M&A and Corporate Valuation

Case: The Best Deal GiIlette Could

Get? Procter & Gamble’s Acquisition
of Gillette
Transaction Summary
Terms and Overview of the Deal
 Stock swap statutory merger by majority vote of both firms’ shareholders

Statutory one-stage
(compulsory) merger
or
or consolidation:
consolidation:
Cash
Cash out
out statutory
statutory merger
merger (form
(form of
of payment
payment something
something other
other than
than acquirer
acquirer
common stock)

Stock for assets

Asset
Asset acquisitions
acquisitions
(buying target assets)

Cash for assets

Forms of Acquistion Stock for stock

Stock acquisitions
(buying target stock via
tender
tender offer)
offer)
Cash for stock

2-stage stock acquisitions (Obtain control & implement backend merger)

Triangular acquisitions

Special
Special applications
applications of
of
basic structures

Leveraged buyouts

Single firm recapitalizations (Minority shareholder “squeeze out”)

 Book value

Asset based
Liquidation
approach

Replacement value

Capitalization of Earnings

Valuation Income based

Approaches approach
DCF

Comparable companies
market multiple

Market based Comparable transactions

approach multiples

Market value (in case of

quoted securities)
 Acquisition Value = FMV + Premium (Discount)

The spread between the seller's

asking price and the fair market
Without a fair market valuation, a
Diligent buyer should know the valuation serves as a useful
buyer has no meaningful
spread between FMV and the reference point for "reality
benchmark of value other than
price they are willing to pay testing" and determining how
what they are willing to pay
deep the buyer is going to have to
dig to find synergies

It enables buyer to decide the

Gives the seller an idea of
structure of the purchase It helps buyer to allocate
minimum price that they could
(100%/deferred buy-out, earn-out purchases price to various assets
expect
clauses, etc.)
True Value of an Acquisition
Value Changes In An Acquisition
 Types of Synergy
Financial
Synergy

Process
Improvement Cost Saving
Synergy

Revenue
Tax Benefits
Enhancement

Financial Process
Engineering Improvements
10
 Job Cuts

6000 job cuts, 4% of the

combined workforce of
140,000. Company
expected to reap $14
Billion in cost savings
Methods of Estimating Synergy

DCF

Implied
Simulation synergy
approach Synergy value by
the market

Real
option
approach

12
Valuation of the Deal
Sum of the Parts Valuation
 Share-Exchange Ratio

SER  PT / PA
PT Negotiated offer price per share of the target stock

PA Acquirer's share price

 Swap Ratio

Too High • There will be a transfer of

wealth from the bidding firm’s
Swap stockholders to the target
Ratio firm’s stockholders

Too Low • There will be transfer of

Swap wealth from the target firm to
the bidding firm’s stockholders
Ratio
 Control Premium

Control premium is an amount

Premium paid, if any, will be
“Beauty lies in the eyes of the that a buyer is usually willing to Research has shown that the
beholder; valuation in that of pay over the fair market value specific to the acquirer and the control premium in India has
target; actual premiums paid
the buyer” of a company to acquire widely ranged from 30-50%
have varied widely
controlling stake in a company

If valuation right, the premiums

The value of control is the It’s common practice to add
should already be incorporated
difference between the firm run arbitrary premiums for brand
in your estimated value and
as is (status quo) and the value name, quality of management,
Paying a premium will be
of the firm run optimally control etc.
double counting

Recent Transactions Control

Premium
Microsoft acquired LinkedIn ~50%
Verizon acquired Fleetmatics ~40%
Oracle acquired Netsuite ~19%
Post Merger EPS

ET  A
PT
N A  [ NT  ]
PA
Valuing Target with Motive Built in

Undervaluation • Value target firm as stand-alone entity: No extra premium

Diversification • Value target firm as stand-alone entity: No extra premium

• Value the firms independently

Operating • Value the combined firm with the operating synergy
• Synergy is the difference between the latter and former
Synergy • Target Firm Value = Independent Value + Synergy
Valuing Target with Motive Built in
Financial • Tax Benefits: Value of Target Firm + PV of Tax Benefits
• Debt Capacity: Value of Target Firm + Increase in Value from Debt

Synergy • Cash Slack: Value of Target Firm + NPV of Projects/ Target

• Value of Target Firm run optimally

• Value of control should be inversely proportional to the perceived
quality of that management and its capacity to maximize firm value.

Control • Value of control will be much greater for a poorly managed firm that
operates at below optimum capacity than it is for a well managed firm.
• Value of Control = Value of firm, with restructuring - Value of firm,
without restructuring
• Negligible or firms which are operating at or close to their optimal value

Manager’s • Value of Target Firm: No additional premium

Interest
What are the Difficulties faced in
Estimating Synergies?

Intense Time Pressure

Most
calculations of
synergy value Limited information
occur under
horrendous
conditions Maintaining confidentiality

30
 Is there any Private Synergy Created in this
Deal?

Private Synergy
When the combination and
integration of the acquiring and
acquired firms’ assets yields
It is difficult for competitors to
capabilities and core competencies
understand and imitate
that could not be developed by
combining and integrating either
firm’s assets with another company

31
 Fixed Shares vs. Fixed Value

Fixed • The number of shares is certain, but the

value of the deal may fluctuate between
the announcement of the offer and the
Shares closing date

Fixed • The number of shares depends on the share

price of the acquirer on the closing date
• The acquiring company bears all the risk: If

value the share price drops, it must issue more

shares to pay the target’s shareholders
Key Deal Dates Compared with Stock
Price of P&G and Gillette
Timeline of the Transaction
 Bases of Exchange Ratio

Earnings Per Market Price

Share Per Share

Book Value
Per Share
 Why Acquisition?

Increasing
Increasing size
market value -
- easy!
much harder!

Firm A should merge with Firm B if ; Value of AB > Value of A +

Value of B + Cost of transaction
 Types of Synergy
Financial
Synergy

Process
Improvement Cost Saving
Synergy

Revenue
Tax Benefits
Enhancement

Financial Process
Engineering Improvements
38
Methods of Estimating Synergy

DCF

Implied
Simulation synergy
approach Synergy value by
the market

Real
option
approach

39
Indian Law Governing Valuation
M&A Process Flow
 Book value

Asset based
Liquidation
approach

Replacement value

Capitalization of Earnings

Valuation Income based

Approaches approach
DCF

Comparable companies
market multiple

Market based Comparable transactions

approach multiples

Market value (in case of

quoted securities)
 Acquisition Value = FMV + Premium (Discount)

The spread between the seller's

asking price and the fair market
Without a fair market valuation, a
Diligent buyer should know the valuation serves as a useful
buyer has no meaningful
spread between FMV and the reference point for "reality
benchmark of value other than
price they are willing to pay testing" and determining how
what they are willing to pay
deep the buyer is going to have to
dig to find synergies

It enables buyer to decide the

Gives the seller an idea of
structure of the purchase It helps buyer to allocate
minimum price that they could
(100%/deferred buy-out, earn-out purchases price to various assets
expect
clauses, etc.)
 Control Premium

Control premium is an amount

Premium paid, if any, will be
“Beauty lies in the eyes of the that a buyer is usually willing to Research has shown that the
beholder; valuation in that of pay over the fair market value specific to the acquirer and the control premium in India has
target; actual premiums paid
the buyer” of a company to acquire widely ranged from 30-50%
have varied widely
controlling stake in a company

If valuation right, the premiums

The value of control is the It’s common practice to add
should already be incorporated
difference between the firm run arbitrary premiums for brand
in your estimated value and
as is (status quo) and the value name, quality of management,
Paying a premium will be
of the firm run optimally control etc.
double counting

Recent Transactions Control

Premium
Microsoft acquired LinkedIn ~50%
Verizon acquired Fleetmatics ~40%
Oracle acquired Netsuite ~19%
 Financial Synergy

Diversification Cash Slack

Tax Benefits Debt Capacity

 Adidas - Reebok
The footwear market in
Adidas offered ~34%
Adidas acquired Reebok North America was
Deal value $ 3.78 billion premium over last
in 2005 mainly dominated by
closing price for Reebok
Nike

Increased market share

and cost cutting through
synergies were clear-cut
strategies for both Adidas
and Reebok
 Biased Comparable and Multiples

Analysis of other acquisitions

reveals that buyers are willing to Basing what you pay on what
Biased samples yield biased
pay 5x, 10x may be even 20x of other acquirers have paid is a
results
EBITDA….. Should you also as an recipe for disaster
acquirer pay the same?

Investment banker will tell you

When we use the pricing metrics When we use exit multiples, we
that acquisitions are accretive. If
of other firms in the sector, one are assuming that what the
your PE is 20 and whereas target
may be basing the price he is market is paying for comparable
company’s PE is just 10… you will
willing to pay on firms that are companies today is what it will
get jump in earnings per share
not truly comparable continue to pay in the future
post acquisition
 Swap Ratio

Too High • There will be a transfer of

wealth from the bidding firm’s
Swap stockholders to the target
Ratio firm’s stockholders

Too Low • There will be transfer of

Swap wealth from the target firm to
the bidding firm’s stockholders
Ratio
Change in Valuation/Price
 Don’t Pay for Buzz Words

Through time, acquirers have always

found ways of justifying paying for
premiums over estimated value by
using buzz words - synergy in the
1980s, strategic considerations in
the 1990s and GMV’s/users in
current decade
GMV or User Based Valuation

Facebook bought WhatsApp in October 2014

for $19 billion.

Last valuation at time of Facebook acquisition:

$1.6 billion

Valuation increase: 1,118%

GMV or User Based Valuation
 Post Merger Share Price

The target stock price will increase by

Frequently, the stock price of both the
somewhat less than the announced
acquirer and the target will adjust
purchase price as arbitrageurs buy the
immediately following the
target's stock in anticipation of a
announcement of the acquisition
completed transaction

The stock price of the acquirer may

decline, reflecting a potential dilution
of its EPS or a growth in EPS of the
combined companies that is Hence, the P/E ratio of acquiring firms
somewhat slower than the growth can go down
rate investors had anticipated foe the
acquiring company without
acquisition
 Share-Exchange Ratio

SER  PT / PA
PT Negotiated offer price per share of the target stock

PA Acquirer's share price

Post Merger EPS

ET  A
PT
N A  [ NT  ]
PA
 The acquirer offers $84.3 for each share of the target. The acquirer expects no change
in the P/E multiple, and conservatively assumes no immediate synergy

Exchange ratio: $84.3/$56.25=1.5

New shares issued by the acquirer: 18,750*1.5=28,125
Total shares of the combined firms = 112,000+28,125=140,125
Postmerger EPS for combined firms = ($281,500+$62,500)/140,125=$2.46
Postmerger EPS of acquirer = $281,500/112,000=$2.51
Premerger P/E = $56,25/$2.51=22.4
Postmerger share price = $2.46*22.4=$55.10 (vs. $56.25 premerger)
Postmerger equity dilution:
Target = 28,125/140,125=20.1%
Acquirer = 79.9%
The acquisition results in a $1.15 reduction in the share price of the acquirer
as a result of a $0.05 decline in the EPS of the combined firms
 Stock vs. Cash Deal

In the 1980s, less than

By 2000, it was more
2% of M&A were paid
than 50%
by stock

In cash transactions,
shareholders take all
the risk. In stock
transaction, the risk is
shared
 Fixed Shares vs. Fixed Value

Fixed • The number of shares is certain, but the

value of the deal may fluctuate between
the announcement of the offer and the
Shares closing date

Fixed • The number of shares depends on the share

price of the acquirer on the closing date
• The acquiring company bears all the risk: If

value the share price drops, it must issue more

shares to pay the target’s shareholders
 Distribution of Price Risk
Preclosing Risk Postclosing Risk
All-Cash
Acquirer All All
Target None None
Fixed-Share Deal
Acquirer Expected % of Actual % of
ownership ownership
Target Expected % of Actual % of
ownership ownership
Fixed-Value Deal
Acquirer All Actual % of
ownership
Target None Actual % of
ownership
 Making Choice!

Valuation of the • If the acquirer believes the market undervalues its shares, it should pay by
cash
Acquirer’s Share • There is evidence that cash payments are positively viewed by the market

• The financing decision also sends signals about the acquirer’s estimation
Synergy Risks of the synergy risks
• Offering stock can hedge the risk that the synergies won’t materialize

• A fixed-share is not a confident signal since the seller’s compensation

Preclosing drops if the value of the shares falls
• A fixed-share approach should be adopted if the preclosing market risk is
Market Risk relatively low
• The market reacts positively to a fixed-value approach
 The threat of a
takeover helps to keep
managers on their toes
—often precipitates
restructuring
 Why Acquisition?

Increasing
Increasing size
market value -
- easy!
much harder!

Firm A should merge with Firm B if ; Value of AB > Value of A +

Value of B + Cost of transaction
Value Changes In An Acquisition
Deal Time Line
 Preparing for the Sale
• Prepare ahead of time – Key financial and
– With your Management customer metrics readily
team & Owners at least available
12 months – Documentation for all
– With your Advisors 3-6 “add backs” and other
months key numbers
• Resolve any disputes • Defensible projections
before going to market – Next 5 years
• All documentation – Next 5 months
• Business / Technical / IP,
Legal, Accounting,
Regulatory, Other Special
Events
• Historical Financial
 Preparing for the Sale
• Prepare your “Story” • – Maximize Total Value,
 Explain the last two versus up front value –
years Sell a piece, not 100%
 Challenges, how they – Keep your job
were solved, why the – Sustain culture &
Company is stronger  employees
Growth opportunities / • – Find a buyer who can
future value drivers “take it to the next level”
• Prepare responses to • ng for the Sale
likely investor questions
regarding: Your Company
• –
•  Your goals – be
prepared to
 Preparing for the Sale
• Prepare in advance • Create competition to
– 80% of the work is maximize valuation
complete before you /terms and ensure
even go to market closure
– “Dress up” your asset; • Have good advisors
prepare for a sale with strong experience
“everyday”
and great references
• Have your team in
place, informed,
sharing similar goals
 Fallacies of Acquisitions
Downstream/upstream
Size (shareholders
integration (internal
would rather have their
transfer at nonmarket
money back, eg Credit
prices, eg Dow/Conoco,
Lyonnais)
Aramco/Texaco)

Diversification into
unrelated industries
(Kodak/Sterling Drug)
Reasons Why Many Acquisitions Fail To Generate Value

Overestimating
synergies

Over Poor
optimistic Value
market post-merger
assessments Destruction integration

Deal price not based on cash

flow value
Typical Losing Pattern For Mergers
Candidates are screened on basis of industry and
company growth and returns

One or two candidates are rejected in basis of

objective DCF analysis

Frustration sets in; pressures build to do a deal; DCF analysis is

tainted by unrealistic expectations of synergies

Deal is consummated at large premium

Postacquisitions experience reveals expected synergies are

illusory

Company’s returns are reduced and stock price falls

Using Industry Structure Analysis
SUBSTITUTES
Questions:
 Do substitutes exist?
 What is their price/
performance?
Potential Action:
 Fund venture capital and
joint venture to obtain
key skills
 Acquire position in new
segment
SUPPLIERS CUSTOMERS
Questions: Questions:
 Is supplier industry  Is the customer base
concentrating? concentrating?
 Is supplier value/cost  Is value added to
added to end product high, COMPETITIVE customer end product
changing? high,changing?
Potential Actions: ADVANTAGE Potential Actions:
 Backward - integrate  Create differentiated
product
 Forward - integrate

BARRIERS TO ENTRY
Questions:
 Do barriers to entry exist?
 How large are the barriers?
 Are they sustainable?
Potential Actions:
 Acquire to achieve scale in
final product or critical
component
 Lock up supply of critical
industry input
 Role of Seller’s Advisor

Determine value of the

Analyze how different Prepare descriptive
company and advise
Develop list of buyers buyers would evaluate materials showing
seller on probable
company strong points
selling price range

Advise on the
Control information Control bidding structure of the
Contact buyers
process process transaction to give
value to both sides

Smooth post
Ensure all nonfinancial
agreement
terms are settled early
documentation
 Role of Buyer’s Advisor

Advise on Evaluate target's

Thoroughly review Advise on target's
probable price options and
target & subs receptiveness
range anticipate actions

Recommend Advise on initial

Consider rival
Devise tactics financial structure approach and
buyers
and plan financing follow-up

Arrange the
Advise on the Help arrange long
purchase of shares
Function as liason changing tactical term financing and
through a tender
situation asset sales
offer
M&A as an Opportunity for Target Company

Benefit from greater

Need value chain
efficiency – avoid cutthroat Company has weak Has several businesses
integration – eg
competition, achieve financials – flat earnings, that have no synergies –
dependent on supplier –
production or distribution overleveraged some growth, some flat
vertical integration
efficiencies

Company has businesses Company wants to do an

Company is in sector with
with incompatible cultures overcapacity – too much
Company wants to buy IPO but is not suitable – eg
– or two different competitor who could end not in a “new economy”
bread (!) – benefit from
companies with up in a rival’s hands business, or the size is
consolidation
compatible cultures insufficient

Conglomerate discount –
Companies in the same company is undervalued in
line of business, but with the market and would be Owner wants to retire
P/E differentials worth more if some
businesses were hived off
If you can’t convince them,
confuse them
—Harry S. Truman
 Discussion Question

What are common high priority needs of public

company shareholders? Private/family owned firm
shareholders?

How would you determine the highest priority

needs of the parties involved?
Major Components of Deal Structuring
Process

Acquisition Post-closing Form of

vehicle organization payment

Form of Legal form of Accounting

acquisition selling entity Considerations

Tax
considerations
 Factors Affecting Alternative Forms
of Legal Entities

Control by Management Continuity of

owners autonomy ownership

Ease of Limitation on
Duration or
transferring ownership
life of entity
ownership liability

Ease of raising
Tax Status
capital
 Discussion Question

What is an acquisition vehicle? What are some

of the reasons an acquirer may choose a
particular form of acquisition vehicle?
 Acquisition Vehicle
Acquirer’s Objective (s) Potential Organization

Maximizing management Corporate (C or S) or

control divisional structure
Facilitating post closing
integration

Minimizing or sharing risk Partnership/joint venture

Holding company
Gaining control while limiting Holding company
investment
Transferring ownership Employee stock ownership
interest to employees plan
 Discussion Question

What is a post-closing organization? What are

some of the reasons an acquirer may choose a
particular form of post-closing organization?
 Post Closing Organization
Acquirer’s Objective (s) Potential Organization
Integrate target immediately Corporate or divisional
Centralize control in parent structure
Facilitate future funding
Implement earn-out Holding company
Preserve target’s culture
Exit business in 5-7 years
Assume minority position

Minimize risk Partnerships

Minimize taxes Limited liability companies
Pass through losses Sub-Chapter S corporations
 Common equity (Possible EPS dilution but defers tax liability)

Preferred equity (Lower shareholder risk in liquidation)

Cash (Simple but
creates immediate
seller tax liability)
Convertible preferred stock (Incl. attributes of common & pref.)

Non-cash forms of
payment

Debt (secured and unsecured; lower risk in liquidation)

Real property (May be tax advantaged through 1031 exchange)

Form of Payment

Some combination (Meets needs of multiple constituencies)

Balance sheet adjustments (Ignores off-balance sheet value)

Earn-outs or contingent payments (May shift risk to seller)

Closing the gap on
price and risk
mitigation
Rights, royalties, and fees (May create competitor & seller tax liability)

Collar arrangements (Often used if acquirer’s share price has a history of

volatility)
Collar Arrangements
Collar Arrangements
Collar Arrangements
 Stock swap statutory merger by majority vote of both firms’ shareholders

Statutory one-stage
(compulsory) merger
or
or consolidation:
consolidation:
Cash
Cash out
out statutory
statutory merger
merger (form
(form of
of payment
payment something
something other
other than
than acquirer
acquirer
common stock)

Stock for assets

Asset
Asset acquisitions
acquisitions
(buying target assets)

Cash for assets

Forms of Acquistion Stock for stock

Stock acquisitions
(buying target stock via
tender
tender offer)
offer)
Cash for stock

2-stage stock acquisitions (Obtain control & implement backend merger)

Triangular acquisitions

Special
Special applications
applications of
of
basic structures

Leveraged buyouts

Single firm recapitalizations (Minority shareholder “squeeze out”)

 Statutory One-Stage Mergers and
Consolidations
Stock Swap • Two legally separate and roughly comparable in size firms merge with only one surviving
• Shareholders of target (selling) firm receive shares in the surviving firm in exchange for their shares

Statutory Merger

Cash-out • Selling firm shareholders receive cash, non-voting preferred or common shares, or debt issued by the purchasing company; no acquirer
shareholder vote required

Statutory Merger

Procedure for • Assume Firm B is merged into Firm A in a share for share exchange with Firm A surviving:
• Firm A absorbs Firm B’s assets and liabilities as a “matter of law.”
• Boards of directors of both firms must approve merger agreement

statutory mergers • Shareholders of both firms must then approve the merger agreement, usually by a simple majority of outstanding shares. Dissenting
shareholders must sell their shares.

Exceptions for
• Parent firm shareholder votes not required when
• Acquiring firm shareholders cannot vote unless their ownership in the acquiring firm is diluted by more than one-sixth or 16.67%, i.e., Firm A
shareholders must own at least 83.33% of the firm’s voting shares following closing. (Small scale merger exception)1
• Parent firm holds over 90% of a subsidiary’s stock. (Parent-sub merger exception; also called a short-form merger)

share exchanges • Certain holding company structures are created (Holding company exception)
• No new acquirer shares must be issued to complete the deal
 Asset Acquisition
Cash for • Acquiring firm pays cash for target firm’s assets, accepting some, all, or none of target’s liabilities.

Assets • If substantially all of its assets are acquired, target firm dissolves after paying off any liabilities not
assumed by acquirer and distributing any remaining assets and cash to its shareholders2
• Shareholders do not vote but are “cashed out”

Acquisition

Stock for • Acquirer issues shares for target’s assets, accepting some, all, or none of target’s liabilities.
• If acquirer buys all of targets assets and assumes all of its liabilities, the acquisition is equivalent to

Assets a merger.
• Listing requirements on major stock exchanges require acquiring firm shareholders to approve
such acquisitions if the issuance of new shares is more than 20% of the firm’s outstanding shares

Acquisition
• Target’s shareholders must approve the transaction if substantially all of its assets are to be sold

Allows acquirer to select only certain target assets and liabilities; asset write-up & no
minority shareholders but lose tax attributes and assets not specified in contract and incur
transfer taxes
 Stock Acquisitions
• Acquirer buys target’s stock with cash directly
Cash for Stock from target’s shareholders and operates target as
a wholly- or partially-owned (if < 100% of target
Acquisitions shares acquired) subsidiary

Stock for • Acquirer buys target’s stock directly from target’s

Stock shareholders, generally operating target in a
parent/subsidiary structure
Acquisitions

Eliminates need for target shareholder vote (buying from target shareholders); tax
attributes, licenses, and contracts transfer to acquirer; and may insulate parent from
subsidiary creditors but responsible for all liabilities and have minority shareholders
 Two Stage Stock Transactions
• Acquirer buys target stock via a tender offer to gain
First stage controlling interest and owns target as a partially
owned subsidiary

Second stage • Acquirer merges a partially owned subsidiary into a

wholly owned subsidiary giving minority
(Backend shareholders cash or debt for their cancelled shares
Merger) • Also known as a “freeze out” or “squeeze out”

Very popular as acquirers gain control more rapidly than if they

attempted a one-step statutory merger which requires boards and
shareholders to approve merger agreement but may require substantial
premium to gain initial control
 Triangular Acquisition
Acquirer creates wholly
owned sub which
merges with target,
with either the target
or the sub surviving

Avoids acquirer shareholder vote as parent sole owner of sub and limits
parent exposure to target liabilities; however, acquirer shareholder vote may
be required in some states if new stock issued dilutes current shareholders by
more than one-sixth
 Single Firm Recapitalization
Firm with minority shareholders
creates a wholly-owned shell
Enables firm to squeeze out
and merges itself into the shell
minority shareholders
through a statutory merger with
shell surviving

All stock in the original firm is

cancelled with the majority
shareholders in the original firm
receiving stock in the surviving
firm and minority shareholders
receiving cash or debt
 Leveraged Buyouts

Stage • Shell corporation raises cash by borrowing

from banks, selling debt to institutional
investors, and receives equity contribution
1 from financial sponsor

Stage • Shell buys 50.1% of target stock, squeezing

out minority shareholders with a back end
merger in which remaining shareholders
2 receive debt or preferred stock
 Discussion Question

What is the difference between the form of

payment and form of acquisition?
 Discussion Question

What factors influence the determination of

form of payment?
 Discussion Question

What factors influence the form of

acquisition?
 Acquisition
Vehicle

Tax Post-Closing
Considerations Organization

Deal
Structuring
Form of
Accounting Payment

Legal Form of Form of

Selling Entity Acquisition

Deal structuring addresses identifying and satisfying as many of the primary objectives of the
parties involved and determining how risk will be shared

Choices made in one area of the “deal” are likely to impact other aspects of the transaction
 Swap Ratio
A shareholder of the target company
If an acquiring company offers a swap will end up with 50% more shares
ratio of 1.5:1, it will provide 1.5 than they had before, but their new
shares of its own company for every shares will be for the acquiring
1 share of the target company company and have the price of the
acquiring company

When TOMCO was emerged with

Hindustan Lever Limited,
shareholders of TOMCO were given
Shares of the target company may the shares of Hindustan Lever Limited
cease to exist  in the ratio of 2:15; that means 2
shares of Hindustan lever Limited
were given in lieu of 15 shares of
TOMCO
 Discussion Question

How is the exchange ratio determined?

 Bases of Exchange Ratio

Earnings Per Market Price

Share Per Share

Book Value
Per Share
 Discussion Questions

Is it better to use a letter of intent or an

unsigned deal summary or to move directly to
negotiate definitive agreements?
 Public-Private Deals

Typically have a formal non-binding term This gives the acquiror a limited period of
sheet (including a binding no shop) that is time to conduct diligence (and thus the
signed prior to preparation of definitive ability to walk away if not satisfied) while
documents reducing the risk of a third party bidder

A term sheet that is reasonably detailed on

This also gives both parties sufficient key economic points (exchange ratio, price
certainty as to economics and key deal adjustment and collar provisions,
terms to be able to conclude they will indemnity provisions) and walk-away rights
reach agreement on definitive documents (MAE out, no shop fiduciary out, key
and thus that the expense of moving closing conditions and termination
forward (and the risk to the target of taking provisions) will also make it more likely
itself off the market) is justified that these tough issues will not derail the
deal at the definitive agreement stage
 Public – Public Deals

Normally the scope of representations

and the need for due diligence are less The need to sign before a press leak Finally, the execution of a term sheet,
critical, indemnity provisions are rare, and before any movement of the or even the preparation of a deal term
and the main issues are economics, parties’ relative trading prices that summary or definitive agreement draft
deal certainty and break up fees, so derails the deal also drives the parties reflecting complete agreement on all
there is less benefit from a term sheet directly key deal terms, can compel public
and it is more typical to move directly to definitive documents disclosure of pending negotiations
to the definitive agreement

For this reason, executed term sheets However, key economic terms are
are rare in material deals involving intentionally omitted from any such
public companies and the parties summary and early drafts of the
normally proceed directly to definitive definitive agreement to reduce the risk
agreements (often preceded by an of being forced to disclose the deal
unsigned deal summary) negotiations
• these cases suggest that buyer should not rely on a
• “general” MAC closing condition as a way out of the deal So, buyer advisors may try to have target stipulate that certain factors are a MAC (or a breach of a stand alone closing condition, or a basis for adjusting the exchange ratio by a specified
amount)—such as specified employee
• or customer attrition levels or more than a X% shortfall from projected revenue or net worth--arguing that the agreed valuation, or the buyer’s basis for doing the deal, is dependent on these factors
• Conversely, the target advisors should try to anticipate the MACs likely to occur to the target pre-closing, and exclude those from the definition (so buyer must close despite the occurrence of such specified exceptions); examples are adverse
changes caused by factors such as:
• Standard MAC Out Exclusions
• n movement in a party’s stock price (buyer will want this too) [collar may limit this]
• n performance of the merger agreement (e.g., agreed layoffs)
• n failure of buyer to agree to requested actions or covenant waivers
• n events affecting target’s industry generally (but not affecting target disproportionately)
• n events caused by “general economic conditions” (but not affecting target disproportionately)
• Heavily Negotiated MAC Out Exclusions
• n shortfall from analysts’ or disclosed projections (target will argue this is fair if valuation already reflects that target will miss street estimates, or because customers will understandably be concerned about integration of the combined
company’s products; buyer will argue this negates the basis for the deal valuation and should be deleted or “capped” at a de minimus shortfall)
• n customer or employee attrition, at least below a certain level or due to deal announcement
> buyer will argue that customers and employees are
• the key value elements in the purchase; target will argue that such attrition is entirely predictable; compromise may be to:
— allow, but cap, the level of attrition deemed
• included within the exception, and make clear that the attrition was directly attributable
to announcement of the deal or to customer
• concerns about the buyer’s announced product
• integration plans, and
— add a separate closing condition that either
• specified key employees accept employment or that other steps be taken to limit employee attrition risk.
• Discuss customary vs. non-customary conditions. What are some of the most effective arguments to use in this regard?
• The analysis here is similar to the MAE stipulation/exception analysis set out above.
• Buyer argues that the financial or strategic basis for the deal and the valuation is that certain factors be true at closing, and a key goal of the financial and legal diligence process
is to identify such factors. Conversely, target will argue that it needs deal certainty to agree to a no shop and that it will only agree to closing conditions that are both clear and certain to occur. Both parties will argue that their respective Board’s
fiduciary duties hinge on the closing conditions being included, excluded or clarified.
• Customary Closing Conditions
• n Representations true [in all material respects (typical
in private deals) vs. except to such an extent as would result in an MAE (typical in public deals)]—argue for
the latter on basis of the target’s need for certainty of closure and that buyer should not walk away where the breach of representations do not rise to the MAE level in the aggregate, and that such a carve out will lessen arguments about
exceptions in the representations; argue for the former on the basis that target should not be misrepresenting anything, and that acquiror would not have agreed to the deal if representations were at all false, and that the negotiated
materiality, knowledge and MAE qualifiers in the representations give target all the deal certainty it needs]
• n Performance of all covenants [in all material respects?] n Absence of MAE [refer to earlier discussion]
n All consents obtained [if material?; if failure to obtain
• would have a MAE?; best efforts rather than absolute covenant?] [target will argue this gives the party from whom a consent (e.g., as to contract assignment) is sought a veto on the deal and too much economic leverage, and that this makes
deal too uncertain]
• n Absence of litigation/HSR issues [shareholder litigation opposing transactions is predictable—target will want buyer to proceed anyway, buyer will not want to “buy
• a lawsuit”, and will not want to close if DOJ or FTC
• mandates disposition of assets]
n Absence of dissenters above a set percentage, say
• 2%-5% [buyer with stock argues it wants to limit cash paid and that Delaware cases often rule that the per share value in an dissenters’ appraisal proceeding is higher than the negotiated deal value; target argues this condition is
not required by either accounting or tax rules and effectively gives minority holders a veto on the deal]
• n In a tender offer for a California corporation, achievement of 90% tender (so can ensure that buyer can cash out minority holders in a back-end short-form merger)
• n Obtaining required shareholder approvals
• Non-Customary Closing Conditions
• n The absence of excessive employee or customer attrition levels or the meeting of projected (or agreed) target interim revenue or net worth thresholds at closing (buyer argues that the agreed valuation, or the buyer’s basis for
doing the deal, is dependent on these factors)
• n Waiver by target officers of option acceleration or severance (target argues that this is pre-agreed and that this gives officers a “veto” on the deal, buyer argues that acceleration adversely impacts retention and adds
unnecessarily to deal costs)
• n Release by all employees of any equity or employment related claims
• n Elimination of certain risks or cost exposures identified in due diligence (such as settlement of a pending claim or lawsuit) (buyer will argue that the deal is too risky or that the contingency is too hard to value until eliminated so
it must be settled or resolved; target will argue this gives the adverse party from whom a release is sought
• a veto on the deal and too much leverage; compromise may be to have no such closing condition but instead include an adjustment to deal value based on estimated range of risk or cost, or have an indemnity by target
shareholders for the identified risk, perhaps subject to an agreed basket and cap)
• n Satisfactory completion of buyer’s diligence investigation [not advisable for target; effectively gives buyer an option to buy]
• What is the range of most likely outcomes for a “typical” public/private merger as to survival of representations and warranties, indemnity and escrow?
• The elimination of the limits fixed by pooling rules gives buyers more flexibility on indemnity, escrow and survival provisions, but targets still push for the old pooling rule limits (escrow (and generally the indemnity cap) not
exceeding 10% of deal value and generally no general indemnities (or survival of representations) beyond the first anniversary of closing). Buyers will instead typically demand survival for at least two years on most claims, but three
to six years on matters such as due authorization, title, capitalization, tax, environmental, ERISA, intellectual property/patent infringement, litigation and intentional misrepresentation. Indemnity escrows rarely exceed 15%- 20%
(and if they do, they frequently decline during the escrow period), and they usually last 1 year (or 2 years
• for specified risks) (although in deals with an earnout,
the buyer will usually reserve the right to set off some or
all types of indemnity claims against earnout payments, perhaps subject to a cap). Indemnity caps are often tied to the escrow amount (say 20%), as specified above, but will often be higher for breaches of representations such as
due authorization, title, capitalization, tax, environmental, ERISA, intellectual property/patent infringement, and litigation matters. Baskets are far more typical than deductibles and baskets range from 1⁄4 of 1% to 1% of the deal
value. The target shareholders’ exposure on identified risk contingencies is often not subject to either the basket or the cap (which is why such claims are often taken into account as a price adjustment based on estimated exposure
instead). Other issues include exclusivity of indemnification remedy, exclusivity of escrow as source of remedy, the definition of damages to include interest and consequential damages, ability to credit tax deductions or insurance
proceeds received by buyer and control of litigation over third party claims.
• Representations and warranties: Which ones really matter?
• The most critical representations are generally those that bear on:
1. the most material potential liabilities or other financial
• exposures of the target; and
2 the key value elements of the target from the buyer’s
• prospective.
• The materiality and probability of potential liabilities and other financial exposures will often depend on the nature and size of the target and its business model. For technology companies, the sufficiency and protection
of the target’s intellectual property and the absence of
• infringement or claims of infringement will often be the most critical representations and warranties. Clearly, representations as to financial statements, absence of contractual conflicts, absence of changes from the balance sheet
date and litigation will be critical to identifying potential liabilities. But others may also be helpful in
• a particular context, such as disclosure as to material customer complaints and order cancellations in the last
12 months, customer indemnity obligations and material warranty claims. Also helpful can be representations as to the ability to collect receivables, usability of inventory and burdensome development obligations. The diligence
process will help identify these potential areas of concern and representations should be tailored to induce full disclosure as to such matters. There is often heated negotiation about the existence and scope of a 10b-5
representation: that all of the other representations are true and correct in all material respects and do not contain material omissions; or that there is no fact, event or condition (known to target) that would (or could) make the
representations untrue.
• CEOs and investment bankers are perhaps best suited to identifying the key elements of value in the target, and in particular those facts or assumptions critical to justifying the deal valuation. The most critical representations bear
on those key value elements. For technology companies, disclosure as to intellectual property, progress against development milestones, customer and employee attrition risks, projections and sufficiency of assets can often be the
most critical. Representations regarding cash position and burn rate may be critical where buyer’s cash position is not strong and the time to cash break even is critical to survival of the combined company.
• Discuss the typical arguments as to including or excluding materiality, knowledge and MAE qualifiers in or from representations and warranties.
• Buyers typically argue that no materiality, knowledge or MAE qualifiers are appropriate in the representations since the buyer simply wants complete disclosure to manage the post- closing business and legal risks and because:
• (a) the buyer has agreed to a “basket” for indemnity claims, so “No double dipping!”, and
• (b) the closing condition that there are no breaches of target representations already has a materiality or MAE qualifier.
• Targets will argue:
• (a) if the target is public, that the size of the deal and the availability of public information about the target (and securities laws liabilities) make representations without these qualifiers unnecessary.
• (b) that these qualifiers are necessary to simplify preparation of the disclosure schedule and to ensure that the disclosure sought is truly material.
• (c) that the target should not be asked to warrant something it cannot know for certain, such as the absence of any risk of patent infringement (counter: this is all about risk allocation).
• Discuss the importance of disclosure schedules and provide tips on how to read them.
• Buyers will want to ensure that the disclosure schedule
does not contain language that negates or modifies the representation or shifts the risk of breach, or that is so ambiguous as to lead to a dispute whether an exception was actually disclosed. Careful review of the disclosure
schedule is the best form of due diligence and it can confirm the results of buyer’s own diligence efforts.
• Where a buyer requires a target to indemnify for breach of representations, as is the case in most public-private deals, the disclosure schedule is the most critical means for the target shareholders to minimize indemnity liability, so
target bankers, counsel and management must scrutinize the disclosure schedule to ensure that all material risks are fully disclosed.
• Where there is no indemnity provision, and the closing condition on representations is subject to an overall MAE exception, as is the case in most public-public deals, there is less precision needed in the disclosure schedule.
• Earn-outs: What are the key issues and pitfalls?
• Tough issues include:
• n lack of alignment of goals post deal
n employee morale issues if earn out not paid
n frequent source of disputes
n hard to anticipate all interpretation issues that will arise
• later
n slows deal negotiations and drafting
n payment milestones can become outdated
• >
• development milestone may become outmoded due to:
— changing customer demands
• — need to integrate products
• >  revenue milestone may cease to be achievable due to
• cost cuts
• >  milestones can be impacted by employee attrition
• >  milestones can be impacted by consolidation or sale
• of buyer’s divisions
•
difficult to anticipate all ways in which buyer can “game”
n

• the milestone, e.g.,

• >  revenue milestone:
– —  change in revenue recognition methodology
– —  buyer’s sales force not incentivized to cross-
– sell
• >  earnings milestone—change in reserves or effective
• tax rate
• >  development milestone—change in available
• resources
When do enhanced scrutiny and Revlon apply?
• In certain circumstances, including a change of control (generally not a stock-for-stock merger of equals), an active bidding process/auction, a sale of a subsidiary with minority shareholders, a break-up of the company or the adoption of defensive measures, courts will review directors’
decisions to ensure that the decision making process was adequate and that the action was reasonable. (While this seems like
a low standard, it allows the judges to look at the result
and not just the process.) In the “defensive” context, “reasonableness” requires that (i) a potential superior competing bid and meaningful stockholder vote not be precluded (such as by excessive voting lock-ups or process constraints) and that stockholders are no coerced (such as by
excessive break-up fees).
• In such cases, the duty of the Board is to get “the best value reasonably available to the stockholders.”
• No single blueprint to get the best value: conduct pre- signing auction or “market check” (limited shopping to most likely bidders) and/or permit subsequent superior offers an opportunity to prevail.
• What are the Board’s duties in negotiating “no shop” and “lock up” arrangements? What are the different flavors of no shop provisions? What are the legal limits on deal protections?
•

•
The board cannot contract away its fiduciary duty.
n
n

• A “No Shop” clause cannot prevent the Board from carrying out its duty in considering unsolicited bids or negotiating the best value reasonably available.
• >  A properly drafted no shop provides a “road map” for
• a third-party bidder to make a superior offer.
• >  Board must show that lock-up measures were
• reasonable and necessary to get the deal (and
• premium).
• >  The differences among (flavors of) no shops generally
• relate to the following:
• >  What must be received from the third party bidder?
• Must the offer be firm, fully financed, superior on its face and in writing (and must a banker so advise?), or merely be an inquiry that the target board in good faith believes could result in a superior offer? Must that offer be made up front or can it result from
• the target providing information or engaging in
• discussions after receipt of an unsolicited inquiry?
• >  What can the target do with the unsolicited inquiry
• or offer? Provide information? Negotiate? Terminate the agreement prior to a shareholder vote? Do any of the above only where counsel advises that same is “required” by or “consistent with” the target board’s fiduciary duty?
• >  As a general rule, the more heavily shopped a deal is pre-signing, and the higher the premium, and the more clear it is that “Revlon” does not apply, the more stringent the no shop can be and the more limited the “fiduciary out” can be.
• >  At a minimum, the target board generally must remain free to “consider” any unsolicited bid it receives, to change its recommendation and to communicate the terms of the alternative deal to its shareholders.
• What are the Board’s duties in evaluating break up fees and what are the usual triggers?
•
Break-up fees must be reasonable (2% per se reasonable - 4% more aggressive).
n

> Break up fees usually triggered by:

• —  Primary acquiror’s decision to abandon deal in response to voluntary actions by target board adverse to the primary deal, such as changes in recommendation to stockholders, endorsing rival bid, etc.
• —  Target’s termination of primary deal in response to a superior rival bid (often after primary buyer fails to match superior offer)
• — Rejection of deal by stockholders (and sometimes, for breach of representations, time-out, or even regulatory terminations), following a rival public bid (not a “naked” no vote) and entry into (and
sometimes closing of) a rival bid (theory is primary bid “teed-up” the better offer and that successful acquiror, rather than target stockholders, will bear the cost).
• > Break-up fees are usually not liquidated damages for a breach of the merger agreement—they are part of the legitimate road map to leave the first deal.
• Voting/tender agreements: Can a deal be “locked up” (with no fiduciary out) by obtaining voting agreements for a majority of the outstanding shares?
• n Omnicare holding: “No, absent a fiduciary out.” In Omnicare, Inc. v. NCS Healthcare, Inc., Nos. 605, 2002 and 649, 2002, Holland, J. (Del. April 4, 2003), the Supreme Court of Delaware held that when a
deal is fully locked up (i.e., it is “mathematically impossible” or “realistically unattainable” for another bidder to succeed), making closing a fait accompli, through
• a combination of deal protection devices, in that
case consisting of (1) specifically enforceable voting agreements committing stockholders with a majority of the voting power to vote for the deal, (2) a “force
the vote” provision, and (3) the absence of an effective “fiduciary out”, so as to prevent the board from being able to effectively exercise its fiduciary duties, then such deal protection devices are
unenforceable. The Court warned target boards that entering into a fully locked deal without an effective “fiduciary out” may be an abdication of the board’s responsibility to retain the ability to
exercise its fiduciary duties in that context. Nevertheless, in the closely held, private target context (i) parties sometimes agree to use a target majority stockholder written consent to approve and “lock”
an acquisition immediately after execution of the merger agreement; and (ii) buyers may argue that Omnicare is limited to its facts.
• n Orman v. Cullman, 794 A.2d 5 (Del. Ch. 2002), distinguished Omnicare and upheld a voting agreement that prohibited the controlling shareholders from voting in favor of a rival bid for 18 months,
where minority holders were given a veto right on the current deal, so they could force the company to remain independent.
• Are there any other creative ways to protect transactions from interlopers?
• Deals are normally protected with the features discussed above:
• n no shop
n voting agreements
n lock up option for 19.9% of target at deal price if it
• accepts a competing bid
n break up fees
n right to top third party bid
• There is some variability in the terms of these features, but collectively they remain subject to the overall limitations discussed earlier, including that in general they cannot, considered as a whole, be
preclusive or coerce shareholders into voting for the first deal.
• Other possible arrangements may include the following, subject to the limitation noted above:
• n Refusal Rights — A right of refusal or right of first offer will often deter potential buyers; it is rarely given easily.
• n Crown Jewel Option — structuring a crown jewel option to give the first buyer access to assets or rights that a known competing bidder will find objectionable.
• n Nominally Non-Preclusive Voting Agreements — obtaining voting agreements covering a non-preclusive number
of shares, from parties collectively owning a preclusive number of shares.
• n Oenerous Business Arrangements — irrevocable business arrangements that are reasonable but that
a potential bidder would find objectionable, such as foreign distribution rights, discounted volume purchase agreements, joint development arrangements, or technology licenses and the like, but such
arrangements may be inconsistent with the target board’s fiduciary duties.
• n Investments — a strategic investment in the form of warrants, convertible debt or preferred stock with significant liquidation preferences will at least give
the holder a place at the negotiating table, since the buyer will often not want such securities to remain outstanding, and may insist that the holder waive certain liquidation preferences in a thin deal to
give employees holding common stock sufficient incentive to remain with the combined company.
• n 10% Interest: Since pooling rules have now been terminated, mere holding of a 10% interest in a company (and thus ability to dissent and preclude pooling) is no longer an absolute obstacle to a deal.
However, since a back end merger following a tender offer for a California corporation cannot be done as a short form merger without achieving a 90% tender, a 10% interest in such entity may be a
deterrent.
• What is the HSR filing threshold? What are the different levels of “effort” that buyer/seller must put forth to achieve antitrust and other regulatory clearance?
• I. Domestic Antitrust Filings (HSR) HSR Filing is required where:
• (a)  The acquiring person will hold more than $59.8 million worth of voting securities and assets of the acquired person and the parties meet the “size-of-person” requirements below; or
• (b)  Regardless of the parties’ sizes, the acquiring person will hold more than $239.2 million worth of voting securities and assets of the acquired person.
• Meeting any one of the following three subtests satisfies the “size-of-person” test:
• (1)  A person with $119.6 million or more of total assets (on its most recent regularly-prepared balance sheet) or annual net sales (from its most recently completed fiscal year) proposes to acquire
voting securities or assets of a person engaged in manufacturing (note that software is not considered manufacturing) with $12.0 million or more of annual net sales or total assets;
• (2)  A person with $119.6 million or more of total assets or annual net sales proposes to acquire voting securities or assets of a person not engaged in manufacturing with $12.0 million or more of total
assets (net sales test does not apply); or
• (3)  A person with $12.0 million or more of total assets or annual net sales proposes to acquire voting securities or assets of a person with $119.6 million or more of annual net sales or total assets.
• Note that “person” means ultimate parent. Note also if the transaction involves the formation of a joint venture or LLC, or involves the acquisition of stock or assets of a foreign company, then certain
additional tests must be met to require notification.
• II. Different Levels of Effort Required to Achieve HSR Clearance
• n None-buyer can terminate where
> HSR “second request” or foreign equivalent
> Government seeks injunction or institutes litigation > Government requires any divestiture or limitation on
• business conduct
n Some-buyer can only terminate if
• > regulatory delay exceeds 3-6 months,
> Requested divestiture or limitation on business
• conduct is “material”
n Extensive-buyer can only terminate if
• > regulatory delay exceeds 9 months
• > fight injunction and file an appeal
n Requested divestiture or limitation on business conduct
• will have MAE
> buyer must agree to non-MAE divestitures; and
> buyer may not agree to acquire any third parties until
• HSR clearance
n Drop Dead Date-extend 3-6 months automatically if HSR
• 2nd request?
 Which is Better?

Common-for-
common
exchange
Options
Asset-for-stock
exchange
If you are with Gillette what will you
choose?

Equity or Cash
If you are with Gillette what will you
choose? Equity or Cash?
• Certainty • Tax
• Ensures payment when • Agency cost
buyers credit worthiness • Immediate
is questionable
capital gain

Cash: Cash:
Merits Demerits

Equity: Equity:
Merits Demerits
• Share in Synergy • Incoming shares may
• Less effort in negotiation be overvalued
• Deferred capital gain
• Dilution in control
• As acquirer size increases probability of stock
purchase decreases
If you are with P&G what will you choose?

Equity or Cash
If you are with Gillette what will you choose?
Equity or Cash?
• Simplicity • Strain on liquidity
• Must rely on
• EPS will be raised contract terms to
• Avoids dilution recover claims

Cash: Cash:
Merits Demerits

Equity: Equity:
Merits Demerits
• High management ownership in target and
desire for stock offers to maintain control
• EPS and P/E
• If targets are private companies - stock uncertain
may be useful to tie in management if they
are needed • Agency cost
Factors Influencing the Decision of Cash vs.
Shares Payment

Sharing • If cash is used, the selling firm’s shareholders will not

participate in the potential gains (or losses) from the
Gains merger

• Control of the acquiring firm is unaffected in a cash

acquisition
Control • Acquisition with voting shares may have implications
for control of the merged firm

Taxes • Cash acquisitions are generally taxable

Factors Influencing the Decision of Cash vs.
Shares Payment

Financial • Growth rate

• EPS

Impact • PER

Motives • Strategic vs. Non strategic

Asymmetric • Investors viewpoint is that if offered stock then the stock is overvalued
• If cash then undervalued
• Cash offers signal a high valuation and therefore designed to be pre-
Information emptive
Factors Influencing the Decision of Cash vs.
Shares Payment

• Tender offer - Direct to shareholders

Type of and may be hostile, usually cash
• Merger offers, friendly and made to
Transaction management usually stock

• Accounting
• Regulatory Requirements
Regulatory • Contingent Payments
• Financing Ability
What are the Other Forms of Payments could
use?
Debt – Secured,
Performance Purchase Price
Unsecured,
Related Earn-Outs Adjustments
Convertible…

Real Properties –
Right to IPR – Royalty from –
RE, PPE, Business,
License, Franchise.. License, Franchise..
Product Line…

Fee based –
Staged or
Consulting, Contingent Value
Distributed
Employment Rights
Payouts
Agreements…
 Valuation Analysis

Current
• P&G and Gillette are publicly traded
Market • Fallacy of bidding below market price

Price
• An unreliable indicator of value
Book • Based on accrual-accounting convention not cash flow
• Ignore value of intangible assets - Brand names, Know-
value how, Excellent store location
• Historical, not forward looking
 Valuation Analysis

• Types..
• P/E
• P/cash flow
Multiple • Market/book
• Active for simplicity
s • Afford no opportunity for careful
sensitivity analysis
• No direct linkages to growth and profit
margins
 Valuation Analysis

• Reliance on accounting data

Comparable •
Ignorance of cyclical
Transactions variations

• Terminal value assumptions

DCF • Constant growth model
 Valuation Analysis

Information • Private financial forecasts

• Hidden values - Land, building and equipment are
Asymmetries worth more than market value terms

• Possible allocation value of synergies between both

Synergies the parties
• Share-for-share exchange will automatically allocate
synergies pro rata between P&G and Gillette
Most Widely Used Valuation Methods
True Value of an Acquisition
Pricing in M&A (Buyer’s Perspective)
Example..
Drivers of Transaction Value
Valuing Target with Motive Built in

Undervaluation • Value target firm as stand-alone entity: No extra premium

Diversification • Value target firm as stand-alone entity: No extra premium

• Value the firms independently

Operating • Value the combined firm with the operating synergy
• Synergy is the difference between the latter and former
Synergy • Target Firm Value = Independent Value + Synergy
Valuing Target with Motive Built in
Financial • Tax Benefits: Value of Target Firm + PV of Tax Benefits
• Debt Capacity: Value of Target Firm + Increase in Value from Debt

Synergy • Cash Slack: Value of Target Firm + NPV of Projects/ Target

• Value of Target Firm run optimally

• Value of control should be inversely proportional to the perceived
quality of that management and its capacity to maximize firm value.

Control • Value of control will be much greater for a poorly managed firm that
operates at below optimum capacity than it is for a well managed firm.
• Value of Control = Value of firm, with restructuring - Value of firm,
without restructuring
• Negligible or firms which are operating at or close to their optimal value

Manager’s • Value of Target Firm: No additional premium

Interest
An Acquirer’s Risk in All-Cash Deals
 Factors Leading to Choosing a ratio in the
Win-Win Zone

Control Premium in Relative contribution of

Bargaining Power
comparable transactions the two firms

Some contribution
Relative pre-merger indicators - operating
share prices of target profits, assets, unit
and buyer sales, revenues, no. of
employees
Synergy

139
What are the Difficulties faced in
Estimating Synergies?

Intense Time Pressure

Most
calculations of
synergy value Limited information
occur under
horrendous
conditions Maintaining confidentiality

140
 Is there any Private Synergy Created in this
Deal?

Private Synergy
When the combination and
integration of the acquiring and
acquired firms’ assets yields
It is difficult for competitors to
capabilities and core competencies
understand and imitate
that could not be developed by
combining and integrating either
firm’s assets with another company

141
 Is there any Real-Option-Synergies in this
Deal?

Components of Synergy

VSynergies = VIn-Place-Synergies + VReal-Option-Synergies

Parallels the decomposition of firm value into “assets-in-place” and “growth

options”

145
 In-Place Synergies
n
FCFt
V Firm 
t 0 (1  WACC ) t

Can arise from improvements

in any of the Free Cash Flow Revenue Cost
components or in WACC Enhancement Reduction

Implied in FCF or WACC are Asset

Tax Reduction
improvements in timing Reduction

146
 Real Option Synergies
• Combination of resources in • Combined firm might
Growth a transaction that creates have greater flexibility in
Option the right to grow, but not the Options waiting on developing a
obligation. For example, the
Synergie matching of licenses to enter to Defer new technology,
new markets with the perhaps by incumbency
s resources to do so advantages

• The combined company

Exit might be more flexible and
Options
• New firm could exit or
option be able to move out of to Alter enter a business more
synergie current strategies and into Operatin
new ones in response to readily
s evolving conditions g Scale

148
 Real Option Synergies

• Combined firm might be

able to switch production
from large plants to smaller
plants as required Valuing Real Option
• Switch production from one
Synergies could be thought
Option plant in a given high cost
location (country) to of as an option on uncertain
s to another in response to
changing labor costs or product development
Switch exchange rates
activities, and valued as a
• Change the mix of inputs or
outputs of the firm, or its
processes
European option
• Switch from one source of
supply to another

149
 Under Operating Synergies, What Type of Synergy is
Expected to be Significant in this Deal?

Operating Synergies
Complementary
Economies of Scale Economies of Scope
Strengths
• Consolidation in • Combination of • Combining the
the number of two activities different relative
firms in the reduces costs strengths of the
industry two firms creates
• Spreading fixed a firm with both
costs strengths that are
• Geographic complementary to
synergies one another

150
 Will Cost Saving Synergy Achievable in this
Deal?

Time taken to
realize cost
savings
Most common Easiest to
type estimate
Resistance to
Hard synergy Work well in change
– high same industry
certainty Acquisitions
Compromise
on quality

151
 Can Revenue Enhancement Synergy be
Achieved in this Deal?
Customer base of the
acquired company, for
instance, may react
negatively to different
prices and product features

Soft synergy – Difficult to

Hard to estimate
predict
Combined customer base
may balk at making too
many purchases from a
Target brings a superior single supplier
Generated from
or complementary
combining different
product to the more
strengths from the two
extensive distribution
organizations
channel of the acquirer
Competitors may lower
their prices as a reaction to
the acquisition

153
 Can Revenue Enhancement Synergy be Achieved in this
Deal?
Cross Selling

Customer Based Geography Based

V M V M

Customers of V & M Area Operated by V & M

Same Territory Different Territory

Different group of customer = Cross Sector Acquisition Similar group of customer = Horizontal Acquisition

154
Horizontal Competitive = Same Customer and Same Territory
Is there any Co-Insurance Effect in this Deal?
WACC

Optimum for Newco as Optimum for Newco

simple sum of two showing effects of co-
stand-alone firms insurance

Debt/(Debt+Equity)

Combination of the buyer and seller could cause

the WACC curve to shift in advantageous ways
162
Estimating Impact of a Lower WACC

Value of the change in WACC = [raVa+rtVt) – rc(Va+Vt)]/rc

Va = pre- Vt = pre- ra and rt =

acquisition value acquisition value corresponding
of the acquirer of the target WACCs

rc = WACC of the
combined firm

163
 Synergy Levels

Levels A & B are related to

enhancement of efficiency. The role
of environment is minimal
according to these perspectives

Levels C & D relate to striving for

Level A: Economies of scale
greater effectiveness, which
Level B: Economies of scope automatically posits a dynamic
Level C: Economies due to
competitive positioning
environment
Level D: Economies due to
corporate positioning
Level E:
Economies due to
financial strategy Level E relates to a portfolio
approach to corporate strategy
Synergy Levels
 Synergy Levels (Sub Levels)

Having uncovered five synergy levels and three stages within each, there would be 15 possible synergy subtypes or
components for examining synergies available in acquisitions
 Ask these Questions while Estimating
Synergies

Will it reduce costs as

What form is the
a percentage of sales Will it increase future
synergy expected to
and increase profit growth?
take?
margins?

When can the synergy Will the gains from If it will take time,
be reasonably synergy show up when can the gains
expected to start instantaneously after be expected to start
affecting cashflows? the takeover? showing up?

178
 James Kilts
• James M. Kilts was a chief executive officer of The Gillette Company. He
negotiated the sale of the company to Procter & Gamble for US$57 billion. Press
investigators estimate that he stood to gain more than $165 million personally in
the purchase. Kilts is currently a partner at Centerview Partners, an investment
banking and private equity firm based in New York City. In that role he was
involved in the sale of Big Heart Pet Brands,[1] and is now looking to raise a 
special purpose acquisition company (SPAC) for a new acquisition.[2]
• He was then elected to the Board of Directors at The New York Times Company in
2005. He is a member of the Cato Institute Board of Directors.[3]
• Kilts is a 1970 graduate of Knox College in Galesburg, Illinois, and received his 
Master of Business Administration degree from the 
University of Chicago Booth School of Business . In addition, as an undergraduate
student at Knox College, Kilts was also a member of the Delta Chapter of 
Tau Kappa Epsilon Fraternity.
•  
 Extraordinary day for Gillette’s James Kilts, the show-
stopping turnaround expert known as the “Razor Boss of
Boston”

Kilts, along with Procter & Gamble chairman Alan Lafley,

had just orchestrated a $57 billion acquisition of Gillette
by P&G

The creation of the world’s largest consumer products

January 27,
company would end Kilts’s four-year tenure as CEO of
2005
Gillette and bring to a close Gillette’s 104-year history as
an independent corporate titan in the Boston area

The deal also capped a series of courtships between

Gillette and other companies that had waxed and waned
at various points throughout Kilts’s stewardship of Gillette

But almost immediately after the transaction was

announced, P&G and Gillette drew criticism from the
media and the state of Massachusetts concerning the
terms of the sale
 Discussion Question

Would this merger actually benefit shareholders,

or was it principally a wealth creation vehicle for
Kilts?
 Soap

Products
for Health
and Beauty Shampoo
Care Consumer
Products
of P&G

Food and Laundry

Beverages Detergent
 Ranging
from Ace
bleach to
Zest soap
Head &
Shoulders Pampers

P&G Brands
(Portfolio of
Olay Approximately Tide
150 Brands)

Crest Folgers

Charmin
 Gillette Best known for its razor P&G
business, but the company
controlled two other brands—
P&G was particularly skilled in
Oral-B toothbrushes and
marketing to women
Duracell batteries—that
produced at least $1 billion in
annual revenue (see Exhibit 1)

Core customer segment was

men (with the memorable
marketing tagline “The Best a
Man Can Get”)

Two companies were naturally stronger in distinct gender segments

Gillette P&G P&G also had several
brands—Head &
Had expanded into
Shoulders dandruff
female product lines
shampoo among them
with its Venus razor
—that targeted male
customers

Gillette understood
how to operate P&G brought expertise
successfully in India in the Chinese market
and Brazil
 Ronald Perelman
• Ronald Perelman
• Ronald Owen Perelm an (born J anuary 1, 1943) is an American businessman, inv est or, and phil anthropist .[3] MacAndrews & Forbes Incorporat ed,[4] his company, has i nv ested i n companies wi th i nterest s in groceri es, cigars, licori ce, makeup, cars, photography, t elev ision, camping suppl ies, securit y, gaming, jewelry, banks, and comi c book publishing.
• Perelman is annuall y one of t he world's l agrest philant hropic donors. As of J anuary 2016, Perelman i s the 36th-ri chest American, and 96th- richest person i n t he worl d, w ith an estimat ed weal th of $12.7 bil li on.[5] In Sept ember, 2017, Forbes magazine named Perelman as one of t he "100 Great est Liv ing Business M inds."[6]
• Contents
• Early life
• Business career
• Belmont Indust ri es
MacAndrews & Forbes Incorporat ed Morgan St anley
• Philanthropy
• Personal donations Pol itical donations Apoll o i n the Hampt ons
• Controversy
• Greenmail Panav i si on
Fred Tepperman
• Personal life
• Marri ages
Fai th Gol ding
• Claudi a Cohen Pat ri ci a Duf El len Bark i n Anna Chapman
• J udaism
• Homes References
• Early life
• Perelman was born in Greensboro, Nort h Carol ina on J anuary 1, 1943, t he son of Ruth (née Caplan) and Ray mond G. Perelman.[7][8] He was raised in a J ewish fami ly.[9] He managed wi th family members t he
• Ronald O. Perelman
• Perelman at t he 2009 Tribeca Fi lm Festival
• Born Ronald Owen Perel man J anuary 1, 1943
• Greensboro, North Carol ina, U.S.
• Residence New York Ci ty, N ew York , U.S.
• Alm a mater Whart on School of the Uni v ersi t y of Pennsy lvani a (BS & MBA)
• Attended Vi llanova Uni versit y School of Business for one semester i n Fall , 1960
• Occupati on Chairman & CEO, MacAndrews & Forbes
• Incorporat ed
• Net worth US$12.1 bil lion (Nov ember 2017)[1][2]
• Spouse(s)
• Fai th Gol ding (1965–1984; di vorced)
Claudi a Cohen (1985–1994; div orced)
• Patricia Duff (1995–1996; div orced)
Ell en Bark in (2000–2006; di v orced)
• Anna Chapman (2010–present )
• Children 8
• Ameri can Paper Product s Corporation. Raymond ev entuall y left the company and bought Belmont Iron Works, a manufacturer of struct ural st eel .[10]
• From hi s fat her, Perelman l earned t he fundamentals of busi ness.[11] By
• t he time Ronald t urned elev en y ears old he regularl y sat i n on board
• meetings of his fat her's company. A 2006 article publ ished in t he
• [12][7]
• Pennsyl vani a where he majored in business. He graduated i n 1964 and completed hi s mast er' s in 1966.
• Business career
• Belmont Industries
• Perelman' s first major business deal took place in 1961 duri ng his Freshman y ear at t he W hart on School of the Uni versit y of
• [14]
• Throughout Perelman' s t enure at t he Bel mont Iron W ork s (later renamed Belmont Indust ries) he assi st ed his fat her on ot her deals. Their general strategy was purchase a company, sel l off superfluous di vi si ons t o reduce debt and generate profit, bri ng the company back t o it s core busi ness, and eit her sell it or hang ont o i t for cash flo.wIn 1978, twel v e y ears after Perel man formall y joined Belmont Indust ries, he was t he v ice presi dent but he stil l st rov e for more power and i nfluence in t he company. Ray mond told him that he had no intention of stepping down any time soon. Perelman resi gned and mov ed t o New oYrk . The t wo barel y spoke t o one anot her for t he next six y ears.[15]
• MacAndrews & Forbes Incorporated
• He orchest rat ed t he purchase of Cohen-Hatfi eld J ewelers in 1978, his first deal as an i ndependent inv est or free of his father's influence and t ook a loan from his wi fe, Fai th Gol ding. W it hin a y ear, Perelman had sold al l of t he company' s ret ail locations and
• [16]
• Perelman acqui red MacAndrew s & Forbes, a di st ri but or of l icori ce extract and chocolat e. He faced resi st ance from the management and inv est ors and filed an unsuccessful l awsui t to prev ent t he acquisition, but Perelman prevail ed. In 1983, Perelman st art ed sel ling bonds to acqui re t he remai ning 66% st ake i n MacAndrew s & Forbes Group Inc. t o take MacAndrews & Forbes Group Inc. privat e.[17]
• Also in 1983, MacAndrew s had acquired Techni color Inc.[18] Despi te the bond debt , in 1984, M acAndrews & Forbes purchased Consol idat ed Cigar Holdings Ltd. from Gulf & W est ern Indust ri es, in addition t o Video Corporation of Ameri ca.[19][20] The Technicolor Inc. di v isions w ere sold off and, in 1988, i ts core business was sold t o Carl ton Communications for 6.5 times t he purchase price. Using t he proceeds from t he Technicolor div ision sell off, M acAndrews & Forbes purchased a 20 percent stake in Compact Vi deo Inc., a telev i si on and fil m syndi cation company. Ronal d Perelman's controlli ng buyout of Compact Video was in 1986.
• In 1989, Perelman acquired New W orl d Ent ertainment , w it h Davi d Charnay' s Four St ar Telev ision becomi ng a unit of Ronald Perel man' s Compact Video, l ater t hat y ear. Ownership of Compact Video Inc. was increased t o 40% i n 1989 after t he buy out of Four Star Int ernational.[21][22][23] After Compact shut down, it s remai ni ng assets, incl udi ng Four St ar, w ere folded int o MacAndrew s and Forbes Incorporated. In 1989, Perel man also acquired New W orld Ent ert ainment wit h Four St ar becoming a di vi si on of New World as part of the t ransaction. Four Star Int ernational was purchased through a gol den parachut e deal that was negotiated wi th Dav id Charnay by Ronald Perel man after Charnay w as notified of stock purchases made by Perelman i n 1989.[24] By t he end of 1989,
• Forbes 400 di scusses their rough relationship in detail .
Perelman first attended Vil lanova Univ ersit y 's School of Business (Fal l, 1960), t hen attended theWharton School of t he Univ ersit y of
• [13]
• Parents Ray mond G. Perel man (father)
• Ruth Perel man (d. 2011) (mot her)
• Relatives J effrey E. Perelman (brot her)
• Website www.macandrewsandforbes.com
• Pennsyl vani a. He and his father bought the Essl inger Brewery for $800,000, then sol d it t hree y ears l ater for a $1 mi ll ion profit .
• reduced the company t o it s l ucrativ e wholesale jewel ry di v isi on, earni ng him $15 mill ion.
• MacAndrews refinanced t he Holding compani es' junk bonds for st andard bank loans. The bulk of New W orld' s film and home v ideo holdings were sol d in J anuary 1990 to Trans-At lantic Pi ct ures, a newl y formed production company founded by a consortium of former New Worl d executiv es.[25]
• His company MacAndrews & Forbes became a holding company wit h int erests i n a div ersified portfol io of publ ic and pri vat e companies and was stil l whol ly owned by Perelman, who serv ed as it s chairman and chief executiv e officer. MacAndrew s & Forbes' s current holdings includeAM General,[26][27] Deluxe,[28] Rev lon,[29] Scientific Games,[30] SIGA Technologies[31] and VTV.[32]
• He has also done deals wi th Rev lon Corporation,[33] t hri fts for $315 mi ll ion and renamed it Fi rst Gibralt ar Bank ,[34][35] Coleman Company, Sunbeam Products,[36] and New W orld Ent ert ainment.[37][38]
• Morgan Stanley
• On February 17, 2005, Perelman fil ed a lawsuit agai nsM t organ Stanley.[39] Two fact s were at i ssue. Di d Mogr an St anley k now about
• t he problems wit h Sunbeam and w as Perel man mi sl ed? During t he discov ery phase, t he judge became exasperat ed w it h what she
• percei v ed as deli berat e st onew al ling on the part of Morgan St anley and ordered t he jury t o assume Morgan St anley deliberat ely and
• [40]
• have fall en for their t ransparent t rick s.[41] After a fiv e-week t ri al, the jury deli berated for two day s, found i n fav or of Perel man, and
• awarded him $1.45 bil lion.[42] The damages stung particularl y because M organ St anl ey passed up Perel man' s offer t o settle t he case
• for $20 mi lli on.[43] Morgan St anley maintained t hat t he court case was i mproperl y decided, ci ting t he judge' s deci sion to use Florida
• law ov er New York law and her deci si on to order t he jury t o consider M organ Stanl ey guil t y before t he t rial began.[44] In 2007, t he
• courts of appeal rev ersed t he judgement . The judges declared Perelman hadn't prov ided any ev idence showi ng he'd suffered any
• act ual damage as a result of Morgan St anl ey ' s actions. Perelman appeal ed,[45] but found hi msel f shot down by the Florida Supreme
• Court who dismissed it in a 5–0 decision.[46] Undeterred ev en after t hat set back, Perel man went back t o the trial court and asked for
• t he case to be reopened because the hi di ng of email ev idence w as "a classi c example of fraud on the court ". The t ri al court reject ed
• [47]
• Through his company, M acAndrews & Forbes est abli shed t he Revl on/UCLA Women's Cancer Research Program i n 1994 for research into t he causes and treat ment of breast and ovari an cancer. The company also founded t he Ronald O. Perel man Depart ment of Dermat ology at NYU Medi cal Cent er. Ov er t he y ears, M acAndrews & Forbes has also prov i ded significant support for such organizations as t he National Breast Cancer Coali tion Fund, Carnegi e Hall , t he Solomon R. Guggenhei m Museum, M emori al Sl oan- Kettering Hospi tal and Perelman's al ma mat e,r The Uni versit y of Pennsy lvani a.
• Personal donations
• In 2008, the Chronicle of Phil ant hropy li st ed Perelman as t he 26th l argest donor i n t he U.S. Perelman has also prov ided personal donations to educational i nstit utions. In 1995, Perelman donat ed t o Pri ncet on Uni v ersit y to creat e t he Ronald O. Perel man Instit ut e for Judaic St udi es.[48] Ot her not abl e donations incl ude $20 mill ion t o t he Uni versit y of Pennsy lvania for nami ng right s to the quadrangl e,[49] $10 mil lion t o New York Uni v ersit y to create t he Ronald O. Perel man Depart ment of Dermat ology,[50] $4.7 mil li on to Princeton Univ ersi ty t o create the Ronal d Perelman Instit ute for Jewi sh St udi es,[51] and $20 mi ll ion t o the Guggenheim Museum.[52] In 2008, Perel man donat ed $63.5 mil li on to causes including, but not limit ed to: Wei ll Medical Coll ege of Cornell Univ ersi ty, St and Up to Cancer (SU2C), Worl d Trade Cent er Memorial Fund and Ford's Theatre. Perel man pledged $25 mill ion t o Weil l Medical Coll ege, in New York , to support research, education, and patient care at the Ronald O. Perelman and Cl audi a Cohen Cent er for Reproductiv e Medicine. Perelman al so pl edged $15 mil lion to St and Up to Cancer, a Pasadena, Cal if., organization t hat supports cancer research and eff ort s to advance treatment for cancer patients; $5-mil li on to the W orld Trade Center M emori al Fund, i n New York ; and $2.5 mil lion to Ford' s Theatre,i n Washington.
• In 2006, Perelman donat ed ov er $60 mi ll ion t o various charitabl e groups and causes including Carnegie Hall and t he World Trade Center Memorial.[53]
• k nowi ngly defrauded Perel man. Hobbled, M organ Stanley had no choi ce but t o argue t hat Perel man was too sav v y an inv est or to
• his argument s, but as of January 2009, he i s beseeching Fl orida' s 4t h Circui t to reopen the case.
• Philanthropy
• In February 2008, Perelman made a $50 mill ion donation t o t he New York Presby terian Hospi tal and Weil l Cornel l Medical Cent er t o create t he Ronal d O. Perelman Heart Instit ut e, and t o prov i de vi tal financial aid t o the Ronald O. Perelman and Cl audi a Cohen Cent er
• [54][55]
• Perelman al so gav e a t otal of $16 mill ion t o 581 nonprofit organizations, incl udi ng Big Brot hers Big Si st ers, in Phil adelphi a; t he Mi chael J. Fox Foundation for Park inson' s Research, i n New York ; t he National Association for t he Advancement of Col ored People, i n Bal timore; the Rainforest Foundation U.S., i n New York ; and ot her art s, education, J ewish, medi cal research, and women's-heal t h groups. Perelman serves as a member of t he Board of Direct ors of t he Pol ice At hletic League of New York Cit y, a nonprofit y out h dev el opment agency serv ing i nner-cit y chi ldren and t eenagers. On J une 3, 2011, Perelman was honored for hi s chari tabl e contri butions at t he New York Pol ice Foundations' 40t h Anni v ersary Gala[56] at the W al dorf Ast oria i n New York Cit y —an ev ent that rai sed $2.3 mill ion for charit y.
• In August 2010, Perelman signed the Gi v ing Pledge, committi ng up to hal f hi s asset s t o be designated for the benefit of charitabl e causes (after his famil y and chi ldren hav e been provi ded for).
• In 2013, Perelman donat ed $50 mil li on to t he NYU Langone Medical Cent er t o creat e the Ronald O. Perelman Cent er for Emergency Serv i ces.[57]
• In 2013, Perelman donat ed $25 mil li on to t he Univ ersit y of Pennsyl vania to creat e a new Center for i ts Economi cs and Poli tical Science Department s.[58][59]
• In May 2013, Perelman donated $100 mi lli on to the Columbia Business School , t he graduat e business school of Columbia Uni versit y. The gift w ill be used t o support the const ruction of new facil ities in M anhattanv ill e, i ncludi ng the Ronal d O. Perelman
• for Reproductiv e Medicine.
• Cent er for Business Innovation.
• [60][61]
• [3]
• In 2016, Perelman donat ed $75 mil li on to rev iv e plans to buil d a performing art s cent er at t he World Trade Center sit e.[62][63]
• In May 2015, Perelman succeededSanford I. Weil l as Chairman of Carnegi e Hall.
• Brook ly n native Barbra St rei sand is serv i ng as Chairwoman of t he Ronal d O. Perelman Performing Arts Cent er.[64] [65] In Sept ember [66]
• 2016, the design for t he Ronal d O. Perelman Performi ng Art s Cent er were unv eiled.
• Political donations
• In 2015, Perelman donat ed $500,000 each to Super PA Cs supporting the presidential candidacies of Li ndsey Graham and J eb Bush.[67]
• Apollo in the Ham ptons
• Since 2010, Perelman has host ed annual benefits for t he Apol lo Theater, raising mi ll ions of doll ars annuall y for t he legendary
• v enue.[68] Richard Gere and Carey Low el l, George Stephanopoulos and Ali Wentw ort h, former Secretary of St ate Coli n Powell,
• Senat or John McCain (R-AZ), Barbra St rei sand hav e att ended the ev ents; performers hav e included Ben E. King, Sting, Betty e
• Lav ette, Jon Bon J ov i , J amie Foxx and Alicia Key s and more. In 2016, the Apoll o in t he Hamptons event raised $5 mill ion for the
• Apollo.,[69] and featured l iv e music from The Root s, Joe Walsh, Gw en St efani and Lionel Ri chi e. In 2017, the Apoll o in t he
• Hamptons ev ent was attended by J enni fer Lopez, Al ex Rodriguez, Chris Rock, Ali ci a Key s and more and featured li v e musi cal
• performances by J ustin Timberlake, Pharrel l Wi lli ams, J amie Foxx and more, and raised more than $5 mi lli on for t he Apol lo
• [70][71]
• Theat er' s educational programs for children.
• Controversy
• Greenmail
• In the lat e 1980s, Perelman w as accused of engagi ng in greenmai l.[72] "Greenmail " occurs when someone buy s a large bl ock of a
• company 's stock and threat ens to t ake ov er t he company unl ess he i s pai d a substantial premium ov er his purchase price. In the case
• of someone wit h a reput ation as a corporat e raider, the mere act of buy ing up shares could send a company i nto a panic and inv estors
• [73] [74]
• int o a buy ing frenzy. Perel man i nsist s he seri ousl y intended to buy ev ery corporation he bought into.
• He was first accused of greenmail in lat e 1986 during a run at CPC International when he bought 8.2% of CPC at around $75 a share
• and indirect ly sold i t back t o CPC through Salomon Brothers a mont h lat er at $88.5 a share for a $40 mi lli on profit. Both CPC and
• Perelman denied i t was greenmai l despit e appearances to t he cont rary, i ncluding w hat looked li ke an artificial pri ce i ncrease by
• [75]
• Another accusation of greenmai ling l evi ed agai nst him was the best-k nown and st emmed from his attempt t o purchase Gill ette in
• Nov ember 1986. Perel man opened negotiations wi th a bid of $4.12 bill ion. Gill ette responded wi th an unsuccessful lawsui t and
• publ ic insinuations of insi der tradi ng. Perelman accumulated 13.8% of Gi ll ette before he made what he would l ater cal l the worst
• deci sion he ev er made and sol d hi s stake to G ill ette lat er t hat mont h for a $34 mi ll ion profit . Gill ette had put word out that Ral st on
• Puri na had agreed t o buy a 20% block of st ock , mak ing any attempt by Perelman t o buy Gil lette much more di fficul t. Perel man
• deci ded t o sell hi s share to Ral st on Puri na, but before he did so Gi ll ette's executiv es call ed him up, ask i ng if he' d sel l hi s shares t o
• [76]
• In April 2001, M&F Worl dwide bought Perel man's 83% stake in Panavi si on for $128 mil lion. This would be unremark abl e except
• t hat Perel man cont roll ed M&F W orl dw ide and the price paid for hi s st ake w as four times market val ue. At t he time, M &F Worldwi de
• was a healt hy company wit h an excell ent balance sheet while Panav ision was bleeding red ink . M&F W orldwi de' s ot her shareholders
• cri ed foul, alleging t he onl y person who stood t o benefit from t he deal was Perelman and t ook t heir complaint s t o the court s.[77]
• Perelman insi st ed t he deal was an excellent one and i n t he best int erest of t he shareholders because Panav isi on was w ell-positioned to
• profit from t he mov e t o di git al cinemat ography.[78] The share pri ce t umbled from si x to t hree after t he deal and reflect ed M&F
• Salomon shortl y before t hey sol d Perelman's shares.
• t hem and they' d sell the shares to Ral st on Puri na. He sold his shares to Gil lette and Ral st on backed out of the deal.
• Panavision
• Worldwi de shareholders' lack of confidence.[79] Perel man t ried to paci fy M&F Worldwi de' s shareholders wit h a $15 mi lli on [80]
• settl ement ,butthejudgereject editasgrossl yi nadequat e.Ul timat el,y Perel managreedt oundothedeal.
• Fred Tepperman
• Perelman hi red Fred Tepperman as his CFO after Tepperman l eft W arner Communi cations i n 1985. Starting w it h Pant ry Pri de,
• Tepperman worked on ev ery singl e busi ness deal Perel man orchest rated throughout Tepperman's sev en-y ear stint at M acAndrew s &
• Forbes. Tepperman' s tenure came t o an abrupt end just after Chri st mas in 1991 when Perel man fired him for being derel ict in his
• duties. Tepperman had been di st ract ed, he cl aimed, by caring for hi s Al zhei mer's-afflicted wi fe of 30 y ears. A cl ause in Tepperman's
• cont ract entit led him t o a large portion of his salary and benefits i n t he ev ent of an i njury t hat prev ent ed him from being able t o work;
• Tepperman cl ai med he had sufered such an injury, al bei t psy chol ogi call y, as a result of t he efect his w ife' s condition had on hi m. His
• demands t otaled $30 mi lli on. That number stems partial ly from Tepperman's sal ary, which started at $275,000 and rose t o $1.2
• mi lli on in 1990[81] and partiall y from hi s large benefit s pack age.[82] Perelman was quick to file a count ersuit for fraud, cl ai ming t hat
• Tepperman had sneak i ly changed the company' s retirement plan i n such a w ay t hat Tepperman woul d personall y gai n mi ll ions of
• [81] [81]
• dollars. It took ov er t hree y ears for the case t o make it t o court . The case ended wit h a sealed settl ement .
• Personal life
• Marriages
• Perelman has been married fiv e times. He married Sterli ng Bank heiress Fait h Golding i n 1965 and t hey div orced in 1984. Hi s marriage t o gossip columnist Claudia Cohen last ed from 1985 t o 1994. He wed social it e Patricia Duff i n 1995 and di v orced in 1996. He w as married to act ress Ellen Bark i n from 2000 t o 2006.[83] On Oct ober 13, 2010, Perel man married Dr. Anna Chapman, a Harvard-educat ed psy chi at rist .
• Faith Golding
• Perelman met hi s first wife, Fait h Golding, in 1965 whil e on a crui se t o Israel . As t he heir t o a fortune made i n real est ate and
• bank ing, Fai th Gol ding cont rol led a personal fort une of around $100 mill ion at t he time of t heir marri age.[84] They adopt ed three
• chi ldren named St even, Josh, and Hope, and Fait h gav e bi rt h to a fourt h chil d named Debra. Their marri age l ast ed until 1984 when
• Fai th di scov ered Perelman was hav ing an affair w ith a local florist after a bi ll for a Bulgari bracelet was sent t o t heir home inst ead of
• Perelman' s office. Fai th t hreat ened t o scuttle Perelman's attempt to take MacAndrews & Forbes pri vat e in 1983 by stak ing a clai m t o
• a t hird of i t due t o a bank l oan i n her name. She furt her declared that Perelman defrauded the owners of the Fi rst Sterli ng Corporation
• (i .e. her) by buy ing thousands of doll ars of gi fts for the florist wit h t he company' s money, and made a v ery publi c spect acl e of t he
• div orce. Perelman responded by hiri ng Roy Cohn and flat ly deny ing all of the all egations. The pair quickl y settl ed the di vorce w it h
• [85]
• Perelman met hi s second w ife, Claudia Cohen, i n 1984 at Le Cirque. They had one daught er together, Samant ha, i n 1990. In August 1993, Ron filed for div orce.[86] Cl audi a left the marri age wit h well ov er $80 mi ll ion.[86] In 2007, Cl audi a di ed after a secret seven-y ear battl e wi th ovarian cancer. Perel man rev ealed duri ng his speech at her funeral t hat he'd k nown about her cancer from t he beginni ng and privately commi ssioned a vaccine as a part of his effort s t o cure her.[87] In March 2008, Perel man deci ded t o change t he name of Logan Hal l, locat ed at t he U ni v ersi ty of Pennsy lvania, t o Cohen Hall, after his lat e ex-wife.[88] He donat ed $20 mil lion t o t he Uni v ersit y to remodel what i s now Perelman Quadrangle and as part of his donation, he had t he option t o change t he name of Logan Hal l. His decision t o rename Logan Hal l di smay ed some Penn facult ,y alumni , and students.[89]
• an estimat ed pay out to Fait h i n excess of $8 mil li on.
• Claudia Cohen
• Ronald and Samant ha Perelman
• Patricia Duff
• Patricia Duff was Perelman's t hird wife. The pair first met i n a Pari s hot el l obby w hen both were still marri ed: Perelman to Cohen,
• and Duff t o Mike M edav oy.[90] After Duff di v orced M edav oy, Duff convert ed to J udai sm[91] and marri ed Perelman, on January 25,
• 1995. She gav e bi rt h t o hi s fourth daught er, Caleigh Sophi a, before t he w eddi ng t ook place.[92] When the marriage bet ween Duff and
• Perelman di si nt egrat ed in 1996, cust ody ov er Caleigh became a major issue. Both Perelman and Duff wanted full custody and t hei r
• prenuptial agreement di d not address t he subject of child support . Initial ly private, t he di vorce proceedings were opened t o the publi c
• at the request of Duff.[93] Neit her party emerged wit h t hei r reputations unscat hed. The court psy chi at rist found Duff to be paranoi d
• and narcissi stic and Perelman t o hav e serious anger management issues,[94] Perelman caught a great deal of flak for t estifyi ng that it
• cost about $3 a day t o feed his daught er,[95] and both si des all eged phy si cal abuse by t he other part y.[96] The judge's seal ed decision
• means t he publ ic w ill never k now t he exact result s of t he case,[93] but i t' s k nown that nei ther part y act ual ly won. Perel man is [97]
• Caleigh's l egal guardian, but Patricia has ext ensi ve v i si tation ri ghts.
• Ellen Barkin
• Perelman met hi s fourt h wi fe, act ress Ellen Barki n, at a Vanit y Fai r Oscar after-party in 1999.[98] After sli ght ly more t han a y ear of
• courtship, the t wo marri ed in June 2000. All account s i ndi cate their fiv e-y ear marriage was a stormy one. M uch of the friction arose
• due to Bark in's acting career and her attendant t rav el schedule. Perelman fil ed and obt ai ned a div orce i n early 2006. The press
• soundly mocked Perelman for hi s actions, the speed and timi ng of w hi ch suggested hi s real motivation was to av oid a cl ause i n hi s
• prenuptial t hat would raise t he amount i n al imony he owed Barki n if he wai ted a few days longer. Dependi ng on the source used,
• Bark in's yearly ali mony ranges from $2 mil li on to $3 mil lion and t he tot al pay out ranged from $20 mil lion t o $65 mil li on.[99] In l at e
• 2007, the pai r exchanged lawsuits. Part of the di vorce settlement required Perelman to i nv est sev eral mi lli on dol lars i n a fil m
• production company Bark i n and her brother George (an aspiri ng screenwrit er) had started. Perelman made only one of the pay ments,
• claimi ng that there was no ev idence t he two were act ual ly producing films. Bark in sued for her money w hi le Perel man counter-sued,
• all eging Bark in and her brother had looted t he film company for t hemselv es.
• [100]
• Anna Chapman
• Perelman began dating psy chiat ri st Dr. Anna Chapman, i n mid-2006.[101] In August 2010, t hey announced t hey are expecting a baby —her first , his sev ent h—v ia a surrogate.[102] In Oct ober 2010, t hey were married.[103] Chapman i s a conv ert t o Judaism.[104] In late November 2010, t he coupl e celebrat ed the birt h of t heir son, Oscar.[105] The coupl e lat er had a second child i n M ay 2012.
• J udaism
• J udaism has had a strong influence on Perelman' s life. He grew up i n a Conservativ e
• househol d. The t emple he went to growi ng up was a Reconst ructioni st t emple,[106]
• and hi s fat her has donat ed mil li ons t o Conservative causes.[107] He had a rel igious
• reawakeni ng at t he age of ei ght een whil e on a fami ly t rip t o Israel .[97] "I fel t not just
• t hi s enormous pride at being a J ew; I felt t hi s enormous v oi d at not being a better
• J ew. So I deci ded t hen to begin being a better J ew. As soon as I got marri ed, we kept
• a kosher house, w e became much more observant. We moved t o New York short ly
• t hereafter and joi ned an Ort hodox sy nagogue and the ki ds grew up wi th much more
• J udaism surroundi ng them than I ev er did".[97] Today, he st rict ly observ es the
• Ell en Bark in
• J ew ish Sabbath, spends three hours every Saturday i n pray er,[108] keeps a kosher home,[109] and donates mi lli ons t o J ewish groups
• and causes, particul arly t he Chabad-Lubav it ch sect .[108] He does not consider hi msel f to be a member of Lubav it ch. He support s
• [97]
• "Près Choi si s" in 1905.
• t hem because he t hink s they are Judaism's best chance for surv i v ing and thriv ing i n modern soci e.ty
• Homes
• Perelman is t he ow ner of "Près Choisis" (now call ed "The Creek s"), a 40-room M edi terranean-st y le v i lla on Georgica Pond i n East Hampton, Long Isl and. It w as buil t in 1899 by t he artist s Adel e andAlbert Herter.
• References
• "Worl d' s Bil lionaires"(https://www.forbes.com/profil e/ronal d-perelman/). 26 Nov ember 2017.
• "The Richest : Ron Perelman Net Worth" (https://w ww.t herichest .com/cel ebnetwort h/cel ebrit y-business/inv est ors/ronald-perelman-net-worth./)
• Pogrebi n, Robin (May 2015)."Ronald Perelman"(https://www.ny times.c om/2015/02/20/art s/music/ronal d-perelman-a-mogul -wit h-muscl e-t akes- ov er-carnegi e-hal l.ht ml ?_r=0).The New Yor k Times. The New York Times Company. Ret riev ed M ay 12, 2015.
• "Ronald O. Perelman: MacAndrews and Forbes Bio"(htt p://www.macan drewsandforbes.com/management /ronald-o-perel man/.)M AF. J anuary 2017. Ret ri ev ed J anuary 1, 2017.
• "Forbes Bi lli onaires List"(https://www.forbes.com/profil e/ronald-perelma n/?li st =bi ll ionai res). Forbes. J anuary 2017. Ret ri ev ed J anuary 1, 2017.
• "Forbes List "100 Greatest Li vi ng Business M ind"s" (https://ww w.forbes. com/100-great est-business-minds/person/ronald-perel man.)For bes. Sept ember 2017. Ret riev ed Sept ember 19, 2017.
• Hack , Richard (1996).When Money Is King. Beverly Hi ll s, CA: D ov e Book s. pp. 1–3. ISBN 0-7871-1033-7.
 Advisors

UBS and Goldman

Merrill Lynch
Sachs represented
represented P&G
Gillette
Key Deal Dates Compared with Stock
Price of P&G and Gillette
Timeline of the Transaction
 P&G Corporate Profile
P&G is a global
A multinational corporation
manufacturer of consumer
On Oct 31, 1837, Procter & headquartered in downtown
goods, including household
Gamble was born. (William Cincinnati, Ohio and
care, beauty care, health,
Procter and James Gamble) manufactures a wide range
baby and family care
of consumer goods
products

In 2011, Fortune magazine

In 2011, P&G recorded $82.6 Most Admired Companies"
ranked P&G at fifth place of
billion dollars in sales list
the "World's

Procter and Gamble is a tier

one sponsor of the London's
Olympic Games 2012 and
sponsors 150 Athletes
The transaction was valued at approximately
$57 billion (USD) based on closing NYSE stock
prices of Jan. 27, 2005
CEO: P&G: A.G. Lafley and Gillette: Jim Kilts
The proposed concentration was
effected through a merger between a
wholly-owned subsidiary of the As a result, Gillette will continue as
Procter & Gamble Company, the surviving operating unit and will
Aquarium Acquisition Cooperation, become a wholly owned subsidiary of
formed for the purpose of the P&G
contemplated merger, with the
Gillette Company

The operation consist in the

acquisition of sole control of Gillette
 Exchange Ratio

Each Gillette common share was converted into

the right to receive 0.975 shares of P&G common
stock. Valuing the stock at $53.94 -- a premium of TheoffervaluedGillette'ssharesatabout$54ashare.
about 18 percent.

Gillette shares held in the BuyDIRECT Plan,

including dividend reinvestment shares, are being Gillette shares held in the Direct Registration
automatically converted into the P&G Shareholder System (“DRS”) are being automatically converted
Investment Program (“SIP”) at the 0.975 rate, with into whole shares of P&G common stock in DRS
resulting fractional shares credited to P&G SIP form
accounts
 Shareholders’ Voting

Shareholders of both companies

overwhelmingly approved P&G's
In announcements at separate
acquisition of Gillette that would
special meetings, the companies
form the world's largest consumer
said 96 percent of the shares that
products company, with such
were voted favored the merger
brands as P&G's Pampers and
Gillette's line of razors
 Stock Price Reaction

News of the deal sent Gillette’s

shares soaring $5.49, or 12
percent, to $51.17 in very heavy
trading midday Friday on the
New York Stock Exchange, while
P&G’s fell $1.50, or 2.7 percent,
to $53.82 also on the NYSE
 Combined Brands

P&G and Gillette would

have 21 brands with
more than $1 billion in
annual sales each
 Job Cuts

6000 job cuts, 4% of the

combined workforce of
140,000. Company
expected to reap $14
Billion in cost savings
 Regulatory Concern

P&G’s focus on more valuable brands

has led to it shedding a number of
ailing lines. It has sold off Sunny
Delight, Sure deodorant and several
detergents, and there is speculation
that Lafley will soon dispose of
underperforming brands from the
Gillette business
 Mr. Buffett

Berkshire Hathaway (
Owns about 33% of Berkshire At the end of the merger, he Research) is Gillette's largest
Hathaway which in part owns would be receiving 93 million shareholder with 96 million
10% of Gillette shares of the new company shares, or about 9 percent of
the company.

"It's a dream deal," Buffett

The deal gives Buffett a one-
said, adding that he would
day profit, on paper, of
increase his holdings so that
roughly $645 million and a
he would end up with 100
whopping $4.4 billion profit
million shares of P&G by the
overall
time the deal closes
 Did the Deal Payoff?
Most of Gillette's senior
P&G's stock has lagged
managers (with the notable The recession buffeted
behind key competitors',
exception of current P&G Gillette's core business --
including Colgate- Palmolive
Vice Chairman Ed Shirley) pricey razors and blades
Co. and Unilever
have left

But it's worse than two of the

three competitors most
P&G's stock is up 12% since That's better than the S&P
directly affected by the deal,
the day before the deal was 500, down 8% over the same
including Colgate-Palmolive
announced in 2005 period
Co. (up 53%) and Unilever (up
36%)

Privately at least, some Some of the incoming Gillette

veteran P&Gers looked down people found the P&Gers
on the marketing skill set of remarkably resistant to new
the incoming Gillette people ideas
 Revised Revenue Growth

Because of expectations
from the deal, P&G raised
the annual revenue growth
outlook to 5 to 7 percent,
rather than its earlier target
of 4 to 6 percent
 Deal
• Procter & Gamble (Research) is already the • "I believe the consumer product industry needs
nation's largest consumer products company, to consolidate," he told analysts. "I'd rather lead
making everything from Pampers to Tide, from it than end up with the leftovers."
Crest toothpaste to Head & Shoulders shampoo • Under the deal announced early Friday, Procter &
• Products from Gillette (Research) include not only Gamble will pay 0.975 share of its common stock
its signature razors but also Duracell batteries for each share of Gillette common stock. Based
and Braun and Oral-B brands dental care on Thursday closing prices, that would represent
products. an 18 percent premium for Gillette shares.
• "This merger is going to create the greatest • The news sent P&G stock down about 2 percent
consumer products company in the world," said while Gillette jumped about 12 percent in
billionaire investor Warren Buffett, whose  afternoon trading.
• That increased power for the largest player in the • P&G tried to assure investors concerned about
U.S. industry is also seen as putting pressure on the dilution of their holdings by announcing it
smaller rivals to eye deals of their own. would spend $18 billion to $22 billion of P&G's
• While P&G and Gillette officials didn't specifically common stock during the next 12 to 18 months.
address what other deals this one could spur, It said that repurchase program should be the
Gillette CEO Jim Kilts said he does expect further equivalent as if the deal were structured as 60
consolidation in the consumer products industry. percent stock and 40 percent cash.
• Executives at the companies said they believe
they'll both be able to grow faster together than
separately, with P&G opening doors for Gillette in
markets such as China and Japan while Gillette
bringing P&G some product segments that are
growing faster than the company's overall current
portfolio of products
 Retailing Advantage

P&G has 16 products that have sales

of more than $1 billion each, and
Gillette has another five, and with the
companies' expanded rosters of must-
have brands, they will have great
leverage in negotiation with retailers
for the all-important display space
 Savings in Advertising

P&G is already the nation's

largest television advertiser,
Savings from broadcasters and
while Gillette spends almost $1
other media companies on
billion a year on ads, primarily
advertising purchases
targeting men rather than P&G's
traditional female customer
Savings in Manufacturing Expenses

The combined company

should also see savings
from manufacturing as well
as the logistics of moving
productions from plants to
stores
Savings in Administrative Costs

The basic corporate

administrative costs
also can be saved
 New Product Development

Executives at the two

companies insisted the
deal will also mean new
product development
for their customers
 Benefits in R&D and Innovation

They said increased scale from "This will enable us to continue

the combination should help to set the pace of innovation,"
improve margins, which in turn said P&G CEO A.G. Lafley. "You
should allow additional either fund innovation or you
investment in research and become more like a commodity
development over time
 Job Cuts

The deal will mean about It said most of the cuts would The current value of the
6,000 job cuts, or about 4 come from eliminating planned cost savings should
percent of the combined management overlaps and come to $14 billion to $16
work force of 140,000 consolidation of business billion, according to the
employees support functions company's statement

P&G CFO Clay Daley said the

He also said that some of the
companies expect to see
staff cuts will come from the
more than $1 billion a year in
P&G side of combination, not
cost savings by the third year
just the Gillette side
after the merger
Transaction Summary
Terms and Overview of the Deal
Valuation of the Deal
Sum of the Parts Valuation
 Xerox Buys ACS
I n 2010, Xerox, a slower growing, cyclical an advantages and disadvantages of
office equipment manufacturer, acquired alternative implementation strategies.)
Affiliated Computer Systems (ACS) for $6.4 3. Speculate as to Xerox’s primary
billion. With annual sales of about $6.5 motivations for acquiring ACS?
billion, ACS handles paper-based tasks such 4. How might the decision to manage
as billing and claims processing for ACS as a separate business affect realizing
governments and private companies. With the full value of the transaction? What
about one-fourth of ACS’ revenue derived other factors could limit the realization of
from the healthcare and government synergy?
sectors through long-term contracts, the
acquisition gives Xerox a greater penetration
into markets which should benefit from the
2009 government stimulus spending and
2010 healthcare legislation. There is little
customer overlap between the two firms.
The sale of services tends to be more stable
and offers higher margins than product
companies.
Previous Xerox efforts to move beyond
selling printers, copiers, and supplies and
into services achieved limited success due
largely to poor management execution.
While some progress in shifting away from
the firm’s dependence on printers and
copier sales was evident, the pace was far
too slow. Xerox was looking for a way to
accelerate transitioning from a product
driven company to one whose revenues
were more dependent on the delivery of
business services.
More than two-thirds of ACS’ revenue
comes from the operation of client back
office operations such as accounting, human
resources, claims management, and other
 -------- Chapter 8 --------
Empirical Tests of M&A Performance

Note: When the statistical results are not significant, this is

stated. If not so noted, the results are understood to be
statistically significant at least at the 10% level or better.
The empirical patterns described below represent our
judgments. Individual samples for particular time periods
with different combinations of variables will yield varying

results.

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 Issues in Empirical Studies
• Tests of alternative theories
• Determine whether or not social value is
enhanced by mergers
– Performance improvements
– Relatedness to fundamental technological,
economic, regulatory, and other forces taking
place in individual industries
– Effects on other firms in same industry
• Guides to management for merger planning
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Merger Performance During the Eighties

• Successful transactions
– Targets earn substantial premiums
• Mergers — likely to be friendly and for stock
– Targets: Positive 20 to 25%
– Buyers: Positive 1 to 2%
• Tender offers — frequently hostile during the eighties
and for cash
– Targets: Positive 30 to 40%
– Buyers: Negative 1 to 2%

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– Time trend of returns to targets has been
upward
• Increase in government protection to targets
• Development of sophisticated defensive tactics
• Opportunity to find competing bidders
– Event returns to bidding firms decreased over
the decades
– Total wealth increase from M&As has
continued to be positive

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• Unsuccessful takeovers
– Target acquired within five years
• Target — premiums higher than initial bids
• Initial bidders — zero or negative returns if rival
succeeds
– Targets not acquired within five years
• Target — stock prices return toward preoffer values
• Bidders — negative returns

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• Single bidder vs. multiple bidders
– Mainly applicable to tender offers
– Targets in tender offers
• Single bidder: 25-30%
• Multiple bidders: 35-40%
– Bidders in tender offers
• Single bidder: 0%
• Multiple bidders: negative 2-4%

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• Method of payment
– Mergers — stock-for-stock, nontaxable
• Targets: 20%
• Bidders: negative 1-2%
– Tender offers — cash-for-stock or assets,
taxable
• Targets: 35%
• Bidders: positive 1-2%

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• Resisted vs. nonresisted
– Resisted — often multiple bidders
– Nonresisted — usually single bidder
– Impact of multiple bidders stronger than
management resistance

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• Methods of payment and managerial
resistance (Huang and Walkling, 1987)
– Controlling for form of payment and managerial
resistance — difference between returns of tender
offers and mergers disappeared
– Controlling for type of acquisition and managerial
resistance — difference between cash and stock
offers remained strong
• Average CARs to target
– Cash offers: 29.3%
– Stock offers: 14.4%
– Mixed payments: 23.3%

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• Reasons why use of cash may result in higher
returns to targets
– Cash transactions are taxable — require higher
premiums to compensate for taxes
– Information effect — bidder uses stock when it is
overvalued
– Signaling effect — use of cash indicates that
target has better investment opportunities
– Securities transactions involve regulatory
approval and longer acquisition interval

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• Bad bidders become good targets
Mitchell and Lehn (1990)
– Announcement of acquisitions
• Negative returns — acquiring firms subsequently
become targets
• Positive returns — acquiring firms do not become
targets
– Divestitures
• Negative returns — subsequent divestitures
• Positive returns — no subsequent divestitures

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• Positive total returns vs. negative total
returns
– Positive total returns
• Targets — higher positive gains
• Bidders — greater likelihood of significant
positive gains
– Negative total returns
• Targets — gains not reduced
• Bidders — greater likelihood of large negative
returns

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• Effects of tender offer regulation
– Targets
• Gains are higher
• Premiums higher after adoption of Williams Act in
1968
– Bidders
• Losses more likely
• Reduced returns due to:
– Waiting period
– Stronger target defenses
– Increased bidder competition

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• Runup vs. markup returns
Schwert (1996)
– Definitions
• Runup — pre-announcement CAR
• Markup — post-announcement CAR
– Tender offers
• Runup 16%
• Markup 20%
– Mergers
• Runup 12%
• Markup 5%

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– Successful deals — runup and markup both
15%
– MBOs — runup and markup both 10%
– Poison pills
• Runup 12%
• Markup 18%
– Multiple bids
• Runup 13%
• Markup 18%

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– Insider trading cases
• Runup 18.3%
• Markup 21.2%
– Runups vs. markups
• Not correlated
• Little substitution
• Runup is added cost to bidder

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• Postmerger performance
– Healy, Palepu, and Ruback (1992)
• Industry-adjusted operating variables
– Ratio of cash flows to sales — no significant change
– Ratio of sales to total assets — significant improvement
– Ratio of cash flows to market value of assets — significant
improvement
– Annual percentage change in employment — declined
significantly
– Pension expenses per employee — reduction but not
statistically significant

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• Investment variables
– Annual change in cash receipts from asset sales as a
percentage of the market value of assets — no significant
change
– Annual change in the book value of asset sales as a
percentage of the market value of assets — significant
increase
– Annual change in R&D expenditures as a percentage of
the market value of assets — no significant reduction

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• Discussion and implications
– High correlation between event return measures and
accounting measures of subsequent performance
– Performance improvement from better asset
management
– Improved returns not from reductions in labor income
– R&D and investment rates not significantly changed

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– Agrawal, Jaffe, and Mandelker (1992)
• Market or economy-wide benchmarks used for
adjusted returns
• Wealth loss to shareholders of acquiring firms of
10% over subsequent five years
• Implication is that M&A activity takes place in
industries depressed relative to the economy

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– Franks, Harris, and Titman (1991)
• Postmerger share-price performance sensitive to
benchmark employed
• Equally weighted benchmark — negative
postmerger performance
• Value-weighted index benchmark — positive
postmerger performance
• Multiportfolio benchmarks — no significant
abnormal performance

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• Industry influences on M&A activity
– Mitchell and Mulherin (1996)
• Significant differences in M&A activity by industry
• M&A activity due to major shocks in relatively few
industries
– International competition — tires, steel, autos, shoes,
machine tools
– Technological change — information processing
– Financial innovations — banks, S&Ls, brokerage firms
– Deregulation — air transport, entertainment, trucking,
health care
– Price shocks — petroleum, air transport, trucking

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– Andrade and Strafford (1999)
• Evidence supports an impact of industry shocks on
merger activity
• Mergers, like internal investments, are a response
to favorable growth potentials
– Industries with excess capacity use own-industry mergers
to achieve consolidation
– In contracting industries, acquiring firms have better
performance, lower capacity utilization, and lower
leverage
• Asset reallocation from mergers results in improved
efficiency

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Merger Performance During the 1990s

• Weston and Johnson (1999)

– Sample
• 364 transactions between 1992 and mid-1998
• Sample of large transactions
– Price paid for target:
» Greater than $500 million for 1992-1996
» Greater than $1 billion for 1997-1998
• Accounted for 40 to 45% of total M&A deal value in
most years, rising to 69% for first half of 1998

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– Pooling versus purchase accounting
• Full sample
– 190 pooling transactions (52.2%)
– 174 purchase transactions (47.8%)
• Bank subsample
– 60 pooling (80%)
– 15 purchase (20%)
– Strong preference for pooling - banks might be strongly averse to
negative impact of goodwill write-offs on reported net income
• Non-bank subsample
– 130 pooling (45%)
– 159 purchase (55%)
– Lack of preference for pooling - economies or synergies sufficiently
strong that increased earnings in new combined firm overcome
goodwill write-offs
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– Method of payment
• Stock: 220 transactions (60.4%)
– Bank mergers: 61 (81.3%)
– Non-bank mergers: 159 (55%)
• Cash: 80 transactions (21.7%)
• Cash and stock: 64 transactions (17.6%)
• Debt: 1 transaction (0.3%)
• Big deals in the 1990s have been mainly stock for
stock
• Smaller transactions are mainly for cash

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– Taxability
• Taxable: 91 transactions (25%)
– Bank mergers: 6 (8%), all were purchase accounting
transactions
– Nonbank mergers: 85 (29.4%), all were purchase
accounting transactions
• Nontaxable: 238 transactions (65.4%)
– Bank mergers: 64 (85.3%), 4 were purchase accounting
transactions
– Nonbank mergers: 174 (60.2%), 44 were purchase
accounting transactions

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– Premium paid
• Premium based on market price of seller stock 30
days before public announcement of deal
• Non-taxable, non-bank deals: 33-40% premium
• Taxable, non-bank deals: 36-44% premium
• Non-bank, pooling transactions: 33% median
premium
• Non-bank, purchase transactions: 37% median
premium

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– Analysis of event returns
• Sample of 309 transactions
• Full sample
– Positive total gains: 202 (65.4%)
– Negative total gains: 107 (34.6%)
• Bank subsample
– Positive total gains: 41 (57.7%)
– Negative total gains: 30 (42.3%)
• Non-bank subsample
– Positive total gains: 161 (67.6%)
– Negative total gains: 77 (32.4%)
• Good deals will have a favorable initial market response

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• Returns to shareholders
(Anslinger and Copeland, 1996)
– In-depth study of 21 successful acquirers
– These companies made 829 seemingly unrelated
acquisitions from 1985-1994
– 80% of the 829 transactions (611) earned their cost of
capital
• Corporate acquirers: averaged 18% per year in total returns
to shareholders over a 10 year period
• Financial buyers: averaged 35% per year in total returns

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– Findings differ from previous McKinsey and
Company studies for the 70s and 80s which found
that two-thirds of all mergers did not earn their
cost of capital
– Successful acquirers focused on a common theme
• Clayton, Dubilier & Rice — stockpiled management capabilities
• Desai Capital Management — focused on retail-related businesses
• Emerson Electric Company — looked for companies with core
competence in component manufacturing to exploit cost-control
capabilities
• Sara Lee — focused on branding in retailing

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• Merger performance in the 1990s
Schwert (1996)
– On average abnormal returns to bidders for
period 1973-1991 was not significantly different
from zero
– Highly competitive nature of takeovers
continued through 1996 — suggests that
abnormal returns to bidders continued at levels
not significantly different from zero

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– Total wealth change continued to be positive
through 1996 since abnormal returns to targets
were in the 35% to 40% range
– Increased ability to make value-increasing
mergers
• Cisco Systems — high growth through acquisitions,
high shareholder returns
• Internet companies — considerable use of
acquisitions to expand customer base, high
shareholder returns

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 Efficiency Versus Market Power
• Ellert (1975, 1976)
– Supports efficiency basis for mergers
– Acquiring firms had positive residuals in prior years,
and acquired firms had negative residuals in prior
years
• Stillman (1983)
– Rivals of firms did not benefit from announcement of
proposed mergers
– Inconsistent with concentration-collusion hypothesis
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• Eckbo (1981)
– No negative effects on rivals when merger is
likely to be blocked by antitrust authorities
– Main effect of merger
• Signal possibility of achieving economies for
merging firms
• Provide information to rivals that such economies
may also be available to them

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 Effects on Concentration
• Impact on macroconcentration
– Share of assets of largest 200 U.S. corporations
to assets of all nonfinancial corporations
• Share was about 38% in 1970
• Declined to 36% by 1980 and to 34% by 1984;
remained stable at about 35% through 1996
• Figures are biased upward since largest 200 firms in
numerator are the ones that rank highest in each
year of measurement

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– Merger activity in recent years has not greatly
affected aggregate concentration
• High rate of divestitures
• Rise of new firms and new industries — computers,
Internet, etc.
– If international competition is taken into
account, share of top 200 companies would be
smaller

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• Impact on microconcentration
– Individual industries concentration measure
• Measures based on share of four largest firms
• Weighted average level of concentration in
individual industries using value added measure has
stayed relatively constant at about 40% over recent
decades
– Industry concentration taking international
factors into account — drops sharply
– For most industries the HHI is below the critical
1,000 level

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The Market for Corporate Control
 Market for Corporate Control
• A (major) reallocation of assets
• External governance mechanism
– One argument that has been raised is that
managerial (mis)behavior is not particularly
interesting because there is a market for control
• A market for managerial talent we might say
• Any suboptimal or inefficient behavior that leads to a
reduction in firm value will lead to an “arbitrage
opportunity” and replacement of existing management
 Market for Corporate Control
• The main point of this discussion and set of
papers is that it appears difficult for a
corporate acquirer to capture the value of any
gains they add to a corporation.
• Example:
– Current stock price is $10 per share
– The raid succeeds if and only if the raider acquires
50% of the outstanding shares
– Post-raid value will be $20 per share
 Market for Corporate Control
• At what price will the raider make a tender offer?
• No current shareholder will tender shares for any price
less than $20 (if it is legitimate to assume that each
shareholder believes his decision will not affect the
success of the offer).
• Therefore, the raider receives none of the gains from
trade. If the improvements involve a personal cost to
the raider, value enhancing takeovers will not occur.
• The market for control becomes suspect as a
governance mechanism.
 Market for Corporate Control
• Solutions:
– The raider can make a “two-tiered” offer. In our example
suppose he makes a first tier offer of $13 per share. If he
acquires 50%, anyone who has not tendered their shares will
automatically receive a bundle of securities worth $12.75. It is
then optimal for all shareholders to immediately tender.
– The raider can dilute a non-tendering shareholder’s value ex
post, so the reservation value for not tendering is no longer $20.
– The raider can acquire a “toehold” anonymously (or before it is
known he plans to make improvements). Takeover costs can
then be compensated through toehold profits. Kyle and Vila
(1991) use noise traders as a way for raider to acquire a toehold.
– If there are a finite number of shareholders the assumption that
all shareholders not pivotal may no longer be valid. Bagnoli and
Lipman (1988).
 Grossman and Hart
• Let q  f (a) be the firm profit under current
management – where a is the action chosen
by the management.
• Let v  f (a)   be the profit under the raider.
• We will be most interested in the case where ε
is positive.
 GH
• For this discussion we can also ignore the
effect of the manager’s choice.
– This is not true for all of GH’s results but it is for
the results I will discuss.
• Thus f (a) is a constant. The question of
whether the possibility of a hostile takeover
alters managerial behavior is an interesting
one but separate from this discussion.
 GH
• We assume that raids succeed if and only if
the raider is able to acquire 50% of the
outstanding shares.
• Let p be the tender offer price.
– Shareholders tender if and only if p is at least v.
– If raids involve costs (under rational expectations),
they should not occur.
 GH
• Resolving the dilemma
– Assume the raider can dilute the value of minority
shareholders ex post.
• He may make advantageous deals with firms of which
he is an owner.
• May pay himself excess compensation. Etc.
– Let Φ be the maximum possible dilution so, ex
post, shares are worth v  .
 GH
• Consider the bid: p  Max(v  , q)
• Shareholders will tender for this offer and will
not do so for any lower offer.
• The raider’s profit is: v  p  c  v  Max(v  , q)  c
  Max(, q  v)  c
 Min(, v  q)  c
– where c is the cost of the raid (or the cost of
improvements).
• Raids occur if and only if both dilution and
improvements exceed the cost.
 GH
• Grossman and Hart go on to assert that firms
can determine (or at least affect) the level of
dilution that is possible.
– Firms do so when setting up their charter. They
choose structures/rules that either encourage or
penalize takeovers.
 GH
• Grossman and Hart characterize the optimal level
of dilution when the value of a raid is given as
v  q  
– i.e. when improvements are unknown ex ante.
• Their main result is that the optimal level of
dilution is interior.
– If dilution is too low, too few raids will occur and if it is
too high, more raids occur but shareholders will be
diluted by too much ex post.
– They also examine the impact of the dilution choice
on the incumbent manager’s behavior.
 Shleifer and Vishney
• Now, dilution is out, the focus is on toeholds.
• A large risk neutral monitor L owns a stake α
which we take as fixed for now.
• The question: will L implement stochastic
value additions?
• The other 1 – α shares are held by atomistic
investors. L can only implement the value
additions if he purchases a controlling stake in
the firm (assumed to be 50%).
 SV
• L’s value addition is uncertain:
– Invests in “research” with intensity I in order to 1)
ascertain whether he can add value and 2) how
large the value improvement will be.
– Assume that with probability I the improvements
will be possible
– Value additions Z are distributed according to cdf
F(Z)
– Research has a cost c(I), increasing and concave
– The takeover itself has a deadweight cost of cT
 SV
• Current share value is q
• Thus the post improvement value, if a
takeover occurs, will be q+z, where z is the
realization of the value improvement
– q plays no role in the analysis so I will set it to 0
• Let π be the tender offer price
• Assume that if fewer than .5 – α shares are
tendered all shares are returned to their
owners
 SV
• Will the monitor act? For a given realization z of
the value of improvements, the monitor will
implement a takeover if
.5 z  (.5   )  cT  0 (1)
• where .5 – α shares are purchased for π
• Note equation (1) can be written
.5( z   )    cT
• This makes it clear that π may exceed z
• Monitor may overbid, losing some on purchased
shares if he profits enough on his toehold
 SV
• Will shareholders tender? Shareholders do not know z,
they have only their expectations based on knowledge
of F(Z) and that knowledge L has acted (a tender is on
the table)
• There are potentially two types of equilibria
– Separating – bids by monitors reveal z
– SV consider semi-pooling in which all types with a z larger
than some threshold implement a takeover and use the
same bid π*
– No argument is made that a separating equilibrium does
not exist, however similar to GH’s argument it seems they
may not. If bids revealed type, shareholders would not
tender for bids less than z. Thus no research and no
takeovers given the costs.
 SV
• Shareholders tender if
E{z .5 z  (.5   ) *  cT }   * (2)
• Let π*(α) be the smallest solution to (2)
• Theorem: there is a sequential eq in which the monitor bids π*(α)
• Lemma 1: takeover premia decrease in the insider’s position
– The insider can offer a low takeover premium if he can convince
investors little value has been added
– With a large ex ante stake, it takes less of a value addition to
implement a takeover, lowering the investors conditional expectation
– Perhaps a bit counter-intuitive, one might expect that the larger the
toehold the more value would be expected to be created and that
larger value creation would be associated with higher premia.
– Also note that when α = 0 eqn (1) can be written z > π and no one
would tender. Takeovers occur only when monitor has a non-trivial
stake – replicating GH’s result.
 SV
• How much research gets done?
– Let zc(α) denote the minimal realization of Z for
which takeovers are profitable.
– Eqn (1) tells us that zc(α) is a decreasing function
of α
– The expected profit of monitors , conditional on
finding a value improvement is
{ ( E[ z z  z c ( )]  cT )}* Pr{z  z c ( )} (3)
– Thus the monitor’s unconditional profit is I times
(3) minus c(I).
 SV
• Writing the FOC and applying the implicit
function theorem gives
• Lemma 3: I(α) is an increasing function of α
• An insider with a large position is more likely to
effect change – higher research intensity – that’s
nice to see.
• However, the average amount of change he
effects is smaller than if he had a smaller stake.
– Here the distribution of Z is independent of I
– The result is different with a different research
production function but much messier
 M&A gains
• Potential sources of gains:
a) Economies of scale or scope (synergies)
b) Target is being mismanaged
c) Transfer from other “stakeholders”
d) Target is simply undervalued
e) Market power
• From a social and macro standpoint, a) and b) are
(maybe) positive, c) and d) are (maybe) neutral,
and e) is negative
• Q: How big are the gains? How are they
distributed? (What are their sources?)
– Policy implications?
• “Fact” 1: Bidders’ average market reaction is
effectively zero.
– Jensen and Ruback: early studies has this negative
– Perhaps slightly positive for successful tender offers*
…but decreasing over time? (Jarrell, Brickley and Netter 1990)
– Perhaps slightly negative for unsuccessful mergers.**
– Negative for large acquirers and stock financed
• Caution: In most cases, these studies use a short
“window.” Market reaction may lie outside this
window or may contain other information.
– Bayazitova et. al., information “leakage” and findings of long run event
studies.
*Open market purchases of stock
**Purchases of stock at terms negotiated with target management. To further complicate
matters, some authors use the term merger only for stock-for-stock deals and acquisition
for cash deals, whereas some use the term merger more generically.
• “Fact” 2: Return to targets is large and positive.
– For mergers it is larger for successful deals.
– For tender offers it is larger for unsuccessful deals
(an indication that offer is likely to go higher?)
• “Fact” 3: Joint gains are positive and large.
– 40-50% of target pre-acquisition value in some
studies
– Most give this at about 20-25%
• “Fact” 4: Distribution of gains between target
and bidder depends on the number of
potential targets and number of potential
bidders in the expected way.
– James and Wier (1987), Jarrell and Bradley (1980)
 Extensions of These Original Studies
• Early studies were based on samples of public firms (bidders and
targets).
– Show significant acquirer losses on average
• Why are firms allowed to acquire other firms?
• SDC data base allowed consideration of private targets.
• Acquirer losses apply only to acquisitions of public targets
(which account for only 20% of all mergers).
– Acquisitions of non-public targets have positive acquirer returns.
Moeller, Schlingemann and Stulz (2004)
– Using SDC data, stock financed acquisitions as well as all mergers
together have positive acquirer returns.
– Data source changes conclusions. But why?
 Sorting out the source of gains…
• Undervalued target theory
– No real support. The price of targets which are not
ultimately acquired is not higher than their pre-event value.
• Other stakeholders?
– IRS: Taxes might explain some of it, but not all. (Auerbach
and Reishus 1987)
– Bondholders: Do not appear to lose (Denis and McConnell
1986 and Lehn and Poulsen 1987)
– Labor: Little systematic evidence.
– Jensen/Ruback and Jarrell/Brickley/Netter seemed
convinced that redistribution cannot explain the gains,
although the evidence is not complete.
 Market Power Hypothesis
• Some literature looks at the stock price reaction of
rivals.
– Stillman (1983), Eckbo (1983) little reaction
• But the testable hypothesis is not clear.
– In the standard Cournot model, a decrease in the
number of firms raises prices and benefits all producers.
• One merger may also signal the beginning of a wave.
– But in some industries being the small guy might be bad
news when the big guy gains market power. In other
words Cournot may not be the right model of industry
competition.
 Morck Shleifer and Vishney
• Why do the acquirers’ managers choose to
acquire?
• Hubris Hypothesis
– “The others have failed but I’m different”
• “Bad” managers want to diversify to protect
themselves
• Bad managers may want growth for growth’s
sake
 MS&V Table V
• Most of their explanatory variables (for bidder gains)
are not significant. The exceptions:
– Multiple bidders tend to reduce gains to bidders
(competition)
– Target sales growth has a negative coefficient
(buying growth is bad)
– Quality of bidder management has a positive sign
– Weak evidence that diversifying purchases are bad
– Coefficient on “equity-financed” has the predicted
negative sign but is insignificant
– We have to remember that these results are based on
public targets.
 MS&V Conclusions
• The evidence is
– inconsistent with hubris hypothesis
• Better managers see higher returns
– “suggestive” of managerial conflict-of-interest,
managers pursuing their own agendas with
shareholder’s money
• eg. Buying growth is a bad idea – but that is one of the most
commonly discussed motivations for mergers by managers
• However Seyhun finds
– Prior to takeover announcements, insiders actually
increase purchases on their own account
– Insiders are betting on their own decisions
 Bayazitova et. al.
• Consider “mega” and “non-mega” mergers
– Largest 1% of mergers by absolute transaction size
(normalized by total market capitalization on day of
announcement)
• Motivated by Moeller, Schlingemann, and Stulz finding that
large acquirers have zero announcement returns and small
acquirers have positive returns.
• These mergers tend to cluster in time between 96 - 01
– Mega-mergers are small subsets of “large acquirers”
(2%) and “public targets” (4%) but about 50% of
money spent on mergers is spent on mega-mergers
– Data considers public and private targets
 Bayazitova et. al.
• Straight announcement returns say:
– Acquirers in mega-mergers have announcement
returns of -3.2%
• Average dollar loss $1.7 b or $415 b in aggregate
– Acquirers in non-mega-mergers have announcement
returns of 1.5%.
• Difference is robust to known determinants of acquirer
returns (acquirer size, target’s public/private status, etc.)
• Difference is robust to measuring deal size excluding the
premium (not driven by premium)
– Acquirers of public targets have negative returns in
both mega-mergers (-3.77%) and non-mega-mergers
(-0.93%)
 Bayazitova et. al.
• A nice innovation in this paper is that they use 3
approaches to try to separate any acquirer
“revaluation” effect from “value creation”
– Consider acquirer’s abnormal return at
announcement that a bid has failed
• If a merger creates value the news of its failure should lead
to negative returns
– Infer value creation from Value Line analyst forecasts
• Pre-closing forecasts are for stand alone firms, post-closing
forecasts are for combined firm
– Consider stock market response for the initial bidder
when a competing bid arrives
• Similar to first approach
 Bayazitova et. al.
• Acquirers of public targets do not destroy value,
value creation measures are positive despite
negative announcement returns.
– Negative value creation only in mega-mergers
– Large acquirers (non-mega) create value
– Acquisitions (non-mega) of public companies create value
– However public/private and acquirer size remains
important
• Large acquirers create less value than small
• Acquisitions of public companies create less value than
acquisitions of private companies
 Bayazitova et. al.
• Mega-mergers are different
• Acquirers only destroy value in mega-mergers
– Average value creation – mega-mergers, -18%, non-
mega-mergers, 8%
• Acquirer returns, when a bid fails, are positive for
mega-mergers and negative for non-mega-
mergers
• Findings suggest managerial motives are behind
mega-mergers
– More free cash flow, more likely to do a mega-merger
– Poor corporate governance, more likely
– Higher acquirer valuation, more likely
 Merger Waves
• Efficient?
– Response to an industry-specific shock
– Add macro-economic value?
• Or distortionary?
– Hubris, herding, or free cash flow driven
Andrade et al
 Waves
• Rank industries in each decade by merger activity.
Correlation of these rankings across time is nearly zero.

– Industries that exhibit high levels of merger in one decade

are no more likely to do so in other decades.
• Mergers come in waves and each wave is different in
terms of industry composition.
– Then, a significant portion of merger activity may be due to
industry level shocks. They cite deregulation as a prime
candidate but note that technology shocks or supply shocks
may also qualify.
Andrade et. al.
Andrade et. al.
 Asset Acquisition:
Acquiring purchases all or substantially all assets of Target

shareholder
shareholder shareholder
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Acquiring corp. Targetcorp.
Target corp.
assets

 Board and shareholder approval of Target

 Board (and maybe shareholder) approval of Acquiring
 assets of Target sold for $$$
 Asset Acquisition:
Acquiring purchases all or substantially all assets of Target

shareholder
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 use Newco subsidiary to acquire assets of Target
 Stock Purchase: Target becomes subsidiary of Acquiring

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stock

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Step #1:
 Acquiring buys stock of Target from shareholders
 Stock Purchase: Target becomes Subsidiary of Acquiring

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shareholder
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Step #2:
 Target becomes subsidiary of Acquiring
 Share Exchange: Acquiring buys Target with its stock

shareholder
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Step #1:
 Board and shareholder approval of Target
 Board (and maybe shareholder) approval of Acquiring
 Share Exchange: Acquiring buys Target with its stock

shareholder
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shareholder shareholder
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 Shareholders of Target exchange their shares of Target for shares of Acquiring
 Acquiring owns Target shares
 Stock Exchange: Acquiring buys Target with its stock

shareholder
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shareholder shareholder
shareholder shareholder
shareholder
AA BB CC DD

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Acquiringcorp.
Acquiring corp.

Board Step #3:

 former shareholders of Target now own shares of Acquiring
Targetcorp.
Target corp.  Target becomes subsidiary of Acquiring
 Corporate Merger: Target into Acquiring

shareholder
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shareholder shareholder
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Acquiringcorp.
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 Board and shareholder approval of Target
 Board (and maybe shareholder) approval of Acquiring
 Corporate Merger: Target into Acquiring

shareholder
shareholder shareholder
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shareholder shareholder
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assets & debts

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 Target merges into Acquiring under Corp. statute
 Shareholders of Target get cash for shares of Target
 Corporate Merger: Target into Acquiring

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 shareholders of Target cashed out
 Acquiring takes assets & debts (and tax attributes) of Target
 Corporate Merger: Target into Acquisition Subsidiary

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 Shareholders of Target get cash for shares of Target
 Corporate Merger: Target into Acquisition Subsidiary

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$$$ $$$
$$$

Board of
Directors

Acquiringcorp.
Acquiring corp.

Newco: acquisition
Newco: acquisitionsub.
sub.
ownsassets
owns assets&&debts
debtsofofTarget
Target

Alternate Step #3:

 Newco acquisition Sub owns assets of Target
 old shareholders of Target cashed out
 Statutory Merger (“short-form” merger)

shareholder
shareholder shareholder
shareholder

Step #1:
 Parent own 90% or more of Subsidiary
 Board of parent approves merger of Sub into Parent
 approval of Board & Shareholders of Sub not required
 minority shareholders cashed out
 have (dissenters’) appraisal rights

Parent
Parent
Board of
Directors $$$ minority
minority
shareholders
shareholders
90% or >
10% or less

subsidiary
subsidiary Board of
Directors
 Statutory Merger (“short-form” merger)

shareholder
shareholder shareholder
shareholder

Step #2:
 Sub merged into Parent
 Parent acquires assets and debts of former Sub

Parent
Parent
Board of former
former
Directors shareholders
shareholders
$$$
$$$
sub merged into parent

subsidiary
subsidiary
 Statutory Merger (“short-form” merger)

shareholder
shareholder shareholder
shareholder

Step #3:
 Parent owns assets and debts of former Sub

Board of
Parent:
Parent: Directors
withassets
with assets&&debts
debts
ofofformer
formerSub
Sub
 Consolidation

shareholders
shareholders shareholders
shareholders

Board of Board of
Directors Directors

Corporation 1 Corporation2:2:
Corporation
business A businessBB
business
 Consolidation

shareholders
shareholders shareholders
shareholders

Board of Board of
Directors Directors

Corporation2:2:
Corporation
Corporation 1
businessBB
business
business A

NewCorporation
New Corporation
 Consolidation

shareholders
shareholders shareholders
shareholders

Board of Board of
Directors Directors

Corporation 1: Corporation2:2:
Corporation
business A businessB
businessB

merger merger

NewCorporation
New Corporation
 Consolidation

shareholders
shareholders shareholders
shareholders

Board of
Directors

NewCorporation:
New Corporation:
businessAA
business
businessBB
business
Divisive Reorganization: Spin-Off

shareholder
shareholder shareholder
shareholder
AA BB

Board of
Directors

Corporation:
Corporation:
BusinessXX
Business
BusinessYY
Business
Divisive Reorganization: Spin-Off

shareholder
shareholder shareholder
shareholder
AA BB

Corporation:
Corporation:
BusinessXX
Business

100%
100%

Newco:
Newco:
BusinessYY
Business
Step #1:
 drop business Y into new subsidiary
Divisive Reorganization: Spin-Off

shareholder
shareholder shareholder
shareholder
AA BB

distribute
shares of Newco

Corporation:
Corporation:
BusinessXX
Business

100%
100%

Newco:
Newco:
BusinessYY
Business
Step #2:
 distribute shares of Newco to
shareholders of Corporation
 Divisive Reorganization: Spin-Off

shareholder
shareholder shareholder
shareholder
AA BB

Corporation:
Corporation: Newco:
Newco:
BusinessXX
Business BusinessYY
Business

Step #3:
 A and B own shares of both Corporation and Newco
 Divisive Reorganization: Split Off

shareholder
shareholder shareholder
shareholder
AA BB

Corporation:
Corporation: Newco:
Newco:
BusinessXX
Business BusinessYY
Business

final result:
 A owns Corporation; B owns Newco
 Foreign Corporation with U.S. Subsidiary

shareholder
shareholder shareholder
shareholder shareholder
shareholder shareholder
shareholder

ForeignCorporation
Foreign Corporation
100%
100%

U.S.subsidiary
U.S. subsidiary

 parent is foreign corporation

 subsidiary operates business in U.S.
 Mergers & Acquisitions

FINC 446 Financial Decision Making

Dr. Olgun Fuat Sahin

427
 Mergers and Acquisitions
• Vertical merger: forward or backward
integration
• Horizontal merger: expansion in a particular
business line
• Conglomerate merger: combination of
companies from unrelated business lines

428
 Value Related Reasons for M&A

• Synergism
• Taxes
• Information Asymmetry
• Agency Costs

429
 Synergism

• Synergism: Whole is worth more than sum of its

parts (M&A math is 2 + 2 = 5)
– Economies of scale – lower costs by combining operations
• Using excess capacity
• Spreading fixed costs over larger volume
– Economies of scope – can carry out more activities
profitably
• Producing similar products
• Backward integration – buying a supplier to reduce costs
• Forward integration – moving control one step closer to customers

430
 Synergism (Continued)

– Economies of financing – larger companies can

raise money more economically
• The more money raised, the lower the issuance costs
on a per dollar raised
• Higher liquidity for the securities reducing cost of
issuance to the firm
– Risk reduction – lower unsystematic risk will
reduce expected bankruptcy costs
– Market power – larger market share allows control
over price
431
 Taxes
• A merger can reduce the tax of a combined firm
because:
1. The acquirer has large cash flows with limited opportunities
– returning cash to shareholders exposes them to taxes
2. Revaluing assets of the target can create depreciation
expense for tax purposes
3. Losses of a target that have been carried forward can be
used by the combined firm
4. Alternative Minimum Tax might encourage acquisitions by
reducing overall tax payment for firms if they are combined
5. Diversification through M&A can increase debt capacity
increasing tax shield
432
 Information Asymmetry
• Acquiring company posses information that is
not available to the investors
• Buying another company implies that the
acquiring firm managers have found a
“bargain”

433
 Agency Costs
• M&A allows inefficient managers to be
replaced
• Activities in the takeover market curb the
agency cost

434
Management Related Reasons for Mergers

• Reduction of Unsystematic Risk

• Takeover Risk
• Size Preference
• Hubris Hypothesis

435
 Reduction of Unsystematic Risk
• Diversification at the firm level will reduce the
unsystematic risk
– Previously this was good because lower
unsystematic risk reduces expected bankruptcy
costs
– Managers also benefit form lower unsystematic
risk because lower variability in earnings increases
job security and stabilizes compensation

436
 Takeover Risk
• If a company is target for a proposed
acquisition then the target can make it difficult
by acquiring another – hard to swallow
• A defensive acquisition can create a regulatory
hurdle for the original suitor as well

437
 Size Preference
• Managers’ self fulfilling prophecies – bigger is
better not necessarily profitable
• Larger firm can provide more compensation
for managers

438
 Hubris Hypothesis
• Hubris hypothesis suggest that acquiring firm
managers rely too much on their abilities to
identify, undertake, and manage potential
targets
• Usual outcome of such acquisitions is a
disaster admitted by divestitures

439
 M&A Process

• Identify a Target
• Valuation
• Mode of Acquisition
• Mode of Payment
• Accounting of Acquisition
– Note: Regulators (Federal Trade Commission –
FTC) can block a deal or require substantial asset
sell off
440
 M&A Process (Continued)
• Identify a Target:
– Based on a sound strategy that can increase
shareholders’ wealth
– Focus on “Value Related Reasons”
– Acquisitions are usually initiated by the acquiring
firm
– Sometimes a target can announce that it is for sale

441
 M&A Process (Continued)
• Valuation:
• Net Cash Flow:
EBIT x (1 – tax rate)
+ depreciation and other non-cash expenses
– acquisition of new assets
+ increases in liabilities other than LTD
= Net cash flow
• Equity Residual Cash Flow:
Net Income
– preferred dividends
+ depreciation and other non-cash expenses
– acquisition of new assets
+ increases (– decreases) in liabilities
+ increases (– decreases) in preferred stocks
= Equity residual cash flow 442
 M&A Process (Continued)

• Valuation:
– Should not ignore the value of strategic options and
payment terms
– In general an acquisition creates wealth for the
acquirer if: What Acquirer Gets
[Target Alone + Synergies + Other]
>= What Acquirer Gives

[Cash Paid + Stock Paid + Debt Assumed]

443
 M&A Process (Continued)
• Mode of Acquisition:
– Refers to whether a proposed acquisition is friendly or hostile
to target managers
• Friendly acquisitions are approved by board of directors
of each firm
• Then shareholders vote on the proposal
• If no negotiation possibility exists then an acquirer can
proceed with a tender offer to target shareholders –
making it hostile
• Hostile takeover can be quite time consuming especially
when target managers fight against the tender offer
444
 M&A Process (Continued)
• Mode of Payment:
– How an acquisition is paid for: cash, stock or
mixed
• If the stock is believed to be undervalued,
then stock should not be used for payment
• If the stock is overvalued then the stock
payment should/can be used

445
 Takeover Defense
• Golden parachute
– A contract designed to give executives substantial
compensation if they are dismissed following a
takeover
• Poison pills, flip-over rights allowing holders to
receive stock in the acquirer if the bidder
acquires 100% of the target
• Poison pills, flip-in rights allowing holders to
receive stock in the target
– It is effective against raiders who seek to acquire
controlling interest
446
 Takeover Defense (Continued)

• Poison puts
– Bond issues that become due if unfriendly
takeover occurs
• Greenmail
– Managers of target buys shares purchased by
acquirer at a substantial premium
• White knight
– A third company acquiring the target with friendly
terms
447
 Accounting Method

• There used to be two methods: Pooling of

Interest and Purchase method for acquisitions
• Pooling of Interest:
– It can be used if payment is made in the form of
acquirer’s stock
– Balance sheet and income statement of the
combined company are generated by adding up
items

448
 Accounting Method (Continued)
• Purchase method:
– Balance sheet of the combined entity is constructed as follows:
If the price paid is same as the net asset value (book value –
total liabilities), balance sheet of the combined company is
generated by adding up items
– If the price paid is less than the net asset value, the assets are
written down
– If the price paid is more than the net asset value, the assets are
appraised. If the price is still more than appraised value of net
assets, the difference is an asset called goodwill
– The income statement reflect the depreciation expenses
adjusted for the revaluation

449
 Accounting for Goodwill
• The Financial Accounting Standards Board (FASB) issued
two statements changing all that:
• FASB Statement No. 141 Business Combinations
– Requires the purchase method of accounting be used for all
business combinations initiated after June 30, 2001
• FASB Statement No. 142 Goodwill and Other Intangible
Assets
– Changes the accounting for goodwill from an amortization
method to an impairment-only approach
– “Goodwill will be tested for impairment at least annually using
a two-step process that begins with an estimation of the fair
value of a reporting unit. The first step is a screen for potential
impairment, and the second step measures the amount of
impairment, if any.”
450
 Target and Acquirer Performance
around Announcement
• Dodd (1980), “Merger proposals, management discretion
and stockholder wealth,” Journal of Financial Economics,
Volume 8, Issue 2, June 1980, Pages 105-137
– 151 targets and 126 bidders over 1970-1977
Bidders Targets
2-day AR * -1.09% 13.41%
Successful Sample Size 60 71
T-statistics -3.0 23.8
2-day AR -1.24% 12.73
Unsuccessful Sample Size 66 80
T-statistics -2.6 19.1
451
* AR is Abnormal Return = Actual – Expected. Reported AR is average of firm ARs.
 Target and Acquirer Performance
around Announcement (Continued)
• Bradley, Desai & Kim (1988), “Synergistic gains from
corporate acquisitions and their division between the
stockholders of target and acquiring firms”, Journal of
Financial Economics, Volume 21, Issue 1, May 1988,
Pages 3-40
– 3-day announcement abnormal return for 236 successful
tender offers over 1963-1984

Sample Bidders Targets

Size
Total Sample 236 0.00% 21.6%
Single Bidders 163 0.65% 22.0%
Multiple Bidders 73 -1.45% 20.8% 452
 Target and Acquirer Performance
around Announcement (Continued)
• Bradley, Desai & Kim (1983), “The gains to bidding
firms from merger,” Journal of Financial Economics,
Volume 11, Issues 1-4, April 1983, Pages 121-139
– 353 targets: 241 successful, 112 unsuccessful
– 94 unsuccessful bidders
– 1983-1980
Sample Size Targets
Unsuccessful Targets 112 35.6%
Subsequently Taken Over 86 39.1%
Not Subsequently Taken Over 26 23.9%
453
Acquirer Performance in the Long-Run
• Long Run Abnormal Return = Long-Run Actual Return
– Long-Run Expected Return
• Long-Run Event Studies are very sensitive to “Joint
Hypothesis Problem”
– They test two hypotheses
• There is no abnormal performance after acquisitions – Null
• The method of risk adjustment (estimation of expected return) is
accurate. This is very important since we do not have an asset
pricing model that can explain security returns well

454
 Acquirer Performance in the Long-
Run (Continued)
Study Sample Expected Returns AR Calculation Major Results
Franks, Harris 399 acquisitions, (1) CRSP equal-weighted Jensen’s α in event- Jensen’s α:
and Titman January 1975- market index time and calendar-time Average Abnormal Returns are (1) -0.2, (2) 0.29,
(1991) December 1984 (2) CRSP value-weighted portfolios (3) -0.11, and (4) -0.11 per month over 36 months.
market index (1) and (2) are significant.
(3) Ten-factor model Calendar-time portfolios:
(4) Eight portfolio (2) 0.37 per month and significant
benchmark (4) does not detect any abnormal performance with
sub-samples as well
Agrawal Jaffe, 1,164 acquisitions, (1) Beta and size CAAR, starting with CAAR for (1) is -10.26 for (+1, +60) and
and Mandelker January 1955- (2) Returns Across Time and AD significant. CAAR for model (2) is similar. No
(1992) December 1987 Securities (RATS) with size abnormal performance during Franks, Harris and
adjustment Titman (1991) study period
Loderer and 1,298 acquisitions, Similar to RATS CAAR, starting with Abnormal Returns are negative and significant over
Martin (1992) 1955-1986 effective date (ED) 3 years after acquisitions but insignificant over 5
years
Loughran and 947 acquisitions, Matching firm based on size Buy-and-Hold BHAR over five years is -6.5 and insignificant.
Vijh (1997) 1970-1989 and book-to-market Abnormal Return Cash BHAR is 18.5 and insignificant and Equity
(BHAR) starting with BHAR is -25 and significant
ED
Rau and 3,517 acquisitions, Size and book-to-market CAAR, starting with CAARs for mergers and tender offers are -4.04 and
Vermaelen (1998) January 1980- matching portfolios CD 8.85, respectively. Both figures are statistically
December 1991 significant
Mitchell and 2,193 acquisitions, Size and book-to-market BHAR and Calendar- BHAR is zero for all acquisitions after adjusting for
Stafford (2000) 1958-1993 matching portfolios Time Abnormal Return cross-sectional dependence, CTAR is negative and
(CTAR) significant for equity financed acquisitions.

455
Google’s Feb 20, 2007
Acquisition of YouTube

Rachit Modi
Rateb Nori
 Topics we will be covering:
• A brief history of Google
• A brief history of YouTube
• Synergies behind this Acquisition
• The Acquisition
• The Aftermath of the Acquisition
 Google
• Started by Larry Page and Sergie Brin – Ph.D.
students from Stanford University
• The search engine gathered a large following
due to it’s simple, uncluttered and “clean”
design – which turned out to be its
competitive advantage
• Google was incorporated on September 7,
1998 and went public March 30, 2006
• Total initial investment raised for Google was
$1.1 million – it now has a market cap of $130
billion
Google’s Dual Class Share Structure
• Class A Stock:
– Similar to common stock but with less voting power
• Class B Stock:
– More “ownership” than anything else
– Has far greater voting rights than Class A
– “By their ownership of 86,753,907 shares of Class B common
stock, three of the company's executives (Eric E. Schmidt,
Larry Page and Sergey Brin) controlled 66.2% of the total
voting power of all the company's shares...even though they
owned only 31.3% of the total shares outstanding” -ZDNet
 Google
• Leading search engine with a 54% market
share, followed by Yahoo which has only 23%
• Google monitors the highest internet traffic of
any website – it gets the most clicks and
searches in a day than any other website
• Google.com is considered the most valuable
online “real estate”.
 Google’s Revenue
• Google’s only source of revenue comes from
advertising – about $7.14 billion in 2006!
• The company began selling advertising
associated with search keywords – which is
based on the number of hits users make upon
the ads.
• Keywords were sold based on a combination
of price, bid and clickthroughs, with bidding
starting at $0.05 per click.
 Google Video
• Google announced Google Video on January
5,2006
• Google planned on a pay-per-view service for
its users to watch copyrighted videos through
partnerships with TV companies such as CBS,
NBA etc, but that was eventually scrapped and
it allowed users to upload their own videos for
others to see
 YouTube

• Founded by Chad Hurley, Steven Chen and

Jawed Karim – all former cofounders of Paypal
Inc.
• Website was started in Nov 2005
• It allowed users to upload their own videos for
other to see – the same concept that Google
Video was aiming for.
 YouTube
• By the summer of 2006, YouTube was one of
the fastest growing websites, outpacing even
behemoths like MySpace
• As of a July 16, 2006 survey, 100 million clips
were viewed daily with an additional 65,000
videos uploaded per 24 hours
• It has an average of 20 million visitors clicking
onto the website each month
• The site has captured 47% of the online video
market, compared to Google's 11%
 Google’s Previous Acquisitions
• All relatively small buyouts
• Radio Advertising company, dMarc
• Pyra Labs  created Blogger
• Upstartle  created Google Documents and Spreadsheets
• Jotspot  wiki technology
• All of these acquisitions were relatively small, but with
Google gaining huge revenues through its advertising, it got
access to greater buying power - leading to the MySpace
acquisition and now YouTube
 Synergies behind this Acquisition:

• Michael Cahill, managing director of

Manhattan-based Chilton Investment Co.
said ”…we're moving from e-mail
dominated traffic to the MP3 player, and
we are going ultimately to video, and that
is going to consume massive amounts of
bandwidth. With Google's (GOOG)
YouTube acquisition... we've witnessed
companies positioning themselves for
video over Internet"
Synergies behind this Acquisition
• Josh Bernoff, an analyst with Forrester
Research. "I think the combination of the
greater potential to make deals and also the
greater technical ability to solve copyright
problems puts (Google) in a much better
position than YouTube is (in) by itself."
Synergies Behind the Acquisition:
• With YouTube in the Top 5 most viewed websites, an
acquisition like this would significantly boost Google’s
advertising revenues - the “social networking” aspect of
YouTube drives this acquisition
• Sergey Brin, Google's co-founder and president of
technology. "Video is a great medium for advertising,"
• More than half of the online video watching market would
be controlled by Google, similar to the internet search
traffic that the company holds.
 The Deal:
• Google paid $1.65 billion to the YouTube owners
– 217,560 shares, and restricted stock units, options and a warrant
exercisable for or convertible into an aggregate of 442,210 shares,
of Google's Class A common stock
– The stock price was averaged over 30 days. The total amount issued
excludes $15 million provided to YouTube between the
announcement and the close. 12.5% of the transaction will be held
in escrow for a year to cover "indemnification obligations."
• YouTube was to remain a separate service under its
own identity for the near future, though YouTube
search results may include Google Video clips, and
vice versa
The Aftermath
 Hedge Fund Strategies
• Eric Gettleman, a senior associate at Goldman
Sachs Asset Management
• You would take a long position on Google
while taking a short position on the industry
the acquiring company is in (online video
sharing)
• Similar to Risk Arbitrage for mergers
 “Indemnification Obligations”
• Some analysts/critics say $1.65bn was too much to pay for
YouTube especially with the legal issues of copyrighted
videos being posted on YouTube
• “Viacom, the parent company of MTV and Comedy
Central, is demanding Google-owned YouTube to
remove all of Viacom's videos. "100,000 video clips
from Viacom-owned properties including MTV
Networks and BET has been asked to be removed."
Viacom reportedly claims "1.2 billion video streams"
have been generated by YouTube without permission
or compensation to the company.” - BusinessWeek
 Catch-22
• Do you think it’s alright for Google to share
YouTube users’ information with media
corporations such as Viacom?
– A) Yes
– B) No
 Catch-22
• If Google complies, it risks angering YouTube's
users, many of whom want their identity
protected and some of whom undoubtedly
visit the site in hopes of viewing leaked or
copyrighted material.
• If it doesn't, it could frighten advertisers about
identifying their brands with unknown user-
generated content and concern regarding
exposure to copyright suits.
 So what do you think?
• Did Google overvalue YouTube by paying 1.65
billion?
– A)Yes
– B)No
 References
• Wall Street Journal
– http://online.wsj.com/article/SB116014813857884917.html?mod=technology_mai
n_whats_news
– http://online.wsj.com/article/SB116039852999986783.html
• BusinessWeek
– http://www.businessweek.com/technology/content/jan2007/tc20070126_817521.h
tm
– http://www.businessweek.com/technology/content/feb2007/tc20070202_568443_
page_2.htm
– http://www.businessweek.com/technology/content/oct2006/tc20061010_083340.h
tm
• ZDNet
– http://news.zdnet.com/2100-9588_22-6060691.html
• Yahoo! Finance
– http://finance.yahoo.com/q?s=goog&x=0&y=0
Questions?