Introduction to Mergers & Acquisitions Kate Creighton Download free books at Kate Creighton Introduction to Mergers & Acquisitions Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions 1st edition © 2013 Catherine Lucy Walker & bookboon.com ISBN 978-87-403-0570-8 Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions Contents Contents Chapter One 1.1 What is M&A? 1.2 The Goal of Acquisitions 1.3 Synergies 1.4 Acquisition Strategies 1.5 Disposal Strategies 1.6 From Strategy to Success 6 6 10 12 2.1 2.2 2.3 2.4 2.5 2.6 13 13 13 15 16 17 19 Chapter Two Private Company Acquisitions: A Process Overview Early Stages Target Analysis and Evaluation Reaching Agreement Due Diligence Sale and Purchase Agreement 360° thinking 360° thinking 360° thinking Discover the truth at www.deloitte.ca/careers © Deloitte & Touche LLP and affiliated entities Discover the truth at www.deloitte.ca/careers Deloitte & Touche LLP and affiliated entities © Deloitte & Touche LLP and affiliated entities Discover the truth at www.deloitte.ca/careers Click on the ad to read more Download free eBooks at bookboon.com © Deloitte & Touche LLP and affiliated entities Dis Introduction to Mergers & Acquisitions Contents Chapter Three 3.1 Private Company Disposals: A Process Overview 3.2 Routes to Disposal 3.3 Demerger 3.4 Controlled auction 3.5 Alternative Methods of Disposal 24 24 24 24 25 28 4.1 4.2 4.3 4.4 4.5 Chapter Four Public Company Takeovers – Introduction Which Rules Apply? Takeover Essentials The Takeover Process: Friendly Bids The Takeover Process: Hostile Bids 30 30 30 31 33 41 5.1 Chapter Five Deal Structuring Essentials 47 47 6.1 6.2 Chapter Six: Successful M&A Success and Failure in Acquisitions From Objectives to Plans 58 58 59 Appendix – Selected Bibliography 65 Increase your impact with MSM Executive Education For almost 60 years Maastricht School of Management has been enhancing the management capacity of professionals and organizations around the world through state-of-the-art management education Our broad range of Open Enrollment Executive Programs offers you a unique interactive, stimulating and multicultural learning experience Be prepared for tomorrow’s management challenges and apply today For more information, visit www.msm.nl or contact us at +31 43 38 70 808 or via admissions@msm.nl For more information, visit www.msm.nl or contact us at +31 43 38 70 808 the globally networked management school or via admissions@msm.nl Executive Education-170x115-B2.indd 18-08-11 15:13 Download free eBooks at bookboon.com Click on the ad to read more Introduction to Mergers & Acquisitions Chapter One Chapter One 1.1 What is M&A? The term ‘mergers and acquisitions’ refers to the buying and selling – acquiring and disposing – of both private businesses and public companies In the case of the acquisition of a publicly traded company, this may also be referred to as a takeover In practice, very few transactions are structured as pure mergers, where two companies come together, combining their businesses and management teams, but with neither of them taking control of each other The vast majority involve the acquisition of one company by another, with a clear target, acquirer (buyer) and vendor (seller) Over many decades, M&A has been a major contributor to world economic growth, and in particular to activity in global financial markets 1.2 The Goal of Acquisitions The objective of an acquisition should be – and usually is – enhancement of shareholder value At its simplest, this means that an acquirer has to be able to generate a better return on its capital than it would achieve otherwise This could be achieved through increasing revenue, cutting costs, making its assets work more efficiently, solving problems with its suppliers or getting access to more opportunities for growth; or it could just come about through paying a low price for good assets In financial terms, enhancement of shareholder value requires that the net present value of the combined business (its post-acquisition cash flows, discounted by the post-acquisition cost of capital) must be greater than the sum of the pre-acquisition value of the acquirer and the acquisition cost A = acquirer; T = target Value (A+T) > (Value A + Cost T) 1.3 Synergies We need, at this stage, to introduce the concept of synergies Synergies are benefits that can only come about when two entities are joined together; so that “two plus two equals five” To enhance shareholder value, the value of two businesses joined together must be greater than they were when they were separate If the total future earnings from the acquisition, or total capital uplift, are less than or equal to the cost of the acquisition, then the deal is a wasted exercise The benefits from the acquisition must outweigh the cost – and to achieve this, either the target must be ‘cheap’, or the acquisition must be able to generate synergies for the buyer Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions Chapter One Synergies are benefits that can only be achieved by putting two businesses together They can be classified as follows: • Commercial synergies: those benefits that come from improvements in the underlying business of the companies For example, increased sales volumes; ability to charge higher prices; reduced production or administration costs; greater efficiencies They will usually result in improved profit margins or better return on capital statistics • Financial synergies: those benefits that come from better use of capital For example, being able to reduce the cost of borrowings or the cost of equity capital; reducing the company’s tax charge; making use of surplus cash; improving the mix of equity and borrowings Financial synergies are usually reflected in lower weighted average cost of capital (WACC) and improved earnings per share (EPS) • Asset synergies: those benefits that come from better use of the acquirer’s or target’s assets For example, combining administration functions and then selling the ‘spare’ head office building; using excess manufacturing capacity to generate higher production volumes; combining a distribution network These synergies can be measured using metrics such as return on capital employed (ROCE) or return on assets (RoA) 1.4 Acquisition Strategies Most acquisitions come about either because the acquirer’s management has spotted an opportunity for growth, or because they have identified an issue which is restricting their growth We could illustrate this using an example company – a UK chocolate manufacturer, called Bubbles 1.4.1 Scale Acquisitions Bubbles may be trying to increase its market share, in a competitive and shrinking market It could this by acquiring a regional competitor business, which would give it a larger share of its existing market while at the same time eliminating an element of competition This type of transaction, aimed just at increasing the scale of operations, is sometimes referred to as a scale acquisition Where are the synergies? These could come from economies of scale: with this larger market share, Bubbles should have greater purchasing power, and be able to purchase raw materials more cheaply and perhaps extract a higher price from retailers Asset synergies could also come from using the distribution networks of the target company more effectively, putting additional volumes through its production facilities and eliminating duplicated head office or other assets In some cases the business could also achieve revenue synergies, if, by sharing brands or sales forces, the combined companies can create higher revenues than they could get independently Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions Chapter One Another area where value can be enhanced is management This could come from applying management skills and expertise to problem-solve and re-energise the target, at the same time as eliminating any duplicated roles And finally, by increasing the critical mass of the company, Bubbles may be able to achieve some financial synergies, through better and cheaper access to debt and equity capital or by pooling working capital resources Example: In July 2013, US hospital operator Tenet Healthcare Corp agreed to acquire its smaller competitor, Vanguard Health Systems for an equity value of $1.73 billion According to Tenet’s CEO Trevor Fetter “You have to have size and scale to succeed [in the current healthcare climate]” The transaction will make Tenet the second largest for-profit hospital operator in the US, leaving Community Health Systems Inc (which attempted a hostile takeover of Tenet in 2011) in third place According to Mr Fetter, buying Vanguard will give Tenet more clout in negotiations with managed care providers, drug companies and medical device makers, while reducing overhead costs 1.4.2 Scope Acquisitions As an alternative to investing in its mainstream business, Bubbles could buy a company which also sells chocolate but in different geographical markets; or it could buy a business which sells different, complementary products (perhaps chocolate biscuits) in the same markets as the purchaser This is sometimes referred to as a scope acquisition – a broadening of the scope of the acquirer – and also sometimes referred to as horizontal integration Either way, Bubbles is staying within its central area of activity, but widening its geographical or product range Another form of scope acquisition is vertical integration This is the term used when a company expands into different stages in its supply chain For example, Bubbles might want to secure its access to good quality, competitively priced cocoa beans, and could this by acquiring a cocoa plantation or harvesting business Alternatively, if it wants to have control over its end markets, it might acquire a chocolate retail business In this case, the synergies would come mainly from cost reduction – cutting out the margins paid to the middleman However, the reduction in the company’s risk will also contribute to an increase in its value Backward integration refers to an acquisition further back along the supply chain – for example, a manufacturer buying a producer of raw materials Forward integration refers to an acquisition further on the supply chain – for example, a motor manufacturer buying a motor retailer or after-sales service business Example: In early 2013, retail giant Tesco announced the £48.6 million acquisition of the Giraffe restaurant chain According to its press release, “the acquisition forms part of Tesco’s strategy to develop the space in some of its larger stores and create even more compelling retail destinations where customers can meet, eat and drink, as well as shop The first Giraffe restaurant to open next to a Tesco store will be near London” Press comment suggested that the move was intended to try to revitalize sales, fighting back against a profit warning in 2012 It followed on from the acquisition of a coffee shop chain the year before Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions Chapter One 1.4.3 Diversification Diversification involves buying a company in an unrelated business If Bubbles decided that there was limited growth in the chocolate market, it might acquire a company in a completely unrelated activity (say, clothing) or in a different but linked activity (such as bakery products) The scope for synergies is far lower with this strategy; in most cases it relies on financial and asset synergies to enhance shareholder value This is a strategy which was popular in Europe and North America in the 1980s but fell out of favour in the 1990s, as investors developed a preference for focused businesses There are some notable exceptions: Berkshire Hathaway, for example, has a very successful model of growth by focused, diversified acquisition The diversified conglomerate corporate model is also strong in much of the Far East One example is Samsung of Korea, which owns businesses as wide-ranging as consumer electronics, military hardware, apartments, ships and an amusement park Example: Hanson Trust was founded in the 1960s with a strategy of buying undervalued businesses and turning them round; by the 1990s the group had bought into clothing, building materials and chemicals as well as acquiring the highprofile Imperial Tobacco Group and Consolidated Goldfields By the mid 1990s diversification was out of favour with the market, and Hanson split itself into four, separately-focused businesses 1.4.4 Other Reasons for Acquisitions Capital efficiency might be a motive for Bubbles to make acquisitions Since the credit crisis, companies have accumulated cash to a point where, according to credit rating agency Moody’s, US non-financial corporates had total cash balances of $1.24 trillion by the end of 2011; Apple, for example, had over $121 billion in cash by the end of 2012 A trading company with significant amounts of surplus cash is likely to find its share price depressed, because this cash is an asset that earns a pitiful return, and dilutes both the company’s earnings per share and its return on capital employed If there is no short-term use for the cash in the business, Bubbles would eventually find itself under pressure from its shareholders to release the cash, either by making acquisitions, or through a return to shareholders in the form of special dividends or share buybacks Example: Predator has €100 million net assets, of which €20 million is surplus cash on deposit The remaining €80 million generates a return of 8%, in line with the sector average The post-tax interest receivable on cash is 1.5% €80 million x 8% = €6.4 million €20 million x 1.5% = €0.3 million €6.7 million Predator’s return on equity is: €6.7 million = 6.7%: well below the sector level of 8% €100 million Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions Chapter One Unusually, a company may be required to buy another for regulatory reasons Under the UK Takeover Code, for example, when a person or persons acting in concert acquire a holding which gives them 30% or more of the voting rights in a public company, they are required to make a mandatory offer for that company; ie, an offer to acquire all the remaining shares of that company Example: In 2011, Hong Kong based investment company Guoco held 29.2% of the voting rights in London-listed Rank, operator of Mecca bingo halls In May 2011, Guoco bought a further 11.6% of Rank’s shares, taking its stake to 40.8% This triggered a mandatory bid whereby Guoco had to make an offer to acquire all of the shares they did not hold The offer had to include a cash option and be priced above a regulatory minimum threshold A whole range of other reasons may lie behind acquisitions Fear of takeover may prompt public companies to make pre-emptive acquisitions This could be to ‘get in first’ with an attack on a potential bidder, to make themselves appear more dynamic, or to make themselves too big to be acquired themselves Other purchasers (like Hanson, above) might specialize in asset-stripping – buying underperforming, failing or illiquid companies at a discount, in order to sell off under-valued assets at a higher price And of course there may be personal elements, such as management ambition, greed, or inter-company feuds, that drive a board towards an acquisition strategy 1.5 Disposal Strategies An active M&A market needs both willing, funded buyers and willing, realistic sellers, with a common view on pricing So, looking now at the other side of the transaction, why are businesses sold? 1.5.1 Strategic Disposals A corporate strategic review may prompt a company to refocus its activities in a particular direction, or to focus only on those activities it considers to be core, so that the board adopts a disposal strategy There are many reasons that specific companies are selected: • Sometimes the businesses to be sold are under-performing, relative to the group, and therefore dilute shareholder returns and EPS • There may be a lack of synergies between the subsidiaries and the group, so that there is no visible logic in keeping them The capital invested in them can be used more profitably elsewhere • The parent may have acquired a company with non-core or unwanted subsidiaries, and choose to sell these off to recover some of the acquisition cost and create a more streamlined whole Cash can of course be a key disposal driver; if a parent company is short of cash and has limited or no access to credit facilities or equity funding, it may have to resort to asset sales, including business disposals, to create liquidity Sometimes there is one particular subsidiary that is highly cash negative, or needs substantial cash to expand, so that the decision is taken to spin it off 10 Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions Chapter Five Example: In March 2013, Hong Kong traded Longlife Holdings Limited agreed to buy trading company V-Express The consideration was HK$45,600,000, satisfied by the issue of 190,000,000 consideration shares, with 90,000,000 of these subject to a one-year lock-up If aggregate net profits for the three years ending 31 December 2015 are less than HK$12,000,000, the vendor is to repay part of the consideration, in cash If these profits are HK$24,000,000 or more, Longlife will pay the vendor a cash bonus of HK$3,000,000 Loan Notes Loan notes are a form of debt instrument, which entitles the holder to repayment of a capital sum, as well as a coupon They can be used as a means of deferring part of the consideration or for providing a very flexible, tax-efficient part of an overall consideration package They may also be referred to as loan stock or promissory notes Most acquisition loan notes are redeemable at face value within six to eighteen months, though this can be longer Some are convertible – ie, carrying an option to convert into equity shares of the issuer at the redemption date The majority have a coupon (ie an entitlement to interest) at six-monthly or annual intervals, but some are zero coupon, in which case they will be redeemable at a premium to face value or issued at a discount Most loan notes are also transferrable to third parties, although there may be restrictions on transfer This range of options explains part of the attraction of loan notes – they can be structured in a number of different ways, providing a flexible consideration alternative Loan notes are debt: therefore they are included in the issuer’s financial covenant calculations However, the interest on loan notes should be tax deductible for the issuer, which helps to reduce their cost Moreover they are relatively quick and straightforward to issue, as they are usually not publicly traded For a vendor, loan notes can provide an attractive, interest-bearing form of deferred consideration A convertible loan note allows it to hedge its bets: if the acquirer’s stock price improves, the vendor can convert, but if it does not, the vendor can redeem In the same way as shares, a loan note can be taxeffective as any capital gains tax is usually not payable until the note is redeemed However, even when listed these instruments are not usually very liquid, and their value is in any event dependent on the issuer’s credit-worthiness Example: In June 2013, AIM-quoted IMIC agreed to acquire Afferro Mining Inc The purchase consideration was 80p in cash, plus a listed 2-year unsecured convertible loan note with par value of 40p and carrying simple annual interest of 8% 5.1.3 What to Buy – Assets or Shares? A company owns a wide number of individual assets, has liabilities, and carries on one or more different businesses The company itself is owned, of course, by its shareholders 51 Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions Chapter Five The acquirer has two options: • To buy the company: that is, to buy the shares of the company from the shareholders, with all of its operations, assets and liabilities In this case, the sale and purchase agreement will be entered into between the acquirer and the vendor shareholders, and the consideration is paid to the shareholders • To buy the business and assets: in this case, the acquirer buys the assets and the right to carry on the business of the company, but does not buy the share capital of the company The sale and purchase agreement is entered into between the acquirer and the corporate entity, and the purchase consideration is paid to the company A share purchase has the advantage of simplicity: the actual transfer of the company involves executing share transfer agreements and paying consideration If the acquirer does not want specific assets owned by the company, these must be transferred out of the company in advance of the purchase Increase your impact with MSM Executive Education For almost 60 years Maastricht School of Management has been enhancing the management capacity of professionals and organizations around the world through state-of-the-art management education Our broad range of Open Enrollment Executive Programs offers you a unique interactive, stimulating and multicultural learning experience Be prepared for tomorrow’s management challenges and apply today For more information, visit www.msm.nl or contact us at +31 43 38 70 808 or via admissions@msm.nl For more information, visit www.msm.nl or contact us at +31 43 38 70 808 the globally networked management school or via admissions@msm.nl Executive Education-170x115-B2.indd 18-08-11 15:13 52 Download free eBooks at bookboon.com Click on the ad to read more Introduction to Mergers & Acquisitions Chapter Five On the other hand, by buying the shares of a company, the acquirer takes on all of its liabilities – both known and unknown – as the company is responsible for all of its historic actions and liable for any claims and lawsuits arising from these in the future In an old established company, there can be many skeletons hidden in the corporate closet A share purchase therefore carries risk for the acquirer, and so there will be a greater emphasis on detailed, extensive warranties and disclosures; and this means that there is also a greater risk of warranty claims for the vendor By contrast, an asset purchase is more complicated, as each asset must be transferred or assigned separately However the acquirer has more scope to ‘cherry-pick’ individual assets and take on selected liabilities, and – most importantly – the skeletons in the closet remain with the vendor, the company itself One other important issue for stand-alone or owner-managed businesses is taxation In an asset purchase, the purchase consideration is paid to the target company, which is then liable for the tax on any capital gain If the company’s shareholders want access to that consideration they must either liquidate the company or declare a dividend: either way there may be a second tax charge to pay One final factor to bear in mind is that the deal parties may have no choice in the matter: if the business being bought is a trading division or a sole trader, there is no corporate entity to buy 5.1.4 Funding Cash Consideration Cash consideration can be funded from the following sources: • Existing cash surpluses (war chests) • New or existing debt facilities • Equity issues In this section we will focus on the question of how the acquirer can use its equity to raise acquisition cash, and what regulatory restrictions there are Prospectus Regulations Within the European Union, the Prospectus Directive requires all companies that offer shares to the public to publish an approved prospectus The form and content of the prospectus is tightly defined and contains extensive disclosures, and it must be approved by the financial regulator of the home state of the issuer of the shares There are, however, a number of exceptions to this rule, and the main ones are: • Issues of shares with a value below €5 million (aggregated with other issues of shares within the last 12 months); • Issues of shares that will only dilute the share capital of the issuer by less than 10% (again, aggregated with other issues of shares within the last 12 months); • Issues where, broadly, shares are not offered to more than 150 retail investors in any EU member state 53 Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions Chapter Five Pre-emption Rights Within the European Union and many other countries, shareholders must be protected with pre-emption rights This is a ‘right of first refusal’ on any new issues of shares for cash; and provides that, if a public company wants to issue new shares in exchange for cash, if must offer those shares first to its existing shareholders, in proportion to their existing shareholding, before offering these shares to third parties If it wants to offer shares to third parties, it must get shareholder approval in advance, and is restricted in the level of price discount it can offer Once again there are exemptions (depending on the jurisdiction) In the UK, the exemptions are: • Issues of shares that will only dilute the share capital of the issuer by less than 10% (aggregated with other issues of shares within the last 12 months); • Issues of shares in exchange for shares (ie, not an issue in exchange for cash) Equity Issue Methods There are three main methods of issuing new shares to raise cash These are rights issues, open offers and placings A rights issue is a pre-emptive issue, as described above, where shares are offered to existing shareholders in proportion to their existing holdings, at a discount to the current market price Example: In March 2013, betting company William Hill announced a fully-underwritten for rights issue in order to raise £375 million to finance the acquisition of the 29% share in William Hill Online that it did not own, from Genuity Services The offer was priced at 245p per share, a discount of 39.5% to the share price immediately before the announcement In the William Hill example above, shareholders are offered two new shares for every nine shares they currently own They can choose to accept the offer and buy shares, thus maintaining their percentage holding in the enlarged company; they can ignore the offer and nothing; or they can sell all or part of their rights to third parties, for a price broadly equivalent to the discount The offer may be underwritten, to guarantee that the acquirer will raise the acquisition funds irrespective of the attitudes of shareholders A rights issue is, realistically, a funding option that is only likely to be available to a publicly traded company The company must send all its shareholders a rights issue document, with full information on the transaction, together with a ‘Provisional allotment letter’ setting out the number of shares each shareholder is entitled to The process is time-consuming, must operate to a strict timetable, and it is not cheap; if it is to raise more than €5 million or 10% of the issuer’s capital, a prospectus is required; and also, because of the discount pricing, the post-rights share price will be diluted However, if the deal appeals to shareholders, it is likely to be a preferred approach of raising equity, particularly for larger transactions where the cost is proportionately less 54 Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions Chapter Five An open offer is a similar method of raising equity Like a rights issue, it is a pre-emptive offer, made to all shareholders in proportion to their existing shareholdings through the publication of a prospectus Unlike a rights issue, though, shareholders only have two options: They can accept their offer and buy their allocation; or they can ignore it They not have the right to sell their rights The pricing of an open offer is also restricted: the maximum discount (in the UK) is 10% below the market price at the time of the announcement This form of equity offer is clearly less attractive to shareholders and is almost always underwritten, through an institutional placing with claw-back An institutional placing is not a pre-emptive offer, as in this case new shares are offered to third party institutional investors in exchange for cash The issuer may need shareholder approval for the disapplication of pre-emption rights, if this has not been obtained already at the AGM Once again, there is a restriction on the discount, which is capped at 10% The offer can be made to a limited number of pre-selected investors (a private placement) or offered more widely in the market One advantage of an institutional placing is that the company has access to a wider pool of investors, who may represent ‘new blood’ in the shareholder base Another advantage is that there may be no need for a prospectus: exemptions are available if the offer is only made to qualified investors, or is for up to 10% of the issuer’s share capital, or is to raise proceeds of less than €5 million GOT-THE-ENERGY-TO-LEAD.COM We believe that energy suppliers should be renewable, too We are therefore looking for enthusiastic new colleagues with plenty of ideas who want to join RWE in changing the world Visit us online to find out what we are offering and how we are working together to ensure the energy of the future 55 Download free eBooks at bookboon.com Click on the ad to read more Introduction to Mergers & Acquisitions Chapter Five In practice, the choice will depend on the timing available, the sums to be raised and the attitude of shareholders to the underlying transaction Deal Effects The choice of consideration will have a significant effect on the post-transaction metrics, and in particular on the very visible, much discussed earnings per share (EPS) If a transaction is EPS-accretive (ie, it increases the earnings generated for each share) then this should increase the share price, and thus increase shareholder wealth If it is dilutive (ie, reduces the earnings generated for each share), then the reverse is true Even if a transaction is dilutive by reference to historic earnings, directors and shareholders want to see that the transaction will be accretive in the near future This could come about through operational or asset synergies – which will usually take time to achieve – or through financial synergies such as the efficient use of capital This is where deal structure can make a difference Take the example of Bidder in its acquisition of Target Bidder Market capitalisation Shares in issue €5,000,000,000 Purchase price €700,000,000 100,000,000 Profit after tax € 80,000,000 Share price Profit after tax Target 50 P/e ratio 8.75x €500,000,000 P/e ratio 10x €5.0 EPS In scenario one, Bidder has available cash of €750 million, currently on deposit generating interest income of 2% after tax, and will use this to fund the acquisition Post-acquisition EPS is €5.660, strongly accretive, calculated as follows: Earnings post-acquisition Shares in issue post-acquisition Bidder €500,000,000 Target € 80,000,000 Less interest income (€ 14,000,000) 100,000,000 (unchanged) EPS: 566,000,000 = €5.660 €566,000,000 100,000,000 56 Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions Chapter Five In scenario two, Bidder has no cash and instead raises debt of €700 million, at an after-tax cost of 7% In this case, post-acquisition EPS is €5.310, again accretive but to a lesser degree, calculated as follows: Earnings post-acquisition Shares in issue post-acquisition Bidder €500,000,000 Target € 80,000,000 Less interest on debt (€49,000,000) 100,000,000 (unchanged) EPS: 531,000,000 = €5.310 €531,000,000 100,000,000 Scenario three sees Bidder using its own shares in a share swap Post-acquisition EPS is now €5.088 – only marginally accretive, as follows: Earnings post-acquisition Shares in issue post-acquisition Bidder €500,000,000 Original: 100,000,000 Target € 80,000,000 New shares: 14,000,000 @€50 €580,000,000 EPS: 580,000,000 = €5.088 114,000,000 Our final scenario shows Bidder carrying out a rights issue to raise cash, at a 25% discount to the current share price (ie, it must issue the shares at a price of €37.50) In this case the post-acquisition EPS is €4.888, making the deal EPS-dilutive, as follows: Earnings post-acquisition Shares in issue post-acquisition Bidder €500,000,00 Original: 100,000,000 Target € 80,000,000 New shares: 18,666,667 @€37.5 €580,000,000 EPS: 580,000,000 = €4.888 118,666,667 57 Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions Chapter Five Chapter Six: Successful M&A 6.1 Success and Failure in Acquisitions In the first chapter, we said that the goal of acquisitions should be the enhancement of shareholder value However, history, and a wide range of far-reaching research, show that the majority of acquisitions never meet their goals A list of some of these studies is shown in the Appendix at the end of this book In summary, the consensus is that some 50%–75% of acquisitions not enhance shareholder value – although success rates have increased in recent years What are the factors behind this? • Strategy: success seems to be more common in transactions involving companies in the same industry than for those in different industries Those involving targets both in different geographies and in different industries have tended to have least success The evidence for ‘full’ diversification strategies is mixed, with some studies showing value being enhanced and others showing value destruction With us you can shape the future Every single day For more information go to: www.eon-career.com Your energy shapes the future 58 Download free eBooks at bookboon.com Click on the ad to read more Introduction to Mergers & Acquisitions Chapter Six: Successful M&A • Price and timing: hindsight is sometimes the only test of whether an acquirer has overpaid for a business; but acquisitions in competitive situations, hostile bids and acquisitions at the top of the market (such as in 2006–7), are priced at high multiples, and inevitably have to struggle harder for financial success When high financial leverage is added to a high price and poor timing, value destruction is almost guaranteed • Post-acquisition integration of the businesses: successful acquisitions are those where management have moved fast, to ensure that the projected synergies can be transformed into actual benefits, and that value is not in fact destroyed Companies with poor cultural fit tend to fare least well The best performing deals are where the acquirer has a long established track record of planning and integrating strategically-motivated acquisitions: these are serial purchasers with extensive experience of creating value These studies vary in their views on the ratio of success to failure, but they agree that in most cases, the cause of value destruction is a failure to implement a robust, objective-focused integration strategy It follows from this that success in M&A depends on preparing a clear integration plan, structured around the underlying deal objectives, and then following the plan through to completion 6.2 From Objectives to Plans Successful acquisitions start with clear objectives; after all, it’s hard to measure success without them So, the acquirer’s management must be able to communicate and justify the purpose of its acquisitions If the deal is part of a wider strategy, where does it fit within this strategy, and why? If it is a stand-alone transaction, what does management hope to gain from the acquisition and how will it achieve this? The vaguer the objective, the lower the chance of success Strategy >>>> Objectives >>>> Barriers to success >>>> Plan >>>> Implementation These objectives should be SMART (Specific, Measurable, Achievable, Realistic and Timely) and they must be linked to the acquirer’s underlying strategy They must also be clearly communicated: firstly, to the deal advisers when the transaction is being identified and negotiated, and later, to line managers and employees once agreement has been reached and the integration must be justified In particular, it is essential that management should be clear as to their underlying M&A objectives and benchmarks for success when due diligence starts This ensures that they can brief the advisers to focus their investigations on the areas that are key to success, as well as making sure that advisers understand what issues would constitute a deal-breaker Any deal structure, such as an earn-out or incentive bonus scheme, should also be structured around the underlying deal objectives and be focused on minimising any threat to these 59 Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions Chapter Six: Successful M&A These objectives will also form the basis of the acquisition integration plan For example: • The corporate strategy is to gain market share The deal objective is to improve market share from 10% to 20% within two years The plan to achieve this is to consolidate the target and acquirer product lines, and combine the sales forces, eliminating overlaps in products and staffing The plan might include reducing the selling price to gain competitive advantage, or ensuring margins are retained by making selective redundancies • The corporate strategy is to create a vertically integrated business The deal objective is to reduce purchases of raw materials from third-party suppliers from 100% to 50% within one year, and improve group gross margins from, say, 25% to 45% in the same time period The plan is to invest in additional production facilities (so that the target can meet the acquirer’s raw material needs) and cancel or scale down third party supply contracts, replacing them with supplies sourced from the target at cost 6.1.1 Implementation Planning Success lies in planning ahead, and the acquirer’s management team should be developing their detailed implementation plan as the deal negotiations progress The implementation plan needs to consider the following main points: • What does success look like? The definition of success can include financial metrics – margins, EPS, share price, return on assets or an industry-specific measure However, it is useful to include non-financial benchmarks for success, such as headcount reduction, customer retention, or industry specific key performance indicators These non-financial benchmarks are much more easily built into management’s day-to-day action plan, creating clarity about the individual steps that need to be taken, and making it clear which individual members of the integration team are accountable for them • How far should the target be integrated into the acquirer’s business? The acquirer has four options: To allow the target full autonomy, so it continues to operate independently This will reduce the potential for synergies, but may work well in transactions where there are major cultural differences, or where the businesses are in very different regions or industries To impose financial controls alone (accounting, setting of performance targets, restrictions on investment, etc.) This may be the best method in a diversification strategy, or for cross-border deals where political and cultural barriers are an issue 60 Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions Chapter Six: Successful M&A To combine only those functions that are key to achieving the deal objectives – such as research and development, manufacturing, or sales and marketing If there is limited synergy or efficiency to be gained from full integration, this may be a simpler and more transparent approach To aim at full integration of the two businesses, so that they will be ‘merged’ at every level of the organisation This approach should achieve the greatest synergistic benefit, but it will also present the most difficulty and complexity • What are the potential barriers to success? Some of these are almost universal issues, found in very many deals, and may have been identified during due diligence These include such problems as resistance on the part of target staff, difficulty in integrating the businesses effectively, problems in integrating information or accounting systems, loss of key staff, customers or suppliers Some of the barriers are deal-specific: legal or regulatory barriers, historic rivalry at senior management level, or management with no integration expertise Either way, the acquirer must anticipate these barriers and take action to avoid them www.job.oticon.dk 61 Download free eBooks at bookboon.com Click on the ad to read more Introduction to Mergers & Acquisitions Chapter Six: Successful M&A Once these key issues have been decided, the detailed planning can start This should focus on the individual steps to be taken to achieve the deal goals The plan should identify priority actions, include deadlines and assign responsibility Priority should be given to ‘leverage’ changes: those that are quick to implement, and have a major impact on the ongoing business The plan should also link in to a communications schedule, so that staff and external investors can be kept up to date The more detail the plan includes, the more likelihood there is that all potential obstacles have been identified 6.1.3 Successful Integration There are two vital components to a successfully implemented integration plan These are timing, and communication Timing Many synergies are dependent on their timing to create value For example, if the plan incudes the sale of an office building within the first three months post-closing, then every month’s delay results in additional cost in the form of insurance, security, utilities, rent or interest expense, and of the course the cost of running two buildings The same applies to all forms of synergy, in that any delay in creating economic benefit reduces potential value Equally, the acquirer must maintain impetus to ensure that value is not destroyed through sheer inertia Plans that never come to fruition, deadlines missed, and commitments shelved, all undermine confidence in management and destroy value There are also certain dates where timely action is crucial in ensuring success • The announcement date In an ideal world, the deal parties would maintain confidentiality with regards the transaction until closing In many cases, however, rumour and speculation or regulation force an announcement before the acquirer is able to take control, and often before the transaction is even agreed Unless this situation is carefully handled, employees may face an extended period of uncertainty over the company’s future and their individual jobs, which can damage morale and create antagonism between two workforces The acquirer must take steps, without delay to : prevent internal rumour spreading, by implementing a communication programme; this is discussed below avoid loss of key staff use public relations and investor relations to ensure the acquisition strategy and rationale are clearly understood 62 Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions Chapter Six: Successful M&A • The closing date At closing, the acquirer takes legal control of the target and has a short window of opportunity to take operational control This will include financial control – transferring signing and budgetary authority – and the introduction of new reporting lines There is also a short window of opportunity here – some say just 48 hours – to take psychological control of the target, by clearly and unequivocally declaring the company’s new mission, standards and procedures, and ensuring all staff are informed officially of the integration process and the changes that are to be made • The first three months A study by consultants Ernst & Young and Warwick Business School in 1997 showed that the first 90 days of an acquisition are critical in determining success: “if [major changes] are not tackled in the first ninety days, they may not be tackled at all” Other studies set the figure at 100 days, or three months, but the consensus is that this early stage is critical Major initiatives that must be focused on include improving terms of business with customers and suppliers; managing difficult staffing issues (including introducing a fair, transparent procedure for redundancies if required); eliminating head office cost duplications; and IT systems integration Communication Acquisitions are dependent for their success on the co-operation and support of a wide range of stakeholders, including employees, customers, suppliers, managers, bankers and shareholders Clear and effective communication with these stakeholders is a vital part of the integration process We’ve already mentioned the damage that can be caused by gossip, rumour and speculation, and these breed in an information vacuum A communication programme should be part of the integration plan, and it should involve senior, respected, articulate managers to communicate internally (to staff) and externally (to external stakeholders) Some of the tools that can be used are: • Using a staff intranet, to be updated regularly, together with FAQs covering, for example, the M&A process, redundancy procedures, and including core documentation such as deal documents in public deals, personnel policies, press statements This should be introduced as soon as the transaction is first announced, even if it is not yet completed • A confidential helpline for staff who have concerns about their own employment status • Company or divisional ‘town hall meetings’ to provide formal updates on the transaction or integration process, and provide a forum for questions • Recognised deal ‘champions’ with regional communication responsibility for each operating area and available for questions • Regular analyst briefings, shareholder updates and investor meetings, where appropriate 63 Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions Chapter Six: Successful M&A Communication is particularly important at each of the critical stages mentioned above (announcement, closing and the first three months) as these are the times at which stakeholder support can most easily be lost or won If the acquirer can explain the logic of the underlying transaction, and the benefits to stakeholders, and can then show that a fair and transparent process is being used for the integration, where staff, customers and employees are sufficiently respected to be kept informed at all stages, then this will go a long way towards gaining stakeholder co-operation with the deal implementation Conclusion Much has been written about success and failure in acquisitions, and there are many elements that go towards making a ‘good’ deal Underlying all successful acquisitions, however, are sound commercial logic; prudent pricing and structure; and a carefully planned, professionally executed implementation plan 64 Download free eBooks at bookboon.com Click on the ad to read more Introduction to Mergers & Acquisitions Appendix – Selected Bibliography Appendix – Selected Bibliography Success and failure in M&A Bain & Company: The Renaissance in Mergers & Acquisitions series by David Harding, Satish Shankar and Richard Jackson: 2013 McKinsey: A new generation of M&A: June 2010 KPMG: The determinants of M&A success: what factors contribute to deal success? February 2010 Michael E Porter: From Competitive Advantage to Corporate Strategy (Harvard Business Review, 1987) Richard P Rumelt: Diversification Strategy and Profitability (Strategic Management Journal, 1982) Nancy Hubbard: Acquisition Strategy and Implementation (Macmillan, 1999) Sudi Sudarsanam: Creating Value from Mergers and Acquisitions (Pearson Education, 2010) Ernst & Young and Warwick Business School: The First 90 Days: a joint research project (1997) Valuation in M&A Bookboon: Company Valuation and Share Price Bookboon: Company Valuation and Takeover Deal Structures CMS Cameron McKenna: CMS European M&A Study (published annually) 65 Download free eBooks at bookboon.com ...Kate Creighton Introduction to Mergers & Acquisitions Download free eBooks at bookboon.com Introduction to Mergers & Acquisitions 1st edition © 2013 Catherine Lucy Walker & bookboon.com ISBN... bookboon.com Click on the ad to read more Introduction to Mergers & Acquisitions Chapter One Chapter One 1.1 What is M&A? The term mergers and acquisitions refers to the buying and selling –... www.deloitte.ca/careers Click on the ad to read more Download free eBooks at bookboon.com © Deloitte & Touche LLP and affiliated entities Dis Introduction to Mergers & Acquisitions Contents Chapter Three