Veritas Financial Group
Introduction to the Financial Universe
Week 2 – Mergers and Acquisitions
Review from last week / Today’s
focus
Today’s discussion
cash
Corporation
Investors
securities
reinvest
Cash flow
dividends,
etc.
tax
Government
Secondary
markets
Today’s Agenda – M&A
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What are Mergers and Acquisitions?
Why do companies enter M&A deals?
How do they pay for these deals?
Case Example: Kraft-Cadbury deal
What role does the investment bank play in
M&A transactions?
• How do companies figure out how much to
pay?
Refresh: Intro to the Banking System
Retail Banks
Commercial Banks
Investment Banks*
Universal Banks
Introduction to the Banking System
Arranging Financing
• Client:
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Corporations
Financial Sponsors
Governments
Large non-profits
• Services
• Equity
• Debt
• Convertible Securities
Advising on M&A
• Client:
• Corporations
• Financial Sponsors
• Services
• Advising Buyer
• Advising Seller
M&A: What is it?
• An acquisition takes place when one
company acquires a smaller one
• A merger takes place when two companies
or relatively equal size form one larger
company.
• Under current law, all mergers are
technically acquisitions.
• One company is always the “surviving”
company, even if it is a merger of equals.
Why complete a M&A deal?
Source: Wikipedia
What are they actually buying?
Assets = Liabilities + Shareholders Equity
Shareholders Equity = Assets – Liabilities
The Big Picture:
- Mergers and Acquisitions enable a company
to get ownership of another company
- There are many reasons a company might
want to do this
Clarification: Public versus Private
Public Companies
• Refers to Equity Ownership
• Equity, in the form of
shares, is split up and listed
in a stock exchange
• Shares are made available
to the public
• The ‘shareholders’ own a
small piece of the company
If own voting shares, get a
vote on corporate affairs
Private Companies
• Also refers to Equity
ownership
• Equity is owned in chunks
by founders, individuals,
investors
• Ownership is more
concentrated and controlled
• Not traded on the stock
market
Clarification: Public versus Private
M&A can be done in many forms:
• A public company with another public company
• A private company ‘taking over’ or merging with
a public company
• A public company ‘taking over’ or merging with a
private company
• A private company and a private company
• An acquisition by an investment firm
Why complete a M&A deal?
• Financial Reasons
• Investment will produce attractive return
• Strategic Reasons
• Growth
• Access to new markets
• Access to new products
• Synergies
• Cost and revenue
• Eliminate competitors
Source: Wikipedia
Revenue Synergies
• Allow the merged company to take in more
money than the sum of the two prior
companies, all at the same costs.
• Example: Bank of America buys MBNA
(credit card firm)
• BofA markets cards in its branches, so revenue
increases with only a minimal increase in costs.
Overly Simplified Hypothetical
• BofA sells no credit card products
• MBNA has 1 million credit accounts
• BofA buys MBNA and sells MBNA legacy
products to BofA customers using existing
branches, tellers, etc.
• BofA subsequently sells 500,000 cards.
• This is a revenue synergy.
Cost Synergies
• Allow the merged company to reduce costs
below the total costs of the two prior
companies, but without experiencing a drop
in revenue.
• Example: Coca-Cola buys Vitaminwater
• Coca-Cola shuts down/sells Vitaminwater
distribution network
• Coca-Cola then uses its existing distribution and
marketing network to sell Vitaminwater products.
• Goal: eliminate redundancy.
Question
If a company is worth $10 billion, would you
ever pay $15 billion for it?
Synergies and the Deal Premium
• Deal Value - Market Value = Deal Premium
• A deal premium may be due to synergy
potential
• If the company is worth $10 billion, but the
synergies are worth $5 billion, as long as the
company pays less than $15 billion, it will
come out ahead.
Synergies and Deal Premium: Illustration
Market Value
$10.0 billion
Expected Revenue Synergies
$2.5 billion
Expected Cost Synergies
$2.5 billion
Expected Total Synergies
$5.0 billion
Bid Price
Market Value
Deal Premium
Value to bidder
$10.0 billion
$10.0 billion
$0.0
$5.0 billion
$11.0 billion
$10.0 billion
$1.0 billion
$4.0 billion
$12.0 billion
$10.0 billion
$2.0 billion
$3.0 billion
$13.0 billion
$10.0 billion
$3.0 billion
$2.0 billion
$14.0 billion
$10.0 billion
$4.0 billion
$1.0 billion
$15.0 billion
$10.0 billion
$5.0 billion
$0.0 billion
$16.0 billion
$10.0 billion
$6.0 billion
-$1.0 billion
How do companies pay for M&A deals?
• Stock
• Better for shareholders if there is confidence in
the deal
• Shareholders expectations still high
• Cash or Debt
• Better for shareholders if the deal is shaky
• Easier to close if there is opposition
• Difficult to raise cash
• Most deals are paid by both shares-issuance
and cash
Case Study: Kraft and Cadbury
• Largest European food and beverage deal on
record
• Why might Kraft and Cadbury want to merge?
Synergies!
• Cadbury has strong growth in emerging markets, like India
and Latin America.
• Kraft (Oreo cookies and Philadelphia cream cheese) derives
over half its sales from the mature North American market
Case Study: Kraft and Cadbury
• Kraft was advised by Lazard, Citi, Deutsche Bank and
Centerview Partners
• Cadbury was advised by Goldman Sachs, Morgan Stanley
and UBS.
• The Deal:
• The cash-and-stock agreement
• Valued each Cadbury share at 840 pence
• Split between 500p of cash and 0.1874 new Kraft shares
Role of Banks in M&A Transactions
• Primary role of banks is to advise clients on both
sides of deals
• Valuation
• How much should we pay? How much should
we accept?
• Price depends on synergies.
• Bankers spend months scouring the ‘books’ for
synergies.
• Consultants often assist with synergies and PMI
• Banks also help arrange financing
The Pitchbook
• Main output from Bankers
• Can Include:
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Executive Summary
Bank’s Experience
Market and Company Positioning
Valuation
(Potential Buyers)
(Financing)
Valuation
• Three common ways to analyze ‘value’
• Generally all three are taken into account
• Discounted Cash Flow (“DCF”)
• “Present Value” of how much cash this company
generate in the future
• Comparable market values (“Comps”)
• What are peers trading at?
• Past transactions multiples
• How much have another companies paid in the past?
What is a DCF?
Discounted Cash Flow: A way of valuing an asset or
company through the concept of time value of money
Would you rather have a dollar today or a dollar tomorrow?
What is present value?
Would you rather have a dollar today or a dollar tomorrow?
• You should always value a dollar today over a dollar
tomorrow
• This is because something might happen before you get
the dollar tomorrow
• So, dollars in the future are worth less than a dollar today
• If you want to give me dollars in the future, I will need to
be compensated somehow for taking on this risk
This is the concept behind “present value”
What is a DCF?
Every DCF analysis needs two things:
Projected cash flows
A discount rate
What is a DCF?
• Let’s go to the Excel…
What is a DCF?
• To get to the present value,
you need a discount rate
• A discount rate is interest rate
used to calculate the present value
of the cash flows
• Rate of compensation that you
need to receive be willing to have
money in the future versus
receiving it today
• The discount rate can be
subjective
• Weighted Average Cost of Capital
(WACC)
• Capital Asset Pricing Model (CAPM)
• Market based
Discount Rate
Present Value
12%
$1,039
10%
$1,104
8%
$1,175
6%
$1,253
4%
$1,338
2%
$1,432
0%
$1,536
Leading Investment Banks for
M&A
Bulge-Bracket Firms
2010 Global M&A League Tables
• Goldman, Sachs & Co.
Deal
Deal
Value
Count
• Bank of America Merrill Lynch Firm
1. Goldman Sachs
$399.2bn
263
• JPMorgan Chase & Co.
2. Morgan Stanley
$355.1bn
287
• Morgan Stanley
3. JPMorgan
$353.1bn
223
• Citi
Boutique Firms
• Lazard
• Greenhill & Company
• Perella Weinberg
• Moelis & Company
• William Blair
4. Credit Suisse
$274.8bn
221
5. BofA Merrill Lynch
$263.4bn
173
6. Deutsche Bank
$250.5bn
192
7. Barclays Capital
$236.0bn
111
8. UBS
$203.9bn
202
9. Lazard
$180.7bn
199
10. Citi
$180.3bn
130
In the News: PPD LBO
• Why are the largest private equity
deals in 2011 so much smaller than
they were in 2007?
• Many of the biggest PE deals in the
last two years have been in the
healthcare industry, why do you think
that is?
• Carlyle and H&F paid a 30%
premium for the stock, why do you
think they feel comfortable doing
this?