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Presentation on theme: "Prof. Eric De Keuleneer Prof. Pierre Francotte Year: 2012-13 FIELD PROJECTS EUROPEAN AND INTERNATIONAL BUSINESS (GEST S-543) AND FINANCIAL MARKETS AND."— Presentation transcript:


2 Reading material Mc Kinsey (2012), “Taking a longer-term look at M&A value creation”, Quarterly series, January, see McKinsey’s website. Mc Kinsey (2011), « Organizing for M&A: McKinsey Global Survey results”, Quarterly series, December; see McKinsey’s website. 2

3 Contents I.Business framework II. Internal process and approvals III. Regulatory approvals Annex: Checklist 3

4 I. Business framework A.Strategic context B.Valuation C.Value generation or destruction D.Financing of transaction 4

5 A. Strategic context M&A transactions are means for a company to achieve their business goals, ideally faster and at lower total costs than alternatives. They are not a end onto itself, but only a means to achieve goals – distinguish company’s goals, strategy, and tactical steps – M&A is part of strategy, not goals. 5

6 Alternatives to M&A Various alternatives: – Organic growth (competition, internal investments) – Alliances (e.g., reciprocity arrangements, exclusive distribution contracts) – Joint ventures (set-up of jointly owned company) complicated, especially between competitors Each has advantages and disadvantages, which make them more or less attractive as a strategy at a given point of time: – no approach is necessarily better for all companies – no approach is necessarily better for given company at all times of development and in all market conditions. 6

7 Merger vs acquisition Legal view: – merger implies disappearance of existing companies and creation of new legal entity – acquisition implies that one company takes over the other and the acquired company ceases to exist – but in reality legal arrangements tend to be more flexible, and are often driven by regulation and tax considerations. Business view: – merger is combination of companies of equivalent value – acquisition is take over of one company or line of business by another which integrates the target company in its own business structure. – smaller company can acquire larger company – many acquisitions presented as « mergers » for “psychological” purposes. 7

8 Nature of transaction M&A is a broad concept that includes: – acquisitions of legal entities (and all of its assets and contracts, including personnel) – acquisitions of lines of business which are not necessarily legal entities (e.g., branches or representative offices), typically with selected: client relationships, personnel (under various legal arrangements, e.g., TUPE, voluntary transfers, etc) relevant assets, such as intellectual property rights, hardware and software, etc. 8

9 Divestiture Sale or exit of a line of business/part of company. Weaning off parts of the existing business must also be part of strategic planning, e.g.,: – if no longer sufficiently productive (or expected to loose value in foreseeable future) for revenue and/or cost reasons – if not part of core capabilities insufficient competitiveness – if company needs cash to invest (opportunity cost: locks up financial and human resources that could be better used in other business lines) to increase core capital (e.g., banks today) to return capital to shareholders Alternatives: outsourcing, JV, etc 9

10 Strategy Strategy: set of major intended means to achieve overarching goals of company. Covers all aspects of the conduct of business at a high level. Examples: – Pricing – Personnel/technology – Geographical reach – Size and critical mass – Vertical or horizontal expansion, or both – In-house reliance or outsourcing/focus on core – etc 10

11 Strategic review Intent: – indispensable to have a clear view of the strategic intent of the M&A transaction and the likelihood of success for each strategic strand. Impact: – should also assess potential unintended strategic consequences of M&A transaction and how to mitigate or exploit them. 11

12 B. Valuation Different methods used to value a business or a company. Often one main method used (e.g., Discounted Cash Flow - DCF), but cross- checked and refined with several other methods (e.g., payback, multiples, etc). To be discussed with external expert in subsequent lesson. 12

13 Evaluation techniques Prof H. Pirotte

14 Goodwill In a M&A transaction, buyer acquires an « earning machine » and typically pays a price exceeding the value of the current assets: = goodwill Is the difference between cost of acquisition and fair value of net assets acquired. Intangible fixed asset on balance sheet – originally, goodwill amortised (over 20 years) – now, under IFRS, no amortisation, but company must review value every year against permanent value reductions. 14

15 Goodwill reviews Companies that have acquired financial assets must review their carrying value at least once a year (IAS 36-39). If the value of the asset has dropped, impairment is required: – impact on P/L – asymmetrical (no upward revaluation if value recovers later) Applies to full price, including – any strategic premium – any sharing of synergy value with sellor. 15

16 C. Value generation or destruction Generalisations hazardous – difficulty to measure value creation/destruction – significant differences between industries and companies But enough major failures to raise questions Patterns tend to show that: – Large/public companies rely more on M&A to grow than smaller/private ones – Companies are more successful with many small deals than a few large ones in growing markets – Large deals tend to be more successful in mature markets – Companies that have M&A experience are more successful at it. 16

17 Value generation M&A can generate shareholder value IF: – undertaken for sound strategic purposes (design) – appropriately valued, and – well executed. M&A is typically higher risk/higher rewards than organic growth, – although sometimes failure to act can be strategically more dangerous. 17

18 Benefits M&A can help speed up achievement of goals: – Reach critical mass – Gain market share, clients in existing geographic sector in new geographic areas – Expand product and service range – Increase profit margins – Reduce unit costs – Acquire tested expertise and intellectual property Speed can translate in increased shareholder value: – lower total costs for market penetration – market share protection/gains. 18

19 Cost synergies Reduce total cost of doing business compared to previous state of affairs: – Personnel (support groups, and sometimes production teams) – IT, especially in service companies (e.g., financial industry) – Fixed assets, plants, real estate, etc. Greatest when companies in a similar line of business, thanks to economies of scale and build-up of critical mass on personnel and production capacity (IT, plants, fixed assets, etc). Mostly under control of company But often more difficult and slower to capture than anticipated (see below). 19

20 Revenue synergies Increase total revenues thanks to transaction Less control by company – Expansion of client base (cross-selling) – New services/products – Greater market share/margins - dominant position Provided transaction approved by competition authorities Subject to ongoing competition law constraints on abuse of dominant positions Often prove to be over-estimated. 20

21 Offense and/or defense M&A can be for « offensive » or « defensive » reasons, – seek to build larger or more diversified business – seek to remain competitive in terms of costs and/or service offering vis-a-vis growing competitors. Can legitimately seek to protect market shares or even build dominant position, within regulatory constraints: – on build up or abuse of dominant positions – on avoidance of excessive systemic risk. Companies rarely take into account externalities if they do not coincide with own shareholders’ value: – need for well calibrated regulation and supervision to set boundaries (e.g., financial sector, energy sector, etc). 21

22 Value destruction Many M&A transactions destroy rather than create value for the stakeholders of the Acquirer and Acquired: – shareholders generally of the acquiring party – clients – employees. 22

23 Why? Wrong incentives (cf next lesson) – Financial rather than industrial logic – P/E game – etc. Inadequate design, strategic fit. Poor execution. 23

24 Costs M&A implies a cost: – Pay for established value – Opportunity cost (cf next lesson) Sharing of synergies estimated value? Control premium (about 20%) even if for partial stake Transaction should generate sufficient return in reasonable time scale over the total cost of the transaction (requires synergies). 24

25 Design risk - examples Inadequate strategic fit – Non-exhaustive identification of strategic implications – Incorrect strategic projections – Weakening of strategic fit over time of implementation Over-estimation of synergies – Cost synergies – Revenue synergies Under-estimation of downsides – loss of clients – cannibalisation of products – stretch of resources (management, IT, investment capabilities) Loss of focus on day to day business Trade-off between integration and service development. 25

26 Execution risk - examples Culture clash (especially in case of true or perceived « merger » of equals) – demotivation of staff – productivity losses – loss of good staff, stuck with less good staff – distraction of senior management. Slow or biased decision-making, – especially on people and IT issues. Loss of focus and follow up – inadequate planning and monitoring – lack of resources concern about integration costs at time of cost synergy focus opportunity cost due to scarcity of financial and human resources. 26

27 D. Financing of transaction Two basic financing means: – payment in cash with available cash with debt – exchange of shares Share exchange often more palatable, but – Valuation more complex (need to value both companies) – Overpayment still leads to shareholder value destruction – Shares of acquiring company must be sufficiently liquid Difficult for non-quoted companies Difficult for companies listed on small, illiquid, exchanges. 27

28 II. Internal process and approvals A.Negotiation process B.Shareholders approval C.Advisory support 28

29 A. Negotiation process M&A negotiations must typically be approved by the Board of Directors (BoD) – conducted by Management (sometimes jointly with Chairman of the Board) within framework approved by the Board – key roles for the CEO (for significant transactions), CFO and corporate strategy group, with expert support from Business line managers Legal division Risk division 29

30 Board of Directors approval Management needs BoD approval to approach target company and to negotiate key terms of significant M&A transactions. BoD recommendation to the shareholders – in acquiring company – in target company 30

31 Hostile or friendly Hostile if the acquiring company proceeds with shareholders of target company without positive recommendation of the BoD of target company – either the BoD is completely bypassed (rare) – or the BoD has been approached but is not satisfied with the proposal, such as the price. Hostile transactions are often less likely to: – materialise: shareholders more suspicious, and in some sectors regulators may block deal. – succeed in generating value: lack of management support makes integration more complicated may lead to client defections. 31

32 B. Shareholders approval Depends on law and Articles of Association. Sometimes, under AoA, depends on whether transaction is for cash or share for share: – may be « de minimis » threshold – sometimes no approval required for share for share transactions provided issuance of new shares does not exceed pre-approved amount. Sometimes qualified majorities required. All these modalities have a major impact on deals and their terms and conditions. 32

33 Shareholder structure BoD and management must take into account shareholders’ expectations and profiles. Many M&A transactions fail because miscalculations about this – special role for shareholders in private or family controlled companies (e.g., dilution concerns, value expectations, financing, etc) – « control » depends on company (concentration of shareholding), on possible shareholders’ pacts, on required majority for decision. 33

34 C. Advisory support – investment bank Investment bank – advises on options, valuation and price, financing means, etc – participates in negotiations as agent of client firm for valuation assumptions, etc also used to float ideas and unblock impasses while keeping face – delivers an independent « fairness opinion » to the Board about reasonableness of the price, but subject to assumptions meant to be a safeguard to Board and eventually shareholders may put boundaries on framework of negotiations – sometimes helps arrange financing of transaction. 34

35 Advisory support- others Strategic advisors – Typically advise client over period of time intimate knowledge of firm (but sometimes CEO too reliant?) has less of a stake than investment bank in whether transaction is completed or not – typically no « success fee » for deal completion – although business mandates often affected after deals – Support for post-merger integration Other advisors – e.g., external legal counsel 35

36 III. Regulation A.Sector regulation B.National interest or security C.Competition law 36

37 A. Sector regulation M&A in some industries require prior approval of regulators, e.g., in financial sector: – Banks – Systemically important financial institutions (e.g., certain banks, CSDs)» – Others, e.g., stock exchanges, other infrastructures. 37

38 Acquisition of bank EU-wide rules on evaluation criteria for prudential assessment of acquisition and increases in holdings of financial institutions. 5 criteria: – reputation of proposed acquirer Integrity and professional competence – Reputation and experience of those who will direct the business Fit and proper test – Financial soundness of proposed acquirer capacity to finance transaction and to maintain viable business – Compliance with prudential requirements transaction should not weaken ability off target on compliance – Suspicion of money laundering or terrorism financing 38

39 Systemically important financial institutions (SIFI) Authority of the supervisor to object to M&A transactions by one of its regulated systemic financial institutions: – Power to intervene to detect potential threats to financial stability. – Obligation of SIFI to report intended strategic decisions, including, specifically, M&A transactions. – Authority to object to strategic decision if: inconsistent with safe and sound management of SIFI, or apt to affect significantly financial stability. 39

40 B. National interest or security Most countries require government or regulatory approval for acquisitions of national companies where security or national interest is deemed to be at stake: – US: Committee on Foreign Investment in the United States (CFIUS) assessment of security implications of foreign acquisitions of major U.S. infrastructure assets E.g., US harbours/Dubai Port (2006) – France: government approval of 33.3% acquisitions in sectors of « national interest » (Décret « anti-OPA » 2005) in the aftermath of rumoured interest of Pepsi in Danone. 40

41 C. Competition law Generally similar rules in US and EU: – Approvals of certain mergers and acquisitions – Prohibition of cartels and abuse of dominant positions Although actual rulings may differ based on technical and political considerations – e.g., NYSE-Euronext/Deutsche Börse in EU vs CME/CBOT in US. 41

42 Basic EU rules Two main rules (articles 101-102 of Rome Treaty): – prohibition of agreements or practices that distort competition, e.g.,: cartels between competitors mergers of firms that create new, or strengthen existing, dominant position – prohibition of abuses of dominant position not illegal to have dominant position or even monopoly but constrains on ability of a dominant firm to leverage its position to the detriment of consumers. 42

43 M&A EU Competition authorities will reject M&A transactions with a Community dimension that significantly impede competition within EU, – in particular if they create a new, or strengthen an existing, dominant position – if they assess that consumers will be worse off after the transaction. More demanding criterion for M&A than for stand alone companies: – M&A: no creation or strengthening of dominant position. – Stand alone: dominant position accepted, only abuse is prohibited. 43

44 Complex set of rules EU competition law rules are highly complex and technical. Substantial guidance provided by the Commission, e.g., – Council Regulation (139/2004) on the Control of Concentration of Undertakings. – Commission Guidelines on assessment of non-horizontal mergers (2008/C-265/07). – Commission Notice on Remedies Acceptable (2008/C-267/01) Yet, requiring competition approval is often a long and uncertain path, which can have significant impact on business in the meantime. 44

45 Definition of dominant position Dominant position assessed by competition authority in circumstances of each case. Firm may be dominant in some services or some geographical markets and not others. Dominant generally determined by reference to market share and/or Herfindahl-Hirschman index – as a general rule: >50% market share means dominant position and < 25% non-dominance, – market share determined by reference to « market ». 45

46 Definition of « market » Two relevant markets: – geographical market: national, regional (e.g., Europe) or global? depends on whether firm involved in supply and demand of the relevant products in areas that are sufficiently homogeneous (and can be distinguished from neighbouring geographic areas because, in particular, conditions of competition are appreciably different in those areas). takes into account existence of barriers to entry, consumer preferences, markets shares, substantial price differences, etc – product market: products are part of the same « product market » if they are interchangeable/substitutable for the consumer, takes into account characteristics of product, prices, and intended use by consumers. 46

47 Beneficial impact of M&A Commission may allow a M&A transaction if efficiencies generated by the concentration counteract the negative effect on competition for consumers. For instance: – cost synergies will be passed on to consumers in the form of tariff reductions – governance arrangements will contribute to protect consumers against abuses of dominant position But efficiencies must be both « likely » and « substantiated ». – demanding standard – cf NYSE-Euronext/Deutsche Börse merger attempt. 47

48 Remedies In order to secure approval, companies may propose « commitments » which eliminate the competition restriction concerns. Two main categories: – Structural: e.g., divestitures – Behavioural: e.g., promise not to increase fees Commission reticent about behavioural remedies If accepted, remedies must be implemented before M&A or within a relatively short period of time after M&A. 48

49 Divestitures Preferred remedy of the Commission. Yet, demanding conditions. Divested business must be viable and competitive – transfer of all relevant assets and staff – including those that are shared with retained businesses, but are necessary for viability or competitiveness of divested unit Preferably a stand-alone unit – carve-outs only allowed if future viability ensured There must be a known or potential suitable buyer, so as to ensure continuing competition. 49

50 Other remedies Commission will only accept non-divestiture remedies if their effects are at least equivalent as a divestiture. – Effect must be to allow the entry of sufficient new competition in the market fast enough. Examples: access rights to infrastructures and networks on a transparent and non-discriminatory basis. Often not sufficient on their own and are combined with some divestitures. General behavioural commitments (e.g., promises not to bundle services, not to raise prices, etc) typically not accepted as being too vague and uncertain. 50

51 Annex: Checklist for deal Strategy Price Regulatory approvals 51

52 Checklist - Strategy Does the M&A transaction have a clear and compelling strategic value? – Realistic upside compared to alternatives, including organic growth? – What is the current strategy of each company and which changes should be made to extract benefits of M&A and how (sequence, timing, management of trade offs, etc) – What are the benefits expected to be generated, what is their size (with stress tests), over what period of time? – Idem about potential risks/downsides. 52

53 Checklist- Price Is the price right? – Are projections of business growth not over-optimistic? – Have synergies been properly estimated? – Has due diligence been properly performed and have appropriate reps and warranties been incorporated (price trade-off)? – Have synergies not been over-estimated and « negative synergies » overlooked? e.g., cost of downsizing, prospects of IT integration (legacy costs), sale value of assets to be divested – Have integration costs been properly included in estimates and has disruption on organic business growth been taken into account? 53

54 Checklist – Approvals Have regulatory approvals and constraints been identified and assessed properly? – approval requirements – constraints over time on combined going concern. Can shareholders be reasonably expected to accept the transaction – shareholders of target company – shareholders of acquiring company (if necessary). 54

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