Vienna MBA Mergers & Acquisitions

1. Vienna MBA Mergers & Acquisitions Instructor: Adlai Fisher

2. About the Course • Mergers, acquisitions, and restructurings • offer a lens into a variety of financial management practices at a critical time in the life of a corporation • Managers make decisions with guidance from • Relevant financial theory • Advanced quantitative methods • Careful study of previous business decisions and outcomes

3. M&A Foundations • Successful transactions require managers to have solid understanding of a variety of finance topics and tools • Valuation • Capital structure • Financial distress • Financial statement analysis • Working capital management • Securities markets • Securities issuance • Agency theory • Corporate governance • Executive compensation • Real and financial derivatives • Etc.

4. Course Outline 4 • 1: Introduction and M&A Overview, Valuation • Theoretical frameworks, historical and international perspective, participants • DCF, multiples, due diligence, wealth effects • Case: Ducati (Instructor presented) • 2: Transaction Structuring • Merger legal process, payment method, deal protection, accounting, tax, antitrust • Case: Seagate • 3: Hostile Transactions • Takeover strategies and defenses, duties of directors • Case: Vodafone

5. An Example of M&A: MSFT bids for Yahoo $44 Billion Yahoo Feb 1, 2008 MSFT 62% premium 7% 47% The combination also offers an increasingly exciting set of solutions for consumers, publishers and advertisers while becoming better positioned to compete in the online services market This odd and opportunistic alliance of Microsoft has anything but the interests of Yahoo!'s stockholders in mind

6. Vienna MBAMergers and Acquisitions M&A Overview: Motives and History

7. Overview Outline • M&A objectives, creating shareholder value • Three theoretical frameworks • Historical and international perspective • Current trends • Participants • Deal taxonomies

8. M&A and Shareholder Value • Creating shareholder value is the dominant paradigm for thinking about the role of the firm • Ways of increasing shareholder value • Operations • Finance • Strategy

9. The Corporate Objective Reconsidered • Legal framework • U.S.: Shareholder value is explicitly the objective • Canada: CBCA expresses goal of maximizing value of the firm (not necessarily the same) • Europe: broad set of explicit stakeholders • Other areas: China? • In practice • Managers may have very different incentives than shareholders (Microsoft / Yahoo) • Other stakeholders can influence decisions • Employees, trade groups, government, consumers, etc. • E.g., China Petroleum / Unocal • Inference: Don’t take the corporate objective for granted, likely many interests at stake

10. Creating Value • An acquisition is only one among many possible tactics or strategies • To create value: focus on areas of expertise or special competencies  competitive advantage • An acquisition may be • a well-planned way of achieving a corporate goal (strategic buyer), and/or • it may be opportunistic (financial buyer ) • An acquisition generally should not be considered a corporate goal in and of itself

11. Bidding Strategies / Winner’s Curse • Common values auction: all participants get a noisy signal Si = V + ei of true value V • Example: Put cash in envelope, and sealed bid auction to class. Everyone gets a noisy signal as described above. • What is the equilibrium strategy? • What happens if everyone bids their signal? • Private values auction: Each individual has a different true value Vi and receives signal Si = Vi + ei • Is the winner’s curse larger or smaller than in common values auction? • How does this relate to the bidding strategies of financial and strategic buyers?

12. Three frameworks that help us to understand M&A #1 – Microeconomics #2 – Principal – Agent Theory #3 – Financial engineering

13. Three Theoretical Frameworks #1 – Microeconomics • Industry structure is an equilibrium involving • Technology • Legal and regulatory environment • Macroeconomy • Dynamics • Slow adjustment: internal investment / disinvestment • Rapid adjustment: M&A becomes more important

14. M&A Frameworks #2 – Principal – Agent Theory • Separation of ownership and management creates agency costs • When do goals of managers and shareholders differ? • Mature firm in declining industry • Significant free cash flow (Jensen’s FCF Hypothesis) • Underperforming firms become takeover targets • LBO’s, MBO’s, and Hostile takeovers • Example: T. Boone Pickens and Mesa Petroleum

15. M&A Frameworks #3 – Financial engineering • Unlocking value by changing corporate or financial structure • Tax motives (Profitable firm buys company with NOLs) • Input hedging (e.g., Dupont Conoco) • Risk synergies (debt capacity)

16. Example: Coca-Cola acquires Huiyuan Juice Corp $2.4 Billion in Cash Huiyuan Sep 3, 2008 Coca 3 times Huiyuan’s price 0.2% 167% This acquisition will deliver value to our shareholders and provide a unique opportunity to strengthen our business in China. 17% 4%

17. Notable Deals… • Magna Int. / Opel, GM division (55% stake, Sept 2009) • Kraft / Cadbury ($17 billion, Sept 2009) • Microsoft intended acquisition to Yahoo ($44 billion, 2008) • Murdoch’s News Corporation/Dow Jones ($5 billion, 2007) • Google / YouTube ($1.65 billion in shares, 2006) • Barrick / Placer ($10.4 billion, hostile then friendly cash and share tender, 2006) • Sanofi / Aventis ($65 billion, 2004) • Cingular / AT&T Wireless ($41 billion cash, 2004) • JP Morgan / Banc One ($58 billion, 2004)

18. Historical Perspective Merger waves • 1895-1904 • 1922-1929 • 1940-1947 • 1965-1969 • 1980’s • 1993-2000 • 2002-2006

19. Historical Perspective 1895-1904 • Economy • Rapid economic expansion • Recession begins in 1903 • Technology • Transcontinental railroads permit national markets • Electricity • Regulatory environment • Permissive • Supreme Court decision in 1903 begins enforcement of Sherman Act

20. Mergers wave around 1900 Source: Mergerstat Review 1989

21. Historical Perspective 1895-1904 (cont.) • Mergers • Mostly horizontal: characterized as “merger for monopoly” • Concentrated within heavy manufacturing • Forms U.S. Steel, DuPont, Standard Oil, GE, Kodak • Activity peaks in 1901: result of failure of some merge

22. Historical Perspective 1922-29 • Economy • Rapid economic expansion • Ends around time of crash • Technology • Automobiles increase consumer mobility, local distribution • Radio permits product differentiation and development of national brands • Regulatory environment • Stricter enforcement against monopolies

23. Historical Perspective 1922-29 (cont.) • Mergers • Characterized as “merger for oligopoly” • Also vertical mergers, product extension, geographic extension • Concentrated in public utilities, banking, food processing, chemicals, mining, retailing • IBM, General Foods, Allied Chemical

24. Historical Perspective 1940-1947 • Rapid growth of the economy • Less technological change, smaller merger wave • Wartime price controls lead to vertical mergers

25. Historical Perspective 1960’s Conglomerate Merger Wave • Economy • Rapid economic expansion • Recession begins in 1971 • Regulatory • Strict antitrust enforcement • Mergers • At peak in 1967-1968, only 17% of mergers are horizontal or vertical • Product extension, 60% • Pure conglomerate, 23% (35% of assets) • Roll-ups of many small-medium firms

26. Historical Perspective 1960’s Conglomerate Merger Wave (cont.) • Other possible factors • Theory that these were defensive/diversification driven: management entrenchment • Impact of management science • EPS bootstrapping

27. Historical Perspective Example: Ling-Temco-Vought (LTV) • Founder James Ling begins with $2000 investment in electronics in 1956 • Acquisitions: • American Microwave • J & L Steel • Wilson – sporting goods, meat packing, and pharmaceuticals • Braniff Air – commercial airline • Temco, Vought – military aircraft • National Car Rental • Banks, insurance companies • Altec sound systems

28. Historical Perspective 1980’s • Economy • Expansion begins in earnest in 1984 • Recession begins in 1990 • Financial innovation • Junk bonds, LBO’s, MBO’s • M & A • Characterized as “undoing the conglomerate merger wave” • Innovation in hostile takeover strategies

29. Historical Perspective 1980’s (cont.) • Sharp decline in 1990-1992 • Recession • Adverse court decisions, state anti-takeover amendments • Failure of junk-bond market and many leveraged transactions

30. Historical Perspective 1960 Source: Houlihan Lokey Howard & Zukin

31. Decline of mergers1970 Source: Mergerstat Review 1989

32. Mergers from 1980-2006 Source: Thompson Securities Financial Data (SDC)

33. Historical Perspective 1993-2000 • Economy in rapid economic expansion • Technology • Telecommunications • Semiconductors, Software • Networking, the internet • Regulatory environment • Anti-trust policy changing because of convergence of previously segmented markets • Technological convergence • Geographic convergence: international • Takeover defenses strengthened • Loosening of restrictions in broadcasting, banking, insurance, utilities

34. Historical Perspective 1993-2000 (cont.) • M&A • Strategic mergers, many across previously segmented but converging businesses • Most are friendly, increasing stock financing • Divestitures to increase focus

35. Historical Perspective 2002-2006 • M&As more successful this time around? • Potential explanations: • Deal management and governance: “Senior management today are much more attuned to shareholder opinions, and are more accountable for demonstrating shareholder value …” • Better due diligence: “… companies have learned from mistakes that were made in the last two merger waves…” • Financial synergies and people integration: “Cultural synergies are taken much more seriously than they were in the previous two merger waves.”

36. Historical Perspective: Summary All of the U.S. merger waves are • Associated with economic expansion, and end with recessions • Greatly affected by the regulatory environment • 1895-1904: Merger for monopoly • 1922-1929: Merger for oligopoly • 1960’s: Conglomerate • 1993-2000: interstate banking, global industrial consolidation • Greatly affected by technology • 1895-1904: Transcontinental railroads permit concentration of heavy manufacturing industries • 1922-1929: Radio permits product differentiation and development of national brands • 1993-2000: telecommunications, semiconductors, the internet • Financial innovation also plays a role • LBO’s, junk bonds, and the merger wave of the 1980’s: Undoing the conglomerate merger wave

37. International Perspective

38. International Perspective • 1999 Data: Dramatic growth in European, cross-border, and Far Eastern M&A volume • North America: $1.5 trillion • Europe: $1.1 trillion • Asia: $232 billion • South America: $21 billion • Cross border • North America – Europe: $350 billion • North America – Asia: $54 billion • Europe – South America: $36 billion • Europe – Asia: $31 billion • North America – South America: $18 billion

39. European Merger Wage Source: Thompson Securities Financial Data (SDC)

40. Australia Merger Wage Source: Thompson Securities Financial Data (SDC)

41. China Merger Wage Source: Thompson Securities Financial Data (SDC)

42. Japan Merger Wage Source: Thompson Securities Financial Data (SDC)

43. Key Elements of a Successful Deal The shocking truth: most acquisitions hurt shareholder value! • Search for synergies • Added hurdle of takeover premium We can generally think of a deal as being composed of four stages: • Strategy • Valuation • Mechanics • Implementation & integration

44. The Principal Participants Buyer / seller • Board of Directors • Managers • Shareholders • Employees Advisors • Bankers • Lawyers • Accountants • Consultants

45. The Principal Participants (cont.) Regulators • Antitrust • Industry regulators • Securities regulators Others • Risk arbitrageurs • Short term financiers All of these parties have separate interests… Inference: Need for leadership and orchestration

46. Deal Taxonomies By economic motivation • Synergies in either costs or revenues • Market power • Wealth transfers from / to shareholders, debtholders, employees, the government • M&A as a solution to agency problems • M&A as a manifestation of agency problems – empire building • The winner’s curse and overpayment

47. Types of Deals Takeover • The transfer of control from one ownership group to another. Acquisition • The purchase of one firm or set of assets by another Merger • The combination of two firms into a new legal entity • A new company is created • Both sets of shareholders have to approve the transaction.

48. Types of TransactionsHow the Deal is Financed Cash Transaction • The receipt of cash for shares by shareholders in the target company. Share Transaction • The offer by an acquiring company of shares or a combination of cash and shares to the target company’s shareholders.

49. Financial Data Source • M&A: Thomson ONE Banker / SDC Platinum (http://toby.library.ubc.ca/resources/infopage.cfm?id=1423 ) • Financial statement and stock price: Yahoo Finance (http://finance.yahoo.com/ ) Google Finance (http://finance.google.com/finance ) • Corporate News Factiva (http://toby.library.ubc.ca/resources/infopage.cfm?id=970 )

50. Vienna MBAMergers & Acquisitions Valuation: DCF Methods