Transaction Framework
Joseph V. Rizzi
March, 2013
Transaction Framework
Strategic Issues
• Do I make the acquisition?
Valuation
• How much do I pay?
Tactics
• How do I make the offer?
Financing
• How do I pay?
Integration
• Implementation of acquisition
2
Transaction and Structuring Overview
Creditors
Rights
Regulatory
and Antitrust
Contract
Business
Plan
Market
Conditions
Deal
Accounting
Transaction
Characteristics
Securities
Financial
Preferences
Corporate
Law
Tax
Competing
Bidders
3
Transaction and Structuring Overview
Creditors
Rights
Regulatory
and Antitrust
Contract
Business
Plan
Market
Conditions
Deal
Accounting
Transaction
Characteristics
Securities
Financial
Preferences
Corporate
Law
Tax
Competing
Bidders
4
Summary of Complicating Factors
Competing Bids
Size
Financial Strength
Dilution Analysis
Strategic Fit
Tax
Capital Gains to
Seller
WHT on divs and int
Basis
NOL’s
Interest deductibility
Tax treaties
Consolidation
Exit planning
Rating Agencies
Regulatory
Contract
Form
Consideration
Pricing
Conditions
Repos and Warranties
Indemnities
Change of Control
Covenants
Securities
Notice
S/H Vote
Tenders
Preemption Rights
Triggers
Bankruptcy Framework
(Inter-creditor Concerns)
Subordination
Guarantees
Corporate
Notice
Percent by Region/State
Lock-Up/Break Up Fee/No Shop
Pills/Defenses
Merger/Consolidation
Antitrust
Hart/Scott/Rodino
Sherman Act
HHI
European Commission
Monopolies & Mergers
Commission
Accounting
Goodwill
Fair Market Value
Net Worth
Consolidation
5
Complex Corporate Structure
Equity
Equity
#1
Equity
#2
European
Holding Company
United States
Holding Company
Preferred Stock
NEWCO
High Yield/Sub Notes
Bank Deal with Upstream Guarantee
Collapsed
After Closing
United States Target
Guarantee
Due to the structural nature of
Subordination in Europe, bank
Debt would be placed at the
Operating subsidiary level.
Domestic
Operating
Subsidiary
Domestic
Operating
Subsidiary
Domestic
Operating
Subsidiary
Foreign
Operating
Subsidiary*
* Tax limitations surrounding guarantees from foreign subs.
6
Structure of an LBO Transaction
Players
LBO financing package
LBO funds (1)
Equity
30%
Target company (2)
100%
= 30 (equity)
+ 70 (debt financing)
Debt financing
70%
Banks
Senior debt
60%
CLO
Debt financing
70%
Hedge funds
Second lien loans
5%
Mezzanine funds
Subordinated debt
5%
Public Markets
High Yield, PIK
Leverage effect
=debt/EBITDA
=70/12
=5.8
(EBITDA 12%)
7
LBO Fund
US Investors
Exempt US Investors
Non US Investors
(1)
LBO fund
LP
A
General
Partner
LP
B
LP
C
Fund I
Investment
A
Investment
B
Investment
C
Target
(2)
Target
Holdco I
Holdco II
OPCO
8
Negotiated Cash Merger Timeline
HSR Review Period (30 Calendar Days)
Pre-Commencement
Day 1
Calendar
Calendar
Calendar
Calendar
Period (1 Week)
Week 2
Day 10
Day 20
Day 30
Day 40
•Engage
Investment
Bankers
• Prepare Merger
Agreement,
Stockholders
Agreement & HSR
Premerger
Notification
• Due Diligence
• Fairness Opinion
Issued and Boards
Approve Merger
Agreement
• Arrange Financing
• Determine
Structure (Tax,
Accounting, Form,
Consideration)
• Sign Merger
Agreement &
Stockholders
Agreement
• File HSR
Premerger
Notification
• Commence
Preparation of
Preliminary
Proxy Materials
(Schedule 14A)
• Issue Press
Release
• File 8Ks and
Schedules 13D
• File
Preliminary
Proxy Materials
(Schedule 14D)
with SEC
• Print and Mail
Proxy Materials
To Target
Stockholders
(Assumes
Definitive
Proxy Materials
Are Available)
• HSR
Waiting
Period
Expires,
Assuming
No Second
Request
• Target
Stockholder
Meeting
Week 7
• Close
Merger
9
Auctions and negotiations differ on five dimensions
Negotiation
Auction
Competition
Low or no competition unless target
and buyer can convince each other that
they have strategic alternatives to a
negotiated transaction (e.g., LBO,
liquidation, etc.)
Highly competitive
Structure
Few rules and deadlines. Some
uncertainty about whether target will be
sold at all.
Clear rules and
deadlines. Strong
probability that the target
will be sold.
Controlled by target management.
Social issues important.
Independent directors
control. Price important.
Flexibility
High
Low
Speed
Slow
Fast
Goals and control
Robert F. Bruner, Copyright © 2007,
Used by Permission
10
Due Diligence
• Making sure you get what you thought you were getting
–
Legal
– Contingencies: ABB
–
–
Accounting:
McKesson/HBOC
Business
Typical violations of U.S. GAAP include:
– Recording revenues that are fictitious, unearned, or
uncertain
– Recording fictitious inventory
– Improperly capitalizing costs
– Licenses
Violators tend to be smaller (by sales and assets),
more leveraged, and faster growing.
– Employment
Warning signs include:
– Leases
– EPA
–
Earnings Revisions Study (Messod D. Beneish)
Etc.
– Increase in days receivables
– Decrease in gross margin
– Increase in percentage of total assets represented by
assets other the PP&E.
– Comparatively hgh rate of sales growth
– Increase in percentage of total assets represented by
accruals.
11
Issues in Structuring a Deal
• Goal of deal structure should be to maximize value – but different
parties have different objectives.
• Some Buyer Shareholder Objectives:
–
Minimize after-tax price paid for the acquisition
–
Minimize the dilution of their pre-merger ownership stake
• Some Seller Shareholder Objectives:
–
Maximize after-tax price received
–
Minimize risk of the offer (for a given dollar value of the deal)
12
Issues in Structuring a Deal
• Goal of deal structure should be to maximize value – but different
parties have different objectives.
• Some Buyer Shareholder Objectives:
–
Minimize after-tax price paid for the acquisition
–
Minimize the dilution of their pre-merger ownership stake
• Some Seller Shareholder Objectives:
–
Maximize after-tax price received
–
Minimize risk of the offer (for a given dollar value of the deal)
13
Deal Terms
• Price
• Form of Transaction
• Form of Payment
• Control and Governance
• Social Issues
• Timing and Deadlines
• Transaction Hedges
14
Deal Terms - Price
• Price
–
Tends to be the focus, but is linked to virtually all other
deal terms as well as a number of external influences
–
Influenced by
– Economic cycle
– Premiums are higher in buoyant stock market conditions
– Current target stock price
– Comparable deal premiums
15
Interplay of Price and Range
Financial Terms
Buyer’s Max Terms
Seller’s Min
Terms
Non-Financial Terms
16
Price/Premium Paid
• Does the price/premium paid really matter if the acquirer is
offering its own stock to pay for the deal?
• Time Warner – AOL
17
Deal Terms – Form of Transaction
•
Form of Transaction – Influencing Factors
–
Taxable or Tax Deferred
– What are the tax consequences for buyer and seller? Is seller subject to double
taxation?
–
Risk Exposure
– Does the structure isolate the hidden liabilities of the target?
–
Control
– Will it require a vote of S/Hs of the target and/or buyer? How will voting control
be affected?
–
Continuity
– Which, if either firm will survive? What are the implications for ability to assign
leases & licenses, for corporate identity, and for stat of incorporation
–
Strongly linked to Form of Payment
18
Deal Structure: Stock vs. Asset Purchase
Stock
Purchases
Asset
Purchases
Advantages
Disadvantages
• Avoids double taxation
• Higher net proceeds to
seller shareholders
• Less documentation
•
Risk fo unknown
liabilities
•
No future tax savings
• Buyer avoids unknown
liabilities
• Possible step-up of asset
tax basis
• Seller keeps identity
• Buyer loses seller’s
NOLs and tax credits
• Rights to licenses,
franchises, patents are not
transferred
• Double taxation
19
Deal Structure: Stock vs. Asset Purchase
Stock
Purchases
Asset
Purchases
Advantages
Disadvantages
• Avoids double taxation
• Higher net proceeds to
seller shareholders
• Less documentation
•
Risk fo unknown
liabilities
•
No future tax savings
• Buyer avoids unknown
liabilities
• Possible step-up of asset
tax basis
• Seller keeps identity
• Buyer loses seller’s
NOLs and tax credits
• Rights to licenses,
franchises, patents are not
transferred
• Double taxation
20
A Note About Taxes
• Tax factors are significant in some mergers (<10% of
mergers)
• Tax effects not the main motivation for mergers
• Tax effects that are seen in mergers could generally be
replicated by a stand-alone firm changing its own leverage
or engaging in an asset sale/leaseback transaction
21
A Note About Taxes
• Tax factors are significant in some mergers (<10% of
mergers)
• Tax effects not the main motivation for mergers
• Tax effects that are seen in mergers could generally be
replicated by a stand-alone firm changing its own leverage
or engaging in an asset sale/leaseback transaction
22
A Note About Taxes
Tax Consequences
(after-tax proceeds)
Riskiness
Of Future
Cash Flows
(creditworthiness)
Form of
Transaction
Price, & Form
of Payment
EPS Consequences
(manager/investor perceptions)
Ownership
Claims
(dilution)
23
Deal Terms – Form of Payment
• Payments to Target Shareholders
–
–
Fixed payments (cash or senior debt) – resolves target S/H
uncertainty about deal value
Contingent payments (mezzanine or “junk” debt, preferred, or
common equity, earn-outs, convertibles, caps, floors & collars) –
allows target S/Hs to participate in upside potential, resolve strong
disagreements about target value, and limit post announcement
adverse stock price movements
• Side Payments
–
Payments to other stakeholders that may influence the success of
the post-merger firm (golden parachutes, buyouts of employments
contracts, consulting commitments to target management)
24
Method of Payment
Type
Characteristics of deal
Cash
• Target shareholders exchange for cash
• Typically taxable transactions
Stock
• Firms negotiate a ratio of acquirer shares to exchange for target
• Market risk high – target shareholders lose when acquirer stock
fails
Stock with
collar
• 25% of stock deals use collars to lower risk
• Many types of collars:
– Specify dollar amount of stock exchanged
– Fixed dollar amount within a max and min
– Fixed stock ratio within a max and min
25
Contingent Payments
• Earnouts and contingent payments in mergers (used in 2.5% of deals)
–
Payment based on future performance of target
–
Provides incentive for owner-managers to stay with acquirer
–
Mostly used to buy small firms with key employees (high tech,
service, etc.)
–
Problem: hard to measure in post-merger performance (high
frequency of lawsuits)
26
Other Deal Terms
• Control & Governance
–
Relative proportions of share ownership and voting rights,
composition of the new board
• Social Issues
–
Identity of executive management team, corporate name,
headquarters location
• Timing and Deadlines
– Time value of money impact on valuation and ability to structure postmerger integration efforts
• Transaction Hedges
– Walk-away fees
27
Documentation
• Confidentiality Agreement
• Letter of Intent
– Exclusive
– Nonexclusive
• Acquisition Agreement
– Reps and Warranties
– Conditions
28