@Team-FLY MERGERS AND ACQUISITIONS FM_Weston_136432-3_IPRO-C 8/21/01 2:03 PM Page i Other books in the McGraw-Hill Executive MBA Series include: SALES MANAGEMENT FINANCE AND ACCOUNTING FOR NONFINANCIAL MANAGERS CORPORATE STRATEGY FM_Weston_136432-3_IPRO-C 8/21/01 2:03 PM Page ii McGraw-Hill New York Chicago San Francisco Lisbon London Madrid Mexico City Milan New Delhi San Juan Seoul Singapore Sydney Toronto MERGERS AND ACQUISITIONS THE McGRAW-HILL EXECUTIVE MBA SERIES J. FRED WESTON SAMUEL C. WEAVER FM_Weston_136432-3_IPRO-C 8/21/01 2:03 PM Page iii Copyright © 2001 by the McGraw-Hill Companies Inc. All rights reserved. Manufactured in the United States of America. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher. The material in this eBook also appears in the print version of this title: 0-07-136432-3. All trademarks are trademarks of their respective owners. Rather than put a trademark symbol after every occurrence of a trademarked name, we use names in an editorial fashion only, and to the benefit of the trademark owner, with no intention of infringement of the trademark. Where such designations appear in this book, they have been printed with initial caps. McGraw-Hill eBooks are available at special quantity discounts to use as premiums and sales pro- motions, or for use in corporate training programs. For more information, please contact George Hoare, Special Sales, at george_hoare@mcgraw-hill.com or (212) 904-4069. TERMS OF USE This is a copyrighted work and The McGraw-Hill Companies, Inc. (“McGraw-Hill”) and its licensors reserve all rights in and to the work. Use of this work is subject to these terms. Except as permitted under the Copyright Act of 1976 and the right to store and retrieve one copy of the work, you may not decompile, disassemble, reverse engineer, reproduce, modify, create derivative works based upon, transmit, distribute, disseminate, sell, publish or sublicense the work or any part of it without McGraw-Hill’s prior consent. You may use the work for your own noncommercial and personal use; any other use of the work is strictly prohibited. Your right to use the work may be terminated if you fail to comply with these terms. THE WORK IS PROVIDED “AS IS”. McGRAW-HILLAND ITS LICENSORS MAKE NO GUAR- ANTEES OR WARRANTIES AS TO THE ACCURACY, ADEQUACY OR COMPLETENESS OF OR RESULTS TO BE OBTAINED FROM USING THE WORK, INCLUDING ANY INFORMA- TION THAT CAN BE ACCESSED THROUGH THE WORK VIA HYPERLINK OR OTHERWISE, AND EXPRESSLY DISCLAIM ANY WARRANTY, EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED TO IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. McGraw-Hill and its licensors do not warrant or guarantee that the func- tions contained in the work will meet your requirements or that its operation will be uninterrupted or error free. Neither McGraw-Hill nor its licensors shall be liable to you or anyone else for any inac- curacy, error or omission, regardless of cause, in the work or for any damages resulting therefrom. McGraw-Hill has no responsibility for the content of any information accessed through the work. Under no circumstances shall McGraw-Hill and/or its licensors be liable for any indirect, incidental, special, punitive, consequential or similar damages that result from the use of or inability to use the work, even if any of them has been advised of the possibility of such damages. This limitation of lia- bility shall apply to any claim or cause whatsoever whether such claim or cause arises in contract, tort or otherwise. DOI: 10.1036/0071386548 abc McGraw-Hill 0-07-138654-8 v CONTENTS Preface vii Chapter 1 Change Forces and Mergers 1 Chapter 2 Antitrust Policies 27 Chapter 3 Strategy 39 Chapter 4 Deal Structuring 61 Chapter 5 Mergers and Takeovers —Theory and Practice 83 Chapter 6 Alternative Paths to Growth 121 Chapter 7 Valuation 133 Chapter 8 Restructuring and Financial Engineering 179 Chapter 9 Cash Flows, Dividends, and Share Repurchases 197 Chapter 10 Takeover Defenses 225 Index 257 FM_Weston_136432-3_IPRO-C 8/21/01 2:03 PM Page v Copyright 2001 The McGraw-Hill Companies, Inc. Click Here for Terms of Use. @Team-FLY This page intentionally left blank. PREFACE From 1992 to 2000, the pace of merger activity rose to unpre- cedented levels. An environment of sustained economic growth and rising stock prices facilitated transactions. Toward the end of 2000, the economic climate shifted and merger activity in the fourth quarter declined. The economy showed only small growth during the first quarter of 2001. Excess capacity in a number of industries had developed, and sales and profit disappointments began to widen. The business cycle had returned. Valuations in Internet companies and other high-tech industries have been sharply revised downward. The pooling method of accounting for mergers is scheduled to be abolished. New challenges face business firms large and small. In this new economic environment, the nature of merger activity will change and the dollar volume may decline. But the economic role of mergers and related activities will expand. The term “mergers and acquisitions (M&As)” encompasses a widen- ing range of activities, including joint ventures, licensing, spin- offs, equity carveouts, tracking stocks, restructuring, alliances, and other corporate interactions such as network relationships. The fundamental role of M&A activities is to enable firms to adjust more effectively to new challenges and opportunities. If done efficiently, M&As can increase revenues and market share, improve profitability, and enhance enterprise values. The data show that mergers overall have increased market val- ues. With excess capacity in a number of industries, mergers to facilitate the consolidation and reduction of capacity will be required. The new technologies will continue to impact indus- tries and create opportunities for business firms of all sizes. There will continue to be opportunities for small firms to come into being and to establish substantial valuations. The venture capital industry and financial buyers will continue to represent important activities. Earlier studies reported that two-thirds of mergers were failures in the sense that they did not earn the required cost of capital for the product-market activity involved. Later studies of strategic mergers of the 1990s suggest that the success rate vii FM_Weston_136432-3_IPRO-C 8/21/01 2:03 PM Page vii Copyright 2001 The McGraw-Hill Companies, Inc. Click Here for Terms of Use. is moving toward 50 percent. This book seeks to convey infor- mation that will help individual firms achieve successful M&A activities. Thousands of articles and books have been written on the many aspects of M&As. Hundreds of new ones appear each year. In this small volume we seek to summarize the findings of the M&A literature without citations to the individual publications themselves. We seek to provide a framework for achieving M&A activities that add value to the firm. We express our appreciation to Juan A. Siu and Brian A. Johnson, who had been our collaborators on many studies on M&As. We also benefited from our continuing interactions with Alexandra Reed Lajoux, who has written wisely and well on many aspects of M&As. We have long benefited from the con- tributions of Martin Sikora, the editor of the Mergers & Acqui- sitions magazine. We have also benefited from our UCLA colleagues who participate in the Anderson School’s twice-a-year Merger Week executive programs. We have learned much from the executives that have participated in these merger programs. We received assistance also from our associates in our Take- overs and Restructuring Program at the Anderson School at UCLA. They include Cindy Chang and Laura Hougham. We also benefited from the continuous assistance from Brigitta Schumacher of the Anderson School finance area support staff. Backup software related to the valuation materials and other topics are available at Weston’s website: http://www. anderson.ucla.edu/faculty/john.weston We invite comments and suggestions from our readers. J. Fred Weston Samuel C. Weaver viii PREFACE FM_Weston_136432-3_IPRO-C 8/21/01 2:03 PM Page viii CHAPTER ONE Change Forces and Mergers Mergers and restructuring activities accelerated through the first quarter of 2000. The volume of deal activities declined quarter by quarter through the first quarter of 2001. But over- capacity in a number of industries will predictably result in con- solidation mergers. The rules of the games are changing as well. The Hart-Scott-Rodino Act of 1976 was amended on December 21, 2000. The abolition of the pooling method of accounting appears to be likely. The rules for writing off goodwill and other intangibles are being changed. So while the pace of M&A activ- ities may decline from the torrid levels of the late 1990s, they continue to represent a major force in the financial and eco- nomic environment. Merger activity in the United States and worldwide rose to unprecedented levels in 1998 and 1999, as shown in Table 1.1. Merger activity leveled off in 2000. The stock market indexes reached their peak in March 2000, and stock prices continued to decline during the fourth quarter. This was associated with a decline in merger activity toward the end of the year. As shown in Table 1.1, the year 2000 represented a leveling off of world- wide M&A activity, but from unusually high levels. The average dollar volume of M&A activity in the United States for the years 1998 through 2000 was slightly more than $1.5 trillion; for the rest of the world the corresponding figure was somewhat more 1 Ch01_136432-3_Weston 8/21/01 2:03 PM Page 1 Copyright 2001 The McGraw-Hill Companies, Inc. Click Here for Terms of Use. [...]... a specified price Mergers are mainly friendly Tender offers may become hostile Types of Mergers From an economic standpoint, mergers may be horizontal, vertical, or conglomerate Horizontal mergers involve firms operating in similar businesses (e.g., Chevron and Texaco) Vertical mergers occur in different stages of production operations (e.g., AOL and Time Warner) In conglomerate mergers, the firms... Page 7 Change Forces and Mergers 7 By M&A activities, we refer to more than mergers and acquisitions They include joint ventures and strategic alliances Also included are restructuring activities such as divestitures, carve-outs, spin-offs, and tracking stocks Changes in ownership structure have taken place through share repurchases, leveraged buyouts, dual-class recapitalizations, and leveraged recapitalizations... publicly available documents, such as financial statements and filings with the Securities and Exchange Commission (SEC) and/ or regulatory agencies Arbitrageurs buy expert advice from lawyers and industry specialists They may hire investment bankers to assist in their assessment of the offer Ch01_136432-3_Weston 8/21/01 2:03 PM Page 11 Change Forces and Mergers 11 In some cases, the investment bankers involved... relationships have developed, even in new industries such as telecommunications and e-commerce The decline and failure rates of firms in some sectors have accelerated Strategy formulation and revisions are more important Real-time financial planning and control information requirements have increased These impacts have expanded opportunities and risks A wide range of adjustment processes have been used by firms... companies From an economic standpoint, different types of mergers or tender offers are grouped on the basis of the stage of economic activity and the degree of relatedness of the firms Horizontal mergers involve firms operating in the same kind of business activity Vertical mergers take place between firms in different stages of production operations Pure conglomerate mergers involve firms engaged... Ch01_136432-3_Weston 8/21/01 2:03 PM Change Forces and Mergers Page 9 9 1 Telecommunications Technological change and deregulation in the United States and abroad (particularly Europe) have stimulated efforts to develop a global presence 2 Media (movies, records, magazines, newpapers) Technological changes have impacted the relationship between the content and delivery segments There is potential overlap... Ch01_136432-3_Weston 8/21/01 2:03 PM Page 5 Change Forces and Mergers 5 The economic and financial environments have also been favorable for deal making Strong economic growth, rising stock prices, and relatively low interest rates have favored internal growth as well as a range of M&A activities Individual entrepreneurship has responded to opportunities and, in turn, created further dynamism in industrial... percent The current merger activity is a part of what has been called the fifth merger movement, which began in 1993 and has been characterized by strategic megamergers Table 1.2 lists the top 10 mergers in all history through January 2001 All these mergers are greater than $50 billion, and have occurred since 1998 The Vodafone–Air Touch transaction involved a foreign (United Kingdom) acquirer The ninth... both sides of the deal Five of the ten were in telecommunications, two in oils and financial services The largest of all was AOL and Time Warner, which will be placed in the Internet/media category, combining the new and old economies To understand the reasons for the strong growth of M&A activity worldwide in recent years and whether the slowing toward the end of 2000 will continue requires some historical... communication and transportation have been greatly reduced (3) Hence markets have become international in scope (4) The forms, sources, and intensity of competition have expanded (5) New industries have emerged (6) While regulations have increased in some areas, deregulation has taken place in other industries (7) Favorable economic and financial environments have persisted from 1982 to 1990 and from 1992 . vii Chapter 1 Change Forces and Mergers 1 Chapter 2 Antitrust Policies 27 Chapter 3 Strategy 39 Chapter 4 Deal Structuring 61 Chapter 5 Mergers and Takeovers —Theory and Practice 83 Chapter 6 Alternative. change and the dollar volume may decline. But the economic role of mergers and related activities will expand. The term mergers and acquisitions (M&As)” encompasses a widen- ing range of activities,. began in 1993 and has been characterized by strategic megamergers. Table 1.2 lists the top 10 mergers in all history through January 2001. All these mergers are greater than $50 billion, and have