Mergers & Acquisitions

• Pro rata distribution of subsidiary shares
• Creating new independent firm (seperate business)
• Shareholders of original company get interest in new company "for free"
• Often previous equity carve-out
• Reasons:
  • Companies seeking buyers for parts of their business are not getting good offers from other firms, or from private equity

• Separation of firm into 2+ parts
• Often via spin-off

• Creation of new class of stock
• Owner of such stock have only an interest in the division
• Value based on CF of division
• Typically limited or no voting rights
• Like equity carve-out but no legal entity
• May be first step of a spin-off or exchange offer
• Reasons:
  • Separate a high-growth division from a larger parent company

• Giving shareholders choice between parent an subsidiary stock
• Creation of seperate public firm

• Learning
• Reversing mistakes
• Changing strategies
• Remain competitive
• Respond to change forces in the economy (e.g. technology, competition...)

1. Improved monitoring & incentives
2. Signaling of information to investors
3. Respond to a change in transaction costs

Empirical results:

• The larger the divestiture, the larger the announcement return
• Positive returns for seller & buyer in asset sales
• R_{Unrelated divestitures} > R_{Related divestitures}
• Diversification discount
• Asset sales, equity carve-outs and spin-offs are valueenhancing (due to efficient use of assets)
• Corporate focus can be source of gain

• Abnormal return is higher in taxable deals for buyer and target:
  • R_Taxable > R_{Partially taxable} > R_Tax-free
• Premium is higher in taxable deals (due to step-up in basis)
• Possible exploitation of net operating loss tax carry-forwards
• Possible exploitation of dept tax shields (leverage+)

1. Immediately taxable

1. Asset deal for cash
2. Purchase of stock
3. Triangular cash mergers
   1. Forward
   2. Reverse 

2. Deferred taxable

1. Statutory merger
2. Statutory consolidation
3. Triangular merger
   1. Forward
   2. Reverse
4. Voting-stock-for-stock acquisition
5. Voting-stock-for-assets acquisition

1. Tax payment immediate or deffered (cash or share)
2. Exposure or shielding from target liabilities
3. Necessity of shareholder votes
4. Existence of minority shareholders
5. Survival of target company
6. Payment restrictions

1. Tax implications
   • Target: Immediately, Shareholders taxed twice (corporate and individual level)
   • Buyer: Step-up in assets if sale price > Book value
2. Exposure from target liabilities
   • Low
3. Necessity of shareholder votes
   • Target: No
   • Buyer: No
4. Existence of minority shareholders
   • No
5. Survival of target company
   • Uncertain
6. Payment restrictions
   • No

Payment using cash or dept securities

1. Tax implications
   • Target: Immediately, no double taxation
   • Buyer: no step-up
2. Exposure from target liabilities
   • High
3. Necessity of shareholder votes
   • Target: No
   • Buyer: No
4. Existence of minority shareholders
   • Yes
5. Survival of target company
   • Yes
6. Payment restrictions
   • No

• Target merges into SubCo
• May take some time
• Short-form merger possible

1. Tax implications
   • Target: Immediately, View as purchase of assets
   • Buyer: Step-up
2. Exposure from target liabilities
   • Low
3. Necessity of shareholder votes
   • Target: Yes
   • Buyer: Maybe
4. Existence of minority shareholders
   • Yes (freeze-out possible via merger)
5. Survival of target company
   • No
6. Payment restrictions
   • No

• SubCo (empty legal entity) merges into target, Target survives
• Top-down-option possible: Buying shares directly from target
• May take some time
• Short-form merger possible

1. Tax implications
   • Target: Immediately, No double taxation
   • Buyer: Step-up
2. Exposure from target liabilities
   • Low
3. Necessity of shareholder votes
   • Target: Yes
   • Buyer: Maybe
4. Existence of minority shareholders
   • Yes (freeze-out possible via merger)
5. Survival of target company
   • Yes
6. Payment restrictions
   • No

• Exchange for buyer's stock
• Time-consuming due to required shareholder approval

1. Tax implications
   • Target: deferred (until sale), Min. 50% to be tax-free
   • Buyer: No step-up
2. Exposure from target liabilities
   • High
3. Necessity of shareholder votes
   • Target: Yes
   • Buyer: Yes
4. Existence of minority shareholders
   • No
5. Survival of target company
   • No
6. Payment restrictions
   • Buyer's stock, typically boot <50%

• A+B=C
• Merger of equals into NewCo

1. Tax implications
   • Target: deferred (until sale)
   • Buyer: No step-up
2. Exposure from target liabilities
   • High
3. Necessity of shareholder votes
   • Target: Yes
   • Buyer: Yes
4. Existence of minority shareholders
   • No
5. Survival of target company
   • No
6. Payment restrictions
   • Buyer's stock, typically boot <50%

• Merger of target into SubCo
• Payment at least 50% of parent stock

1. Tax implications
   • Target: deferred (until sale) if substantially all assets are acquired, No tax-free deal within 2 years of a spin-off
   • Buyer: No step-up
2. Exposure from target liabilities
   • Low (limited to SubCo)
3. Necessity of shareholder votes
   • Target: Yes
   • Buyer: No
4. Existence of minority shareholders
   • No
5. Survival of target company
   • No
6. Payment restrictions
   • Buyer's stock, typically boot <50%

Merger of SubCo into target

1. Tax implications
   • Target: deferred (until sale) if more than 80% are paid in the buyer's stock
   • Buyer: No step-up
2. Exposure from target liabilities
   • Low (limited to SubCo)
3. Necessity of shareholder votes
   • Target: Yes
   • Buyer: No
4. Existence of minority shareholders
   • No
5. Survival of target company
   • Yes
6. Payment restrictions
   • At least 80% buyer's voting stock

• Exchange only voting, common, or preferred stock
• Similar to reverse triangular merger
• >80% control

1. Tax implications
   • Target: deferred (until sale)
   • Buyer: No step-up
2. Exposure from target liabilities
   • Low (limited to SubCo)
3. Necessity of shareholder votes
   • Target: Maybe
   • Buyer: No
4. Existence of minority shareholders
   • Possible
5. Survival of target company
   • Yes
6. Payment restrictions
   • 100% in buyer's voting stock

• Exchange of buyer's voting stock for target's assets
• Target liquidates after transaction and distributes shares in the buyer to its shareholders
• May involve legal and administration costs (numerous assets)

1. Tax implications
   • Target: deferred (until sale)
   • Buyer: No step-up
2. Exposure from target liabilities
   • High
3. Necessity of shareholder votes
   • Target: Maybe
   • Buyer: No
4. Existence of minority shareholders
   • No
5. Survival of target company
   • No
6. Payment restrictions
   • At least 80% buyer's voting stock

Topics:

• Financial rstructuring
• Leveraged buyouts (LBOs)
• Financial distress
• Analysis of LBOs

Cash:

1. Cash on hand
2. Issue of dept
3. Issue of stock (requires approval of buyer's shareholders)

Stock:

1. Issue of stock (requires approval of buyer's shareholders)
2. Shares in treasury

1. Preemption strategy (to prevent from competitive bids)
2. Contingency strategy (not overpaying, e.g. two-tier offer)

1. Mix of types

• Pecking order theory: from internal to external source of capital
• Cash (from previous profits) → dept → new shares

2. Maturity

• Short-term (commercial paper), intermediate-term (notes), long-term (bonds)

3. Fixed or floating yield

4. Currency

5. Exotic terms

• Plain bonds, hybris, convertible bonds...

6. Control features

⇒ See FRICTO

7. Distribution

• E.g. capital gains or dividends

Framework to evaluate financing strategies regarding:

• Flexibility
• Risk
• Income
• Control
• Timing
• Other

1. Leverage and leveraged recapitalizations

2. Exchange offers

3. Involuntary Recap (bankruptcy)

4. Financial Engineering

5. Liquidation an take-over bust-ups

6. MBO/LBO

Leveraged recaps (LR)

• Company levers itself (Buy back shares or pay out cash dividend)
• Discouraging potential acquirers (defensive tactic against hostile takeover)
• Cashing out owners
• Funding of tax liabilities (e.g. funding acquisitions)
• Pressure to improve efficiency
• Dedication of FCF (to avoid agency costs of FCF)

Dual class recaps (DCRs)

\(V_{Levered}=V_{Unlevered}+t \times D\)

with t x D = PV of DTS

Criticism:

Model does not capture default risk (costs of bankruptcy)

EV of all equity financed firm

+ PV of tax shields

+ PV of other benefits from leverage

+ PV of benefits from control change

+ PV of benefits from M&A

+ PV of benefits from changes in strategy, policy, structure...

- PV of costs of financial distress

= EV of an leveraged firm

5) \(\text{Share price}_{New}={\text{MV of firm}_{New} \over \text{Shares outstanding}_{Old}}={3'240 \over 100}=32.40\)

6) \(\text{Shares repurchased}_{New}={\text{Amount of dept}_{New} \over \text{Share price}_{New}}= {600 \over 32.40}=18.52\)

See example

Effect on equity value per share if new debt of 600 is fully distributed as dividend to shareholders?

\({2'640 \over 100}=26.40+{600 \over 100}=32.40\)

- Create second class of stock with limited voting right

- Preferential claim on CFs

• E.g.
• Class A: 100 shares, 1 vote, 50% interest, 100/110 CF claim
• Class B: 10 shares, 10 votes, 50% interest, 10/110 CF claim

- Reasons:

• Consolidate control (e.g. founding family)
• Complex operations → superior understanding
• Problem: Mgmt entrenchment (but higher dividends)

= Dept exchange

- Right or option to exchange existing obligations for different class

- E.g.

• Dept ⇔ Common stock
• Preffered stock ⇔ Common Stock
• Dept ⇔ Preffered stock

- Empirical evidence:

• Leverage to equity: Negative
• Equity to leverage: Positive

- Reasons:

• To improve on the terms and conditions of the existing bonds (due to financial distress)
• To improve liquidity position by extending the maturity
• Often distressed firms avoiding bankruptcy

- Use of calls, puts, swaps, forwards and futures to influence payoff of intended takeover

- Reason:

• Limit financial exposure of business and investors

Involuntary

• Bankruptcy
• "Worth more dead than alive"
• Creditors force firm to liqudate

Voluntary

• Shareholders receive more if firm is being sold
• Threat of bust-up acquisitions (Hostile takeover and buyer liquidates firm)