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Chapter 16 Acquisitions Chapter 16 Acquisitions

Chapter 16 Acquisitions - PowerPoint Presentation

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Chapter 16 Acquisitions - PPT Presentation

and selling a business Corporate Financial Strategy 4th edition Dr Ruth Bender Acquisitions contents Learning objectives Some reasons for making an acquisition Relating synergies to value drivers ID: 661697

shares acquisition risk target acquisition shares target risk business cash shareholders bidder issues debt deal strategy buyer financing synergies eps company seller

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Slide1

Chapter 16Acquisitions and selling a business

Corporate Financial Strategy

4th edition

Dr Ruth BenderSlide2

Acquisitions: contentsLearning objectivesSome reasons for making an acquisition

Relating synergies to value drivers

Synergy checklist

Adding value in an acquisitionClassifying synergiesIllustrative due diligenceFinancing the acquisition with cashFinancing the acquisition with sharesBuying a company for shares – some issuesBuying a company for cash – some issues

Acquisition strategies to enhance epsFinancing the deal – who gets what?Financing strategy – regardless of the acquisitionEarn-outs and deferred considerationSome defence strategiesIndicative sales process

2Slide3

Acquisitions: learning objectivesUnderstand how and why companies make acquisitions.

Critically evaluate the synergies claimed for an acquisition, and how they affect the valuation of the target business.

Explain the different ways in which an acquisition can be financed, and understand how to select the most appropriate funding strategy.

Appreciate the governance and finance issues surrounding hostile bids.Identify situations where an earn-out might be of use, and explain the advantages and disadvantages of this deal structure.Outline some key areas of consideration in the sale of a business.

3Slide4

Some reasons for making an acquisition

Support strategy

Complement strategy by adding in:

products, markets, risk reduction, supply of raw materials, geographic expansion, etc.

Grow

the business

Support growth that can’t be achieved organically

Frustrate competitorsMake an acquisition in order to prevent a competitor doing so Show better profitsManipulating published financial results can improve appearance but does not add shareholder value Managerial utility Acquisitions are quite good fun!

4Slide5

Relating synergies to value drivers

Value

driver

Examples of some possible synergiesIncrease sales growthUse Target distribution network for Bidder products, or vice versa.

Complementary products can increase volumes for both.Increase operating profit marginCost efficiencies (e.g. economies of scale or scope, or better procurement practices).

Increase selling prices, e.g. due to economies of scope.

Reduce cash tax rate

More tax-efficient location of operations.

Reduce incremental investment in capital expenditure

Combine operations and sell off surplus assets.

Reduce investment in working capitalCombine operations and reduce inventories.Increase time period of competitive advantageStrengthened branding or R&D from the business combination.Reduce cost of capitalShould only occur if one of the companies is not already financed in the most efficient manner.5Slide6

Synergy checklistStrategic

Which of the value drivers will be affected by this transaction?

In which direction?

Why?Financial By how much will it change?When will this happen?

Operational What critical success factors need to be in place to ensure this happens?What needs to be measured?

Who is responsible for making it happen?

6Slide7

Adding value in an acquisition

Value to Vendor

Increased sales

Cost efficiencies

Value to Acquirer

Deal costs

Working capital

Maximum to pay

Zone of negotiation

7Slide8

Classifying synergiesSynergies that any bidder could realize

(

E.g., arising through better

management)Synergies that any bidder within the industry could realize (E.g. arising through consolidation of manufacturing, or distribution

chains)Synergies unique to this bidder

(

E.g., involving the application of a particular brand or

R&D

capability)

8Slide9

Illustrative due diligence

Financial performance

historical information

systems of internal control

accounting policies

review of forecasts

Taxation

existing and potential liabilities

arrangements (intra-group)

transaction

Economic and commercialindustry analysis and key playersPESTLEcompetitive positionstrategic assetsorder bookcontractsProduction and operationstechnologies and systemsInformation systemsIT systems and integrationPeople and culturewho’s who – management and lower tierscapabilities

cultural fit

Environmental and social

potential liabilities

legal & regulatory impact

CR stance

Intellectual property

existence and ownership

Legal and governance

review of contracts

potential problems and contingencies

competition issues?

Pensions

scheme details

deficit? (And assumptions)powers of trustees9Slide10

Financing the acquisition with cash

Target

Shareholders in Target

Bidder

Before the acquisition

After the acquisition

Shareholders in Target

Bidder

Cash paid to shareholders

Target

Target’s shareholders have no stake in the business after the acquisition

10Slide11

Financing the acquisition with shares

Target

Shareholders in Target

Bidder

Before the acquisition

After the acquisition

Bidder

Target

Shareholders in Target

Target’s shareholders own shares in an enlarged Bidder after the acquisition

11Slide12

Buying a company for shares – some issues

1. If the consideration is shares, who is buying whom?

2. Issuing new shares may dilute the voting control of a dominant shareholder – especially if the target has a

block-holder3. Selling shareholders share the risk of the transaction

4. Selling shareholders share the synergies5. Both companies need to be valued

6. Offer a fixed number of shares, or fixed value?

7. Tax implications

sellers can defer a gain

8. May not be possible to offer shares in a cross-border transaction

9. Cash resources may not be available10. Buying for shares may increase eps if acquirer has higher p/e12Slide13

Buying a company for cash – some issues

1. Can we afford it?

2. How much will be bridge financing, how much will be longer term?

3. If bridging

, when and how will a refinancing be effected?4. Effect on the company’s credit rating, banking covenants, etc.

5. Where to raise the debt

? (

Banks or capital markets?)

6. Additional considerations for cross-border acquisitions

where do we raise the money?– in what currency?– tax issues, etc.7. Buying for cash might increase eps if interest rates are less than inverse of target P/E13Slide14

Acquisition strategies to enhance eps

‘Rule’ 1

Buy companies with a higher p/e using debt or an earn-out, to avoid dilution of eps in the short term Buy companies with a lower p/e using equity ‘Rule’ 2 Use debt if after-tax cost of debt is less than inverse of target p/e

14

Enhancing eps is not the same as increasing shareholder valueSlide15

Funding the deal – who gets what?

Buyer raises

Seller gets

Cash

Shares

Cash/ debt

Shares

No further relationship between buyer and seller

.

No risk to seller

. Buyer is geared.Buyer cannot afford debt, and seller does not want risk of shares, so rights issue or sale in market to fund deal, or cash underwritten offerSeller gains from synergies and shares all risksUnlikelyDeal may not be structured as all cash or all debt – could be a mixtureDeal may also be structured so that seller gets loan stock – still has some exposure to the buyerNeed to consider raising funds conditionallyInitial funding may not be the final structure. Borrow to do the deal, and then refinance. The refinancing may be with new debt (on better terms) or with convertibles, or with equity. Alternatively, the refinancing may be from selling assets. 15Slide16

Financing strategies – regardless of the acquisition

business

risk – v

. highfinancial

risk – v. lowfunding – equitydivi pay-out – nilp/e v. high

business

risk – high

financial

risk – low

funding – equity

divi pay-out – nominalp/e highLAUNCHGROWTHMATURITYDECLINEbusiness risk – lowfinancial risk – highfunding – debtdivi pay-out – totalp/e v. lowbusiness risk – medfinancial risk – mediumfunding – debtdivi pay-out – highp/e – medX

X

Business risk

Gearing

H

H

L

The financial strategy for the acquisition should be in line with the

company’s

overall financing strategy

16Slide17

Earn-outs and deferred consideration

BUYER CONSIDERATIONS

Delays payment, or delays issue of new shares

Limits eps dilution if share eventually issued at higher priceLimits dilution of control, dittoUseful if future results of target are uncertainRetain managers’ commitment in handover period

But…Is it sloppy negotiating?Can be difficult to combine businessesWho runs the business?

Short termism

. What

happens after the earn-out?

What if own share price falls before the end of the period

?

SELLER CONSIDERATIONS Gives possibility of more consideration at a later dateMay wish to earn salary in handover periodRetains their involvement in their businessBut…Is it sloppy negotiating?May not want to stay onProtect against buyer changing the business modelWill buyer have sufficient funds to meet the eventual liability?Fixed value or fixed number of shares for additional consideration?Will we be able to sell the shares?Tax issues need to be considered17Slide18

Some defence tactics

Make sure company is priced correctly

Strategic issues and profit forecast

Good relations with City

Friendly shareholders

Buy another company

Sell/demerge units

Look for a

white knight

Referral to

competition authoritiesJoint ventures Poison pills18Slide19

Indicative sales processIn the pre-sale period you need to

choose advisers

, undertake pre-sale grooming, review the alternatives

Information memorandum to be preparedIdentify potential purchasers and make contact. (Use confidentiality letters?)Initial meetings are likely to be off-site; after receiving indicative valuations, preferred bidders can have site visitsNegotiations around price (often P/E-based), deal structure and conditions will lead to Heads of Agreement with preferred bidderDue diligence is done. (May use a data room)

Legals completed – contracts, warranties, etc.Based on ‘Selling a Business, Corporate Finance Faculty, ICAEW, Feb 2009

19