History of Mergers and Acquisitions

Mergers and Acquisitions

• Corporations strive to increase their earnings per share over time.
Methods:

Organic approaches:
• Increase sales of existing divisions while maintaining level
operating margins
• Increase operating margins with constant sales
Mergers and Acquisitions:
• Seek to merge or acquire another corporation, with resulting
corporation’s size and earnings enhanced by combination
A Brief History of Mergers and Acquisitions

• M&A transactions date back to 19th century

• Horizontal acquisitions: acquiring competitors in the same industry

and then systematically reducing costs of acquired company by

integrating its operations into acquirer's company

• Vertical acquisitions: acquiring companies in own supply chain

• massive trusts, or business holding companies

A Brief History of Mergers and Acquisitions
In the 1920’s, 1960’s, and 1980’s, M&A activity reached historic highs and

corresponded to positive performance of the stock market.

– 1920’s: combinations of firms within industries

– 1960’s: conglomerate approach (e.g. LTV, ITT)

– 1980’s: use of large amounts of debt as the means to

finance acquisitions of companies with cheaply priced

assets through leveraged buyouts

A Brief History of Mergers and Acquisitions
• In the 2000’s, Wall Street declined due to lower asset values and

increased government regulation; strategic horizontal mergers are

becoming more common.

 Strong banks are absorbing weak ones before/after FDIC seizes them.

 Chemical, pharmaceutical and commodities firms are merging in order to increase global

reach and reduce cost per unit of production.

 Leveraged buyout firms (now private equity firms) have decreased their activity due to

losses from 2007/2008 vintage investments and reduction in debt availability.

 Completed deals have lower levels of debt and therefore, either a lower price or more

equity.
 How Companies Can Work Together

• Article 2 of the Uniform Commercial Code (UCC):

set of contractual rules for sale of goods between companies

• Vendor-customer relationships are governed by purchase

orders (POs): short form of contract, containing standard

provisions and blank spaces for price, quantity, and shipment

date of goods involved

 How Companies Can Work Together

Strategic alliance (or teaming agreement):

parties work together on a single project for a finite

period of time
Do not exchange equity

Do not create permanent entity to mark relationship

Written memorandum of understanding (MOU):

memorializes strategic alliance and sets forth how parties
plan to work together
 How Companies Can Work Together
Joint venture: parties work together for lengthy or indeterminate period of time

 Form new, third entity

 Divide ownership and control of new entity, determine who will contribute what

resources

 Advantage: two entities can remain focused on their core businesses while letting

joint venture pursue the new opportunity

 Downside: governance issues and economic fairness issues create friction and

eventual disbandment
 How Companies Can Work Together

Acquisition: acquired company becomes subsidiary of

purchasing company
 Most permanent

 Eliminates governance and economic fairness issues

Forms of acquisitions
 Merger

 Stock acquisition

 Asset acquisition
 How Companies Can Work Together

• Merger: two companies legally become one

• All assets and liabilities being merged out of existence become assets

and liabilities of surviving company

• Stock acquisition: acquired company becomes subsidiary of

acquiring company

• Asset acquisition: assets but not liabilities become assets of

acquiring firm
 How and Why to do an Acquisition

• If acquisition will create positive present value when

weighing outflow (acquisition price) versus future
inflow (cash flow of acquired company plus any
synergies), then transaction makes financial sense.
Difficulty: determine what exactly are the outflows, inflows,
and synergies (both revenue/cost synergies)
 How and Why to do an Acquisition
• Common synergies
• Cost Savings:
 One has lower existing costs due to efficiency, scale, etc.

 One has better cost management

 Combined company has greater economies of scale

 One has better credit rating/balance sheet and therefore cheaper

financing costs

 Transactions costs eliminated in vertical merger

 Reduction in employee costs (layoffs)

 Reduction in taxes if acquirer has NOLs and is not limited by Section

382 of IRC
• Common synergies (continued)

• Revenue enhancements:

Use of each other’s distributors and other channels

“Bundling” opportunities from combined product offering

makes company more attractive

Combined company can raise prices (greater market power)

How and Why to do an Acquisition

• Companies will hire a group of advisors to assist in

evaluating and consummating transaction 

investment bank, law firm with expertise in mergers

and acquisitions, accounting firm, valuation firm

The Politics and Economics of Acquisitions

• Key political elements of a transaction

1. Which entity will survive or be parent company

2. What will new company’s board of directors look like

3. Who will manage company day-to-day

 The Politics and Economics of an
Acquisition
• Smaller company will typically become
subsidiary of larger company
– Smaller company may have token representation
on Board of Directors of parent
– Management of smaller company will typically
either remain at subsidiary or exit
The Politics and Economics of an Acquisition –
Merger of Equals

• Board positions often allocated 50/50

• “Office of the Chairman” or “Office of CEO”:

formed to share management authority

• Murky lines of authority or shared power can lead to

difficulty and conflict
 The Politics and Economics of an Acquisition
• Buyer will offer price based on whether transaction
will be accretive: increases earnings per share of
acquiring company

• Seller will seek premium over its existing stock price

(if public) or price in line with public traded
comparables or recent public disclosed M&A
transaction multiples based on price to earnings, price
to EBITDA or price to sales (if private)
LBOs, Hostile Takeovers and Reverse M&A
• Leveraged Buy Outs (LBOs): purchases of stock of company
where a significant percentage of purchase price is paid for
with proceeds of debt
 Became prominent in 1970’s and 1980’s with rise of LBO shop

 Debt financing to fund:

• High yield (junk) bonds

Hostile takeovers: acquisition in which “target’s” board of directors does not

consent to transaction
– Tender offer: Potential buyer or “raider” makes cash offer directly to
shareholders, thereby bypassing board of directors
 LBOs, Hostile Takeovers and Reverse
M&A

Reverse M&A (add value through divestiture)

• Four forms of reverse M&A:

1. Simple sale of division or subsidiary: asset sale,

stock sale, or merger

LBOs, Hostile Takeovers and Reverse M&A

2. Spin-off: corporation issues dividend of shares of

subsidiary to be spun-off corporation’s shareholders
– Shareholders of parent participate in spin-off on pro rata
based on their ownership percentage in parent
Prior to spin-off, parent may extract cash from subsidiary

• “19.9% IPO”: subsidiary is taken public and all or large portion of

proceeds are then allocated to parent

• Transfer certain debts to subsidiary so that parent ends up with less

leveraged balance sheet post spin-off

• Parent has subsidiary dividend to parent a portion of subsidiary’s

cash
 LBOs, Hostile Takeovers and Reverse M&A

3. Split-off: shareholder in parent corporation elects to take

shares in subsidiary being split-off, but ends up with fewer

shares of parent corporation

4. Split-up: shareholder elects to take shares in one part of split

company or other

– Less common than spin-offs and split-offs because most shareholders

like having parts of both parent and entity divested