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
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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
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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?
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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
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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)
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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
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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
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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
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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
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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
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