1. Vienna MBA Mergers & Acquisitions
Transaction Structuring I

2. Outline Legal structure of mergers
Choice of consideration: stock vs. cash
Fixed value vs. fixed ratio stock transactions
Deal Collars
Deal Protection Mechanisms

3. 1. The Legal Structure of Mergers
The merger process:
Managers come to an agreement
Both boards of directors approve a resolution (the “merger agreement”)
File a proxy statement / information circular with securities regulator
Securities regulator can ask for amendments, which may delay the process
Proxy materials are sent to target shareholders, who have at least 20 days to vote
The merger plan / plan of arrangement is submitted to state / province, which issues a certificate of merger
Short-form merger bypasses shareholder approval and typically requires 80% holdings for insiders

4. Minority shareholder: Freeze-out problem
You want to merge with a target:
Buy 51% shares of target
Appoint your brother-in-law as the new target CEO
Appoint your wife, sisters, mother-in-law as the new target directors
Offer a very low price to merge
Target CEO and board (your wife and mother-in-law) will approve
Exploit minority shareholders (49% shares)
Inference: protections needed for minority shareholders

5. Rights of minority shareholders
If a merger is approved, minority shareholders must sell their shares (“freeze-out” or “squeeze-out”)
U.S.: the minority has “shareholder appraisal rights” to ask for review of fair value in court
Difficult for plaintiffs to win: courts do not like to overturn business outcomes unless evidence is clear (e.g., just payed 20 for shares and now merging for 10)
Canada: In a “related party transaction” board must appoint committee to assure fair value for minority shareholders, including independent appraisal

6. 2. Cash vs. Stock
Trend of Merger Financing By # of deals (would look different for $ value)

7. Why All Takeovers Aren’t Created Equal (In Your Readings Packet)
Article by Roger Lowenstein in WSJ
Discusses five-year returns following a transaction for bidders who
Pay cash
Pay stock
By whether friendly or hostile
Relative to a neutral benchmark of control stocks

8. Five-year stock return after merger

9. Choice of consideration
Interpreting these results
The information content of stock vs. cash transactions
Differences in risk
Differences in motive (thinking about strategic acquirers vs. financial buyers)
Data mining
Lots of research attempting to explain, no firm conclusions

10. Choice of consideration
Information / signalling
A stock transaction =a cash transaction + a seasoned equity issuance
Using stock is a signal that the acquiring management team believes the stock is overvalued
Risk
In a cash transaction, all of the post-acquisition risk is borne by the acquirer
In a stock transaction, this risk is shared with the target shareholders

11. Choice of consideration
Any benefits to stock?
Strategic buyers can use stock to keep the target employees and management vested in the ongoing firm.
There are definite tax benefits to using stock
Only option for firms that do not have sufficient cash

12. 3. Two types of stock transactions
Fixed Share (same as “Fixed Ratio”)
The merger agreement sets what the exchange ratio (e.g., 2:1) will be at the closing date
Final value to seller’s will vary depending on fluctuations in target share price during closing period
Fixed value
The merger agreement established what the $ value of the transaction will be to sellers at the closing date (e.g., $20 worth of bidder stock at closing)
The final exchange ratio thus depends on the bidder’s share price in a window near closing (usually an average of closing prices over the last couple weeks)
The acquirer thus bears all pre-closing price risk.

13. Fixed Ratio vs. Fixed Value
$ to target
Exchange Ratio

14. 4. Allocating Deal Risk with Collars
A deal collar
Specifies changes in exchange ratio or fixed value of a deal depending on variations in the bidder stock price
E.g., fixed value with two-sided collar specifies a fixed value, switching to a fixed ratio at sufficiently high or low bidder closing prices (Travolta)
Other examples: fixed ratio with two sided collar (Egyptian), one-sided collars, etc.

15. Collar Examples

16. The Global-Crossing Frontier Collar (Readings Packet)
A fixed value deal with down-side collar only
Frontier
$63
Global Crossing
1 share
If Global Crossing stock price falls below $35,then
Frontier
1.82 shares
Global Crossing
1 share

17. Allocating Risk Via Collars
The fixed value with down-side collar is the most common type of collar. Why?
$ Value
to target
Without collar, the acquiring firm is so diluted that it may effectively become the aquired
Shares
to target

18. Allocating Deal Risk: An example
Bidder: $10/share * 20M shares = $200 M
Target: $5/share * 20M shares= $100 M
Three basic structures considered:
A cash purchase of $120 million, or $6 per share.
A fixed share purchase, at 0.6 bidder shares per target share.
A fixed value purchase: each target share receives $6 worth of bidder stock, based on bidder’s closing-date price.
Target
$120M
Bidder
Announced: Feb. 1, 2000
Closing: June 1, 2000

19. Allocating Deal Risk: An example
Target
($100M)
$120M
Bidder
($200M)
Feb. 1, 2000
Market dislikes this deal: The combined value of the two companies is $240 M on closing date (loss of $60 million)
Cash: Acquirer share price is ( )/20 = $6, target receives $6 as promised  the acquirer bore all the risk
Fixed ratio stock: Acquirer share price is ( )/(20+0.6*20)=$7.50, target receives stock worth 0.6*7.5=$4.50  acquirer and target share risk
Fixed value stock: Acquirer share price is $6, target receives $6 worth of acquirer stock (both same as cash), implies that the exchange ratio must be 1:1  the acquirer bears all of the pre-closing risk, but pays for downside risk through dilution rather than paying out cash, the target shareholders are exposed to post-closing risk
Consider other possibilities on your own (who gains / who loses):
Market likes the deal: The combined value is $400 million on the closing date (gain of $100 million)
Market likes the deal, BUT: 3 years subsequent to the closing, the combined value is $240 million.
June 1, 2000

20. 5. Allocating Post-closing Risk: Earn-outs
Earn-out definition: A two-part payment with
A standard up-front payment at closing, and
A deferred payment contingent on target’s future performance
Motivation: a way to bridge valuation disagreements in negotiations…
The bidder reduces exposure to the risk of overpayment, or non-realization of synergies
Helps target to signal quality, and can provide incentives to target management
Overall, helps cash payment to have a “stock-like” post-closing shared risk allocation

21. Earn-outs II Empirical evidence(Kohers and Ang, 2000):
Earn-outs more likely in deals with higher information asymmetry (private firms, divested assets, different industries/countries, intangible assets),
Bidder CARs are positive and target premium are higher in deals with earn-outs
Challenges / Limitations:
Agreement on a performance standard; accounting transparency, differing horizons.
Performance metric on target stand-alone value; merger might need structural integration.

22. 6. Deal Protection Mechanisms
Overview
Walk-away right : bidder/target can walk away from an announced deal
No-shop provision: prohibits the target from cooperating with other potential acquirers
The fiduciary out: permits the board of directors to terminate a proposed merger if a better deal arises with another party
Break-up fee: stipulates fees that would be paid by each party if they cannot complete the deal.
Stock lock-up : bidder has the option to acquire target’s share

23. The No-shop provision & Fiduciary Out
An exclusivity arrangement: prevents management from actively seeking out or cooperating with another bid
But if another bidder comes to the target management, the “fiduciary out” is the idea that management may be obliged to seek an outcome that maximizes shareholder interest
Example: Wachovia-Citibank announced Sep. 29, 2008 for $2.2 billion, includes no-shop provision
Wells Fargo reaches merger agreement with Wachovia four days later (Oct. 3) for $15.5 billion
Court challenges, etc., finally favor Wells Fargo
A similar conflict in one of our supplemental readings, relating to legal battle between Texaco and Pennzoil over acquisition of Getty Oil.

24. Break-Up Fee
Break-up fee: specifies penalty for breaking up a deal after merger/purchase agreement is signed
Break-up fees in the case of Wachovia-Citibank have not been discussed in the press
Break-up fees allow the quick resolution of disputes arising from broken merger agreements since they specify damages
Typically in the range of 2-3% of deal value, up to 5 or 6%, which courts generally regard as a reasonable upper end
Meant to compensate buyers for their costs, etc., not make breakup impossible
If a break-up fee is not specified, then the only remedy for a breached contract is the courts
Damages can be large (e.g., Texaco-Pennzoil) but are uncertain
Break-up fees may be specified on either or both sides in a merger / purchase agreement
May also be contingent on circumstances: e.g., if shareholders vote against, etc.

25. Walk-Away Right
A walk-away right in a merger / purchase agreement specifies conditions under which one or both sides may walk away without penalty (or with reduced penalty)
E.g., if stock price of acquirer decreases substantially before closing, then the contract may specify that the target can “walk away”, etc.

26. Stock Lock-up
The stock lock-up acts like a break-up fee, but value is tied to value of target to another acquirer
E.g., suppose an original merger agreement states that acquirer will buy 100% of target for $20 per share
A stock lock-up might specify that if the target breaks up the deal (say to be acquired by another buyer) then the original buyer will have an option to acquire 10% of acquirer shares, say 100K shares, for $20 per share (or $15 or some other value)
Suppose that a second buyer comes along and breaks up the initial deal by offering $25 per share
Now the original buyer will be able to make 100K*(25-20)= $500,000 from this break-up
Thus, the more value the target has to a second buyer, the better off is the original buyer who has a stock lock-up
Also can mean shares committed to a potential buyer by third-party shareholders of a target (more common usage in Canada)

27. Payoff to Initial Buyer in Stock Lock-Up
Lock-up has an option like payoff
Initial bidder gains when the target receives a higher offer
Incentivize initial bidder to maximize target value to second bidder
Rewards initial bidder for their due diligence, etc. that may contribute to a higher second bidder price

28. Crown Jewels Lock-up
Specifies that if the target terminates a deal, then the acquirer will have the right to acquire certain (highly prized) assets of the target at a certain price.
E.g. a specific patent, oil field, production facility, etc.

29. 7. Extras
New TSX Rules on Acquisitions bright line test for when acquirer shareholder approval is needed (dilution > 50%)

30. Earn-out Example eBay to Acquire Skype, September 12, 2005
eBay will acquire all of the outstanding shares of privately-held Skype for a total up-front consideration of approximately $2.6 billion, which is comprised of $1.3 billion in cash and the value of 32.4 million shares of eBay stock, plus performance-related compensation.
The maximum amount potentially payable under the performance-based earn-out is approximately $1.5 billion, and would be payable in cash or eBay stock, at eBay’s discretion, with an expected payment date in 2008 or 2009…
eBay reaches deal to sell Skype, September 1, 2009
“eBay will keep a 35% stake in the firm, which it has been trying to sell for some time. It has said that Skype had "limited synergies" with it. “

31. Vienna MBA Mergers & Acquisitions
Transaction Structuring II

32. Outline Reading market reactions Accounting treatment of transactions
Tax Issues
Antitrust

33. 1. Reading Market Reactions
Target price: At least three factors affect the target price after a deal is announced, but before closing
Deal risk: What is the probability that the deal will fall apart before closing?
Major obstacles: shareholder dissent, financing, antitrust
Target shares may therefore sell at a discount.
Sweetened bid: An improved offer may follow, either from the same or a new bidder
May reduce the discount, or even cause a premium, in the market price relative to initial offer.
In a stock deal where the target also bears pre-closing risk (e.g., fixed share), then the performance of the acquirer will also affect the target price.

34. Reading Market Reactions
In a fixed ratio stock deal, we can isolate the effects of the first two components by comparing the implied exchange ratio (from market prices) to the agreed upon exchange ratio.
Acquirer price: the acquirer price will be affected by
The net synergies anticipated by the market
The premium paid by the acquirer
Not surprisingly, the market anticipates, more often than not, a net loss to the acquirer
The initial market reaction has been shown to be a good predictor of the long run performance of a deal

35. 2. Accounting Issues
Current practice (since 2001 in U.S., longer elsewhere): use purchase accounting for all transactions
Revalue the identifiable assets of the purchased company to fair market value (FMV) and put them on your books
The “step-up” in the basis of these assets will result in a higher level of depreciation of the assets
Any excess of the purchase price over the FMV of the identifiable assets is recorded as goodwill
Annually, test whether goodwill has been “impaired” (i.e., is goodwill less valuable? Note the difficulty of carrying out the impairment test!)
If goodwill is “impaired,” (i.e., if the accountants tell you to) write down goodwill to “fair value” and recognize a loss in current year.
Old (pre-2001) standard for goodwill (versions of this may still apply in some jurisdictions)
Ammortize goodwill over a specified period (e.g., 40 years)

36. Origins of the Goodwill “Impairment” Test
Prior to 2001, all of the world except U.S. used purchase accounting for virtually all transactions
The U.S. permitted “pooling” accounting (moreso than other jurisdictions), with requirements linked to use of stock for consideration and ongoing interest of target shareholders
Under pooling, the balance sheets of the two companies are simply combined, with no goodwill, etc.
CEO’s in the rest of the world complained that U.S. firms had an advantage in M&A because of pooling accounting
Less ammortization expense under pooling = higher future earnings
Likewise, U.S. CEO’s did not want to lose pooling
Introducing the impairment test to purchase accounting helped to alleviate some concerns about high levels of goodwill ammortization following a transaction

37. Why Might Accounting Methods Matter?
Previously, firms would often pay higher premiums, spend substantial amounts to obtain pooling treatment vs. purchase, or refuse transactions if they could not obtain pooling treatment
Why might pooling vs. purchase matter even if it has no impact on CF??
If accounting data matters to market valuation, independently of cash flows
Generally, the accounting literature finds that accounting differences which are well understood do not have price impacts
Bond indentures may use accounting data
Management compensation may be tied to accounting data

38. Example of the Purchase Method
Bidder purchases Target firm for $1,250 in cash on June 30, 2006.

39. Example of the Purchase Method
Goodwill = Price paid – MV of Target firm Equity
= $1,250 – (MV of target assets – MV of target Liabilities)
= $1,250 – ($2,200 - $1,050)
= $100
Acquisitor Value pre merger + Target Firm (FMV) = Acquisitor Post Merger
Book Values are not relevant.

40. Surf’s Up! Wave of M&A Related Write-Offs seen
Impact of Goodwill Accounting (Impairment Test) in a Negative Environment
Surf’s Up! Wave of M&A Related Write-Offs seen
(November, 2008) Reuters notes that with share values plummeting, companies who have done recent transactions will likely face large write-offs due to “impairments in goodwill”
Possible impacts on covenants, compensation

41. 3. Tax Issues Non-taxable (or tax deferred) transactions
Personal taxes: No tax to target shareholders on share portion of consideration until new shares are sold
The basis to target shareholders is held constant at conversion (I.e. if shareholder original basis is $10 and exchange ratio is 2:1 then basis in new shares is $5 each)
Corporate taxes: basis of target assets is carried over to acquirer – no possibility of step-up in FMV of assets
NOL and tax-credit carryovers, but with restrictions
Restrictions on NOL carry forwards were put forward in 1980s to reduce pure tax loss motivations for transactions
Maximum NOL use per year is limited (approximately) to the total value of the loss corporation at acquisition (target) * the interest rate on treasury bills. link
This amount is roughly what the profits on the target would be if it earned a T-bill rate of return.

42. Taxable Transactions
In a taxable transaction, the target shareholders pay any capital gains taxes immediately (depending on their original basis)
The acquirer uses as much as possible of the purchase price over original book value to step up the depreciable tax basis of assets
Asset basis step-up for tax purposes increases future depreciation and decreases future taxes
In certain settings, goodwill may be ammortizable for tax purposes (e.g., in U.S. goodwill ammortized for tax purposes over 15 years)
Note that accounting treatment and tax treatment are not necessarily the same (in fact are often different, see link above)
Cannot carry over NOLs and target tax credits in a taxable transaction

43. Impact of Tax on a Recent Transaction
On Tuesday, Sep. 30, 2008 the U.S. Treasury announced a new interpretation of Sec. 382 of the code which limited use of NOL carryforwards in an acquisitions.
The new IRS interpretation focused specifically on bank mergers, and had an immediate impact on the Citibank-Wachovia transaction, announced one day earlier link
Under existing estimates, an acquirer of Wachovia would write down approximately $74 billion of losses on the Wachovia loan portfolio
Prior IRS interpretation would limit use of the NOL’s to approximately $1 billion per year, for a maximum of 20 years.
The new ruling could remove limits on using the entire amount of NOLs, producing large potential benefits for a potential acquirer
Wells Fargo is profitable, Citibank is not
By the end of the week (Oct. 3) Wells Fargo announced its $15 billion offer for Wachovia
The new IRS ruling as a policy tool in encouraging profitable banks to acquire damaged balance sheets.

44. Hypothetical Value of Wachovia

45. Tax Status of an Acquisition
Three basic types of transactions
Purchases of assets
Purchase of shares
Statuatory merger / amalgamation
If a transaction is appropriately structured, consideration received in shares can be tax-deferred to acquirer shareholders, while cash is immediately taxable.
In Canada, the acquirer must be Canadian for a transaction to receive tax-deferred status
A foreign acquirer will typically set up a Canadian subsidiary to carry out a transaction if it wants to obtain tax deferred status

46. Tax-Free Reorganizations in U.S.
Type A – statuatory merger or consolidation
Generally no more than 50% of consideration in other than voting stock
The “boot” – other consideration such as cash, debt, convertible, may be taxed immediately on its tax basis
Tax basis in new shares proportional to previous tax basis
Includes forward triangular below
Type B – acquisition of stock
Must buy at least 80% of target stock
Only consideration allowed is voting common
Includes reverse triangular below
Type C – acquisition of assets
not common in U.S.

47. Reverse triangular: subsidiary merges into target
Triangular Mergers
Triangular mergers: variants of basic transaction structures; the acquirer uses a subsidiary to purchase or merge with the target
May help to isolate liability in the subsidiary
May help to to avoid a vote of parent shareholders
Forward triangular: subsidiary acquires assets or stock of target or target merges into sub
Reverse triangular: subsidiary merges into target
(e.g., the target acquires the subsidiary, giving parent target shares and making target a parent subsidiary)

48. 4. Anti-Trust Considerations
Main statutes in the U.S.
Sherman Act (1890)
Sec 1 prohibits all contracts, combinations, and conspiracies in restraint of trade
Sec 2 prohibits any attempts or conspiracies to monopolize
Clayton Act (1914)
Makes transactions illegal that adversely affect competition (more general)
Hart-Scott-Rodino (1976)
Provides for pre-merger review (30 days for mergers, 15 for tender offers)
Agencies can issue “second requests” for information to get more time for review

49. Anti-Trust Considerations
The evolution of antitrust theory
Concentration Ratios
The Hirschman-Herfindahl Index
Potential competition and barriers to entry
A trade off between innovation and pricing?
The goal is consumer protection
Globalization and product market convergence have led to more relaxed standards in recent years. That may change in the future…

50. Concentration Ratios 1968 Justice department merger guideline
Concentration ratio: market shares owned by the top 4 firms in an industry
1968 Justice department merger guideline
highly concentrated industry if this ratio >=75%
Market
Bidder
Target
Highly concentrated 4%
4% +
10%
2% +
15%
1% +
Less concentrated 5%
5%+
4%+
3%+
20%
2%+
25%
1%+

51. Hirschman-Herfindahl Index
Consider an industry composed of 8 firms; Each firm has a 12.5% market share
If two of these equal-size firms merge, then new HH is
HHI perceived to be a better measure than concentration ratio
Dominated by market weights of large players, but captures information about structure of entire market

52. DOJ/FTC Horizontal Merger Guidelines (1997)
HHI Analysis Matrix
In analyzing competitive effects of a horizontal merger, regulators consider both post-merger concentration and the change in concentration
Change in HHI
<50
50<Δ<100
>100
Post-Merger HHI
<1000
Unlikely to have adverse competitive
1000<HHI<1800
effects
Raises significant competitive concerns
>1800
Presumed to create or enhance market power
The initial analysis of HHI concentration in a market is often followed by further consideration of additional factors (potential competition, efficiencies, failing firm concerns, etc.)
DOJ/FTC Horizontal Merger Guidelines (1997)

53. Horizontal Merger Analysis: Five Steps
Define the relevant market or markets where there is current or potential overlap between merging parties
Market defined by product and geography
2) Carry out the HHI analysis in each market to determine where there are potential concerns
3) Consider the impacts of potential entrants, and how they could minimize anticompetitive impacts
Relevant question: In the event of a significant increase in prices (5%) would new entry be “timely, likely, and sufficient” (enough to deter the price increase in the first place)
4) Are the economic efficiencies to be gained from the merger sufficient to outweigh competitive concerns?
How large are the efficiencies? Will they be passed on to consumers? Are there other ways of achieving these efficiencies besides merger?
5) “Failing firm” defense: will one of the firms disappear anyway if this merger does not occur
Need to show real economic losses and no alternatives

54. Potential Outcomes
A preliminary merger analysis might lead to the conclusion that there are no significant problems, in which case the merger can proceed
The agency may on the other hand ask for more information (“second request”) which substantially delays the consummation of the merger
Ultimately, the agency may decide to
Let the merger proceed
Negotiate with the parties conditions under which the deal may proceed (“remedies”, e.g., asset sales / divestitures in problem markets, licensing agreements with competitors, etc.)
Block the deal
The parties have legal rights to contest agency decisions in courts, which is both time-consuming and costly

55. Horizontal Merger Analysis Example
In 1996, Staples proposed to acquire Office Depot.
The FTC carried out an analysis showing that prices were substantially higher in areas covered by only one “office superstore” relative to markets where competition existed.
The agency concluded that after the merger Staples would have been able to raise prices an average of 13%.
Ultimately, the agency decided to block the merger, and their decision was upheld in U.S. District Court.
See a comparison of this decision with a similar case where two of three competing railroads were allowed to merge, with “disastrous consequences for freight shipments in the American Southwest in the late 1990’s.”

56. Vertical and Conglomerate Mergers
Vertical mergers occur within the value chain.
Example: U.S. Steel and Tennessee Coke and Coal
Antitrust concerns:
Theory of potential competition: combination of a current player with a potential player
Barriers to entry from vertical mergers: if two markets are tightly linked, the need to enter both simultaneously could create barriers to entry (product tying, exclusivity arrangements, etc.)
Conglomerate mergers occur among firms unrelated by value chain or peer competition (e.g., GE)
Generally do not raise anticompetitive concerns (but also do not generally have obvious economic synergies)

57. Events in Antitrust
(Oct. 17, 2008) DoJ / FCC expected to clear wireless deals
Verizon acquiring Alltel for $28.1 billion, creating largest cell company in North America, closes on January 9, 2009
$14.5 billion wireless broadband pact involving Sprint Nextel Corp., Clearwire Corp., Google Inc., Intel Corp. and three cable providers.
Policy differences seem to appear between DoJ and FTC enforcement another link
DoJ perceived as soft
“Antitrust enforcement has been a low priority for the Bush administration. How low? Until recently, the Department of Justice hadn't challenged a single case in court.”
FTC (another agency jointly responsible for enforcement) wants a more aggressive approach, previously attempted to block merger of Whole Foods and Wild Oats Markets, blocked a hospital merger, etc.
Microsoft raises antitrust concerns about Google-Yahoo

58. Competition Policy in Canada / Worldwide
Competition policy in Canada and Europe is similar in principle to U.S.
In Canada, governed by the Competition Act and implemented by the Commissioner of Competition
Challenges may be brought prior to or within three years following a transaction
Pre-merger notification of Competition Commissioner is required
In a global environment, merging two large multinational corporations may require numerous simultaneous reviews in different jurisdictions
Example: In 2001, the merger of GE and Honeywell – both U.S. corporations – was blocked by the E.U.
Commission: “The merger between GE and Honeywell … would have severely reduced competition in the aerospace industry and resulted ultimately in higher prices for customers, particularly airlines."
GE: “We strongly disagree with the commission‘s conclusions… This acquisition would have clearly benefited consumers in terms of quality, service and prices.“

59. 5. Due Diligence
Due Diligence: The process of thoroughly investigating the value of a transaction to shareholders
A fiduciary duty of managers and directors
Who carries out due diligence, acquirers or targets?
In general, both
For targets, especially important if stock consideration is involved
When does the process begin and end?
Begins with first negotiations, does not end until closing
A process of continually increasing the level of scrutiny, negotiating for greater access, etc.

60. The Due Diligence Process
Due diligence is much more difficult for a buyer in a hostile situation than in a friendly setting
Access to information is more difficult: Citigroup complained about having less access to information than Wells during their dispute over Wachovia
Negotiating the specifics of due diligence to be facilitated/allowed by the other party is an important part of the transaction structuring process in a friendly transaction
Analogy to placing “inspection” conditions on a real estate purchase
In a common scenario
The buyer wants as much information as possible before closing
The seller wants to receive consideration quickly, with as few conditions as possible
Both sides are sensitive to prematurely allowing access to competitively sensitive information
Due diligence complexity is one reason for lengthy closing periods

61. How Due Diligence Fits with Deal Structuring
Ideally, the due diligence process is about closing gaps in information asymmetries, while protecting the interests of both parties
A well-structured merger agreement should allow economically beneficial agreements to close
At the same time, a merger agreement should provide a way out for deals that are found during the due diligence process to have negative economic consequences

62. Due Diligence as an Excuse
In the Wachovia battle, Citigroup publicly maintained a commitment to completing the deal at all times, but in unattributed comments, as the tide favored Wells Fargo, Citigroup insiders expressed to the financial press the idea that they backed off the deal because of due diligence findings.
“While Citigroup insisted publicly that it still was willing to buy most of Wachovia, people close to the company said that additional due diligence uncovered questions that made executives uncomfortable about proceeding with the deal. An important sticking point was the valuation of Wachovia assets, particularly the bank's large securities portfolio.”

63. Due Diligence in Practice
Laundry lists: Legal; accounting; tax; IT; risk and insurance; environmental; market presence and sales; operations; property; intellectual and intangible assets; finance; cross-border; organization and HR; culture; ethics
Specific concerns: inventories, pension plan assets, debt guarantees and covenants, threatened litigation, tax delinquincies, warranties and defects, severance payments, uncollected receivables, etc.
Sources: SEC filings, 8-K, 10-K, 10-Q; proxy statements;
auditor’s work; management letters; operating budgets; cash flow projections; consultant opinions; interviews with employees, customers, and analysts, etc.
The ideal is complete and thoughtful probing of the business model…

64. 6. More on Citigroup, Wells Fargo, and Wachovia
The exclusivity agreement: “Wachovia shall not …encourage any other Acquisition Proposal…”
“The parties agree that in any breach, the parties would be irreparably harmed, and could not be made whole by monetary damages.”
Compare with the idea of a breakup fee.
$60 B Lawsuit
$2.2 B
$15 B
Citigroup: our shareholders have been unjustly and illegally deprived of the opportunity the transaction created.
Wachovia: We look forward to completing our merger with Wells Fargo, which is in the best interest of shareholders, employees, creditors and retirees as well as the American taxpayers.

65. Related Events Buffet bids for Burlington
Berkshire Press Release (great transaction structuring issues)
EU objects to Oracle’s takeover of Sun
EU says US comment on Oracle Sun deal “unusual”