Chapter 16 Acquisitions and selling a business

1. Corporate Financial Strategy4th edition Dr Ruth Bender Chapter 16Acquisitions and selling a business

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

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

4. Some reasons for making an acquisition

5. Relating synergies to value drivers

6. Synergy checklist • Strategic • Which of the value drivers will be affected by this transaction? • In which direction? • Why? • Financial • By how much will it change? • When will this happen? • Operational • What critical success factors need to be in place to ensure this happens? • What needs to be measured? • Who is responsible for making it happen?

7. Adding value in an acquisition Deal costs Working capital Cost efficiencies Zone of negotiation Increased sales Value to Vendor Value to Acquirer Maximum to pay

8. Classifying synergies • Synergies that any bidder could realize (E.g., arising through better management) • Synergies that any bidder within the industry could realize (E.g. arising through consolidation of manufacturing, or distribution chains) • Synergies unique to this bidder (E.g., involving the application of a particular brand or R&D capability)

9. Illustrative due diligence Financial performance • historical information • systems of internal control • accounting policies • review of forecasts Taxation • existing and potential liabilities • arrangements (intra-group) • transaction Economicandcommercial • industry analysis and key players • PESTLE • competitive position • strategic assets • order book • contracts Productionandoperations • technologies and systems Informationsystems • IT systems and integration People and culture • who’s who – management and lower tiers • capabilities • cultural fit Environmental and social • potential liabilities • legal & regulatory impact • CR stance Intellectual property • existence and ownership Legal and governance • review of contracts • potential problems and contingencies • competition issues? Pensions • scheme details • deficit? (And assumptions) • powers of trustees

10. Financing the acquisition with cash Bidder Bidder Cash paid to shareholders Shareholders in Target Shareholders in Target Target’s shareholders have no stake in the business after the acquisition Target Target Before the acquisition After the acquisition

11. Financing the acquisition with shares Bidder Bidder Shareholders in Target Shareholders in Target Target’s shareholders own shares in an enlarged Bidder after the acquisition Target Target Before the acquisition After the acquisition

12. Buying a company for shares – some issues

13. Buying a company for cash – some issues

14. Acquisition strategies to enhance eps ‘Rule’ 1 Buy companies with a higher p/e using debt or an earn-out, to avoid dilution of eps in the short term Buy companies with a lower p/e using equity ‘Rule’ 2 Use debt if after-tax cost of debt is less than inverse of target p/e Enhancing eps is not the same as increasing shareholder value

15. Funding the deal – who gets what? Seller gets Deal may not be structured as all cash or all debt – could be a mixture Deal may also be structured so that seller gets loan stock – still has some exposure to the buyer Need to consider raising funds conditionally Initial funding may not be the final structure. Borrow to do the deal, and then refinance. The refinancing may be with new debt (on better terms) or with convertibles, or with equity. Alternatively, the refinancing may be from selling assets. Cash Shares No further relationship between buyer and seller. No risk to seller. Buyer is geared. Cash/ debt Unlikely Buyer raises Buyer cannot afford debt, and seller does not want risk of shares, so rights issue or sale in market to fund deal, or cash underwritten offer Seller gains from synergies and shares all risks Shares

16. Financing strategies – regardless of the acquisition GROWTH LAUNCH business risk – high financial risk – low funding – equity divi pay-out – nominal p/e high business risk – v. high financial risk – v. low funding – equity divi pay-out – nil p/e v. high MATURITY DECLINE business risk – low financial risk – high funding – debt divi pay-out – total p/e v. low business risk – med financial risk – medium funding – debt divi pay-out – high p/e – med H  X The financial strategy for the acquisition should be in line with the company’s overall financing strategy Gearing X  L Business risk H

17. BUYER CONSIDERATIONS Delays payment, or delays issue of new shares Limits eps dilution if share eventually issued at higher price Limits dilution of control, ditto Useful if future results of target are uncertain Retain managers’ commitment in handover period But… Is it sloppy negotiating? Can be difficult to combine businesses Who runs the business? Short termism. What happens after the earn-out? What if own share price falls before the end of the period? SELLER CONSIDERATIONS Gives possibility of more consideration at a later date May wish to earn salary in handover period Retains their involvement in their business But… Is it sloppy negotiating? May not want to stay on Protect against buyer changing the business model Will buyer have sufficient funds to meet the eventual liability? Fixed value or fixed number of shares for additional consideration? Will we be able to sell the shares? Tax issues need to be considered Earn-outs and deferred consideration

18. Some defence tactics • Make sure company is priced correctly • Strategic issues and profit forecast • Good relations with City • Friendly shareholders • Buy another company • Sell/demerge units • Look for a white knight • Referral to competition authorities • Joint ventures • Poison pills

19. Indicative sales process • In the pre-sale period you need to choose advisers, undertake pre-sale grooming, review the alternatives • Information memorandum to be prepared • Identify potential purchasers and make contact. (Use confidentiality letters?) • Initial meetings are likely to be off-site; after receiving indicative valuations, preferred bidders can have site visits • Negotiations around price (often P/E-based), deal structure and conditions will lead to Heads of Agreement with preferred bidder • Due diligence is done. (May use a data room) • Legals completed – contracts, warranties, etc. Based on ‘Selling a Business, Corporate Finance Faculty, ICAEW, Feb 2009