PART 5

THE IB BUSINESS OF
MERGERS AND ACQUISITIONS
CONTENT

1 M&A Motivations

2 Strategic planning

3 Valuation & Financing

4 Takeover defenses

Chapter 7
After finishing this part, you should be
able to
• Understand the business of M&A, the M&A
motivations, the theory and practice of M&A
• The role of IB in M&A
• Have a knowledge on equity seperations
• Understand the valuation techniques, pricing, fee
structure and financing in M&A
1. Mergers and Acquisitions – M&A
▫ M&A are transactions in which the ownership
of companies, other business organizations or their
operating units are transferred or combined
▫ Mergers and acquisitions (M&A) are complex,
involving many parties and issues, including:
 Corporate governance
 Form of payment
 Legal issues
 Contractual issues
 Regulatory approval
▫ M&A analysis requires the application of valuation
tools to evaluate the M&A decision
1. Mergers and Acquisitions – M&A

Company
A
Company
X

Company Company
C X

Company
Company
Company
B Y
Y

Merger with consolidation Acquisition

1. Mergers and Acquisitions – M&A
▫ Merger: In a merger, the boards of directors for two
companies approve the combination and
seek shareholders' approval. After the merger, the
acquired company ceases to exist and becomes part
of the acquiring company
▫ Acquisition: In a simple acquisition, the acquiring
company obtains the majority stake, asset in the
acquired firm
▫ Parties
 The target company (or target) is the company being
acquired
 The acquiring company (or acquirer / bidder) is the company
acquiring the target
1. Mergers and Acquisitions – M&A

Nhiều hình thức M&A được thực hiện trên thực tế:
• Mua lại toàn bộ doanh nghiệp
• Mua lại và hợp nhất doanh nghiệp
• Mua lại và sáp nhập
• Mua, bán, hoán đổi cổ phiếu
• Thâu tóm thông qua mua lại tài sản doanh nghiệp
• Thâu tóm doanh nghiệp thông qua mua nợ
• Thâu tóm doanh nghiệp đối với một số doanh
nghiệp đặc thù
1. Mergers and Acquisitions – M&A
▫ Điều 194. Hợp nhất doanh nghiệp - Hai hoặc một số công ty (công ty bị hợp
nhất) có thể hợp nhất thành một công ty mới (công ty hợp nhất), đồng thời
chấm dứt tồn tại của các công ty bị hợp nhất
▫ Điều 195. Sáp nhập doanh nghiệp - Một hoặc một số công ty (công ty bị sáp
nhập) có thể sáp nhập vào một công ty khác (công ty nhận sáp nhập) bằng
cách chuyển toàn bộ tài sản, quyền, nghĩa vụ và lợi ích hợp pháp sang công
ty nhận sáp nhập, đồng thời chấm dứt sự tồn tại của công ty bị sáp nhập
Luật Doanh nghiệp 2014

▫ Điều 24. Đầu tư theo hình thức góp vốn, mua cổ phần, phần vốn góp vào tổ
chức kinh tế
▫ Điều 25. Hình thức và điều kiện góp vốn, mua cổ phần, phần vốn góp vào tổ
chức kinh tế
▫ Điều 26. Thủ tục đầu tư theo hình thức góp vốn, mua cổ phần, phần vốn góp
Luật Đầu tư 2014
1. Mergers and Acquisitions – M&A
Classify M&A activities based on forms of integration
and types of mergers
▫ Consolidation: Two or more firms terminate their legal
existence and combine into a new corporate identity
▫ Subsidiary merger: Acquired firm maintains its own former
identity
▫ Statutory merger: Acquired firm is consolidated into
acquiring firm with no further separate identity
Classified based on endorsement of parties’ management
▫ A hostile takeover is when the target company board of
directors objects to a takeover offer
▫ A friendly transaction is when the target company
board of directors endorses the M&A offer
1. Mergers and Acquisitions – M&A

Classified by the relatedness of business

activities of the parties to the combination
Type Characteristic Example

Horizontal Companies are in the Walt Disney Company

merger same line of business, buys Lucasfilm (October
often competitors 2012)

Vertical merger Companies are in the Google acquired Motorola

same line of production Mobility Holdings (June
(e.g., supplier–customer) 2012)

Conglomerate Companies are in Berkshire Hathaway

merger unrelated lines of business acquires Lubrizol (2011)
1. Mergers and Acquisitions – M&A
M&A in Vietnam
▫ 8/2016 Tập đoàn LafargeHolcim (Thụy Sỹ) bán lại toàn
bộ 65% vốn pháp định cho Tập đoàn Siam City Cement
(Thái Lan)
▫ 11/2016 Kido thâu tóm 65% dầu thực vật Tường An;
5/2017, Kido hoàn tất mua 27% Vocarimex, nâng sở
hữu lên 51%
▫ 4/2017 Shinhan Việt Nam mua lại mảng bán lẻ ANZ
▫ 7/2017 CJ Group (Hàn Quốc) thâu tóm thực phẩm Cầu
Tre
▫ 5/2017 Tập đoàn Hóa chất Earth Chemical (Nhật Bản)
mua lại 100% vốn CTCP Á Mỹ Gia (AMG)
▫ 12/2017 SBT mua lại HAGL Sugar và sáp nhập BHS
1. Mergers and Acquisitions – M&A

Motivations
▫ Buyer's Motivations
 Creating value
 Dubious motives
 Cross border mergers
▫ Seller's Motivations
1. Mergers and Acquisitions – M&A

Creating value
• Synergy: the capability to make a corporate
combination more profitable than the profit of the
individual firms. A general definition is 1+1 = 3,
meaning that the combined companies will not only put
their businesses together, but will also add something
extra to the new one
• Synergy is realized when the value of the combined
entity exceeds the value of the simple sum of its parts
• Economies of scale
• Cross-product selling
• Resource complementarities
• Managerial synergies
• Financial synergies
1. Mergers and Acquisitions – M&A
Creating value
• Growth
• Sometimes it can be cheaper, quicker and less risky
for an acquirer to merge with a competitor (external
growth) than to achieve growth internally (organic
growth)
• Increasing market power
• Horizontal or vertical integration to increase strength
in the industry. Market power is a benefit often
pursued in horizontal mergers
1. Mergers and Acquisitions – M&A
Creating value
• Acquiring unique capabilities or resources
• Resources include patents, technology, trademarks,
or raw materials
• Unlocking hidden value
• Improve management, reorganize structure, or
liquidations
• Undervalued shares
• Revaluation of shares because of new information
generated during the merger negotiations
1. Mergers and Acquisitions – M&A
Dubious motives
• Diversification
• Companies may engage in M&A in order to diversify
their businesses, and help experience lower earnings
volatility
• However, investors can diversify in their own portfolios,
so there is generally no value to companies to diversify
• Bootstrapping earnings
• Occurs when a company's EPS increases as a result
of the merger transaction, not due to economic benefits
of the business combination
• The shares of the acquirer trade as a higher P/E ratio
than shares of the target
• The acquirer's P/E does not fall after the merger
1. Mergers and Acquisitions – M&A
Dubious motives
• Managers’ personal incentives
• Enjoy higher compensation and perks
• More prestigious to run a larger firm
• Decrease their personal employment risk
• Tax considerations
• A company may acquire a target that is carrying
significant accumulated tax losses so that it can
reduce its own tax liablilities
1. Mergers and Acquisitions – M&A

Cross border mergers

• Exploiting market imperfections
• Cheaper labor in one market
• Lower-cost raw materials
• Overcoming adverse government policy
• Circumvent tariffs
• Circumvent barriers to trade
• Technology transfer
• Facilitate entry into a country’s market
• Gain access to new technology or resources
1. Mergers and Acquisitions – M&A

Cross border mergers

• Product differentiation
• Enhance product line
• Expand into a country’s market
• Following clients
• Make sure that the business of clients do not go to
another company once the client expands to
another country
1. Mergers and Acquisitions – M&A
• Synergy
• Example: Suppose that the Big Company has made an
offer for the Little Company that consists of the purchase of
1 million shares at $18 per share. The value of Little
Company stock before the bid was made public was $15
per share. Big Company stock is trading at $40 per share,
and there are 10 million shares outstanding. Big Company
estimates that it is likely to reduce costs through economics
of scale with this merger of $2 million per year, forever. The
appropriate discount rate for these gains is 10%.
1. What are the synergistic gains from this merger?
2. What parties, if any, share in these gains?
3. What is the estimated value of the Big Company post-
merger?
1. Mergers and Acquisitions – M&A
•Synergy

Target shareholders’ gain = Premium = P T – VT

where
PT = price paid for the target company
VT = pre-merger value of the target company

Acquirer’s gain = Synergies – Premium = S – (P T – VT)

where
S = synergies created by the business combination

VA* = VA + VT + S – C
where
VA* = post-merger value of the combined companies
VA = pre-merger value of the acquirer
C = cash paid to target shareholders
1. Mergers and Acquisitions – M&A
•Synergy
1. Synergistic gains = $2 million / 0.10 = $20 million

2. Division of gains:
Target gain = $18 million – $15 million = $3 million
Acquirer’s gain = $20 million – 3 million = $17 million

Little get $3 million / $20 million = 15% of the gain

Big get $17 million / $20 million = 85% of the gain

3. Value of Big Company post-merger

= $400 million + $15 million + $20 million – $18 million =
$417 million
1. Mergers and Acquisitions – M&A
• Bootstrapping earnings is the increase in earnings per share
(EPS) as a result of a merger, combined with the market’s use of
the pre-merger P/E to value post-merger EPS
• Assumptions:
• Exchange ratio: 1 share of Company One for 2 shares of
Company Two
• Market applies pre-merger P/E of Company One to post-
merger earnings
Company One
Company One Company Two Post-Acquisition
Earnings $100 million $50 million $150 million
Number of shares 100 million 50 million 125 million
Earnings per share $1 $1 $1.20
P/E 20 10 20
Price per share $20 $10 $24
Market value of stock $2,000 million $500 million $3,000 million
1. Mergers and Acquisitions – M&A

• 
• Assumptions:
• Exchange ratio: 1 share of Company One for 2 shares of
Company Two
• Market applies weighted average P/E to the post-merger
company

Company One
Company One Company Two Post-Acquisition
Earnings $100 million $50 million $150 million
Number of shares 100 million 50 million 125 million
Earnings per share $1 $1 $1.20
P/E 20 10 16.67
Price per share $20 $10 $20
Market value of stock $2,000 million $500 million $2,500 million
1. Mergers and Acquisitions – M&A

Motivations
1. Mergers and Acquisitions – M&A

Seller's Motivations
• Owners and managers sell as part of their
retirement and estate planning, or as a strategy to
other business ambitions
• Another reason is the recurring need for
expansion capital when the public markets are
either not desirable or unavailable
• Large companies divest businesses that do not fit
into their strategic plans
• Sales are forced by VC as an exist strategy
1. Mergers and Acquisitions – M&A

Characteristics

Form of the • Stock purchase

Transaction • Asset purchase
• Cash
Method of • Securities
Payment
• Combination of cash and securities

Attitude of • Hostile
Management • Friendly
1. Mergers and Acquisitions – M&A

Form of acquisition
▫ In a stock purchase, the acquirer provides cash,
stock, or combination of cash and stock in
exchange for the stock of the target firm
 A stock purchase needs shareholder approval
▫ In an asset purchase, the acquirer buys the
assets of the target firm, paying the target firm
directly
 An asset purchase may not need shareholder
approval
1. Mergers and Acquisitions – M&A
Method of payment
▫ Cash offering
 Cash offering may be cash from existing acquirer balances
or from a debt issue
▫ Securities offering
 Target shareholders receive shares of common stock,
preferred stock of the acquirer
 The exchange ratio determines the number of securities
received in exchange for a share of target stock
Factors influencing method of payment:
 Sharing of risk among the acquirer and target shareholders
 Signaling by the acquiring firm
 Capital structure of the acquiring firm
1. Mergers and Acquisitions – M&A

Attitude of management
Friendly merger: Offer made through Hostile merger: Offer made directly
the target’s board of directors to the target shareholders

Approach target management. Types

• Bear hug
• Tender offer
Enter into merger discussions. • Proxy fight

Perform due diligence.

Enter into a definitive merger agreement.

Shareholders and regulators approve.

1. Mergers and Acquisitions – M&A

Attitude of management
▫ The classification of a merger as friendly or hostile
is from the perspective of the board of directors of
the target company
 A friendly merger is one in which the board negotiates
and accepts an offer
 A hostile merger is one in which the board of the target
firm attempts to prevent the merger offer from being
successful
1. Mergers and Acquisitions – M&A
Attitude of management
▫ Bear hug - an indication to the board of a target company
that an offer of takeover is under consideration. A strong
bear hug is a formal notice to the target company of an
intended takeover. A teddy bear hug is an indication from
a target company that it will favorably consider a
takeover, but at a higher price than offered
▫ Tender offer - when acquirers propose buying shares
from every shareholder of a publicly traded company for
a certain price at a certain time. The investor normally
offers a higher price per share than the company’s stock
price, providing shareholders a greater incentive to sell
their shares
1. Mergers and Acquisitions – M&A

Attitude of management
▫ Proxy fight - refers to the process when a group of
shareholders are persuaded to join forces and gather
enough shareholder proxies to win a corporate vote. By
doing this, they overpower the decision of the
management. This is referred to also as a proxy battle.
The acquirer will persuade existing shareholders to vote
out company management so that the company will be
easier to takeover
2. Strategic planning
• If acquisition is determined, a team of internal and
external professionals plan and implement
strategies during the acquisition process
• Companies rely on in house personnel or hire
investment bankers to complete the acquisition
• The strategic needs and preferences of
management determine the initial selection
criterion of targets
• The key to evaluating an acquisition candidate is
an understanding of the acquirer’s business
strategy and of reactions to the deal among
shareholders
2. Strategic planning
CEO’s and strategists should address to ensure a successful M&A
journey:
• Internal capabilities: The process of assessing and integrating of
a target company should be carried by a business development
team
• Strategic goals and alignment: It is very important to evaluate a
company’s strategic and financial goals —determining if they can
be achieved faster or more easily via organic growth or an
acquisition
• Selection criteria: should be based on post-acquisition market
share, cost reduction and synergy opportunities. Flexibility should
be maintained as criteria in one industry may not apply to another
• Target selection: The target selection process needs to be
carried out quickly keeping in mind that it should be explicit and
transparent
2. Strategic planning
Investment banking fees and agreements
▫ The fees in an M&A are structured to help smooth out
the conflicts that can arise when a company is being
advised by an investment banker
▫ Retainer Fees: investment banks often require a non-
refundable retainer fee, sometimes called an upfront
fee, work fee or an engagement fee, which increases
with the size of the transaction, but not in direct
proportion
▫ Success Fees: also called backend fee, success fees
are paid upon a successful closing. The success fee
should always be the most significant component of
the total compensation
2. Strategic planning
▫ An important contract is the confidentiality agreement,
which is to protect sellers against the misuse of
confidential information provided to potential buyers.
The agreement contains
 Confidentiality provisions to protect the seller against the
business risks of disclosure or misuse of information by
competitors
 Standstill provisions to protect the seller against
unsolicited takeover attempts by bidders
▫ Types of information bidders require include financial,
legal, technical and human resource materials
▫ The target may, through its investment banker and
legal counsel, provide bidding guidelines that govern
the substance, timing and manner of offers
2. Strategic planning
• Sell-side M&A
• Seller typically hires an IB and its team of trained
professionals (“sell-side advisor”) to ensure that key objectives
are met and a favorable result is achieved. Sell-side advisor
seeks to achieve the optimal mix of value maximization, speed
of execution, and certainty of completion among other deal-
specific considerations for the selling party
▫ Auctions
▫ Organization and Preparation
▫ First Round
▫ Second Round
▫ Negotiations
▫ Closing
▫ Negotiated Sale
2. Strategic planning
• Sell-side M&A
▫ Auctions An auction is a staged process whereby a target is
marketed to multiple prospective buyers (“buyers” or
“bidders”)
 Broad Auction
 Targeted Auction
▫ Organization and Preparation
 Identify Seller Objectives and Determine Appropriate Sale
Process
 Perform Sell-Side Advisor Due Diligence and Preliminary
Valuation Analysis
 Select Buyer Universe
 Prepare Marketing Materials
 Prepare Confidentiality Agreement
2. Strategic planning
• Sell-side M&A
▫ First Round
 Contact Prospective Buyers
 Negotiate and Execute Confidentiality Agreements with
Interested Parties
 Distribute Confidential Information Memorandum and
Initial Bid Procedures Letter
 Prepare Management Presentation
 Set up Data Room
 Prepare Stapled Financing Package (if applicable)
 Receive Initial Bids and Select Buyers to Proceed to
Second Round
2. Strategic planning
• Sell-side M&A
▫ Second Round
 Conduct Management Presentations
 Facilitate Site Visits
 Provide Data Room Access
 Distribute Final Bid Procedures Letter and Draft Definitive
Agreement
 Receive Final Bids
▫ Negotiations
 Evaluate Final Bids
 Negotiate with Preferred Buyer(s)
 Select Winning Bidder
 Render Fairness Opinion (if required)
 Receive Board Approval and Execute Definitive Agreement
2. Strategic planning
• Sell-side M&A
▫ Closing
 Obtain Necessary Approvals
 Financing and Closing
▫ Negotiated Sale
While auctions were prevalent as a sell-side mechanism
during the LBO boom of the mid-2000s, a substantial
portion of M&A activity is conducted through negotiated
transactions. In contrast to an auction, a negotiated sale
centers on a direct dialogue with a single prospective buyer
2. Strategic planning
• Buy-side M&A
• Facilitates a company’s ability to continuously grow, evolve,
and re-focus in accordance with ever-changing market
conditions, industry trends, and shareholder demands
▫ Buyer motivation
▫ Acquisition Strategies
▫ Form of Financing
▫ Deal Structure
▫ Buy-Side Valuation
▫ Consequences Analysis
3. Valuation and Financing
▫ The valuation process involves a self-evaluation by
the acquiring firms and the valuation of the acquisition
candidates
▫ The self-evaluation phase estimates the value of the
acquiring firm and examines how it is affected by each
of the various scenarios
▫ After identifying a suitable candidate, the acquirer
undertakes the target’s valuation to determine what
price to offer
▫ The valuation techniques are used only in determining
the price range reference for the target company.
Equally important, a risk analysis should be performed
3. Valuation and Financing
Valuation Techniques
▫ The discounted cash flow (DCF) method
▫ The comparable transaction analysis
▫ The comparable company approach
▫ Target stock price history analysis
▫ The M&A multiples technique
▫ Gross revenue multiplier
▫ The multiple of earnings per share method
▫ LBO analysis
▫ The leveraged recapitalization method
▫ The breakup valuation technique
▫ The book value approach
▫ Liquidation analysis
3. Valuation and Financing
The discounted cash flow (DCF) method
▫ Is widely used in evaluating acquisitions. DCF method
determines the value by projecting future cash flows of
the target and discounting those projections to the
present value
▫ Steps:
 Make assumptions and pro forma financial statements
 Use pro forma financial statements to estimate FCF
▫ How does one incorporate the value of synergies in a
DCF analysis? Free cash flows that include the value
an acquirer and target can achieve through
combination and are referred to as combined or
merger cash flows
3. Valuation and Financing
The discounted cash flow (DCF) method
▫ Advantages of using the DCF method
 The model allows for changes in cash flows in the future
 The cash flows and estimated value are based on forecasted
fundamentals
 The model can be adapted for different situations
▫ Disadvantages of using the DCF method
 For a rapidly growing company, the FCF and net income may
be misaligned (e.g., higher-than-normal capital expenditure)
 Estimating CFs is difficult because of the uncertainty
 Estimating discount rates is difficult, and these rates may
change over time
 The terminal value estimate is sensitive to the assumptions
and model used
3. Valuation and Financing

The comparable transaction analysis (Precedent

transactions analysis)
▫ Analyzes transactions involving companies in the
target’s industry or similar industries over the past
several years

Collect
Information on Calculate Estimate
Recent Takeover Multiples for Takeover Value
Transactions of Comparable Based on
Comparable Companies Multiples
Companies
3. Valuation and Financing
The comparable transaction analysis
▫ Example: Suppose an analyst has gathered the following
information on the target company, the MNO Company

Average of Multiples of
MNO Company Comparable Transactions
Earnings $10 million P/E of comparables 15 times
Cash flow $12 million P/CF of comparables 20 times
Book value of equity $50 million P/BV of comparables 5 times
Sales $100 million P/S of comparables 3 times

▫ Estimate the value of the MNO Company using the

comparable transaction analysis, giving the cash flow
multiple 70% and the other methods 10% each
3. Valuation and Financing

• The
  comparable transaction analysis
Comparables’
Transaction
Multiples Estimated
Stock Value
Earnings $10 million × 15 $150 million
Cash flow $12 million × 20 $240 million
Book value of equity $50 million × 5 $250 million
Sales $100 million × 3 $300 million

▫ Value $238 million

3. Valuation and Financing

The comparable transaction analysis

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3. Valuation and Financing

The comparable transaction analysis

▫ Advantages
 Does not require estimation of a takeover premium
 Based on recent market transactions, so information
is current and observed
 Reduces litigation risk
▫ Disadvantages
 There may not be sufficient transactions to observe
the valuations
 Does not include changes to be made in target
3. Valuation and Financing

The comparable company approach

▫ Makes an assessment of how the value of the
potential acquisition candidate compares with
the market prices of publicly traded companies
with similar characteristics
3. Valuation and Financing

The comparable company approach

Select Comparable Companies
• Publicly traded companies that are similar to the subject company
• Same or similar industry

Calculate Relative Value Measures

• Enterprise value multiples
• Price multiples

Apply Metrics to Target

• Judgment needed to select appropriate metric

Estimate Takeover Price

• Takeover premium added
3. Valuation and Financing
The comparable company approach
▫ Suppose an analyst has gathered the following information
on the target XYZ company

XYZ Company Average of Comparables

Earnings $10 million P/E of comparables 30 times
Cash flow $12 million P/CF of comparables 25 times
Book value of equity $50 million P/BV of comparables 2 times
Sales $100 million P/S of comparables 2.5 times

▫ If the typical takeover premium is 20%, what is the XYZ

Company’s value in a merger using the comparable company
approach?
3. Valuation and Financing
The comparable company approach
▫ Assuming that the average of the values from the
different multiples is most appropriate
Comparables’ Estimated
Multiples Stock Value
Earnings $10 million × 30 $300 million
Cash flow $12 million × 25 $300 million
Book value of equity $50 million × 2 $100 million
Sales $100 million × 2.5 $250 million
Average = $237.5 million

▫ Estimated takeover price of the XYZ Company = $237.5

million × 1.2 = $285 million
 3. Valuation and Financing

The comparable company approach

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3. Valuation and Financing

The comparable company approach

▫ Advantages
 Provides reasonable estimate of the target
company’s value
 Estimates based on market’s value of company
▫ Disadvantages
 Sensitive to market mispricing
 Sensitive to estimate of the takeover premium, and
historical premiums may not be accurate to apply
to subsequent mergers
 Does not consider changes that may be made in
the target post-merger
3. Valuation and Financing

Target stock price history analysis

▫ Examines the stock trading range of the target
over a time period. The offering price is based
on the index plus some premium
The M&A multiples technique
▫ Analyzes the current and past broad
acquisition multiples and the change-of-control
premium. The limitation is that a broad market
average may be inapplicable to a single
transaction
3. Valuation and Financing

Gross revenue multiplier (price to sales ratio)

▫ The value is some multiple of the sales the
target generates. This method may be useful
when acquiring a private company when gross
sales are the only reliable data available
The multiple of earnings per share method
▫ Involves taking the past or future earnings per
share and multiplying by an earnings multiplier
(P/E)
3. Valuation and Financing

LBO analysis
▫ Leveraged buyout analysis is performed when the
target is a potential candidate for LBO. The
objective is to determine the highest price a LBO
group would pay
▫ LBOs are typically used by “financial sponsors” (PE
firms) who are looking to acquire companies in hopes
that they can be sold at a profit in several years
▫ To maximize returns from these investments, LBO
firms generally try to use as much borrowed capital as
possible to fund the acquisition, thereby minimizing
equity capital that the sponsor itself must invest 
3. Valuation and Financing

LBO analysis
LBO model
▫ A LBO model shows what happens when a PE
firm acquires a company using a combination of
equity and debt
▫ In this process the private equity firm aims to earn
a return of almost 20 – 25%
▫ LBO’s are similar to normal M&A deals, but in an
LBO you assume that the buyer sells the target in
the future
3. Valuation and Financing
The leveraged recapitalization method
▫ Aims at identifying the maximum value that a public
company can deliver to its shareholders today
▫ A leveraged recapitalization is a corporate strategy in
which a company takes on significant additional debt with
the intention of paying a large cash dividend to
shareholders and repurchasing its own stock shares.
Such recapitalizations are executed via issuing bonds to
raise money and using the proceeds to buy the
company's stock or to pay dividends
▫ This technique focuses on the target’s capital structure,
and is largely affected by the availability of debt financing
3. Valuation and Financing
The breakup valuation technique
▫ Involves analyzing each of the target’s business lines
and summing these individual values to arrive at a
value for the entire company
▫ Breakup value tells us how much a company would be
worth to shareholders if it were stripped down and sold off
in pieces
▫ This is usually applied to large cap stocks that are likely to
operate in several different markets or industries. A
breakup value analysis may be brought about
by investors if the market cap of the stock is less than the
breakup value for a prolonged period of time
▫ Determine a potential floor for the stock, or a
potential entry point for a prospective buyer
3. Valuation and Financing

The breakup valuation technique

Events
▫ There is a liquidity crisis at the company
▫ Management is seen as ineffective
▫ One or more businesses are doing very well,
while others lag behind
▫ Stock price is not keeping up with business results
▫ The company has shown a willingness to sell off
non-performing assets
3. Valuation and Financing

The book value approach

▫ Is an accounting based concept and may not represent
the earnings power. This method may be appropriate
for firms with no intangible assets, commodity-type
assets valued at market, and stable operations
▫ Disadvantages:
 This method depends on accounting practices that vary
across firms
 Ignores intangible assets like brand names, patents,
technical know-how, managerial competence
 Ignores price appreciation due, for instance, to inflation
 Book value method is backward looking. It ignores the
positive or negative operating prospects of the firm
3. Valuation and Financing
Liquidation analysis
▫ The sale of assets at a point in time. May be
appropriate for firms in financial distress, or more
generally, for firms whose operating prospects are very
cloudy
▫ Establish a floor for valuation
▫ Disadvantages
 Difficult to get a consensus valuation
 Key judgment: How finely one might break up the
company: Group? Division? Product line? Region?
Plant? Machines?
 Physical condition will affect values
 May ignore valuable intangible assets
3. Valuation and Financing
Financing
▫ Summary of some the more commonly used methods
that companies use to finance their M&A activities
including
 using available cash
 obtaining a new or amended credit facility
 obtaining mezzanine debt financing
 exchanging stock
 raising equity financing
 accessing public debt financing
 obtaining a bridge facility
 utilizing vendor takeback financing
 negotiating earn-outs
3. Valuation and Financing

Financing
▫ Using available cash
 If the buyer is generating significant excess cash
from operations, it may use that available cash
to finance an acquisition
 Or the buyer may have room under its
existing credit facility and may draw down on
that facility to finance an acquisition
▫ Obtaining a new or amended credit facility
 The buyer may negotiate a new or amended
credit facility with its lender
3. Valuation and Financing

Financing
▫ Obtaining mezzanine debt financing
 Mezzanine debt may take the form of convertible
debt, senior subordinated debt or private
"mezzanine" securities (debt with warrants or
preferred equity)
▫ Exchanging stock
 Many public companies prefer to use their shares as
currency when completing an acquisition and will
issues shares in their own company in exchange for
the outstanding shares of the target company
3. Valuation and Financing

Financing
▫ Raising equity financing
 When the seller wants cash and the buyer wants
to issue equity, the buyer might raise the money
to finance the acquisition by selling additional
equity
▫ Accessing public debt financing
 Rather than issuing equity, the buyer may
choose to issue bonds or debentures to third
party investors
3. Valuation and Financing
Financing
▫ Obtaining a bridge facility
 A buyer may obtain a “bridge facility” from a lender to
bridge the gap between the time of the closing of the
acquisition and the time that replacement financing can
be sourced. Bridge facilities are structured to incentivize
quick repayment/replacement
▫ Utilizing vendor takeback financing
 Where the buyer cannot access financing from traditional
sources at affordable rates, and the seller is motivated to
sell, the parties may agree that some or all of the
purchase price may be paid in the form of a “vendor take-
back” financing. This is an arrangement where the seller
“loans” the buyer part of the purchase price
3. Valuation and Financing

Financing
▫ Negotiating earn-outs
 Where the buyer and the seller cannot agree on the
value of the business at the time of closing, or where
the seller will remain with management, they
sometimes agree to an “earn-out” provision. This
typically provides for the seller to receive additional
payments upon the achievement of certain future
performance criteria
 The formula for additional compensation is often
based on financial performance which relies on
operating-based contingency instead of profit-based
4. Takeover defenses
▫ Takeover defenses are intended to either prevent
the transaction from taking place or to increase
the offer
 Pre-offer defense mechanisms are triggered by
changes in control, generally making the target
less attractive
 Post-offer defense mechanisms tend to address
ownership of shares and reduce the hostile
acquirer’s power gained from its ownership
interest in the target
4. Takeover defenses
Pre-Offer Takeover Defense Post-Offer Takeover Defense
Mechanisms Mechanisms
• Poison pills (flip-in pill and flip-over • “Just say no” defense
pill) • Litigation
• Poison puts • Greenmail
• Incorporation in a state with • Share repurchase
restrictive takeover laws
• Leveraged recapitalization
• Staggered board of directors
• “Crown jewels” defenses
• Restricted voting rights
• “Pac-Man” defense
• Supermajority voting provisions
• White knight defense
• Fair price amendments
• White squire defense
• Golden parachutes
4. Takeover defenses
▫ Pre-offer defense mechanisms
 Poison Pill: This gives the current shareholders
of the target company a right to purchase
additional shares of the new entity at a discount
 Poison Put: This gives a right to the existing
bondholders of the target entity to ask for
immediate redemption of their debt
 States with Restrictive Takeover Laws:
Companies would like to be incorporated in the
countries which have restrictive takeover laws
as it would be very cumbersome for the acquirer
to fulfil the requirements
4. Takeover defenses
▫ Pre-offer defense mechanisms
 Staggered Board of Directors: Only a part of
BOD can be changed every year
 Restricted Voting Rights: A provision can be
added that if the stake of one of the
shareholders crosses a threshold percentage,
that shareholder will lose his voting rights
 Supermajority Voting Provision for Mergers: A
provision can be included where a majority of
(e.g. more than 51%) is required to approve a
takeover
4. Takeover defenses
▫ Pre-offer defense mechanisms
 Fair Price Amendment: This provision restricts
the takeover to happen unless the shareholders
are being paid a “fair price” for their shares
 Golden Parachutes: Compensation agreements
can be made between the target company and
the top-level management for lucrative cash
pay-outs in case they leave the company
following an acquisition
4. Takeover defenses
▫ Post-offer defense mechanisms
 Just Say “NO” Defence: The target company can
make a public announcement addressing the
shareholders why the offer is not in the shareholder’s
best interest
 Litigation: File a lawsuit against the acquirer claiming
that some law will be violated if this acquisition takes
place
 Greenmail: Some amount is paid to the acquirer to
terminate the takeover offer. In some cases, the
target company purchase the shares from the
acquirer at a premium following an agreement that
the acquirer will not make another takeover attempt
4. Takeover defenses
▫ Post-offer defense mechanisms
 Share Repurchase: The target company can
submit a tender offer for its own shares which will
compete with the bid offered by the acquirer
 Levered Recapitalisation: The target company
takes up large amount of debt just to make
significant changes in the capital structure and
make the acquisition less attractive for the acquirer
 Crown Jewel Defence: The target entity might sell
of the subsidiary or the asset that was the major
reason behind the offer made by the acquirer
4. Takeover defenses
▫ Post-offer defense mechanisms
 Pac-Man Defence: The target makes a counter
offer to acquire the acquirer
 White Knight Defence: The target company
invites a friendly third party with a good strategic
fit to get acquired
 White Squire Defence: The target company
invites a friendly third party, but this time to
acquire a minority stake in the entity, just to
block the hostile acquirer from gaining enough
shares to complete the merger