Presentation on theme: "Chapter 16 Acquisitions and selling a business"— Presentation transcript:
1 Chapter 16 Acquisitions and selling a business Corporate Financial Strategy 4th editionDr Ruth BenderChapter 16 Acquisitions and selling a business
2 Acquisitions: contents Learning objectivesSome reasons for making an acquisitionRelating synergies to value driversSynergy checklistAdding value in an acquisitionClassifying synergiesIllustrative due diligenceFinancing the acquisition with cashFinancing the acquisition with sharesBuying a company for shares – some issuesBuying a company for cash – some issuesAcquisition strategies to enhance epsFinancing the deal – who gets what?Financing strategy – regardless of the acquisitionEarn-outs and deferred considerationSome defence strategiesIndicative sales process
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 Support strategyComplement strategy by adding in: products, markets, risk reduction, supply of raw materials, geographic expansion, etc. Grow the businessSupport growth that can’t be achieved organically Frustrate competitorsMake an acquisition in order to prevent a competitor doing so Show better profitsManipulating published financial results can improve appearance but does not add shareholder value Managerial utilityAcquisitions are quite good fun!
5 Relating synergies to value drivers Examples of some possible synergiesIncrease sales growthUse Target distribution network for Bidder products, or vice versa.Complementary products can increase volumes for both.Increase operating profit marginCost efficiencies (e.g. economies of scale or scope, or better procurement practices).Increase selling prices, e.g. due to economies of scope.Reduce cash tax rateMore tax-efficient location of operations.Reduce incremental investment in capital expenditureCombine operations and sell off surplus assets.Reduce investment in working capitalCombine operations and reduce inventories.Increase time period of competitive advantageStrengthened branding or R&D from the business combination.Reduce cost of capitalShould only occur if one of the companies is not already financed in the most efficient manner.
6 Synergy checklist Strategic Financial Operational Which of the value drivers will be affected by this transaction?In which direction?Why?FinancialBy how much will it change?When will this happen?OperationalWhat 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 Working capitalDeal costsCost efficienciesZone of negotiationIncreased salesValue to VendorValue to AcquirerMaximum 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 performancehistorical informationsystems of internal controlaccounting policiesreview of forecastsTaxationexisting and potential liabilitiesarrangements (intra-group)transactionEconomic and commercialindustry analysis and key playersPESTLEcompetitive positionstrategic assetsorder bookcontractsProduction and operationstechnologies and systemsInformation systemsIT systems and integrationPeople and culturewho’s who – management and lower tierscapabilitiescultural fitEnvironmental and socialpotential liabilitieslegal & regulatory impactCR stanceIntellectual propertyexistence and ownershipLegal and governancereview of contractspotential problems and contingenciescompetition issues?Pensionsscheme detailsdeficit? (And assumptions)powers of trustees
10 Financing the acquisition with cash BidderCash paid to shareholdersBidderShareholders in TargetShareholders in TargetTargetTarget’s shareholders have no stake in the business after the acquisitionTargetBefore the acquisitionAfter the acquisition
11 Financing the acquisition with shares BidderBidderShareholders in TargetShareholders in TargetTarget’s shareholders own shares in an enlarged Bidder after the acquisitionTargetTargetBefore the acquisitionAfter the acquisition
12 Buying a company for shares – some issues 1. If the consideration is shares, who is buying whom?2. Issuing new shares may dilute the voting control of a dominant shareholder – especially if the target has a block-holder3. Selling shareholders share the risk of the transaction4. Selling shareholders share the synergies5. Both companies need to be valued6. Offer a fixed number of shares, or fixed value?7. Tax implications – sellers can defer a gain8. May not be possible to offer shares in a cross-border transaction9. Cash resources may not be available10. Buying for shares may increase eps if acquirer has higher p/e
13 Buying a company for cash – some issues 1. Can we afford it?2. How much will be bridge financing, how much will be longer term?3. If bridging, when and how will a refinancing be effected?4. Effect on the company’s credit rating, banking covenants, etc.5. Where to raise the debt? (Banks or capital markets?)6. Additional considerations for cross-border acquisitions– where do we raise the money?– in what currency?– tax issues, etc.7. Buying for cash might increase eps if interest rates are less than inverse of target P/E
14 Acquisition strategies to enhance eps ‘Rule’ 1Buy companies with a higher p/e using debt or an earn-out, to avoid dilution of eps in the short termBuy companies with a lower p/e using equity‘Rule’ 2Use debt if after-tax cost of debt is less than inverse of target p/eEnhancing eps is not the same as increasing shareholder value
15 Funding the deal – who gets what? Seller getsCashSharesDeal may not be structured as all cash or all debt – could be a mixtureDeal may also be structured so that seller gets loan stock – still has some exposure to the buyerNeed to consider raising funds conditionallyInitial 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.No further relationship between buyer and seller. No risk to seller. Buyer is geared.Cash/ debtUnlikelyBuyer raisesBuyer cannot afford debt, and seller does not want risk of shares, so rights issue or sale in market to fund deal, or cash underwritten offerSeller gains from synergies and shares all risksShares
16 Financing strategies – regardless of the acquisition GROWTHLAUNCHbusiness risk – highfinancial risk – lowfunding – equitydivi pay-out – nominalp/e highbusiness risk – v. highfinancial risk – v. lowfunding – equitydivi pay-out – nilp/e v. highMATURITYDECLINEbusiness risk – medfinancial risk – mediumfunding – debtdivi pay-out – highp/e – medbusiness risk – lowfinancial risk – highfunding – debtdivi pay-out – totalp/e v. lowHXThe financial strategy for the acquisition should be in line with the company’s overall financing strategyGearingXLBusiness riskH
17 Earn-outs and deferred consideration BUYER CONSIDERATIONSDelays payment, or delays issue of new sharesLimits eps dilution if share eventually issued at higher priceLimits dilution of control, dittoUseful if future results of target are uncertainRetain managers’ commitment in handover periodBut…Is it sloppy negotiating?Can be difficult to combine businessesWho runs the business?Short termism. What happens after the earn-out?What if own share price falls before the end of the period?SELLER CONSIDERATIONSGives possibility of more consideration at a later dateMay wish to earn salary in handover periodRetains their involvement in their businessBut…Is it sloppy negotiating?May not want to stay onProtect against buyer changing the business modelWill 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
18 Some defence tacticsMake sure company is priced correctlyStrategic issues and profit forecastGood relations with CityFriendly shareholdersBuy another companySell/demerge unitsLook for a white knightReferral to competition authoritiesJoint venturesPoison pills
19 Indicative sales process In the pre-sale period you need to choose advisers, undertake pre-sale grooming, review the alternativesInformation memorandum to be preparedIdentify 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 visitsNegotiations around price (often P/E-based), deal structure and conditions will lead to Heads of Agreement with preferred bidderDue diligence is done. (May use a data room)Legals completed – contracts, warranties, etc.Based on ‘Selling a Business, Corporate Finance Faculty, ICAEW, Feb 2009