M&A: CONCEPTS AND THEORIES

NEW YORK INSTITUTE OF FINANCE

Stating the acquisition process part 1

So we'll talk about starting the process, some of the successful deals. I said the key
risks. And the attractive deals, if you could find a company that's similar that's
having some problems, are usually the cheapest. Companies that are growing,
companies that are owned by families and that are smaller than yours often are
priced appropriately. We've discussed some of that.

The other issue, which we hadn't talked about, is that many companies are
auctioned by investment banking groups. If you can find companies that are not
auction as a buyer, you're going to save some money. Generally speaking, if buyers
are starting with their core business when they buy something, then as they buy up
too many companies in their core business they have to get companies that are
related. Eventually, they might try to diversification.

If you haven't heard about this model, it's essential that you at least hear about it,
because this is a lot of what the big buyers think about. Boston Consulting Group
sort of started this. It's still popular. Basically, if you've got a low growth business, it
generates a lot of positive cash flow to company. I mean, you could pay a big
dividend, right? You could pay a big dividend stockholders.

But generally speaking, the cash flow from this low growth business is reinvested in
businesses that the buyer thinks are high growth. So it's a little bit of a swan effect,
I guess. And if there's a business that is low growth and doesn't generate a lot of
cash flow, you generally want to sell that. So that's something you are going to hear
about in this line of work.

Now that we know the Boston growth approach and some of the other tactics and
motivations, how do you start? It's how do you find a deal. That's a real challenge.
Now, as we mentioned a few minutes ago, a lot of big corporations like Hewlett-
Packard, General Electric, certainly any corporations over a couple of billion in
revenue, is going to have its own in-house people.

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So these are people whose job is to look for deals, to take calls from investment
bankers who are selling companies, to go out and look for competitors that might
sell but aren't on the market yet, and so on. Sometimes it's called the corporate
development department. Now, if you get to a smaller company-- say, $300, $400
million in revenue-- there may not be a real active programme like that. Therefore,
the CFO and the CEO are doing most of the legwork.

Sometimes they might have someone help them out, like a consulting firm.
Sometimes they subcontract the process to an investment bank. My firm does some
of what we call buy-side work, working for buyers, looking for deals. So sometimes
they use advisors; sometimes they don't.

But if you do use an investment bank as a buyer, what can the advisor help you
with? They can help you get valuation information in the market. They can help you
with negotiations. Just the whole process, if you haven't worked at it five or six
times, is a little confusing from time to time. Some banks will have good industry
knowledge. And if you're a local company that hasn't done much international stuff--
let's say you're French and you want to buy something in the US-- it might be a
good idea to hire a US investment bank to help you.

So let's just go over an example. There's a Chinese company, let's say, that wants to
expand. It owns a lot of the Chinese market. It wants to expand.

Their first look is going to be, of course, in China. That's where they know things
the. Most of times, the second look will be geographies nearby, like Asia, like
Thailand or Malaysia or South Korea. And to do this, it can use its own employees to
run around looking for transactions, or they could try using an investment bank to
do it.

So when you're this Chinese company, you're thinking of buying something, how do
you define your parameters? There's thousands of companies for sale at any given
moment. So how do you narrow the field? It's a little bit like looking for an
apartment.

Let's say you want to look for an apartment here in Manhattan. Where would you
start? Well, I would start-- one is what neighbourhood I want to live in. So from
their point of view, it's like which country do we want to look for, or what
continent?

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And then you might say, well, what's my budget? That would be another thing you
think about. What's my budget? So companies think along the same lines, like you
might in real estate.

So first, you've got to define your parameters. Then you have to methodically look
at what's available. Then you contact the targets, negotiate, investigate them, and
then get the money and close the deal from a legal point of view.

Well, everything's sellable at a price. Yeah, but you can't do hostile takeovers in the
United States-- not anymore you can't.

Because the laws have been set up to benefit management. And you can't do it in
most foreign countries. It's impossible to do a hostile takeover. So you can buy
shares, but it's hard to buy control.

And if a company is privately owned by some family, you can call up the family and
make an offer. Doesn't mean they have to say anything, like yes. So I think it's a
little bit like looking for an apartment and obviously more sophisticated.

So most deals, as we've talked about, are going to be in the buyer's industries or
closely similar industries. And good working budget for your average buyer is
maybe one third of the buyer's size. Now, if you're searching for real estate,
generally the lender's going to say, well, we don't want you buying an apartment
that's going to cost more than, say, three times your annual income.

So in the industry size, we want to look at the competitors, complementary line,

maybe a strategic diversification. And then you want to look at what are the prices
of transaction. Just like when you're searching for real estate, you're looking at
what's the price of this apartment on Third Avenue versus the price of another
apartment three blocks away.

So you want to compare prices. You also want to know the pricing of deals. And
then lastly, you want to know the amount of dilution you can endure given the
price. So sometimes the investment banks can help you with this sort of thought
process.

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