin�er��iscusses�price�or�any�si�nifican���erms�of���e��ransac�ion.)�If�you�c�oose��o�use�a�broker�or�fin�er���make�sure���e�fees�an���erms�are�clearly�s�ipula�e��in�wri�in�.�Keep�a�wri��en�recor��of�all��elep�one�conversa�ions�an��mee�in�s�wi�����e�fin�er�or�broker.�T�ese�may�be�use��in�cour��a��a�la�er��a�e�if���e�broker�or�fin�er�sues�for�fees���a��may�be�in��ispu�e.

6� �c�ual�fee�formulas�are�mos��of�en�base��on���e�purc�ase�price.�T�e�so�calle��Lehman formula��was�a��one��ime�a�commonly�use��fee�s�ruc�ure�in�w�ic��broker�or�fin�er�fees�woul��be�equal��o��5�percen��of���e�firs��$1�million�of���e�purc�ase�price�����percen��of���e�secon������percen��of���e���ir����2�percen��of���e�four�����an��1�percen��of���e�remain�er.�To�ay�����is�formula�is�of�en�i�nore��in�favor�of�a�ne�o�ia�e��fee�s�ruc�ure�consis�in��of�a�basic�fee�(or�re�ainer)�pai��re�ar�less�of�w�e��er���e��eal�is�consumma�e����an�a��i�ional�closin��fee�pai��on�closin����an��an�“ex�raor�inary”�fee�pai��un�er�unusual�circums�ances���a��may��elay�even�ual�closin����suc��as��ainin��an�i�rus��approval�or�ac�ievin��a��os�ile��akeover.�Fees�vary�wi�ely���bu��1�percen��of���e��o�al�purc�ase�price�plus�reimbursemen��of�expenses�is�of�en�consi�ere��reasonable.�For�small��eals���inves�men��bankers�of�en�insis��on���e�Le�man�formula.

Mergers and Acquisitions Basics160

s�or�ene��by�i�en�ifyin��a��ar�e��se�men��wi��in���e�in�us�ry.�For�example���a�s�eel�fabrica�ion�company�may��eci�e��o��iversify�by�acquirin��a�manufac��urer�of�aluminum�fla��rolle��pro�uc�s.�W�ereas���e�primary�searc��cri�erion�mi�����ave�been�any�firms�in���e�aluminum�fla��rolle��pro�uc�s�in�us�ry���a�secon�ary�cri�erion�coul��s�ipula�e�a� se�men�in��of� ��e�marke�� �o� i�en�ify�only���ose�companies���a��manufac�ure�aluminum��ubular�pro�uc�s.

Product LineT�e�pro�uc��line�cri�erion�i�en�ifies�a�specific�pro�uc��line�wi��in���e��ar��e��marke��se�men�.�For�example�����e�same�s�eel�fabrica�ion�company�may��eci�e��o�focus�i�s�searc��on�companies�manufac�urin��aluminum��ubular�pro�uc�s�use��for�lawn�an��pa�io�furni�ure.

ProfitabilityT�e�profi�abili�y� cri�erion� s�oul��be��efine�� in� �erms�of� ��e�percen�a�e�re�urn� on� sales��� asse�s��� or� �o�al� inves�men�.�T�is� �efini�ion� allows� a�more�accura�e�comparison�amon��can�i�a�es�of��ifferen��sizes.���firm�wi���af�er��ax�earnin�s�of�$5�million�on�sales�of�$100�million�may�be�less�a��rac�ive���an�a� firm�earnin��$��million�on�sales�of�$50�million�because���e� la��er�firm�may�be�more�efficien�.

Degree of Leverage�eb���o�equi�y�or��eb���o��o�al�capi�al�ra�ios�are�use���o�measure���e�level�of�levera�e�or�in�eb�e�ness.�T�e�acquirin��company�may�no��wan���o�pur�c�ase�a�company�w�ose��eavy��eb��bur�en�may�cause���e�combine��com�pany’s�levera�e�ra�ios��o�jeopar�ize�i�s�cre�i��ra�in�.

Market ShareT�e�acquirin��firm�may�be�in�eres�e��only�in�firms���a��are�number�one�or��wo�in�marke��s�are�in���e��ar�e�e��in�us�ry���or�in�firms�w�ose�marke��s�are�is�some�mul�iple�(e.�.���2����e�nex��lar�es��compe�i�or).�Firms��av�in��subs�an�ially��rea�er�marke��s�are���an���eir�compe�i�ors�of�en�are�able��o�ac�ieve�lower�cos��posi�ions���an���eir�compe�i�ors�because�of�econo�mies�of�scale�an��experience�curve�effec�s.

Cultural Compatibility�l��ou���cul�ural�compa�ibili�y�be�ween���e�acquirer�an����e��ar�e��may�be�more��ifficul���o�quan�ify���an�o��er�measures���public�s�a�emen�s�abou����e� �ar�e�’s� vision� for� ��e� fu�ure� an�� i�s� �overnance� prac�ices��� as� well� as�

The Role of the Acquisition Plan, Finding a Target, and Making First Contact 161

i�s� repu�a�ion� as� a� responsible� corpora�e� ci�izen� wi��in� i�s� in�us�ry��� will�provi�e� some� subjec�ive� measure.� Insi���s� can� be� �aine�� by� examinin��employee��emo�rap�ics��� suc�� as� ��e� approxima�e� avera�e� a�e� an���iver�si�y�of���e�workforce���an���ow�lon����e�po�en�ial��ar�e���as�been�in�busi�ness.��merica��nline’s�2001�acquisi�ion�of�Time�Warner��i��li���e���ow��ifficul�� i��can�be��o� in�e�ra�e�a�youn�����e�ero�eneous�employee�popula��ion�wi���a�muc��ol�er���more��omo�eneous��roup.��lso���as�a�muc��newer�firm�����L��a��a�muc��less�s�ruc�ure��mana�emen��s�yle���an�was�foun��in�Time�Warner’s�more�s�ai��environmen�.�Finally���an�acquirer�nee�s��o��e�er�mine�w�e��er�i��can�a�ap���o���e�c�allen�es�of��ealin��wi���forei�n�firms���suc��as��ifferen��lan�ua�es�an��cus�oms.

contacting the Selected target

Usin��bo�����e�primary�an��secon�ary�selec�ion�cri�eria�makes�i��possible��o�brin����e�searc���o�a�close�an��be�in���e�nex��par��of� ��e�acquisi�ion�plannin��process.�T�is� process� be�ins�wi��� con�ac�in�� ��e� selec�e�� �ar�e��company.�T�e� subsequen�� s�eps—�evelopin�� a� s�ra�e�y� for� ne�o�ia�ions����e�erminin�� an� ini�ial�offer�price��� an���evelopin�� financin�� an�� in�e�ra��ion�plans—are��iscusse��in�C�ap�ers���������an��10.

First ContactT�e�approac��for�ini�ia�in��con�ac��wi���a��ar�e��company��epen�s�on���e�size�of���e�company���w�e��er���e��ar�e��is�publicly�or�priva�ely��el����an����e�acquirer’s��ime�frame�for�comple�in��a��ransac�ion.�T�e��ime�frame�can�be�ex�remely� impor�an�.� If� �ime�permi�s��� ��ere� is�no�subs�i�u�e� for��evel�opin��a�personal�rela�ions�ip�wi�����e�sellers—especially�if���eirs�is�a�pri�va�ely��el��firm.��evelopin��a�rappor��of�en�makes�i��possible��o�acquire�a�company���a��is�no����ou�����o�be�for�sale.

Personal�rela�ions�ips�mus��be�forme��only�a����e��i��es��levels�wi��in�a�priva�ely��el���ar�e��firm.�Foun�ers�or���eir��eirs�of�en��ave�a�s�ron��pa�er�nalis�ic�view�of���ese�businesses���w�e��er���ey�are�lar�e�or�small.�Suc��firms�of�en��ave��rea��flexibili�y�in�ne�o�ia�in��a��eal���a��“feels�ri�����”�ra��er���an�simply��ol�in��ou��for���e��i��es��possible�price.�In�con�ras����personal�rela��ions�ips�can��o�only�so�far�in�ne�o�ia�in��wi���a�public�company���a���as�a�fi�uciary�responsibili�y��o�i�s�s�are�ol�ers��o��e����e�bes��price.

If��ime�is�a�cri�ical�fac�or���acquirers�may�no���ave���e�luxury�of��evel�opin�� close� personal� rela�ions�ips� wi��� ��e� seller.� Un�er� ��ese� circum�s�ances���a�more�expe�i�ious�approac��mus��be��aken.

Mergers and Acquisitions Basics162

Small CompaniesFor� small� companies� ($25� million� in� sales)� wi��� w�ic�� ��e� buyer� �as�no� �irec�� con�ac�s��� i�� may� only� be� necessary� �o� ini�ia�e� con�ac�� ��rou���a�va�uely�wor�e�� le��er�expressin�� in�eres�� in�a� join��ven�ure�or�marke��in��alliance.��urin����e�follow�up��elep�one�call���be�prepare���o��iscuss�a�ran�e�of�op�ions�wi�����e�seller.

Prepara�ion� before� ��e� firs�� �elep�one� con�ac�� is� essen�ial.� If� possible���scrip�� your� commen�s.� Ge�� �o� ��e� poin�� quickly� bu�� in�irec�ly.� I�en�ify�yourself��� your� company��� an�� i�s� s�ren���s.��emons�ra�e� your�un�ers�an��in�� of� ��e� con�ac�’s� business� an�� �ow� an� informal� par�ners�ip� coul��make�sense.�Be�able� �o�explain���e�benefi�s�of�your�proposal� �o� ��e�con��ac����quickly� an�� succinc�ly.� If� ��e�oppor�uni�y� arises���propose� a� ran�e�of�op�ions���inclu�in��an�acquisi�ion.�Lis�en�carefully��o���e�con�ac�’s�reac�ion.�If���e�con�ac��is�willin���o�en�er�ain���e�no�ion�of�an�acquisi�ion���reques��a�face��o�face�mee�in�.�

Medium-Size CompaniesFor�me�ium�size�companies�(be�ween�$25�an��$100�million)���use�an�in�er�me�iary��o�make�con�ac��a�� ��e��i��es�� level�possible� in���e��ar�e�� firm’s�or�aniza�ion.� In�erme�iaries� inclu�e� members� of� ��e� acquirer’s� boar��of� �irec�ors� or� ��e� firm’s� ou�si�e� le�al� counsel��� accoun�in�� firm��� len�er����broker/fin�er���or�inves�men��banker.�Usin��in�erme�iaries�can�be�less�in�imi���a�in����an��akin��a��irec��approac�.

Large CompaniesFor�lar�e���publicly��ra�e��companies���con�ac��also�s�oul��be�ma�e���rou���an� in�erme�iary��� a�� ��e� �i��es�� level� possible.� �iscre�ion� is� ex�remely�impor�an��because�of� ��e� �ar�e�’s�concern�abou��bein��“pu�� in�o�play”—��a��is���w�en�circums�ances�su��es����a��i��may�be�an�a��rac�ive�inves�men��oppor�uni�y�for�o��er�firms.�Even�rumors�of�an�acquisi�ion�can��ave�sub�s�an�ial���a�verse�consequences�for���e��ar�e�.�Curren��or�po�en�ial�cus�omers��may� express� concern� abou�� ��e� uncer�ain�y� associa�e�� wi��� a� c�an�e� of�

�� To�ensure�confi�en�iali�y���c�oose�a�mee�in��place���a��provi�es�sufficien��privacy.�Crea�e�a�wri��en�a�en�a�for���e�mee�in��af�er�solici�in��inpu��from�all�par�icipan�s.�T�e�mee�in��s�oul��s�ar��wi���a�review�of�your�company�an��your�perspec�ive�on���e�ou�look�for���e�in�us�ry.�Encoura�e���e�po�en�ial��ar�e��firm��o�provi�e�informa�ion�on�i�s�own�opera�ions�an��i�s�ou�look�for���e�in�us�ry.�Look�for�areas�of�consensus.

The Role of the Acquisition Plan, Finding a Target, and Making First Contact 163

owners�ip.� Suc�� a� c�an�e� coul�� imply� varia�ion� in� pro�uc�� or� service�quali�y��� reliabili�y��� an�� ��e� level� of� service� provi�e�� un�er� pro�uc�� war�ran�y�or�main�enance�con�rac�s.�Suppliers�worry�abou��possible��isrup�ions�in� ��eir� pro�uc�ion� sc�e�ules� as� ��e� �ransi�ion� �o� ��e� new� owner� �akes�place.� Employees� worry� abou�� possible� layoffs� or� c�an�es� in� compensa��ion.�Compe�i�ors�will��o�w�a����ey�can��o�fan���ese�concerns�in�an�effor���o�persua�e�curren��cus�omers��o�swi�c��an��po�en�ial�cus�omers��o��efer�buyin���ecisions;�key�employees�will�be�encoura�e���o��efec���o���e�com�pe�i�ion.�S�are�ol�ers�may�experience�a��izzyin��ri�e�as�arbi�ra�eurs���buy�in��on���e�rumor���bi��up���e�price�of���e�s�ock�only��o�bail�ou��if��enial�of���e�rumor�appears�cre�ible.

Discussing ValueNei��er� ��e�buyer�nor� seller��as� any� incen�ive� �o�be� ��e� firs�� �o�provi�e�an�es�ima�e�of�value.�I��is��ifficul���o�back�away�from�a�number�pu��on���e��able�by�ei��er�par�y���s�oul��new�informa�ion�emer�e.�Ge��in��a�ran�e�may�be���e�bes��you�can��o.

�iscussin�� values� for� recen�� acquisi�ions� of� similar� businesses� is� one�way� �o� �e�� a� ran�e.��no��er� is� �o� a�ree� �o� a� formula� for� calcula�in�� ��e�purc�ase�price.�For�example�����e�purc�ase�price�may�be��efine��in��erms�of�a�price��o�curren��year�earnin�s�mul�iple.�T�is�way���bo���par�ies�are�able��o�procee���o�performin���ue��ili�ence��o�reac��a�consensus�on���e�ac�ual�curren��year’s�earnin�s�for���e��ar�e��firm.

Preliminary Legal DocumentsTypically���an��early�on���par�ies��o�M&���ransac�ions�ne�o�ia�e�a�confi�en��iali�y�a�reemen�����erm�s�ee����an��le��er�of�in�en�.

Confidentiality Agreement�ll�par�ies� �o� ��e��eal�are� likely� �o�wan��a�confidentiality agreement� (also�calle�� a� non�isclosure� a�reemen�)��� w�ic�� is� �enerally� mu�ually� bin�in�;���a��is���i��covers�all�par�ies��o���e��ransac�ion.�In�ne�o�ia�in����e�confi�en��iali�y� a�reemen���� ��e�buyer� reques�s� as�muc��au�i�e���is�orical��a�a� an��supplemen�al� informa�ion�as� ��e� seller� is�willin�� �o�provi�e.�T�e�pru�en��seller� reques�s� similar� informa�ion� abou�� ��e� buyer� �o� assess� ��e� buyer’s�financial� cre�ibili�y.� I�� is� impor�an�� for� ��e� seller� �o� �e�ermine� ��e� buy�er’s�cre�ibili�y�early�in���e�process�so�as�no���o�was�e��ime�wi���a�po�en��ial� buyer� incapable�of� raisin�� ��e� financin�� �o� comple�e� ��e� �ransac�ion.��

Mergers and Acquisitions Basics164

T�e�a�reemen�� s�oul��cover�only� informa�ion� ��a�� is�no��publicly�avail�able�an��s�oul���ave�a�reasonable�expira�ion��a�e.�No�e���a����e�confi�en��iali�y�a�reemen��can�be�ne�o�ia�e��in�epen�en�ly�or�as�par��of���e��erm�s�ee��or�le��er�of�in�en�.

Term Sheet��term sheet�ou�lines���e�primary��erms�wi�����e�seller�an��is�of�en�use��as���e�basis�for�a�more��e�aile��le��er�of�in�en�.�Involvin��lawyers�an��accoun��an�s�may�no��be�necessary�a����is�s�a�e.�I��is���e�las��poin��before���e�par��ies��o���e�po�en�ial��ransac�ion�s�ar��incurrin��si�nifican��le�al���accoun�in����an��consul�in��expenses.

��s�an�ar�� �erm�s�ee�� is� �ypically� �wo���o� four�pa�es� lon��an��s�ipu�la�es� ��e� �o�al� consi�era�ion�or�purc�ase�price� (of�en�as� a� ran�e)���w�a�� is�bein��acquire��(i.e.���asse�s�or�s�ock)��� limi�a�ions�on���e�use�of�proprie�ary��a�a���a�no-shop agreement�preven�in����e�seller�from�s�arin����e��erms�of���e� buyer’s� proposal�wi���o��er� po�en�ial� buyers�wi��� ��e��ope�of� ins�i��a�in��an�auc�ion�environmen����an��a��ermina�ion��a�e.�Many��ransac�ions�skip���e��erm�s�ee��an���o��irec�ly��o�ne�o�ia�in��a�le��er�of�in�en�.

Letter of IntentUnlike���e�confi�en�iali�y�a�reemen����no��all�par�ies��o���e��ransac�ion�may�wan��a�le��er�of�in�en��(L�I).��l��ou�����e�L�I�can�be�useful�in�i�en�ify�in�� areas� of� a�reemen�� an���isa�reemen�� early� in� ��e� process��� ��e� ri���s�of� all� par�ies� �o� ��e� �ransac�ion��� an�� cer�ain� pro�ec�ive� provisions��� i��may��elay���e�si�nin��of�a��efini�ive�a�reemen��of�purc�ase�an��sale�an��may�also�resul��in�some�le�al�risk��o�ei��er���e�buyer�or�seller�if���e��eal�is�no��consumma�e�.�Public�companies���a��si�n�a�le��er�of�in�en��for�a��ransac��ion�likely��o��ave�a�“ma�erial”�impac��on���e�buyer�or�seller�may�nee���o�announce���e�L�I�publicly��o�comply�wi���securi�ies�law.

T�e�L�I� formally� s�ipula�es� ��e� reason� for� ��e� a�reemen�� an��major��erms� an��con�i�ions.� I�� also� in�ica�es� ��e� responsibili�ies�of�bo���par�ies�w�ile���e�a�reemen��is�in�force���a�reasonable�expira�ion��a�e���an���ow�all�fees�associa�e��wi�����e��ransac�ion�will�be�pai�.�Major��erms�an��con�i��ions�inclu�e�a�brief�ou�line�of���e�s�ruc�ure�of���e��ransac�ion���w�ic��may�en�ail���e�paymen��of�cas��or�s�ock�for�cer�ain�asse�s�an����e�assump�ion�of�cer�ain��ar�e��company�liabili�ies.�T�e�le��er�may�also�specify�cer�ain�con��i�ions���suc��as�an�a�reemen����a��selec�e��personnel�of���e��ar�e��will�no��compe�e�wi�����e�combine��companies�for�some�perio��s�oul����ey�leave.��no��er� con�i�ion� may� in�ica�e� ��a�� a� cer�ain� por�ion� of� ��e� purc�ase�

The Role of the Acquisition Plan, Finding a Target, and Making First Contact 165

price�will�be�alloca�e���o���e�noncompe�e�a�reemen�.�Suc��an�alloca�ion�of���e�purc�ase�price�is�in���e�in�eres�s�of���e�buyer�because���e�amoun��of���e�alloca�ion�can�be�amor�ize��over���e�life�of���e�a�reemen�.��s�suc����i��can�be��aken�as�a��ax��e�uc�ible�expense.�However���i��may�cons�i�u�e��ax�able�income�for���e�seller.�T�e�a�reemen��also�may�place�a�por�ion�of���e�purc�ase�price�in�escrow.

T�e�propose��purc�ase�price�may�be�expresse��as�a�specific��ollar�fi��ure���as�a�ran�e���or�as�a�mul�iple�of�some�measure�of�value���suc��as�opera��in��earnin�s�or�cas�� flow.�T�e�L�I�also� specifies� ��e� �ypes�of��a�a� �o�be�exc�an�e�� an�� ��e��ura�ion� an�� ex�en��of� ��e� ini�ial� �ue��ili�ence.�T�e�L�I�usually�will��ermina�e�if���e�buyer�an����e�seller��o�no��reac��a�ree�men��by�a�cer�ain��a�e.�Le�al���consul�in����an��asse���ransfer�fees�(i.e.���pay�men�s� ma�e� �o� �overnmen�al� en�i�ies� w�en� owners�ip� c�an�es� �an�s)�may�be�pai��for�by���e�buyer�or�seller���or���ey�may�be�s�are�.

�epen�in��on��ow���e�L�I� is�wri��en��� i��may�or�may�no��be� le�ally�bin�in�.���well�wri��en�L�I�usually�con�ains�lan�ua�e�limi�in����e�ex�en���o�w�ic�� ��e�a�reemen��bin�s� ��e� �wo�par�ies.�Price�or�o��er�provisions�are��enerally� subjec�� �o� closin�� con�i�ions��� suc�� as� ��e�buyer��avin�� full�access��o�all�of���e�seller’s�books�an��recor�s;��avin��comple�e���ue��ili��ence;� ob�ainin�� financin�;� an�� �avin�� receive�� approval� from�boar�s� of��irec�ors��� s�ock�ol�ers��� an�� re�ula�ory� bo�ies.� ���er� s�an�ar�� con�i�ions�inclu�e�requirin��si�ne��employmen��con�rac�s�for�key��ar�e��firm�execu��ives�an����e�comple�ion�of�all�necessary�M&���ocumen�s.�Failure��o�sa��isfy�any�of���ese�con�i�ions�will� invali�a�e���e�a�reemen�.���well�wri��en��L�I� s�oul�� also� �escribe� ��e� �ue� �ili�ence� process� in� some� �e�ail.� I��s�oul��s�ipula�e��ow���e�po�en�ial�buyer�s�oul��access� ��e�po�en�ial� sell�er’s�premises�����e�frequency�an���ura�ion�of�suc��access���an���ow�in�rusive�suc��ac�ivi�ies�s�oul��be.�T�e�L�I�s�oul��in�ica�e��ow���e�buyer�s�oul��mee��an���iscuss���e��eal�wi�����e�seller’s�employees���cus�omers���an��sup�pliers.� Some�imes� ��e� provisions� of� a� s�an�ar�� confi�en�iali�y� a�reemen��are�ne�o�ia�e��as�par��of� ��e�L�I.�T�e� le��er�of� in�en��becomes� ��e��ov�ernin���ocumen��for���e��eal���a����e�po�en�ial�acquirer�can�s�ow��o�pro�spec�ive�financin��sources.

T�e�L�I�may�crea�e�le�al�liabili�ies�if�one�of���e�par�ies�is�la�er�accuse��of�no��ne�o�ia�in��in�“�oo��fai��.”�T�is�is���e�basis�for�many�lawsui�s�file��w�en� �ransac�ions� are� un�er�aken� bu�� no�� comple�e�� as� a� resul�� of� �is�a�reemen�s���a��emer�e��urin��len���y�an��of�en��ea�e��ne�o�ia�ions.

In�recen��years���some�le��ers�of�in�en���ave�inclu�e��go-shop provisions���w�ic��allow���e�seller��o�con�inue��o�solici���i��er�bi�s�for�several�mon��s.�

Mergers and Acquisitions Basics166

However���if���e�seller�accep�s�ano��er�bi������e�seller�woul���ave��o�pay�a�breakup�fee��o���e�bi��er�wi���w�om�i���as�a�si�ne��a�reemen�.

*�*�*

Ex�ibi�� ���� recaps� ��e� componen�s� of� a� �ypical� acquisi�ion� plannin��process�as��iscusse��in���is�c�ap�er.�Ne�o�ia�ion�����e�offer�price���financin����an��in�e�ra�ion�are���e�subjec��of���e�nex��c�ap�ers.

EXHIBIT 7-4 Acquisition Planning for the Acquiring Firm1. Plan objectives: Identify the specific purpose of the acquisition, including

the specific goals to achieve (e.g., cost reduction; access to new custom-cost reduction; access to new custom-ers, distribution channels, or proprietary technology; expanded production capacity) and how achieving the goals will better enable the acquiring firm) and how achieving the goals will better enable the acquiring firm to implement its business strategy.

2. Resource/capability evaluation: Evaluate the acquirer’s financial and mana-gerial capability to complete an acquisition. Identify affordability limits in terms of the maximum amount the acquirer should pay for an acquisition. Explain how this figure is determined.

3. Management preferences: Indicate the acquirer’s preferences for a “friendly” acquisition; controlling interest; using stock, debt, cash, or some combina-tion; etc.

4. Timetable: Establish a timetable for completing the acquisition, includ-ing integration if the target firm is to be merged with the acquiring firm’s operations.

5. Search criteria: Develop criteria for identifying target firms and explain plans for conducting the search, why the target ultimately selected was chosen, and how you will make initial contact with the target firm.

6. Negotiation strategy: Identify key buyer/seller issues. Recommend a deal structure that addresses the primary needs of all parties involved. Comment on the characteristics of the deal structure. Such characteristics include the proposed acquisition vehicle (i.e., the legal structure used to acquire the target firm), the postclosing organization (i.e., the legal framework used to manage the combined businesses following closing), and form of payment (i.e., cash, stock, or some combination). Other characteristics include the form of acqui-sition (i.e., whether assets or stock are being acquired) and tax structure (i.e., whether it is a taxable or a nontaxable transaction). Indicate how you might “close the gap” between the seller’s price expectations and the offer price.

7. Determine initial offer price: Provide projected five-year income, bal-ance sheet, and cash-flow statements for the acquiring and target firms

(Continued)

The Role of the Acquisition Plan, Finding a Target, and Making First Contact 167

EXHIBIT 7-4 (Continued) individually, and for the consolidated acquirer and target firms with and

without the effects of synergy. (Note that the projected forecast period can be longer than five years if deemed appropriate.) Develop a prelimi-nary minimum and maximum purchase price range for the target. List key forecast assumptions. Identify an initial offer price, the composition (i.e., cash, stock, debt, or some combination) of the offer price, and why you believe this price is appropriate in terms of meeting the primary needs of both target and acquirer shareholders. The appropriateness of the offer price should reflect your preliminary thinking about the deal structure.

8. Financing plan: Determine if the proposed offer price can be financed with-out endangering the combined firm’s creditworthiness or seriously eroding near-term profitability and cash flow. For publicly traded firms, pay particu-lar attention to the near-term impact of the acquisition on the earnings per share of the combined firms.

9. Integration plan: Identify integration challenges and possible solutions. For financial buyers, identify an “exit strategy.”

�� T�is�case�is�a�ap�e��from�a�paper�wri��en�by�Cur��C�arles���Tuukka�Luolamo���Jeffrey�Ra��el���Ryan�Koma�ome���an��Julius�Kumar���Loyola�Marymoun��Universi�y����pril�2����200�.�I��is�an�a��emp���o�recons�ruc����e�preclosin��even�s��o�illus�ra�e��ow���e�acquisi�ion�process��iscusse��in�C�ap�ers���an��5���as�well�as���e�specific�process�s�eps��e�aile��in�C�ap�er�6�an����is�c�ap�er���may��ave�been�applie��in���is��ransac�ion.�I��su��es�s�a��i��ly�con�ense��version�of�an�ac�ual�business�an��acquisi�ion�plan.

A Case in Point: K2 Incorporated Acquires Fotoball USA8

Our story begins in the early 2000s. K2 is a sporting goods equipment manufac-turer whose portfolio of brands includes Rawlings, Worth, Shakespeare, Pflueger, Stearns, K2, Ride, Olin, Morrow, Tubbs, and Atlas. The company’s diversified mix of products is used primarily in team and individual sports activities, and its pri-mary customers are sporting goods retailers, many of which are not strongly capitalized. Historically, the firm has been able to achieve profitable growth by introducing new products into fast-growing markets. Most K2 products are man-ufactured in China, which helps ensure cost competitiveness but also potentially subjects the company to a variety of global uncertainties.

K2’s success depends on its ability to keep abreast of changes in taste and style and to offer competitive prices. The company’s external analysis at the time

Mergers and Acquisitions Basics168

showed that the most successful sporting goods suppliers would be those with the greatest resources, including management talent and capital; the ability to produce or source high-quality, low-cost products and deliver them on a timely basis; and access to distribution channels with a broad array of products and brands. Management expected that large retailers would prefer to rely on fewer and larger sporting goods suppliers to help them manage the supply of prod-ucts and the allocation of shelf space.

The firm’s primary customers are sporting goods retailers. At the time, many of K2’s smaller retailers and some larger retailers were not strongly capitalized. Adverse conditions in the sporting goods retail industry could adversely impact the ability of retailers to purchase K2 products. Secondary customers included individuals, both hobbyists as well as professionals.

The firm had a few top competitors, but there were other large sporting goods suppliers with substantial brand recognition and financial resources with whom K2 did not compete. However, they could easily enter K2’s currently served markets. In the company’s secondary business, sports apparel, it did face stiff competition from some of these same suppliers, including Nike and Reebok.

K2’s internal analysis showed that the firm was susceptible to imitation, despite strong brand names, and that some potential competitors had sub-stantially greater financial resources than K2. One key strength was the relation-ships K2 had built with collegiate and professional leagues and teams, not easily usurped. Larger competitors may have had the capacity to take away some of these relationships, but K2 had so many that it could withstand the loss of one or two. The primary weakness of K2 was its relatively small size in comparison to major competitors.

As a long-term strategic objective, K2 set out to be number one in market share in the markets it served by becoming the low-cost supplier. To that end, K2 wanted to meet or exceed its corporate cost of capital of 15 percent; achieve sustained double-digit revenue growth, gross profit margins above 35 percent, and net profit margins in excess of 5 percent within five years; and reduce its debt-to-equity ratio to the industry average of 25 percent in the same period. The business strat-egy for meeting this objective was to become the low-cost supplier in new niche segments of the sporting goods and recreational markets. The firm would use its existing administrative and logistical infrastructure to support entry into these new segments, new distribution channels, and new product launches through existing distribution channels. Also, K2 planned to continue its aggressive cost cutting and expand its global sourcing to include low-cost countries other than China.

All this required an implementation strategy. K2 decided to avoid product or market extension through partnering because of the potential for loss of control and for creating competitors once such agreements lapse. Rather, the strategy would build on the firm’s great success, in recent years, acquiring and

The Role of the Acquisition Plan, Finding a Target, and Making First Contact 169

integrating smaller sporting goods companies with well-established brands and complementary distribution channels. To that end, M&A-related functional strategies were developed. A potential target for acquisition would be a com-pany that holds many licenses with professional sports teams. Through its rela-tionship with those teams, K2 could further promote its line of sporting gear and equipment.

In addition, K2 planned to increase its R&D budget by 10 percent annu-ally over five years to focus on developing equipment and apparel that could be offered to the customer base of firms it acquired during the period. Existing licensing agreements between a target firm and its partners could be enhanced to include the many products K2 now offers. If feasible, the sales force of a target firm would be merged with that of K2 to realize significant cost savings.

K2 also thought through the issue of strategic controls. The company had incentive systems in place to motivate work toward implementing its business strategy. There were also monitoring systems to track the actual performance of the firm against the business plan.

In its acquisition plan, K2’s overarching financial objective was to earn at least its cost of capital. The plan’s primary nonfinancial objective was to acquire a firm with well-established brands and complementary distribution channels. More specifically, K2 sought an acquisition with a successful franchise in the market-ing and manufacturing of souvenir and promotional products that could be eas-ily integrated into K2’s current operations.

The acquisition plan included an evaluation of resources and capabilities. K2 established that after completion of a merger, the target’s sourcing and manu-facturing capabilities must be integrated with those of K2, which would also retain management, key employees, customers, distributors, vendors and other business partners of both companies. An evaluation of financial risk showed that borrowing under K2’s existing $205 million revolving credit facility and under its $20 million term loan, as well as potential future financings, could substantially increase current leverage, which could—among other things—adversely affect the cost and availability of funds from commercial lenders and K2’s ability to expand its business, market its products, and make needed infrastructure invest-ments. If new shares of K2 stock were issued to pay for the target firm, K2 deter-mined that its earnings per share could be diluted unless anticipated synergies were realized in a timely fashion. Moreover, overpaying for any firm could result in K2 failing to earn its cost of capital.

Ultimately, management set some specific preferences: the target should be smaller than $100 million in market capitalization and should have positive cash flows, and it should be focused on the sports or outdoor activities market. The initial search, by K2’s experienced acquisition team, would involve analyzing cur-rent competitors. The acquisition would be made through a stock purchase—K2

Mergers and Acquisitions Basics170

chose to consider only friendly takeovers involving 100 percent of the target’s stock—and the form of payment would be new K2 nonvoting common stock. The target firm’s current year P/E should not exceed 20.

After an exhaustive search, K2 identified Fotoball USA as its most attractive target due to its size, predictable cash flows, complementary product offering, and many licenses with most of the major sports leagues and college teams. Fotoball USA represented a premier platform for expansion of K2’s marketing capabilities because of its expertise in the industry and place as an industry leader in many sports and entertainment souvenir and promotional product categories. K2 believed the fit with the Rawlings division would make both com-panies stronger in the marketplace. Fotoball also had proven expertise in licens-ing programs, which would assist K2 in developing additional revenue sources for its portfolio of brands. In 2003, Fotoball had lost $3.2 million, so it was antici-pated that the company would be receptive to an acquisition proposal and that a stock-for-stock exchange offer would be very attractive to Fotoball sharehold-ers because of the anticipated high-earning growth rate of the combined firms.

Negotiations ensued, and the stock-for-stock offer contained a significant premium, which was well received. Fotoball was a very young company at the time, and many of its investors were looking to make their profits through the growth of the stock. The offer would allow Fotoball shareholders to defer taxes until they decided to sell their stocks and be taxed at the capital gains rate. Earnouts were also included in the deal to give management incentives to run the company effectively and meet deadlines in a timely order.

Valuations for both K2 and Fotoball reflected anticipated synergies due to economies of scale and scope, namely, reductions in selling expenses of approx-imately $1 million per year, in distribution expenses of approximately $500,000 per year, and in annual G&A expenses of approximately $470,000. The combined market value of the two firms was estimated at $909 million—an increase of $82.7 million over the sum of the standalone values of the two firms.

Based on Fotoball’s outstanding common stock of 3.6 million shares, and the stock price of $4.02 at that time, a minimum offer price was determined by multiplying the stock price by the number of shares outstanding. The minimum offer price was $14.5 million. Were K2 to concede 100 percent of the value of synergy to Fotoball, the value of the firm would be $97.2 million. However, shar-ing more than 45 percent of synergy with Fotoball would have caused a serious dilution of earnings. To determine the amount of synergy to share with Fotoball’s shareholders, K2 looked at what portion of the combined firms’ revenues would be contributed by each of the players and then applied that proportion to the synergy. Because 96 percent of the projected combined firms’ revenues in fiscal year 2004 were expected to come from K2, only 4 percent of the synergy value was added to the minimum offer price to come up with an initial offer price of $17.8 million, or $4.94 per share. That represented a premium of 23 percent over the market value of Fotoball’s stock at the time.

The Role of the Acquisition Plan, Finding a Target, and Making First Contact 171

The synergies and Fotoball’s relatively small size compared to K2 made it unlikely that the merger would endanger K2’s creditworthiness or near-term profitability. Although the contribution to earnings would be relatively small, the addition of Fotoball would help diversify and smooth K2’s revenue stream, which had been subject to seasonality in the past.

Organizationally, the integration of Fotoball into K2 would be achieved by operating Fotoball as a wholly owned subsidiary of K2, with current Fotoball management remaining in place. All key employees would receive retention bonuses as a condition of closing. Integration teams consisting of employees from both firms were set to move expeditiously according to a schedule estab-lished prior to closing the deal. The objective would be to implement the best practices of both firms.

On January 26, 2004, K2 Inc. completed the purchase of Fotoball USA in an all-stock transaction. Immediately after, senior K2 managers communicated (onsite, where possible) with Fotoball customers, suppliers, and employees to allay any immediate concerns.

Things to Think About:1. How did K2’s acquisition plan objective support the realization of its corpo-

rate mission and strategic objectives?2. What alternatives to M&As could K2 have employed to pursue its growth

strategy? Why were the alternatives rejected?3. How did the K2 negotiating strategy seek to meet the primary needs of the

Fotoball shareholders and employees?4. Do you believe K2 paid a fair price for Fotoball? Explain your answer.

Answers can be found at: www.elsevierdirect.com/companion.jsp?ISBN=9780123749482

173Mergers and Acquisitions Basics� ©�2011�Elsevier�Inc.ISBN:�����0�12��������2�� ��I: �ll ri���s reserve�.����0�12��������2�� ��I: �ll ri���s reserve�.�����I:� �ll�ri���s�reserve�.

CHAPTER

201110.1016/B����0�12��������2.0000��1

The Negotiation, Integration Planning, and Closing Phases

T�e�ne�o�ia�ion�p�ase�of�en�is���e�mos��complex�aspec��of���e�acquisi�ion�process.�I��involves�refinin����e�preliminary�valua�ion���s�ruc�urin����e��eal���con�uc�in���ue��ili�ence���an���evelopin��a�financin��plan.�I��is�in�erac�ive�an��i�era�ive.��c�ivi�ies�unfol��concurren�ly.�I��is��urin����is�p�ase���a����e�ac�ual� purc�ase� price� pai�� for� ��e� acquire�� business� is� �e�ermine�—an��frequen�ly���e�price�will�be�qui�e�a�bi���ifferen��from���e�ini�ial�valua�ion�of���e��ar�e��company���w�ic��was�probably�ma�e�before��ue��ili�ence�an��wi���only�limi�e����publicly�available�informa�ion.

In���is�c�ap�er�����e�emp�asis�is�on�ne�o�ia�ion�in���e�con�ex��of�prob�lem� solvin�� or� in�eres��base�� bar�ainin���� in� w�ic�� par�ies� look� a�� ��eir�un�erlyin��in�eres�s�ra��er���an�simply�s�a�e�posi�ions�an��make��eman�s.�In�mos��successful�ne�o�ia�ions���par�ies��o���e��ransac�ion�searc��join�ly�for�solu�ions��o�problems.��ll�par�ies�mus��be�willin���o�make�concessions���a��sa�isfy���eir�own�nee�s�as�well�as���e��i��es��priori�y�nee�s�of���e�o��ers�involve��in���e�ne�o�ia�ion.

You�will� learn� �ere� �ow� �o� �evelop� an� effec�ive� ne�o�ia�in�� s�ra�e�y�an���ow�par�ies� �o� a� �ransac�ion� can� reac�� consensus�on�purc�ase�price.�You�will�also�learn�abou����e�elemen�s�of�in�e�ra�ion�plannin��an��closin�.

NegotiatioN Phase

T�e�ne�o�ia�ion�p�ase�comprises� four� i�era�ive�ac�ivi�ies� ��a��may�be�in�a���ifferen���imes�bu���en���o�overlap.��ne�ac�ivi�y�is�refinin����e�preliminary�valua�ion���w�ic��provi�es� ��e� s�ar�in��poin�� for�ne�o�ia�in�� ��e�a�reemen��of�purc�ase�an�� sale.�T�is� is�base��on�new� informa�ion�uncovere��as�par��of� �ue� �ili�ence��� ano��er� of� ��e� four� ac�ivi�ies���w�ic�� provi�es� a��i�ional�informa�ion��o�enable���e�buyer��o�un�ers�an��be��er���e�na�ure�of���e�lia�bili�ies���a��may�be�assume��an���o�confirm�perceive��sources�of�value.�(�ue��ili�ence���in�fac����is�also�essen�ial�in�pos�ne�o�ia�ion�p�ases.)��eal�s�ruc�urin��involves�mee�in����e�nee�s�of�bo���par�ies�by�a��ressin��issues�of�risk�an��rewar��by�cons�ruc�in��an�appropria�e� se��of�compensa�ion��� le�al��� �ax���an��accoun�in��s�ruc�ures.�T�e�four���of���ese�ac�ivi�ies�is��evelopin��a�financin��

8

Mergers and Acquisitions Basics174

plan���w�ic��provi�es�a�reali�y�c�eck�for���e�buyer�by��efinin����e�maximum�amoun����e�buyer�can�reasonably�expec���o�finance�an����in��urn���pay�for���e��ar�e��company.�Eac��of���ese�ac�ivi�ies�is��e�aile��in���e�followin��sec�ions.

Refining ValuationT�e�s�ar�in��poin��for�ne�o�ia�ion�is��o�up�a�e���e�preliminary��ar�e��com�pany�valua�ion���base��on�new� informa�ion.���buyer� reques�s� an��reviews�a�� leas�� ��ree� �o� five�years’�wor���of��is�orical� financial� �a�a.��l��ou��� i��is��i��ly��esirable��o�examine��a�a���a���ave�been�au�i�e��in�accor�ance�wi��� Generally��ccep�e���ccoun�in�� Principles� (G��P)��� suc�� �a�a� may�no��be�available�for�small���priva�ely�owne��companies.�In�fac����small�com�panies� rarely� �ire� ou�si�e� accoun�in�� firms� �o� con�uc�� expensive� au�i�s�unless���ey�are�require���o��o�so�as�par��of�a�loan�a�reemen�.

T�e� �is�orical� �a�a� s�oul�� be� normalize���� or� a�jus�e�� for� nonrecur�rin���ains���losses���or�expenses.�Nonrecurrin���ains�or�losses�can�resul��from���e�sale�of�lan����equipmen����pro�uc��lines���pa�en�s���sof�ware���or�copyri���s.�Nonrecurrin�� expenses� inclu�e� severance� paymen�s��� employee� si�nin��bonuses���an��se��lemen�s�of�li�i�a�ion.�T�ese�a�jus�men�s�allow���e�buyer��o�smoo���ou�� irre�ulari�ies� in� ��e��is�orical� informa�ion�an��be��er�un�er�s�an�� ��e�un�erlyin�� �ynamics� of� ��e� business.��f�er� ��e� �a�a� �ave� been�normalize���� eac�� major� expense� ca�e�ory� s�oul�� be� expresse�� as� a� per�cen�a�e�of�revenue.�T�rou���observance�of�year��o�year�c�an�es�in���ese�ra�ios���sus�ainable��ren�s�in���e��a�a�are�more��iscernable.

Deal StructuringIn�purely�financial��erms����eal�s�ruc�urin��involves���e�alloca�ion�of�cas��flow� s�reams� (wi��� respec�� �o�amoun��an�� �imin�);� ��e�alloca�ion�of� risk;�an���� ��erefore��� ��e� alloca�ion� of� value� be�ween� �ifferen�� par�ies� �o� ��e��ransac�ion.�However���because�of���e��uman�elemen��involve��in�ne�o�ia��ion����eal�s�ruc�urin��mus��also�be�a�process�of�i�en�ifyin��an��sa�isfyin��as�many�of���e��i��es��priori�y�objec�ives�of���e�par�ies�involve��in���e��rans�ac�ion� as� possible��� subjec�� �o� ��eir� �olerance� for� risk.�T�e� process� be�ins�wi���eac��par�y��e�erminin��i�s�own�ini�ial�ne�o�ia�in��posi�ion���po�en�ial�risks���op�ions�for�mana�in��risk���levels�of��olerance�for�risk���an��con�i�ions�un�er�w�ic��ei��er�par�y�will�“walk�away”�from���e�ne�o�ia�ions.�(T�ese�elemen�s� of� ne�o�ia�ion� are� �iscusse�� in� consi�erably� more� �e�ail� a�� ��e�en��of���is�c�ap�er���un�er�“T�ou���s�on�Ne�o�ia�in���ynamics.”

In� prac�ice��� �eal� s�ruc�urin�� is� abou�� un�ers�an�in�� po�en�ial� sources�of��isa�reemen�—from� simple� ar�umen�s�over�basic� fac�s� �o� subs�an�ially�more�complex�issues���suc��as���e�form�of�paymen��an��le�al���accoun�in����

The Negotiation, Integration Planning, and Closing Phases 175

an���ax�s�ruc�ures.�I��also�requires�un�ers�an�in����e�po�en�ial�conflic�s�of�in�eres����a��can�influence���e�ou�come�of��iscussions.�For�example���w�en�a� por�ion�of� ��e� purc�ase� price� �epen�s� on� ��e� lon���erm�performance�of���e�acquire��business���i�s�mana�emen�—of�en���e�former�owner—may�no��be�ave�in�a�manner���a��serves���e�acquirer’s�bes��in�eres�s.

�ecisions�ma�e���rou��ou����e��eal�s�ruc�urin��process�influence�var�ious�a��ribu�es�of� ��e��eal��� inclu�in���ow�owners�ip� is��e�ermine�����ow�asse�s� are� �ransferre���� �ow� owners�ip� is� pro�ec�e�� (i.e.��� �overnance)��� an���ow�risk�is�appor�ione��amon��par�ies��o���e��ransac�ion.����er�a��ribu�es�inclu�e���e��ype���number���an��complexi�y�of���e��ocumen�s�require��for�closin�;���e��ypes�of�approvals�require�;�an����e��ime�nee�e���o�comple�e���e� �ransac�ion.�T�ese� �ecisions� also� will� influence� �ow� ��e� combine��companies�will�be�mana�e������e�amoun��an���imin��of�resources�commi���e����an����e�ma�ni�u�e�an���imin��of�curren��an��fu�ure��ax�liabili�ies.1

�eal�s�ruc�urin��mus��also�accoun��for�fee�back�effec�s���w�ere�one�ele�men��of���e�process���suc��as���e�na�ure�of�paymen��(inclu�in��amoun�����im�in����an��risk)���may�affec��ano��er�elemen�—in���is�example����ax�s�ra�e�ies.

Given� i�s� complexi�y��� ��e� deal-structuring process� s�oul�� be� viewe�� as�comprisin��a�number�of�in�er�epen�en��componen�s.����a�minimum�����ese�componen�s� inclu�e� ��e�acquisi�ion�ve�icle���pos�closin��or�aniza�ion��� le�al�form� of� ��e� sellin�� en�i�y��� form� of� paymen���� form� of� acquisi�ion��� an�� �ax�consi�era�ions.�T�e� acquisition vehicle� refers� �o� ��e� le�al� s�ruc�ure� (e.�.���corpora�ion�or�par�ners�ip)�use���o�acquire���e��ar�e��company.�T�e�pos��closin��or�aniza�ion�is���e�or�aniza�ional�an��le�al�framework�(e.�.���corpo�ra�ion�or�par�ners�ip)�use�� �o�mana�e� ��e� combine��businesses� followin����e�comple�ion�of���e��ransac�ion.�T�e�legal form of the selling entity�refers��o�w�e��er� ��e� seller� is� a�C�or� subc�ap�er�S�corpora�ion��� a� limi�e�� liabil�i�y�company���or�a�par�ners�ip.�T�ese�consi�era�ions�will�affec��bo�����e��ax�s�ruc�ure�of���e��eal�an��form�of�paymen�.�T�e�form of payment�may�con�sis�� of� cas���� common� s�ock��� �eb���� or� some�combina�ion.� Some�por�ion�of���e�paymen��may�be��eferre��or�be��epen�en��on���e�fu�ure�performance�of� ��e� acquire��en�i�y.�T�e� form of acquisition� reflec�s�bo���w�a�� is�bein��acquire�� (e.�.��� s�ock� or� asse�s)� an�� ��e� form� of� paymen�.� Consequen�ly�����e� form�of� acquisi�ion� lar�ely��e�ermines� ��e� �ax� s�ruc�ures.��s� a��eneral�rule��� a� �ransac�ion� is� �axable� if� remunera�ion�pai�� �o� ��e� �ar�e�� company’s�s�are�ol�ers�is�primarily�some��in��o��er���an���e�acquirer’s�s�ock���an��i��is�non�axable�(i.e.����ax��eferre�)�if�w�a����ey�receive�is�lar�ely�acquirer�s�ock.�Finally���tax considerations�refer��o���e�po�en�ial�impac��of�financial�repor�in��

1� McCar��y�(1���);�Tillin��as��(1���).

Mergers and Acquisitions Basics176

requiremen�s�on���e�earnin�s�vola�ili�y�of�business�combina�ions����ue��o���e�nee���o�perio�ically�revalue�acquire��asse�s��o���eir�fair�marke��value�as�new�informa�ion� becomes� available.� Fair� marke�� value� is� w�a�� a� willin�� buyer�an��seller��avin��access��o���e�same�informa�ion�woul��pay�for�an�asse�.2

Conducting Due DiligenceDue diligence� is� an� ex�aus�ive� review� of� recor�s� an�� facili�ies� an�� �ypi�cally�con�inues� ��rou��ou�� ��e�ne�o�ia�ion�p�ase.��l��ou���some��e�ree�of�pro�ec�ion�is�ac�ieve����rou���a�well�wri��en�con�rac����le�al��ocumen�s�s�oul�� never� be� viewe�� as� a� subs�i�u�e� for� con�uc�in�� formal� �ue� �ili��ence.��l��ou����ue��ili�ence�is�mos��of�en�associa�e��wi���buyers���bo���sellers�an��len�ers�will�also�con�uc���ue��ili�ence.�

T�e�acquirer��ypically�a��emp�s��o�pro�ec��i�self���rou����ue��ili�ence���ex�ensive�represen�a�ions�an��warran�ies�(i.e.���claims�an��promises�ma�e�by���e�seller)���or�some�combina�ion�of���e��wo.�In�some�ins�ances���buyers�an��sellers� may� a�ree� �o� an� abbrevia�e�� �ue� �ili�ence� perio�� on� ��e� ��eory���a�� ��e�buyer�can�be�pro�ec�e��in�a�well�wri��en�a�reemen��of�purc�ase�an��sale�in�w�ic����e�seller�is�require���o�make�cer�ain�represen�a�ions�an��warran�� ��a�� ��ey� are� �rue.�T�ese� represen�a�ions� coul�� inclu�e� ��e� sell�er’s�acknowle��emen����a��i��owns�all�asse�s� lis�e��in���e�a�reemen��“free�an��clear”�of�any�liens���wi���a�mec�anism�for�compensa�in����e�buyer�for�any� ma�erial� loss� (�efine�� in� ��e� con�rac�)� s�oul�� ��e� represen�a�ion� be�breac�e��(i.e.���foun��no���o�be��rue).�Relyin��on�reps�an��warran�ies�as�a�subs�i�u�e�for�a���orou����ue��ili�ence�effor��is�rarely�a��oo��i�ea.

�n� expensive� an�� ex�aus�in�� process��� �ue� �ili�ence� is��� by� i�s� na�ure����i��ly� in�rusive�an��places� consi�erable��eman�s�on�mana�ers’� �ime�an��a��en�ion.�Frequen�ly�����e�buyer�wan�s�as�muc���ime�as�necessary��o�com�ple�e��ue��ili�ence���w�ereas� ��e� seller�will�wan�� �o� limi�� ��e� len���� an��scope�as�muc��as�possible.

�ue��ili�ence�rarely�works��o���e�a�van�a�e�of���e�seller�because�a�lon��an���e�aile���ue��ili�ence�process�is�likely��o�uncover�i�ems���e�buyer�will�use�as�a�reason��o�lower���e�purc�ase�price.�Consequen�ly���sellers�may�seek��o��ermina�e��ue��ili�ence�before���e�buyer�feels�i��is�appropria�e.��If���e�

�� For�a��e�aile���iscussion�of���e��ue��ili�ence�process�an��bes��prac�ices���see�Selim�(200�).�� �ne�way�sellers��ry��o�limi���ue��ili�ence�is��o�seques�er���e�acquirer’s��eam�in�a�data room.�Typically���

��is�is�a�conference�room�fille��wi���file�cabine�s�an��boxes�of��ocumen�s�reques�e��by���e�buyer’s��ue��ili�ence��eam.�Formal�presen�a�ions�by���e�seller’s�key�mana�ers�are��iven�in���e�of�en�crampe��con�i�ions�of���e��a�a�room.�In�o��er�ins�ances�����e�po�en�ial�buyer�may��ave�limi�e��access��o�informa�ion�on�a�passwor��pro�ec�e��websi�e.

2� For�a�more��e�aile���iscussion�of��ow��o�s�ruc�ure�M&���ransac�ions���see��ePamp�ilis�(2010).

The Negotiation, Integration Planning, and Closing Phases 177

�ar�e�� firm� succee�s� in� re�ucin�� ��e�amoun��of� informa�ion��isclose�� �o���e��ar�e��firm���i��can�expec���o�be�require���o�make�more�represen�a�ions�an��warran�ies�as��o���e�accuracy�of�i�s�claims�an��promises�in���e�purc�ase�an��sale�a�reemen�.�T�is�will�no��oub��a����o���e�ne�o�ia�in���ime.5

The Components of Due DiligenceT�ree�primary�reviews�comprise��ue��ili�ence;���ey�are�of�equal�impor�ance�an��of�en�occur�concurren�ly.�T�e�s�ra�e�ic�an��opera�ional�review�con�uc�e���by�senior�opera�ions�an��marke�in��mana�emen��asks�ques�ions���a��focus�on���e�seller’s�mana�emen�� �eam���opera�ions���an��sales�an��marke�in��s�ra�e�ies.�T�e�financial�review��irec�e��by�financial�an��accoun�in��personnel�focuses�on� ��e� accuracy��� �imeliness��� an�� comple�eness� of� ��e� seller’s� financial� s�a�e�men�s.���le�al�review���con�uc�e��by���e�buyer’s�le�al�counsel����eals�wi���cor�pora�e� recor�s��� financial�ma��ers���mana�emen�� an�� employee� issues��� �an�ible�an��in�an�ible�asse�s�of���e�seller���an��ma�erial�con�rac�s�an��obli�a�ions�of���e�seller���suc��as�li�i�a�ion�an��claims.���ri�orous��ue��ili�ence�process�requires���e� crea�ion� of� compre�ensive� c�ecklis�s.�T�e� in�erview� process� provi�es�invaluable�sources�of�informa�ion.�By�askin����e�same�ques�ions�of�a�number�of�key�mana�ers�����e�acquirer�is�able��o�vali�a�e���e�accuracy�of�i�s�conclusions.

Buyer Due DiligenceBuyers� use� �ue� �ili�ence� �o� vali�a�e� assump�ions� un�erlyin�� valua�ion.�T�e�primary�objec�ives�of�buyer’s��ue��ili�ence�are��o� i�en�ify�an��con�firm�sources�of�value�or�syner�y�an��mi�i�a�e�real�or�po�en�ial�liabili�y�by�lookin��for�fa�al�flaws���a��re�uce�value.�Ex�ibi����1�ca�e�orizes�po�en�ial�sources�of�value�from�syner�y���a��may�be�uncovere��or�confirme���urin���ue��ili�ence�an����e�impac����ey�may��ave�on�opera�in��performance.

Seller Due Diligence�l��ou��� ��e� bulk� of� �ue� �ili�ence� is� performe�� by� ��e� buyer� on� ��e�seller��� ��e�pru�en��seller�s�oul��also�perform��ue��ili�ence�on���e�buyer.�In��oin��so�����e�seller�can��e�ermine�w�e��er���e�buyer��as���e�financial�w�erewi��al��o�finance���e�purc�ase.�Frequen�ly���as�par��of�i�s�own��ue��il�i�ence���a�seller�will�require�i�s�mana�ers��o�si�n�affi�avi�s�a��es�in��(�o���e�“bes��of���eir�knowle��e”)��o���e��ru��fulness�of�w�a��is�bein��represen�e��in���e�con�rac����a��per�ains��o���eir�areas�of�responsibili�y.

Pru�en��sellers�also�con�uc��in�ernal��ue��ili�ence.�T�rou���an�inves�i��a�ion�of�i�s�own�opera�ions�����e�seller��opes��o�mi�i�a�e�liabili�y�s�emmin��

5� ��buyer�is�well�a�vise���o�rely�more�on�an�onsi�e�review�of�facili�ies�an��recor�s�an��personnel�in�erviews���an�on�a�seller’s�con�rac��obli�a�ions.�S�oul��a�seller��eclare�bankrup�cy����isappear���or�move�asse�s��o�offs�ore�accoun�s���receivin��remunera�ion�for�breac��of�con�rac��may�be�impossible.

Mergers and Acquisitions Basics

178EXHIBIT 8-1 Identifying Potential Sources of ValuePotential Source of Value Examples Potential Impact

Operating Synergy:l Elimination of functional overlapl Productivity improvementl Purchasing discountsl Working capital management

l Facilities management– Economies of scale– Economies of scope

l Organizational realignment

l Reduction in duplicate overhead positions (e.g., management)l Increased output per employeel Volume discounts on material purchasesl Reduced days in receivables due to improved collection of

accounts receivablel Fewer days in inventory due to improved inventory turns

l Increased production in underutilized facilitiesl Data centers, R&D functions, call centers, etc., support

multiple product lines/operationsl Reduction in the number of layers of management

l Improved marginsl Samel Samel Improved return on total

assetsl Same

l Samel Same

l Improved communicationl Reduced bureaucratic inertia

Financial Synergy:l Increased borrowing capacityl Increased leverage

l Target has little debt and many unencumbered assetsl Access to lower-cost source of funds

l Increased access to financingl Lower cost of capital

Marketing/Product Synergy:l Access to new distribution channelsl Cross-selling opportunitiesl Research & developmentl Product development

l Increased sales opportunitiesl Selling acquirer products to target customers and vice versal Cross-fertilization of ideasl Increased advertising budget

l Increased revenuel Samel More innovationl Improved market share

Control:l Opportunity identificationl More proactive management style

l Acquirer sees opportunities not seen by target’s managementl More decisive decision making

l New growth opportunitiesl Improved financial returns

The Negotiation, Integration Planning, and Closing Phases 179

from�inaccuracies�in���e�seller’s�represen�a�ions�an��warran�ies�ma�e�in���e��efini�ive�a�reemen��of�purc�ase�an��sale.

Lender Due DiligenceIf� ��e�acquirer� is�borrowin���o�buy�a� �ar�e�� firm��� ��e� len�er(s)�will�wan���o� perform� ��eir� own� �ue� �ili�ence� in�epen�en�� of� ��e� buyer’s� effor�.�Mul�iple�len�er��ue��ili�ences���of�en�performe��concurren�ly���can�be�qui�e�bur�ensome��o���e��ar�e��firm’s�mana�emen��an��employees���an����e�seller�s�oul��a�ree��o���ese��isrup�ive�ac�ivi�ies�only�if�confi�en����a����e��rans�ac�ion�will�be�consumma�e��wi��in�a�reasonable�perio�.

Developing the Financing PlanT�e�las��of���e�four�ne�o�ia�ion�p�ase�ac�ivi�ies�is��o��evelop�balance�s�ee����income��� an�� cas��flow� s�a�emen�s� for� ��e� combine�� firms.� Unlike� ��e�financial�projec�ions�of�cas��flow�ma�e��o�value���e��ar�e������ese�s�a�emen�s�s�oul��inclu�e���e�expec�e��cos��of�financin����e��ransac�ion.��evelopin����e�financin��plan�is�a�key�inpu��in��e�erminin����e�purc�ase�price�because�i��places�a�limi�a�ion�on���e�amoun����e�buyer�can�offer���e�seller.�I��lar�ely�is� use�� as� a� marke�in�� or� sales� �ocumen�� �o� ne�o�ia�e� ��e� bes�� possible��erms�for�financin����e�propose���ransac�ion.�(T�e�financin��plan�an��way��ransac�ions�are�finance��are��iscusse��in�more��e�ail�in�C�ap�er��.)

T�e�financin��plan�is�appen�e���o���e�acquirer’s�business�an��acquisi��ion�plans�an�� is�use�� �o�ob�ain� financin�� for� ��e� �ransac�ion.�No�ma��er���e�size�of���e��ransac�ion���len�ers�an��inves�ors�will�wan���o�see�a�co�eren��analysis�of�w�y���e�propose���ransac�ion�is�a��oo��inves�men��oppor�uni�y.

Mos��well�wri��en�a�reemen�s�of�purc�ase�an��sale�con�ain�a�financin��con�in�ency.�T�e�buyer� is�no�� subjec�� �o� ��e� �erms�of� ��e�con�rac�� if� ��e�buyer�canno��ob�ain�a�equa�e�fun�in���o�comple�e���e��ransac�ion.�Breakup�fees�(see�C�ap�er��)�can�be�par�icularly�useful��o�ensure���a����e�buyer�will�a��emp�� �o�ob�ain� financin�� as� a��ressively� as� possible.� In� some� ins�ances�����e�seller�may�require���e�buyer��o�pu��a�nonrefun�able��eposi��in�escrow��o�be�forfei�e��if� ��e�buyer�is�unable��o�ob�ain�financin���o�comple�e���e��ransac�ion.�(Escrow�is��iscusse��fur��er�a����e�en��of���is�c�ap�er.)

iNtegratioN PlaNNiNg Phase

T�e� eup�oria� ��a�� surroun�s� ��e� successful� comple�ion� of� a� �ransac�ion�ero�es�quickly�w�en� ��e� c�allen�es�of�makin�� ��e� combine�� firms�per�form�in�line�wi�����e�pre�ic�ions�lai��ou��in���e�business�an��acquisi�ion�

Mergers and Acquisitions Basics180

plans�become�apparen�.��f�er���e��ocumen�s�are�si�ne������e�buyer��as�los��mos����if�no��all���levera�e�over���e�seller.

Par��of���e�premer�er�in�e�ra�ion�plannin��process�involves���e�preclosin���ue��ili�ence�ac�ivi�y.��ne�responsibili�y�of���e��ue��ili�ence��eam�is��o�i�en��ify�ways�in�w�ic��asse�s���processes���an��o��er�resources�can�be�combine���o�realize�cos��savin�s���pro�uc�ivi�y�improvemen�s���or�o��er�perceive��syner�ies.�T�is�informa�ion�is�also�essen�ial�for�refinin����e�valua�ion�process�by�enablin��planners� �o� un�ers�an�� be��er� ��e� necessary� sequencin�� of� even�s� an�� ��e�resul�in��pace�a��w�ic����e�expec�e��syner�ies�may�be�realize�.�Consequen�ly���un�ers�an�in�� �ow� an�� over� w�a�� perio�� ��e� in�e�ra�ion� will� be� imple�men�e�� is� impor�an�� in��e�erminin�� ��e�ma�ni�u�e�an�� �imin��of� ��e�cas��flows�of���e�combine��companies�use���o�make���e�final�assessmen��of�value.

In�e�ra�ion�plannin��also�involves�a��ressin���uman�resource���cus�omer���an��supplier� issues���a��overlap���e�c�an�e�of�owners�ip.�T�ese�are� transi-tional� issues� �o� resolve� as�par��of� ��e� a�reemen��of�purc�ase� an�� sale��� an��i��is�cri�ical���a����e�seller’s�responsibili�ies�be�ne�o�ia�e��before�closin���o�make���e�ac�ual��ransi�ion�as�smoo���as�possible.��lso���a�coopera�ive�effor��is�mos��likely�prior��o�closin�.�For�example�����e�a�reemen��may�s�ipula�e��ow��ar�e��company�employees�will�be�pai��an���ow���eir�benefi��claims�will�be�processe�.6�Similar��imin��issues�exis��for��ar�e��company�cus�omers�an��suppliers.�For�example�����e�mer�er�a�reemen��s�oul��specify��ow���e�seller�s�oul�� be� reimburse�� for� pro�uc�s� s�ippe�� or� services� provi�e�� by� ��e�seller�before�closin����bu��no��pai��for�by���e�cus�omer�un�il�af�er�closin�.�

�� ��pru�en��buyer��ypically�woul��be���e�recipien��of�suc��paymen�s�because���e�seller’s�previous�lockboxes�(i.e.���c�eckin��accoun�s)�woul���ave�been�close��an��replace��by���ose�of���e�buyer.�Likewise�����e�buyer�will�wan���o�be�reimburse��by���e�seller�for�monies�owe���o�suppliers�for�pro�uc�s�or�services�provi�e���o���e�seller�before�closin����bu��no��bille��un�il�af�er�closin�.�T�e�mer�er�a�reemen��may�in�ica�e���a��bo���par�ies�will�keep��rack�of�cus�omer�an��supplier�invoices�pai���urin����e�60��o��0��ays�followin��closin��an��will�submi����em�for�reimbursemen���o���e�o��er�par�y�a����e�en��of���a��perio�.

6� Sys�ems�mus��be�in�place��o�ensure���a��employees�of���e�acquire��company�con�inue��o�be�pai��wi��ou���isrup�ion.�If���e�number�of�employees�is�small�����is��ask�may�be�accommo�a�e��easily�by�loa�in����e�acquirer’s�payroll�compu�er�sys�em�wi�����e�necessary�salary�an��personnel�informa�ion�before�closin����or�by��avin��a���ir��par�y�payroll�processor�perform���ese�services.�For�lar�er�opera�ions�or�w�ere�employees�are��isperse���eo�rap�ically�����e��ar�e�’s�employees�may�con�inue��o�be�pai��for�a�specific�perio��usin����e��ar�e�’s�exis�in��payroll�sys�em.��s�for�benefi�s���employee��eal���care�or��isabili�y�claims��en���o�escala�e�jus��before�a��ransac�ion�closes���an��s�u�ies�s�ow���a��employees���w�e��er���ey�leave�or�s�ay�wi�����e�new�firm���file�more��isabili�y�claims�for�lon�er�perio�s�af�er��ownsizin��(The Wall Street Journal,�November�21���1��6).�T�e�s�arp�increase�in�suc��expenses�can�pose�an�unexpec�e��financial�bur�en�for���e�acquirer�if���e�responsibili�y�for�payin��suc��claims��as�no��been�a��resse��in���e�mer�er�a�reemen�.�For�example�����e�a�reemen��may�rea����a��all�claims�incurre��wi��in�a�specific�number�of��ays�before�closin����bu��no��submi��e��by�employees�for�processin��un�il�af�er�closin����will�be�reimburse��by���e�seller�af�er���e�closin�.��l�erna�ively���suc��claims�may�be�pai��from�an�escrow�accoun��con�ainin��a�por�ion�of���e�purc�ase�price�se��asi�e��o�cover���ese��ypes�of�expenses.

The Negotiation, Integration Planning, and Closing Phases 181

��pru�en��buyer�will�wan���o�inclu�e�cer�ain�assurances�in���e�a�ree�men��of�purc�ase�an��sale� �o� limi�� i�s�pos�closin��risk.�Mos�� seller� repre�sen�a�ions�an��warran�ies�ma�e��o���e�buyer�refer��o���e�pas��an��presen��con�i�ion�of���e�seller’s�business.�T�ey�per�ain��o�i�ems�suc��as���e�owner�s�ip� of� securi�ies;� real� an�� in�ellec�ual� proper�y;� curren�� levels� of� receiv�ables���inven�ory���an���eb�;�pen�in��lawsui�s���worker��isabili�y���an��cus�omer�warran�y�claims;�an��an�assurance���a����e��ar�e�’s�accoun�in��prac�ices�are�in� accor�ance�wi���Generally��ccep�e���ccoun�in��Principles.��l��ou���“reps�an��warran�ies”�apply�primarily��o���e�pas��an��curren��s�a�e�of���e�seller’s�business�����ey��o��ave�ramifica�ions�for���e�fu�ure.�For�example���if�a�seller�claims���a����ere�are�no�lawsui�s�pen�in��an��a�lawsui��is�file��s�or�ly�af�er�closin������e�buyer�may�seek��o�recover��ama�es�from���e�seller.

T�e�buyer�also�may�insis����a��cer�ain�con�i�ions�be�sa�isfie��before�closin��can� �ake� place.�Common� con�i�ions� inclu�e� employmen�� con�rac�s��� a�ree�men�s� no�� �o� compe�e��� financin���� an�� re�ula�ory� an�� s�are�ol�er� approval.�T�e�buyer�usually�will� insis�� ��a��key� �ar�e��company�employees� si�n�con��rac�s�obli�a�in����em��o�remain�wi�����e�newly�forme��company�for�a�spe�cific�perio�.�T�e�former�owners���mana�ers���an��o��er�key�employees�also�are�aske���o�si�n�a�reemen�s�preclu�in����em�from��oin��in�o�any�business���a��woul���irec�ly�compe�e�wi�����e�new�company��urin����e��ura�ion�of���e�noncompe�e�a�reemen�.�Finally�����e�buyer�will�wan���o�make���e�final�closin��con�in�en�� on� receivin�� approval� from� ��e� appropria�e� re�ula�ory� a�encies�an��s�are�ol�ers�of�bo���companies�before�any�money�c�an�es��an�s.

Earning Trust�ecisions� ma�e� before� closin�� affec�� pos�closin�� in�e�ra�ion� ac�ivi�y.�Benefi�s� packa�es��� employmen�� con�rac�s��� an�� re�en�ion� bonuses� �o� keep�key� employees� �ypically� are� ne�o�ia�e�� before� closin�.� Con�rac�ual� cov�enan�s� an�� con�i�ions� also� affec�� in�e�ra�ion.� Earnouts��� w�ic�� are� pay�men�s��o���e�seller�base��on���e�acquire��business�ac�ievin��cer�ain�profi��or� revenue� �ar�e�s��� an�� �eferre�� purc�ase� price� paymen�s��� involvin�� ��e�placemen��of� some�por�ion�of� ��e�purc�ase�price� in�escrow�un�il�cer�ain�con�rac�ual�con�i�ions��ave�been�realize����can� limi�� ��e�buyer’s�abili�y� �o�in�e�ra�e� ��e� �ar�e�� effec�ively� in�o� ��e� acquirer’s�opera�ions.�Successfully�in�e�ra�in��firms�requires��e��in��employees�in�bo���firms��o�work��owar��ac�ievin��common�objec�ives.�T�is�comes�abou�� ��rou���buil�in��cre�i�bili�y�an���rus����no����rou���superficial�slo�ans���pep��alks���an��emp�y�prom�ises.�Trus��comes�from�coopera�ion�an��experiencin��success.

Mergers and Acquisitions Basics182

Earnouts�n�earnou��is�usually�a�very�poor�way��o�crea�e��rus��an��of�en�represen�s�a�major� impe�imen�� �o� ��e� in�e�ra�ion�process.�T�e� �wo� firms� �enerally�are� kep�� p�ysically� separa�e.��ccoun�in�� an�� mana�emen�� repor�in�� sys��ems�are�no��mer�e�� imme�ia�ely����a�a�cen�ers� remain� separa�e��� an�� sales�forces� remain� lar�ely� in�epen�en�.�T�e�buyer’s� concern� is� ��a�� ��e�effor���o�in�e�ra�e���e�firms�as�soon�as�possible�af�er�closin��will�make��rackin����e�financial�pro�ress�of���e�acquire��company��owar��mee�in��i�s�earnou���oals� �ifficul�.� Moreover��� ��e� mer�in�� of� facili�ies� an�� sales� forces� coul��crea�e�a��i��ly�con�en�ious�si�ua�ion�af�er���e�earnou��perio���as�elapse��if���e�acquire��company��i��no��mee����e�earnou���oals.�Employees�covere��by���e�earnou��coul��ar�ue�in�cour����a����ey�were�preven�e��from�mee��in��earnou���oals�because���e�buyer��i��no��allow���em��o�implemen����e�business�plan�on�w�ic����e�earnou��was�base�.

Choosing the Integration Manager and Other Critical DecisionsT�e�buyer� s�oul���esi�na�e� an� in�e�ra�ion�mana�er�w�o�possesses� excel�len�� in�erpersonal� an�� projec�� mana�emen�� skills.� �urin�� ��e� in�e�ra�ion�p�ase��� in�erpersonal� skills� are� frequen�ly�more� impor�an�� ��an�professional�an���ec�nical�skills.�T�e�buyer�mus��also��e�ermine�w�a��is�cri�ical��o�con��inuin�� ��e� acquire�� company’s� success� �urin�� ��e� firs�� 12� �o� 2��mon��s�followin��closin�.�Cri�ical�ac�ivi�ies�inclu�e�i�en�ifyin��key�mana�ers���ven��ors��� an�� cus�omers��� an�� w�a�� is� nee�e�� �o� re�ain� ��em� as� value�� asse�s.�Preclosin�� in�e�ra�ion� plannin�� ac�ivi�ies� s�oul�� also� �e�ermine� opera��in��norms�or�s�an�ar�s�require��for�con�inue��opera�ion�of���e�businesses:�execu�ive�compensa�ion���labor�con�rac�s���billin��proce�ures���pro�uc���elivery��imes���an��quali�y�me�rics.�Finally�����ere�mus��be�a�communica�ion�plan�for�all� s�ake�ol�ers� ��a�� can�be� implemen�e�� imme�ia�ely� followin�� closin�.��C�ap�er�10��escribes�in��e�ail��ow���e�in�e�ra�ion�plan�is�implemen�e�.

ClosiNg Phase

In� ��e� closing� p�ase� of� ��e� acquisi�ion� process��� you� ob�ain� all� necessary�s�are�ol�er��� re�ula�ory���an����ir��par�y�consen�s� (e.�.���cus�omer�an��ven��or�con�rac�s)�an��also�comple�e���e��efini�ive�a�reemen��of�purc�ase�an��sale.�Like�all�o��er�p�ases�����is�ac�ivi�y�benefi�s�from�si�nifican��plannin��a��

�� Por�er�an��Woo��(1���).

The Negotiation, Integration Planning, and Closing Phases 183

��e�ou�se��if�i��is��o��o�smoo��ly.�Unfor�una�ely�����is�is�frequen�ly�imprac�i�cal�because�so�many�ac�ivi�ies�are�un�erway��urin����e�acquisi�ion�process���an����ey��en���o�conver�e�on���e�closin���a�e.

Assigning Customer and Vendor ContractsIn� a� purc�ase� of� asse�s��� many� cus�omer� an�� ven�or� con�rac�s� canno�� be�assi�ne�� �o� ��e�buyer�wi��ou�� receivin��wri��en�approval� from���e�o��er�par�ies.��l��ou��� ��is�may� be� lar�ely� a� formali�y��� bo��� ven�ors� an�� cus��omers�may�view�i��as�an�oppor�uni�y��o�a��emp���o�ne�o�ia�e�more�favor�able� �erms.� Licenses� mus�� be� approve�� by� ��e� licensor��� w�ic�� can� be� a�major�impe�imen���o�a��imely�closin��if�no��properly�planne�.�For�exam�ple��� a� major� sof�ware� ven�or� �eman�e�� a� subs�an�ial� increase� in� royal�y�paymen�s�before�a�reein���o��ransfer���e�sof�ware�license��o���e�buyer.�T�e�ven�or�knew���a�� ��e� sof�ware�was�cri�ical� for� ��e�on�oin��opera�ion�of���e� �ar�e��company’s��a�a�cen�er.�From���e�buyer’s�perspec�ive��� ��e�exor�bi�an��increase�in���e�fee��a��an�a�verse�impac��on���e�economics�of���e��ransac�ion�an��nearly�cause����e��eal��o�collapse.

T�ere� are� also� ��e� transitional� issues��� in�ro�uce�� earlier��� ��a�� mus�� be�a��resse�� before� closin���� inclu�in�� con�inue�� payroll� processin�� suppor��by���e�seller���on�be�alf�of���e�buyer���un�il���e�buyer�is�able��o�assume���is�func�ion��� an�� ��e� re�urn� of� c�ecks� receive�� by� ��e� seller� from� cus�om�ers� con�inuin�� �o� sen�� c�ecks� �o� ��e� seller’s� bank� accoun�s� af�er� closin�.�Similarly�����e�buyer�will�wan���o�be�reimburse��by���e�seller�for�paymen�s�ma�e�by���e�buyer��o�ven�ors�for�ma�erials�supplie��or�services�provi�e��before�closin����bu��no��pai��un�il�af�er�closin�.

Gaining the Necessary ApprovalsT�e� buyer’s� le�al� counsel� is� responsible� for� ensurin�� ��a�� ��e� �ransac�ion�is� in� full� compliance�wi��� securi�ies��� an�i�rus���� an�� s�a�e� corpora�ion� laws.�Si�nifican��plannin��before�closin��is�a�ain�crucial��o�minimizin��roa�blocks���a��a��ar�e��company�may�place�before���e�buyer.�Grea��care�mus��be�exer�cise�� �o� ensure� ��a�� all� filin�s� require�� by� law��ave� been�ma�e�wi��� ��e�Fe�eral�Tra�e�Commission�an����e��epar�men��of�Jus�ice.�Noncompliance�can� �elay� or� preven�� a� mer�er� or� acquisi�ion.� Finally��� many� �ransac�ions�require�approval�by���e�acquirer�an���ar�e��company�s�are�ol�ers.

Completing the Acquisition/Merger AgreementT�e�acquisi�ion/mer�er�a�reemen��is���e�corners�one�of���e�closin���oc�umen�s.� I�� in�ica�es� all� of� ��e� ri���s� an�� obli�a�ions� of� ��e� par�ies� bo���

Mergers and Acquisitions Basics184

before� an�� af�er� closin�.�T�is� a�reemen�� also� may� be� referre�� �o� as� ��e��efini�ive�a�reemen��of�purc�ase�an��sale;�i�s�len�����epen�s�on���e�com�plexi�y�of���e��ransac�ion.

Deal ProvisionsIn�an�asse��or�s�ock�purc�ase�����e��eal�provisions�sec�ion�of���e�a�reemen���efines� ��e� consi�era�ion� or� form� of� paymen�� an�� �ow� i�� will� be� pai����an����e�specific�asse�s�or�s�ares��o�be�acquire�.�In�a�mer�er�����is�sec�ion�of���e� a�reemen�� �efines� ��e� number� (or� frac�ion)� of� acquirer� s�ares� �o� be�exc�an�e��for�eac���ar�e��s�are.

PriceT�e�purc�ase�price�or��o�al�consi�era�ion�may�be�fixe��a����e��ime�of�clos�in����subjec���o�fu�ure�a�jus�men����or�i��may�be�con�in�en��on�fu�ure�per�formance.�T�e�purc�ase�price�may�be� fixe�� ini�ially�base��on� ��e� seller’s�represen�a�ions� of� ��e� firm’s� �o�al� asse�s��� �o�al� book� value��� �an�ible� book�value���or�some�o��er�measure�of�value.�However�����e�price�may�be�a�jus�e��followin��a�pos�closin��au�i�.�In�asse���ransac�ions���i��is�common��o�exclu�e�cas��on���e��ar�e�’s�balance�s�ee��from���e��ransac�ion;���e�price�pai��for�noncurren��asse�s���suc��as�plan��an��in�an�ible�asse�s�will�be�fixe����bu����e�price�for�curren��asse�s�will��epen��on���eir�levels�a��closin�.

Allocation of PriceT�e�buyer��ypically��as�an�incen�ive��o�alloca�e�as�muc��of� ��e�purc�ase�price� as� possible� �o� �epreciable� asse�s��� suc�� as� fixe�� asse�s��� cus�omer� lis�s���an��noncompe�e�a�reemen�s���w�ic��will�enable���e�buyer��o��eprecia�e�or�amor�ize� ��ese�upwar�ly�revise��asse�s�an��re�uce� fu�ure� �axable� income.�However��� suc��an�alloca�ion�may�cons�i�u�e� �axable� income� �o� ��e� seller.�Bo���par�ies�s�oul��a�ree�on��ow���e�purc�ase�price�s�oul��be�alloca�e���o� ��e� various� asse�s� acquire�� in� an� asse�� �ransac�ion�before� closin�.�T�is�a�reemen��elimina�es���e�c�ance���a����e�par�ies�involve��will��ake��iffer�en��posi�ions�for��ax�purposes.�None��eless�����e�IRS�may�s�ill�c�allen�e���e��ransac�ion.

Payment MechanismPaymen��may�be�ma�e�a��closin��by�wire��ransfer�or�cas�ier’s�c�eck.�T�e�buyer�may��efer���e�paymen��of�a�por�ion�of���e�purc�ase�price�by�issu�in��a�promissory�no�e��o���e�seller.�T�e�buyer�may�a�ree��o�pu����e�unpai��por�ion�of���e�purc�ase�price�in�escrow�or���rou���a��ol�back�allowance����

The Negotiation, Integration Planning, and Closing Phases 185

��ereby� facili�a�in�� ��e� se��lemen�� of� claims� ��a�� mi���� be� ma�e� in� ��e�fu�ure.�T�e� escrow� accoun�� involves� ��e� buyer� pu��in�� a� por�ion� of� ��e�purc�ase�price�in�an�accoun���el��by�a���ir��par�y���w�ereas���e��ol�back�allowance��enerally��oes�no�.

Assumption of LiabilitiesT�e� seller� re�ains� ��ose� liabili�ies�no�� assume��by� ��e�buyer.� In� ins�ances�suc�� as� environmen�al� liabili�ies��� unpai�� �axes��� an�� ina�equa�ely� fun�e��pension�obli�a�ions�����e�cour�s�may��o�af�er���e�buyer�an��seller.�In�con��ras������e�buyer�assumes�all�known�an��unknown�liabili�ies�in�a�mer�er�or�purc�ase�of�s�ares.

Representations and WarrantiesT�e�reps�an��warran�ies�s�oul��provi�e�for�full��isclosure�of�all�informa��ion� �ermane� �o� ��e� �ransac�ion��� �ypically� coverin�� ��e� areas� of� �rea�es��concern� �o�bo���par�ies.��reas�commonly�covere�� inclu�e� ��e� followin�:�corpora�e� or�aniza�ion� an�� �oo�� s�an�in���� capi�aliza�ion��� financial� s�a�e�men�s���absence�of�un�isclose��liabili�ies���curren��li�i�a�ion���con�rac�s����i�le��o�asse�s����axes�an���ax�re�urns���no�viola�ion�of�laws�or�re�ula�ions���employee�benefi��plans���labor�issues���an��insurance�covera�e.

CovenantsCovenants�are�a�reemen�s�by���e�par�ies�abou��ac�ions���ey�a�ree��o��ake���or�refrain� from��akin����be�ween�si�nin����e��efini�ive�a�reemen��an����e�closin�.� For� example��� ��e� seller� may� be� require�� �o� con�inue� con�uc��in��business� in� ��e�usual�an��cus�omary�manner.�T�e�seller�of�en�will�be�require���o�seek�approval�for�all�expen�i�ures���a��may�be�consi�ere��ou��of���e�or�inary���suc��as�one��ime��ivi�en��paymen�s�or�sizeable�increases�in�mana�emen��compensa�ion.

Closing ConditionsT�e� sa�isfac�ion�of� ne�o�ia�e�� con�i�ions� �e�ermines�w�e��er� a� par�y� �o���e�a�reemen��mus���o� forwar��an��consumma�e� ��e��eal.�T�ese�con�i��ions� coul�� inclu�e� ��e� con�inue�� accuracy�of� ��e� seller’s� reps� an��war�ran�ies� an�� ��e� ex�en�� �o� w�ic�� ��e� seller� is� livin�� up� �o� i�s� obli�a�ions�un�er���e�covenan�s.����er�examples�inclu�e�ob�ainin��all�necessary�le�al�opinions�����e�execu�ion�of�o��er�a�reemen�s�(e.�.���promissory�no�es)���an����e�absence�of�any�“ma�erial�a�verse�c�an�e”�in���e�con�i�ion�of���e��ar�e��company.

Mergers and Acquisitions Basics186

T�e�effec�s�of�ma�erial�a�verse�c�an�e�clauses�(M�Cs)�in�a�reemen�s�of�purc�ase�an��sale�became�very�visible��urin����e��isrup�ion�in���e�finan�cial�marke�s� in�200�.�Many�firms���a���a��si�ne��M&��con�rac�s� looke��for�a�way�ou�.�T�e�mos��common�c�allen�e�in�ne�o�ia�in��suc��clauses�is��efinin��w�a��cons�i�u�es�ma�eriali�y;�for�example���is�i��a�20�percen��re�uc��ion�in�earnin�s�or�sales?�Because�of���e�in�eren��ambi�ui�y�����e�con�rac��lan�ua�e�is�usually�va�ue���an��i��is���is�very�ambi�ui�y���a���as�enable��so�many�acquirers��o�wi���raw�from�con�rac�s.�Len�ers����oo���use���ese�clauses��o�wi���raw�financin��(see���e�“Financin��Con�in�encies”�sec�ion).

IndemnificationIn�effec����indemnification�is���e�reimbursemen��of���e�o��er�par�y�for�a�loss�incurre��followin��closin��for�w�ic��i��was�no��responsible.�T�e��efini�ive�a�reemen��requires���e�seller��o�in�emnify�or�absolve���e�buyer�of�liabili�y�in���e�even��of�misrepresen�a�ions�or�breac�es�of�warran�ies�or�covenan�s.�Similarly��� ��e� buyer� usually� a�rees� �o� in�emnify� ��e� seller.� Bo��� par�ies��enerally� wan�� �o� limi�� ��e� perio�� �urin�� w�ic�� ��e� in�emni�y� clauses�remain�in�force.����leas��one�full�year�of�opera�ion�an��a�full�au�i��are�nec�essary��o�i�en�ify�claims.�Some�claims�(e.�.���environmen�al)�ex�en��beyon����e�survival�perio��of���e�in�emni�y�clause.�Usually���nei��er�par�y�can�sub�mi��claims��o���e�o��er�un�il�some�minimum���res�ol����expresse��in��erms�of���e�number�or��ollar�size�of�claims����as�been�excee�e�.

Merger Agreements��mer�er� is� s�ruc�urally� simpler� ��an� an� asse�� a�reemen��because� i���oes�no�� require� ��e� s�ipula�ion� of� asse�s� bein�� �ransferre�� �o� ��e� buyer� an��liabili�ies�assume��by� ��e�buyer.��l��ou��� i��may� �ake� less� �ime� �o�ne�o��ia�e� an�� �raf�� ��an� an� asse�� a�reemen���� i�� may� �ake� lon�er� �o� comple�e.����mer�er�wi���a�public�company��enerally�requires�approval�of���e��ar�e��company’s� s�are�ol�ers� an��mus�� comply�wi��� ��e� full� public� �isclosure�an��filin��requiremen�s�of�bo���fe�eral�an��s�a�e�securi�ies�laws.

Other Closing DocumentsIn� a��i�ion� �o� resolvin�� ��e� issues� ou�line�� previously��� closin�� may� be�complica�e��by���e�number�an��complexi�y�of�o��er��ocumen�s�require���o�comple�e���e��ransac�ion.�In�a��i�ion��o���e�a�reemen��of�purc�ase�an��sale�����e�more�impor�an���ocumen�s�of�en�inclu�e�pa�en�s���licenses���royal�y�a�reemen�s��� �ra�e� names��� an�� �ra�emarks;� labor� an�� employmen�� a�ree�men�s;� leases;� mor��a�es��� loan� a�reemen�s��� an�� lines� of� cre�i�;� s�ock� an��

The Negotiation, Integration Planning, and Closing Phases 187

bon��commi�men�s�an���e�ails;�supplier�an��cus�omer�con�rac�s;��is�ribu��or�an��sales�represen�a�ive�a�reemen�s;�s�ock�op�ion�an��employee�incen��ive�pro�rams;��eal���an��o��er�benefi��plans� (w�ic��mus��be� in�place�a��closin�� �o�elimina�e� lapse��covera�e);� comple�e��escrip�ion�of� all� forei�n�pa�en�s���facili�ies���an��inves�men�s;�insurance�policies���covera�e���an��claims�pen�in�;�in�erme�iary�fee�arran�emen�s;�li�i�a�ion�pen�in��for�an��a�ains��eac�� par�y;� environmen�al� compliance� issues� resolve�� or� on� �rack� �o� be�resolve�;�seller’s�corpora�e�minu�es�of���e�boar��of��irec�ors�an��any�o��er�si�nifican�� commi��ee� informa�ion;� an�� ar�icles� of� incorpora�ion��� bylaws���s�ock�cer�ifica�es���an��corpora�e�seals.�

Financing ContingenciesMos�� well�wri��en� a�reemen�s� of� purc�ase� an�� sale� con�ain� a� financin��con�in�ency.�T�e�buyer� is�no�� subjec�� �o� ��e� �erms�of� ��e�con�rac�� if� ��e�buyer�canno��ob�ain�a�equa�e�fun�in���o�comple�e���e��ransac�ion.��s�pre�viously��iscusse����breakup�fees�can�be�par�icularly�useful��o�ensure���a����e�buyer�will�a��emp��as�a��ressively�as�possible��o�ob�ain�financin�.�In�some�ins�ances�����e�seller�may�require���e�buyer��o�pu��a�nonrefun�able��eposi��in�escrow��o�be�forfei�e��if���e�buyer�is�unable��o�ob�ain�financin���o�com�ple�e���e��ransac�ion.

Len�ers����oo���exercise�financial�con�in�encies���invokin��ma�erial�a�verse�c�an�e� clauses� �o� back�ou�� of� len�in�� commi�men�s.� For� example��� con�cerne�� ��a�� ��ey�will� �ave� �o��iscoun�� suc�� loans�w�en� ��ey� are� resol����Mor�an�S�anley�an��UBS�balke��a��commi�men�s��o�fun����e�purc�ase�of��Re��y� Ice� Hol�in�s� an�� Genesco� in� la�e� 200�.� Similarly��� Le�man� an���J.P.�Mor�an�were�par��of�a��roup�of�banks���a���elpe��force�Home��epo���o��ake�$1.��billion�less�for�i�s�cons�ruc�ion�supply�business.10

Is Closing Ever Simple?T�e� closin�� experience� runs� ��e� �amu�� from�min��numbin�� rou�ine� �o�bombas�ic� confron�a�ion.�T�e� smoo��ness� of� ��e� process� �epen�s� on� i�s�overall�complexi�y�an����e�level�of��rus��be�ween���e�par�ies�involve�.

Transac�ion� size� is� no�� a� �oo�� in�ica�or� of� complexi�y.�Transac�ions���a�� are� rela�ively� small� in� �erms� of� revenue� or� purc�ase� price� can� be��orrifically� complica�e�� w�ere� mul�iple� par�ies� are� involve���� si�nifican���

����� S�erman�(2006).10� �l��ou���only���e�10���lar�es���ransac�ion�of�200��in��erms�of�price�����e�Home��epo���eal�became�

one�of���e�mos��impor�an��by�mi�year�as�amon����e�firs��of���e�lar�e����i��ly�levera�e���ransac�ions��o�be�rene�o�ia�e��followin����e�collapse�of���e�subprime�mor��a�e�marke��in�la�e�summer.

Mergers and Acquisitions Basics188

off�balance� s�ee�� liabili�ies�exis����or�mul�iple� levels�of� re�ula�ory�approval�are�require�.�Even�w�en�i��appears� ��a��bo���par�ies��ave�reac�e��a�ree�men�� on� ��e� major� issues��� w�a�� were� previously� minor� issues� seem� �o�resurface�on�a�more�c�allen�in��scale.�Some�imes���is��appens�because���e�par�ies� �i��no�� realize� an� issue’s� si�nificance�un�il� ��e� las��minu�e.����er��imes���one�par�y��akes�a��ar��line�on�an�issue�as���e�closin���a�e�approac�es����opin���o��ain�a�ne�o�ia�in��a�van�a�e.�In�one�ins�ance���a�buyer�of�a�com�pu�er�main�enance�business� sa�� in� ��e�seller’s�ma�o�any�fille��boar�room�jus��minu�es�before���e�closin���ocumen�s�were��o�be�si�ne��an��be�an��o�enumera�e�concerns��e��a��wi�����e��eal.��s��empers�be�an��o�flare���only���e�seller’s���rea���o�walk�away�from���e��ransac�ion�compelle����e�buyer��o�relen��an��close���e��ransac�ion.�Suc���ac�ics�are�ill�a�vise�.

Money� issues� �en�� �o� be� amon�� ��e� more� c�allen�in�� �o� resolve.�Pos�closin��balance� s�ee�� a�jus�men�s� an��escrow�accoun�s��� earnou�s� an��o��er� con�in�en�� paymen�s��� con�in�en�� value� ri���s��� s�a�in�� inves�men����ri���s� �o� in�ellec�ual� proper�y��� licensin�� fees��� an�� consul�in�� a�reemen�s�commonly�are�use���o�consumma�e���e��eal�w�en�buyers�an��sellers�are�fin�in��i���ifficul���o�reac��a�reemen��on�purc�ase�price.�T�ese�issues�are��iscusse��in�more��e�ail�la�er���un�er�“T�ou���s�on�Closin����e�Price�Gap.”

�l��ou���closin��normally�involves�one�cen�ral�loca�ion���offsi�e�loca�ions�may�be�nee�e��if��ocumen�s�for��ransferrin���ee�s�an���i�les��o�asse�s�mus��be�si�ne��an��file��from�remo�e�loca�ions.�T�ese�loca�ions�subs�i�u�e�for�face��o�face� si�nin�s� ��a��may� be� �ifficul�� because� of� �is�ance� or� cos�.�Remo�e�si�nin�s�may�be�comple�e��by��avin��power�of�a��orney�for���e�buyer�an��seller��ransferre���o�local�a��orneys�a��eac��remo�e�si�e.�I��is�also�a��oo��i�ea��o��ave�separa�e�conference�rooms�for���e�buyer�an��seller��o�ensure�privacy���an��ano��er�room�in�w�ic����e�par�ies�mee���o�execu�e���e��ocumen�s.�Finally���len�ers�s�oul��be�kep��separa�e�from�eac��o��er��o�minimize�any�exc�an�e�of� informa�ion��urin��closin����a��mi����cause���em��o�reopen��iscussions�be�ween���e�buyer�an����e�len�er�abou����e��erms�an��con�i�ions�of�loans.

For� small��� uncomplica�e�� �ransac�ions��� faxes� may� suffice� a�� firs���� wi����ocumen�s�sen��back�an��for���be�ween���e�buyer�an��seller��o�ensure���a����ere�is�comple�e�a�reemen��on���e�closin���ocumen�s.�Si�na�ure�pa�es�are���en�si�ne��by�one�par�y�an��sen��overni�����o���e�o��er�par�y�for�si�na�ure.

thoughts oN NegotiatiNg DyNamiCs

Ne�o�ia�in�� is� essen�ially� a�process� in�w�ic�� �wo�or�more�par�ies��� repre�sen�in���ifferen�� in�eres�s��� a��emp�� �o� ac�ieve�a�consensus�on�a�par�icular�

The Negotiation, Integration Planning, and Closing Phases 189

issue.� I�� is� useful� �o� s�ar�� a� ne�o�ia�ion� by� �e�erminin�� any� areas� of� �is�a�reemen����w�ic��can�be��one�by��avin��all�par�ies�review���e�fac�s�per��ainin�� �o� ��e� �eal� a�� ��e� be�innin�.� Generally��� par�ies� reac�� a�reemen��on� mos�� fac�s� rela�ively� easily.� From� ��ere��� i�� is� easy� �o� i�en�ify� areas� in��ispu�e.�Goo��ne�o�ia�ors�make�concessions�on�issues�no��consi�ere���eal�breakers—any��in�� �o� w�ic�� a� par�y� canno�� a�ree� wi��ou�� makin�� ��e��eal�unaccep�able—bu��only�if� ��ey�receive�some��in��in�re�urn.�If� ��ere�are�deal breakers�����ey�mus��be���e��i��es��priori�y�in�a�ne�o�ia�ion.��eal�breakers�mus��be�resolve��if�a�ne�o�ia�e��se��lemen��is��o�be�reac�e�.

T�e�easies��areas�of��isa�reemen��s�oul��be�resolve��firs�.�By���e��ime�only�a�few�remain���all�par�ies��o���e�ne�o�ia�ion��ave�inves�e��a��rea���eal�of� money��� �ime��� an�� emo�ional� commi�men�� �o� ��e� process� an�� will� be�lookin��forwar���o�resolvin��any�remainin��issues�quickly.

In�a�ne�o�ia�ion���all�posi�ions�s�oul��be�explaine��lo�ically.�Unreason�able��eman�s�a��any�poin��in���e�ne�o�ia�ion�are�likely��o�evoke�frus�ra�ion�an��encoura�e�someone��o�en���iscussions.�If���e�par�ies�can�reac��a�poin��a��w�ic��one�si�e�is�a��leas��willin���o�s�a�e�a�price�ran�e���final�a�reemen��is�in�si���.

Soun��plannin��is���e�key��o�successful�ne�o�ia�ion.�Prior��o�ne�o�ia��in����eac��par�y�s�oul���e�ermine�i�s�own��oals�(i.e.����i��es��priori�y�nee�s)�an��priori�ize� ��ose��oals.� Is�money� ��e�major� issue���or� is� i��more�abou���ainin�� con�rol?� Eac�� par�y� s�oul�� also� make� an� effor�� �o� i�en�ify� ��e�o��er�par�y’s��oals�an��priori�ies�base��on�public�s�a�emen�s�an��ac�ions���as�well�as� informa�ion�uncovere���urin���ue��ili�ence.�Wi���clearly� i�en�i�fie���oals���eac��par�y�can��evelop�s�ra�e�ies�for�ac�ievin����ose��oals.�Eac��par�y� nee�s� �o� reco�nize� ��a�� allowances�mus�� be�ma�e� so� o��er� par�ies�can�ac�ieve—or�a��leas��believe���ey��ave�ac�ieve�—��eir�primary��oals.

�ll� moves� in� a� ne�o�ia�ion� s�oul�� be� suppor�e�� by� ��e� mos�� objec��ive�ra�ionale�possible;�a�well�reasone��an��well�s�ruc�ure��proposal�is��if�ficul�� �o� coun�er.�T�e� firs��move�of� any�ne�o�ia�ion�can� se�� ��e� �one� for���e�en�ire�process.���reasonable�offer�is�more�likely��o�appeal��o���e�o��er�si�e� an�� more� likely� �o� elici�� a� reasonable� coun�eroffer.� Skille�� ne�o�ia��ors�of�en�employ�a�series�of��ec�niques��o�reac��consensus.�For�example���ne�o�ia�ors�may��ry��o��e�ermine���e�minimum�ou�come���e�o��er�par�y�will�accep��an����en�a�jus����eir��eman�s�accor�in�ly���wi��ou���ivin��up���eir��i��es��priori�y�objec�ives.

Tra�i�ional�ne�o�ia�in���as�been�referre���o�as���e�“win–lose”�approac����base��on���e�assump�ion���a��one’s��ain�is�necessarily�ano��er’s�loss.�T�is�is��rue�w�en�only�one�issue�is�a��s�ake.�For�example���if�a�seller�accep�s�a�lower�

Mergers and Acquisitions Basics190

cas��purc�ase�price���an��if�cas��is�a��i���priori�y�concern��o���e�buyer�an����e�seller�����e�buyer��ains�a����e�seller’s�expense.�“Win–win”�ne�o�ia�ions���in�con�ras����presume���ere�are�ou�comes�in�w�ic��bo���par�ies��o�a�ne�o�i�a�ion��ain;���ese�ne�o�ia�ions�involve�mul�iple�rela�e��issues.�In�a�win–win�ne�o�ia�ion���one�par�y�can�conce�e�w�a��i��believes��o�be�a�rela�ively�low�priori�y� i�em� in� exc�an�e� for� ��e�o��er�par�y’s� accep�ance�of� some��in��else���a��i��believes��i��ly�impor�an�.

W�en�i��comes��o�issues�of�money���i��can�be�impor�an���o�reac��a�ree�men��firs��on�a�formula�or�framework�for��e�erminin��w�a��bo���par�ies�believe� is� a� fair� value.�Reac�in�� suc�� an� a�reemen��may� require� in�ense��iscussion.���formula�mi����be���a����e�purc�ase�price�will�be�some�mul�i�ple�of�earnin�s�or�cas��flow;�a�framework�mi����comprise�a�series�of�s�eps���suc��as���e�ex�en��of��ue��ili�ence��o�be�allowe����before�a�purc�ase�price�is�propose�.�T�e�formula�or�framework�can��elp�avoi����e���orny�issue�of��ow�muc���o�offer�a����e�ou�se����an��enables�ne�o�ia�ors��o�procee���o���e��a�a�collec�ion�or��ue��ili�ence�s�a�e.11

thoughts oN ClosiNg the PriCe gaP

��ain��� ��e� seller�may� insis�� ��e�buyer� s�a�e�a�price� ran�e�before�allowin����e�buyer��o�perform��ue��ili�ence�an��before�en�erin��in�o�ne�o�ia�ions.��ue� �ili�ence� may� uncover� issues� ��a�� cause� ��e� prospec�ive� buyer� �o�re�uce���e�offer�price���w�ic����e�seller�is�likely��o�resis�.�To�reac��a�se��le�men����bo���par�ies�mus����ink�crea�ively.

In�an�all�cas���ransac�ion�����e�risks�accrue�en�irely��o���e�buyer.��espi�e�ex�aus�ive��ue��ili�ence�����ere�is�no�assurance���a����e�buyer�will��ave�uncov�ere�� all� ��e� risks� associa�e�� wi��� ��e� �ar�e�.� �urin�� ��e� ne�o�ia�ion� p�ase�����e�buyer�an��seller�maneuver��o�s�are���e�perceive��risk�an��appor�ion���e�po�en�ial�re�urns.�In��oin��so���subs�an�ial��ifferences�arise�be�ween�w�a����e�buyer�is�willin���o�pay�an��w�a����e�seller�believes���e�business�is�wor��.

Buyers�an��sellers�use�pos�closin��balance�s�ee��a�jus�men�s�an��escrow�accoun�s���earnou�s�an��o��er�con�in�en��paymen�s���con�in�en��value�ri���s���s�a�in�� inves�men���� ri���s� �o� in�ellec�ual� proper�y��� licensin�� fees��� consul��in��a�reemen�s���an��seller�financin��w�en���ey�canno��reac��a�reemen��on�purc�ase� price.� Pos�closin�� price� a�jus�men�� mec�anisms� inclu�e� escrow�or��ol�back�accoun�s� an��a�jus�men�s� �o� ��e� �ar�e�’s�balance� s�ee�.�T�ese�mec�anisms�rely�on�a�pos�closin��au�i��of���e��ar�e��firm��o��e�ermine�i�s�

11� �ePamp�ilis�(2010).

The Negotiation, Integration Planning, and Closing Phases 191

“�rue”�value.�Generally�����e�buyer�an��seller�s�are���e�cos��of���e�au�i�.�In��eneral���suc��mec�anisms�are�applicable�only�w�en�w�a��is�bein��acquire��is�clearly�i�en�ifiable���suc��as�in�a�purc�ase�of��an�ible�asse�s.�Moreover�����ese�mec�anisms� mos�� of�en� are� use�� in� cas��for�s�ock� purc�ases��� ra��er� ��an�s�ock�for�s�ock� purc�ases��� par�icularly� w�en� ��e� number� of� �ar�e�� s�are��ol�ers�is�lar�e.����emp�in���o�recover�a�por�ion�of���e�s�ares�pai���o��ar�e��s�are�ol�ers�may� �ri��er� li�i�a�ion.��lso��� re�ainin�� a� por�ion� of� ��e� s�ares�pai���o��ar�e��s�are�ol�ers�may�communica�e�suspec�e��problems�wi�����e��ar�e��an���ri��er�a�sale�by��ar�e��s�are�ol�ers�of���e�s�ares.�Goo�le’s�s�are�for�s�are�purc�ase�of�YouTube�involve��a��ol�back�of�a�por�ion�of���e�pur�c�ase�price�because�of���e�po�en�ial�for�copyri����infrin�emen��li�i�a�ion.

Wi���escrow�accoun�s�����e�buyer�re�ains�a�por�ion�of���e�purc�ase�price�un�il� comple�ion� of� a� pos�closin�� au�i�.� Balance� s�ee�� a�jus�men�s� mos��of�en�are�use��in�purc�ases�of�asse�s�w�en���ere�is�a�len���y��ime�be�ween���e� a�reemen��on�price� an�� ��e� ac�ual� closin���a�e���of�en� resul�in�� from���e� nee�� �o� ob�ain� re�ula�ory� or� s�are�ol�er� approvals� �o� comple�e� ��e��ransac�ion.� �urin�� ��is� perio���� balance� s�ee�� i�ems—par�icularly� ��ose�rela�e�� �o�workin��capi�al—may�c�an�e� si�nifican�ly.�For�example��� if� ��e�book�value�of���e�acquire��ne��asse�s�(i.e.�����e��ifference�be�ween�acquire��asse�s� an��assume�� liabili�ies)��ecreases�be�ween� ��e� si�nin��of� an�a�ree�men��an����e�ac�ual�closin������e�buyer�will�be�en�i�le���o�a�price�re�uc�ion�equal��o���e��ecline�in�acquire��ne��asse�s.�T�e�ma�ni�u�e�of���e��ecline�is��e�ermine���urin����e�pos�closin��au�i�.

Earnou�s� an�� warran�s� frequen�ly� are� use�� w�enever� ��e� buyer� an��seller� canno�� a�ree� on� ��e� probable� performance� of� ��e� seller’s� business�over�some�perio��in�o���e�fu�ure���or�w�en���e�par�ies�involve��wis���o�par��icipa�e�in���e�upsi�e�po�en�ial�of���e�business.�Earnou�s�may�also�be�use���o�re�ain�an��mo�iva�e�key��ar�e��firm�mana�ers.��n�earnou��is�a�financial�con�rac��w�ereby�a�por�ion�of� ��e�purc�ase�price�of� a�company� is� �o�be�pai�� in� ��e� fu�ure��� con�in�en�� on� ��e� realiza�ion� of� a� previously� a�ree��upon�fu�ure�earnin�s�level�or�some�o��er�performance�measure.�T�e��erms�of���e�earnou��are�s�ipula�e��in���e�a�reemen��of�purc�ase�an��sale.

Subscrip�ion�warran�s���more�commonly�known�as�warran�s��� are�a� �ype�of� securi�y�of�en� issue��wi���a�bon��or�preferre�� s�ock.�T�ey�are�ano��er�mec�anism� ��a�� s�if�s� some�of� ��e� risk� associa�e��wi��� ��e� �ar�e�’s� fu�ure�performance� �o� ��e� �ar�e�� firm’s� s�are�ol�ers.�By� accep�in��warran�s� as� a�form�of�paymen�����ar�e��s�are�ol�ers�are�able��o�s�are�in�any�fu�ure�appreci�a�ion�of���e�value�of���e�business.���warran��en�i�les���e��ol�er��o�purc�ase�an�amoun��of�common�s�ock�a��a� s�ipula�e��exercise�price���usually��i��er�

Mergers and Acquisitions Basics192

��an���e�price�a����e��ime���e�warran��is�issue�.�Warran�s�may�be�conver�e��over�a�perio��of�many�mon��s��o�many�years.�In�con�ras����a�ri���s�offerin���o�buy�common� s�ares�normally��as� an�exercise�price�below� ��e� curren��marke��value�of���e�s�ock�an��a�life�of�four��o�ei����weeks.

In�M&���ransac�ions��� contingent value rights� (CVRs)�are�commi�men�s�by���e�issuin��company�(i.e.�����e�acquirer)��o�pay�a��i�ional�cas��or�securi�ies��o���e��ol�er�of�a�CVR�(i.e.�����e�seller)�if���e�s�are�price�of���e�issuin��com�pany�falls�below�a�specifie��level�a��some�fu�ure��a�e.�CVRs�provi�e�a��uaran��ee�of�fu�ure�value�as�of�a�poin��in��ime�for�one�of�various�forms�of�paymen��ma�e��o���e�seller���suc��as�cas����s�ock���or��eb�.��l��ou���rela�ively�rare���suc��ri���s� are� some�imes� �ran�e�� in� �eals� in� w�ic�� ��ere� are� lar�e� �ifferences�be�ween���e�buyer�an��seller�wi���respec���o���e�purc�ase�price.�Suc��ri���s�may�also�be�use��w�en���e��ar�e��firm�wan�s�pro�ec�ion�for�any�remainin��minori�y�s�are�ol�ers�fearful�of�bein���rea�e��unfairly�by���e�buyer.

Tembec�Inc.’s�1����acquisi�ion�of�Cres�brook�Fores��Pro�uc�s���L��.���illus��ra�es��ow�CVRs�work.�Eac��Cres�brook�s�are�ol�er�receive��a�CVR���a��enable����e�s�are�ol�er��o�receive�a�one��ime�paymen��on�Marc���1���2000���of�up��o�a�maximum�of�$1.50�per�s�are.�T�e�size�of���e�payou���epen�e��on� ��e� amoun�� by� w�ic�� ��e� avera�e� price� of� woo�� pulp� for� 1����excee�e�� $5��.00/�on.� Similarly��� in� a� 1��5� �ransac�ion��� Mac�n�rews� &��Forbes�provi�e��eac��s�are�ol�er�of��bex�Inc.�a�CVR�per�common�s�are�equal� �o� $10.00� �o� ensure� ��a���bex� s�are�ol�ers�woul�� receive� a�� leas����a��amoun��per�s�are.�In�200����Frenc��u�ili�y�E�F�was�able��o�overcome�resis�ance� from�cer�ain�Bri�is��Ener�y� s�are�ol�ers�by�offerin��a�combi�na�ion�of�cas��an��a�CVR���a��enable��inves�ors��o�s�are�in�fu�ure�prof�i�s�w�enever�elec�rical�ou�pu��an��ener�y�prices�rise���wi�����e�amoun��of�fu�ure�payou�s��epen�en��on���e�amoun��of���e�increase�in�profi�s.

Distributed payments� or� staged payouts� involve� purc�ase� price� pay�men�s�con�in�en��on���e��ar�e��sa�isfyin��an�a�ree��upon�miles�one.�Suc��miles�ones�coul��inclu�e�ac�ievin��a�profi��or�cas��flow��ar�e����successfully�launc�in�� a� new� pro�uc���� ob�ainin�� re�ula�ory� or� pa�en�� approval��� an��so� on.� �is�ribu�in�� ��e� payou�� over� �ime� allows� ��e� acquirer� �o� mana�e���e�risk�by�re�ucin��some�of���e�uncer�ain�y�abou��fu�ure�cas��flows.��n�acquirer�coul��also�avoi���avin���o�finance���e�en�ire�cas��purc�ase�price�in�a�lar�e��ransac�ion�a��one��ime.�In�200������e�Swiss�p�armaceu�ical�firm�Novar�is�acquire��Nes�le’s�con�rollin��in�eres��in�eye�care�company��lcon�for�$���billion���bu�—�iven���e�200��cre�i��crisis—�eferre��financin����e�bulk�of���e��ransac�ion�for�several�years.

Ri���s� �o� in�ellec�ual� proper�y��� royal�ies� from� licenses��� an�� fee�base��consul�in�� or� employmen�� a�reemen�s� are� o��er� forms� of� paymen�� ��a��

The Negotiation, Integration Planning, and Closing Phases 193

can�be�use�� �o�close� ��e��ap�be�ween�w�a�� ��e�buyer� is�willin�� �o�offer�an�� w�a�� ��e� seller� expec�s.� Havin�� ��e� ri���� �o� use� a� proprie�ary� pro�cess�or� �ec�nolo�y� free�or� a�� a� ra�e�below� ��e�prevailin��marke��may�be�of� in�eres�� �o� ��e� former�owners� as� ��ey�pursue�o��er�business�oppor�u�ni�ies.12� �bviously��� suc�� arran�emen�s� s�oul�� be� couple�� wi��� reason�able�a�reemen�s�no���o�compe�e�in���e�same�in�us�ry�as���eir�former�firm.�Con�rac�s�may�be�ex�en�e�� �o�bo��� ��e� former�owners� an�� ��eir� family�members.� By� sprea�in�� ��e� paymen�� of� consul�in�� fees� or� salary� over� a�number�of�years�����e�seller�may�be�able��o�re�uce���e�income��ax�liabili�y���a��mi�����ave�resul�e��from�receivin��a�lar�er�lump�sum�purc�ase�price.

Seller financing� is� a� loan� provi�e�� by� ��e� seller� of� a� proper�y� �o� ��e�buyer��o�cover�all�or�par��of���e�sale�price.��lso�known�as�owner�carry�back�or�owner�financin������is�process�is�use��in�a�varie�y�of�si�ua�ions.�For�small��eals�in�w�ic��a�lar�e�percen�a�e�of�purc�ase�price�is�cas����seller�financin��may�be�use���o�cover���e�balance�of���e�purc�ase�price.�In�ex�en�in��suc��financin������e�seller�is�expressin��a�willin�ness��o�s�oul�er�a�por�ion�of���e�risk�associa�e��wi�����e��eal.

*�*�*

T�e� key� �o� successful� ne�o�ia�ion��� in�e�ra�ion��� an�� closin�� is� soun��plannin�.� �evelopin�� an� in�e�ra�ion� plan� wi��� ��e� coopera�ion� of� ��e�seller� is� a� cri�ical� fac�or� con�ribu�in�� �o� a� successful� in�e�ra�ion� of� ��e�acquirer� an�� �ar�e�� businesses� followin�� closin�.� �ll� ac�ivi�ies� conver�e�on� ��e� closin���a�e�on�w�ic��owners�ip� �ransfers� from� ��e� seller� �o� ��e�buyer—an��i��can�be�a��ime�of��i���s�ress.

C�ap�er� �� �e�ails� ��e� financin�� of� �ransac�ions��� an�� C�ap�er� 10� �is�cusses���e�final�p�ase�of�M&�:�pos�closin��in�e�ra�ion.

12� No�e���a��suc��an�arran�emen����if�price��a��below�marke��ra�es�or�if�free��o���e�seller���woul��cons�i�u�e��axable�income��o���e�seller.

A Case in Point: InBev Buys an American Icon for $52 BillionFor many Americans, Budweiser is synonymous with American beer, and American beer is synonymous with beer giant Anheuser-Busch (AB). Ownership of this American icon changed hands on July 14, 2008, when Anheuser-Busch agreed to be acquired by Belgian brewer InBev for $52 billion in an all-cash deal. The combined firms would have annual revenue of about $36 billion and control about 40 percent of the U.S. beer market and 25 percent of the global market.

Mergers and Acquisitions Basics194

InBev’s purchase is part of a wave of consolidation in the global beer indus-try, which reflects an attempt to offset rising commodity costs by achieving greater scale and purchasing power. Although the transaction is likely to gener-ate cost savings of about $1.5 billion annually by 2011, InBev stated publicly that it is about the two firms being complementary rather than overlapping.

The announcement marked a reversal from AB’s publicly stated position only a week earlier that InBev’s offer undervalued the firm. Subsequently, AB sued InBev for “misleading statements” it had allegedly made about the strength of its financing. To court public support, AB publicized its history as a major ben-efactor in its hometown area of St. Louis, Missouri. The firm argued that its own long-term business plan would create more shareholder value than the pro-posed deal. To make the transaction too expensive for InBev, AB contemplated acquiring the half of Grupo Modelo, the Mexican brewer of Corona, it did not already own. Meanwhile, AB was under substantial pressure from major inves-tors, including Warren Buffet, to agree to the deal because the firm’s stock had been lackluster for the past several years.

While publicly professing to want a friendly transaction, InBev wasted no time turning up the heat. The firm launched a campaign to replace AB’s board with its own slate of candidates, including a Busch family member. In an effort to win additional shareholder support, InBev raised its initial $65 bid to $70. To eliminate concerns over its ability to finance the deal, InBev agreed to document its credit sources fully, rather than rely on more traditional but less certain credit commitment letters. In an effort to placate AB’s board, manage-ment, and the myriad politicians who railed against the proposed transaction, InBev agreed to name the new firm Anheuser-Busch InBev, keep Budweiser as the new firm’s flagship brand, and maintain North American headquarters in St. Louis. In addition, AB would be given two seats on the board, including one for August A. Busch IV, AB’s CEO and patriarch of the firm’s founding family. InBev also announced that AB’s 12 U.S. breweries would remain open.

Things to Think About:1. Explain InBev’s motives for acquiring Anheuser-Busch. Be specific.2. What unusual hurdles did InBev have to overcome in acquiring Anheuser-

Busch? Be specific.3. Why did InBev initially undertake a friendly takeover of Anheuser-Busch? Be

specific.4. What developments in 2009 suggest that InBev may have overpaid signifi-

cantly for Anheuser Busch?5. How might certain concessions made by InBev to close the deal make it dif-

ficult for the firm to reach its desired financial returns? Be specific.

Answers can be found at: www.elsevierdirect.com/companion.jsp?ISBN=9780123749482

195Mergers and Acquisitions Basics� ©�2011�Elsevier�Inc.ISBN:�����0�12��������2�� ��I: �ll ri���s reserve�.����0�12��������2�� ��I: �ll ri���s reserve�.�����I:� �ll�ri���s�reserve�.

CHAPTER

201110.1016/B����0�12��������2.0000���

Financing Transactions

��mer�er�an��acquisi�ion�financin��plan�comprisin��balance�s�ee����income���an�� cas��flow� s�a�emen�s� for� ��e� combine�� firms� s�oul�� be� �evelope��before� ne�o�ia�ions� �ave� been� comple�e�.�Unlike� ��e� financial� s�a�emen�s�use���o�value���e��ar�e�� firm���financial� s�a�emen�s��ere�s�oul��inclu�e���e�expec�e��cos��of�financin����e��ransac�ion—cri�ical�inpu��because�i��places�a�limi��on��ow�muc��of���e�propose��purc�ase�price���e�buyer�can�offer���e�seller.�T�e�financial�plan�also�provi�es�insi���s�in�o���e�appropria�e�composi��ion�of���e�purc�ase�price�by�projec�in����e�po�en�ial�for�earnin�s�per�s�are�(EPS)��ilu�ion�if���e�acquirer�issues�a�subs�an�ial�number�of�new�s�ares���as�well�as���e�po�en�ial�for��i��er�borrowin��cos�s�if�levera�e�is�increase��si��nifican�ly.�Consequen�ly���by� simula�in��al�erna�ive� financial� s�ruc�ures� (e.�.����eb���o�equi�y�ra�ios)��� ��e�acquirer�can��ain�insi���� in�o�w�a��mi����con�s�i�u�e���e�leas��cos�ly�way�of�financin����e��ransac�ion.�T�e�financin��plan�may�be�sai������erefore����o�cons�i�u�e�a�reali�y�c�eck�for���e�buyer.

T�is�c�ap�er��iscusses��ow��ransac�ions�are�finance��an��a��resses���e�complex�capi�al� s�ruc�ures�of��i��ly� levera�e���ransac�ions��� suc��as� lever�a�e��buyou�s�an��ways�of�selec�in����e�appropria�e�capi�al�s�ruc�ure.

Financing OptiOns: BOrrOwing

�nce�a�prospec�ive��ar�e���as�been�i�en�ifie������e�buyer�may�c�oose�from�a�number�of� financin��al�erna�ives.�For� ��e� risk�averse�acquirer��� ��e� i�eal�mec�anism�may�be��o�finance���e��ransac�ion�wi���cas���el��by���e��ar�e��in�excess�of�normal�workin��capi�al�requiremen�s—bu��suc��si�ua�ions�are�rare.�Ven�ure� capi�al� or� so�calle�� an�el� inves�ors� also�may� be� available� �o�fun�� ��e� �ransac�ion.�However��� ��is�op�ion�may� represen��very�expensive�financin��because� ��e�buyer�may��ave� �o��ive�up�majori�y�owners�ip�of���e�acquire��company.�Use�of���e�buyer’s�s�ock�may�be�an�appropria�e�way��o�minimize���e�ini�ial�cas��ou�lay���bu����a��op�ion�is�rarely�available�in�a�mana�emen��buyou��or�a�buyou��by�priva�ely��el��companies.

T�e�seller�may�be�willin���o�accep���eb��issue��by���e�buyer�if�an�upfron��cas��paymen��is�no��impor�an�.��oin��so�may�be��i��ly��isa�van�a�eous��o���e�buyer�if���e�seller�places�subs�an�ial�res�ric�ions�on��ow���e�business�may�

9

Mergers and Acquisitions Basics196

be�mana�e�.�T�e�use�of�a�public�issue�of�lon���erm��eb���o�finance���e��rans�ac�ion�may�minimize���e�ini�ial�cas��ou�lay���bu��i��is�also�subjec���o�res�ric�ions�place�� on� �ow� ��e� business� may� be� opera�e�� by� ��e� inves�ors� buyin�� ��e�issue.�Moreover���public�issues�are�expensive�in��erms�of�a�minis�ra�ive���mar�ke�in����an��re�ula�ory�repor�in��cos�s.�T�ese�reasons�explain�w�y�asse��base��len�in���as�emer�e��as�an�a��rac�ive�al�erna�ive��o�usin��cas����s�ock���or�public��eb��issues���if���e��ar�e���as�sufficien���an�ible�asse�s��o�serve�as�colla�eral.

Asset-Based or Secured LendingUn�er� asse��base�� len�in���� ��e� borrower� ple��es� cer�ain� asse�s� as� colla��eral.��sse��base��len�ers�look�a����e�borrower’s�asse�s�as���eir�primary�pro��ec�ion�a�ains����e�borrower’s�failure��o�repay.�T�ese�loans�are�of�en�s�or���erm� (i.e.��� less� ��an�one�year� in�ma�uri�y)� an�� secure��by� asse�s� ��a�� can�be� liqui�a�e��easily��� suc��as�accoun�s�receivable�an�� inven�ory.�Borrowers�of�en�seek�revolvin��lines�of�cre�i����a����ey��raw�upon�on�a��aily�basis��o�run���eir�business.�Un�er�a�revolvin��cre�i��arran�emen������e�bank�a�rees��o�make� loans�up� �o�a� specifie��maximum�for�a� specifie��perio����usually�a�year�or�more.��s���e�borrower�repays�a�por�ion�of���e�loan���an�amoun��equal� �o� ��e� repaymen�� can� be� borrowe�� a�ain� un�er� ��e� �erms� of� ��e�a�reemen�.�In�a��i�ion��o�in�eres��on���e�no�es�����e�bank�c�ar�es�a�fee�for���e�commi�men���o��ol����e�fun�s�available.�For�a�fee�����e�borrower�may�c�oose��o�conver����e�revolvin��cre�i��line�in�o�a��erm�loan.���term loan�usually��as�a�ma�uri�y�of�2��o�10�years�an���ypically�is�secure��by���e�asse����a��is�bein��finance����suc��as�new�capi�al�equipmen�.

�cquirin�� firms� of�en� prefer� �o� borrow� fun�s� on� an� unsecure�� basis�because� ��e� a��e�� a�minis�ra�ive� cos�s� involve�� in�ple��in�� asse�s� as� secu�ri�y� si�nifican�ly� raise� ��e� �o�al� cos�� of� borrowin�.� Secure�� borrowin�� can�be�onerous�because���e�securi�y�a�reemen�s�can�severely�limi��a�company’s�fu�ure�borrowin��an��abili�y��o�pay��ivi�en�s���make�inves�men�s���an��mana�e�workin��capi�al�a��ressively.�In�many�ins�ances�����ou�����borrowers�may��ave�li��le�c�oice�bu���o�ob�ain�secure��len�in��for�a��leas��a�por�ion�of���e�pur�c�ase�price.��sse��base�� len�ers� �enerally� require�personal� �uaran�ees� from���e�buyer� suc�� as� ple��in�� a�personal� asse�� (e.�.��� ��e�buyer’s� primary� resi��ence).�T�is�is�especially��rue�in�small��ransac�ions�if���e�buyer��oes�no���ave�a��emons�ra�e���rack�recor��of�buyin��an��opera�in��businesses�successfully.

Loan DocumentationT�e� len�in��process� en�ails� some�ne�o�ia�ion� an�� resul�s� in� several� �oc�umen�s.�T�e� loan agreement� s�ipula�es� ��e� �erms� an�� con�i�ions� un�er�w�ic����e�len�er�will�loan���e�firm�fun�s;���e�security agreement�specifies��

Financing Transactions 197

w�ic��of���e�borrower’s�asse�s�will�be�ple��e���o�secure���e�loan;�an����e�promissory note�commi�s���e�borrower��o�repay���e�loan���even�if���e�asse�s���w�en� liqui�a�e���� �o� no�� fully� cover� ��e� unpai�� balance.�T�ese� a�ree�men�s�con�ain�cer�ain�securi�y�provisions�an��pro�ec�ive�covenan�s�limi�in��w�a����e�borrower�may��o�as�lon��as���e�loan�is�ou�s�an�in�.�T�e�securi�y�a�reemen��is�file��a��a�s�a�e�re�ula�ory�office�in���e�s�a�e�w�ere���e�colla��eral�is�loca�e�.�Fu�ure�len�ers�can�c�eck�wi�����is�office��o�see�w�ic��asse�s�a�firm��as�ple��e��an��w�ic��are�free��o�be�use��as�fu�ure�colla�eral.�T�e�filin�� of� ��is� securi�y� a�reemen�� le�ally� es�ablis�es� ��e� len�er’s� securi�y�in�eres��in���e�colla�eral.�If���e�borrower��efaul�s�on���e�loan�or�o��erwise��fails��o��onor���e��erms�of���e�a�reemen������e�len�er�can�seize�an��sell���e�colla�eral��o�recover���e�value�of���e�loan.1

Pledging Receivables and Inventory�epen�in�� on� ��e� ex�en�� �o� w�ic�� ��ey� are� collec�able��� len�ers� may�len��as�muc��as��0� �o��0�percen��of� ��e�book�value�of� ��e� receivables.2��sse��base��len�ers��enerally�are�willin���o�len��a�ains��only���ose�receiv�ables��ue�wi��in��0��ays�an��usually�less���an�100�percen��of���eir�value���because� ��ey� are� aware� ��a�� some�por�ion�will� no�� be� collec�able.�T�ose���a��are�more���an��0��ays�pas���ue�are�likely��o�be��ifficul���o�collec�.

Inven�ories�also�are�commonly�use���o�provi�e�colla�eral�for�levera�e��buyou�� (LB�)� �ransac�ions.� Inven�ories� (raw� ma�erial��� work�in�process���an�� finis�e�� �oo�s)��� like� receivables��� can� be� �i��ly� liqui�.� Len�ers� �en�erally� consi�er�only� raw�ma�erial� an�� finis�e�� �oo�s� inven�ories� as� sui��able�colla�eral.�T�e�amoun��a� len�er�will� a�vance�a�ains�� ��e�book�value��of�inven�ory��epen�s�on�i�s�ease�of�i�en�ifica�ion�an��i�s�liqui�i�y.�Typically���len�ers�will�loan�be�ween�50�an���0�percen��of���e�value�of�inven�ory�an��will��en���o�loan�less�if���e�inven�ory�is�peris�able���is�subjec���o�rapi��obso�lescence���or��as�rela�ively�few�po�en�ial�buyers.

Pledging Equipment and Real Estate to Support Term Loans���erm�loan�can�be�s�ruc�ure��suc����a����e�perio��of���e�loan�correspon�s�wi��� ��e� economic� life� of� ��e� i�em�bein�� finance���� an��borrowers� of�en�prefer� ��ese� loans�because� ��ere�are�no�concerns� abou�� ��e� loan�nee�in���o�be�renewe�.��urable�equipmen��an��real�es�a�e�of�en�are�use���o�secure��erm�loans.�Len�ers�are�frequen�ly�willin���o�len��up��o��0�percen��of���e�appraise��value�of�equipmen��(bu��no��special�purpose�equipmen����w�ic��

1� T�e�process�of��e�erminin��w�ic��of�a�firm’s�asse�s�are�free�from�liens�is�ma�e�easier��o�ay�by�commercial�cre�i��repor�in��reposi�ories�suc��as��un�&�Bra�s�ree����Experian���Equifax���an��TransUnion.

2� Kre�low���McGui�an���an��Moyer�(1���).

Mergers and Acquisitions Basics198

is�likely��o��ave�few�po�en�ial�buyers)�an��50�percen��of���e�value�of�lan�.�T�e�cas��flows��enera�e��by���e�asse�s�will�be�use���o�pay�off���e�loan.

Term� loans� are� some�imes� use�� in� LB�� �ransac�ions� �o� re�uce� ��e�overall�cos��of�borrowin�.�Because� ��ey�are�ne�o�ia�e��priva�ely�be�ween���e�borrower�an��len�er�����ey�can�be�muc��less�cos�ly���an�floa�in��a�pub�lic��eb��or�s�ock�issue.

Security Provisions and Protective CovenantsSecuri�y�provisions�an��pro�ec�ive�covenan�s�in�loan��ocumen�s�are�in�en�e���o�ensure���a����e�principal�an��in�eres��of�ou�s�an�in��loans�will�be�repai��in� a� �imely� fas�ion.�Typical� securi�y� provisions� inclu�e� ��e� assi�nmen�� of�paymen�s� �ue� un�er� a� specific� con�rac�� �o� ��e� len�er��� an� assi�nmen�� of� a�por�ion�of���e�receivables�or�inven�ories���an��a�ple��e�of�marke�able�securi��ies��el��by���e�borrower.����ers�inclu�e�a�mor��a�e�on�proper�y���plan����an��equipmen���el��by���e�borrower���an����e�assi�nmen��of���e�cas��surren�er�value�of�a�life�insurance�policy��el��by���e�borrower�on�key�execu�ives.

�n�affirmative covenant� in� a� loan� a�reemen�� specifies� ��e� ac�ions� ��e�borrowin��firm�a�rees��o��ake��urin����e��erm�of���e�loan.�T�ese�ac�ions��ypically� inclu�e� furnis�in�� perio�ic� financial� s�a�emen�s� �o� ��e� len�er���carryin��sufficien��insurance��o�cover�insurable�business�risks���main�ainin��a� minimum� amoun�� of� ne�� workin�� capi�al��� an�� re�ainin�� key� mana�e�men��personnel�accep�able��o���e�len�in��ins�i�u�ion.���negative covenant�res�ric�s� ��e� ac�ions� of� ��e� borrower.�T�ese� ac�ions� inclu�e� limi�in�� ��e�amoun��of��ivi�en�s���a��can�be�pai������e�level�of�salaries�an��bonuses���a��may�be��iven��o���e�borrower’s�employees�����e��o�al�amoun��of�in�eb�e��ness���a��can�be�assume��by���e�borrower���inves�men�s�in�plan��an��equip�men��an��acquisi�ions���an����e�sale�of�cer�ain�asse�s.

�ll� loan� a�reemen�s� �ave� �efaul�� provisions� permi��in�� ��e� len�er� �o�collec�� ��e� loan� imme�ia�ely� un�er� cer�ain� con�i�ions� suc�� as� ��e� bor�rower�failin���o�pay�in�eres����principal���or�bo���accor�in���o���e��erms�of���e�loan�a�reemen�;���e�borrower�ma�erially�misrepresen�in��informa�ion�on���e�firm’s�financial�s�a�emen�s;�an����e�borrower�failin���o�observe�any�of� ��e� affirma�ive� or� ne�a�ive� covenan�s.� Loan� a�reemen�s� also� �ypically��ave�cross-default provisions���a��allow�a�len�er��o�collec��i�s�loan�imme�i�a�ely�if���e�borrower�is�in��efaul��on�a�loan��o�ano��er�len�er.

Cash-Flow or Unsecured LendersCas��flow�len�ers�view�a�borrower’s�fu�ure�cas��flow��enera�ion�capabil�i�y� as� ��e� primary� means� of� recoverin�� a� loan� an�� ��e� borrower’s� asse�s�as� a� secon�ary� source� of� fun�s� in� ��e� even�� of� �efaul�� by� ��e� borrower.�

Financing Transactions 199

Cas��flow–base�� len�in�� for� LB�s� became� more� commonplace� �urin����e�mi���o�la�e�1��0s.�Many�LB�s’�capi�al� s�ruc�ures�assume�� increasin��amoun�s�of�unsecure���eb�.�To�compensa�e� for�a��i�ional� risk��� ��e�unse�cure��len�ers�woul��receive�bo���a��i��er�in�eres��ra�e�an��warran�s���a��were�conver�ible�in�o�equi�y�a��some�fu�ure��a�e.

Unsecure���eb�� ��a�� lies�be�ween�senior��eb��an����e�equi�y� layers� is�of�en�referre�� �o�as�mezzanine financing.� I�� inclu�es� senior� subor�ina�e���eb����subor�ina�e���eb����bri��e�financin����an��LB��par�ners�ip�financin�.�I�� frequen�ly� consis�s� of� �i���yiel�� junk� bon�s��� w�ic�� may� also� inclu�e�zero�coupon��eferre��in�eres���eben�ures�(i.e.���bon�s�w�ose�in�eres��is�no��pai��un�il�ma�uri�y)�use���o�increase���e�pos�acquisi�ion�cas��flow�of���e�acquire��en�i�y.�In�liqui�a�ion���unsecure���eb��lies�be�ween���e�secure��or�asse��base���eb��an��preferre��an��common�equi�y.�Unsecure�� financin��of�en�consis�s�of� several� layers�of��eb����eac��subor�ina�e� in� liqui�a�ion��o���e�nex��mos�� senior� issue.�T�ose�wi��� ��e� lowes�� level�of� securi�y� �ypi�cally�offer� ��e��i��es��yiel�s� �o�compensa�e� for� ��eir��i��er� level�of� risk�in���e�even��of��efaul�.�Bridge financing�is�unsecure��loans���of�en�provi�e��by�inves�men��banks�or��e��e�fun�s����o�supply�s�or���erm�financin��pen��in�� ��e� placemen�� of� subor�ina�e�� �eb�� (i.e.��� lon���erm�or�“permanen�”�financin�);���e�usual�expec�a�ion�is���a��bri��e�financin��will�be�replace��six��o�nine�mon��s�af�er���e�closin���a�e�of���e�LB���ransac�ion.

Types of Long-Term FinancingT�e�a��rac�iveness�of� lon���erm��eb�� is� i�s� rela�ively� low�af�er��ax�cos��as�a�resul��of� ��e��ax��e�uc�ibili�y�of� in�eres�.� In�a��i�ion��� levera�e�can��elp�improve� earnin�s� per� s�are� an�� re�urns� on� equi�y.� However��� �oo� muc���eb��can�increase���e�risk�of��efaul��on�loan�repaymen�s�an��bankrup�cy.

Lon���erm� �eb�� �enerally� is� classifie�� accor�in�� �o� w�e��er� i�� is�secure�.�Secured debt�issues��ypically�are�referre���o�as�mor��a�e�bon�s�or�equipmen�� �rus��cer�ifica�es.�Debentures�are� issues�no�� secure��by�specific�asse�s���an���ence���eir�quali�y��epen�s�on���e��eneral�cre�i�wor��iness�of���e�issuin��company.

Convertible Debt and DebenturesConver�ible� bon�s� or� �eben�ures� are� �ypes� of� �eb�� ��a�� are� conver�ible��� a��some�pre�e�ermine�� ra�io� (i.e.��� a� specific�number�of� s�ares�per�bon�)��� in�o�s�ares� of� s�ock�of� ��e� issuin�� company.� Suc���eb�� of�en� is� referre�� �o� as� a��ybri��securi�y�because�i���as�bo����eb��an��equi�y�c�arac�eris�ics.�I��normally��as�a�rela�ively�low�coupon�ra�e�(i.e.�����e�fixe��number�of��ollars��o�be�pai��eac��paymen��perio��as�a�percen��of���e�value�of���e�bon�s�w�en�issue�).

Mergers and Acquisitions Basics200

T�e�bon��buyer�is�compensa�e��primarily�by���e�abili�y��o�conver����e�bon���o�common�s�ock�a��a� subs�an�ial��iscoun�� from���e� s�ock’s�marke��value.�Issuers�of�suc���eb��benefi��by��avin���o�make�a�lower�cas��in�eres���paymen�.�However���curren��s�are�ol�ers�will�experience�earnin�s�or�own�ers�ip��ilu�ion�w�en���e�bon��ol�ers�conver����eir�bon�s�in�o�new�s�ares.�For�example���a� s�are�ol�er�no���ol�in����e�conver�ible��eb��bu��ownin��10�percen��of���e�s�ares�of�a�firm�wi���one�million�s�ares�ou�s�an�in��will�see���a��owners�ip�posi�ion�re�uce���o�5�percen��if�one�million�new�s�ares�are�issue�����ue��o���e�conversion�of�suc���eb��in�o�equi�y.

Senior and Junior DebtLon���erm� �eb�� issues� also� are� classifie�� by� w�e��er� ��ey� are� senior� or�junior� in� liqui�a�ion.� Senior� �eb���as� a� �i��er�priori�y� claim� �o� a� firm’s�earnin�s�an��asse�s���an�junior��eb�.�Unsecure���eb��also�may�be�classifie��accor�in���o�w�e��er�i��is�subor�ina�e���o�o��er��ypes�of��eb�.�In��eneral���subor�ina�e���eben�ures�are�junior��o�o��er��ypes�of��eb����inclu�in��bank�loans���an��even�may�be�junior��o�all�of�a�firm’s�o��er��eb�.

IndenturesT�e�ex�en���o�w�ic��a��eb��issue�is�junior��o�o��er��eb���epen�s�on���e�res�ric�ions�place��on� ��e�company� in�an�a�reemen��calle��an� in�en�ure���w�ic��is�a�con�rac��be�ween���e�firm���a��issues���e�lon���erm��eb��secu�ri�ies�an����e�len�ers.�T�e�in�en�ure��e�ails���e�na�ure�of���e�issue���specifies���e�way� in�w�ic�� ��e� principal�mus�� be� repai���� an�� specifies� affirma�ive�an��ne�a�ive�covenan�s�applicable��o���e�lon���erm��eb��issue.�Typical�cov�enan�s� inclu�e�main�ainin��a�minimum�in�eres��covera�e�ra�io���minimum�level�of�workin��capi�al���maximum�amoun��of��ivi�en�s���a����e�firm�can�pay���an��res�ric�ions�on�equipmen��leasin��an��issuin��a��i�ional��eb�.

Bond Ratings�eb��issues�are�ra�e��by�various�ra�in��a�encies�accor�in���o���eir�rela�ive��e�ree�of�risk.�T�e�a�encies�consi�er�a�varie�y�of�fac�ors���inclu�in��a�firm’s�earnin�s�s�abili�y���in�eres��covera�e�ra�ios�����e�rela�ive�amoun��of��eb��in���e�firm’s�capi�al�s�ruc�ure�����e��e�ree�of�subor�ina�ion�of���e�issue�bein��ra�e����an����e�firm’s�pas��performance�in�mee�in��i�s��eb��service�requiremen�s.�

�� Ra�in��a�encies�inclu�e�Moo�y’s�Inves�ors�Services�an��S�an�ar��&�Poor’s�Corpora�ion.�Eac���as�i�s�own�scale�for�i�en�ifyin����e�risk�of�an�issue.�For�Moo�y’s�����e�ra�in�s�are��aa�(��e�lowes��risk�ca�e�ory)����a�������Baa���Ba���B���Caa���Ca���an��C�(��e��i��es��risk).�For�S&P��������eno�es���e�lowes��risk�ca�e�ory���an��risk�rises�pro�ressively���rou���ra�in�s����������BBB���BB���B���CCC���CC���C���an���.

Financing Transactions 201

Junk BondsJunk bonds�are��i���yiel��bon�s���a��cre�i��ra�in��a�encies��ave��eeme��ei��er� �o� be� below� inves�men�� �ra�e�or� ��a�� ��ey��ave� no�� ra�e�� a�� all.��W�en� ori�inally� issue���� junk� bon�s� frequen�ly� yiel�e�� more� ��an� four�percen�a�e� poin�s� above� ��e� yiel�s� on� U.S.�Treasury� �eb�� of� comparable�ma�uri�y.

Junk�bon��financin��explo�e��a����e�be�innin��of���e�1��0s�bu���rie��up�by���e�en��of���e��eca�e.5��bou����ree�four��s�of���e��o�al�procee�s�of�junk�bon�s�issue��be�ween�1��0�an��1��6�were�use���o�finance���e�capi��al�requiremen�s�of��i����row���corpora�ions;���e�remain�er�was�use���o�finance��akeovers.6

Leveraged Bank LoansLeveraged loans� are� of�en� �efine�� as� unra�e�� or� noninves�men���ra�e�bank� loans�w�ose� in�eres�� ra�es� are�equal� �o�or��rea�er� ��an� ��e�Lon�on�In�erbank� Ra�e� (LIB�R)� plus� 150� basis� poin�s� (1.5� percen�a�e� poin�s).�Levera�e�� loans� inclu�e� secon��mor��a�es���w�ic�� �ypically��ave� a� floa��in�� ra�e� an�� �ive� len�ers� a� lower� level� of� securi�y� ��an� firs�� mor��a�es.�Some� analys�s� inclu�e� o��er� forms� of� �eb�� ins�rumen�s� in� ��is� marke����suc��as�mezzanine�or�senior�unsecure���eb�����iscusse��earlier�in���is�c�ap��er���an��paymen��in�kin��no�es��� for�w�ic��in�eres�� is�pai�� in���e�form�of��more��eb�.

In� ��e� Uni�e�� S�a�es��� ��e� volume� of� suc�� loans� subs�an�ially� excee�s���e� volume� of� junk� bon�� issues.�T�is� represen�s� a� revival� in� bank� loan�financin��as�an�al�erna�ive��o�financin���ransac�ions�wi���junk�bon�s�af�er�junk�bon��issues��rie��up�in���e�la�e�1��0s;�a����e��ime���bank�loans�were�more�expensive.�Levera�e��loans�are�of�en�less�cos�ly���an�junk�bon�s�for��

�� Moo�y’s�usually�ra�es�noninves�men���ra�e�bon�s�Ba�or�lower;�for�S&P���i��is�BB�or�lower.5� Rapi���row���of���e�junk�bon��marke��coinci�e��wi���a��rowin���e�eriora�ion��urin����e�1��0s�in�

��eir�quali�y���as�measure��by�in�eres��covera�e�ra�ios�(i.e.���earnin�s�before�in�eres��an���axes/in�eres��expense)����eb�/ne���an�ible�book�value���an��cas��flow�as�a�percen�a�e�of��eb��(Wi�more���1���).�Cumula�ive��efaul��ra�es�for�junk�bon�s�issue��in���e�la�e�1��0s�reac�e��as��i���as����percen��by�1��6�(�squi�����Mullins���an��Wolff���1���)���bu��firms���a��emer�e��from�bankrup�cy�mana�e���o�recover�some�por�ion�of���e�face�value�of���e�junk�bon�.��l�man�an��Kis�ore�(1��6)�foun����a��recovery�ra�es�for�senior�secure���eb��avera�e��abou��5��percen��of���e�ori�inal�principal�an����a����e�ac�ual�realize��sprea��be�ween�junk�bon�s�an��10�year�U.S.�Treasury�securi�ies�was�ac�ually�abou��four�percen�a�e�poin�s�be�ween�1����an��1������ra��er���an�more���an�four�percen�a�e�poin�s�w�en���ey�were�issue��ori�inally.�T�is�source�of�LB��financin���rie��up�in���e�la�e�1��0s�af�er�a�series�of��efaul�s�of�overlevera�e��firms���couple��wi���alle�e��insi�er��ra�in��an��frau��a��companies�suc��as��rexel�Burn�am�����e�primary�marke��maker�for�junk�bon�s�a����a���ime.

6� Ya�o�(1��1).

Mergers and Acquisitions Basics202

borrowers�because���ey�may�provi�e�a��i��er�level�of�securi�y���an�unse�cure��junk�bon�s.

Globally��� ��e� syn�ica�e�� loan�marke�� (w�ic�� inclu�es� levera�e�� loans���senior�unsecure���eb����an��paymen��in�kin��no�es)�is��rowin��more�rap�i�ly� ��an� public�marke�s� for� �eb�� an�� equi�y.� Syn�ica�e�� loans� are� ��ose��ypically� issue�� ��rou��� a� consor�ium� of� ins�i�u�ions��� inclu�in�� �e��e�fun�s��� pension� fun�s��� an�� insurance� companies��� �o� in�ivi�ual� borrowers.�Because� suc�� len�in�� usually� avoi�s� ��e� public� �eb�� marke�s��� i�� of�en� is�referre���o�as���e�“priva�e��eb��marke�.”

The “Road Show”To�arran�e�bo���bri��e�an��permanent financing��� ��e�buyer�will��evelop�elabora�e� presen�a�ions� �o� convince� po�en�ial� len�ers� of� ��e� a��rac�ive�ness�of���e�len�in��oppor�uni�y.�I��is�referre���o�as�a�“roa��s�ow”�for��oo���reason—immacula�ely� �resse�� borrowers� passiona�ely� �isplay� confi�ence�in���eir�business�plan���rou���carefully�re�earse��an��c�oreo�rap�e��mul��ime�ia�presen�a�ions�in�s�uffy�conference�rooms���rou��ou����e�coun�ry.�T�e�roa��s�ow�is�an�oppor�uni�y�for�po�en�ial�len�ers��o�see�mana�emen��an���o�ask��ou���ques�ions.�If���e�roa��s�ow�succee�s���a��leas��several�len��ers�will�compe�e�for�all�or�a�por�ion�of���e�bon��issue���resul�in��in�lower�in�eres��ra�es�an��less�onerous�loan�covenan�s.�

Assessing Risk Associated with Alternative Capital StructuresCompu�er� mo�els� ��a�� simula�e� ��e� financial� impac�� of� various� financial�s�ruc�ures�on���e�combine�� firms�are�excellen�� �ools� for��e�erminin����e�appropria�e� capi�al� s�ruc�ure.��l��ou��� levera�e� raises� ��e� po�en�ial� ra�e�of� re�urn� �o� equi�y� inves�ors��� i�� also� a��s� �o� risk.� Increasin�� cre�i�� obli��a�ions� �o� len�ers� implies� increasin�� fixe�� in�eres�� expense��� w�ic�� raises���e� poin�� a�� w�ic�� ��e� firm’s� revenue� covers� i�s� cos�s� (i.e.��� i�s� breakeven�poin�).��n�unan�icipa�e���own�urn� in� ��e�economy�or�a��ressive�pricin��ac�ions�by�compe�i�ors�can�ero�e�cas��flow�an����e�firm’s�abili�y��o�mee��

�� Swiss��ru��manufac�urer�Roc�e�Hol�in�s�con�uc�e��a�European�roa��s�ow�in�early�200���o�arran�e��eb��financin��for���e�firm’s�planne��$�2�billion�buyou��of���e����percen��of�U.S.�bio�ec�nolo�y�firm�Genen�ec��i���i��no��alrea�y�own.�Roc�e�raise��$10�billion�from���e�public�bon��marke����$25�billion�from�a�syn�ica�e�of�12�banks���an��planne���o�fun����e�remain�er�of���e�purc�ase�price�wi���i�s�own�cas��an��marke�able�securi�ies.����i�ional�s�or���erm�capi�al�coul��be�raise��by�issuin��commercial�paper�(i.e.���s�or���erm��eb��backe��unsecure���eb�).

Financing Transactions 203

i�s� in�eres�� expense���w�ic�� coul��ul�ima�ely� lea�� �o�bankrup�cy.�T�is� risk�can�be�measure��by�crea�in��various�scenarios���eac��represen�in��a��ifferen���capi�al�s�ruc�ure�an��sales��row���ra�e.

Financing OptiOns: Equity and HyBrid sEcuritiEs

In� con�ras�� �o� �eb�� an�� preferre�� equi�y��� income� paymen�s� on� com�mon� s�ock—w�ic�� represen�s� s�are�ol�er� owners�ip� in� a� corpora�ion’s�equi�y—can�vary�over��ime.�T�e��o�al�re�urn�on�capi�al�s�ock�reflec�s�bo�����e� �ivi�en�s� pai�� as� well� as� any� capi�al� apprecia�ion� �ue� �o� increasin��expec�e��earnin�s�an��cas��flow.�Common�s�ock�ol�ers�par�icipa�e�in���e�firm’s�fu�ure�earnin�s�because���ey�may�receive�a�lar�er��ivi�en��if�earn�in�s� increase.� If� ��e�corpora�ion� is� force���o� liqui�a�e����owever���common�s�are�ol�ers� �ave� ri���s� �o� ��e� firm’s� asse�s� only� af�er� bon��ol�ers� an��preferre��s�ock�ol�ers�are�pai�.

T�ere�are�many�varie�ies�of� common� s�ock.�Some�pay��ivi�en�s� an��offer�vo�in��ri���s���en�i�lin����e�owner��o�par�icipa�e�in�cer�ain�corpora�e��ecisions���suc��as�elec�in��members�of���e�boar��of��irec�ors.����er�com�mon�s�ares�(of�en�calle��supervo�in��s�ares)��ave�mul�iple�vo�in��ri���s.�In�a��i�ion��o�vo�in��ri���s���common�s�are�ol�ers� some�imes�receive�ri���s�offerin�s� ��a�� allow� ��em� �o� main�ain� ��eir� propor�ional� owners�ip� in���e�company�in���e�even����a����e�company�issues�ano��er�s�ock�offerin�.�Common�s�are�ol�ers�wi��� ri���s�may���bu�� are�no��obli�a�e�� �o��� acquire�as�many�s�ares�of���e�new�s�ock�as�nee�e���o�main�ain���eir�propor�ional�owners�ip�in���e�company.

Like� common� s�ock��� preferre�� s�ock� is� par�� of� s�are�ol�ers’� equi�y.��l��ou��� preferre�� s�ock�ol�ers� receive� �ivi�en�s� ra��er� ��an� in�eres��paymen�s��� ��eir� s�ares� are� consi�ere�� a� fixe�� income� securi�y.��ivi�en�s�on�preferre��s�ock�are��enerally�cons�an��over��ime���like�in�eres��paymen�s�on��eb����bu����e�firm�is��enerally�no��obli�a�e���o�pay���em�a��a�specific��ime.�Unpai���ivi�en�s�may�cumula�e�for�even�ual�paymen��by���e�issuer�if���e�preferre��s�ock�is�a�special�cumula�ive�issue.

In�liqui�a�ion���bon��ol�ers�are�pai��firs��an����en�preferre��s�ock�ol��ers;�common�s�ock�ol�ers�are�pai��las�.�I�s�fixe��income�securi�y�s�a�us�an����is�senior�claim�compare���o�common�s�ock�is�w�y�preferre��s�ock�of�en�is� issue�� �o� ��ose� provi�in�� equi�y� in� financin�� levera�e�� buyou�� �rans�ac�ions.�To�conserve�cas����LB�s� frequen�ly� issue�pai��in�kin��(PIK)�pre�ferre��s�ock���w�ere�issuin��a��i�ional�par�amoun�s�of���e�preferre��securi�y�can�sa�isfy���e��ivi�en��obli�a�ion.

Mergers and Acquisitions Basics204

sEllEr Financing

Seller�financin��(also�known�as�“owner�financin�”�or�“owner�carry�back”)�is�a��i��ly�impor�an��source�of�financin��an��one�way��o�“close���e��ap”�be�ween�w�a��a�seller�wan�s�an��a�buyer�is�willin���o�pay�on���e�purc�ase�price.�T�is� �ype�of� financin�� involves� ��e� seller��eferrin�� ��e�receip��of�a�por�ion�of���e�purc�ase�price�un�il�some�fu�ure��a�e—in�effec����provi�in��a�loan��o���e�buyer.���buyer�may�be�willin���o�pay���e�seller’s�askin��price�if�a�por�ion�is��eferre��because���e�buyer�reco�nizes���a����e�loan�will�re�uce���e�purc�ase�price�in�presen��or�curren��value��erms.�T�e�a�van�a�es��o���e�buyer� inclu�e�a� lower�overall� risk�of� ��e��ransac�ion���because�of� ��e�nee���o�provi�e�less�capi�al�a����e��ime�of�closin����an����e�s�if�in��of�opera�ional�risk��o���e�seller�if���e�buyer�ul�ima�ely��efaul�s�on���e�loan��o���e�seller.

Businesses� ��a�� �ave� excellen�� cas�� flow� bu�� very� few� �an�ible� asse�s���a�� can� serve� as� colla�eral� may� fin�� banks� unwillin�� �o� len�.�T�a�� may�make�seller�financin��a�mus�.�

In� a� �ypical� seller�finance�� �ransac�ion��� ��e� buyer� con�ribu�es� a� lar�e�por�ion�of���e�purc�ase�price�in�cas��an����en�ne�o�ia�es�wi�����e�seller�a�payback�sc�e�ule�an��in�eres��ra�e�for���e�remainin��balance.�Sellers�of�en�are�willin�� �o�carry�a�promissory�no�e� for� some�por�ion�of� ��e�purc�ase�price� w�en� ��e� buyer� is� unable� �o� �e�� a� bank� loan� or� unwillin�� �o� pu��a��i�ional�cas��or�equi�y�in���e�purc�ase�price.

Generally���seller�financin��is�unsecure�.�If���e�business�bein��purc�ase��is�par��of�a�lar�er�paren��company�����e�borrower�may�be�able��o�ob�ain�cer��ain�concessions�from���e�paren�.�For�example�����e�paren��may�be�willin���o�con�inue��o�provi�e�cer�ain�pro�uc�s�an��services��o���e�business�a��cos���o�increase���e�likeli�oo����a����e�business�can�repay�i�s�no�e�in�a��imely�fas�ion.

Sellers�may�use���eir�willin�ness��o�provi�e�suc��financin��as�a�way��o�marke�� ��eir� business� w�en� i�� is� �ifficul�� for� buyers� �o� ob�ain� financin�.�By�offerin�� �o� finance�a�por�ion�of� ��e�purc�ase�price���a� seller�makes�an�implici�� commi�men�� �o� ��e�buyer� ��a�� s�ows�confi�ence� in� ��e�curren��an��con�inuin��financial�viabili�y�of���e�business.�I��is���is�confi�ence���a���rives���e�willin�ness��o��ake�on�a�por�ion�of���e�risk.

�� Many�businesses��o�no��wan���o�use�seller�financin��because�i��requires���a����ey�accep����e�risk���a����e�no�e�will�no��be�repai�.�Suc��financin��is�necessary�����ou�����w�en�bank�financin��is�no��an�op�ion.�T�e��ryin��up�of�bank�len�in��in�200��an��200���ue��o���e�slumpin��economy�an��crisis�of�confi�ence�in���e�cre�i��marke�s�resul�e��in�increase��reliance�on�seller�financin���o�comple�e���e�sale�of�small���o�in�erme�ia�e�size�businesses.

Financing Transactions 205

Ex�ibi����1�summarizes� ��e�al�erna�ive� forms�of� financin��by��ype�of�securi�y�an��source�of�fun�s.

HigHly lEvEragEd transactiOns

T�e�leveraged buyout���or�LB����is�a�common�example�of�a��i��ly�levera�e���ransac�ion�in�w�ic��a�lar�e�por�ion�of���e�purc�ase�price�is�finance��wi����eb�.�LB���ar�e�s�can�be�priva�e�or�public�firms���an��can�involve�an�en�ire�company�or� a� �ivision�of� a� company.��n�LB�� inves�or� is� of�en� calle�� a�financial buyer�or�sponsor�an��may�be�incline���o�use�a� lar�e�amoun��of��eb���o�finance�as�muc��of���e��ar�e�’s�purc�ase�price�as�possible.�Financial�buyers��en���o�concen�ra�e�on�ac�ions���a��en�ance���e��ar�e��firm’s�abili�y�

EXHIBIT 9-1 Financing Mergers and AcquisitionsAlternative Types Debt Equity

Asset-Based Lending (Collateralized by fixed assets, accounts receivable, and inventories)

Cash-Flow-Based Lending(Based on projected cash flow)

Revolving Credit LinesTerm LoansSale/Lease-Back

Seller Financing Deferred PaymentsEarnoutsInstallment Sales

Common StockPreferred Stock

Public Offering and Private Placements

SeniorConvertibleSubordinated

Common StockPreferred Stock

Alternative Sources Commercial BanksInsurance CompaniesPension FundsInvestment/Merchant

BanksHedge Funds and Private

Equity Partnerships

Hedge or Buyout FundsPrivate Equity InvestorsVenture CapitalStrategic InvestorsIndividual Investors

(“Angels”)

Mergers and Acquisitions Basics206

�o��enera�e�cas���o�sa�isfy���eir�subs�an�ial��eb��service�requiremen�s.�Hi���levera�e�makes���e�po�en�ial�re�urns��o�equi�y�muc��more�a��rac�ive���an�less�levera�e���ransac�ions�(see�Ex�ibi����2).

T�e�fun�s�borrowe��for�a� levera�e��buyou��are�use���o�pay� for�mos��of� ��e� purc�ase� price���wi��� ��e� remain�er� provi�e��by� a� financial� spon�sor��� suc�� as� a� priva�e� equi�y� inves�or� �roup�or��e��e� fun�.�Typically��� ��e��an�ible�asse�s�of���e�firm��o�be�acquire��are�use��as�colla�eral�for���e�loans�in�a�levera�e��buyou����wi�����e�mos���i��ly�liqui��asse�s—suc��as�receiv�ables�an��inven�ory—use��for�colla�eral��o�ob�ain�bank�financin��an��fixe��asse�s�use���o�secure�a�por�ion�of�lon���erm�senior�financin�.�Subor�ina�e���eb��(of�en�junk�bon��financin�)���ei��er�unra�e��or�low�ra�e���eb����is�use���o�raise���e�balance�of���e�purc�ase�price.

W�en� a� public� company� is� subjec�� �o� an�LB���� i�� is� sai�� �o�be�going private� in� a�public��o�priva�e� �ransac�ion���because� ��e� equi�y�of� ��e� firm��as�been�purc�ase��by�a�small��roup�of�inves�ors�an��is�no�lon�er�publicly��ra�e�.�T�e�buyin���roup�of���e�firm��ar�e�e���o�become�a�levera�e��buy�ou��of�en�comprises� incumben��mana�ers� from���a��very� firm�in�w�a�� is�calle��a�management buyout�(MB�).

�l��ou���priva�e� equi�y� inves�ors� an���e��e� fun�s� playe�� an� impor��an�� role� as� financial� sponsors� (i.e.��� equi�y� inves�ors)� in� �i��ly� levera�e���ransac�ions���rou��ou����e���ree�mer�er�waves�since���e�early�1��0s�����eir�role�was�lar�ely�a�secon�ary�one��urin����e�1��0s��ec��boom.�T�e�buyou��

EXHIBIT 9-2 Impact of Leverage on Return to Shareholders*

All-Cash Purchase

50% Cash/ 50% Debt

20% Cash/ 80% Debt

Purchase Price $100 $100 $100Equity (Cash Investment) $100 $50 $20Borrowings 0 $50 $80Earnings Before Interest and Taxes $20 $20 $20Interest @ 10% 0 $5 $8Income Before Taxes $20 $15 $12Less Income Taxes @ 40% $8 $6 $4.8Net Income $12 $9 $7.2After-Tax Return on Equity 12% 18% 36%

*Unless�o��erwise�no�e����all�numbers�are�in�millions�of��ollars.

Financing Transactions 207

bin�e�came��o�a��rin�in���al��w�en�LB��financin���rie��up�in�la�e�200��an����rou��ou��200�.�

Ex�ibi������summarizes���e��ypes�of�securi�ies�an��sources�of�fun�in��of�en�use���o�finance�an�LB�.

Financing transactiOns By sElling discrEtiOnary assEts

Tar�e�� firm� asse�s� no�� consi�ere�� cri�ical� �o� implemen�in�� ��e� acquirer’s�business�s�ra�e�y�coul��be�sol���o�finance���e�purc�ase�of���e��ar�e��firm.��bviously��� ��e� bes�� �ime� �o� sell� a� business� is� w�en� ��e� owner� �oes� no��nee���o�sell���or�w�en���e��eman��for���e�business��o�be��ives�e��is��rea�es�.�T�e��ecision��o�sell�s�oul��also�reflec����e�broa�er�financial�environmen�.�Sellin��w�en�business�confi�ence�is��i�����s�ock�prices�are�risin����an��in�er�es��ra�es�are�low�is�likely��o�fe�c��a��i��er�price.�If�a�business��o�be�sol��is��i��ly�cyclical�����e�sale�s�oul��be��ime���o�coinci�e�wi�����e�firm’s�peak�year�earnin�s.�Businesses�also�can�be��ime���o�sell�w�en���ey�are�consi��ere��mos��popular.�In�1��0�����e�oil�explora�ion�business�was�boomin�;�by�1������i��was�in���e��ol�rums.�I��recovere��a�ain�by���e�mi��1��0s.�W�a�’s��o���o�ay�can�fizzle��omorrow.���similar�s�ory�coul��be��ol��abou��many�of� ��e��i���flyin��In�erne��rela�e��companies�of� ��e� la�e�1��0s�an��wi���commo�i�y�firms�in�200����rou���2010.

T�e�sellin��process�may�be�reac�ive�or�proac�ive.�Reac�ive�sales�occur�w�en�a�buyer�unexpec�e�ly�approac�es���e�paren��wi���in�eres��in�ei��er���e�en�ire�firm�or�a�por�ion�of���e�firm���suc��as�a�pro�uc��line�or�subsi�iary.��If� ��e�bi��is�sufficien�ly�a��rac�ive�����e�paren��firm�may�c�oose��o�reac��a�ne�o�ia�e��se��lemen��wi�����e�bi��er�wi��ou��inves�i�a�in��o��er�op�ions.�

�� LB���ransac�ions�sur�e��in���e�1��0s���culmina�in��in���e�$�1.5�billion�(inclu�in��assume���eb�)�buyou��in�1����of�RJR�Nabisco�by�Ko�lber��Kravis�Rober�s�&�Co.�T�is�boom�perio���issipa�e���ue��o���e�1��1�recession�an��poli�ical�backlas��a�ains��suc���ransac�ions.�Followin����e�la�e�1��0s��ec��booms�����e��/11��erroris��a��acks���an����e�2001�recession����i��ly�levera�e���ransac�ions�once�a�ain�sur�e��upwar����peakin��in�early�200�—fuele��lar�ely�by�a�s�ron��economy���low�in�eres��ra�es���an��easy�cre�i��con�i�ions.�W�en���e�boom�came��o�a��al��in�la�e�200��an��early�200����i��force��priva�e�equi�y�an���e��e�fun�s��o�re�renc��an�—as�a�si�n�of���e��imes—��ere�were��1��efaul�s��lobally��o�alin��$2�5�billion�by�priva�e�equi�y�backe��companies��urin��200��(accor�in���o�S�an�ar��&�Poor’s).�Reflec�in����e�perceive��risk�associa�e��wi����i��ly�levera�e���ransac�ions����i���yiel��sprea�s�(i.e.�����e��ifference�be�ween��i���risk�corpora�e��eb��an��U.S.�Treasury�bon��ra�es)�reac�e��recor��levels�in�la�e�200��of�more���an�1��percen�a�e�poin�s���more���an��wice���eir��is�orical�avera�e.

Mergers and Acquisitions Basics208

EXHIBIT 9-3 Leveraged Buyout Capital StructureType of Security Debt

Backed By Lenders Loan Up To

Lending Source

Secured Debt– Short-Term (1

Year) Debt– Intermediate-

Term (1–10 Years) Debt

– Liens generally on receivables and inventories

– Liens on land and equipment

– 50–80% depending on quality

– Up to 80% of appraised value of equipment and 50% of real estate

– Banks and finance companies

– Life insurance companies, private equity investors, pension and hedge funds

Unsecured or Mezzanine Debt (Subordinated and Junior Subordinated Debt, including Seller Financing)

– First Layer– Second Layer– Etc.Bridge FinancingPayment-in-Kind

Cash-generating capabilities of the borrower

Face value of securities

Life insurance companies, pension funds, private equity, and hedge funds

Equity

Preferred Stock– Payment-in-

Kind

Cash-generating capabilities of the borrower

Life insurance companies, pension funds, hedge funds, private equity, and angel investors

Common Stock Cash-generating capabilities of the borrower

Life insurance companies; pension, private equity, hedge, and venture capital funds; and angel investors

Financing Transactions 209

T�is�may�occur�if���e�paren��is�concerne��abou��po�en�ial��e�ra�a�ion�of�i�s�business���or���a��of�a�subsi�iary���if�i�s�in�eres��in�sellin��becomes�public�knowle��e.

In� con�ras���� proac�ive� sales� may� be� c�arac�erize�� as� public� or� priva�e�solici�a�ions.� In�a�public solicitation��� a� firm�can�announce�publicly� ��a�� i��is�pu��in��i�self���a�subsi�iary���or�a�pro�uc��line�up�for�sale.�Po�en�ial�buyers���en�con�ac����e�seller.�T�is�is�a�way��o�i�en�ify�in�eres�e��par�ies�rela�ively�easily.�Unfor�una�ely�����is�approac��can�also�a��rac��unqualifie��bi��ers�w�o�lack� ��e� financial� resources� necessary� �o� comple�e� ��e� �eal.� In� a� private solicitation��� ��e�paren�� firm�may��ire�an� inves�men��banker�or�un�er�ake�on�i�s�own��o�i�en�ify�po�en�ial�buyers.�W�en�a�lis��of�perceive��qualifie��buyers�is�compile����con�ac��is�ma�e.�(C�ap�er����e�ails���is�screenin��an��con�ac�in��process.)

In� ei��er� a� public� or� priva�e� solici�a�ion��� in�eres�e�� par�ies� are� aske���o� si�n� confi�en�iali�y� a�reemen�s� before� bein�� �iven� access� �o� proprie��ary�informa�ion.�In�a�priva�e�solici�a�ion�����ey�may�also�be�aske���o�si�n�a�s�an�s�ill�a�reemen��requirin����em�no���o�make�an�unsolici�e��bi�.�Par�ies�willin���o�si�n���ese�a�reemen�s�are���en�aske���o�submi��preliminary���non�bin�in��“in�ica�ions�of�in�eres�”�(i.e.���a�sin�le�number�or�a�bi��expresse��as�a�ran�e).�Par�ies���a��submi��preliminary�bi�s�are���en�ranke��by���e�sellin��company�in��erms�of�bi��size���form�of�paymen��(i.e.���composi�ion)�����e�abil�i�y�of���e�bi��er��o�finance���e��ransac�ion���form�of�acquisi�ion�(i.e.���w�e��er���e�bi��er�proposes��o�buy�s�ock�or�asse�s)���an��ease�of��oin����e��eal.�T�e�la��er�fac�or�involves�an�assessmen��of���e��ifficul�y�in�ob�ainin��re�ula�ory�approval���if�require����an��of���e�in�e�ri�y�of���e�bi��er.���small�number�of���ose�submi��in��preliminary�bi�s�are���en�aske���o�submi��a�bes��an��final�offer�(B�F�).�Suc��offers�mus��be�bin�in��on���e�bi��er.������is�poin������e�seller�may�c�oose��o�ini�ia�e�an�auc�ion�amon����e�mos��a��rac�ive�bi�s�or��o��irec�ly�in�o�ne�o�ia�in��a�purc�ase�a�reemen��wi���a�sin�le�par�y.

Estimating tHE impact OF altErnativE Financing structurEs

To�es�ima�e���e�impac��of�al�erna�ive�financin��s�ruc�ures�����e�consoli�a�e���ar�e��an��acquirin��firms’�financial�s�a�emen�s—a�jus�e���o�reflec����e�ne��effec�s�of�syner�y—are�run���rou���a�series�of�scenarios��o��e�ermine��ow���ey� affec��variables� suc�� as� earnin�s��� levera�e��� covenan�s��� an��borrowin��cos�s.� For� example��� eac�� scenario� coul�� represen�� �ifferen�� amoun�s� of�levera�e�as�measure��by���e�firm’s��eb���o�equi�y�ra�io.

Mergers and Acquisitions Basics210

Selecting the Appropriate Capital or Financing StructureIn���eory�����e�op�imal�capi�al�or�financin��s�ruc�ure�is���e�one���a��maxi�mizes���e�firm’s�s�are�price�or�marke��value�(i.e.�����e�number�of�s�ares�ou��s�an�in���imes���e�price�per�s�are).�Reinves�in��borrowe��fun�s�a��a�re�urn�above���e�firm’s�cos��of�capi�al�(i.e.�����e�minimum�financial�re�urn�require��by�inves�ors�an��len�ers)�increases���e�firm’s�marke��value�because��eman��for���e�firm’s�s�ares�increases.�However����i��er��eb��levels�also�increase���e�minimum� financial� re�urn� inves�ors� require� �o� inves�� in� ��e� increasin�ly�levera�e�� firm� as� ��e� po�en�ial� for� bankrup�cy� increases.� �ssumin�� ��e�firm��oes�no�� improve� i�s�expec�e�� financial� re�urns��� ��e� increase�� lever�a�e�coul��lower���e�firm’s�s�are�price�as�inves�ors�sell���e�firm’s�s�ares�in�an�icipa�ion� of� ��e� firm’s� inabili�y� �o� make� fu�ure� in�eres�� an�� principal�repaymen�s.�Because�many�fac�ors�affec��s�are�price���i��is��ifficul���o��e�er�mine���e�exac��capi�al�s�ruc�ure���a��maximizes���e�firm’s�s�are�price.

In�prac�ice���financial�mana�ers�a��emp���o�forecas���ow�c�an�es�in��eb��will� affec�� ��ose�cre�i�� ra�ios� ��a�� affec�� a� firm’s�cre�i�wor��iness.�Fac�ors�inclu�e� ��e� in�eres�� covera�e� ra�io� (i.e.��� pre�ax� an�� in�eres�� opera�in��income/in�eres��expense)����eb���o�equi�y�ra�io���curren�� ra�io� (i.e.���curren��asse�s� less�curren�� liabili�ies)���an��so�on.�Mana�ers� ��en��iscuss� ��eir�pro�jec�e�� pro forma� financial� s�a�emen�s� (i.e.��� projec�e�� financial� s�a�emen�s)�wi��� len�ers� an�� bon�� ra�in�� a�encies��� w�o� may� make� a�jus�men�s� �o���e�firm’s�projec�e��financial�s�a�emen�s�an��w�o���en�compare���e�firm’s�cre�i�� ra�ios�wi��� ��ose�of�o��er� firms� in� ��e� same� in�us�ry� �o�assess� ��e�likeli�oo�� ��a�� ��e� borrower� will� be� able� �o� repay� ��e� borrowe�� fun�s�(wi��� in�eres�)� on� sc�e�ule.�Ul�ima�ely��� ��is� in�erac�ion� amon��borrower���len�ers��� an�� ra�in�� a�encies� �e�ermines� ��e� amoun�� an�� composi�ion� of���e�combine��firms’�capi�al�s�ruc�ure�(i.e.�����e�acquirer’s�an���ar�e�’s�com�bine��amoun��of��eb��rela�ive��o�equi�y).10

Buyers� of�en� buil�� financial� mo�els� �o� �e�ermine� ��e� appropria�e�financin��s�ruc�ure.�T�e�appropria�e�s�ruc�ure�can�be�es�ima�e��by�selec��in�� ��a�� s�ruc�ure�w�ic��sa�isfies�cer�ain�pre�e�ermine��selec�ion�cri�eria.�T�ese� selec�ion� cri�eria� s�oul�� be� �e�ermine�� as� par�� of� ��e� process� of�

10� Cre�i��ra�in��a�encies’�fees��o�ay�are�pai��by���e�very�firms�w�ose�cre�i�wor��iness���ey�analyze—a�po�en�ial�conflic��of�in�eres�.�T�e�failure�of���ese�a�encies�in�200��an��200���o�an�icipa�e���e��u�e�sur�e�in�corpora�e��efaul�s�an��bankrup�cies�un�erscores���e�limi�a�ions�of���is�prac�ice.���encies�can��ive��op�inves�men��ra�in�s��o���ose���a��pay���e��i��es��fees�an��can�fin��even���e�mos��exo�ic�forms�of�financin��accep�able�even�w�en���eir�s�ruc�ures�may�be�problema�ic.�Some�observers�ar�ue���a����is�is��ow�me�a�insurance�company��IG�main�aine����e��i��es��cre�i��ra�in�s�well�in�o�200�����espi�e��avin��issue��billions�of��ollars�in�cre�i���efaul��swap�con�rac�s�wi��ou��main�ainin��a�equa�e�reserves.

Financing Transactions 211

�evelopin����e�acquisi�ion�plan.�T�e�acquirer—w�e��er�a�priva�e�or�public�company—s�oul��selec����e�financin��s�ruc�ure���a��enables���ree�cri�eria��o�be�sa�isfie�:���e�acquirer�is�able��o�ac�ieve�i�s�financial�re�urn�objec�ives�for� ��e�combine��companies;� i��mee�s� ��e�primary�nee�s�of� ��e�acquirer�an�� �ar�e�� firm’s� s�are�ol�ers;� an�� ��ere� is� no� si�nifican�� increase� in� ��e�cos��of��eb��or�viola�ion�of�loan�covenan�s.�For�public�companies���an�a��e��cri�erion� s�oul��be� ��a��earnin�s�per� s�are��ilu�ion��� if� any��� is�minimize����an��re�uc�ions�in�repor�e��financial�re�urns�are��emporary.

T�e�financial�re�urn�objec�ives�of�publicly��ra�e��companies�are�of�en�couc�e�� in� �erms� rea�ily� un�ers�oo�� by� inves�ors��� suc�� as� earnin�s� per�s�are.��cquirin�� companies� mus�� be� able� �o� convince� inves�ors� ��a�� any�EPS� �ilu�ion� is� �emporary� an�� ��a�� ��e� lon���erm� EPS� �row��� of� ��e�combine��companies�will�excee��w�a�� ��e�acquirer�coul���ave�ac�ieve��wi��ou����e�acquisi�ion.�Financial�re�urns�for�bo���public�an��priva�e�com�panies�also�may�be��escribe��as� ��e�firm’s�es�ima�e��cos��of�capi�al���or� in��erms�of���e�re�urn�on��o�al�capi�al�(i.e.����eb��plus�equi�y)���asse�s���or�equi�y.�Moreover�����e�combine��companies’�cas��flow�mus��be�sufficien���o�mee��any�incremen�al�in�eres��an��principal�repaymen�s�resul�in��from�borrow�in��un�er�aken��o�finance�all�or�some�por�ion�of���e�purc�ase�price���wi���ou��viola�in��exis�in��loan�covenan�s�or��evia�in��from��eb��service�ra�ios��ypical�for���e�in�us�ry.�If�loan�covenan�s�are�viola�e����len�ers�may�require���e�combine��companies��o��ake�imme�ia�e�reme�ial�ac�ion�or�be��eclare��in� �ec�nical� �efaul�� an�� force�� �o� repay� ��e� ou�s�an�in�� loans� promp�ly.�Fur��er��� if� ��e�combine�� firms’� in�eres��covera�e�or��eb���o�equi�y�ra�ios��evia�e�si�nifican�ly�from�w�a��is�consi�ere��appropria�e�for�similar�firms�in���e�same�in�us�ry���borrowin��cos�s�may�escala�e�s�arply.

The Importance of Stating AssumptionsT�e�cre�ibili�y�of�any�valua�ion�ul�ima�ely��epen�s�on���e�vali�i�y�of� i�s�un�erlyin��assump�ions.�Valua�ion�rela�e��assump�ions��en���o�fall�in�o�five�major�ca�e�ories.�Market assumptions�are��enerally���ose���a��rela�e��o���e��row���ra�e�of�uni��volume�an��pro�uc��price�per�uni�.�Income statement assumptions�inclu�e���e�projec�e���row���in�revenue�����e�implie��marke��s�are�(i.e.�����e�firm’s�projec�e��revenue�as�a�percen��of�projec�e��in�us�ry�revenue)���an����e��row���in���e�major�componen�s�of�cos��in�rela�ion��o�sales.�Balance sheet assumptions�may� inclu�e� ��e� �row��� in� ��e�primary�componen�s�of�workin��capi�al���an��fixe��asse�s�in�rela�ion��o���e�projec�e���row��� in� sales.� No�e� ��a�� implici�� assump�ions� abou�� cas�� flow� alrea�y�

Mergers and Acquisitions Basics212

are� inclu�e�� in� assump�ions� abou�� ��e� income� s�a�emen�� an�� c�an�es�in� ��e�balance� s�ee����w�ic�� �o�e��er��rive�c�an�es� in�cas�� flow.�Synergy assumptions� rela�e� �o� ��e� amoun�� an�� �imin�� associa�e�� wi��� eac�� �ype�of� an�icipa�e�� syner�y��� inclu�in�� cos�� savin�s� from�workforce� re�uc�ions���pro�uc�ivi�y� improvemen�s� as� a� resul�� of� ��e� in�ro�uc�ion� of� new� �ec��nolo�ies�or�processes���an��revenue��row���as�a�resul��of�increase��marke��pene�ra�ion� or� cross�sellin�� oppor�uni�ies.� Finally��� examples� of� impor�an��valuation assumptions� inclu�e� ��e� acquirin�� firm’s� �ar�e�� �eb���o�equi�y�ra�io�use��in�calcula�in����e�cos��of�capi�al�����e��iscoun��ra�es�use���urin����e� forecas��an�� s�able��row���perio�s���an�� ��e��row���assump�ions�use��in��e�erminin����e��erminal�value.

*�*�*

No�ma��er���e�size�or�composi�ion�of���e�offer�price���len�ers�an��equi�y�inves�ors�will�wan�� �o� see� a� co�eren�� analysis�of�w�y� ��e�propose�� �rans�ac�ion� is� a� �oo�� inves�men�� oppor�uni�y.� Len�ers� will� wan�� assurances���a�� ��ey�will�be�repai��on�a� �imely�basis�an��a��a�ra�e� ��a��will�compen�sa�e���em�for���e�perceive��risk�of���e��eal.�Similarly���equi�y�inves�ors�will�require� some��e�ree�of� confi�ence� ��a�� ��ey�will�be� rewar�e��a�equa�ely�for���e�risk���ey�woul��be�assumin����especially�because���ey�are�subor�ina�e��o�len�ers�in���e�even����e�firm�is�ul�ima�ely�liqui�a�e�.�Consequen�ly�����e�financin��plan�is�combine��wi�����e�acquirer’s�business�an��acquisi�ion�plans�an��use���o�ne�o�ia�e���e�bes��possible��erms�for���e�propose���ransac�ion.

A Case in Point: Financing LBOs—The SunGard TransactionWith their cash hoards accumulating at an unprecedented rate, there was little that buyout firms could do but to invest in larger firms. Consequently, the aver-age size of LBO transactions grew significantly during 2005. Late that year, seven private investment firms banded together as an investor group and acquired 100 percent of the outstanding stock of SunGard Data Systems Inc., a finan-cial software firm known for providing application and transaction software services and creating backup data systems in the event of disaster. As a single buyer group, the firms—Silver Lake Partners, Bain Capital, The Blackstone Group, Goldman Sachs Capital Partners, Kohlberg Kravis Roberts & Co., Providence Equity Partners, and Texas Pacific Group—spread the risk of such a large deal and reduced the likelihood of a bidding war. It was a move reminiscent of the blockbuster buyouts of the late 1980s.

Financing Transactions 213

SunGard’s software manages 70 percent of the transactions made on the NASDAQ stock exchange, but its biggest business is creating backup data sys-tems in case a client’s main systems are disabled by a natural disaster, blackout, or terrorist attack. Its large client base for disaster-recovery and backup systems provides a substantial and predictable cash flow. The software side of SunGard is believed to have significant growth potential, while the disaster-recovery side provides a large, stable cash flow.

Unlike many LBOs, the deal was announced as being all about growth of the financial services software side of the business. It was structured as a merger, because SunGard was to be merged into a shell corporation created by the buyer group. Going private would allow SunGard to invest heavily in software without being punished by investors because such investments are expensed and reduce reported earnings per share. Going private would also allow the firm to eliminate the burdensome reporting requirements of being a public company.

The buyout represented a potentially significant source of fee income for the investor group. In addition to the 2 percent management fees buyout firms collect from investors in the funds they manage, they receive substan-tial fee income from each investment they make on behalf of their funds. For example, the buyout firms receive a 1 percent deal completion fee, which was more than $100 million in the SunGard transaction. Buyout firms also receive fees for arranging financing, paid for by the target firm that is “going private.” Moreover, there are fees for conducting due diligence and for monitoring the ongoing performance of the firm taken private. Finally, when the buyout firms exit their investments in the target firm via a sale to a strategic buyer or a secondary IPO, they receive 20 percent (i.e., so-called carry fee) of any profits.

Under the terms of the agreement, SunGard shareholders received $36 per share, a 14 percent premium over the SunGard closing price as of the announce-ment date of March 28, 2005, and 40 percent more than when the news first leaked about the deal a week earlier. From the SunGard shareholders’ perspec-tive, the deal was valued at $11.4 billion dollars: $10.9 billion for outstanding shares and “in-the-money” options (i.e., options whose exercise price is less than the firm’s market price per share), plus $500 million in debt on the balance sheet.

The seven equity investors provided $3.5 billion in capital, with the remain-der of the purchase price financed by commitments from a lending consortium comprising Citigroup, JPMorgan Chase & Co., and Deutsche Bank. The loans financed the merger and were to be used to repay or refinance SunGard’s exist-ing debt, provide ongoing working capital, and pay fees and expenses incurred in connection with the merger. The total funds necessary to complete the merger, and related fees and expenses, were approximately $11.3 billion, con-sisting of approximately $10.9 billion to pay SunGard’s stockholders and about

Mergers and Acquisitions Basics214

$400.7 million to pay fees and expenses related to the merger and the financ-ing arrangements (comprising nearly 4 percent of the purchase price). Ongoing working capital needs and capital expenditures required obtaining commit-ments from lenders well in excess of $11.3 billion.

The merger financing comprised several tiers of debt and “credit facilities” (i.e., arrangements for extending credit). The senior secured debt and senior subordinated debt were intended to provide “permanent” or long-term financ-ing. Senior debt covenants included restrictions on new borrowing, invest-ments, sales of assets, mergers and consolidations, prepayments of subordinated indebtedness, capital expenditures, liens and dividends and other distributions, as well as a minimum interest coverage ratio and a maximum total leverage ratio.

As part of the deal, the banks providing the financing committed to mak-ing up to $3 billion in loans under a senior subordinated bridge credit facility if the offering of notes was not completed on or prior to the closing. The bridge loans were intended as a form of temporary financing to satisfy immediate cash requirements until permanent financing could be arranged. A special-purpose SunGard subsidiary would purchase receivables from SunGard, with the purchases financed through the sale of the receivables to the lending con-sortium. The lenders subsequently financed the purchase of the receivables by issuing commercial paper, which is repaid as the receivables are collected. Based on the value of receivables at closing, the subsidiary could have pro-vided up to $500 million. The obligation of the lending consortium to buy the receivables was negotiated to expire on the sixth anniversary of the closing of the merger.

Things to Think About:1. SunGard is a software company with relatively few tangible assets. Yet, the

ratio of debt to equity is almost 5 to 1. Why do you think lenders would be willing to engage in such a highly leveraged transaction for a firm of this type?

2. Under what circumstances would SunGard refinance the existing $500 million in outstanding senior debt after the merger? Be specific.

3. In what ways is this transaction similar to and different from those common in the 1980s? Be specific.

4. Why are payment-in-kind securities (e.g., debt or preferred stock) particu-larly well suited for financing LBOs? Under what circumstances might they be most attractive to lenders or investors?

5. Explain how the way in which the LBO is financed affects the way it is oper-ated and the timing of when equity investors choose to exit the business. Be specific.

Answers can be found at: www.elsevierdirect.com/companion.jsp?ISBN=9780123749482

215Mergers and Acquisitions Basics� ©�2011�Elsevier�Inc.ISBN:�����0�12��������2�� ��I: �ll ri���s reserve�.����0�12��������2�� ��I: �ll ri���s reserve�.�����I:� �ll�ri���s�reserve�.

CHAPTER

201110.1016/B����0�12��������2.00010�X

M&A Postmerger Integration

�f�er�a��ransac�ion�closes���in�e�ra�ion�is�on���e�a�en�a.�T�e�ca�e�ory�in�o�w�ic����e�acquirer�falls�will�influence�consi�erably���e�ex�en��of�in�e�ra��ion�an����e�pace�a��w�ic��i���akes�place.�Financial�buyers—��ose�w�o�buy�a�business�for�even�ual�resale—�en��no���o�in�e�ra�e���e�acquire��business�in�o� ano��er� en�i�y.� Ra��er� ��an� mana�e� ��e� business��� ��ey� are� incline���o�moni�or���e�effec�iveness�of�curren��mana�emen��an��in�ervene�only�if���ere�is�a�si�nifican��an��sus�aine���evia�ion�be�ween�ac�ual�an��projec�e��performance.�In�con�ras����strategic�buyers�wan���o�make�a�profi��by�mana��in����e�acquire��business�for�an�ex�en�e��perio����ei��er�as�a�separa�e�sub�si�iary�in�a��ol�in��company�or�by�mer�in��i��in�o�ano��er�business.

For� our� purposes� �ere��� assume� ��a�� in�e�ra�ion� is� ��e� �oal� of� ��e�acquirer�imme�ia�ely�af�er���e��ransac�ion�closes.�T�e�in�e�ra�ion�p�ase�is�an�impor�an��con�ribu�or��o���e�ul�ima�e�success�of���e�mer�er�or�acquisi��ion���an��ineffec�ive�in�e�ra�ion�is�commonly��iven�as�one�of���e�reasons�M&�s�fail� �o�mee��or�excee��expec�a�ions.���prac�ical�process�makes� for�effec�ive�in�e�ra�ion.�T�e�cri�ical�success�fac�ors�inclu�e�plannin��carefully�prior� �o���e�mer�er���main�ainin��can�i��an��con�inuous�communica�ion���a�op�in����e�ri����pace�for�combinin����e�businesses���appoin�in��an�in�e��ra�ion�mana�er�an���eam�wi���clearly��efine���oals�an��lines�of�au��ori�y���an��makin����e��ifficul���ecisions�early�in���e�process.

The Role of InTegRaTIon In SucceSSful MeRgeRS and acquISITIonS

Rapi�� in�e�ra�ion� is� more� likely� �o� resul�� in� a� mer�er� ��a�� ac�ieves� ��e�acquirer’s�expec�a�ions.1�For�our�purposes�����e��erm�rapid�is��efine��as�rela��ive��o���e�pace�of�normal�opera�ions�for�a�firm.��n�ersen�Consul�in��s�u��ie�� 100� �lobal� acquisi�ions��� eac�� value�� a�� more� ��an� $500� million��� an��conclu�e����a��mos��pos�mer�er�ac�ivi�ies�are�comple�e��wi��in�six�mon��s��o� one� year� an�� ��a�� in�e�ra�ion� �one� quickly� �enera�es� ��e� financial�

10

1� Business Week�(1��5);�Coopers�&�Lybran��(1��6);�Marks�(1��6);�McKinsey�Company�(1���).

Mergers and Acquisitions Basics216

re�urns� expec�e�� by� s�are�ol�ers� an�� minimizes� employee� �urnover� an��cus�omer�a��ri�ion.2

Realizing Projected Financial Returns�� simple� example� �emons�ra�es� ��e� impor�ance� of� rapi�� in�e�ra�ion� �o�realizin��projec�e��financial�re�urns.�Suppose�a�firm’s�curren��marke��value�of�$100�million�accura�ely�reflec�s���e�firm’s�fu�ure�cas��flows��iscoun�e��a��i�s�cos��of�capi�al�(i.e.�����e�financial�re�urn���e�firm�mus��earn�or�excee���o� sa�isfy� ��e� expec�a�ions� of� i�s� s�are�ol�ers� an�� len�ers).� �ssume� an�acquirer� is� willin�� �o� pay� a� $25� million� premium� for� ��is� firm� over� i�s��curren��s�are�price���believin��i��can�recover���e�premium�by�realizin��cos��savin�s�resul�in��from�in�e�ra�in����e��wo�firms.�T�e�amoun��of�cas����e�acquirer�will��ave��o��enera�e��o�recover���e�premium�will�increase���e�lon��er�i���akes��o�in�e�ra�e���e��ar�e��company.�If���e�cos��of�capi�al�is�10�per�cen��an��in�e�ra�ion�is�comple�e��by���e�en��of���e�firs��year�����e�acquirer�will��ave��o�earn�$2�.5�million�by���e�en��of���e�firs��year��o�recover���e�con�rol�premium�plus� i�s�cos��of�capi�al� ($25��$25��0.10).� If� in�e�ra��ion� is�no��comple�e��un�il� ��e�en��of� ��e�secon��year��� ��e�acquirer�will��ave��o�earn� incremen�al�cas�� flow�of�$�0.25�million�($2�.5��$2�.5���0.10)���an��so�on.

The Impact of Employee Turnover�l��ou��� ��ere� is� li��le� evi�ence� ��a�� firms� necessarily� experience� an�ac�ual� re�uc�ion� in� ��eir� �o�al� workforce� followin�� an� acquisi�ion��� ��ere�is�evi�ence�of�increase���urnover�amon��mana�emen��an��key�employees�af�er�a�corpora�e��akeover.��Some�loss�of�mana�ers�is�in�en�ional�as�par��of�an� effor�� �o� elimina�e� re�un�ancies� an�� overlappin�� posi�ions��� bu�� o��er�mana�ers�qui���urin����e�in�e�ra�ion��urmoil.�In�many�acquisi�ions����alen��an��mana�emen��skills�represen����e�primary�value�of���e��ar�e��company��o���e�acquirer—especially�in��i����ec�nolo�y�an��service�companies�for�w�ic��asse�s�are� lar�ely���e�embo�ie��knowle��e�of���eir�employees��—an�� i�� is� �ifficul�� �o� measure� w�e��er� employees� w�o� leave� represen�� a�si�nifican��“brain��rain��”�or�loss�of�key�mana�ers.�If���is� loss�is�si�nifican������ou�����i���e�ra�es���e�value�of���e��ar�e��company���makin����e�recovery�of�any�premium�pai���o��ar�e��s�are�ol�ers��ifficul��for���e�buyer.

�� S�iv�asani�(1���);�Wals��(1���);�Wals��an��Ellwoo��(1��1).�� Lor��an��Ranf��(2000).

2� �n�ersen�Consul�in��(1���).

M&A Postmerger Integration 217

T�e�cos��also�may�be��i���simply�because���e��ar�e��firm’s��op���expe�rience�� mana�ers� are� remove�� as� par�� of� ��e� in�e�ra�ion� process� an��replace�� wi��� new� mana�ers—w�o� �en�� �o� �ave� a� �i��� failure� ra�e� in��eneral.�W�en�a�firm�selec�s�an�insi�er�(i.e.���a�person�alrea�y�in���e�employ�of���e�mer�e��firms)��o�replace�a��op�mana�er�(e.�.���CE�)�����e�failure�ra�e�of���e�successor�(i.e.�����e�successor�is�no�lon�er�wi�����e�firm�1��mon��s�la�er)� is� ��� percen�.�W�en� ��e� boar�� selec�s� an� ou�si�e� successor� (i.e.��� a�person�selec�e��w�o�is�no��in���e�employ�of���e�mer�e��firms)��o�replace���e� �epar�in�� senior� mana�er��� ��e� 1��mon��� failure� ra�e� is� 55� percen�.�T�erefore���more���an��alf�of� ��e��ime���an�ou�si�e�successor�will�no��suc�cee����wi���an�insi�er�succee�in��abou���wo���ir�s�of���e��ime.5

T�e� cos�� of� employee� �urnover� �oes� no�� s�op� wi��� ��e� loss� of� key�employees.�T�e� loss�of� any� si�nifican��number�of�employees�can�be�very�cos�ly.� Curren�� employees� �ave� alrea�y� been� recrui�e�� an�� �raine�;� lose���em��� an�� you� will� incur� new� recrui�men�� an�� �rainin�� cos�s� �o� replace���em�wi���equally�qualifie��employees.�Moreover�����e�loss�of�employees�is�likely��o�re�uce���e�morale�an��pro�uc�ivi�y�of���ose�w�o�remain.

Acquisition-Related Customer Attrition�urin��normal�opera�ions���a�business�can�expec��a�cer�ain�level�of�c�urn�in�i�s�cus�omer�lis�.��epen�in��on���e�in�us�ry���normal�c�urn�as�a�resul��of�compe�i�ive�con�i�ions�can�be�anyw�ere�from�20��o��0�percen�.���newly�mer�e��company�will�experience�a�loss�of�ano��er�5��o�10�percen��of�i�s�exis�in�� cus�omers� as� a� �irec�� resul�� of� a� mer�er��6� reflec�in�� uncer�ain�y�abou�� on��ime� �elivery� an�� pro�uc�� quali�y� an�� more� a��ressive� pos��mer�er�pricin��by�compe�i�ors.�Moreover���many�companies� lose� revenue�momen�um�as���ey�concen�ra�e�on�realizin��expec�e��cos��syner�ies.�T�e�loss�of�cus�omers�may�con�inue�well�af�er�closin�.�

Rapid Integration Does Not Mean Doing Everything at the Same PaceRapi��in�e�ra�ion�may�resul��in�more�imme�ia�e�realiza�ion�of�syner�ies���bu��i��also�con�ribu�es��o�employee�an��cus�omer�a��ri�ion.�T�erefore���in�elli�en��

5� �al�on�(2006).6� �own�(1��5).�� ��McKinsey�s�u�y�of�160�acquisi�ions�by�15��publicly��ra�e��firms�in�11��ifferen��in�us�ries�in�1��5�

an��1��6�foun����a����on�avera�e�����ese�firms��rew�four�percen�a�e�poin�s�less���an���eir�peers��urin����e���ree�years�followin��closin�.�Moreover����2�percen��of���e�sample�ac�ually�los���roun�.��nly�12�percen��of���e�sample�s�owe��revenue��row���si�nifican�ly�a�ea��of���eir�peers�(Bekier���Bo�ar�us���an���l��am���2001).

Mergers and Acquisitions Basics218

in�e�ra�ion� involves� mana�in�� ��ese� �ra�eoffs� by� quickly� i�en�ifyin�� an��implemen�in��projec�s� ��a��offer���e�mos�� imme�ia�e�payoff�an���eferrin����ose�w�ose��isrup�ion�woul��resul��in���e��rea�es��revenue�loss.��cquirers�of�en� will� pos�pone� in�e�ra�in�� �a�a� processin�� an�� cus�omer� service� call�cen�ers� un�il� muc�� la�er� in� ��e� in�e�ra�ion� process��� if� suc�� ac�ivi�ies� are�seen�as�pivo�al��o�main�ainin��on��ime��elivery�an���i���quali�y�cus�omer�service.� Some�imes��� si�nifican���ifferences� in� ��e� corpora�e� cul�ures�of� ��e�acquirer�an���ar�e��firms�will�require�a�more�measure��pace�of�in�e�ra�ion.

Viewing Integration as a ProcessSix�major� ac�ivi�ies� are� involve�� in� in�e�ra�in�� an� acquire��business� in�o���e� acquirer’s� opera�ions��� an�� some� are� lo�ically� sequen�ial.� T�ey� fall�loosely� in�o� ��e� followin�� sequence:�plannin�� ��e�premer�er� in�e�ra�ion���resolvin��communica�ion� issues����efinin�� ��e�new�or�aniza�ion����evelop�in�� s�affin�� plans��� in�e�ra�in�� func�ions� an�� �epar�men�s��� an�� buil�in�� a�new� corpora�e� cul�ure.� Some� ac�ivi�ies��� ��ou����� are� con�inuous� an���� in�some� respec�s��� unen�in�.� In� prac�ice��� for� ins�ance��� communica�in�� wi���all�major�s�ake�ol�er��roups�an���evelopin��a�new�corpora�e�cul�ure�are�lar�ely�con�inuous�ac�ivi�ies��� runnin����rou�����e� in�e�ra�ion�perio��an��beyon�.�Ex�ibi��10�1�ou�lines���e�sequence.

PReMeRgeR InTegRaTIon PlannIng

�l��ou��� some� ar�ue� ��a�� in�e�ra�ion� plannin�� s�oul�� be�in� as� soon� as���e� mer�er� is� announce����� assump�ions� ma�e� before� ��e� closin�� base��on� informa�ion� accumula�e�� �urin�� �ue� �ili�ence� mus�� be� reexamine��af�er� ��e� �ransac�ion� is� consumma�e�� �o� ensure� ��eir� vali�i�y.�T�e� pre�mer�er� in�e�ra�ion� plannin�� process� enables� ��e� acquirin�� company� �o�refine� i�s� ori�inal� es�ima�e� of� ��e� value� of� ��e� �ar�e�� company� an�� �eal�wi��� �ransi�ion� issues� in� ��e� con�ex��of� ��e��efini�ive� a�reemen��of� pur�c�ase� an�� sale.� Fur��ermore��� i�� �ives� ��e� buyer� an� oppor�uni�y� �o� inser��in�o���e�a�reemen����e�appropria�e�represen�a�ions�(claims)�an��warran�ies�(�uaran�ees)���as�well�as�con�i�ions�of�closin����a��facili�a�e���e�pos�mer�er�in�e�ra�ion�process.�Finally�����e�plannin��process�crea�es�a�pos�mer�er�in�e��ra�ion� or�aniza�ion� �o� expe�i�e� ��e� in�e�ra�ion� process� followin�� clos�in�.� I�� is� impor�an�� �o� inclu�e� represen�a�ives� from� ��e�ne�o�ia�in�� �eam��in� ��e� pos�mer�er� in�e�ra�ion� or�aniza�ion.� �s� ne�o�ia�ors� �an�� off� �o�

�� Carey�an�����en�(200�).

M&A Postm

erger Integration219

EXHIBIT 10-1 Viewing Merger and Acquisition Integration as a ProcessIntegration Planning

Developing Communication Plans

Creating a New Organization

Developing Staffing Plans

Functional Integration

Building a New Corporate Culture

Premerger Planning: – Refine valuation – Resolve transition issues – Negotiate

contract assurances

Stakeholders: – Employees – Customers – Suppliers – Investors – Lenders – Communities

(including regulators)

Learn from the past

Determine personnel requirements for the new organization

Revalidate due diligence data

Identify cultural issues through corporate profiling

Business needs drive organizational structure

Determine resource availability

Conduct performance benchmarking

Integrate through shared – Goals – Standards – Services – Space

(Continued)

Mergers and Acquisitions Basics

220

Establish staffing plans and timetables

Integrate functions: – Operations – Information

technology– Finance – Sales – Marketing – Purchasing – R&D – Human resources

Develop compensation strategy

Create supporting information systems

Integration Planning

Developing Communication Plans

Creating a New Organization

Developing Staffing Plans

Functional Integration

Building a New Corporate Culture

EXHIBIT 10-1 (Continued)

M&A Postmerger Integration 221

��ose�responsible�for�pos�mer�er�in�e�ra�ion�����ere�is�of�en�a�lack�of�s�are��un�ers�an�in�� as� �o� w�y� cer�ain� i�ems� were� inclu�e�� in� ��e� a�reemen����w�y�o��ers�were�exclu�e����an��w�a��cer�ain�con�rac���erms�mean.

To� minimize� po�en�ial� confusion��� i�� is� cri�ical� �o� �e�� ��e� in�e�ra�ion�mana�er� involve�� in� ��e� process� as� early� as� possible—i�eally��� as� soon� as���e� �ar�e�� �as� been� i�en�ifie�� or� a�� leas�� well� before� ��e� evalua�ion� an��ne�o�ia�ion�process�be�ins.���oin��so�makes� i��more� likely���a�� ��e�s�ra��e�ic�ra�ionale�for���e��eal�remains�well�un�ers�oo��by���ose�involve��in�con�uc�in���ue��ili�ence�an��pos�mer�er�in�e�ra�ion.�(C�ap�er���provi�es�fur��er��e�ail�abou����e�premer�er�in�e�ra�ion�plannin��process).

Putting the Postmerger Integration Organization in Place before Closing�� pos�mer�er� in�e�ra�ion� or�aniza�ion� wi��� clearly� �efine�� �oals� an��responsibili�ies�s�oul��be�in�place�before�closin�.�For�frien�ly�mer�ers�����e�or�aniza�ion—inclu�in�� suppor�in�� work� �eams—s�oul�� comprise� in�i�vi�uals�from�bo�����e�acquirin��an���ar�e��companies�wi���a�ves�e��in�er�es�� in� ��e� newly� forme�� company.� �urin�� a� �os�ile� �akeover��� of� course���assemblin�� suc�� a� �eam� can� be� problema�ic��� �iven� ��e� lack� of� �rus�� ��a��may�exis��be�ween���e�par�ies��o���e��ransac�ion.�T�e�acquirin��company�will� likely� fin�� i�� �ifficul�� �o� access� nee�e�� informa�ion� an�� involve� ��e��ar�e��company’s�mana�emen��in���e�plannin��process�before���e��ransac��ion�ac�ually�closes.

If� ��e� plan� is� �o� in�e�ra�e� ��e� �ar�e�� firm� in�o� one� of� ��e� acquirer’s�business� uni�s��� i�� is� cri�ical� �o� place� responsibili�y� for� in�e�ra�ion� in� ��a���business�uni�.�Personnel�from���e�business�uni��s�oul��be�well�represen�e��on���e��ue��ili�ence��eam��o�ensure���ey�un�ers�an���ow�bes���o�in�e�ra�e���e��ar�e���o�realize�syner�ies�expe�i�iously.

Postmerger Integration Organization: Composition and ResponsibilitiesT�e�pos�mer�er� in�e�ra�ion�or�aniza�ion� s�oul�� comprise� a�management integration team�(MIT)�an��in�e�ra�ion�work��eams�focuse��on�implemen��in�� a� specific� por�ion� of� ��e� in�e�ra�ion� plan.� Senior�mana�ers� from� ��e��wo�mer�e��or�aniza�ions�serve�on���e�MIT���w�ic��is�c�ar�e��wi���imple�men�in��syner�ies�i�en�ifie���urin����e�preclosin���ue��ili�ence.�Involvin��senior� mana�ers� from� bo��� firms� cap�ures� ��e� bes�� �alen�� from� bo����

�� U�laner�an��Wes��(200�).

Mergers and Acquisitions Basics222

or�aniza�ions�an��also�sen�s�a�comfor�in��si�nal��o�all�employees���a����ere�are��ecision�makers�involve��w�o�un�ers�an����eir�par�icular�si�ua�ions.

T�e�MIT’s�emp�asis��urin����e�in�e�ra�ion�perio��s�oul��be�on�ac�iv�i�ies� ��a�� crea�e� ��e� �rea�es�� value� for� s�are�ol�ers.�T�e� �eam’s� primary�responsibili�y�is��o�focus�on�key�concerns�suc��as�lon���erm�revenue���cos����an��cas��flow�performance��ar�e�s���as�well�as�pro�uc��an��cus�omer�s�ra�e��ies.�Ex�ibi��10�2�summarizes���e�key��asks���a��s�oul��be�performe��by���e�MIT��o�realize�an�icipa�e��syner�ies.

In�a��i�ion� �o��rivin�� ��e� in�e�ra�ion�effor���� ��e�MIT�ensures� ��a�� ��e�mana�ers� no�� involve�� in� ��e� en�eavor� remain� focuse�� on� runnin�� ��e�business.� �e�ica�e�� in�e�ra�ion� work� �eams� perform� ��e� �e�aile�� in�e�ra��ion�work.�T�ese�work��eams�s�oul��also�inclu�e�employees�from�bo�����e�acquirin��an���ar�e��companies.����er��eam�members�mi����inclu�e�ou�si�e�a�visors���suc��as�inves�men��bankers���accoun�an�s���a��orneys���an��consul�an�s.

T�e�MIT�alloca�es��e�ica�e��resources��o���e�in�e�ra�ion�effor����clarifies�non�eam�members�ip�roles���an��enables��ay��o��ay�opera�ions��o�con�inue�a��premer�er�levels.�T�e�MIT�s�oul��be�careful��o��ive���e�work��eams�no��only���e�responsibili�y��o��o�cer�ain��asks�bu��also���e�au��ori�y�an��resources��o��e����e�job��one.�T�e��eams�s�oul��be�encoura�e���o�injec��i�eas�in�o���e�process��o�fos�er�crea�ivi�y�by�encoura�in��solu�ions�ra��er���an�by��ic�a�in��

EXHIBIT 10-2 Key Management Integration Team Responsibilities

1. Build a master schedule of what should be done by whom and by what date.

2. Determine the required economic performance for the combined entity.3. Establish work teams to determine how each function and business unit will

be combined (e.g., structure, job design, and staffing levels).4. Focus the organization on meeting ongoing business commitments and

operational performance targets during the integration process.5. Create an early warning system consisting of performance indicators to

ensure that both integration activities and business performance stay on plan.

6. Monitor and expedite key decisions.7. Establish a rigorous communication campaign to support aggressively the

integration plan. Address both internal (e.g., employees) and external (e.g., customers, suppliers, and regulatory authorities) constituencies.

M&A Postmerger Integration 223

processes�an��proce�ures.�To�be�effec�ive�����e�work��eams�mus���ave�access��o��imely���accura�e�informa�ion�an��s�oul��receive�can�i�����imely�fee�back.�T�e��eams�nee�� �o�be�kep�� informe��of� ��e�broa�er� perspec�ive�of� ��e�overall�in�e�ra�ion�effor���o�avoi��becomin���oo�narrowly�focuse�.

develoPIng coMMunIcaTIon PlanS foR Key STaKeholdeRS

Before�publicly� announcin�� an� acquisi�ion��� ��e� acquirer� s�oul��prepare� a�communica�ion�plan����evelope��join�ly�by���e�MIT�an����e�public�rela�ions�(PR)��epar�men��or�ou�si�e�PR�consul�an�.�T�e�plan� s�oul��con�ain�key�messa�es�an��specify��ar�e��s�ake�ol�ers�an��appropria�e�me�ia�for�convey�in����e�messa�es��o�eac���roup.�Major�s�ake�ol�er��roups�inclu�e�employ�ees���cus�omers���suppliers���inves�ors���len�ers���communi�ies���an��re�ula�ors.

Employees: Addressing the “Me” Issues ImmediatelyTar�e�� firm� employees� �ypically� represen�� a� subs�an�ial� por�ion� of� ��e�acquire��company’s� value���par�icularly� for� �ec�nolo�y� an�� service�rela�e��businesses�wi��� few� �an�ible� asse�s.�T�erefore��� preservin�� ��e�value�of� an�acquisi�ion� requires� sensi�ivi�y� �o� ��e� �imin���� approac���� an�� accuracy� of�w�a�ever�is�communica�e���o�employees.

T�e� CE�� s�oul�� lea�� ��e� effor�� �o� communica�e� �o� employees� a�� all�levels� ��rou���onsi�e�mee�in�s�or�via� �eleconferencin�.�Communica�ion� �o�employees�s�oul��be�as�frequen��as�possible;�i��is�be��er��o�repor����a����ere�is�no�c�an�e���an��o�remain�silen�.��irec��communica�ion��o�all�employees�a��bo���firms�is�cri�ical.��e�eriora�in��job�performance�an��absences�from�work�are� clear� si�ns�of�workforce� anxie�y���w�ic��may�manifes��no��only� amon��employees�of���e��ar�e��firm�bu��also�amon��acquirer�firm�employees���w�o�un�ers�an����a��mos��mer�ers�will�resul��in�s�aff�re�uc�ions�across���e�boar�.

Many� companies� fin�� i�� useful� �o� crea�e� a� sin�le� informa�ion� source�accessible� �o� all� employees��� w�e��er� i�� is� an� in�ivi�ual� w�ose� job� is� �o�answer�ques�ions�or�a�menu��riven�au�oma�e��p�one�sys�em�pro�ramme���o�respon���o�commonly�aske��ques�ions.�T�e�bes��way�of�communica�in��in�a�crisis����owever���is��o��ol��re�ularly�sc�e�ule��employee�mee�in�s.

�ll�ex�ernal�communica�ion�in���e�form�of�press�releases�s�oul��be�coor��ina�e��wi�����e�public�rela�ions� (PR)��epar�men�� �o�ensure���a�� ��e�same�informa�ion�is�release��concurren�ly��o�all�employees.�In�ernal�e�mail�sys�ems���voicemail���or� in�rane�s�may�be�use���o�facili�a�e�employee�communica�ions.�

Mergers and Acquisitions Basics224

In� a��i�ion��� personal� le��ers��� ques�ion�an��answer� sessions��� newsle��ers��� or��vi�eos�are��i��ly�effec�ive�ways��o��eliver�messa�es.

Employees�are� in�eres�e�� in�any� informa�ion�per�ainin�� �o� ��e�mer�er�an���ow� i��will� affec�� ��em.�T�ey�wan�� �o�know��ow�c�an�es� affec�� ��e�overall� s�ra�e�y��� business� opera�ions��� job� securi�y��� workin�� con�i�ions��� an���o�al�compensa�ion.�T�e��uman�resources�(HR)�s�aff�plays�an�impor�an��role�in�communica�in���o�employees.�Usin��surveys���in�erviews���focus��roups���or�employee�mee�in�s���HR�represen�a�ives�mus�� learn�w�a��employees�know�an�� wan�� �o� know��� w�a�� ��e� prevailin�� rumors� are��� an�� w�a�� employees�fin��mos���isconcer�in�.

Customers: Undercommitting and OverdeliveringSome�a��ri�ion� is� inevi�able� in�an�acquisi�ion.� I��can�be�minimize�� if� ��e�newly�mer�e��firm�commi�s��o�cus�omers���a��i��will�main�ain�or�improve�pro�uc�� quali�y��� on��ime� �elivery��� an�� cus�omer� service.� Commi�men�s�s�oul�� be� realis�ic� in� �erms� of� w�a�� nee�s� �o� be� accomplis�e�� �urin����e� in�e�ra�ion�p�ase.�T�e� firm�mus��communica�e� �o�cus�omers� realis�ic�benefi�s�associa�e��wi�����e�mer�er.�From���e�cus�omers’�perspec�ive��� ��e�mer�er�can� increase� ��e� ran�e�of�pro�uc�s�or� services�offere��or�provi�e�lower�sellin��prices�as�a�resul��of�economies�of�scale�an��new�applica�ions�of��ec�nolo�y.�T�e�firm’s�ac�ions�mus��suppor��i�s��alk.

Suppliers: Developing Long-Term Vendor RelationshipsJus��as�a�curren��cus�omer�is�of�en�wor���more���an�a�new�one���so��oo�is�a�curren��supplier�wi���a�proven��rack�recor�.��l��ou���subs�an�ial�cos��sav�in�s�are�possible�by�“mana�in�”�suppliers��� ��e�new�company�s�oul��seek�lon���erm�rela�ions�ips�ra��er���an�simply�ways��o�re�uce�cos�s.����ressive�ne�o�ia�ion� may� win� �i���quali�y� pro�uc�s� an�� services� a�� lower� prices�in���e�s�or��run���bu����a��may�be��ransi�ory�if���e�new�company�is�a�lar�e�cus�omer�of���e�supplier�an��if���e�supplier’s�mar�ins�are�squeeze��con�in�ually.�T�e�supplier’s�pro�uc��or�service�quali�y�will�suffer���an����e�supplier�even�ually�may�exi����e�business.

Investors: Maintaining Shareholder LoyaltyT�e�new�firm�mus��be�able��o�presen���o�inves�ors�a�compellin��vision�of���e�fu�ure.�In�a�s�are�for�s�are�exc�an�e�����ere�are�compellin��reasons�for�appealin���o�curren��inves�ors�of�bo�����e�acquirer�an���ar�e��companies.�Tar�e��s�are�ol�ers�will�become�s�are�ol�ers�in���e�newly�forme��com�pany.�Loyal�s�are�ol�ers��en���o�provi�e�a�more�s�able�owners�ip�base�an��

M&A Postmerger Integration 225

may� con�ribu�e� �o� lower� s�are�price� vola�ili�y.��ll� firms� a��rac�� par�icular��ypes�of�inves�ors—some�wi���a�preference�for��i����ivi�en�s�an��o��ers�for� capi�al� �ains—an�� ��ey�may� clas�� over� ��eir� preferences��� as��merica��nline’s�acquisi�ion�of�Time�Warner�in�January�2000�illus�ra�es.�T�e�com�bine��marke��value�of���e��wo�firms�los��11�percen��in���e�four��ays�fol�lowin����e�announcemen����as�inves�ors�fre��e��over�w�a���a��been�crea�e��an�� ��ere�was� a� sellin�� frenzy� ��a�� likely� involve�� inves�ors�w�o�bou����Time�Warner� for� i�s� s�able� �row��� an���merica��nline� for� i�s�me�eoric��row���ra�e�of��0�percen��per�year.

Communities: Building Strong, Credible RelationshipsGoo��workin�� rela�ions�wi��� surroun�in��communi�ies� are� simply��oo��public� rela�ions.�Companies� s�oul�� communica�e� plans� �o� buil��or� keep�plan�s��� s�ores���or�office�buil�in�s� in� a� communi�y� as� soon�as� ��ey�can�be�confi�en����a����ese�ac�ions�will�be�implemen�e�.�Suc��s�eps�of�en��rans�la�e�in�o�new�jobs�an��increase���axes�for���e�communi�y.

cReaTIng a new oRganIzaTIon

Crea�in�� a� new� �op� �eam� is� �i��ly� c�allen�in�� in� ��e� frene�ic� perio��imme�ia�ely� before� or� af�er� closin�.� I��mus�� be� �one� a�roi�ly� an�� expe��i�iously��� �espi�e� ��a�� i�� can� be� a� �ime�consumin�� process� ��a�� involves�appoin�in�� anyw�ere� from� 10� �o� �0� execu�ives��� inclu�in�� �ea�s� of� key�func�ions��� �roups��� an�� even� �ivisions.�T�e� combine�� firms’� new� lea�ers�mus��appoin����e�bes��possible��op�mana�emen���eam��o�ac�ieve���e�new�company’s��oals.�T�e�role�of�eac��senior�mana�er�mus��be�clearly��efine���o�ac�ieve�effec�ive�collabora�ion.

Establishing a StructureTra�i�ionally��� organization� or� structure� is� �efine�� in� �erms� of� �i�les� an��repor�in��rela�ions�ips—an����a��is���e��efini�ion�applicable��ere.���prop�erly� s�ruc�ure�� or�aniza�ion� s�oul�� suppor���� no�� re�ar���� ��e� accep�ance�of�a�cul�ure� in���e�new�company���a�� is��esire��by��op�mana�emen�.��n�effec�ive�s�ar�in��poin��is��o�reco�nize���a����e�nee�s�of���e�business��rive�s�ruc�ure�an��no����e�o��er�way�aroun�.

Buil�in�� new� repor�in�� s�ruc�ures� for� combinin�� companies� requires�knowle��e� of� ��e� �ar�e�� company’s� prior� or�aniza�ion��� some� sense� as� �o���e�effec�iveness�of� ��is�or�aniza�ion� in���e��ecision�makin��process���an����e� fu�ure� business� nee�s� of� ��e� newly� combine�� companies.�T�erefore���

Mergers and Acquisitions Basics226

in� crea�in�� ��e� new�or�aniza�ion��� i�� is� necessary� �o� be�in� from�previous�or�aniza�ion�c�ar�s.�T�ey�provi�e�insi���s�in�o��ow�in�ivi�uals�from�bo�����e��ar�e��an��acquirin��companies�will�in�erac��wi��in���e�new�company�because���ey�reveal���e�pas��experience�an��fu�ure�expec�a�ions�of�in�ivi��uals�wi���re�ar���o�repor�in��rela�ions�ips.�T�e�nex��s�ep�is��o�move�from���e�pas��in�o���e�fu�ure�by�crea�in��a�s�ruc�ure���a��focuses�on�mee�in����e�business�nee�s�of���e�combine��companies.

T�ere� are� ��ree�basic� �ypes�of� s�ruc�ures.� In� a� functional organization���w�ic�� �en�s� �o� be� ��e� mos�� cen�ralize�� an�� is� becomin�� less� common���people�are�assi�ne���o� specific��roups�or��epar�men�s� suc��as�accoun�in����en�ineerin���� marke�in���� sales��� �is�ribu�ion��� cus�omer� service��� manufac�ur�in����or�main�enance.�In�a�product or service organization���func�ional�special�is�s�are��roupe��by�pro�uc�� line�or� service�offerin����an��eac���as� i�s�own�accoun�in�����uman�resources���sales���marke�in����cus�omer�service���an��pro��uc���evelopmen��s�affs.�T�ese��ypes�of�or�aniza�ions��en���o�be�somew�a���ecen�ralize���� an�� ��e� in�ivi�uals� in� ��em� of�en� �ave� mul�iple� repor�in��rela�ions�ips���suc��as�a�finance�mana�er�repor�in���o�a�pro�uc��line�mana�er�an����e�firm’s�CF�.�Divisional organizations�con�inue��o�be���e��ominan��form�of�or�aniza�ional�s�ruc�ure���in�w�ic���roups�of�pro�uc�s�are�combine��in�o�in�epen�en���ivisions�or�“s�ra�e�ic�business�uni�s.”�Suc��or�aniza�ions��ave���eir�own�mana�emen���eams�an���en���o�be��i��ly��ecen�ralize�.

T�e�populari�y�of��ecen�ralize��versus�cen�ralize��mana�emen��s�ruc��ures� varies�wi��� ��e� s�a�e�of� ��e� economy.��urin�� recessions���w�en� �op�mana�emen�� is� un�er� �rea�� pressure� �o� cu�� cos�s��� companies� may� �en���o�move� �owar�� cen�ralize��mana�emen�� s�ruc�ures��� only� �o� �ecen�ralize�w�en���e�economy�recovers.�Hi��ly��ecen�ralize��au��ori�y�can�re�ar����e�pace�of�in�e�ra�ion�because���ere�is�no�sin�le�au��ori�y��o�resolve�issues�or��e�ermine�policies.

�� cen�ralize�� s�ruc�ure� may� make� pos�mer�er� in�e�ra�ion� muc�� eas�ier.� Senior� mana�emen�� can� �ic�a�e� policies� �overnin�� all� aspec�s� of� ��e�combine�� companies��� cen�ralize� all� �ypes� of� func�ions� ��a�� provi�e� sup�por���o�opera�in��uni�s���an��resolve�issues�amon����e�opera�in��uni�s.�S�ill���cen�ralize��con�rol�can�be��i��ly��e�rimen�al�an���es�roy�value�if�policies�impose�� by� ��e� cen�ral� �ea�quar�ers� are� inappropria�e� for� ��e� opera�in��uni�s—suc��as�policies���a��impose��oo�many�ri�i��con�rols���focus�on���e�wron��issues����ire�or�promo�e���e�wron��mana�ers���or�es�ablis����e�wron��performance�measures.�Moreover���cen�ralize��companies�of�en��ave�mul��iple� layers� of� mana�emen�� an�� cen�ralize�� func�ions� provi�in�� services��o���e�opera�in��uni�s.�T�e�paren��companies�pass���e�cos�s�of�cen�ralize��

M&A Postmerger Integration 227

mana�emen�� an�� suppor�� services� on� �o� ��e� opera�in�� uni�s��� an�� ��ese�cos�s�of�en�ou�wei�����e�benefi�s.10

T�e�ri����s�ruc�ure�may�be�an�evolvin��one.�T�e�subs�an�ial�benefi�s�of�a�well�mana�e����rapi��in�e�ra�ion�of��wo�businesses�su��es��a�cen�ralize��man�a�emen��s�ruc�ure�ini�ially�wi���rela�ively�few�layers�of�mana�emen�.�In��en�eral���fla��er�or�aniza�ions�are�becomin��common�amon��lar�e�companies.�T�e��is�ance�be�ween���e�CE��an���ivision��ea�s���measure��in��erms�of�in�erme��ia�e�posi�ions����as��ecrease��subs�an�ially���w�ereas���e�span�of�a�CE�’s�au��or�i�y��as�wi�ene�.11�T�is��oes�no��mean���a��all�in�e�ra�ion�ac�ivi�ies�s�oul��be��riven�from���e��op���wi���no�inpu��from�mi��le�mana�ers�an��supervisors�of�bo���companies.�I���oes�mean��akin���ecisive�an���imely�ac�ion�base��on���e�bes��informa�ion�available.�W�en�in�e�ra�ion�is�viewe��as�rela�ively�comple�e�����e�new�company�s�oul��move��o�a�more��ecen�ralize��s�ruc�ure�in�view�of���e�well��ocumen�e��cos�s�of�cen�ralize��corpora�e�or�aniza�ions.

Developing Staffing PlansS�affin��plans�s�oul��be�formula�e��as�early�as�possible�in���e�in�e�ra�ion�process.� In� frien�ly� acquisi�ions��� ��e�process� s�oul��be�in�before� closin�.�T�e�early��evelopmen��of�suc��plans�provi�es�an�oppor�uni�y��o�inclu�e�key� personnel� from� bo��� firms� in� ��e� in�e�ra�ion� effor�.� ���er� benefi�s�inclu�e���e�increase��likeli�oo��of�re�ainin��employees�wi���key�skills�an���alen�s���main�ainin��corpora�e�con�inui�y���an��buil�in���eams.

Personnel RequirementsT�e�appropria�e�or�aniza�ional�s�ruc�ure�is�one���a��can�mee����e�curren��func�ional� requiremen�s� or� nee�s� of� ��e� business� an�� is� flexible� enou����o� be� expan�e�� �o� sa�isfy� fu�ure� business� requiremen�s.�T�e� process� for�crea�in��suc��a� s�ruc�ure� s�oul�� involve� inpu�� from�all� levels�of�mana�e�men����be�consis�en��wi�����e�combine��firms’�business�s�ra�e�y���an��reflec��expec�e��sales��row��.�Before�es�ablis�in����e�or�aniza�ional�s�ruc�ure�����e�in�e�ra�ion��eam�s�oul��a�ree�on���e�specific�func�ions�nee�e���o�run���e�combine��businesses� an�� ��en�projec��eac�� func�ion’s�personnel� require�men�s�base��on�a��escrip�ion�of���e�func�ion’s�i�eal�s�ruc�ure��o�ac�ieve�i�s�objec�ives.�Inpu��from��epar�men��personnel�a����is�s�a�e�can�elici��useful�insi���s�an���elp�buil��consensus�for�c�an�in����e�or�aniza�ion.

10� �lexan�er���Campbell���an��Goul��(1��5);�Campbell���Sa�ler���an��Koc��(1���).11� Wulf�an��Rajan�(200�)�repor�e��a�25�percen���ecrease�in�in�erme�ia�e�posi�ions�be�ween�1��6�an��

1������wi���abou��50�percen��more�posi�ions�repor�in���irec�ly��o���e�CE�.

Mergers and Acquisitions Basics228

Employee AvailabilityEmployee� availabili�y� refers� �o� ��e� number� of� eac�� �ype� of� employee�require�� by� ��e� new� or�aniza�ion.�T�e� skills� of� ��e� exis�in�� workforce�s�oul��be��ocumen�e��an��compare��wi��� ��e�curren��an�� fu�ure� func��ional� requiremen�s� of� ��e� new� company.�T�e� local� labor� pool� can� be� a�source� of� po�en�ial� new� �ires� for� ��e� combine�� firms� �o� au�men�� ��e�exis�in�� workforce.� �a�a� s�oul�� be� collec�e�� on� ��e� e�uca�ional� levels���skills���an���emo�rap�ic�composi�ion�of���e�local�workforce���as�well�as�pre�vailin��wa�e�ra�es�by�skill�ca�e�ory.

Staffing Plans and Timetable���e�aile�� s�affin�� plan� can� be� �evelope�� af�er� ��e� prece�in�� s�eps� �ave�been�comple�e�.�Gaps�in���e�firm’s�workforce���a��nee���o�be�fille��from�ou�si�e�recrui�men��can�be�rea�ily� i�en�ifie�.�T�e�effor�� �o�recrui��ex�er�nally� s�oul�� be� �empere�� by� i�s� po�en�ially� a�verse� impac�� on� curren��employee�morale.�Fillin��nee�e��jobs�s�oul��be�priori�ize��an��p�ase��in�over��ime�in�reco�ni�ion�of���e��ime�require���o�fill�cer�ain��ypes�of�posi��ions�an����e�impac��of�major��irin��pro�rams�on�local�wa�e�ra�es�in�com�muni�ies�wi���a�limi�e��availabili�y�of�labor.

�f�er� mana�emen�� posi�ions� �ave� been� fille���� ��e� mana�ers� s�oul��evalua�e� an�� selec�� new� employees� �o� fill� job� openin�s� in� ��eir� �epar��men�s� an�� opera�ions.� Senior� mana�emen�� s�oul�� s�ress� ��e� impor�ance�of�fillin��job�openin�s���par�icularly�w�en���e�skills�require��are�crucial��o�comple�in�� ��e� in�e�ra�ion� of� ��e� acquire�� business.��urin�� in�e�ra�ion���mana�ers�are�un�er���e�s�ress�of��avin���o�con�uc��normal�business�opera��ions�as�well�as�in�e�ra�e�por�ions�of���e�acquire��business.

T�e� increase�� workloa�� an�� assump�ion� of� a��i�ional� responsibili��ies�of�en�lea��mana�ers��o��efer���e��ime�consumin���irin��process.�T�is��elay� �ur�s� mana�er� morale� an�� �eal��� an�� can� s�ymie� comple�ion� of���e� in�e�ra�ion� process� because� mana�ers� of�en� are� insufficien�ly� �raine���o� �an�le� many� of� ��e� responsibili�ies� ��ey� �ave� assume�.� Key� employ�ees� inevi�ably�will�be� los�� �o� ��e�new�company.����er�employees� s�oul��be��raine���o�fill�posi�ions�consi�ere��cri�ical��o���e�lon���erm�viabili�y�of���e�or�aniza�ion.�T�is�can�be�accomplis�e��by��evelopin��job��escrip�ions���a�� clearly� i�en�ify� ��e� skills� require�� �o� fill� ��e� posi�ions� an�� ��en� by�cross��rainin��o��er�workers�in���e�posi�ions.

CompensationMer�in��compensa�ion�plans�can�be�one�of���e�mos��c�allen�in��ac�ivi�ies�of���e�in�e�ra�ion�process.�I��mus��be��one�in�compliance�wi���prevailin��

M&A Postmerger Integration 229

re�ula�ions�an��wi���a��i����e�ree�of�sensi�ivi�y.�To�al�compensa�ion�con�sis�s�of�base�pay���bonuses�or�incen�ive�plans���benefi�s���an��special�con�rac�ual�a�reemen�s.�Bonuses�may� �ake� ��e� form�of�a� lump� sum�of�cas��or� s�ock�pai���o�an�employee�for�mee�in��or�excee�in��cer�ain��ar�e�s.�Special�con��rac�ual�a�reemen�s�may�consis��of�noncompe�e�a�reemen�s�in�w�ic��key�employees��� in� exc�an�e� for� an� a�ree��on� amoun��of� compensa�ion��� si�n�a�reemen�s� no�� �o� compe�e� a�ains�� ��e� newly� forme�� company� if� ��ey�s�oul�� leave.�Special� a�reemen�s�also�may� �ake� ��e� form�of��ol�en�para�c�u�es� (i.e.��� lucra�ive� severance�packa�es)� for� senior�mana�emen�.�Finally���re�en�ion�bonuses�of�en�are��iven��o�employees�if���ey�a�ree��o�s�ay�wi�����e�new�company�for�a�specific�perio�.12

T�e� ex�en�� �o� w�ic�� compensa�ion� plans� are� in�e�ra�e�� �epen�s� on�w�e��er���e��wo�companies�are��oin���o�be�mana�e��separa�ely.�Financial�acquirers�may�be� in�en��on�resellin�� ��e�acquire��business� in�a� few�years�an��so�may�op���o�keep�compensa�ion�plans�separa�e.�T�e�s�ra�e�ic�acquirer�also�may�keep���e�plans�separa�e�especially�if�i��is�movin��in�o�an�in�us�ry�in�w�ic�� compensa�ion��iffers� from� ��a�� prevailin�� in� i�s� curren�� in�us��ry.�W�en���e�paren���eci�es��o�combine�plans�����e��esi�n�of�a�new�plan��enerally� is� �one� in� consul�a�ion� wi��� ��e� acquire�� uni�’s� mana�emen�.�T�e�paren��will�se���ui�elines���suc��as��ow�muc��s�ock�senior�execu�ives�s�oul��own�(e.�.���a�percen�a�e�of�base�pay)�an���ow�mana�ers�will�receive���e�s�ock�(e.�.���w�e��er���ey�will�be�awar�e��s�ock�or�will��ave��o�buy�i��a��a��iscoun��from�i�s�curren��marke��price).�T�e�paren��will�also�se���ui�e�lines�for�base�pay.�For�example�����e�paren��may��eci�e���a��base�pay�will�be�a��marke����below�marke����or�above�marke��a�jus�e��for�re�ional��ifferences�in� ��e�cos��of� livin�.�Moreover��� ��e�paren��may��eci�e��ow�bonuses�will�be�pai����wi�����e�opera�in��uni���e�erminin��w�o�receives� ��em.�Finally�����e�paren��will��e�ermine���e�benefi�s�policy�an��plans.

Personnel Information SystemsT�e� acquirin�� company�may� c�oose� �o�mer�e� all� personnel� �a�a� in�o� a�new��a�abase���mer�e�one�corpora�e��a�abase�in�o�ano��er���or�main�ain���e�separa�e� personnel� �a�abases� of� eac�� business.��� sin�le� �a�abase� enables�au��orize�� users� �o� access� employee� �a�a� more� rea�ily��� plan� more� effi�cien�ly� for� fu�ure� s�affin�� requiremen�s��� an�� con�uc�� workforce� analyses.�Main�enance�expense�associa�e��wi���a�sin�le��a�abase�also�may�be�lower.�

12� Followin��i�s�acquisi�ion�of�Merrill�Lync��in�200����Bank�of��merica�offere��Merrill’s��op�financial�a�visers�re�en�ion�bonuses��o�minimize�po�en�ial�a��ri�ion—believin����a����e�loss�of���e��i��es��pro�ucers�amon��Merrill’s�1���000�brokers�woul���ave�seriously�ero�e����e�value�of���e�firm��o�Bank�of��merica.

Mergers and Acquisitions Basics230

T�e� �ecision� �o� keep� personnel� �a�abases� separa�e� may� reflec�� plans� �o��ives����e�uni��a��some��ime�in���e�fu�ure.

funcTIonal InTegRaTIon

So�far���you��ave�learne��abou����e�s�eps�involve��in�planning���e�in�e�ra��ion�process.�Now�le�’s�look�a��func�ional�in�e�ra�ion—��e�ac�ual�execution�of���e�plans.

Firs���� ��e� mana�emen�� in�e�ra�ion� �eam� mus�� �e�ermine� ��e� ex�en���o�w�ic����e��wo�companies’�opera�ions�an��suppor��s�affs�are��o�be�cen��ralize��or��ecen�ralize�.�T�e�main� areas�of� focus� s�oul��be� informa�ion��ec�nolo�y�(IT)���manufac�urin��opera�ions��� sales���marke�in���� finance���pur�c�asin���� researc�� an���evelopmen�� (R&�)��� an�� ��e� requiremen�s� �o� s�aff���ese� func�ions.� However��� before� any� ac�ual� in�e�ra�ion� �akes� place��� i�� is�crucial��o�revali�a�e��a�a�collec�e���urin���ue��ili�ence�an��benc�mark�all�opera�ions�by�comparin����em��o�in�us�ry�s�an�ar�s.

Revalidating Due Diligence Data�a�a� collec�e�� �urin�� �ue� �ili�ence� s�oul�� be� revali�a�e�� imme�ia�ely�af�er�closin�.�T�e�pressure�exer�e��by�bo���buyer�an��seller��o�comple�e���e��ransac�ion�of�en�resul�s�in�a��ap�azar��preclosin���ue��ili�ence�review.�For�example����o�compress���e��ime��evo�e���o��ue��ili�ence���sellers�of�en�allow�buyers�access�only��o�senior�mana�ers.�Mi��le�level�mana�ers���supervisory�personnel���an��equipmen��opera�ors�may�be�exclu�e��from���e�in�erview�process.� For� similar� reasons��� si�e� visi�s� by� ��e� buyer� of�en� are� limi�e�� �o���ose� si�es�wi��� ��e� lar�es��number�of�employees;�consequen�ly��� risks�an��oppor�uni�ies���a��mi����exis��a��o��er�si�es�are�i�nore��or�remain�uncov�ere�.�T�e�buyer’s� le�al�an��financial� reviews��ypically�are�con�uc�e��only�on���e�lar�es��cus�omer�an��supplier�con�rac�s���promissory�no�es���an��oper�a�in�� an�� capi�al� leases.�Receivables� are� evalua�e�� an��p�ysical� inven�ory�is� coun�e�� usin�� samplin�� �ec�niques.�T�e� effor�� �o� �e�ermine� w�e��er�in�ellec�ual�proper�y��as�been�properly�pro�ec�e����wi���key��ra�emarks�or�service�marks�re�is�ere��an��copyri���s�an��pa�en�s�file����is�of�en�spo��y.

Benchmarking PerformanceBenc�markin�� impor�an�� func�ions� suc��as� ��e�acquirer�an�� �ar�e��man�ufac�urin�� an�� IT�opera�ions� an�� processes� is� a� useful� s�ar�in�� poin�� for��e�erminin���ow��o�in�e�ra�e���ese�ac�ivi�ies.�S�an�ar��benc�marks�inclu�e���e� In�erna�ional� �r�aniza�ion� for� S�an�ar�iza�ion (IS�) �000 �uali�yS�an�ar�iza�ion (IS�) �000 �uali�y� (IS�)� �000� �uali�y��

M&A Postmerger Integration 231

Sys�ems—Mo�el�for��uali�y��ssurance�in��esi�n����evelopmen����Pro�uc�ion���Ins�alla�ion���an��Servicin�.����er�benc�marks���a��can�be�use��inclu�e���e�U.S.�Foo��an���ru����minis�ra�ion’s�Goo��Manufac�urin��Prac�ices�an����e��epar�men��of�Commerce’s�Malcolm�Bal�ri�e��war�.1�

Integrating Manufacturing OperationsT�e��a�a�revali�a�ion�process�for�in�e�ra�in��an��ra�ionalizin��facili�ies�an��opera�ions�requires�in��ep����iscussions�wi���key��ar�e��company�person�nel� an�� onsi�e� visi�s� �o� all� facili�ies.�T�e� objec�ive� s�oul�� be� �o� reevalu�a�e� overall� capaci�y��� ��e� po�en�ial� for� fu�ure� cos�� re�uc�ions��� ��e� a�e� an��con�i�ion� of� facili�ies��� ��e� a�equacy� of� main�enance� bu��e�s��� an�� com�pliance� wi��� environmen�al� laws.�T�e� in�e�ra�ion� s�oul�� consi�er� care�fully�w�e��er��ar�e��facili�ies���a���uplica�e�manufac�urin��capabili�ies�are�po�en�ially�more�efficien�� ��an� ��ose�of� ��e�buyer.��s�par��of� ��e�benc��markin��process�����e�opera�ions�of�bo�����e�acquirer�an����e��ar�e��com�pany� s�oul�� be� compare�� wi��� in�us�ry� s�an�ar�s� �o� properly� evalua�e���eir�efficiency.

Process�effec�iveness� is�an�accura�e� in�ica�or�of�overall�opera�ional�effi�ciency.1�� Four� processes� s�oul�� be� examine�.�T�e� firs�� �wo� are� production planning� an�� materials ordering.� Pro�uc�ion� plannin�� is� of�en� very� inaccu�ra�e��� par�icularly� w�en� ��e� opera�ions� are� no�� easily� c�an�e�� an�� require�lon���erm� sales� forecas�s.�T�e�pro�uc�ion�plannin�� an��ma�erials� or�erin��func�ions�nee�� �o�coor�ina�e�ac�ivi�ies�because� ��e�quan�i�y�an��composi��ion�of���e�ma�erials�or�ere���epen�s�on���e�accuracy�of�sales�projec�ions.�Inaccura�e�projec�ions�resul��in�s�or�a�es�or�cos�ly�excess�inven�ory�accumu�la�ion.�T�e���ir��process��o�examine���order entry���may�offer�si�nifican��oppor��uni�ies� for� cos�� savin�s.� Companies� ��a�� pro�uce� in� an�icipa�ion� of� sales�of�en�carry�lar�e�finis�e���oo�s�inven�ories.�For���is�reason���companies�suc��as� personal� compu�er� manufac�urers� are� buil�in�� inven�ory� accor�in�� �o�or�ers�receive���o�minimize�workin��capi�al�requiremen�s.���key�in�ica�or�of���e�effec�iveness�of�quality control�����e�las��of���e�processes��o�examine���is���e�percen�a�e�of�pro�uc�s���a���o���rou�����e�manufac�urin��process�wi���ou��bein��inspec�e�.�Companies�w�ose�“firs��run�yiel�”�(i.e.�����e�percen�a�e�of�finis�e��pro�uc�s���a���o�no���ave��o�be�reworke���ue��o�quali�y�prob�lems)�is�in���e��0��o��0�percen��ran�e�may��ave�serious�quali�y�problems.

1�� San�erson�an��Uzumeri�(1������p.�1�5)�provi�e��a�compre�ensive�lis��of�s�an�ar�s�se��in��or�aniza�ions.

1�� Por�er�an��Woo��(1���).

Mergers and Acquisitions Basics232

Plan��consoli�a�ion�be�ins�by�a�op�in��a� se��of�common�sys�ems�an��s�an�ar�s� for� all� manufac�urin�� ac�ivi�ies.� Suc�� s�an�ar�s� inclu�e� cycle��ime�be�ween�pro�uc�ion�runs���cos��per�uni��of�ou�pu����firs��run�yiel����an��scrap�ra�es.�Links�be�ween���e��ifferen��facili�ies�are���en�crea�e��by�s�ar�in�� informa�ion� mana�emen�� an�� processin�� sys�ems��� inven�ory� con�rol���supplier� rela�ions�ips���an���ranspor�a�ion� links.�Ver�ical� in�e�ra�ion�can�be�ac�ieve��by�focusin��on��ifferen��s�a�es�of�pro�uc�ion.��ifferen��facili�ies��specialize� in� ��e� pro�uc�ion� of� selec�e�� componen�s��� w�ic�� are� ��en�s�ippe���o�o��er�facili�ies��o�assemble���e�finis�e��pro�uc�.�Finally���a�com�pany�may�close�cer�ain�facili�ies�w�enever���ere�is�excess�capaci�y.

Integrating Information TechnologyIT�spen�in��cons�i�u�es�an�ever�increasin��s�are�of�mos��business�bu��e�s—�an��abou���0�percen��of�sof�ware�projec�s� fail� �o�mee����eir�performance�expec�a�ions�or��ea�lines.15�Nearly�one��alf�are�scrappe��before�comple��ion���an��abou��one��alf�cos���wo�or���ree��imes���eir�ori�inal�bu��e�s�an���ake���ree��imes�as�lon��as�expec�e���o�comple�e.16

Mana�ers�seem��o�focus��oo�muc��on��ec�nolo�y�an��no��enou���on���e�people�an��processes���a��will�use���a���ec�nolo�y.�If���e�buyer�in�en�s��o�opera�e���e��ar�e��company�in�epen�en�ly�����e�informa�ion�sys�ems�of���e��wo�companies�may�be�kep��separa�e�as�lon��as�communica�ions�links�be�ween� ��em� can� be� es�ablis�e�.� If� ��e� buyer� in�en�s� �o� in�e�ra�e� ��e��ar�e���� ��ou����� ��e�process�can�be��aun�in�.�Nearly��0�percen��of�buyers�c�oose� �o� combine� ��eir� informa�ion� sys�ems� imme�ia�ely� af�er� closin����an��almos���0�percen��of�acquirers�even�ually�combine���ese�opera�ions.1�

Integrating FinanceSome� �ar�e�� companies� will� be� opera�e�� as� s�an�alone� opera�ions;� o���ers�will�be�comple�ely�mer�e��wi�����e�acquirer’s�exis�in��business.�Many�in�erna�ional� acquisi�ions� involve� companies� in� areas� ��a�� are� �eo�rap�i�cally�remo�e�from���e�paren��company�an��opera�e�lar�ely�in�epen�en�ly�from���e�paren�.�T�is�requires�a��rea���eal�of�effor���o�ensure���a����e�buyer�can�moni�or�financial�resul�s�from�a��is�ance���even�if���e�paren���as�i�s�rep�resen�a�ive�permanen�ly�on�si�e.

T�e�acquirer�s�oul��es�ablis��a�bu��e�in��process�an��si�na�ure�approval�levels� �o� con�rol� spen�in�.� Si�na�ure� approval� levels� refer� �o� levels� of��

15� Financial Times�(1��6).16� The Wall Street Journal�(November�1����1��6).1�� Cossey�(1��1).

M&A Postmerger Integration 233

expen�i�ures���a��mus��be�approve��in�wri�in��by�a��esi�na�e��mana�er;���ey�will�vary�by���e�size�of���e�firm.����a�minimum�����e�bu��e��s�oul��require�projec�ions�of�mon��ly�cas��inflows�an��ou�flows�for���e�comin��year.

Integrating SalesW�e��er���e�sales�forces�of���e��wo�firms�are�w�olly�in�e�ra�e��or�opera�e��in�epen�en�ly��epen�s�on���eir�rela�ive�size�����e�na�ure�of���eir�pro�uc�s��an�� marke�s��� an�� ��eir� �eo�rap�ic� loca�ion.��� rela�ively� small� sales� force�may�be�rea�ily�combine��wi�����e�lar�er�sales�force�if���ey�sell�sufficien�ly�similar�pro�uc�s�an��serve�sufficien�ly�similar�marke�s.�T�e�sales�forces�may�be�kep��separa�e�if���e�pro�uc�s���ey�sell�require�in��ep���un�ers�an�in��of���e�cus�omers’�nee�s�an��a��e�aile��knowle��e�of���e�pro�uc�.�I��is�qui�e�common� for� firms� ��a�� sell��i��ly� complex�pro�uc�s� suc�� as� robo�ics�or�en�erprise�sof�ware��o�employ�a�par�icularly�well��raine��an��very�sop�is��ica�e�� sales� force� ��a�� mus�� employ� ��e�“consul�a�ive� sellin�”� approac�;���is�may� require� keepin�� ��e� sales� forces� of�mer�e�� firms� separa�e.� Sales�forces�in��lobally��isperse��businesses�of�en�are�kep��separa�e��o�reflec����e�uniqueness�of���eir�marke�s.�However���suppor��ac�ivi�ies�suc��as�sales��rain�in�� or� �ec�nical� suppor�� of�en� are� cen�ralize�� an�� use�� �o� suppor�� sales�forces�in�several��ifferen��coun�ries.

Si�nifican�� cos�� savin�s� may� be� ac�ieve�� by� in�e�ra�in�� sales� forces���w�ic��elimina�es��uplica�e�sales�represen�a�ives�an��rela�e��suppor��expenses�suc��as��ravel�an��en�er�ainmen��expenses����rainin����an��mana�emen�.���sin��le�sales�force�may�also�minimize�po�en�ial�confusion�by�allowin��cus�omers��o��eal�wi���a�sin�le�sales�represen�a�ive�w�en�purc�asin��mul�iple�pro�uc�s�an��services.�Moreover���an�in�e�ra�e��sales�force�may�facili�a�e�pro�uc��cross�sellin��(i.e.�����e�sale�of�one�firm’s�pro�uc�s��o���e�o��er�firm’s�cus�omers).

Integrating MarketingEnablin����e�cus�omer��o�see�a�consis�en��ima�e�in�a�ver�isin��an��promo��ional�campai�ns�may�be���e��rea�es��c�allen�e�facin����e�in�e�ra�ion�of���e�marke�in��func�ion.�S�eps��o�ensure�consis�ency����owever���s�oul��no��con�fuse���e�cus�omer�by�ra�ically�c�an�in��a�pro�uc�’s�ima�e�or��ow�i��is�sol�.

T�e� loca�ion� an�� �e�ree� of� in�e�ra�ion� of� ��e� marke�in�� func�ion��epen��on���e��lobal�na�ure�of���e�business�����e��iversi�y�or�uniqueness�of�pro�uc��lines���an����e�pace�of�c�an�e�in���e�marke�place.���business�wi���opera�ions� worl�wi�e� may� be� incline�� �o� �ecen�ralize� marke�in�� �o� ��e�local� coun�ries� �o� increase� awareness� of� local� laws� an�� cul�ural� pa��erns.�Companies�wi���a�lar�e�number�of�pro�uc��lines���a��can�be��roupe��in�o�

Mergers and Acquisitions Basics234

lo�ical�ca�e�ories�or���a��require�ex�ensive�pro�uc��knowle��e�may��eci�e��o��isperse���e�marke�in��func�ion��o���e�various�opera�in��uni�s��o�keep�marke�in��personnel�as�close��o���e�cus�omer�as�possible.

Integrating PurchasingMana�in�� ��e� mer�e�� firm’s� purc�asin�� func�ion� a��ressively� an�� effi�cien�ly� can� re�uce� ��e� �o�al� cos�� of� �oo�s� an�� services� purc�ase�� by�mer�e��companies�by�10� �o�15�percen�.1��T�e�oppor�uni�y� �o� reap� suc��subs�an�ial� savin�s� from� suppliers� comes� imme�ia�ely� af�er� closin��of� ��e��ransac�ion.��� mer�er� crea�es� uncer�ain�y� amon�� bo��� companies’� sup�pliers��� par�icularly� if� ��ey�mi���� �ave� �o� compe�e� a�ains�� eac�� o��er� for�business�wi��� ��e�combine�� firms.�Many�will�offer�cos�� savin�s�an��new�par�ners�ip�arran�emen�s����iven���e�mer�e��or�aniza�ion’s��rea�er�bar�ain�in��power��o�rene�o�ia�e�con�rac�s.�T�e�new�company�may�c�oose��o�real�ize�savin�s�by�re�ucin����e�number�of�suppliers.��s�par��of���e�premer�er��ue��ili�ence���bo�����e�acquirer�an����e�acquire��company�s�oul��i�en�ify�a�s�or��lis��of���eir�mos��cri�ical�suppliers���wi���a�focus�on���ose�accoun��in��for���e�lar�es��s�are�of�purc�ase��ma�erials�expenses.

Integrating Research and DevelopmentR&��is� an�ex�remely� impor�an�� source�of�value� in�many�M&�s.��f�en�����e�buyer�an��seller�R&��or�aniza�ions�are�workin��on��uplica�e�projec�s�or�projec�s�no���ermane��o���e�buyer’s�lon���erm�s�ra�e�y.�T�e�in�e�ra�ion��eam�mus���efine�fu�ure�areas�of�R&��collabora�ion�an��se��priori�ies�for�fu�ure�R&��researc��(subjec���o�senior�mana�emen��approval).

Barriers��o�R&��in�e�ra�ion�aboun�.�Some�projec�s�require�consi�er�ably�more��ime�(measure��in�years)��o�pro�uce�resul�s���an�o��ers.��no��er�obs�acle�is���a��some�personnel�s�an���o�lose�in��erms�of��i�les���pres�i�e���an��power�if���ey�collabora�e.�Finally�����e�acquirer’s�an����e��ar�e�’s�R&��finan�cial�re�urn�expec�a�ions�may��iffer.�T�e�acquirer�may�wis���o��ive�R&��a��i��er�or�lower�priori�y�in���e�combine��opera�ion�of���e��wo�companies.

��s�ar�in��poin��for�in�e�ra�in��R&��is��o��ave�researc�ers�from�bo���companies� s�are� ��eir� work� wi��� eac�� o��er� an�� co�loca�e.�Work� �eams�also� can� follow� a� balance�� scorecar�� approac�� for� ob�ainin�� fun�in�� for���eir� projec�s��� scorin�� R&�� projec�s� accor�in�� �o� ��eir� impac�� on� key�

1�� C�apman�e��al.�(1���)���in�an�analysis�of�50�M&�s���foun����a��companies�were�able��o�recover�a��leas���alf�of���e�premium�pai��for���e��ar�e��company�by�movin��a��ressively��o�mana�e���eir�purc�asin��ac�ivi�ies.�For���ese�firms���purc�ase���oo�s�an��services���inclu�in��office�furni�ure���raw�ma�erials���an��ou�si�e�con�rac�ors���cons�i�u�e��up��o��5�percen��of���e�firms’��o�al�spen�in�.

M&A Postmerger Integration 235

s�ake�ol�ers���suc��as�s�are�ol�ers�an��cus�omers.�T�ose�projec�s�receivin����e��i��es��scores�are�fully�fun�e�.

Integrating Human ResourcesTra�i�ionally���HR��epar�men�s��ave�been��i��ly�cen�ralize��an���ave�been�responsible�for�con�uc�in��opinion�surveys���assessin��mana�erial�effec�iveness����evelopin���irin��an��s�affin��plans���an��provi�in���rainin�.�HR��epar�men�s��are�of�en�ins�rumen�al� in�con�uc�in��s�ra�e�ic�reviews�of���e�s�ren���s�an��weaknesses�of�po�en�ial��ar�e��companies���in�e�ra�in����e�acquirer’s�an���ar��e�’s�mana�emen���eams���recommen�in��an��implemen�in��pay�an��benefi��plans��� an���issemina�in�� informa�ion�abou�� acquisi�ions.� In� recen��years��� as��i��ly�cen�ralize��HR�func�ions��ave�been�foun���o�be�very�expensive�an��nonresponsive�����e��ren���as�been��o�move���e�HR�func�ion��o���e�opera��in��uni����w�ere��irin��an���rainin��may�be��one�more�effec�ively.�Mos��of���e��ra�i�ional�HR�ac�ivi�ies�are�con�uc�e��a����e�opera�in��uni�s�wi�����e�excep�ion�of���e�a�minis�ra�ion�of�benefi��plans���mana�emen��of�HR�infor�ma�ion�sys�ems���an��(in�some�cases)�or�aniza�ional��evelopmen�.1�

BuIldIng a new coRPoRaTe culTuRe

Corporate culture� is� a� common� se�� of� values��� �ra�i�ions��� an�� beliefs� ��a��influence� mana�emen�� an�� employee� be�avior� wi��in� a� firm.� Lar�e����iverse�businesses��ave�an�overarc�in��cul�ure�an��a� series�of� subcul�ures���a�� reflec�� local� con�i�ions.�W�en� �wo� companies� wi��� �ifferen�� cul��ures�mer�e�����e�newly�forme��company�of�en�will��ake�on�a�new�cul�ure�qui�e� �ifferen�� from� ei��er� ��e� acquirer’s� or� ��e� �ar�e�’s� cul�ure.�Cul�ural��ifferences� are� no�� in�eren�ly� ba�� or� �oo�.�T�ey� can� ins�ill� crea�ivi�y� in���e�new�company�or�crea�e�a�con�en�ious�environmen�.�Because�spee��in�in�e�ra�in����e�acquirer�an���ar�e��firms�is�cri�ical��o�realizin��an�icipa�e��syner�ies����ealin��wi���po�en�ially�con�en�ious�cul�ural� issues�early� in���e�in�e�ra�ion�process�is�crucial.

�� firm’s� cul�ure� �akes� bo��� �an�ible� an�� in�an�ible� forms.�Tan�ible�symbols�of�cul�ure�inclu�e�s�a�emen�s��un��on�walls�con�ainin����e�firm’s�mission�an��principles���as�well�as�s�a�us�associa�e��wi�����e�execu�ive�office�floor�an���esi�na�e��parkin�� spaces.� In�an�ible� forms� inclu�e� ��e�be�av�ioral�norms�communica�e�� ��rou��� implici��messa�es� abou���ow�people�are�expec�e���o�ac�.�Because���ey�represen����e�ex�en���o�w�ic��employees�

1�� Por�er�&�Woo��(1���).

Mergers and Acquisitions Basics236

and managers actually “ walk the talk, ” these messages are often far more influential in forming and sustaining corporate culture than the tangible trappings of corporate culture. 20

Trust in the corporation is undermined immediately after a merger, in part by the ambiguity of the new organization ’ s identity. Employee acceptance of a common culture can build identification with and trust in the cor-poration. As ambiguity abates and acceptance of a common culture grows, trust can be restored, especially among those who closely identified with their previous organization. 21

Identifying Cultural Issues through Cultural Profiling The first step in building a new corporate culture is to develop a cultural profile of both the acquirer and acquired companies through employee surveys and interviews and by observing management styles and prac-tices. The information is then used to show the similarities and differ-ences between the two cultures as well as their comparative strengths and weaknesses. A common difference is that one culture values individualism, whereas the other values teamwork.

The relative size and maturity of the acquirer and target firms can have major implications for cultural integration. Startup companies typically are highly unstructured and informal in terms of dress and decision making. Compensation may be largely stock options and other forms of deferred income. Benefits, beyond those required by state and federal law, and “ perks ” such as company cars are largely nonexistent. Company policies frequently do not exist or are not in writing or are drawn up as needed. Internal controls covering employee expense accounts are often minimal. In contrast, larger, mature companies are often more highly structured, with well-defined internal controls, compensation structures, benefits pack-ages, and employment policies all in place because the firms have grown too large and complex to function in an orderly manner without them. Employees usually have clearly defined job descriptions and career paths. Decision making, whether decentralized at the operating unit level or cen-tralized within a corporate office, has a well-defined process. It may be ponderous, requiring consensus within a large management bureaucracy.

21 Maguire and Phillips (2008).

20 Kennedy and Moore (2003) argued that the most important source of communication of cultural biases in an organization is the individual behavior of others, especially those with the power to reward appropriate and to punish inappropriate behavior.

M&A Postmerger Integration 237

Cul�ural� �ifferences� may� be� exacerba�e�� w�en� firms� are� combine��from� �ifferen�� or� even� across� se�men�s� wi��in� ��e� same� in�us�ry.�W�en�Travelers�mer�e��wi���Ci�icorp�����e��u�e��ifferences�be�ween�inves�men��bankin��salaries�an����ose�in�insurance�fuele��resen�men��in�some�par�s�of���e�combine��company.

�f�er�senior�mana�emen��reviews���e�informa�ion�in���e�cul�ural�profile���i��mus���eci�e�w�ic��c�arac�eris�ics�of�bo���cul�ures� �o�emp�asize� in� ��e�new�cul�ure.�T�e�mos�� realis�ic� expec�a�ion� is� ��a�� employees� in� ��e�new�company�can�be�encoura�e���o�a�op��a�s�are��vision���a�se��of�core�values���an��be�aviors��eeme��impor�an��by�senior�mana�emen�.��ny��in��more�is�probably�wis�ful���inkin�:�a�company’s�cul�ure�evolves�over�a�lon��perio�.�However����e��in���o���e�poin��a��w�ic��employees�w�olly�embrace�man�a�emen�’s��esire��cul�ure�may��ake�years�a��bes��or�may�never�be�ac�ieve�.

Overcoming Cultural DifferencesS�arin��common��oals���s�an�ar�s���services���an��space�can�be�a��i��ly�effec��ive�an��prac�ical�way��o�in�e�ra�e��ispara�e�cul�ures.22�Common��oals��rive��ifferen�� uni�s� �o� coopera�e.� For� example��� a�� ��e� func�ional� level��� se��in��exac���ime�ables�an��processes�for�new�pro�uc���evelopmen��can��rive��if�feren��opera�in��uni�s��o�collabora�e�as�projec���eams�s�rive��o�in�ro�uce���e�pro�uc��by���e��ar�e���a�e.������e�corpora�e�level���incen�ive�plans�spannin��many�years�can�focus�all�opera�in��uni�s��o�pursue���e�same��oals.��l��ou���i��is��elpful�in���e�in�e�ra�ion�process��o��ave�s�are��or�common��oals���in�i�vi�uals�mus��s�ill��ave�specific��oals��o�minimize���e��en�ency�of�some��o�un�erperform�w�ile�benefi�in��from���e�collec�ive�performance�of�o��ers.

S�are��s�an�ar�s�or�prac�ices�enable�one�uni��or�func�ion��o�a�op����e�“bes��prac�ices”�foun��in�ano��er.�S�an�ar�s�inclu�e�opera�in��proce�ures����ec�nolo�ical�specifica�ions���e��ical�values���in�ernal�con�rols���employee�per�formance�measures���an��comparable�rewar��sys�ems���rou��ou����e�com�bine��companies.

Some� func�ional� services� can� be� cen�ralize�� an�� s�are�� by� mul�iple��epar�men�s� or� opera�in�� uni�s.� Commonly� cen�ralize�� services� inclu�e�accoun�in����le�al���public�rela�ions���in�ernal�au�i����an��informa�ion��ec�nol�o�y.�T�e�mos�� common�way� �o� s�are� services� is� �o� use� a� common� s�aff.��l�erna�ively���a�firm�can�crea�e�a�suppor��services�uni��an��allow�opera�in��uni�s� �o� purc�ase� services� from� i�� or� �o� buy� similar� services� ou�si�e� ��e�company.

22� Malekza�e��an��Na�avan�i�(1��0).

Mergers and Acquisitions Basics238

Isola�in�� �ar�e�� company� employees� in� a� separa�e� buil�in�� or� even� a�floor� of� ��e� same� buil�in�� will� impair� ��e� in�e�ra�ion� process.� Mixin��offices�or�even�loca�in��acquire��company�employees�in�space�a�jacen���o���e� paren�’s� offices� is� a� �i��ly� �esirable�way� �o� improve� communica�ion�an�� i�ea� s�arin�.� Common� labora�ories��� compu�er� rooms��� libraries��� an��lunc�rooms�also�facili�a�e�communica�ion�an��coopera�ion.2�

*�*�*

Successfully�in�e�ra�e��M&�s�are���ose���a���emons�ra�e�lea�ers�ip�by�can�i�ly� an��con�inuously� communica�in�� a� clear� vision��� a� se��of� values���an��clear�priori�ies��o�all�employees.�Successful�in�e�ra�ion�effor�s�are���ose���a��are�well�planne������a��appoin��an�in�e�ra�ion�mana�er�an��a��eam�wi���clearly��efine��lines�of�au��ori�y���an����a��make���e��ou����ecisions�early�in���e�process���w�e��er���ey�are�abou��or�aniza�ional�s�ruc�ure���repor�in��rela�ions�ips��� spans�of� con�rol���personnel� selec�ion��� roles� an�� responsibili��ies���or�workforce�re�uc�ion.�T�e�focus�mus��be�on���ose� issues�wi�����e��rea�es��near��erm�impac�.

2�� S�ill�����e�c�allen�es�are�enormous�in�companies�wi����ispara�e�cul�ures.�In�early�2006���Jeffrey�Bewkes�����e�presi�en��of�Time�Warner���s�oppe��requirin��corpora�e�uni�s��o�coopera�e.�T�is�policy�c�an�e�was�a�comple�e��urnabou��from���e�p�ilosop�y�espouse��followin����e�firm’s�2001�mer�er�wi�����L.�T�en���execu�ives�promise���o�crea�e�a�well�oile��ver�ically�in�e�ra�e��profi���enera�or.�Books�an��ma�azines�an��o��er�forms�of�con�en��woul��fee����e��elevision���movie���an��In�erne��opera�ions.�T�e�2006�c�an�e�encoura�e��mana�ers��o�coopera�e�only�if���ey�coul��no��make�more�money�on���e�ou�si�e.����er�me�ia�companies�suc��as�Viacom�an��Liber�y�Me�ia��ave�broken���emselves�up�because���eir�effor�s��o�ac�ieve�corpora�e�wi�e�syner�ies�wi����ispara�e�me�ia�businesses�prove��unsuccessful.

2�� T�is�case�relies�on�informa�ion�provi�e��in�an�in�erview�wi���Jérôme�Granboulan�(formerly�of��rcelor)�an��William��.�Sco��in��(formerly�of�Mi��al)�����e��wo�execu�ives�c�ar�e��wi����irec�in����e�pos�mer�er�in�e�ra�ion�effor����an��is�a�ap�e��from��e�M�e���an��Van�Hoey�(200�).

A Case in Point: The Challenges of Integrating Steel Giants Arcelor and Mittal24

You read in Chapter 3 of the June 2006 merger of Arcelor and Mittal that created the world’s largest steel company, ArcelorMittal—a behemoth that accounts for about 10 percent of global output, has 320,000 employees in 60 countries, and had 2007 revenue of $105 billion. The focus here is the formation of the integra-tion team, the importance of communications, and the realization of anticipated synergies.

M&A Postmerger Integration 239

The two firms’ downstream (raw material) and upstream (distribution) oper-ations proved highly complementary, with Mittal owning much of its iron ore and coal reserves and Arcelor having extensive distribution and service center operations. As in most mergers, ArcelorMittal faced the challenge of integrating management teams; sales, marketing, and product functions; production facili-ties; and purchasing operations. In this, unlike many mergers involving direct competitors, a relatively small portion of cost savings would come from elimi-nating duplicate functions and operations.

The goal of the merger was to combine what were viewed as entities hav-ing highly complementary assets and skills—quite different from how Mittal had grown through acquisitions of turnaround targets focused on cost and productiv-ity improvements. The merged firm’s top management set three driving objectives before undertaking the postmerger integration effort: achieve rapid integration, manage daily operations effectively, and accelerate revenue and profit growth (viewed as the primary motivation for the merger). The formal phase of the inte-gration effort was to be completed in six months, which made it crucial to agree on the role of the management integration team, key aspects of the integration process such as how decisions would be made, and the roles and responsibilities of team members. Activities were undertaken in parallel rather than sequentially.

Teams comprised employees from both firms, with task force leaders coming from the business units (e.g., commercial integration issues were resolved by the commercial business units). Teams were then asked to propose a draft organiza-tion to the MIT, including the profiles of the people who were to become senior managers. Once selected, these senior managers would build their own teams to identify synergies and create action plans for realizing the synergies. Teams were formed before the organization was announced, and implementation of certain actions began before detailed plans had been developed fully. Progress to plan was monitored on a weekly basis, enabling the MIT to identify obstacles facing the 25 decentralized task forces and, when necessary, to resolve issues.

Considerable effort was spent in getting line managers involved in the plan-ning process and selling the merger to their respective operating teams. Initial communication efforts included the launch of a top-management “road show.” The new company also established a website and introduced Web TV. Senior executives gave two-to-three minute interviews on various topics; anyone with a PC could watch.

To address the high level of employee uncertainty that resulted from the merger, managers were given a well-structured message about the significance of the merger and the direction of the new company that they could then trans-mit to employees. The new brand, ArcelorMittal, was launched at a spring 2007 meeting attended by 500 of the firm’s top managers, marking the end of the for-mal integration process.

Mergers and Acquisitions Basics240

ArcelorMittal’s management used the merger as an opportunity to conduct interviews and surveys with employees to gain an understanding of their views about the two companies. Employees were asked about the combined firms’ strengths and weaknesses and how the new firm should present itself to its vari-ous stakeholder groups. This process resulted in a complete rebranding of the combined firms.

All communication of information disseminated throughout the organization was focused rather than general. External communication was conducted in sev-eral ways. Immediately following closing, senior managers traveled to all the major cities and sites of operations to talk to local managers and employees. Typically, media interviews were also conducted during these visits, which gave ArcelorMittal opportunities to convey its message to the communities. In March 2007, the new firm held a media day in Brussels, with presentations on the merger status. Journalists were invited to go to the different businesses and review the progress.

Within the first three months following closing, customers were informed about the advantages of the merger for them, such as enhanced R&D capabili-ties and wider global coverage. The sales forces of the two organizations were charged with the task of creating a single “face” to the market.

With respect to operational and functional integration, ArcelorMittal man-agement set a $1.6 billion target for annual cost savings. The task forces were charged with validating this number from the bottom up and then telling the MIT how the synergies would be achieved. As the merger progressed, it was necessary to get the business units to assume ownership of the process to for-mulate the initiatives, timetables, and key performance indicators that could be used to track performance against objectives. In some cases, synergy potential was larger or smaller than anticipated. The expectation was that the synergy could be realized by mid-2009.

Integration was deemed complete when the new organization, the brand, the “one face to the customer” requirement, and the synergies were finalized. This occurred within eight months of the closing, though cultural differences between employees of both firms continue. The integration objectives were included in the 2007 annual budget plan. As of the end of 2007, the combined firms were on track to realize their goal with annualized cost savings running $1.4 billion.

Things to Think About1. Why is it important to establish both top-down and bottom-up estimates of

synergy?2. How did ArcelorMittal attempt to bridge cultural differences during the inte-

gration? Be specific.3. Why are communication plans so important? What methods did

ArcelorMittal employ to achieve these objectives? Be specific.

M&A Postmerger Integration 241

4. The formal phase of the postmerger integration period was to be completed within six months. Why do you believe that ArcelorMittal’s management was eager to integrate the two businesses so rapidly? Be specific. What integration activities were to extend beyond the proposed six-month integration period?

Answers can be found at: www.elsevierdirect.com/comapnion.jsp?ISBN9780123749482

243

Abnormal return The return to shareholders due to nonrecurring events that differs from what would have been predicted by the market. It is the return due to an event such as a merger or acquisition.

Acquirer; acquiring company A firm that attempts to acquire a controlling interest in another company.

Acquisition The purchase by one company of a controlling ownership interest in another firm, a legal subsidiary of another firm, or selected assets of another firm.

Acquisition premium See purchase premium.Acquisition vehicle The legal structure used to acquire another company.Advance notice provision A condition that requires announcement of shareholder pro-

posals well in advance of the actual vote.Affirmative covenant A portion of a loan agreement that specifies the actions the bor-

rowing firm agrees to take during the term of the loan.Agency problem The conflict of interest between a firm’s incumbent managers and

shareholders.Antigreenmail provisions Amendments to corporate charters restricting a firm’s ability

to repurchase shares from specific shareholders at a premium.Antitrust laws Federal laws prohibiting individual corporations from assuming too much

market power.Appraisal rights Rights to seek “fair value” for their shares in court given to target com-

pany shareholders who choose not to tender shares in the first or second tier of a ten-der offer.

Arbitrageurs (“arbs”) In the context of M&As, speculators who attempt to profit from the difference between the bid price and the target firm’s current share price.

Articles of incorporation A document filed with a state government by the founders of a corporation.

Back-end merger The merger following either a single or two-tier tender offer, consist-ing of either a long form or short form merger, with the latter not requiring a target firm shareholder vote.

Balance sheet assumptions Assumptions about growth in major balance sheet components.Bear hug A takeover tactic involving the mailing of a letter containing an acquisition

proposal to the board of directors of a target company without prior warning, and demanding a rapid decision.

Bidder See acquirer.Breakup fee A fee that would be paid to the potential acquirer if the target firm decides

to accept an alternative bid.Bridge financing Temporary, unsecured, short-term loans provided by investment banks

to pay all or a portion of the purchase price and meet immediate working capital requirements until permanent or long-term financing is found.

Business alliance A generic term referring to all forms of business combinations other than mergers and acquisitions.

Business-level strategies Strategies pertaining to a specific operating unit or product line within a firm.

Glossary

Glossary244

Business plan A comprehensive analysis of all aspects of a business resulting in a vision for the firm and a strategy for achieving that vision.

Business strategy That portion of a business plan detailing the way a firm intends to achieve its vision.

Buyout Change in controlling interest in a corporation.Certificate of incorporation A document received from the state after the articles of

incorporation have been approved.Classified board election An antitakeover defense involving the separation of a firm’s

board into several classes, only one of which is up for election at any one time. Also called a staggered board election.

Closing The phase of the acquisition process in which ownership is transferred from the target to the acquiring firm in exchange for some agreed-upon consideration follow-ing the receipt of all necessary shareholder, regulatory, and third-party approvals.

Confidentiality agreement A mutually binding accord defining how information exchanged among the parties may be used and the circumstances under which the dis-cussions may be made public. Also known as a nondisclosure agreement.

Conglomerate discount The share prices of conglomerates often trade at a discount from focused firms or from their value if they were broken up and sold in pieces.

Conglomerate Firms that operate in a number of largely unrelated industries.Conglomerate merger Transaction in which the acquiring company purchases firms in

largely unrelated industries.Consent solicitation A process enabling dissident shareholders in certain states to obtain

shareholder support for their proposals simply by obtaining their written consent.Consolidation A business combination involving two or more companies joining to

form a new company, in which none of the combining firms survive.Contingency plans Actions that are undertaken if a firm’s current business strategy

appears not to be working.Contingent value rights In M&A transactions, commitments by the acquirer to pay

additional cash or securities to the seller if the share price of the issuing company falls below a specified level at some future date.

Control premium The excess over the target’s current share price the acquirer is willing to pay to gain a controlling interest. A pure control premium would be one in which the anticipated synergies are small, and the perceived value of the purchase is in gain-ing control to direct the activities of the target firm.

Corporate bylaws Rules governing the internal management of a corporation, which are determined by the corporation’s founders.

Corporate charter A state license defining the powers of a firm and the rights and responsibilities of its shareholders, board of directors, and managers. The charter con-sists of articles of incorporation and a certificate of incorporation.

Corporate culture The common set of values, traditions, and beliefs that influence behavior of a firm’s employees.

Corporate-level strategies Strategies that cut across business unit organizational lines and that entail decisions such as financing the growth of certain businesses, operating others to generate cash, divesting some units, or pursuing diversification.

Corporate governance The systems and controls in place to protect the rights of corpo-rate stakeholders.

Corporate restructuring Actions taken to expand or contract a firm’s basic operations or fundamentally change its asset or financial structure.

Glossary 245

Cost leadership A strategy designed to make a firm the cost leader in its market by con-structing efficient production facilities, tightly controlling overhead expense, and elimi-nating marginally profitable customer accounts.

Covenants Promises made by a borrower that certain acts will be performed and others will be avoided.

Cram down A legal reorganization occurring whenever one or more classes of creditors or shareholders approve, even though others may not.

Creeping takeover strategy Takeover in which bidders acquire target voting shares in relatively small amounts until they have achieved effective control of the target.

Cross-default provisions Clauses in loan agreements that allow a lender to collect its loan immediately if the borrower is in default on a loan to another lender.

Crown jewels lockup An arrangement in which the initial bidder obtains an option to buy important strategic assets of a target, if the target chooses to sell to another party.

Cumulative voting rights In an election for a board of directors, each shareholder is entitled to as many votes as shall equal the number of shares the shareholder owns multiplied by the number of directors to be elected. Furthermore, the shareholder may cast all of these votes for a single candidate or for any two or more of them.

Deal breakers Issues that a party to the negotiation cannot concede without making the deal unacceptable.

Deal-structuring process A process focused on satisfying as many of the primary objec-tives of the parties involved and determining how risk will be shared.

Debentures Long-term debt issues not secured by specific assets, and hence their quality depends on the general creditworthiness of the issuing company.

Defensive acquisition An acquisition made to reduce a firm’s cash position or borrow-ing capacity.

Differentiation A strategy to create a perception by customers that a product or service offered is slightly different from other product or service offerings in the marketplace.

Distributed payments Purchase price payments contingent on the target satisfying an agreed-upon milestone, such as reaching a profit or cash flow target, successfully launching a new product, obtaining regulatory or patent approval, and so on.

Diversification A strategy of buying firms outside the company’s primary line of business.

Diversification discount See conglomerate discount.Diversification strategy A strategy at the corporate level to enter new businesses, which

may be related or completely unrelated to a corporation’s existing business portfolio.Divestiture The sale of all or substantially all of a company or product line to another

party for cash or securities.Divisional organization An organizational structure in which groups of products are

combined into independent divisions or “strategic business units.”Dual class recapitalization A takeover defense in which a firm issues multiple classes

of stock in which one class has voting rights that are 10 to 100 times those of another class. Such stock is also called supervoting stock.

Due diligence The process by which the acquirer seeks to determine the accuracy of the target’s financial statements, evaluate the firm’s operations, validate valuation assump-tions, determine fatal flaws, and identify sources and destroyers of value.

Earnouts Payments to a seller based on the acquired business achieving certain profit or revenue targets.

Economies of scale The spreading of fixed costs over increasing production levels.

Glossary246

Economies of scope The use of a specific set of skills or an asset currently used to pro-duce a specific product to produce related products

Employee stock ownership plan (ESOP) A trust fund or plan that invests in the securi-ties of the firm sponsoring the plan on behalf of the firm’s employees. Such plans are generally employee defined contribution retirement plans.

Equity carve-out A transaction in which the parent firm issues a portion of its stock or that of a subsidiary to the public.

Escape clause A feature common to poison pills enabling the board of the issuing com-pany to redeem the pill through a nominal payment to the shareholders.

Exchange offer A tender offer involving a share-for-share exchange.Experience curve A concept which postulates that as the cumulative historical volume

of a firm’s output increases, cost per unit of output decreases.External analysis The development of an in-depth understanding of a business’s custom-

ers and their needs, underlying market dynamics or factors determining profitability, and emerging trends that affect customer needs and market dynamics.

Fair price provisions A takeover defense requiring that all target shareholders of a suc-cessful tender offer receive the same price as those tendering their shares.

Financial buyer Acquirer who focuses on relatively short-to-intermediate financial returns.Financial restructuring Actions taken by a firm to change its total debt and equity

structure.Financial risk A buyer’s willingness and ability to leverage a transaction, as well as the

willingness of shareholders to accept near-term earnings per share dilution.Financial synergy The reduction in the cost of capital as a result of more stable cash

flows, financial economies of scale, or a better matching of investment opportunities with available funds.

Flip-in poison pill A shareholders’ rights plan in which the shareholders of the target firm can acquire stock in the target firm at a substantial discount.

Flip-over poison pill A shareholders’ rights plan in which target firm shareholders may convert such rights to acquire stock of the surviving company at a substantial discount.

Float The amount of stock that can be most easily purchased by the acquirer.For cause provisions Clauses that specify the conditions for removing a member of the

board of directors.Focus strategy A strategy in which firms tend to concentrate their efforts by selling a

few products or services to a single market and compete primarily on the basis of understanding their customers’ needs better than the competition.

Form of acquisition An acquisition that reflects what is being acquired (i.e., stock or assets).

Form of payment A payment that may consist of cash, common stock, debt, or some combination. Some portion of the payment may be deferred or dependent on the future performance of the acquired entity.

Franchise A privilege given to a dealer by a manufacturer or franchise service organiza-tion to sell the franchisor’s product or service in a given area.

Freeze-out A situation in which an acquirer decides not to acquire 100 percent of the target’s stock but the remaining shareholders become dependent on the decisions made by the majority shareholders.

Friendly takeover A takeover situation in which the target’s board and management are receptive to the idea and recommend shareholder approval.

Glossary 247

Functional organization An organization in which employees are assigned to specific groups or departments such as accounting, engineering, marketing, sales, distribution, customer service, manufacturing, or maintenance.

Functional strategies Policies that describe in detail how each major function (see func-tional organization) within the firm will support the business strategy.

Golden parachute An employee severance arrangement triggered whenever a change in control takes place.

Going private The purchase of the publicly traded shares of a firm by a group of investors.

Go-shop provision A clause that allows a seller to continue to solicit other bidders for a specific period after an agreement has been signed but before closing. However, if the seller accepts another bid, it must pay a breakup fee to the bidder with whom they had a signed agreement.

Greenmail The practice of a firm buying back its shares at a premium from an investor threatening a takeover.

Growth strategy A business strategy that concentrates on growing a firm’s revenues, profit, and cash flow.

Hedge fund Private investment limited partnerships (for U.S. investors) or an off-shore investment corporation (for non-U.S. or tax-exempt investors) in which the general partner has made a substantial personal investment. Hedge fund bylaws generally allow the fund to engage in a wide variety of investing activities.

Highly leveraged transactions Those transactions involving a substantial amount of debt relative to the amount of equity invested.

Horizontal merger A combination of two firms within the same industry.Hostile takeover A takeover that occurs when the initial bid was unsolicited, the target

was not seeking a merger at the time of the approach, the approach was contested by the target’s management, and control changed hands.

Hostile tender offer A tender offer that is unwanted by the target’s board.Hubris An explanation for takeovers that attributes a tendency to overpay to excessive

optimism about the value of a deal’s potential synergy or excessive confidence in man-agement’s ability to manage the acquisition.

Implementation strategy The way in which a firm chooses to execute its business strategy.

Income statement assumptions Assumptions related to projected growth in revenue, the implicit market share, and the major components of cost.

Incentive systems Bonus, profit sharing, or other performance-based payments made to motivate both acquirer and target company employees to work to implement the busi-ness strategy for the combined firms.

Industry A collection of markets.Internal analysis The determination of a firm’s strengths and weaknesses as compared to

its competitors.Initial public offering (IPO) The first offering to the public of common stock of a for-

merly privately held firm.Indemnification A common contractual clause requiring a seller to indemnify or absolve

the buyer of liability in the event of misrepresentations or breaches of warranties or covenants. Similarly, the buyer usually agrees to indemnify the seller. In effect, it is the reimbursement of the other party for a loss for which it was not responsible.

Glossary248

In play A situation in which a firm is believed by investors to be vulnerable to or willing to undergo a takeover due to a bid or rumors of a bid.

Investment banks Advisors who offer strategic and tactical advice and acquisition oppor-tunities; screen potential buyers and sellers; make initial contact with a seller or buyer; and provide negotiation support, valuation, and deal-structuring advice.

Joint venture A cooperative business relationship formed by two or more separate enti-ties to achieve common strategic objectives.

Junk bond High-yield bonds that credit-rating agencies have deemed either to be below investment grade or that they have not rated at all. Also called high-yield debt.

Legal form of the selling entity A term that refers to whether the seller is a C or sub-chapter S corporation, a limited liability company, or a partnership.

Letter of intent A preliminary agreement between two companies intending to merge that stipulates major areas of agreement between the parties, as well as their rights and limitations.

Leveraged buyout A transaction involving the purchase of a company financed primarily by debt.

Leveraged loan Unrated or noninvestment-grade bank loan whose interest rate is equal to or greater than the London Interbank Rate (LIBOR) plus 150 basis points (1.5 per-centage points).

Leveraged recapitalization A situation in which a firm assumes substantial amounts of new debt, often used to buy back stock, finance a dividend to shareholders, or make it less attractive to a potential bidder.

License The authority to grant to others rights to use specific proprietary assets.Liquidating dividend The dividend paid to shareholders from the proceeds of a liquida-

tion of a company, distributed from proceeds remaining after outstanding obligations have been paid to creditors.

Loan agreement An agreement that stipulates the terms and conditions under which a lender will loan a firm funds.

Management buyout A leveraged buyout in which managers of a firm to be taken pri-vate are also equity investors in the transaction.

Management entrenchment theory A theory that managers use a variety of takeover defenses to ensure their longevity with a firm.

Management integration team A team of senior managers from two merged organiza-tions charged with delivering on sales and operating synergies identified during the preclosing due diligence.

Managerialism theory A theory espousing that managers acquire companies to increase the acquirer’s size and their own remuneration.

Market A collections of customers, whether individual consumers or other firms, exhibit-ing common characteristics and needs.

Market assumptions Assumptions about the growth rate of unit volume and product price per unit.

Market power A situation in which the merger of two firms will enable the resulting com-bination to profitably maintain prices above competitive levels for a significant period.

Merger A combination of two or more firms in which all but one legally cease to exist.Merger/acquisition plan A specific type of implementation strategy that describes in

detail the motivation for the acquisition and how and when it will be achieved.Merger of equals A merger framework usually applied whenever the merger participants

are comparable in size, competitive position, profitability, and market capitalization.

Glossary 249

Mezzanine financing Unsecured debt that lies between senior debt and the equity layers.Minority investment A less-than-controlling interest in another firm.Monitoring systems Systems implemented to track the actual performance of combined

firms against a business plan.Negative covenant A loan agreement that restricts the actions of a borrower.No-shop agreement An agreement that prohibits a takeover target from seeking other

bids or making public information that is not currently readily available while in dis-cussions with a potential acquirer.

Open-market purchase The act of a corporation buying its shares in the open market at the prevailing price as any other investor, as opposed to a tender offer for shares or a repurchase resulting from negotiation such as with an unwanted investor.

Operational restructuring The outright or partial sale of companies or product lines, or downsizing by closing unprofitable or nonstrategic facilities.

Operating risk The ability of a buyer to manage an acquired company.Operating synergy A concept that consists of both economies of scale and scope.Overpayment risk The dilution of earnings per share or a reduction in the earnings

growth rate resulting from paying significantly more than the economic value of an acquired company.

Permanent financing Financing usually consisting of long-term unsecured debt.Poison pill A new class of securities issued as a dividend by a company to its sharehold-

ers, giving shareholders the right to acquire more shares at a discount. These securities have no value unless an investor acquires a specific percentage of the target firm’s vot-ing stock.

Private solicitation The behavior of a firm seeking potential buyers on its own or hiring an investment banker to identify potential buyers.

Product or service organization An organization in which functional specialists are grouped by product line or service offering.

Product life cycle A pattern characterizing a product’s evolution in four stages: embry-onic, growth, maturity, and decline.

Promissory note A legal document that commits a borrower to repay a loan, even if the assets, when liquidated, do not fully cover the unpaid balance.

Proxy contest An attempt by dissident shareholders to obtain representation on the board of directors or to change a firm’s bylaws.

Proxy statement According to SEC regulations, target shareholders must receive mate-rials that include the date of the shareholders’ meeting at which approval of the trans-action is to be solicited, details of the merger agreement, company backgrounds, reasons for the proposed merger, and opinions of legal and financial advisors. Proxy statement materials may also be required for other governance-related issues, such as the election board of members.

Public solicitation A firm’s public announcement that it is putting itself, a subsidiary, or a product line up for sale.

Purchase premium The excess of an offer price over a target’s current share price, which reflects both the value of expected synergies and the amount necessary to obtain control.

Pure control premium The value an acquirer believes can be created by replacing incompetent management or by changing the strategic direction of a firm.

Q-ratio The ratio of the market value of a firm to the cost of replacing its assets.Reincorporation The act of a firm changing its state of incorporation to one in which

the laws are more favorable for implementing takeover defenses.

Glossary250

Retention bonus Incentives granted to key employees of a target firm if they remain with the combined companies for a specific period following completion of the transaction.

Reverse breakup fee A fee paid to a target firm in the event the bidder wants to with-draw from a signed contract.

Secured debt Long-term debt issues, typically referred to as mortgage bonds or equip-ment trust certificates.

Security agreement A legal document stipulating which of a borrower’s assets will be pledged to secure a loan.

Self-tender offer A tender offer used when a firm seeks to repurchase its stock from its shareholders.

Seller financing A loan provided by the seller of a property to the buyer to cover all or part of the sale price. Also known as owner carry back or owner financing.

Shareholder interests theory The presumption that management resistance to proposed takeovers is a good bargaining strategy to increase the purchase price for the benefit of the target firm shareholders.

Shark repellents Specific types of takeover defenses that can be adopted by amending either a corporate charter or its bylaws.

Squeeze-out See freeze-out.Spinoff A transaction in which a parent creates a new legal subsidiary and distributes

shares it owns in the subsidiary to its current shareholders as a stock dividend.Staged payouts See distributed payments.Staggered board election A takeover defense involving the division of a firm’s directors

into a number of different classes, with no two classes up for reelection at the same time. Also called a classified board election.

Stakeholders Groups having interests in a firm such as customers, shareholders, employ-ees, suppliers, regulators, and communities.

Standstill agreement A contractual arrangement in which the acquirer agrees not to make any further investments in a target’s stock for a stipulated period.

Statutory consolidation Two or more companies joining to form a new company, but technically not a merger because all legal entities that are consolidated are dissolved during the formation of the new company, which usually has a new name.

Statutory merger The combination of acquiring and target firms, in which one firm ceases to exist, in accordance with the statutes of the state in which the combined businesses will be incorporated.

Stock lockup An option granted to a bidder to buy a target firm’s stock at that bidder’s initial offer that is triggered whenever a competing bid (usually higher) is accepted by the target firm.

Strategic alliance An informal cooperative arrangement, such as an agreement to co-develop a technology, product, or process.

Strategic realignment A theory suggesting that firms use takeovers as a means of rapidly adjusting to changes in their external environment such as deregulation and techno-logical innovation.

Subsidiary merger A transaction in which the target becomes a subsidiary of the parent.Success factors Those strengths or competencies necessary to compete successfully in

the firm’s chosen market.

Glossary 251

Super-majority rules A takeover defense requiring a higher level of approval for amend-ing the charter or for certain types of transactions such as a merger or acquisition.

Supervoting stock A class of voting stock having voting rights many times those of other classes of stock.

SWOT analysis The external and internal analyses undertaken to determine a business’s strengths, weaknesses, opportunities, and threats.

Syndicate A large group of investment banks.Synergy The notion that the value of combined enterprises will exceed the sum of their

individual values.Synergy assumptions Assumptions related to the amount and timing of expected synergy.Takeover Generic term referring to a change in the controlling ownership interest of a

corporation.Takeover defenses Protective devices put in place by a firm to frustrate, slow down, or

raise the cost of a takeover.Target; target company A firm that is being solicited by an acquiring company.Tax considerations Structures and strategies determining whether a transaction is tax-

able or nontaxable to the seller’s shareholders.Tender offer The offer to buy shares in another firm, usually for cash, securities, or both.Term loan A loan usually having a maturity of 2 to 10 years and typically secured by the

asset that is being financed, such as new capital equipment.Term sheet A document outlining the primary areas of agreement between buyer and

seller, often used as the basis for a more detailed letter of intent.Termination fee See breakup fee.Two-tiered offer A tender offer in which target shareholders receive an offer for a spe-

cific number of shares. Immediately following this offer, the bidder announces its intentions to purchase the remaining shares at a lower price or using something other than cash.

Unfriendly takeover See hostile takeover.Valuation assumptions Assumptions about an acquirer’s target debt-to-equity ratio, dis-

count rates, and growth assumptions.Vertical merger A merger in which companies that do not own operations in each

major segment of the value chain choose to backward integrate by acquiring a supplier or to forward integrate by acquiring a distributor.

White knight A potential acquirer that is viewed more favorably by a target firm’s man-agement and board than the initial bidder.

Winner’s curse The tendency of auction winners to show remorse believing that they may have paid too much. 

253

RefeRences

ACNielsen, Retailer support is essential for new product success, Bases, http://www.bases .com/news/news112002.html

Agrawal A, Jaffe JF: The post-merger performance puzzle, Working Paper Series, Soc Sci Res Netw, December 1999.

Akhigbe A, Borde SF, Whyte AM: The source of gains to targets and their industry rivals: evi-dence based on terminated merger proposals, Financ Manage 29:101–118, Winter 2000.

Aktas H, de Bodt E, Roll R: Learning, hubris and corporate serial acquisitions, Working Paper, UCLA, 2007.

Alexander M, Campbell A, Gould M: Parenting advantage. In Prism, ed 2 Quarter, pp 23–33, 1995, Arthur D. Little, Inc.

Altman EI, Kishore VM: Almost everything you wanted to know about recoveries on defaulted bonds, Financ Anal J 52:57–64, December 1996.

Andersen Consulting: Global survey: acquistiion and allliance integration, 1999. http://www .ac.com/overiew

Andrade G, Mitchell ML, Stafford E: New evidence and perspecives on mergers, J Econ Perspect 15:103–120, 2001.

Ang J, Kohers N: The takeover market for privately held companies: the U.S. experience, Cambridge J Econ 25:723–748, 2001.

Ang JS, Cheng Y: Direct evidence on the market-driven acquisition theory, J Financ Res 29:199–216, 2006.

Asquith P, Mullins D, Wolff E: Original issue high yield bonds: aging analysis of defaults, exchanges and calls, J Financ 44:923–952, September 1989.

Asli AN, McInish TH, Wood RA: Merger announcements and trading, J Financ Res 25(2):263–278, Summer 2002.

Ayers BC, Lefanovicz CE, Robinson JR: Shareholder taxes in acquisition premiums: the effect of capital gains taxation, J Financ 58:2783–2801, 2003.

Bao J, Edmans A: How should acquirers select advisors? Persistence in investment bank performance, Working Paper, University of Pennsylvania, 2008.

Barber BM, Lyon JD: Detecting long-run abnormal stock returns: the empirical power and specification of test statistics, J Financ Econ 43:341–372, 1997.

Barkema HG, Schijven M: Towards unlocking the full potential of acquisitions: the role of organizational restructuring, Acad Manage J 34:594–611, 2008.

Bebchuk LA, Coates J, Subamaniam G: The powerful anti-takeover force of staggered boards: theory, evidence, and policy, Stanford Law Rev 54:887–951, 2002.

Bebchuk LA, Coates JC IV, Subramanian G: The powerful antitakeover force of staggered boards, Working Paper, Harvard Law School, and NBER, 2003.

Bebchuk LA, Cohen A, Ferrell A: What matters in corporate governance, Discussion Paper, No. 49, Harvard University Law School, 2005.

Bekier MM, Bogardus AJ, Oldham T: Why mergers fail, McKinsey Q 4:3, 2001. Berger PG, Ofek E: Diversification’s effect on firm value, J Financ Econ 37:39–65, January

1995. Best R, Hodges CW: Does information asymmetry explain the diversification discount?

J Financ Res 27:235–249, Summer 2004. Bhagat S, Dong M, Hirshleifer D, Noah R: Do tender offers create value? New methods

and evidence, J Financ Econ 76:3–60, April 2005. Billett MT, Xue H: The takeover deterrent effect of open market share repurchases, J Financ

62:1827–1851, 2007.

References254

Billett MT, King T-HD, Mauer DC: Bondholder wealth effects in mergers and acquisitions: new evidence from the 1980s and 1990s, J Financ 59:107–135, 2004.

Billett MT, Qian Y: Are overconfident managers born or made? Evidence of self-attribution bias from frequent acquirers, AFA 2006 Boston Meetings Paper. http://ssrn.com/abstract687534

Black BS: Shareholder activism and corporate governance in the United States. In Newman P, editor: The new palgrave dictionary of economics and the law, New York, 1998, Palgrave Macmillan.

Black EL, Carnes TA, Jandik T: The lon-term success of cross-border mergers and acaquisitions, Social Science Researh Network Electronic Paper Collection, December 2000. http//papers.ssrn.com/5013/delivery,crn/ssrn_id272782_010705100.pdf

Boston Consulting Group: The strategy development process, Boston, 1985, The Boston Consulting Group.

Boyle GW, Carer RB, Stover RD: Extraordinary anti-takeover provisions and insider ownership structure: the case of converting savings and loans, J Financ Quant Anal 33:291–304, 1998.

Bradley M, Desai A, Kim EH: Synergistic gains from corporate acquisitions and their divi-sion between the stockholders of target and acquiring firms, J Financ Econ 21:3, 1988.

Brav A, Jiang W, Partnoy F, Thomas R: Hedge fund activism, corporate governance, and firm performance, ECGI-Finance Working Paper 13912006, Duke University, 2006.

Brealey R, Myers S: Principles of corporate finance, ed 7, New York, 2003, McGraw-Hill, pp 229, 321.

Brickley JA, Coles JL, Jarrell G: Leadership structure: separating the CEO and chairman of the board, J Corp Financ 3:189–220, 1997.

Brouthers KD, van Hastenburg P, van den Ven J: If most mergers fail, why are they so popu-lar? Long Range Plann 31:347–353, 1998.

Business Week: The case against mergers, October 31, 1995, pp 122–125.Burch TR: Locking out rival bidders: the use of lockup options in corporate mergers,

J Financ Econ 60:103–141, 2001. Bygrave WD, Timmons JA: Venture capital at the crossroads, Boston, 1992, Harvard Business

School Press. Campa J, Simi K: Explaining the diversification discount, J Financ 57:135–160, 2002. Campbell A, Sadler D, Koch R: Breakup! When companies are worth more dead than alive,

Oxford, 1997, Capstone. Carey DC, Ogden D: The human side of M&A, 2004, Oxford University Press, p 164. Carlton D, Perloff J: Modern industrial organization, ed 3, New York, 1999, Addison Wesley

Longman, p 27. Chapman TL, Dempsey JJ, Ramsdell G, Bell TE: Purchasing’s big moment—after a merger,

McKinsey Q 1:56–65, 1998. Clifford C: Value creation or destruction: hedge funds as shareholder activists, Working Paper,

Arizona State University, 2007.Coates JC: Takeover defenses in the shadow of the pill: a critique of the scientific evidence,

Tex Law Rev 79:271–382, 2000. Comment R, Schwert GW: Poison or placebo: evidence on the deterrence and wealth

effects of modern anti-takeover measures, J Financ Econ 39:3–43, 1995. Coopers & Lybrand: Most acquisitions fail, C&L study says, Mergers & Acquisitions, Report

7, 47:2, November 1996.Cossey B: Systems assessment in acquired subsidiaries, Accountancy 16:98–99, January 1991. Cremers M, Nair V: Governance mechanisms and equity prices, J Financ 60:2859–2894,

2005. Dahya J, McConnell JJ: Outside directors and corporate board decisions: a natural experiment,

Working Paper, Purdue University, 2001.Dalton DR: CEO tenure, boards of directors, and acquisition performance, J Bus Res

60:331–338, 2006.

References 255

Daniel KD, Hirshleifer D, Subrahmanyam A: Investor psychology and security market under and over-reactions, J Financ 53:1839–1886, 1998.

Davis G, Kim H: Business ties and proxy voting by mutual funds, J Financ Econ 85:552–570, 2007.

DeAngelo H, DeAngelo L: Proxy contests and the governance of publicly held corporations, J Financ Econ 23:29–60, 1989.

DeAngelo H, Rice E: Anti-takeover charter amenments and stockholder wealth, J Financ Econ 11:329–360, 1983.

DeLong G: Does long-term performance of mergers match market expectations? Financ Manage 32:5–25, Summer 2003.

De Mdedt , Van Hoey M: Integrating steel giants: an interview with the ArcelorMittal post-merger managers, McKinsey Q, February 2008.

Deogun N, Lipin S: Big mergers in ’90s prove disappointing to shareholders, Salomon Smith Barney study quoted in Wall St J, October 30, 2000, p C12.

DePamphilis DM: Mergers, acquisitions, and other restructuring activities: an integrated approach to process, tools, cases, and solutions, ed 5, San Diego, 2009, Academic Press.

DePamphilis DM: Mergers and acquisitions basics: negotiations and deal structuring, San Diego, 2010, Academic Press.

DePamphilis DM: Managing through acquisition—time tested techniques for the entrepre-neur, Int J Entrep Innov 2:195–207, October 2001.

Deusen C, Williamson S, Babson HC: Business policy and strategy: the art of competition, ed 7, New York, 2007, Auerbach.

Dittmar A, Shivdasani A: Divestitures and divisional investment policies, J Financ 58:2711–2744, December 2003.

Dong M, Hirshleifer D, Richardson S, Teoh SH: Does investor misvaluation drive the take-over market? J Financ 61:725–762, April 2006.

Down JW: The M&A game is often won or lost after the deal, Manage Rev Exec Forum:10, November 1995.

Draper P, Paudyal K: Acquisitions: private versus public, Eur Financ Manage 12:57–80, 2006. Economic Report to the President, Washington D.C., February 2003, U.S. Government

Printing Office.Ellis C: Briefings from the editors, Harv Bus Rev 74:8, July/August 1996. Ertimur Y, Ferri F, Stubben S: Board of directors responsiveness to shareholders: evidence from share-

holder proposals, Working Paper, Harvard Business School, February 2008.Faleye O: Cash and corporate control, J Financ, October 2004. Fama EF, Jensen. MC: Separation of ownership and control, J Law Econ 26:301–325, 1983. Fama EF: Market efficiency, long-term returns, and behavioral finance, J Financ Econ

47:427–465, 1998. Farzad R: Fidelity’s divided loyalties, Bus Week:12, October 16, 2006. Fauver L, Houston J, Narango A: Capital market development, international integration,

and the value of corporate diversification: a cross-country analysis, J Financ Quant Anal 38:138–155, March 2003.

Federal Reserve Bulletin, Board of Governors, U.S. Federal Reserve System, December 2003, p 33.

Field LC, Karpoff JM: Takeover defenses of IPO firms, J Financ 57:1629–1666, 2002. Financial Times, April 12, 1996. Bugged by Failures, 8.Franks J, Mayer C: Hostile takeovers and the correction of managerial failure, J Financ Econ

40:163–181, 1996. Frick KA, Torres A: Learning from high tech deals, McKinsey Q 1:2, 2002. Fuller K, Netter J, Stegmoller MA: What do returns to acquiring firms tell us? Evidence

from firms that make many acquisitions, J Financ 57:1763–1793, 2002. Gaspara J-M, Matos P: Shareholder investment horizons and the market for corporate con-

trol, J Financ Econ 76:135–165, 2005.

References256

Gell J, Kengelbach J, Roos A: The return of the strategist: creating value with M&A in downturns, 2008, The Boston Consulting Group.

Ghosh A: Increasing market share as a rationale for corporate acquisitions, J Bus, Financ, Account 31:78–91, March 2004.

Ghosh A, Lee C-WJ: Abnormal returns and expected managerial performance of target firms, Financ Manage 29:40–52, Spring 2000.

Gillan S, Starks L: The evolution of shareholder activism in the United States, J Appl Corp Financ 19:55–73, 2007.

Gompers PA, Ishii J, Metrick A: An analysis of U.S. dual class companies, Rev Financ Stud 23:1051–1088, 2010.

Goyal VK, Park CW: Board leadership structure and CEO turnover, J Corp Financ 8:49–66, 2002.

Graham J, Lemmon M, Wolf J: Does diversification destroy firm value? J Financ 57:695–720, 2002.

Greenwood R, Schor M: Hedge fund investor activism and takeovers, J Financ Econ 92:362–375, 2009.

Grinblatt M, Titman S: Financial markets and corporate strategy, ed 2, New York, 2002, McGraw-Hill.

Groton C, Kahl M, Rosen R: Eat or be eaten: a theory of merger waves, Working Paper, University of Pennsylvania, 2007.

Gugler K, Mueller DC, Yurtoglu BB, Zulehner C: The effects of mergers: an international comparison, Int J Ind Organ 21:625–653, May 2003.

Guo S, Hotchkiss ES, Song W: Do buyouts (still) create value? March 21, 2008. Available at SSRN, http://ssrn.com/abstract1009281.

Gurung A, Lerner J: The global economic impact of private equity (vol 1), World Economic Forum and Harvard Business School, February 24, 2009.

Hackbarth D, Morellec E: Stock returns in mergers and acquisitions, J Financ 63:1213–1252, June 2008.

Harding D, Rovit S: Mastering the merger: four critical decisions that make or break the deal, Cambridge, MA, 2004, Harvard Business School Press.

Harford J: What drives merger waves, J Financ Econ 77:529–560, September 2005. Harford J: Corporate cash reserves and acquisitions, J Financ 54:1969–1997, 2005. Harrison JS, Oler D, Allen MR: Event studies and the importance of longer term measures in assess-

ing the performance outcomes of complex events, Working Paper, Indiana University, 2005.Henry D: A fair deal—but for whom, Bus Week:108–109, 2003. Hermalin BE: Trends in corporate governance, J Financ 60:2351–2384, October 2006. Heron R, Lie E: Operating performance and the method of payment in takeovers, J Financ

Quant Anal:137–155, 2002. Hill CWL, Jones GR: Strategic management: an integrated approach, ed 5, Boston, 2001,

Houghton-Mifflin, pp 158–233. Hotchkiss E, Qian J, Song W: Holdup, regegotiation, and deal protection in mergers, Working

Paper, Boston College, 2005.Houston J, James C, Ryngaert M: Where do merger gains come from? J Financ Econ:285–

331, May/June 2001. Hunger D, Wheeler TL: Concepts: strategic management and business policy, ed 11, Upper Saddle

River, NJ, 2007, Prentice Hall. Huson MR, Parrino R, Starks LT: Internal monitoring mechanism and CEO turnover: a

long-term perspective, J Financ 55:2265–2297, 2001. Hyland D: Why firms diversify: an empirical examination, Working Paper, University of Texas,

Arlington, 2001.Jarrell G, Poulsen AB: Shark repellents and stock prices: the effects of antitakeover amend-

ments since 1980, J Financ Econ 19:127–168, September 1987.

References 257

Jensen MC: Agency costs of overvalued equity, Financ Manage 34:5–19, Spring 2005. Jindra J, Walkling R: Arbitrage spreads and the market pricing of proposed acquisitions, Working

Paper, Ohio State University, 1999.Kaplan SM, Schoar A: Returns, persistence and capital flows, J Financ 60:1791–1823, 2005. Karolyi GA, Shannon J: Where’s the risk in risk arbitrage? Working Paper, Richard Ivey School

of Business, The University of Western Ontario, 1998.Karpoff JM: The impact of shareholder activism on target companies: a survey of empirical findings,

Working Paper, University of Washington, 2001.Karpoff JM, Malatesta PH: The wealth effects of second generation state takeover legislation,

J Financ Econ 25:291–322, 1989. Karpoff JM, Walkling RA: Corporate governance and shareholder initiatives: empirical evi-

dence, J Financ Econ 42:365–395, 1996. Kennedy K, Moore M: Going the distance: why some companies dominate and others fail, Upper

Saddle River, New Jersey, 2003, Prentice Hall, p 155. Kini I, Kracaw W, Mian S: The nature of discipline by corporate takeovers, J Financ 59:1511–

1552, August 2004. Klein KE: Urge to merge? Take care to beware, Bus Week:68, July 1, 2004. Klein A, Zur E: Entrepreneurial shareholder activism: hedge funds and other private inves-

tors, J Financ 64:187–230, 2009. Kretlow JR, McGuigan JR, Moyer C: Contemporary financial management, ed 7, Georgetown,

Tx, 1998, Southwestern Publishing. Lehn KM, Zhao M: CEO Turnover after acquisitions: are bad bidders fired? J Financ

61:1383–1412, August 2006. Linn SC, Switzer JA: Are cash acquisitions associated with better post combination operating

performance than stock acquisitions? J Bank Financ 25:1113–1138, June 2001. Linn SC, McConnell JJ: An empirical investigation of the impact of anti-takeover amend-

ments on common stock prices, J Financ Econ 11:361–399, 1983. Lins K, Servaes H: International evidence on the value of corporate diversification, J Financ

54:2215–2239, 1999. Lord MD, Ranft AL: Acquiring new knowledge: the role of retaining human capital in the

acquisition of high tech firms, J High Technol Manage Res 11:295–320, Autumn 2000. Luo Y: Do insiders learn from outsiders? Evidence from mergers and acquisitions, J Financ

60:1951–1982, August 2005. Lyon JD, Barber BM, Tsai C-L: Improved methods for tests of long-run abnormal stock

returns, J Financ 54:165–201, 1999. Maguire S, Phillips N: Citibankers at Citigroup: a study of the loss on institutional trust after

a merger, J Manage Stud 45:372–401, 2008. Maksimovic V, Phillips GM: The market for corporate assets: who engages in mergers and

asset sales and are there efficiency gains, J Financ 56:332–355, December 2001. Malatesta PH, Walkling RA: Poison pills securities: stockholder wealth, profitability and

ownership structure, J Financ Econ 20:347–376, January/March 1988. Malekzadeh AR, Nahavandi A: Making mergers work by managing cultures, J Bus Strat

11:55–57, May/June 1990. Mallea J: A review of mergers of equals, 2008. http://www.mergermetrics.com.Maquierira CP, Megginson WL, Nail LA: Wealth creation versus wealth redistributions in

pure stock-for-stock mergers, J Financ Econ 48:3–33, 1998. Marks ML: From turmoil to triumph: new life after mergers, acquisitions, and downsizing, Lanham,

MD, 1996, Lexington Books. Martynova M, Renneboog L: A century of corporate takeovers: what have we learned and

where do we stand? J Bank Financ 32:2148–2177, 2008. Masulis RW, Wang C, Xie F: Corporate governance and acquirer returns, J Financ 62:1851–

1890, 2007.

References258

McCarthy P: Legal aspects of acquiring U.S. enterprises. In BenDaniel DJ, Rosenbloom AH, editors: International M&A, joint ventures & beyond: doing the deal, New York, NY, 1998, Wiley & Sons, pp 27–57.

McKinsey & Company: Creating shareholder value through merger and/or acquisition: a McKinsey & Company perspective. An internal 1987 memorandum cited in Copeland T, Koller T, Murrin J: Valuation: measuring and managing the value of companies, New York, 1990, John Wiley & Sons, p 321.

McNamara G, Dykes BJ, Haleblian J: The performance implications of participating in an acquisition wave, Acad Manage J 51:113–130, 2008.

McWilliams VB: Tobin’s Q and the stock price effects of anti-takeover amendment propos-als, Financ Manage 22:16–18, 1993.

Megginson WL, Morgan A, Nail L: The determinants of positive long-term performance in strategic mergers: corporate focus and cash, J Bank Financ 25:1113–1138, 2003.

Mehran H, Peristiani S: Financial visibility and the decision to go private, Working Paper, Federal Reserve Bank of New York, April 2006.

Mercer Management Consulting: 1995 and 1997 surveys cited in Alexandra Reed Mergerstat LP, Dealmakers Hope for Better Days Ahead in 2002, January 2, 2002, Press Release. http://www.mergerstat.com.

Metrick A, Yasuda A: The economics of private equity funds, Working Paper, University of Pennsylvania Wharton School of Finance, September 15, 2007.

Mitchell ML, Mulherin JH: The impact of industry shocks on takeover and restructuring activity, J Financ Econ 41:193–229, 1996.

Mitchell ML, Pulvino TC: Characteristics of risk and return in arbitrage, J Financ 56:2135–2175, December 2001.

Mitchell M, Pulvino T, Stafford E: Price pressure around mergers, J Financ 59:31–63, February 2004.

Moeller SB, Schlingemann FP, Stulz RM: Firm size and the gains from acquisitions, J Financ Econ 73:201–228, 2004.

Moeller SB, Schlingemann FP, Stulz RM: Wealth destruction on a massive scale? A study of the acquiring firm returns in the recent merger wave, J Financ 60:757–782, April 2005.

Moeller SB, Schlingemann FP, Stulz RM: How do diversity of opinion and information asymmetry affect acquirer returns? Rev Financ Stud 20:2047–2078, 2007.

Morck R, Shleifer A, Vishny RW: Characteristics of targets of hostile and friendly take-overs. In Auerbach AJ, editor: Corporate takeovers: causes and consequences, Chicago, 1988, University of Chicago Press, pp 101–129.

Morellec E, Zhdanov A: Financing and takeovers, J Financ Econ 87:556–581, March 2008. Mulherin JH, Boone AL: Comparing acquisitions and divestitures, Working Paper Series, Soc

Sci Res Netw:38, April 19, 2000. Mulherin JH, Poulsen AB: Proxy contests and corporate change: implications for share-

holder wealth, J Financ Econ 47:279–313, 1998. Officer MS: Termination fees in mergers and acquisitions, J Financ Econ 69:431–467, 2003. Palepu KG, Healy PM, Bernard VL: Business analysis and valuation, ed 3, Mason, OH, 2004,

Thomson Southwestern. Palter RN, Srinivasan D: Habits of the busiest acquirers, McKinsey Q, July 2006. Pinkowitz L: The market for corporate control and corporate cash holdings, Working Paper,

Georgetown University, 2002.Porter R, Wood CN: Post-merger integration. In BenDaniel DJ, Rosenbloom AH, edi-

tors: International M&A: joint ventures and beyond, New York, 1998, John Wiley & Sons, pp 459–497.

Porter ME: Competitive advantage, New York, 1985, The Free Press. Rau PR, Vermaelen T: Glamour, value, and the post-acquisition performance of acquiring

firms, J Financ Econ 49:223–253, August, 1998.

References 259

Renneboog L, Szilagyi P: Corporate restructuring and bondholder wealth, Eur Financ Manage 14:792–819, 2007.

Renneboog L, Szilagyi P: How do mergers and acquisitions affect bondholders in Europe? Evidence on the impact and spillover of governance and legal standards, Working Paper 125, ECGI Finance, 2006.

Rhodes-Kropf M, Viswanathan S: Market valuation and merger waves, J Financ 59:2685–2718, 2004.

Roll R: The hubris hypothesis of corporate takeovers, J Bus 59:197–216, 1986. Romano R: Competition for corporate charters and the lesson of takeover statutes, Fordham

Law Rev 61:843–864, 1993. Romano R: Less is more: making institutional investor activism a valuable mechanism of

corporate governance, Yale J Regul 18:174–251.Rossi S, Volpin PF: Cross-country deteminants of mergers and acquisitions, Working Paper No.

25/2003, AFA 2004 San Diego Meetings, ECGI-finance, September 2004.Ryngaert M: The effects of poison pill securities on stockholder wealth, J Financ Econ

20:377–417, January/March 1988. Sanderson S, Uzumeri M: The innovative imperative: strategies for managing products, models, and

families, Burr Ridge, IL, 1997, Irwin Professional Publishing. Savor PG, Lu Q: Do stock mergers create value for acquirers? J Financ 64:1061–1097,

2009. Schumpeter JA: Capitalism, socialism, and democracy, New York, NY, 2008, Harper’s Perennial

Modern Classics. Schwert GW: Hostility in takeovers: in the eyes of the bidder? J Financ 55:2599–2640,

2000. Selim G: Mergers, acquisitions, and divestiturres: control and audit best practices, New York, 2003,

Institute of Internal Auditing Research Foundation. Shahrur H: Industry structure and horizontal takeovers: analysis of wealth effects on rivals,

suppliers, and corporate customers, J Financ Econ 76:61–98, April 2005. Sherman A: Mergers and acquisitions from A to Z: strategic and practical guidance for small- and

middle-market buyers and sellers, ed 2, New York, 2006, AMACOM. Shin H-H, Stulz R: Are internal capital markets efficient?, Q J Econ 113:531–552, 1998. Shivdasani A: Board composition, ownership structure, and hostile takeovers, J Account Econ

16:167–198, 1993. Shleifer A, Vishny RW: Stock market driven acquisitions, J Financ Econ 70:295–311, 2003. Singh H, Montgomery C: Corporate acquisition strategies and economic performance,

Strategic Manage J 8:377–386, 2008. Song HH, Walking RA: Abnormal returns to rivals of acquisitions targets: a test of the

acquisition probability hypothesis, J Financ Econ 55:439–457, 2000. Stout LA: Do antitakeover defenses decrease shareholder wealth? The ex post/ex ante valu-

ation problem, Stanford Law Rev 55:845–861, December 2002. Stefanini F: Investment strategies of hedge funds, New York, 2006, John Wiley & Sons. Stryker SC: Plan to succeed: a guide to strategic planning, Princeton, NJ, 1986, Petrocelli Books. Sullivan MJ, Jensen MRH, Hudson CD: The role of medium of exchange in merger offers:

examination of terminated merger proposals, Financ Manage 23:51–62, 1994. Sweeney P: Who says it’s a fair deal? J Accountancy 188:6–10, 1999. The Deal, February 6–10, 2006.The Economist, A survey of the world economy, September 16, 2006, p 12.Thompson SC: Business planning for mergers and acquisitions, Charlotte, NC, 2007, Carolina Press. Tillinghast DR: Tax aspects of inbound merger and acquisitions and joint venture transac-

tions. In BenDaniel DJ, Rosenbloom AH, editors: International M&A, joint ventures and beyond: doing the deal, New York, 1998, John Wiley & Sons, pp 151–180.

Uhlaner RT, West AS: Running a winning M&A shop, McKinsey Q, 2008.

References260

Uysal V: Deviation from the target capital structure and acquisition choices, Working Paper, University of Oklahoma, 2006.

Vachon M: Venture capital reborn, Venture Cap J:32, January 1993. Villalonga B: Diversification discount or premium? New evidence from the business infor-

mation tracking series, J Financ 59:479–506, April 2004. Wall St J, When things go wrong, November 18, 1996, p R–25.Walsh JP: Doing a deal: merger and acquisition negotiations and their impact upon target

company top management turnover, Strategic Manage J 10:307–322, July/August 1989. Walsh JP, Ellwood JW: Mergers, acquisitions, and the pruning of managerial deadwood,

Strategic Manage J 12:201–217, March 1991. Wasserstein B: Big deal: the battle for control of America’s leading corporations, New York, 1998,

Warner Books, pp 601–644. Wigmore B: The decline in credit quality of junk bond issues, 1980-1988. In Gaughan PS,

editor: Readings in mergers and acquisitions, Cambridge, UK, 1994, Basil Blackwell, pp 171–184.

Wiltbank R, Boeker W: Returns to angel investors in groups, SSRN, Kansas City, MO, November 2007, Ewing Marion Kauffman Foundation.

Wulf J: Do CEOs in mergers trade power for premium? Evidence from mergers of equals, J Law Organ 20:60, 2004.

Wulf J, Rajan R: The flattening firm: evidence from panel data on the changing nature of corporate hierarchies, Working Paper, University of Chicago, 2003.

Yago G, Bonds J: How high yield securities restructured corporate America, New York, 1991, Oxford University Press.

Zellner W: This big oil deal shouldn’t hurt a bit, Bus Week:42, May 9, 2005. Zola M, Meier D: What is M&A performance? Acad Manage Perspect 22:55–77, 2008.

261

AAbex Inc., 192Abnormal returns, 34, 35, 38, 40, 41,

90–91acquirer and financial returns, size of, 38cash deals and equity-financed deals,

39–40private/subsidiary targets, 38–39target size, role of, 39

Accountants, roles and responsibilities of, 102

Accounting-related growth objectives, 137Acquirer experience, 41Acquirer returns, 38–40Acquisition, occurrence of, 15–16Acquisition premium. See Purchase

premiumAcquisition process, 125

planning and decision making, 125–126pre- and postpurchase decision activities,

126–127process flow diagram, 126

Acquisition vehicle, 175Activist investors, 109

hedge funds and private equity firms, 111–112

mutual funds and pension funds, 109–111

Advance notice provisions, 83advantages and disadvantages, 80

Affirmative covenant, 198Agency problems, 10Agreement of purchase and sale, 183

closing conditions, 185–186closing documents, 186–187covenants, 185deal provisions, 184indemnification, 186liabilities, assumption of, 185merger agreements, 186payment mechanism, 184–185price, 184

allocation, 184representations and warranties, 185

Alternative capital structures, risk factors of, 202–203

Amazon.com, 132, 135Americans with Disabilities Act, 120American Tobacco, 24America Online, 15, 161, 225, 230Ameritech, 14Angel investors, 109Anheuser-Busch, 90, 193Antigreenmail provisions, 83

advantages and disadvantages, 80Antitakeover defenses, 53Antitrust laws, 118Arbitrageurs (arbs), 56–57, 112–113Arcelor, 70–72, 238–241Articles of incorporation, 78Asset-based lending, 196

loan documentation, 196–197pledging equipment and real estate,

197–198pledging receivables and inventory, 197

Asset swaps, 143AT&T, 46, 132

BBack end merger, 61Backward integration, 15Balance sheet assumptions, 211BankAmerica, 14Bank lending, 28Bank of America, 99, 123Bayer AG, 88Bear hug, 56–57, 69Bear Stearns, 99Beecham Group PLC, 26BellSouth, 46Berkshire Hathaway, 19Bewkes, Jeffrey, 240Bidder returns, 36, 41Bidding strategy, developing, 66–70Blackstone Outmaneuvers Vornado, 120–122Board of directors/management, 51Boise Cascade, 15Bondholder pay-offs, 42

Index

Index262

Bondholders, 93–94Bond ratings, 200Book value, 10Borrowing, 195

alternative capital structures, risk factors of, 202–203

asset-based/secured lending, 196–198cash-flow/unsecured lenders, 198–199junk bonds, 201leveraged bank loans, 201–202long-term financing, 199–200“road show”, 202security provisions and protective

covenants, 198Breakup fee, 65, 179Bridge financing, 199British Petroleum Corporation, 26, 143Broadband technology, 8Business alliance, 18, 44–47Business combinations, 14Business-level strategies, 125, 138

focus/niche strategies, 140–141hybrid strategies, 141price/cost leadership, 138–140product differentiation, 140

Business plan, 123and acquisition plan, 169acquisition process, 125–127business-level strategies, 138

focus/niche strategies, 140–141hybrid strategies, 141price/cost leadership, 138–140product differentiation, 140

business strategy, selecting, 128as communication document, 145–148corporate-level strategies, 137–138external analysis, 127, 128–134functional strategies, 128, 143–145implementation strategies, 128, 141intangible factors, role of, 142–143internal analysis, 127, 134–136mission statement, 128, 136–137objectives, setting, 128planning-based approach, 124–125strategic controls, 128, 145

Business strategy, 124, 125Business unit-level business plan, key

features of, 146–147

Buyback plans, 89Buyer due diligence, 177

CCampeau Corporation of Canada, 26Capital availability, 24Capital-to-asset ratios, 28Carnegie Steel, 24Cash-flow lenders, 198–199Cash-for-share exchange, 75Causes of mergers and acquisitions, theories

of, 3Celler-Kefauver Act of 1950, 119Certificate of incorporation, 78Change agents, mergers and acquisitions

as, 2Chrysler, 14Cingular, 46Cisco, 15Citibank, 14Citicorp, 237Citicorp–Travelers merger, 8Citigroup, 5, 14, 108, 143Classified board election, 78Clayton Antitrust Act, 118, 119Closing phase, of acquisition process, 182

agreement, 183closing conditions, 185–186closing documents, 186–187covenants, 185deal provisions, 184indemnification, 186liabilities, assumption of, 185merger agreements, 186payment mechanism, 184–185price, 184price allocation, 184representations and warranties, 185

approvals, gaining, 183complexity, 187–188customer and vendor contracts, assigning,

183financing contingencies, 187

Coca-Cola, 141Commercial banks, 8, 103–104Communication plans, developing, 223

for communities, 225for customers, 224

Index 263

for employees, 223–224for investors, 224–225for suppliers, 224

Communities, developing communication plans for, 225

Compensation plan, 52, 228–229Competition

degree of competition, determining, 129–134

intensity of industry competition, determinants of, 130–133

location, determination of, 129market/industry competitive dynamics,

131Conglomerate discount, 7Conglomerate era, M&A waves in, 25Conglomerate merger, 14–15Conglomerates, 7Consent solicitation, 82Contacting selected target, in acquisition

plan, 161first contact, 161–163

large companies, 162–163medium-size companies, 162small companies, 162

preliminary legal documents, 163confidentiality agreement, 163–164letter of intent (LOI), 164–166term sheet, 164

value discussion, 163Contingency plans, 125Contingent value rights (CVRs), 192Control premium, 16Convertible debt and debentures, 199–200Corporate bylaws, 78Corporate charter, 78Corporate culture

building, 235–238and values, 53

Corporate governance, 49control model, 51definition, 49factors affecting, 50factors external to the firm, 53

institutional activists, 54legislation and the legal system,

53–54regulators, 54

internal factors affecting, 51antitakeover defenses, 53board of directors/management, 51corporate culture and values, 53internal controls and incentive systems,

52–53M&A in, 54–55market model, 51

Corporate-level strategies, 124, 137–138Corporate restructuring, 2, 89–90

advantages and disadvantages, 87Corporate restructuring, alternative forms

of, 13, 17acquisition, 15–16divestiture, 15–16equity carve-out, 15–16leveraged buyout (LBO), 16mergers and consolidations, 13

economic perspective, 14–15legal perspective, 13–14

spinoff, 15–16Corporate takeover markets, 49

alternative takeover tactics, 68advantages and disadvantages, 69

friendly approach in, 55–56hostile approach. See Hostile takeovers

Corporate takeovers, 49Corporate value chain, 15Cost leadership, 138–140“Creative destruction”, 45Creeping takeover strategy, 62Crestbrook Forest Products, Ltd., 192Cross-border deals, in retrenchment era,

26Cross-default provisions, 198Cultural compatibility between acquirer

and target, 160–161Cumulative voting rights, 82Customer and vendor contracts, assigning,

183Customers, developing communication

plans for, 224

dDaimler-Benz, 14DaimlerChrysler, 14Deal breakers, 189Debentures, 199–200

Index264

Debt financed 2003–2007 M&A boom, 28Decision making, 125–126Defensive acquisition, 90Defensive strategy, 137–138Degree of leverage, 160Department of Justice (DoJ), 118–119Digital camera technology, 8–9Discretionary assets, selling, 207–209Distributed payments, 192Diversification, 6

discount, 6–7objectives, 137–138

Divestiture, 15–16Divisional organizations, 226Dollar value of transactions, 28–29

U.S. versus global M&A, 30Dow Jones, 15Dual class recapitalization, 84Due diligence, 176

buyer, 177components, 177lender, 179seller, 177–179

Dun & Bradstreet, 158

eEarnings per share (EPS), 155, 195Earnouts, 181, 182, 191Eastman Kodak, 24eBay, 9Eckerd Drugstore, 6Economies of scale, 4Economies of scope, 4, 5Employees, developing communication

plans for, 223–224Employee stock ownership plans (ESOPs),

86, 88advantages and disadvantages, 87

Equipment, pledging and real estate to support term loans, 197–198

Equity and hybrid securities, 203Equity carve-out, 16Equity offers, 40Equity Office Properties (EOP), 120–122Equity overvaluation, 40Escape clauses, 83Exchange offer, 60

External analysis, 127, 128competition

degree of competition, determining, 129–134

location of, 129Exxon, 14

FFailure to meet expectations, 43

defining, 43overestimating synergies, 44overpaying, 43–44slow integration, 44

Fair price provisions, 84advantages and disadvantages, 80

Family and Medical Leave Act, 120Federal Trade Commission (FTC), 118–119Federated Department Stores, 26Finance, integration of, 232–233Financial buyer, 205–206, 215Financial objectives, in acquisition plan, 152Financial restructuring, 13, 138Financial risk, 155Financial Services Modernization Act of

1999, 8Financial synergy, 5Financing transactions, 195

alternative financing structures, 209appropriate capital, selecting, 210–211market assumptions, 211–212

borrowing, 195alternative capital structures, risk

factors of, 202–203asset-based/secured lending, 196–198cash-flow/unsecured lenders, 198–199junk bonds, 201leveraged bank loans, 201–202long-term financing, 199–200“road show”, 202security provisions and protective

covenants, 198discretionary assets, selling, 207–209equity and hybrid securities, 203highly leveraged transactions, 205–207seller financing, 204–205

First contact, with target company, 161large companies, 162–163

Index 265

medium-size companies, 162small companies, 162

“Five Forces” framework, 130Fixed costs, 4Flexibility objectives, 137Flip-in poison pill, 75–76, 77

advantages and disadvantages, 79Flip-over poison pill, 75, 77

advantages and disadvantages, 79Float, 64Focus strategies, 141“For cause” provision, 82Form of acquisition, 175Form of payment, 175Fortune 500, 2Forward integration, 15Franchise, 19Friendly takeovers, 55, 66

versus hostile takeovers, 16–18Functional integration, 230

due diligence data revalidation, 230finance, 232–233human resources, 235information technology, 232manufacturing operations, 231–232marketing, 233–234performance, benchmarking, 230–231purchasing, 234research and development, 234–235sales, 233

Functional organization, 226Functional strategies, 125, 128, 143–145

GGazprom, 143General Electric, 6, 24Generally Accepted Accounting Principles

(GAAP), 102, 174, 181Genesco, 187Getty Oil, 41Gillette, 14Global exposure, 134“Going private”, 90, 206Golden parachutes, 85

advantages and disadvantages, 79Goldman Sachs, 19, 99Google, 15, 191

Greenmail, 83, 86advantages and disadvantages, 87

Guidant Corporation, 6

HHart–Scott–Rodino Antitrust

Improvements Act (HSR), 119Hedge funds, 111–112

and private equity funds, 105–108Highly leveraged transaction, 16, 205–207Honda, 5Horizontal consolidation, 24, 32Horizontal merger, 14Hostile takeovers, 18, 56

aggressive approach, 63–64bear hug, 56–57hostile tender offer, 18

advantages, 63implementation, 60–61legal filings in, 62multitiered offers, 61–62post-tender offer, 62–63pre-tender offer tactics, 59–60

proxy contests, 57impact on shareholder value, 59implementation, 58legal filings in, 58

Hubris, 9Human resources, integrating, 235Hybrid strategies, 141Hypothetical SWOT analysis, for Amazon.

com, 135

IImplementation strategy, 125, 128, 141, 142,

144–145InBev, 90, 193–194Incentive systems, 52–53, 145Income statement assumptions, 211Indentures, 200Industry competition, intensity of,

130–133Industry shocks, 24Information technology, integrating, 232Initial public offering (IPO), 101

and takeover defenses, 93Institutional activism, 54, 109

Index266

Institutional investors and lenders, 103angel investors, 109commercial banks, 103–104hedge and private equity funds, 105–108insurance companies, 104mutual funds, 104–105pension funds, 104sovereign wealth funds (SWFs), 108venture capital firms, 108–109

Insurance companies, 104Intangible factors, role of, 142–143Integration manager, choosing, 182Integration planning phase, 179

earning trust, 181earnouts, 182

integration manager, choosing, 182Internal analysis, 127, 134–136Internet value chain, 15Inventories, 197

pledging, 197Investment banks, roles and responsibilities

of, 99–101Investors, developing communication plans

for, 224–225

JJCPenney, 6Johnson & Johnson, 6Joint venture (JV), 18–19, 143J. P. Morgan, 24, 187JPMorgan Chase, 99Junior and senior debt, 200Junk bonds, 201

KK2 Incorporated, 167

external analysis, 167–168internal analysis, 168

Key players, in mergers and acquisitions, 99activist investors, 109

activist investors, 112hedge funds and private equity firms,

111–112mutual funds and pension funds,

109–111institutional investors and lenders, 103

angel investors, 109

commercial banks, 103–104hedge and private equity funds,

105–108insurance companies, 104mutual funds, 104–105pension funds, 104sovereign wealth funds (SWFs), 108venture capital firms, 108–109

M&A arbitrageurs, 112–114regulators, 114

Federal Trade Commission and Department of Justice, 118–119

Securities and Exchange Commission, 117–118

specialized services providers, 99accountants, 102investment banks, 99–101lawyers, 101–102proxy solicitors, 102public relations firms, 103

Kohlberg, Kravis & Roberts (KKR), 26

LLawyers, roles and responsibilities of,

101–102Legal form of the selling entity, 175Legislation and legal system, 53–54Lehman Brothers, 99, 187Lehman formula, 159Lender due diligence, 179Letter of intent (LOI), 65Leverage, rebirth of, 27–29Leveraged bank loans, 201–202Leveraged buyout (LBO), 16

capital structure, 208transactions, 197, 205–206

Leveraged recapitalization, 88Liberty Media, 240License, 19Liquidating dividend, 90Litigation, 67, 90

advantages and disadvantages, 69, 87Loan agreement, 196Loan documentation, 196–197London Interbank Rate (LIBOR), 201Long-term financing, 199

bond ratings, 200

Index 267

convertible debt and debentures, 199–200

indentures, 200senior and junior debt, 200

Long-term performance, 44–47Louisiana Teachers Retirement System, 110

MM&A waves, 23

acquirer experience, 41acquirer returns, varying of, 38–40bidder returns, 41bondholder pay-offs, 42determinants of, 23

conglomerate era, 25horizontal consolidation, 24increasing concentration, 25rebirth of leverage, 27–29retrenchment era, 25–26strategic mega-merger, age of, 27

importance, 31pay off

for shareholders, 31–43for society, 42–43

postmerger returns to shareholders, 37–38

premerger returns to shareholders, 34–37reasons for, 23–29similarities and differences among,

29–31, 32–33MacAndrews & Forbes, 192Management buyout (MBO), 206Management entrenchment index, 92Management entrenchment theory, 55Management integration team (MIT),

221–222responsibilities, 222

Managerialism theory, 11Manufacturing operations, integrating,

231–232Market assumptions, 211Market/industry competitive dynamics, 131Marketing, integrating, 233–234Market power, 12Market segment, 159–160Market share, in targeted industry, 160Mars Corporation, 20–21

Materials ordering, 231McDonald’s, 141MCI, 46, 94–97Merger/acquisition plan, 125Merger of equals, 14Mergers and consolidations, 13

economic perspective, 14–15legal perspective, 13–14

Merrill Lynch, 99, 108, 231Mezzanine financing, 199Minority investment, 19Mismanagement, 10Mission statement, defining, 136

strategic/long-term business objectives, setting, 136–137

Misvaluation, 12, 24Mittal and Steel Giants Arcelor, integrating,

238–241Mittal Steel Co., 70, 140Mobil, 14Monitoring systems, 145Morgan Stanley, 99, 108, 187Multitiered tender offers, 61–62Mutual funds, 104–105, 109–111

nNationsBank, 14Negative covenant, 198Negotiation phase, 173, 188–190

deal structuring, 174–176due diligence, 176–179

buyer, 177components, 177lender, 179seller, 177–179

financing plan, developing, 179valuation, refining, 174

Nestle, 192New corporate culture, building, 235

cultural differences, overcoming, 237–238

cultural profiling, 236–237New entrants, potential for, 132New organization, creating, 225

staffing plans development, 227–230structure establishment, 225–227

News Corp., 76

Index268

New York Stock Exchange (NYSE), 53–54Niche strategies, 140–141Nokia

business strategy of, 148–149implementation strategy, 149vision for future, 148

Nonfinancial objectives, in acquisition plan, 152

No-shop agreement, 65, 164Novartis, 192NT operating systems, 5

OOfficeMax, 15Old Mutual PLC, 113One-tier offer, 61Open market purchase, 18, 59–60, 69Operating risk, 155Operating synergy, 4–5Operational restructuring, 13, 137–138Oracle, 14Order entry, 231Overestimating synergies, 44Overpayment, 16, 43–44

risk, 155–156Over-the-Counter (OTC) Market, 117Overvalued shares, 12Owner carry back. See Seller financingOwner financing. See Seller financing

PPayoffs for society, 42–43Pennzoil, 41Pension funds, 104, 109–111PeopleSoft, 14Permanent financing, 202Pfizer, 6, 65Planning-based approach, to mergers and

acquisitions, 124business strategy, 124–125implementation stage, 125planning stage, 124

Planning process, of acquisition, 151for acquiring firm, 166–167and business plan, 153–154contacting selected target, 161

first contact, 161–163preliminary legal documents, 163–166

value discussion, 163pretarget selection, 152

initial search results screening, 159–161

management preferences, 156objectives, 152–153potential acquisition targets, searching

for, 156–159resource/capability evaluation, 154–156timetable, 156

steps, 152Poison pills, 75

acquirer shareholder dilution due to, 77advantages and disadvantages, 79

Postmerger integration, 215communication plans, developing, 223

for communities, 225for customers, 224for employees, 223–224for investors, 224–225for suppliers, 224

functional integration, 230due diligence data revalidation, 230finance, 232–233human resources, 235information technology, 232manufacturing operations, 231–232marketing, 233–234performance, benchmarking, 230–231purchasing, 234research and development, 234–235sales, 233

new corporate culture, building, 235cultural differences, overcoming,

237–238cultural profiling, 236–237

new organization, creating, 225staffing plans development, 227–230structure establishment, 225–227

organization, 221composition and responsibilities,

221–223premerger integration planning, 218–223rapid integration, 215

acquisition-related customer attrition, 217

employee turnover, impact of, 216–217

Index 269

as a process, 218, 219–220realizing projected financial returns,

216Postmerger returns to shareholders, 37–38Postoffer takeover defenses, 74

advantages and disadvantages, 87corporate restructuring, 89–90employee stock ownership plans

(ESOPs), 88greenmail, 86litigation, 90share repurchase or buyback plans, 89white knights, 86–88

Potential acquisition targets, searching for, 156–159

Preliminary legal documentsconfidentiality agreement, 163–164letter of intent (LOI), 164–166term sheet, 164

Premcor Inc., 10Premerger integration planning, 218–223Premerger returns to shareholders, 34–37Pre-offer takeover defenses, 73

advantages and disadvantages, 79antigreenmail provisions, 83fair price provisions, 84golden parachutes, 85poison pills, 75–78reincorporation, 85shark repellents, 78–83supervoting stock, 84–85

Present value, 16Pretarget selection, in acquisition plan, 152

initial search results screening, 159–161management preferences, 156plan objectives, 152–153potential acquisition targets, searching

for, 156cultural compatibility, 160–161degree of leverage, 160market segment, 159–160market share, 160product line, 160profitability, 160

resource/capability evaluation, 154–156timetable, 156

Pretender offer tactics, 59–60Price gap, closing, 190–193

Price leadership, 138–140Price-to-earnings (P/E) ratios, 25Private equity firms, 111–112Private equity funds, 105–108Private firms/subsidiaries, returns for,

38–39Private solicitation, 209Procter & Gamble, 5, 14Product differentiation, 140Production planning, 231Product life cycle, 139Product line, 160Product–market matrix, 6Product/service organization, 226Profitability, 160Profits and cash flow, determinants of,

133–134Promissory note, 197Protective covenants, in loan documents,

198Proxy contest, 55, 57, 69

impact on shareholder value, 59implementation, 58legal filings in, 58

Proxy solicitors, roles and responsibilities of, 102

Proxy statements, 58Public Company Accounting Oversight

Board, 53–54Public relations firms, roles and

responsibilities of, 103Public solicitation, 209Purchase premium, 16Purchasing, integration of, 234Pure control premium, 18

QQ-ratio, 9–10Quality control, 231

RRapid integration, 215

acquisition-related customer attrition, 217

employee turnover, 216–217as a process, 218, 219–220realizing projected financial returns,

216

Index270

Real estate, pledging, 197–198Reasons for mergers and acquisitions, 3

diversification, 6–7hubris and “winner’s curse”, 9managerialism, 11market power, 12mismanagement, 10misvaluation, 12strategic realignment, 7

regulatory change, 7–8technological change, 8–9

synergy, 4financial, 5operating, 4–5

tax considerations, 11theories, 3undervalued assets, buying, 9–10

Rebirth of leverage, 27–29Recapitalization

advantages and disadvantages, 87dual class, 84leveraged, 88

Receivables, pledging, 197Reddy Ice Holdings, 187Regulators, 114

Federal Trade Commission and Department of Justice, 118–119

Securities and Exchange Commission, 117–118

Regulatory compliance, 134Reincorporation, 85Research and development, integrating,

234–235Retention bonuses, 145Retrenchment era, 25–26Reverse breakup fee, 65RJR Nabisco, 26“Road show”, 202Roche Holdings, 202Royal Dutch Shell, 143

SSales, integrating, 233Sarbanes–Oxley Act, 53–54Satellite radio, 9SBC Communications, 14, 46Schering AG, 88

Secured debt, 199Securities Act of 1933, 117Securities and Exchange Commission

(SEC), 53–54, 58, 100–101, 117–118

Securities Exchange Act of 1934, 117Security agreement, 196–197Security provisions, in loan documents, 198Self-tender offers, 18Seller due diligence, 177–179Seller financing, 193, 204–205Senior and junior debt, 200“Shadow poison pill”, 75Share buy back plans

advantages and disadvantages, 87Share-for-share exchange, 75–76Shareholder interest’s theory, 55Shareholder value

and takeover defences, 92–93increasing, 18–21

Share repurchase, 89Shark repellents, 78–83

advantages and disadvantages, 79Sherman Antitrust Act, 118Shocks

in operating environments, 23–24Short form merger, 13Siebel Systems Inc., 110Skandia AB, 113Skype Technologies, 9SmithKline Beckman Corporation, 26Society, pay-offs for, 42–43Solo ventures, 44–47, 142Sovereign wealth funds (SWFs), 108Specialized services providers, 99

accountants, 102investment banks, 99–101lawyers, 101–102proxy solicitors, 102public relations firms, 103

Spinoff, 15–16Sprint and Nextel Communications, 46Sprint Corp., 110Staffing plans development, 227

and timetable, 228compensation, 228–229employee availability, 228

Index 271

personnel information systems, 229–230personnel requirements, 227

Staged payouts. See Distributed paymentsStaggered board election, 78Stakeholders, 124Standard & Poor’s Corporation, 200Standard Oil Corporation, 24, 26Standstill agreement, 55–56, 86

advantages and disadvantages, 87Statutory consolidation, 13Statutory merger, 13Steel Giants Arcelor and Mittal, challenges

of integrating, 238–241Stock financing, 40Stock lockup, 66“Stock watch” programs, 73Strategic alliance, 19Strategic buyers, 215Strategic/long-term business objectives,

setting, 136–137Strategic mega-merger, age of, 27Strategic realignment theory, 7

regulatory change, 7–8technological change, 8–9

Strategy implementation. See Implementation strategy

Subsidiary merger, 13Substitute products and services, potential

for, 132SunGard Data Systems Inc., 212Sunrise oil sands field, 143Super-majority rules, 83Supervoting stock, 84–85Suppliers, developing communication plans

for, 224SWOT analysis, 127, 135Symbian, 148Synergy, 4

assumptions, 211–212financial, 5operating, 4–5

TTakeover defenses, 73

and bondholders, 93–94experience, 91–92and initial public offerings, 93

postoffer defensescorporate restructuring, 89–90employee stock ownership plans

(ESOPs), 88greenmail, 86litigation, 90share repurchase or buyback plans, 89white knights, 86–88

pre-offer defenses, 73antigreenmail provisions, 83fair price provisions, 84golden parachutes, 85poison pills, 75–78reincorporation, 85shark repellents, 78–83supervoting stock, 84–85

and shareholder value, 92–93Takeovers of U.S. companies, by foreign

firms, 25–26Takeover strategy, developing, 66–70Target stock purchasing, in open market,

59–60Tax considerations, 11, 175–176Tax Reform Act of 1986, 85Technological change, 8–9Technology objectives, 137Telecommunications Act of 1996, 8Telecommunications industry, consolidation

in, 45–47Tembec. Inc., 192Tender offer, 18

advantages and disadvantages, 69Termination fee, 65Texaco, 41TIAA–CREF, 110Time Warner, 15, 161, 225Travelers, 14, 237Trends in mergers and acquisitions activity,

28Trust, earning, 181–182Turnaround strategy, 137–138Two-tiered offer, 61

UUBS, 108, 187Undervalued assets, buying, 9–10Unfriendly takeover, 18

Index272

UNIX, 5Unsecured lenders, 198–199Unsuccessful bids, 34–36U.S. historical merger waves, 32–33

conglomerate era, 25horizontal consolidation, 24increasing concentration, 25rebirth of leverage, 27–29retrenchment era, 25–26strategic mega-merger, age of, 27

U.S. merger and acquisition price spreads, 114

U.S. Steel, 24U.S. tax code, 52U.S. versus global M&A, 30

VValero Energy Corp., 10Valuation assumptions, 212Valuation-related growth objectives, 137Variable costs, 4–5Venture capital, 195Venture capital firms, 108–109Verizon, 46, 94–97, 132

Vertical mergers, 15Viacom, 240Vonage, 46

WWallace Act (1967), 119Wallace Act prenotification period (1967),

91Wall Street Journal, 158White knights, 86–88

advantages and disadvantages, 87White squires, advantages and disadvantages,

87Williams Act, 117–118“Win–lose” approach, 189–190Winner’s curse, 9Worker Adjustment and Retraining

Notification Act (WARN), 120Work stoppages, 133Wrigley Corporation, 20–21Wyeth, 65

YYahoo, 15