Introduction to Mergers, Acquisitions,

1
Introduction to Mergers, Acquisitions, Other
Restructuring Activities
2
If you give a man a fish, you feed him for a day.
If you teach a man to fish, you feed him for a
life time.

Lao
Tze
3
Cross-Border Transactions
4
Course Learning Objectives

• Define what corporate restructuring is and why it
  occurs
• Identify commonly used valuation techniques
• Describe how corporate restructuring
  creates/destroys value
• Identify commonly used takeover tactics and
  defenses
• Develop a highly practical planning based
  approach to managing the MA process
• Identify challenges and solutions associated with
  each phase of the MA process
• Describe advantages and disadvantages of
  alternative MA deal structures
• Describe how to plan, structure, and manage JVs,
  partnerships, alliances, licensing arrangements,
  equity partnerships, franchises, and minority
  investments

5
Current Chapter Learning Objectives

• Primary objective What corporate restructuring
  is and why it occurs
• Secondary objective Provide students with an
  understanding of
• MA as a form of corporate restructuring
• Alternative ways of increasing shareholder value
• MA activity in an historical context
• The primary motivations for MA activity
• Key empirical findings
• Primary reasons some MAs fail to meet
  expectations

6
MAs as a Form of Corporate Restructuring

• Restructuring Activity
• Corporate Restructuring
• Balance Sheet
• Assets Only
• Financial Restructuring (liabilities only)
• Operational Restructuring

• Potential Strategy
• Redeploy Assets
• Mergers, Break-Ups, Spin-Offs
• Acquisitions, divestitures, etc.
• Increase leverage to lower cost of capital or as
  a takeover defense
• Divestitures, widespread employee reduction, or
  reorganization

7
Alternative Ways of Increasing Shareholder Value

• Solo venture (AKA going it alone or organic
  growth)
• Partnering (Marketing/distribution alliances,
  JVs, licensing, franchising, and equity
  investments)
• Mergers and acquisitions
• Minority investments in other firms
• Asset swaps
• Financial restructuring
• Operational restructuring

8
Discussion Questions

1. What factors do you believe are most likely to
   impact senior managements selection of one
   strategy (e.g., solo venture, MA) to increase
   shareholder value over the alternatives? Be
   specific.
2. In your opinion, how might the conditions of the
   business (e.g., profitability) and the economy
   affect the choice the strategy?

9
Remembering the Past

• Those who do not remember the past are condemned
  to relive it.
• Alexis De Tocqueville

10
Merger Waves(Boom Periods)

• Horizontal Consolidation (1897-1904)
• Increasing Concentration (1916-1929)
• The Conglomerate Era (1965-1969)
• The Retrenchment Era (1981-1989)
• Age of Strategic Megamerger (1992-2000)
• Age of Cross Border and Horizontal Megamergers
  (2003-2007)

11
Causes and Significance of MA Waves

• Factors contributing to merger waves
• Shocks (e.g., technological change, deregulation,
  and escalating commodity prices)
• Ample liquidity and low cost of capital
• Overvaluation of acquirer share prices relative
  to target share prices
• Why it is important to anticipate MA waves
• Financial markets reward firms pursuing promising
  opportunities early on and penalize those that
  follow later in the cycle.
• Acquisitions made early in the wave often earn
  substantially higher financial returns than those
  made later in the cycle.

12
Horizontal Consolidation (1897-1904)

• Spurred by
• Drive for efficiency,
• Lax enforcement of antitrust laws
• Westward migration, and
• Technological change
• Resulted in concentration in metals,
  transportation, and mining industry
• MA boom ended by 1904 stock market crash and
  fraudulent financing

13
Increasing Concentration (1916-1929)

• Spurred by
• Entry of U.S. into WWI
• Post-war boom
• Boom ended with
• 1929 stock market crash
• Passage of Clayton Act which more clearly defined
  monopolistic practices

14
The Conglomerate Era (1965-1969)

• Conglomerates buy earnings streams to boost their
  share price
• Overvalued firms acquired undervalued high growth
  firms
• Number of high-growth undervalued firms declined
  as conglomerates bid up their prices
• Higher purchase price for target firms and
  increasing leverage of conglomerates brought era
  to a close

15
The Retrenchment Era (1981-1989)

• Strategic U.S. buyers and foreign multinationals
  dominated first half of decade
• Second half dominated by financial buyers
• Buyouts often financed by junk bonds
• Drexel Burnham provided market liquidity
• Era ended with bankruptcy of several large LBOs
  and demise of Drexel Burnham

16
Age of Strategic Megamerger (1992-2000)

• Dollar volume of transactions reached record in
  each year between 1995 and 2000
• Purchase prices reached record levels due to
• Soaring stock market
• Consolidation in many industries
• Technological innovation
• Benign antitrust policies
• Period ended with the collapse in global stock
  markets and worldwide recession

17
Age of Cross Border and Horizontal Megamergers
(2003 2007)

• Average merger larger than in 1980s and 1990s,
  mostly horizontal, and cross border
• Concentrated in banking, telecommunications,
  utilities, healthcare, and commodities (e.g.,
  oil, gas, and metals)
• Spurred by
• Continued globalization to achieve economies of
  scale and scope
• Ongoing deregulation
• Low interest rates
• Increasing equity prices, and
• Expectations of continued high commodity prices
• Period ended with global credit market meltdown
  and 2008-2009 recession

18
Debt Financed 2003-2007 MA Boom
Low Interest Rates Declining Risk Aversion
Drive Increasing --Sub-Prime Mortgage
Lending --LBO Financing Other Highly
Leveraged Transactions
Investment Banks Repackage Underwrite --Mortga
ge Backed --High Yield Bonds
Banks Hedge Funds Create --Collateralized
Debt Obligations (CDOs) --Collateralized Loan
Obligations CLOs)
Foreign Investors Buy Highest Rated Debt
Hedge Funds Buy Lower Rated debt
Investment Banks Lend to Hedge Funds
19
Similarities and Differences Among Merger Waves

• Similarities
• Occurred during periods of sustained high
  economic growth
• Low or declining interest rates
• Rising stock market
• Differences
• Emergence of new technology (e.g., railroads,
  Internet)
• Industry focus
• Type of transaction (e.g., horizontal, vertical,
  conglomerate, strategic, or financial)

20
Discussion Questions

1. What can senior management learn by studying
   historical merger waves?
2. What can government policy makers learn by
   studying historical merger waves?
3. What can investors learn by studying historical
   merger waves?

21
Motivations for MA

• Strategic realignment
• Technological change
• Deregulation
• Synergy
• Economies of scale/scope
• Cross-selling
• Diversification (Related/Unrelated)
• Financial considerations
• Acquirer believes target is undervalued
• Booming stock market
• Falling interest rates
• Market power
• Ego/Hubris
• Tax considerations

22
Illustrating Economies of Scale

• Period 1 Firm A (Pre-merger)
• Assumptions
• Price 4 per unit of output sold
• Variable costs 2.75 per unit of output
• Fixed costs 1,000,000
• Firm A is producing 1,000,000 units of output per
  year
• Firm A is producing at 50 of plant capacity
• Profit price x quantity variable costs
• fixed costs
• 4 x 1,000,000 - 2.75 x 1,000,000
• - 1,000,000
• 250,000
• Profit margin ()1 250,000 / 4,000,000
  6.25
• Fixed costs per unit 1,000,000/1,000,000 1

• Period 2 Firm A (Post-merger)
• Assumptions
• Firm A acquires Firm B which is producing 500,000
  units of the same product per year
• Firm A closes Firm Bs plant and transfers
  production to Firm As plant
• Price 4 per unit of output sold
• Variable costs 2.75 per unit of output
• Fixed costs 1,000,000
• Profit price x quantity variable costs
• fixed costs
• 4 x 1,500,000 - 2.75 x 1,500,000
• - 1,000,000
• 6,000,000 - 4,125,000 - 1,000,000
• 875,000
• Profit margin ()2 875,000 / 6,000,000
  14.58
• Fixed costs per unit 1,000,000/1.500,000 .67

Key Point Profit margin improvement is due to
spreading fixed costs over more units of output.
1Margin per of revenue 4.00 - 2.75 - 1.00
.25 2Margin per of revenue 4.00 - 2.75 -
.67 .58
23
Illustrating Economies of Scope

• Pre-Merger
• Firm As data processing center supports 5
  manufacturing facilities
• Firm Bs data processing center supports 3
  manufacturing facilities

• Post-Merger
• Firm As and Firm Bs data processing centers are
  combined into a single operation to support all 8
  manufacturing facilities
• By combining the centers, Firm A is able to
  achieve the following annual pre-tax savings
• Direct labor costs 840,000.
• Telecommunication expenses 275,000
• Leased space expenses 675,000
• General administrative expenses 230,000

Key Point Cost savings due to expanding the
scope of a single center to
support all 8 manufacturing facilities of the
combined firms.
24
Empirical Findings

• Around transaction announcement date, abnormal
  returns average
• 20 for target shareholders in friendly
  transactions 30-35 in hostile transactions
• Bidders shareholders on average earn zero to
  slightly negative returns
• Positive abnormal returns to bidders often are
  situational and include the following
• Target is a private firm or a subsidiary of
  another firm
• The acquirer is relatively small
• The target is small relative to the acquirer
• Cash rather than equity is used to finance the
  transaction
• Transaction occurs early in the MA cycle
• No evidence that alternative strategies (e.g.,
  solo ventures, alliances) to MAs are likely to
  be more successful

25
Primary Reasons Some MAs Fail to Meet
Expectations

• Overpayment due to over-estimating synergy
• Slow pace of integration
• Poor strategy

26
Discussion Questions

1. Discuss whether you believe current conditions in
   the U.S. and global markets are conducive to high
   levels of MA activity? Be specific.
2. Of the factors potentially contributing to
   current conditions, which do you consider most
   important and why?
3. Speculate about what you believe will happen to
   the number of MAs over the next several years in
   the U.S.? Globally? Defend your arguments.

27
Application Xerox Buys ACS

• In late 2009, Xerox, traditionally an office
  equipment manufacturer, acquired Affiliated
  Computer Systems (ACS) for 6.4 billion. With
  annual sales of about 6.5 billion, ACS handles
  paper-based tasks such as billing and claims
  processing for governments and private companies.
  With about one-fourth of ACS revenue derived
  from the healthcare and government sectors
  through long-term contracts, the acquisition
  gives Xerox a greater penetration into markets
  which should benefit from the 2009 government
  stimulus spending and 2010 healthcare
  legislation. There is little customer overlap
  between the two firms.
• Previous Xerox efforts to move beyond selling
  printers, copiers, and supplies and into services
  achieved limited success due largely to poor
  management execution. While some progress in
  shifting away from the firms dependence on
  printers and copier sales was evident, the pace
  was far too slow. Xerox was looking for a way to
  accelerate transitioning from a product driven
  company to one whose revenues were more dependent
  on the delivery of business services.
• More than two-thirds of ACS revenue comes from
  the operation of client back office operations
  such as accounting, human resources, claims
  management, and other outsourcing services, with
  the rest coming from providing technology
  consulting services. ACS would also triple
  Xeroxs service revenues to 10 billion. Xerox
  chose to run ACS as a separate standalone
  business.
• Discussion Questions
• 1. What alternatives to a merger do you
  think they could have considered?
• 2. Why do you think they chose a merger
  strategy? (Hint Consider the
• advantages and disadvantages of alternative
  implementation strategies.)
• 3. How are Xerox and ACS similar and how are
  they different? In what way will their
• similarities and differences help or hurt the
  long-term success of the merger?
• 4. How might the decision to manage ACS as a
  separate business affect realizing the full
  value of the transaction?

28
Things to Remember

• Motivations for acquisitions
• Strategic realignment
• Synergy
• Diversification
• Financial considerations
• Hubris
• Common reasons MAs fail to meet expectations
• Overpayment due to overestimating synergy
• Slow pace of integration
• Poor strategy
• MAs typically reward target shareholders far
  more than bidder shareholders
• Success rate of MA not significantly different
  from alternative ways of increasing shareholder
  value