Ottawa University Mergers and Acquisitions Summary

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Mergers, Acquisitions,
and Corporate
Restructurings
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Mergers, Acquisitions,
and Corporate
Restructurings
Seventh Edition
PATRICK A. GAUGHAN
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Copyright © 2018 by John Wiley & Sons, Inc. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
The Sixth Edition was published by John Wiley & Sons, Inc. in 2015.
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Library of Congress Cataloging-in-Publication Data:
Names: Gaughan, Patrick A., author.
Title: Mergers, acquisitions, and corporate restructurings / Patrick A. Gaughan.
Description: Seventh edition. | Hoboken : Wiley, 2017. | Series: Wiley corporate F&A |
Revised edition of the author’s Mergers, acquisitions, and corporate restructurings, 2015. |
Includes index. |
Identifiers: LCCN 2017034914 (print) | LCCN 2017036346 (ebook) |
ISBN 9781119380757 (pdf) | ISBN 9781119380733 (epub) |
ISBN 9781119380764 (hardback) | ISBN 9781119380757 (ePDF)
Subjects: LCSH: Consolidation and merger of corporations. | Corporate reorganizations. |
BISAC: BUSINESS & ECONOMICS / Accounting / Managerial.
Classification: LCC HD2746.5 (ebook) | LCC HD2746.5 .G38 2017 (print) |
DDC 658.1/6—dc23
LC record available at https://lccn.loc.gov/2017034914
Cover Design: Wiley
Cover Image: © Image Source RF/Alan Schein
Printed in the United States of America.
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Contents
Preface
xi
PART I: BACKGROUND
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Chapter 1: Introduction
3
Recent M&A Trends
Terminology
Valuing a Transaction
3
11
13
Types of Mergers
Merger Consideration
13
14
Merger Professionals
Merger Arbitrage
Leveraged Buyouts and the Private Equity Market
Corporate Restructuring
Merger Negotiations
Deal Structure: Asset versus Entity Deals
Merger Agreement
Merger Approval Procedures
Deal Closing
Short-Form Merger
15
18
19
20
21
24
28
29
31
31
Freezeouts and the Treatment of Minority Shareholders
Appraisal Arbitrage
Reverse Mergers
32
33
34
Chapter 2: History of Mergers
41
Merger Waves
First Wave, 1897–1904
Second Wave, 1916–1929
The 1940s
Third Wave, 1965–1969
41
43
48
49
49
Trendsetting Mergers of the 1970s
54
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Fourth Wave, 1984–1989
59
Fifth Wave, 1992–2001
Sixth Wave, 2004–2007
64
68
Chapter 3: Legal Framework
71
Laws Governing Mergers, Acquisitions, and Tender Offers
Other U.S. Takeover Rules
Takeovers and International Securities Laws
U.S. State Corporation Laws and Legal Principles
State Antitakeover Laws
72
85
86
96
99
Regulation of Insider Trading
Antitrust Laws
108
110
Measuring Concentration and Defining Market Share
117
Example of the HH Index
European Competition Policy
118
121
Research Note: Event Studies Methodology
M&A Research: Event Studies
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124
124
Chapter 4: Merger Strategy
127
Growth
Synergy
Operating Synergy
127
136
138
Diversification
Focus Hypothesis
146
151
Possible Explanation for the Diversification Discount
152
Do Diversified or Focused Firms Do Better Acquisitions?
Other Economic Motives
156
157
Hubris Hypothesis of Takeovers
Do Managerial Agendas Drive M&A?
Other Motives
168
171
176
PART II: HOSTILE TAKEOVERS
Chapter 5: Antitakeover Measures
183
Management Entrenchment Hypothesis versus Stockholder
Interests Hypothesis
184
Rights of Targets’ Boards to Resist: United States Compared to the
Rest of the World
185
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◾
vii
Preventative Antitakeover Measures
Poison Pills
Corporate Charter Amendments
186
187
199
Changing the State of Incorporation
210
Active Antitakeover Defenses
211
Information Content of Takeover Resistance
234
Chapter 6: Takeover Tactics
237
Preliminary Takeover Steps
238
Tender Offers
245
Advantages of Tender Offers over Open Market Purchases
Proxy Fights
260
267
Chapter 7: Hedge Funds as Activist Investors
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279
Macroeconomic Foundations of the Growth of Activist Funds
Leading Activist Hedge Funds and Institutional Investors
Hedge Funds as Acquirers
281
282
288
Hedge Fund Activism and Firm Performance
Buyout Premiums: Activist Hedge Funds versus Private Equity Firms
292
294
PART III: GOING-PRIVATE TRANSACTIONS AND LEVERAGED
BUYOUTS
Chapter 8: Leveraged Buyouts
305
Terminology
Historical Trends in LBOs
Management Buyouts
305
306
314
Conflicts of Interest in Management Buyouts
318
U.S. Courts’ Position on Leveraged Buyout Conflicts
319
Financing for Leveraged Buyouts
328
Returns to Stockholders from LBOs
336
Returns to Stockholders from Divisional Buyouts
337
Empirical Research on Wealth Transfer Effects
342
Protection for Creditors
343
Intra-Industry Effects of Buyouts
344
Chapter 9: The Private Equity Market
History of the Private Equity and LBO Business
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Private Equity Market
346
Computing Private Equity Internal Rates of Return
360
Characteristics of Private Equity Returns
Replicating Private Equity Investing
361
365
Board Interlocks and Likelihood of Targets to Receive Private Equity
Bids
366
Secondary Market for Private Equity Investments
366
Chapter 10: High-Yield Financing and the Leveraged
Loan Market
History of the Junk Bond Market
Leveraged Loan Market
Stapled Financing
369
369
380
383
PART IV: CORPORATE RESTRUCTURING
Chapter 11: Corporate Restructuring
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389
Divestitures
392
Divestiture and Spinoff Process
403
Managerial Ownership and Sell-Off Gains
408
Activists and Sell-Offs
408
Shareholder Wealth Effects of Spinoffs: U.S. versus Europe
Equity Carve-Outs
Voluntary Liquidations or Bust-Ups
Tracking Stocks
417
424
430
431
Master Limited Partnerships and Sell-Offs
433
Chapter 12: Restructuring in Bankruptcy
437
Types of Business Failure
438
Causes of Business Failure
Bankruptcy Trends
U.S. Bankruptcy Laws
Reorganization versus Liquidation
Reorganization Process
439
444
448
449
450
Benefits of the Chapter 11 Process for the Debtor
Prepackaged Bankruptcy
Workouts
457
461
465
Corporate Control and Default
Liquidation
470
471
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Investing in the Securities of Distressed Companies
Chapter 13: Corporate Governance
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472
477
Structure of Corporations and Their Governance
CEO Severance Payments
Managerial Compensation, Mergers, and Takeovers
CEO Compensation and Power
Golden Parachutes
477
494
494
495
499
Compensation Characteristics of Boards That Are More Likely to
Keep Agency Costs in Check
501
Role of the Board of Directors
Antitakeover Measures and Board Characteristics
502
512
Disciplinary Takeovers, Company Performance, CEOs, and Boards
Merger Strategy and Corporate Governance
CEO Compensation and M&A Programs
515
516
516
Do Boards Reward CEOs for Initiating Acquisitions and Mergers?
516
CEO Compensation and Diversification Strategies
517
Agency Costs and Diversification Strategies
518
Interests of Directors and M&As
Managerial Compensation and Firm Size
519
520
Corporate Control Decisions and Their Shareholder Wealth Effects
Does Better Corporate Governance Increase Firm Value?
Corporate Governance and Competition
521
522
523
Executive Compensation and Postacquisition Performance
524
Mergers of Equals and Corporate Governance
525
Chapter 14: Joint Ventures and Strategic Alliances
Contractual Agreements
Comparing Strategic Alliances and Joint Ventures with Mergers
and Acquisitions
Joint Ventures
Strategic Alliances
Chapter 15: Valuation
535
535
536
536
542
551
Valuation Methods: Science or Art?
553
Managing Value as an Antitakeover Defense
553
Benchmarks of Value
How the Market Determines Discount Rates
554
566
Valuation of the Target’s Equity
579
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Marketability of the Stock
Takeovers and Control Premiums
579
583
Valuation of Stock-for-Stock Exchanges
588
Shareholder Wealth Effects and Methods of Payment
Exchange Ratio
589
595
Fixed Number of Shares versus Fixed Value
602
Merger Negotiations and Stock Offers: Halliburton versus Baker
Hughes
603
International Takeovers and Stock-for-Stock Transactions
603
Desirable Financial Characteristics of Targets
604
Chapter 16: Tax Issues in M&A
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Financial Accounting for M&As
Taxable versus Tax-Free Transactions
614
614
Tax Consequences of a Stock-for-Stock Exchange
Asset Basis Step-Up
Changes in the Tax Laws
617
618
619
Role of Taxes in the Merger Decision
620
Role of Taxes in the Choice of Sell-Off Method
Organizational Form and M&A Premiums
Capital Structure and Propensity to Engage in Acquisitions
622
622
623
Taxes as a Source of Value in Management Buyouts
Miscellaneous Tax Issues
624
625
Glossary
Index
631
643
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Preface
T
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he field of mergers and acquisitions has undergone tumultuous changes over the
past four decades. The fourth merger wave of the 1980s featured a fascinating
period of many hostile deals and leveraged buyouts along with many more “plain
vanilla” deals. The 1990s witnessed the fifth merger wave—a merger wave that was
truly international in scope. After a brief recessionary lull, the merger frenzy began once
again and global megamergers began to fill the corporate landscape. This was derailed by
the subprime crisis and the Great Recession. When the economic recovery was initially
slow, so too was the rebound in M&A activity. However, by 2013 and 2014, M&A volume
rebounded strongly and has continued in the years that followed.
Over the past quarter of a century, we have noticed that merger waves have become
more frequent. The time periods between waves also has shrunken. When these trends
are combined with the fact that M&A has rapidly spread across the modern world, we
see that the field is increasingly becoming an ever more important part of the worlds of
corporate finance and corporate strategy.
As the field has evolved we see that many of the methods that applied to deals of
prior years are still relevant, but new techniques and rules are also in effect. These new
methods and techniques consider the mistakes of prior periods along with the current
economic and financial conditions. Participants in M&As tend to be an optimistic lot and
often focus on the upside of deals while avoiding important issues that can derail a transaction. There are many great lessons that can be learned from the large history of M&As
that is available. What is interesting is that, as with many other areas of finance, learning
from past mistakes proves challenging. Lessons that are learned tend to be short-lived.
For example, the failures of the fourth merger wave of the 1980s were so pronounced
that corporate decision makers loudly proclaimed that they would never enter into such
foolish transactions. However, there is nothing like a stock market boom to render past
lessons difficult to recall while bathing in the euphoria of rising equity values.
The focus of this book is decidedly pragmatic. We have attempted to write it in a
manner that will be useful to both the business student and the practitioner. Since the
world of M&A is clearly interdisciplinary, material from the fields of law and economics
is presented along with corporate finance, which is the primary emphasis of the book.
The practical skills of finance practitioners have beenintegrated with the research of the
academic world of finance. In addition, we have an expanded chapter devoted to the valuation of businesses, including the valuation of privately held firms. This is an important
topic that tends not to receive the attention it needs, as a proper valuation can be the
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◾ Preface
key between a successful and a failed transaction. Much of the finance literature tends
to be divided into two camps: practitioners and academicians. Clearly, both groups have
made valuable contributions to the field of M&As. This book attempts to interweave these
contributions into one comprehensible format.
The increase in M&A activity has given rise to the growth of academic research in
this area. In fact, M&A seems to generate more research than other areas of finance.
This book attempts to synthesize some of the more important and relevant research
studies and to present their results in a straightforward and pragmatic manner. Because
of the voluminous research in the field, only the findings of the more important studies
are highlighted. Issues such as shareholder wealth effects of antitakeover measures
have important meanings to investors, who are concerned about how the defensive
actions of corporations will affect the value of their investments. This is a good example
of how the academic research literature has made important pragmatic contributions
that have served to shed light on important policy issues. It is unfortunate that
corporate decision makers are not sufficiently aware of the large body of pragmatic,
high-quality research that exists in the field of M&A. It is amazing that senior managers
and the boards regularly approve deals or take other actions in supporting or opposing
a transaction without any knowledge on the voluminous body of high-quality research
on the effects of such actions. One of the contributions we seek to make with this book
is to render this body of pragmatic research readily available, understandable, and
concisely presented. It is hoped, then, that practitioners can use it to learn the impacts
of the deals of prior decision makers.
We have avoided incorporating theoretical research that has less relevance to those
seeking a pragmatic treatment of M&As. However, in general, much of M&A research
has a pragmatic focus. For decision makers, this research contains a goldmine of knowledge. The peer-reviewed research process has worked to produce a large volume of quality studies that can be invaluable to practitioners who will access it. We have endeavored
to integrate the large volume of ongoing research into an expansive treatment of the
field. The rapidly evolving nature of M&As requires constant updating. Every effort has
been made to include recent developments occurring just before the publication date.
We wish the reader an enjoyable and profitable trip through the world of M&As.
Patrick A. Gaughan
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I
PAR T ONE
Background
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Mergers, Acquisitions, and Corporate Restructurings, Seventh Edition. Patrick A. Gaughan.
© 2018 John Wiley & Sons, Inc. Published 2018 by John Wiley & Sons, Inc.
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1
CHAPTER ONE
Introduction
RECENT M&A TRENDS
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The pace of mergers and acquisitions (M&As) picked up in the early 2000s after
collapsing in the wake of the subprime crisis. M&A volume was quite strong over the
period 2003–2007. This strength was apparent globally, not just in the United States.
However, the United States entered the Great Recession in 2008 and the recovery from
this strong economic downturn would prove difficult. A number of deals that were
planned in 2007 were canceled.
Figure 1.1 shows that the aforementioned strong M&A volume over the years 2003
to 2007 occurred in both Europe and the United States. M&A volume began to rise in
2003 and by 2006–2007 had reached levels comparable to their peaks of the fifth wave.
With such high deal volume, huge megamergers were not unusual (see Tables 1.1 and
1.2). In the United States, M&A dollar volume peaked in 2007, whereas in Europe, this
market peaked in 2006. Fueled by some inertia, the value of total M&A was surprisingly
strong in 2008 when one considers that we were in the midst of the Great Recession.
The lagged effect of the downturn, however, was markedly apparent in 2009 when M&A
volume collapsed.
The rebound in U.S. M&A started in 2010 and became quite strong in 2011, only to
weaken temporarily in 2012 before resuming in 2013. The U.S. M&A market was very
strong in 2014, and in 2015 it hit an all-time record, although, on an inflation-adjusted
basis, 2000 was the strongest M&A year. In 2016, the M&A market was still strong in
the United States, although somewhat weaker than 2015.
The story was quite different in Europe. After hitting an all-time peak in 2006 (it
should be noted, though, that on an inflation-adjusted basis, 1999 was the all-time
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Mergers, Acquisitions, and Corporate Restructurings, Seventh Edition. Patrick A. Gaughan.
© 2018 John Wiley & Sons, Inc. Published 2018 by John Wiley & Sons, Inc.
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◾ Introduction
4
Value of Europe M&A: 1980–2016
1,500,000
1,500,000
$ Millions
2,000,000
1,000,000
1,000,000
500,000
0
0
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
500,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
Average Value of U.S. M&A Deals: 1980–2016
350.0
Average Value of Europe M&A Deals: 1980–2016
$ Millions
300.0
250.0
200.0
150.0
k
100.0
50.0
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
0.0
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
k
Number of Europe M&A Deals: 1980–2016
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
Number
900.0
800.0
700.0
600.0
500.0
400.0
300.0
200.0
100.0
0.0
Number of U.S. M&A Deals: 1980–2016
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
Number
5,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
$ Millions
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
$ Millions
Value of U.S. M&A: 1980–2016
2,000,000
(a)
(b)
FIGURE 1.1
Value of M&As 1980–2016: (a) United States and (b) Europe.
peak in M&A for Europe), the market weakened a little in 2007 and 2008, although
it was still relatively strong. However, Europe’s M&A business shrank dramatically in
2009 and 2010 as Europe was affected by the U.S. Great Recession and also its financial
system also suffered from some of the same subprime-related issues that affected the U.S.
financial system.
The M&A business rebounded well in 2011, only to be somewhat blunted by a
double-dip recession in Europe, which was partly caused by the European sovereign
debt problems. The Eurozone had a 15-month recession from the second quarter of
2008 into the second quarter of 2009, but then had two more downturns from the
fourth quarter of 2011 into the second quarter of 2012 (9 months) and again from
the fourth quarter of 2012 into the first quarter of 2013 (18 months). M&A volume
was more robust in 2015 and 2016 but unlike in the United States, Europe remained
well below the level that was set in 2006.
k
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11/30/1999
12/27/2000
12/1/1998
1/17/2000
107,649.95
75,960.85
78,945.79
89,167.72
98,189.19
101,100.89
SmithKline Beecham PLC
Mobil Corp
Warner-Lambert Co
ABN-AMRO Holding NV
SABMiller PLC
Philip Morris Intl Inc
Verizon Wireless Inc
Altice SA
Time Warner
Mannesmann AG
Target Name
Source: Thomson Financial Securities Data, January 12, 2017.
11/2/2007
6/19/2000
10/4/2016
9/16/2015
11/4/1999
3/28/2008
8/29/2007
130,298.32
145,709.25
164,746.86
202,785.13
Value of Transaction
($ Millions)
k
4/25/2007
8/9/2015
2/21/2014
6/26/2015
9/2/2013
4/12/2000
1/12/2001
11/14/1999
1/10/2000
Date
Effective
Top 10 Worldwide M&As by Value of Transaction
Date
Announced
TABLE 1.1
Exxon Corp
Glaxo Wellcome PLC
United States
United Kingdom
Netherlands
RFS Holdings BV
Pfizer Inc
Shareholders
Anheuser-Busch Inbev SA/NV
Switzerland
United Kingdom
Netherlands
Switzerland
Belgium
Verizon Communications Inc
United States
United States
United States
Altice SA
Luxembourg
United Kingdom
United Kingdom
United States
United States
Luxembourg
United States
Vodafone AirTouch PLC
America Online Inc
United States
Acquirer Nation
Germany
Acquirer Name
Target Nation
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5
06/19/00
8/9/2015
03/28/08
10/4/2016
11/02/07
12/27/00
07/20/08
02/15/16
09/01/15
07/22/08
11/14/99
6/26/2015
08/29/07
9/16/2015
04/25/07
01/17/00
10/28/04
04/08/15
6
k
09/29/14
02/25/06
60,856.45
65,891.51
69,445.02
74,558.58
75,960.85
98,189.19
101,100.89
107,649.95
145,709.25
202,785.13
Value of Transaction
($mil)
Royal Dutch Petroleum Co
Royal Dutch Shell PLC
UBS AG
Gaz de France SA
United Kingdom
United Kingdom
Switzerland
France
Suez SA
UBS AG
BG Group PLC
Shell Transport & Trading Co
Netherlands
RFS Holdings BV
Glaxo Wellcome PLC
Netherlands
United Kingdom
France
Switzerland
Netherlands
Netherlands
United Kingdom
Switzerland
Belgium
Anheuser-Busch Inbev SA/NV
United Kingdom
Luxembourg
Altice SA
Shareholders
United Kingdom
Luxembourg
Vodafone AirTouch PLC
Germany
Acquirer Nation
Switzerland
Acquirer Name
Target Nation
SmithKline Beecham PLC
ABN-AMRO Holding NV
SABMiller PLC
Philip Morris Intl Inc
Altice SA
Mannesmann AG
Target Name
k
Source: Thomson Financial Securities Data, January 12, 2017.
Date
Effective
Top 10 European M&As by Value of Transaction
Date
Announced
TABLE 1.2
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Recent M&A Trends
200,000
150,000
$ Millions
150,000
50,000
100,000
50,000
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
100,000
150,000
$ Millions
200,000
China
$ Millions
200,000
100,000
7
Japan
Australia
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
$ Millions
200,000
◾
South Korea
150,000
100,000
50,000
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
50,000
Hong Kong
200,000
100,000
50,000
k
150,000
100,000
50,000
India
150,000
100,000
50,000
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
$ Millions
200,000
Taiwan
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
$ Millions
150,000
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
$ Millions
200,000
FIGURE 1.2 Value of M&A 1984–2016: By nation. Source: Thomson Financial Securities
Data, January 12, 2017.
Deal volume in most regions of the world generally tends to follow the patterns in
the United States and Europe (see Figure 1.2). Australia, for example, exhibits such a
pattern, with deal volume growth starting in 2003 but falling off in 2008 and 2009 for
the same reason it fell off in the United States and Europe. Australian deals rebounded
in 2013 and have grown since except for a modest decline in 2016.
The situation was somewhat different in China and Hong Kong. The value of deals in
these economies has traditionally been well below the United States and Europe but had
been steadily growing even in 2008, only to fall off sharply in 2009. China’s economy
has realized double-digit growth for a number of years and is now more than one-half of
the size of the U.S. economy (although on a purchasing power parity basis it is approximately the same size). Economic growth slowed in recent years from double-digit levels
to just under 7% per year even with significant government efforts to try to return to
prior growth levels.
k
k
Date
Effective
08/25/14
06/03/15
08/17/00
11/13/00
10/15/08
06/03/15
10/31/15
12/31/12
11/17/08
07/25/07
Date
Announced
03/26/14
01/09/15
02/29/00
10/04/00
05/25/08
01/09/15
10/14/15
08/22/12
8
k
05/12/08
04/11/07
Source: Thomson Financial Securities Data, January 12, 2017.
SK Corp-Petrochemical Business
St George Bank Ltd
China Telecom Corp-3G Assets
China-Telecommun Tower Assets
Huchinson Whampoa Ltd
China Netcom Grp (HK) Corp Ltd
Beijing Mobile, 6 others
Cable & Wireless HKT
Cheung Kong (Hldg) Ltd-Ppty
CITIC Ltd
South Korea
Australia
China
China
Hong Kong
Hong Kong
China
Hong Kong
Hong Kong
China
Target Nation
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Target Name
Top 10 Asian M&A by Value of Transaction
TABLE 1.3
China
China
Australia
South Korea
China Tower Corp
China Telecom Corp Ltd
Westpac Banking Corp
Shareholders
25,416.14
Hong Kong
Hong Kong
Hong Kong
China Telecom Hong Kong Ltd
China Unicom Ltd
Hong Kong
Pacific Century CyberWorks Ltd
Cheung Kong (Holdings) Ltd
34,161.79
Hong Kong
Shareholders
16,984.45
17,932.98
18,047.28
18,349.33
23,639.61
37,442.15
36,890.56
42,247.47
Hong Kong
CITIC Pacific Ltd
Value of
Transaction ($mil)
Acquirer Nation
Acquirer Name
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Recent M&A Trends
◾
9
There are many regulatory restrictions imposed on M&As in China that inhibit deal
volume from rising to levels that would naturally occur in a less-controlled environment.
The Chinese regulatory authorities have taken measures to ensure that Chinese control of certain industries and companies is maintained even as the economy moves to a
more free market status. This is why many of the larger Asian deals find their origins in
Hong Kong (see Table 1.3). Nonetheless, the M&A business in China over the past few
years has been at its highest levels. While Chinese demand for foreign targets rose to
impressive heights in 2016, in the second half of 2016 and 2017 the Chinese government took measures to limit capital from leaving China—something that is necessary
to complete most foreign deals. Financing for such deals became more difficult, and the
Chinese Commerce Ministry began taking a hard line on some large deals.
In Hong Kong, the number of deals has been rising over the past three years and the
outlook remains positive. The same is true of Taiwan and South Korea.
The M&A business has been increasing in India, as that nation’s economy continues
to grow under the leadership of its very probusiness Prime Minister Modi. The demographics of the Indian economy imply future economic growth, and are the opposite of
Japan. This helps explain why the Japanese economy has been in the doldrums for the
past couple of decades. Since 2011, M&A volume in Japan has been steady, but without
major growth or a return to the pre-subprime crisis days.
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VODAFONE TAKEOVER OF MANNESMANN:
LARGEST TAKEOVER IN HISTORY
V
odafone Air Touch’s takeover of Mannesmann, both telecom companies (and
actually alliance partners), is noteworthy for several reasons in addition to the
fact that it is the largest deal of all time (see Table 1.1). Vodafone was one of the
world’s largest mobile phone companies and grew significantly when it acquired Air
Touch in 1999. This largest deal was an unsolicited hostile bid by a British company
of a German firm. The takeover shocked the German corporate world because
it was the first time a large German company had been taken over by a foreign
company—and especially in this case, as the foreign company was housed in Britain
and the two countries had fought two world wars against each other earlier in
the century. Mannesmann was a large company with over 100,000 employees and
had been in existence for over 100 years. It was originally a company that made
seamless tubes, but over the years had diversified into industries such as coal and
steel. In its most recent history, it had invested heavily in the telecommunications
industry. Thus, it was deeply engrained in the fabric of the German corporate world
and economy.
It is ironic that Vodafone became more interested in Mannesmann after the
latter took over British mobile phone operator Orange PLC. This came as a surprise
to Vodafone, as Orange was Vodafone’s rival, being the third-largest mobile operator
in Great Britain. It was also a surprise as Vodafone assumed that Mannesmann would
pursue alliances with Vodafone, not move into direct competition with it by acquiring
one of its leading rivals.a
Mannesmann tried to resist the Vodafone takeover, but the board ultimately
agreed to the generous price paid. The Mannesmann board tried to get Vodafone
(continued )
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◾ Introduction
(continued )
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to agree to maintain the Mannesmann name after the completion of the deal. It
appeared that Vodafone would do so, but eventually they chose to go with the
Vodafone name—something that made good sense in this age of globalization, as
maintaining multiple names would inhibit common marketing efforts.
Up until the mid-1990s, Germany, like many European nations, had a limited
market for corporate control. The country was characterized as having corporate
governance institutions, which made hostile takeovers difficult to complete. However, a number of factors began to change, starting in the second half of the 1990s
and continuing through the 2000s. First, the concentration of shares in the hands of
parties such as banks, insurance companies, and governmental entities, which were
reluctant to sell to hostile bidders, began to decline. In turn, the percentage of
shares in the hands of more financially oriented parties, such as money managers,
began to rise. Another factor that played a role in facilitating hostile deals is that
banks had often played a defensive role for target management. They often held
shares in the target and even maintained seats on the target’s board and opposed
hostile bidders while supporting management. One of the first signs of this change
was apparent when WestLB bank supported Krupp in its takeover of Hoesch in 1991.
In the case of Mannesmann, Deutsche Bank, which had been the company’s bank
since the late 1800s,b had a representative on Mannesmann’s board but he played
no meaningful role in resisting Vodafone’s bid. Other parties who often played a
defensive role, such as representatives of labor, who often sit on boards based on
what is known as codetermination policy, also played little role in this takeover.
The position of target shareholders is key in Germany, as antitakeover measures
such as poison pills (to be discussed at length in Chapter 5) are not as effective
due to Germany’s corporate law and the European Union (EU) Takeover Directive,
which requires equal treatment of all shareholders. However, German takeover law
includes exceptions to the strict neutrality provisions of the Takeover Directive,
which gives the target’s board more flexibility in taking defensive measures.
It is ironic that Vodafone was able to take over Mannesmann, as the latter
was much larger than Vodafone in terms of total employment and revenues. However, the market, which was at that time assigning unrealistic values to telecom
companies, valued Mannesmann in 1999 at a price/book ratio of 10.2 (from 1.4
in 1992) while Vodafone had a price/book ratio of 125.5 in 1999 (up from 7.7 in
1992).c This high valuation gave Vodafone “strong currency” with which to make a
stock-for-stock bid that was difficult for Mannesmann to resist.
The takeover of Mannesmann was a shock to the German corporate world.
Parties that were passive began to become more active in response to a popular
outcry against any further takeover of German corporations. It was a key factor in
steeling the German opposition to the EU Takeover Directive, which would have
made such takeovers easier.
a
Simi Kidia, “Vodafone Air Touch’s Bid for Mannesmann,” Harvard Business School Case
Study #9-201-096, August 22, 2003.
b
Martin Hopner and Gregory Jackson, “More In-Depth Discussion of the Mannesmann
Takeover,” Max Planck Institut für Gesellschaftsforschung, Cologne, Germany, January 2004.
c
Martin Hopner and Gregory Jackson, “Revisiting the Mannesmann Takeover: How Markets
for Corporate Control Emerge,” European Management Review 3 (2006): 142–155.
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Terminology
Central America (1985–2016)
100
Number
$ Millions
40,000
30,000
20,000
10,000
80
60
40
20
85
90
95
00
05
10
85
15
South America (1985–2016)
120,000
100,000
80,000
Number
$ Millions
11
Central American M&A Deals: 1985–2016
120
50,000
◾
60,000
40,000
20,000
85
90
95
00
05
10
15
90
95
00
05
10
15
South American M&A Deals: 1985–2016
500
450
400
350
300
250
200
150
100
50
85
90
95
00
05
10
15
FIGURE 1.3 Central America and South America, 1985–2016. Source: Thomson Financial
Securities Data, January 12, 2017.
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The total volume of deals in South and Central America (see Figure 1.3 and
Table 1.4) is small compared to the United States and Europe. South America has been
relatively weak in recent years. Argentina has experienced years of economic problems
and only now has a pro-business president, Mauricio Macri, who faces major challenges
trying to undo the effects of years of poorly thought out economic policies. Brazil, once
the powerhouse of South American M&A, has been rocked by a recessionary economy
that has been badly hurt by falling commodity prices and political scandals.
In considering the combined Central America and Mexico market, the larger deals
are attributable to Mexico. Mexico had been undergoing something of an economic
resurgence with annual growth as high as 5.1% in 2010. This growth had been
boosted by recent attempts to deregulate major industries, such as petroleum and
telecommunications, while fostering greater competition. Factors such as falling
commodity prices have slowed Mexican economic growth to a little over 2%. This has
contributed to weak M&A volume in the combined Mexico/Central America region.
TERMINOLOGY
A merger differs from a consolidation, which is a business combination whereby two or
more companies join to form an entirely new company. All of the combining companies
are dissolved and only the new entity continues to operate. One classic example of a consolidation occurred in 1986 when the computer manufacturers Burroughs and Sperry
combined to form Unisys. A more recent example of a consolidation occurred in 2014
when Kinder Morgan consolidated its large oil and gas empire. It had Kinder Morgan,
k
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12
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17,995.711
17,807.347
16,170.822
15,098.655
06/04/13
06/16/10
06/10/08
02/07/01
9,742.793
05/28/15
Acquirer Name
America Movil SA de CV
Anheuser-Busch Mexico Holding
America Movil SA de CV
Shareholders
Shareholders
Target Nation
Mexico
Mexico
Mexico
Mexico
Mexico
BM&F
Telefonica SA
Telefonica Brasil SA
Brazil
Brazil
Brazil
Bovespa Holding SA
Telecummunicacoes de Sao Paulo
GVT Participacoes SA
Brazil
Spain
Brazil
Spain
Brazil
Petro Brasileiro SA
Repsol SA
Acquirer Nation
Mexico
Mexico
Mexico
Mexico
Mexico
Acquirer Nation
Acquirer Name
Brazil
Target Nation
Argentina
YPF SA
Brazil-Oil & Gas Blocks
Target Name
Top 5 South American M&A by Value of Transaction
America Movil SA
Telmex Internacional SAB de CV
Carso Global Telecom SAB de CV
Crupo Modelo SAB de CV
America Telecom SA de CV
Target Name
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Source: Thomson Financial Securities Data, January 12, 2017.
10,309.087
10,213.310
05/08/08
06/24/99
07/10/00
42,877.032
13,151.700
09/29/10
Value of Transaction ($mil)
31,756.677
01/19/07
Date Effective
Value of Transaction ($mil)
Top 5 Central American M&A by Value of Transaction
Top 5 Central American M&A by Value of Transaction, Top 5 South American M&A by Value of Transaction
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Date Effective
TABLE 1.4
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Types of Mergers
◾
13
Inc., acquire Kinder Morgan Energy Part LP, Kinder Morgan Management LLC, and El
Paso Pipeline Partners LP. The acquired entities were master limited partnerships that
provided certain tax benefits but that limited the ability of the overall business to grow
and do larger M&As.
In a consolidation, the original companies cease to exist and their stockholders
become stockholders in the new company. One way to look at the differences between
a merger and a consolidation is that with a merger, A + B = A, where company B is
merged into company A. In a consolidation, A + B = C, where C is an entirely new
company. Despite the differences between them, the terms merger and consolidation,
as is true of many of the terms in the M&A field, are sometimes used interchangeably.
In general, when the combining firms are approximately the same size, the term
consolidation applies; when the two firms differ significantly in size, merger is the more
appropriate term. In practice, however, this distinction is often blurred, with the term
merger being broadly applied to combinations that involve firms of both different and
similar sizes.
VALUING A TRANSACTION
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Throughout this book, we cite various merger statistics on deal values. The method used
by Mergerstat is the most common method relied on to value deals. Enterprise value is
defined as the base equity price plus the value of the target’s debt (including both shortand long-term) and preferred stock less its cash. The base equity price is the total price
less the value of the debt. The buyer is defined as the company with the larger market
capitalization or the company that is issuing shares to exchange for the other company’s
shares in a stock-for-stock transaction.
TYPES OF MERGERS
Mergers are often categorized as horizontal, vertical, or conglomerate. A horizontal
merger occurs when two competitors combine. For example, in 1998, two petroleum
companies, Exxon and Mobil, combined in a $78.9 billion megamerger. Another
example was the 2009 megamerger that occurred when Pfizer acquired Wyeth for
$68 billion. If a horizontal merger causes the combined firm to experience an increase
in market power that will have anticompetitive effects, the merger may be opposed
on antitrust grounds. In recent years, however, the U.S. government has been somewhat liberal in allowing many horizontal mergers to go unopposed. In Europe, the
European Commission has traditionally been somewhat cautious when encountering
mergers that may have anticompetitive effects or that may create strong competitors of
European companies.
Vertical mergers are combinations of companies that have a buyer-seller relationship. A good example is the U.S. eyeglasses industry. One company, an Italian
manufacturer, Luxottica, expanded into the U.S. market through a series of acquisitions.
It was able to acquire retailers such as LensCrafters and Sunglasses Hut, as well as
major brands such as Ray-Ban and Oakley. It is surprising to some that the company
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◾ Introduction
was allowed by regulators to assume the large vertical position it enjoys in the U.S.
eyeglasses market.1 In 2017, Luxottica announced it planned to merge (pending
global antitrust approval) with the French lens company Essilor, creating a $49 billion
company in terms of market value.
A conglomerate merger occurs when the companies are not competitors and
do not have a buyer–seller relationship. One example was Philip Morris, a tobacco
company, which acquired General Foods in 1985 for $5.6 billion, Kraft in 1988 for
$13.44 billion, and Nabisco in 2000 for $18.9 billion. Interestingly, Philip Morris,
which later changed its name to Altria, had used the cash flows from its food and
tobacco businesses to become less of a domestic tobacco company and more of a food
business. This is because the U.S. tobacco industry has been declining, although the
international tobacco business has not been experiencing such a decline. The company
eventually concluded that the litigation problems of its U.S. tobacco unit, Philip Morris
USA, were a drag on the stock price of the overall corporation and disassembled the
conglomerate. The aforementioned megamergers by Philip Morris/Altria were later
undone in a serious of selloffs.
Another major example of a conglomerate is General Electric (GE). This company
has done what many others have not been able to do successfully—manage a diverse
portfolio of companies in a way that creates shareholder wealth (most of the time). GE is
a serial acquirer, and a highly successful one at that. As we will discuss in Chapter 4, the
track record of diversifying and conglomerate acquisitions is not good. We will explore
why a few companies have been able to do this while many others have not.
In recent years the appearances of conglomerates have changed. We now have
“new-economy” conglomerates, such as Alphabet, the parent company of Google,
Amazon, and perhaps even Facebook. These companies grew from one main line of
business that generated significant cash flows that enabled them to branch out into
other fields through M&As. For example, Alphabet/Google controls Android, YouTube,
and Waze. Facebook acquired Instagram, WhatsApp, and Oculus. Amazon acquired
Zappos.com, Kiva Systems, Twitch, and in 2017, Whole Foods. These companies
look different from the conglomerates of old but they also have many characteristics
in common.
MERGER CONSIDERATION
Mergers may be paid for in several ways. Transactions may use all cash, all securities,
or a combination of cash and securities. Securities transactions may use the stock of
the acquirer as well as other securities, such as debentures. The stock may be either
common stock or preferred stock. They may be registered, meaning they are able to be
freely traded on organized exchanges, or they may be restricted, meaning they cannot
be offered for public sale, although private transactions among a limited number of buyers, such as institutional investors, are permissible.
1
Patrick A. Gaughan, Maximizing Corporate Value through Mergers and Acquisitions: A Strategic Growth Guide
(Hoboken, NJ: John Wiley & Sons, 2013), 160–163.
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Merger Professionals
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◾
15
If a bidder offers its stock in exchange for the target’s shares, this offer may provide
for either a fixed or floating exchange ratio. When the exchange ratio is floating, the bidder offers a dollar value of shares as opposed to a specific number of shares. The number
of shares that is eventually purchased by the bidder is determined by dividing the value
offered by the bidder’s average stock price during a prespecified period. This period, called
the pricing period, is usually some months after the deal is announced and before the closing of the transaction. The offer could also be defined in terms of a collar, which provides
for a maximum and minimum number of shares within the floating value agreement.
Stock transactions may offer the seller certain tax benefits that cash transactions
do not provide. However, securities transactions require the parties to agree on not only
the value of the securities purchased but also the value of those that are used for payment. This may create some uncertainty and may give cash an advantage over securities
transactions from the seller’s point of view. For large deals, all-cash compensation may
mean that the bidder has to incur debt, which may carry with it unwanted, adverse risk
consequences.
Merger agreements can have fixed compensation or they can allow for variable
payments to the target. It is common in deals between smaller companies, or when
a larger company acquires a smaller target, that the payment includes a contingent
component. Such payments may include an “earn out” where part of the payments is
based on the performance of the target. A related concept is contingent value rights
(CVRs). CVRs guarantee some future value based on the occurrence of some events
such as a sales target. An example of their use was pharmaceutical firm Allergan’s
2016 acquisition of Tobira Therapeutics, where Allergan paid $28.35 for each share of
Tobira but also gave CVRs that could equal up to $49.84 based on certain regulatory
and business achievements.
Sometimes merger agreements include a holdback provision. While alternatives
vary, such provisions in the merger agreement provide for some of the compensation to
be withheld based upon the occurrence of certain events. For example, the buyer may
deposit some of the compensation in an escrow account. If litigation or other specific
adverse events occur, the payments may be returned to the buyer. If the events do not
occur, the payments are released to the selling shareholders after a specific time period.
MERGER PROFESSIONALS
When a company decides it wants to acquire or merge with another firm, it typically
does so using the services of attorneys, accountants, and valuation experts. For smaller
deals involving closely held companies, the selling firm may employ a business broker
who may represent the seller in marketing the company. In larger deals involving
publicly held companies, the sellers and the buyers may employ investment bankers.
Investment bankers may provide a variety of services, including helping to select the
appropriate target, valuing the target, advising on strategy, and raising the requisite
financing to complete the transaction. Table 1.5 is a list of leading investment bankers
and advisors.
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◾ Introduction
TABLE 1.5
Rank
Gaughan c01.tex V1 – 11/07/2017 6:58am Page 16
U.S. Financial Advisor Rankings, 2016
Legal Advisor
Total Deal Value ($ Billions)
Total Number of Deals
1
Goldman Sachs & Co.
705.4
173
2
Morgan Stanley
603.7
142
3
Bank of America Merrill Lynch
597.0
118
4
JPMorgan Chase & Co
522.4
174
5
Citigroup
449.1
100
6
Credit Suisse
425.8
102
7
Barclays Plc
412.7
116
8
Evercore Partners Inc.
272.3
120
9
Lazard
258.2
97
Centerview Partners LLC
243.9
33
10
Source: Mergerstat Review, 2017.
Investment Bankers
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The work that investment bankers do for clients is somewhat different, based on whether
they are on the sell side or the buy side of a transaction. On the buy side, they can assist
their clients in developing a proposal that, in turn, contemplates a specific deal structure.
They may handle initial communications with the seller and/or its representatives. In
addition, they do due diligence and valuation so that they have a good sense of what the
market value of the business is. Investment bankers may have done some of this work in
advance if they happened to bring the deal to the buyer.
On the sell side, investment bankers consult with the client and may develop
an acquisition memorandum that may be distributed to qualified potential buyers.
The banker screens potential buyers so as to deal only with those who both are truly
interested and have the capability of completing a deal. Typically, those who qualify
then have to sign a confidentiality agreement prior to gaining access to key financial
information about the seller. We will discuss such agreements a little later in this
chapter. Once the field has been narrowed, the administrative details have to be worked
out for who has access to the “data room” so the potential buyers can conduct their due
diligence.
The investment banker often will handle communications with buyers and their
investment bankers as buyers formulate offers. The bankers work with the seller to evaluate these proposals and select the most advantageous one.
Legal M&A Advisors
Given the complex legal environment that surrounds M&As, attorneys also play a key
role in a successful acquisition process. Law firms may be even more important in hostile takeovers than in friendly acquisitions because part of the resistance of the target
may come through legal maneuvering. Detailed filings with the Securities and Exchange
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Merger Professionals
TABLE 1.6
Rank
17
U.S. Top 10 Legal Advisors, 2016
Legal Advisor
Total Deal Value
($ Billions)
Total Number of Deals
1
Sullivan & Cromwell LLP
619.0
116
2
Cravath Swaine & Moore LLP
489.0
63
104
3
Simpson Thacher & Bartlett LLP
419.4
4
Wachtell Lipton Rosen & Katz
417.6
72
5
Weil Gotshal & Manges LLP
386.0
154
6
Skadden, Arps, Slate, Meagher & Flom LLP
354.6
159
7
Davis Polk & Wardwell LLP
310.0
98
8
Jones Day LP
287.1
267
9
Kirkland & Ellis LLP
259.4
319
Latham & Watkins LLP
252.0
244
10
◾
Source: Mergerstat Review, 2017.
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Commission (SEC) may need to be completed under the guidance of legal experts. In both
private and public M&As, there is a legal due diligence process that attorneys should be
retained to perform. Table 1.6 shows the leading legal M&A advisors. Accountants also
play an important role in M&As by conducting the accounting due diligence process.
In addition, accountants perform various other functions, such as preparing pro forma
financial statements based on scenarios put forward by management or other professionals. Still another group of professionals who provide important services in M&As
are valuation experts. These individuals may be retained by either a bidder or a target
to determine the value of a company. We will see in Chapter 14 that these values may
vary, depending on the assumptions employed. Therefore, valuation experts may build
a model that incorporates various assumptions, such as different revenue growth rates
or costs, which may be eliminated after the deal. As these and other assumptions vary,
the resulting value derived from the deal also may change.
AVIS: A VERY ACQUIRED COMPANY
S
ometimes companies become targets of an M&A bid because the target seeks
a company that is a good strategic fit. Other times the seller or its investment
banker very effectively shops the company to buyers who did not necessarily have
the target, or even a company like the target, in their plans. This is the history of
the often-acquired rent-a-car company, Avis.
Avis was founded by Warren Avis in 1946. In 1962, the company was acquired
by the M&A boutique investment bank Lazard Freres. Lazard then began a process
where it sold and resold the company to multiple buyers. In 1965, it sold Avis to its
(continued )
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conglomerate client ITT. When the conglomerate era came to an end, ITT sold Avis
off to another conglomerate, Norton Simon. That company was then acquired by
still another conglomerate, Esmark, which included different units, such as Swift &
Co. Esmark was then taken over by Beatrice, which, in 1986, became a target of a
leveraged buyout (LBO) by Kohlberg Kravis & Roberts (KKR).
KKR, burdened with LBO debt, then sold off Avis to Wesray, which was an
investment firm that did some very successful private equity deals. Like the private
equity firms of today, Wesray would acquire attractively priced targets and then sell
them off for a profit—often shortly thereafter.
This deal was no exception. Wesray sold Avis to an employee stock ownership
plan (ESOP) owned by the rent-a-car company’s employees at a high profit just a
little over a year after it took control of the company.
At one point, General Motors (GM) took a stake in the company: For a period
of time, the major auto companies thought it was a good idea to vertically integrate
by buying a car rental company. The combined employee-GM ownership lasted for
about nine years until 1996, when the employees sold the company to HFS. Senior
managers of Avis received in excess of $1 million each while the average employee
received just under $30,000. One year later, HFS took Avis public. However, Cendant,
a company that was formed with the merger of HFS and CUC, initially owned
one-third of Avis. It later acquired the remaining two-thirds of the company. Avis
was then a subsidiary within Cendant—part of the Avis Budget group, as Cendant
also had acquired Budget Rent A Car. Cendant was a diversified company that
owned many other subsidiaries, such as Century 21 Real Estate, Howard Johnson,
Super 8 Motels, and Coldwell Banker. The market began to question the wisdom
of having all of these separate entities within one corporate umbrella without any
good synergistic reasons for their being together. In 2006, Cendant did what many
diversified companies do when the market lowers its stock valuation and, in effect,
it does not like the conglomerate structure—it broke the company up, in this case,
into four units.
The Avis Budget Group began trading on the New York Stock Exchange in
2006 as CAR. Avis’s curious life as a company that has been regularly bought and
sold underscores the great ability of investment bankers to sell the company and
thereby generate fees for their services. However, despite its continuous changing
of owners, the company still thrives in the marketplace.
MERGER ARBITRAGE
Another group of professionals who can play an important role in takeovers is
arbitragers. Generally, arbitrage refers to the buying of an asset in one market and selling it in another. Risk arbitragers look for price discrepancies between different markets
for the same assets and seek to sell in the higher-priced market and buy in the lower
one. Practitioners of these kinds of transactions try to do them simultaneously, thus
locking in their gains without risk. With respect to M&A, arbitragers purchase stock of
companies that may be taken over in the hope of getting a takeover premium when the
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deal closes. This is referred to as risk arbitrage, as purchasers of shares of targets cannot
be certain the deal will be completed. They have evaluated the probability of completion
and pursue deals with a sufficiently high probability.
The merger arbitrage business is fraught with risks. When markets turn down and
the economy slows, deals are often canceled. This occurred in the late 1980s, when the
stock market crashed in 1987 and the junk bond market declined dramatically. The junk
bond market was the fuel for many of the debt-laden deals of that period. In addition,
when merger waves end, deal volume dries up, lowering the total business available.
It occurred again in 2007–2009, when the subprime crisis reduced credit availability to finance deals and also made bidders reconsider the prices they offered for
target shares.
In general, the arbitrage business has expanded over the past decade. Several active
funds specialize in merger arbitrage. These funds may bet on many deals at the same
time. They usually purchase the shares after a public announcement of the offer has
been made. Under certain market conditions, shares in these funds can be an attractive
investment because their returns may not be as closely correlated with the market as
other investments. In market downturns, however, the risk profile of these investments
can rise.
We will return to the discussion of merger arbitrage in Chapter 6.
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LEVERAGED BUYOUTS AND THE PRIVATE EQUITY MARKET
In a leveraged buyout (LBO), a buyer uses debt to finance the acquisition of a company.
The term is usually reserved, however, for acquisition of public companies where the
acquired company becomes private. This is referred to as going private because all of the
public equity is purchased, usually by a small group or a single buyer, and the company’s
shares are no longer traded in securities markets. One version of an LBO is a management
buyout. In a management buyout, the buyer of a company, or a division of a company, is
the manager of the entity.
Most LBOs are buyouts of small and medium-sized companies or divisions of large
companies. However, what was then the largest transaction of all time, the 1989 $25.1
billion LBO of RJR Nabisco by Kohlberg Kravis & Roberts, shook the financial world.
The leveraged buyout business declined after the fourth merger wave but rebounded in
the fifth wave and then reached new highs in the 2000s (Figure 1.4). While LBOs were
mainly a U.S. phenomenon in the 1980s, they became international in the 1990s and
have remained that way since.
LBOs utilize a significant amount of debt along with an equity investment. Often
this equity investment comes from investment pools created by private equity firms.
These firms solicit investments from institutional investors. The monies are used to
acquire equity positions in various companies. Sometimes these private equity buyers
acquire entire companies while in other instances they take equity positions in companies. The private equity business grew significantly between 2003 and 2007; however,
when the global economy entered a recession in 2008 the business slowed markedly
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20
Value of U.S. LBOs, 1980–2016
450,000
400,000
350,000
300,000
250,000
200,000
150,000
100,000
50,000
0
Number of U.S. LBOs, 1980–2016
800
700
600
500
400
300
200
100
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
$ Millions
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Value of Europe LBOs, 1984–2016
300,000
Number of Europe LBOs, 1984–2016
$ Millions
250,000
1,400
1,200
200,000
1,000
150,000
800
100,000
600
400
50,000
200
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
0
Value of Asia LBOs, 1986–2016
60,000
Number of Asia LBOs, 1986–2016
120
$ Millions
50,000
80
30,000
60
20,000
k
40
10,000
20
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2016
2014
2012
2010
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
0
1986
k
100
40,000
FIGURE 1.4 The value of worldwide leveraged buyouts, 1980–2016. Source: Thomson
Financial Securities Data, January 12, 2017.
for some time but rebounded strongly in the years 2013–2017. We will discuss this
further in Chapter 9.
CORPORATE RESTRUCTURING
The term corporate restructuring usually refers to asset sell-offs, such as divestitures. Companies that have acquired other firms or have developed other divisions through activities such as product extensions may decide that these divisions no longer fit into the
company’s plans. The desire to sell parts of a company may come from poor performance
of a division, financial exigency, or a change in the strategic orientation of the company.
For example, the company may decide to refocus on its core business and sell off non-core
subsidiaries. This type of activity increased after the end of the third merger wave as
many companies that engaged in diverse acquisition campaigns to build conglomerates began to question the advisability of these combinations. There are several forms
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of corporate sell-offs, with divestitures being only one kind. Spin and equity carve-outs
are other ways that sell-offs can be accomplished. The relative benefits of each of these
alternative means of selling off part of a company are discussed in Chapter 11.
MERGER NEGOTIATIONS
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Most M&As are negotiated in a friendly environment. For buyer-initiated takeovers,
the process usually begins when the management of one firm contacts the target
company’s management, often through the investment bankers of each company.
For seller-initiated deals, the seller may hire an investment banker, who will contact
prospective bidders. If the potential bidders sign a confidentiality agreement and agree
to not make an unsolicited bid, they may receive nonpublic information. The seller and
its investment banker may conduct an auction or may choose to negotiate with just one
bidder to reach an agreeable price. Auctions can be constructed more formally, with
specific bidding rules established by the seller, or they can be less formal.
The management of both the buyer and seller keep their respective boards of directors up to date on the progress of the negotiations because mergers usually require the
boards’ approval. Sometimes this process works smoothly and leads to a quick merger
agreement. A good example of this was the 2009 $68 billion acquisition of Wyeth Corp.
by Pfizer. In spite of the size of this deal, there was a quick meeting of the minds by management of these two firms, and a friendly deal was agreed to relatively quickly. However,
in some circumstances, a quick deal may not be the best. AT&T’s $48 billion acquisition
of TCI is an example of a friendly deal, where the buyer did not do its homework and the
seller did a good job of accommodating the buyer’s (AT&T’s) desire to do a quick deal at
a higher price. Speed may help ward off unwanted bidders, but it may work against a
close scrutiny of the transaction.
Sometimes friendly negotiations may break down, leading to the termination of the
bid or a hostile takeover. An example of a negotiated deal that failed and led to a hostile bid was the tender offer by Moore Corporation for Wallace Computer Services, Inc.
Here, negotiations between two archrivals in the business forms and printing business
proceeded for five months before they were called off, leading to a $1.3 billion hostile bid.
In 2003, Moore reached agreement to acquire Wallace and form Moore Wallace. One
year later, Moore Wallace merged with RR Donnelley.
In other instances, the target opposes the bid right away and the transaction quickly
becomes a hostile one. One classic example of a very hostile bid was the 2004 takeover
battle between Oracle and PeopleSoft. This takeover contest was unusual due to its protracted length. The battle went on for approximately a year before PeopleSoft finally
capitulated and accepted a higher Oracle bid.
Most merger agreements include a material adverse change clause. This clause may
allow either party to withdraw from the deal if a major change in circumstances arises
that would alter the value of the deal. This occurred in 2017 when Verizon and Yahoo!
both agreed to reduce the price paid for Yahoo!’s Internet business by $350 million,
down to $4.48 billion, as a result of the data breaches at Yahoo!
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Auctions versus Private Negotiations
Many believe that auctions may result in higher takeover premiums. Boone and Mulherin analyzed the takeover process related to 377 completed and 23 withdrawn acquisitions that occurred in the 1990s.2 Regarding the auctions in their sample, they found
that, on average, 21 bidders were contacted and 7 eventually signed confidentiality and
standstill agreements. In contrast, the private negotiated deals featured the seller dealing
with a single bidder.
Boone and Mulherin found that more than half of deals involved auctions; the belief
in the beneficial effects of auctions raised the question of why all deals are not made
through auctions. One explanation may be agency costs. Boone and Mulherin analyzed
this issue using an event study methodology, which compared the wealth effects to targets of auctions and negotiated transactions. Somewhat surprisingly, they failed to find
support for the agency theory. Their results failed to show much difference in the shareholder wealth effects of auctions compared to privately negotiated transactions. This
result has important policy implications as there has been some vocal pressure to require
mandated auctions. The Boone and Mulherin results imply that this pressure may be
misplaced.
Confidentiality Agreements
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When two companies engage in negotiations, the buyer often wants access to nonpublic information from the target, which may serve as the basis for an offer acceptable to
the target. A typical agreement requires that the buyer, the recipient of the confidential
information, not use the information for any purposes other than the friendly deal at
issue. This excludes any other uses, including making a hostile bid. While these agreements are negotiable, their terms often are fairly standard.
Confidentiality agreements, sometimes also referred to as nondisclosure agreements (NDAs), define the responsibilities of recipients and providers of confidential
information. They usually cover not just information about the operations of the target,
including intellectual property like trade secrets, but also information about the deal
itself. The latter is important in instances where the target does not want the world to
know it is secretly shopping itself.
NDAs often include a standstill agreement, which limits actions the bidder can take,
such as purchases of the target’s shares. Standstill agreements often cover a period such
as a year or more. We discuss them further in Chapter 5. However, it is useful to merely
point out now that these agreements usually set a stock purchase ceiling below 5%,
as purchases beyond that level may require a Schedule 13D disclosure (discussed in
Chapter 3), which may serve to put the company in play.
In cases where there is a potential merger between horizontal competitors, the parties may also sign a joint defense agreement (JDA) that governs how confidential information will be handled after a possible merger agreement but where there is opposition
by antitrust or other regulatory authorities.
2 Audra L. Boone and J. Harold Mulherin, “How Are Firms Sold?” Journal of Finance 62, no. 20 (April 2007):
847–875.
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Initial Agreement
When the parties have reached the stage where there are clear terms upon which the
buyer is prepared to make an offer that it thinks the seller may accept, the buyer prepares
a term sheet. This is a document that the buyer usually controls but that the seller may
have input into. It may not be binding, but it is prepared so that the major terms of the
deal are set forth in writing, thus reducing uncertainty as to the main aspects of the deal.
The sale process involves investing significant time and monetary expenses, and the term
sheet helps reduce the likelihood that parties will incur such expenses and be surprised
that there was not prior agreement on what each thought were the major terms of the
deal. At this point in the process, a great deal of due diligence work has to be done before
a final agreement is reached. When the seller is conducting an auction for the firm, it
may prepare a term sheet that can be circulated to potential buyers so they know what
is needed to close the deal.
While the contents will vary, the typical term sheet identifies the buyer and
seller, the purchase price, and the factors that may cause that price to vary prior to
closing (such as changes in the target’s financial performance). It will also indicate the
consideration the buyer will use (i.e., cash or stock), as well as who pays what expenses.
While many other elements could be added based on the unique circumstances of the
deal, the term sheet should also include the major representations and warranties the
parties are making.
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Letter of Intent
The term sheet may be followed by a more detailed letter of intent (LOI). This letter delineates more of the detailed terms of the agreement. It may or may not be binding on the
parties. LOIs vary in their detail. Some specify the purchase price while others may only
define a range or formula. It may also define various closing conditions, such as providing for the acquirer to have access to various records of the target. Other conditions,
such as employment agreements for key employees, may also be noted. However, many
merger partners enter into a merger agreement right away. An LOI is something less
than that, and it may reflect one of the parties not necessarily being prepared to enter
into a formal merger agreement, For example, a private equity firm might sign an LOI
when it does not yet have firm deal financing. This could alert investors, such as arbitragers, that the deal may possibly never be completed.
Given the nonbinding nature of many LOIs, one may wonder what their real purpose is. However, they can help set forth some initial major deal parameters such as price.
They also can be used to establish the seriousness of the merger partners before lenders.
The LOI may also contain an exclusivity provision which may limit the seller’s ability to
shop the target. This latter benefit will be subject to Revlon Duties—an issue that will be
explored in Chapters 3 and 5.
The due diligence process varies greatly from deal-to-deal. It is a process that
involves the extensive use of accounting, legal, and valuation consultants. It is so
extensive that it is worthy of a book of its own; thus we will not go further into the
process here.
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Disclosure of Merger Negotiations
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Before 1988, it was not clear what obligations U.S. companies involved in merger
negotiations had to disclose their activities. However, in 1988, in the landmark Basic
v. Levinson decision, the U.S. Supreme Court made it clear that a denial that negotiations are taking place, when the opposite is the case, is improper.3 Companies may
not deceive the market by disseminating inaccurate or deceptive information, even
when the discussions are preliminary and do not show much promise of coming to
fruition. The Court’s decision reversed earlier positions that had treated proposals or
negotiations as being immaterial. The Basic v. Levinson decision does not go so far as
to require companies to disclose all plans or internal proposals involving acquisitions.
Negotiations between two potential merger partners, however, may not be denied.
The exact timing of the disclosure is still not clear. Given the requirement to disclose,
a company’s hand may be forced by the pressure of market speculation. It is often
difficult to confidentially continue such negotiations and planning for any length of
time. Rather than let the information slowly leak, the company has an obligation to
conduct an orderly disclosure once it is clear that confidentiality may be at risk or that
prior statements the company has made are no longer accurate. In cases in which there
is speculation that a takeover is being planned, significant market movements in stock
prices of the companies involved—particularly the target—may occur. Such market
movements may give rise to an inquiry from the exchange on which the company
trades. Although exchanges have come under criticism for being somewhat lax about
enforcing these types of rules, an insufficient response from the companies involved
may give rise to disciplinary actions against the companies.
DEAL STRUCTURE: ASSET VERSUS ENTITY DEALS
The choice of doing an asset deal as opposed to a whole entity deal usually has to do with
how much of the target is being sold. If the deal is for only part of the target’s business,
then usually an asset deal works best.
Asset Deals
One of the advantages for the acquirer of an asset deal is that the buyer does not have
to accept all of the target’s liabilities. This is the subject of negotiation between the parties. The seller will want the buyer to accept more liabilities while the buyer wants fewer
liabilities. The benefit of limiting liability exposure is one reason a buyer may prefer an
asset deal. Another benefit of an asset acquisition is that the buyer can pick and choose
which assets it wants and not have to pay for assets that it is not interested in. All the
assets acquired and liabilities incurred are listed in the asset purchase agreement.
3
Basic, Inc. v. Levinson, 485 U.S. 224 (1988). The U.S. Supreme Court revisited this case in 2014 and addressed
the case’s reliance on the efficiency of markets in processing information. The Court declined to reverse Basic
on this issue.
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Still other benefits of an asset deal are potential tax benefits. The buyer may be able to
realize asset basis step-up. This can come from the buyer raising the value of the acquired
assets to fair market value as opposed to the values they may have been carried at on
the seller’s balance sheet. Through such an increase in value the buyer can enjoy more
depreciation in the future, which, in turn, may lower its taxable income and taxes paid.
Sellers may prefer a whole entity deal. In an asset deal, the seller may be left with
assets it does not want. This is particularly true when the seller is selling most of its assets.
Here, they are left with liabilities that they would prefer getting rid of. In addition, the
seller may possibly get hit with negative tax consequences due to potential taxes on the
sale of the assets and then taxes on a distribution to the owners of the entity. Exceptions
could be entities that are 80% owned subsidiaries, pass-through entities, or businesses
that are LLPs or LLCs. Tax issues are very important in M&As. This is why much legal
work is done in M&As not only by transactional lawyers but also by tax lawyers. Attorneys who are M&A tax specialists can be very important in doing deals, and this is a
subspecialty of the law separate from transactional M&A law.
There are still more drawbacks to asset deals, in that the seller may have to secure
third-party consents to the sale of the assets. This may be necessary if there are clauses
in the financing agreements the target used to acquire the assets. It also could be the
case if the seller has many contracts with nonassignment or nontransfer clauses associated
with them. In order to do an asset deal, the target needs to get approval from the relevant
parties. The more of them there are, the more complicated the deal becomes. When these
complications are significant, an asset deal becomes less practical, and if a deal is to be
done, it may have to be an entity transaction.
Entity Deals
There are two ways to do an entity deal—a stock transaction or a merger. When the
target has a limited number of shareholders, it may be practical to do a stock deal, as
securing approval of the sale by the target’s shareholders may not be that difficult. The
fewer the number of shareholders, the more practical this may be. However, when dealing with a large public company with a large and widely distributed shareholder base, a
merger is often the way to go.
Stock Entity Deals
In a stock entity deal, deals that are more common involving closely held companies, the
buyer does not have to buy the assets and send the consideration to the target corporation as it would have done in an asset deal. Instead, the consideration is sent directly to
the target’s shareholders, who sell all their shares to the buyer. One of the advantages of
a stock deal is that there are no conveyance issues, such as what there might have been
with an asset deal, where there may have been the aforementioned contractual restrictions on transfer of assets. With a stock deal, the assets stay with the entity and remain
at the target, as opposed to the acquirer’s level.
One other benefit that a stock deal has over a merger is that there are no appraisal
rights with a stock deal. In a merger, shareholders who do not approve of the deal may
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want to go to court to pursue their appraisal rights and seek the difference between the
value they received for their shares in the merger and what they believe is the true value
of the shares. In recent years, the volume of appraisal litigation in Delaware has risen.
This is, in part, due to the position the Delaware court has taken regarding the wide
latitude it has in determining what a “fair value” is.4 We will discuss appraisal litigation
later in this chapter.
One of the disadvantages of an entity deal is that the buyer may have to assume
certain liabilities it may not want to have. One way a buyer can do a stock deal and
not have to incur the potential adverse exposure to certain target liabilities it does not
want is to have the seller indemnify it against this exposure. Here, the buyer accepts
the unwanted liabilities but gets the benefit of the seller’s indemnification against this
exposure. However, if the buyer has concerns about the long-term financial ability of
the target to truly back up this indemnification, then it may pass on the stock deal.
Another disadvantage of a stock-entity deal is that the target shareholders have to
approve the deal. If some of them oppose the deal, it cannot be completed. When this is
the case, then the companies have to pursue a merger. When the target is a large public
corporation with many shareholders, this is the way to go.
Merger Entity Deals
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Mergers, which are more common for publicly held companies, are partly a function
of the relevant state laws, which can vary from state-to-state. Fortunately, as we will
discuss in Chapter 3, more U.S. public corporations are incorporated in Delaware than
any other state, so we can discuss legal issues with Delaware law in mind. However, there
are many similarities between Delaware corporation laws and those of other states.
In merger laws, certain terminology is commonly encountered. Constituent corporations are the two companies doing the deal. In a merger, one company survives, called
the survivor, and the other ceases to exist.
In a merger, the surviving corporation succeeds to all of the liabilities of the nonsurviving company. If this is a concern to the buyer, then a simple merger structure is not
the way to go. If there are assets that are unwanted by the buyer, then these can be spun
out or sold off before the merger is completed.
In a merger, the voting approval of the shareholders is needed. In Delaware the
approval of a majority of the shareholders is required. This percentage can vary across
states, and there can be cases where a corporation has enacted supermajority provisions
in its bylaws. Shareholders who do not approve the deal can go to court to pursue their
appraisal rights.
Forward Merger
The basic form of a merger is a forward merger, which is sometimes also called a statutory
merger. Here the target merges directly into the purchaser corporation, and then the
target disappears while the purchaser survives. The target shares are exchanged for cash
4
Huff Fund Investment Partnership v. CKX, Inc., C.A, No, 6844-VCG (Del Ch. Nov. 1, 2013).
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or a combination of cash and securities. The purchaser assumes the target’s liabilities,
which is a drawback of this structure. However, given the assumption of these liabilities,
there are usually no conveyance issues. Another drawback is that Delaware law treats
forward mergers as though they were asset sales, so if the target has many contracts
with third-party consents or nonassignment clauses, this may not be an advantageous
route for the parties. Given the position of Delaware law on forward mergers, these deals
look a lot like assets deals that are followed by a liquidation of the target, because the
assets of the target move from the target to the buyer and the target disappears while
the deal consideration ends up with the target’s shareholders.
A big negative of a basic forward merger is that the voting approval of the shareholders of both companies is needed. This can add an element of uncertainty to the
deal. Another drawback is that the buyer directly assumes all of the target’s liabilities,
thereby exposing the buyer’s assets to the target’s liabilities. It is for these reasons that
this deal structure is not that common. The solution is for the buyer to “drop down” a
subsidiary and do a subsidiary deal. There are two types of subsidiary mergers—forward
and reverse.
Forward Subsidiary Merger
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This type of deal is sometimes called a forward triangular merger, given the structure
shape shown in Figure 1.5. Instead of the target merging directly into the purchaser, the
purchaser creates a merger subsidiary and the target merges directly into the subsidiary.
There are a number of advantages of this structure. First, there is no automatic vote
required to approve the deal. In addition, the purchaser is not exposing its assets to the
liabilities of the target. In this way, the main purchaser corporation is insulated from this
potential exposure.
As with much of finance, there are exceptions to the approval benefit. If the buyer
issues 20% or more of its stock to finance the deal, the New York Stock Exchange and
NASDAQ require approval of the purchaser’s shareholders. There could also be concerns
about litigants piercing the corporate veil and going directly after the purchaser corporation’s assets.
Compensation
from Acquirer
Acquirer
Acquirer
Subsidiary
FIGURE 1.5
Target
Shareholders
Target
Forward triangular merger.
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Target
Shareholders
Acquirer
m
on
fro
ti
sa
en
mp
Co
f
so
re
a
Sh
Acquirer
Subsidiary
FIGURE 1.6
Target
Reverse triangular merger.
Reverse Subsidiary Merger
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Reverse subsidiary mergers, also called reverse triangular mergers (see Figure 1.6),
improve upon the forward subsidiary merger by reversing the direction of the merger.
The acquirer subsidiary pays the target’s shareholders and receives the shares in the
target in exchange. Here, the subsidiary formed for the purposes of the deal merges
directly into the target. The target corporation survives, and the subsidiary goes out of
existence.
There are key advantages of this structure. One is that the assets of the target do
not move anywhere. Therefore, there should be no problems with nonassignment or
nonassignability clauses.
MERGER AGREEMENT
Once the due diligence process has been completed, the law firms representing the parties prepare a detailed merger agreement. It is usually initiated by the buyer’s law firm
and is the subject of much back-and-forth negotiation. This document is usually long
and complex—especially in billion-dollar deals involving public companies. However,
some of the key components are sections that define the purchase price and consideration to be used. The agreement also includes all representations and warranties, what is
expected of the seller and buyer prior to closing, the details of the closing (i.e., location
and date), and what could cause a termination of the agreement. If the buyer incurs a
penalty if it terminates, those termination fees are defined. Attached to the merger agreement is a whole host of supporting documents. These may include copies of resolutions
by the seller’s board of directors approving the deal as well as many other documents
that are far too numerous to be listed here.
As noted earlier, the merger agreement may contain a material adverse event (MAE)
or change clause that may allow the buyer to back out upon the occurrence of certain
adverse events. Usually, if the buyer opts out based on this clause, protracted litigation
may ensue.
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Merger Approval Procedures
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MERGER APPROVAL PROCEDURES
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In the United States, each state has a statute that authorizes M&As of corporations. The
rules may be different for domestic and foreign corporations. Once the board of directors
of each company reaches an agreement, it adopts a resolution approving the deal. This
resolution should include the names of the companies involved in the deal and the name
of the new company. The resolution should include the financial terms of the deal and
other relevant information, such as the method that is to be used to convert securities of
each company into securities of the surviving corporation. If there are any changes in
the articles of incorporation, these should be referenced in the resolution.
For the target company, this is the point in the deal process at which it is taken to the
shareholders for approval. In deals where the bidder is financing the offer using 20% or
more of its own stock, NYSE, AMEX, and NASDAQ rules require shareholder approval.
Recent research shows that when bidders issue as much as 20% or more of their shares
to acquire the target, they experience a 4.3% increase in their announcement returns.5
Presumably, this may be related to greater expected synergies and a lower likelihood
of overpayment. The researchers found this effect was concentrated among acquirers
with greater institutional ownership —investors who are in a better position to evaluate
the deal.
Friendly deals that are a product of a free negotiation process between the management of the two companies are typically approved by shareholders. Following shareholders’ approval, the merger plan must be submitted to the relevant state official, usually the
secretary of state. The document that contains this plan is called the articles for merger
or consolidation. Once the state official determines that the proper documentation has
been received, it issues a certificate of merger or consolidation. SEC rules require a proxy
solicitation to be accompanied by a Schedule 14A. Item 14 of this schedule sets forth
the specific information that must be included in a proxy statement when there will be a
vote for an approval of a merger, sale of substantial assets, or liquidation or dissolution
of the corporation. For a merger, this information must include the terms and reasons
for the transaction as well as a description of the accounting treatment and tax consequences of the deal. Financial statements and a statement regarding relevant state and
federal regulatory compliance are required. Fairness opinions and other related documents must also be included. Following completion of a deal, the target/registrant must
file a Form 15 with the SEC terminating the public registration of its securities.
Special Committees of the Board of Directors
The board of directors may choose to form a special committee of the board to evaluate
the merger proposal. Directors who might personally benefit from the merger, such as
when the buyout proposal contains provisions that management directors may potentially profit from the deal, should not be members of this committee. The more complex
5
Kai Li, Tingting Liu, and Juan (Julie) Wu, “Shareholder Approval in Mergers and Acquisitions,” paper
presented at the American Finance Association Annual Meetings, 2017.
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◾ Introduction
the transaction, the more likely it is that a committee will be appointed. This committee
should seek legal counsel to guide it on legal issues, such as the fairness of the transaction, the business judgment rule, and numerous other legal issues. The committee, and
the board in general, needs to make sure that it carefully considers all relevant aspects of
the transaction. A court may later scrutinize the decision-making process, such as what
occurred in the Smith v. Van Gorkom case (see Chapter 15).6 In that case the court found
the directors personally liable because it thought that the decision-making process was
inadequate, even though the decision itself was apparently a good one for shareholders.
Fairness Opinions
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It is common for the board to retain an outside valuation firm, such as an investment
bank or a firm that specializes in valuations, to evaluate the transaction’s terms and
price. This firm may then render a fairness opinion, in which it may state that the offer
is in a range that it determines to be accurate. This became even more important after
the Smith v. Van Gorkom decision, which places directors under greater scrutiny. Directors who rely on fairness opinions from an expert are protected under Delaware law from
personal liability.7 In an acquisition, the fairness opinion focuses on the financial fairness of the consideration paid by the buyer to the seller. In connection with a divestiture, the fairness opinion focuses on the fairness to the corporation as opposed to the
stockholders of the company. Only if the shareholders directly receive the buyer’s consideration will the fairness opinion focus on fairness to the holders of the seller’s shares.
A fairness opinion could focus on fairness to the buyer in light of the amount it is
paying. Like all valuations, fairness opinions are specific to a valuation date, and the
issuers of such opinions generally disclaim any responsibility to update them with the
passage of time and the occurrence of other relevant events.8
It is important to note that fairness opinions tend to have a narrow financial focus
and usually do not try to address the strategic merits of a given transaction. Writers of
such opinions also try to avoid making recommendations to shareholders on how they
should vote on the transactions. They also avoid consideration of many relevant aspects
of a deal, such as lockup provisions, no-shop provisions, termination fees, and financing
arrangements.
The cost of fairness opinions can vary, but it tends to be lower for smaller deals compared to larger ones. For deals valued under $5 billion, for example, the cost of a fairness
opinion might be in the $500,000 range. For larger deals, however, costs can easily be
several million dollars. The actual opinion itself may be somewhat terse and usually features a limited discussion of the underlying financial analysis. As part of the opinion that
is rendered, the evaluator should state what was investigated and verified and what was
not. The fees received and any potential conflicts of interest should also be revealed.
6
Smith v. Van Gorkom, 488 A.2d 858, 3 EXC 112 (Del. 1985).
Delaware General Corporation Law Section 141(e).
8 In re Southern Peru Copper Corp. Shareholder Derivative Litigation, C.A. No. 961-CS (Del. Ch. Oct 14, 2011).
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Short-Form Merger
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Voting Approval
Upon reaching agreeable terms and receiving board approval, the deal is taken before the
shareholders for their approval, which is granted through a vote. For example, in 2016,
99% of Monsanto’s shareholders who voted, representing 75% of all shares outstanding,
approved the $66 billion merger of the company with Bayer.9
The exact percentage necessary for stockholder approval depends on the articles of
incorporation, which, in turn, are regulated by the prevailing state corporation laws.
Following approval, each firm files the necessary documents with the state authorities
in which each firm is incorporated. Once this step is completed and the compensation
has changed hands, the deal is completed.
DEAL CLOSING
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The closing of a merger or acquisition often takes place well after the agreement has
been reached. This is because many conditions have to be fulfilled prior to the eventual
closing. Among them may be the formal approval by shareholders. In addition, the parties may also need to secure regulatory approvals from governmental authorities, such
as the Justice Department or Federal Trade Commission as well as regulators in other
nations in the case of global firms. In many cases, the final purchase price will be adjusted
according to the formula specified in the agreement.
SHORT-FORM MERGER
A short-form merger may take place in situations in which the stockholder approval
process is not necessary. Stockholder approval may be bypassed when the corporation’s
stock is concentrated in the hands of a small group, such as management, which is advocating the merger. Some state laws may allow this group to approve the transaction on
its own without soliciting the approval of the other stockholders. The board of directors
simply approves the merger by a resolution.
A short-form merger may occur only when the stockholdings of insiders are beyond
a certain threshold stipulated in the prevailing state corporation laws. This percentage
varies, depending on the state in which the company is incorporated. Under Delaware
law, the short-form merger percentage is 90%. This is the relevant percentage for most
states although a few, such as Alabama, Florida, and Montana, have an 80% threshold.
A short-term merger may follow a tender offer as a second-step transaction, where
shareholders who did not tender their shares to a bidder who acquired substantially all
of the target’s shares may be frozen out of their positions.
9
“Monsanto Shareowners Approve Merger with Bayer,” Monsanto Newsroom Release, December 13, 2016.
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◾ Introduction
FREEZEOUTS AND THE TREATMENT OF MINORITY
SHAREHOLDERS
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Typically, a majority of shareholders must provide their approval before a merger can
be completed. A 51% margin is a common majority threshold. When this majority
approves the deal, minority shareholders are required to tender their shares to the
controlling shareholder, even though they may not have voted in favor of the deal.
Minority shareholders are said to be frozen out of their positions. This majority
approval requirement is designed to prevent a holdout problem, which may occur
when a minority attempts to hold up the completion of a transaction unless they
receive compensation over and above the acquisition stock price. This is not to say that
dissenting shareholders are without rights. Those shareholders who believe that their
shares are worth significantly more than what the terms of the merger are offering may
go to court to pursue their shareholder appraisal rights. To successfully pursue these
rights, dissenting shareholders must follow the proper procedures. Paramount among
these procedures is the requirement that the dissenting shareholders object to the deal
within the designated period of time. Then they may demand a cash settlement for the
difference between the “fair value” of their shares and the compensation they actually
received. Of course, corporations resist these maneuvers because the payment of cash
for the value of shares will raise problems relating to the positions of other stockholders.
Such suits are difficult for dissenting shareholders to win. Dissenting shareholders may
file a suit only if the corporation does not file suit to have the fair value of the shares
determined, after having been notified of the dissenting shareholders’ objections. If
there is a suit, the court may appoint an appraiser to assist in the determination of the
fair value.
Freezeouts can occur following tender offers as well as controlling shareholder
closeouts in going private transactions. Prior to the 2001 Siliconix decision, all freezeout
bids in Delaware were subject to the demanding “entire fairness” standard governing
such transactions.10 In Siliconix, the Delaware Chancery Court decided that freezeouts
in tender offers would not be subject to this standard. Subramanian analyzed a database
of freezeouts in the years immediately following the Siliconix decision and found out
that controlling shareholders paid less to minority shareholders in tender offers than
they did in mergers.11
Following an M&A, it is not unusual that months after the deal, as many as 10% to
20% of shareholders still have not exchanged their frozen-out shares for compensation.
For a fee, companies, such as Georgeson Securities Corporation, offer services paid by
th…
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