Key Definitions in M&A PDF

KEY DEFINITION IN M&A Session 4 Rachele Anconetani Disclaimer Slides with the indication “Food for Thoughts” are not mandatory for the exam. 2 1 Key Definitions in M&A ...

KEY DEFINITION IN M&A Session 4 Rachele Anconetani Disclaimer Slides with the indication “Food for Thoughts” are not mandatory for the exam. 2 1 Key Definitions in M&A  Key Definitions in M&A M&A in the context of corporate restructuring (not intended in a negative way!) Workforce Corporate restructuring is often broken in reduction/ realignment two categories: Joint venture/ Operational restructuring, which entails Operational Strategic alliance changes in the composition of a firm’s Restructuring Merger asset structure (e.g., business Divestiture, spin- off or carve-out combinations, sale, spin-off, downsizing, Friendly Consolidation etc.). takeover Takeover or Corporate buyout Financial restructuring, which describes Restru-cturing Hostile Takeover Acquisition changes in a firm’s capital structure (e.g., Leveraged/ management share repurchases). buyout Financial Reorganization/ Restructuring liquidation Stock buyback 4 Source: Author’s elaboration.  Key Definitions in M&A Mergers and consolidations – overview Before Merger/Consolidation A merger is a combination of two or more firms, often comparable in size, in which all but one ceases to exist legally. X Y W Z A consolidation is a combination of two or A B more firms, which are joining to form a new company. After Merger/Consolidation X Y W Z A (Including B) | C = A + B Shareholder Approval 5 Source: Author’s elaboration.  Key Definitions in M&A Acquisitions, stock sale vs asset sale (1/3). Before stock sale Before asset acquisition One firm buys another assets or shares. Unlike a merger, acquisition can occur at any share control percentage and X Y W Z X Y W Z involve minority, majority, or totality stakes. Type: A B A B Asset sale: the purchase of individual assets and liabilities. Stock sale: the purchase of the owner's After stock sale After asset acquisition shares of a corporation. Approximately 30% of all transactions are historically stock sales. However, this figure varies significantly by X Y X Y W Z company size, with larger transactions having a greater likelihood of being stock sales. A A B W They may B remain or Asset transfer Z not 6 Source: Author’s elaboration.  Key Definitions in M&A Acquisitions, stock sale vs asset sale (2/3). Buyer’s Viewpoint Seller’s Viewpoint  Tax benefits. By allocating a higher value for assets X Higher taxes. Intangible assets, such as goodwill, are that depreciate quickly (like equipment, which has a 3- taxed at capital gains rates, other "hard" assets can be 7 year life) and by allocating lower values on assets subject to higher ordinary income tax rates. In the US, that amortize slowly (like goodwill, which has a 15 year capital gains rates are currently 20%. Ordinary income life), the buyer can gain additional tax benefits, tax rates depend on the seller's tax bracket. improving the company's cash flow during the first years. X Double taxation. The corporation is first taxed upon selling the assets to the buyer. The corporation's  Avoid inheriting potential liabilities, especially owners are then taxed again when the proceeds contingent liabilities in the form of product liability, transfer outside the corporation. contract disputes, product warranty issues, or employee lawsuits. X Difficult to transfer some assets. Risk of assignability, legal ownership, and third-party consents issues (i.e., certain intellectual property, contracts, etc.). 7 Source: Author’s elaboration.  Key Definitions in M&A Acquisitions, stock sale vs asset sale (3/3). 8 Source: https://www.youtube.com/watch?v=Kw4cTum_fVo&ab_channel=Morse  Key Definitions in M&A Acquisitions, friendly vs hostile takeovers. Before stock sale Before asset acquisition A friendly (hostile) takeover occurs when one acquiring corporation take over the target firm, with (without) the agreement of X Y W Z X Y W Z the target corporation’s board of directors. A B A B A hostile takeover is accomplished by: tender offer: the corporation seeks to purchase shares from outstanding shareholders of the target corporation at After stock sale After asset acquisition a premium to the current market price. proxy fight: the acquiring corporation X Y X Y W Z tries to persuade shareholders to use their proxy votes to install new management or take other types of A A B corporate action. W They may The P&G/Peltz battle B remain or Asset transfer (see video slide) Z not 9 Source: Author’s elaboration.  [Foods for thought] Key Definitions in M&A Case study - P&G and Mr. Peltz Battle. 10 Source: https://www.youtube.com/watch?v=9EC58heUTSw&t=2s&ab_channel=FinancialTimes  [Foods for thought] Key Definitions in M&A Case study - P&G and Mr. Peltz Battle. 11 Source: Financial times.  [Foods for thought] Key Definitions in M&A Case study - P&G and Mr. Peltz Battle. Aug 2017 Oct 2017 Dec 2017 12 Source: Reuters, WSJ, The New York Times.  [Foods for thought] Key Definitions in M&A Case study - P&G and Mr. Peltz Battle. On Dec. 15, 2017, sixty-six days after holding its annual meeting, The Procter & Gamble Company announced that Nelson Peltz, founding partner and chief executive officer of Trian Fund Management, L.P., would join Procter & Gamble’s board in March 2018, marking a dramatic conclusion to the so-called “largest proxy fight in history” and the “the largest boardroom battle in the history of director insurgencies.” The winning margin of Mr Peltz was about 0.0016%! (WSJ) 13 Source: Financial times.  [Foods for thought] Key Definitions in M&A Case study - P&G and Mr. Peltz Battle – Lessons learned Trian’s strategy - and ultimate success - in this blockbuster fight for board representation at Procter & Gamble offers key lessons for both activists and companies sitting across the table from activists. The latest proxy season proved that no company is too big to be immune from activism. 1. A strategy that does not overreach and represents a sensible offer hard to refuse pays off. 2. Focus on the long-term value-creation strategy aligns and unites shareholder interests. 3. Keep the message simple enough to align with retail investors. 14 Source: Lessons Learned from Trian’s Campaign at Procter & Gamble, Harvard Law School Forum on Corporate Governance  [Foods for thought] Key Definitions in M&A Case study - P&G and Mr. Peltz Battle – Lessons learned When Mr Peltz left the company When Mr Peltz joined the company 15 Source: https://seekingalpha.com/article/4518005-with-nelson-peltz-on-board-a-long-ul-short-pg-pair-trade-is-available  Key Definitions in M&A The Economic Perspective of M&A Horizontal M&A involves firms that operate in the same industry.  Usually, the goal is to achieve economies of scale. Examples: Disney acquisition of 21st Century Fox in 2019; Facebook acquisition of Instagram in 2012. Vertical M&A involves firms that operate in the same industry but at different stage of the supply chain. Usually, the goal is to achieve economies of scope. Example: eBay acquisition of PayPal in 2002. Conglomerates involves firms that operate in different industries. Usually, the goal is to lower the operational risk by implementing a diversification strategy. Example: Amazon acquisition of Whole Foods in 2017. 16 Source: Lessons Learned from Trian’s Campaign at Procter & Gamble, Harvard Law School Forum on Corporate Governance  [Foods for thought] Key Definitions in M&A Amazon Acquisition of Whole Foods A bigger physical retail footprint for Amazon. More fulfillment centers.  quicker deliveries. A saving grace for Wholefoods.  pressure from activist investor Jana Partners. A competitive edge for Amazon.  enriched product catalogue. A stronger presence in the home for Amazon. 17 Key Definitions in M&A What’s Going on in the Media Industry? (1/2) 18 Key Definitions in M&A What’s Going on in the Media Industry? (1/2) 19 2 Other Restructuring Activities Other Restructuring Activities Asset Divestitures Divestiture is the sale of a portion of a firm’s assets to an outside party, generally resulting in a cash infusion to the parent. Such asset may include a product line, subsidiary, or division. Corporations that took a disciplined approach to divestiture created nearly twice as much value for shareholders as the average firms.” 21 Other Restructuring Activities Asset Divestitures Why? Divested assets may have a higher value to the buyer of these assets. For assets to have a higher value, they have to either generate higher cash flows for the buyers or result in lower risk (leading to a lower discount rate). The higher cash flows can occur because the buyer is more efficient in utilizing the assets, or because the buyer finds synergies with its existing businesses. The lower discount rate may reflect the fact that the owners of the buying firm are more diversified that the owners of the firm selling the assets. In either case, both sides can gain from the divestiture, and share in the increased value. Satisfy a cash-flow need. Firms that find themselves unable to meet their current operating or financial expenses may have to sell assets to raise cash. For instance, many leveraged acquisitions in the 1980s were followed by divestitures of assets. The cash generated from these divestitures was used to retire and service debt. Restructure the portfolio and unfold value of the existing businesses. In some cases, a firm may find the cash flows and values of its core businesses affected by the fact that it has diversified into unrelated businesses. This lack of focus can be remedied by selling assets or businesses that are peripheral to the main business of a firm (example Conglomerate Discount). 22 Other Restructuring Activities Asset Divestitures To sell or not to sell? Economic convenience: Estimate the enterprise value of the business on a stand-alone basis (DCF approach) Adjustments to cash flows. To decide if a business is worth more to the shareholder if sold the parent must first esti mate the after-tax cash flows of the business viewed on a stand-alone basis (i.e., as if it were operated as an independent operating unit). - This requires adjusting the cash flows for intercompany sales and the cost of services (e.g., legal, treasury, and audit) provided by the parent. Define the cost of capital. Once the after-tax stand-alone cash flows have been determined, a discont rate should be estimated that reflects the risk characteristics of the industry in which the business competes.. The cost of capital of other firms in the same industry (or firms in other industries exhibiting similar profitability, growth opportunities and risks characteristics) is often a good proxy for the discount rate of the Business being analyzed. Compare the enterprise value with the after tax sale value (VS) If Value > after tax sale value (VS)  retain If Value < after tax sale value (VS)  divest Timing of sales 23 Other Restructuring Activities Spin-off and split-up A demerger is a separation of the activities of a group: the original shareholders become the shareholders of the separated companies. The transaction can be carried out by distributing the shares of a subsidiary (a spin-off), or by dissolving the parent company and distributing the shares of the ex-subsidiaries to the shareholders (a split- up). There is no infusion of new cash. Why? Reviewing the Corporate portfolio and divest assets that are difficult to sell. Rewarding shareholders with a nontaxable dividend (if properly structured) 24 Other Restructuring Activities Spin-off and split-up Motorola announced on March 26, 2008, its intention to create two independent, publicly traded firms in 2009: one for the Mobile Devices and the other for the Broadband & Mobility Solutions businesses. The Mobile Devices business designs, manufactures, and sells mobile handsets and accessories globally. The Broadband & Mobility Solutions business manufactures, designs, integrates, and services voice and data communication solutions and wireless broadband networks for business and government agencies. By splitting these two companies Motorola separate the loss-generating handset (as it was losing market positions to Nokia and Samsung Electronics) division from the other business. Once independent, the handset operation could become more attractive to Asian handset manufacturers eager to improve their U.S. market share. The split-up would take the form of a tax-free distribution to Motorola's shareholders, with shareholders holding shares of two independent and publicly traded firms. Motorola had been seeking a buyer for months but none had emerged. A stand-alone firm is unencumbered by intracompany relations. Moreover, all liabilities and assets associated with the handset business already would have been determined making it easier for a potential partner to value the business. Prior to the split up shares of of Motorola had fallen more than 60% since October 2006, making the Motorola board vulnerable to a proxy contest. Under the pressure from an intensifying proxy battle against activits investor Carl Icahn (who owned a 6,3% stake in Motorola), the firm management felt compelled to make a dramatic move before the May 2008 shareholders’ meeting. Icahn had submittd a slate of four directors to replace those up for reelection. 25