Corporate Financial Strategy

4th edition
Dr Ruth Bender
Chapter 16

Acquisitions and selling a business

Corporate Financial Strategy

 Acquisitions: contents

 Learning objectives
 Some reasons for making an
acquisition
 Relating synergies to value drivers
 Synergy checklist
 Adding value in an acquisition
 Classifying synergies
 Illustrative due diligence
 Financing the acquisition with cash
 Financing the acquisition with
shares
 Buying a company for shares –
some issues
 Buying a company for cash – some
issues
Corporate Financial Strategy
 Acquisition strategies to enhance
eps
 Financing the deal – who gets
what?
 Financing strategy – regardless of
the acquisition
 Earn-outs and deferred
consideration
 Some defence strategies
 Indicative sales process
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Acquisitions: learning objectives

1. Understand how and why companies make acquisitions.

2. Critically evaluate the synergies claimed for an acquisition, and how
they affect the valuation of the target business.
3. Explain the different ways in which an acquisition can be financed, and
understand how to select the most appropriate funding strategy.
4. Appreciate the governance and finance issues surrounding hostile
bids.
5. Identify situations where an earn-out might be of use, and explain the
advantages and disadvantages of this deal structure.
6. Outline some key areas of consideration in the sale of a business.

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Some reasons for making an acquisition

Complement strategy by adding in:

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

Support growth that can’t be achieved

 Grow the business organically

Make an acquisition in order to prevent a

 Frustrate competitors competitor doing so

Manipulating published financial results

 Show better profits can improve appearance but does not
add shareholder value

 Managerial utility Acquisitions are quite good fun!

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Relating synergies to value drivers

Value driver Examples of some possible synergies

Increase sales growth Use Target distribution network for Bidder products, or vice
versa.
Complementary products can increase volumes for both.
Increase operating profit Cost efficiencies (e.g. economies of scale or scope, or better
margin 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 Combine operations and sell off surplus assets.
expenditure
Reduce investment in
working capital Combine operations and reduce inventories.

Increase time period of

competitive advantage Strengthened branding or R&D from the business combination.

Reduce cost of capital Should only occur if one of the companies is not already
financed in the most efficient manner.

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Synergy checklist

Strategic
1. Which of the value drivers will be affected by this transaction?
2. In which direction?
3. Why?

Financial
4. By how much will it change?
5. When will this happen?

Operational
6. What critical success factors need to be in place to ensure this
happens?
7. What needs to be measured?
8. Who is responsible for making it happen?

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Adding value in an acquisition

Working capital Deal costs

Cost efficiencies
Zone of
negotiation
Increased
sales

Value to Value to Maximum

Vendor Acquirer to pay

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Classifying synergies

 Synergies 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 commercial
− industry analysis and key players
− PESTLE
− competitive position
−
strategic assets
− order book
− contracts
Production and operations
− technologies and systems
Corporate Financial Strategy
Information systems
− IT systems and integration
People and culture
− who’s who – management and lower tiers
− capabilities
− 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 trustees
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Financing the acquisition with cash

Cash paid to
shareholders

Bidder Bidder
Shareholders in Shareholders in
Target Target

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

Before the acquisition After the acquisition

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Financing the acquisition with shares

Shareholders in
Target

Bidder Bidder
Shareholders in
Target

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

Before the acquisition 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-holder

3. Selling shareholders share the risk of the transaction

4. Selling shareholders share the synergies

5. 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 available

10. Buying for shares may increase eps if acquirer has higher p/e

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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/E

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 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

Enhancing eps is not the same as increasing shareholder value

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Funding the deal – who gets what?

Seller gets
Cash Shares Deal may not be structured as
all cash or all debt – could be
a mixture
No further
relationship between
Cash/ Deal may also be structured
buyer and seller. No Unlikely
debt risk to seller. Buyer so that seller gets loan stock –
is geared. still has some exposure to the
buyer

Buyer raises Need to consider raising funds

conditionally

Buyer cannot afford

Seller gains Initial funding may not be the
debt, and seller does
from synergies final structure. Borrow to do
Shares not want risk of shares,
and shares all the deal, and then refinance.
so rights issue or sale in
risks The refinancing may be with
market to fund deal, or
cash underwritten offer new debt (on better terms) or
with convertibles, or with
equity. Alternatively, the
refinancing may be from
selling assets.

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 Financing strategies – regardless of the acquisition

GROWTH LAUNCH
business risk – high business risk – v. high
financial risk – low financial risk – v. low
funding – equity funding – equity
divi pay-out – nominal divi pay-out – nil
p/e high p/e v. high

MATURITY DECLINE
business risk – med business risk – low
financial risk – medium financial risk – high
funding – debt funding – debt
divi pay-out – high divi pay-out – total
p/e – med p/e v. low H

 X
Gearing
The financial strategy for
the acquisition should be X 
in line with the company’s
overall financing strategy L Business risk H

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Earn-outs and deferred consideration

BUYER CONSIDERATIONS SELLER CONSIDERATIONS

Delays payment, or delays issue of new Gives possibility of more consideration at a
shares later date
Limits eps dilution if share eventually issued at May wish to earn salary in handover period
higher price Retains their involvement in their business
Limits dilution of control, ditto
Useful if future results of target are uncertain
Retain managers’ commitment in handover
period

But… But…
 Is it sloppy negotiating?  Is it sloppy negotiating?
 Can be difficult to combine businesses  May not want to stay on
 Who runs the business?  Protect against buyer changing the business
 Short termism. What happens after the earn- model
out?  Will buyer have sufficient funds to meet the
 What if own share price falls before the end of eventual liability?
the period?  Fixed value or fixed number of shares for
additional consideration?
 Will we be able to sell the shares?
 Tax issues need to be considered

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Some defence tactics

1. Make sure company is priced correctly

2. Strategic issues and profit forecast
3. Good relations with City
4. Friendly shareholders
5. Buy another company
6. Sell/demerge units
7. Look for a white knight
8. Referral to competition authorities
9. Joint ventures
10. Poison pills

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Indicative sales process

1. In the pre-sale period you need to choose advisers, undertake pre-sale

grooming, review the alternatives

2. Information memorandum to be prepared

3. Identify potential purchasers and make contact. (Use confidentiality

letters?)

4. Initial meetings are likely to be off-site; after receiving indicative

valuations, preferred bidders can have site visits

5. Negotiations around price (often P/E-based), deal structure and

conditions will lead to Heads of Agreement with preferred bidder

6. Due diligence is done. (May use a data room)

7. Legals completed – contracts, warranties, etc.

Based on ‘Selling a Business, Corporate Finance Faculty, ICAEW, Feb 2009

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