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M&A Strategy and Valuation, Oct 3 and 4 - 2012

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  • 1. Course Organised in co-operation with Eureka Financial Ltd 3/4 October 2012 Prof Scott Moeller, Director, M&A Research Centre, Cass Business School, London MERGERS, ACQUISITIONS AND DIVESTITURES 1© Scott Moeller, 2012
  • 2. PROGRAMME OVERVIEW  Objectives  Identify key value drivers  Understand the process of M&A  Assess the needs and benefits of M&A for a company and therefore the right and wrong reasons to do a deal  Understand synergies and how to quantify them  Learn the different methods of M&A valuation and pricing, and the appropriate application of these methods  Understand M&A due diligence  Analyse alternative deal structures  We will achieve this through the extensive use of  Real life examples of transactions (case studies)  Discussion amongst all participants  Break-out groups© Scott Moeller, 2012 2 Course organised in co-operation with Eureka Financial Ltd
  • 3. COURSE PROGRAMME  Day 1: Morning: Reasons for doing deals, funding and exit requirements, risk and regulation.  Day 1: Afternoon: Deal process, deal teams, strategy, due diligence and negotiation, post-deal integration  Day 2: Morning: Financial engineering (deal structuring, financing, pricing vs valuation, covenants)  Day 2: Afternoon: Synergies and summary case study.© Scott Moeller, 2012 3 Course organised in co-operation with Eureka Financial Ltd
  • 4. M&A FACTS 30% Probability 3% Deals that are hostile that a US Fortune 1000 company will 91% US deals over $100 million pursue a significant that were merger in any challenged in one year £174 Amount each deal court million contributes to the UK economy 31% Likelihood a hostile target company will remain 12% Chance of being made independent redundant following an 19.8% UK Deals with suspicious acquisition trading pre- deal 37% Deals in emerging markets 9 40% of deals don’t complete months within this time after announcement© Scott Moeller, Business School, Towers Watson, Cornerstone Research, Bernstein Research, J.P. Morgan Sources: Cass 2012 Course organised in co-operation with Eureka Financial Ltd
  • 5. Day 1 Mergers, Acquisitions & Divestitures Morning, Session 1 INTRODUCTION AND DEAL DRIVERS© Scott Moeller, 2012 5
  • 6. IT’S NO LONGER TRUE THAT MOST DEALS FAIL…  ‘Headlines’ focus on failures  The press and many boards still believe this  Yes, it was once true: 1987 McKinsey 116 acquisitions 61% failed . Porter 56% of all acquisitions get sold off 1996 Mercer/ 150 deals 57% failure rate / 30% had substantial losses Business Week . Economist 150 acquisitions 70% failed to meet expectations . McKinsey 160 acquisitions Only 12% accelerated their growth 1997 Sirower 168 mergers Only 20% return in 4 years 1998 A. T .Kearney 115 mergers 58% added no value 1999 McKinsey 77% fail to yield expected synergies 2001 KPMG 118 acquisitions 70% created no value / 31% destroyed value 2004 BCG 277 deals 64% destroyed value for acquirers’ shareholders© Scott Moeller, 2012 6 Course organised in co-operation with Eureka Financial Ltd
  • 7. STUDIES SINCE 20071 SHOW DEALS NOW SUCCEED MORE OFTEN THAN FAIL… 1© Scott Moeller, 2012 School, Towers Watson, McKinsey, BCG Sources: Cass Business Course organised in co-operation with Eureka Financial Ltd
  • 8. QUARTERLY PERFORMANCE OF COMPLETED DEALS 10.0 8.5 8.0 The line below (2.5pp) shows the The red line below (2.4pp) median-adjusted performance of all shows the median-adjusted 6.0 acquirers throughout the period. performance of all acquirers 5.1 4.9 over a three year rolling 4.3 period. Percentage Points 4.3 4.0 4.0 4.1 4.0 3.1 2.5 2.1 2.2 2.0 2.0 1.5 0.0 -0.4 -1.0 -0.8 -2.0 -2.8 -2.7 -4.0 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010 Q3 2010 Q4 2010 Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Sources: Towers Watson / Cass Business School© Scott Moeller, 2012 8 Course organised in co-operation with Eureka Financial Ltd
  • 9. MIDDLE EAST M&A ACTIVITY  Slow in 2012: Only 20 deals in H1 vs 42-57 annually in 2007-11  Megadeals:  Qatar Telecom’s $2.2 billion purchase of the remaining 48% of Wataniya (August) and 60% for Asiacell of Iraq for $1.5 billion (June)and Qatar Petroleum’s partial sale of Industries Qatar for $3.9 billion (August)  National Bank of Kuwait / Boubyan Bank for $2.1 billion (June)  Average size of deal <$100 million when above excluded  Why?  Only 6 deals in H1 into the region vs 10-15 in each of past three years  Only 5 deals in H1 out of the region vs 13-16 annually in past three years  But within Middle East is strong.  For the first time, investment in the region exceeded outbound investment.  But reasons to be optimistic as the principal GCC sectors are poised for activity: Financial, Real Estate, Industrials, Energy & Power, even if TMT now appears strongest. 9© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 10. MIDDLE EAST M&A ACTIVITY: QUARTERLY ACTIVITY ESPECIALLY STRONG COMPARED TO 2011 $10,000 300 $9,000 $8,000 250 $7,000 200 $6,000 $5,000 150 $4,000 $3,000 100 $2,000 50 $1,000 $0 0 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2010 2010 2011 2011 2011 2011 2012 2012 2012 Deal Value ($ mm) No. of DealsSource: Zephyr Course organised in co-operation with Eureka Financial Ltd
  • 11. M&A MATURITY Country Index 1 Yr 2 Yr Country Index 1 Yr 2 Yr Scor Δ Δ Scor Δ Δ e e 1 USA 85 0 0 20 United Arab 72 -1 6 Emirates 2 Singapore 84 0 0 45 Qatar 61 -5 0 3 United 82 0 1 Kingdom 59 Saudi Arabia 58 -2 7 4 Hong Kong 81 0 3 62 Bahrain 57 1 1 5 South Korea 81 0 0 64 Kuwait 56 0 -6 6 Germany 80 0 -3 65 Egypt 56 1 0 7 Canada 80 0 -1 66 Oman 56 -1 9 8 France 80 0 3 67 Iran 55 0 -10 9 China 79 1 4 73 Jordan 52 1 -310 Japan 79 2 -1 78 Lebanon 51 4 7 11 Course organised in co-operation with Eureka Financial Ltd
  • 12. M&A MATURITY SCORE AND FACTORS FOR KUWAIT Kuwait70% 67% 60% 60%60% 56% 52%50% 43%40%30%20%10% 0% CASS MARC M&A REGULATORY AND ECONOMIC AND TECHNOLOGICAL SOCIO-ECONOMIC INFRASTRUCTURE AND MATURITY SCORE POLITICAL FINANCIAL ASSETSOpportunity: Economic and Financial Factors (Development of Equity market and availabilityof Domestic Banking Credit)Threat: Technological (High Technology Exports 15%) 12 Course organised in co-operation with Eureka Financial Ltd
  • 13. MIDDLE-EAST MATURITY INDEX CASS MARC M&A REGULATORY ECONOMIC AND INFRASTRUCTURE Country name TECHNOLOGICAL SOCIO-ECONOMIC Ranking MATURITY SCORE AND POLITICAL FINANCIAL AND ASSETS United Arab 72% 78% 66% 63% 70% 83% 20 Emirates Turkey 64% 61% 54% 56% 79% 68% 37 Qatar 61% 73% 65% 41% 61% 66% 45 Saudi Arabia 58% 70% 53% 53% 68% 46% 59 Bahrain 57% 63% 63% 39% 58% 63% 62 Kuwait 56% 60% 67% 43% 60% 52% 64 Oman 56% 73% 50% 43% 56% 56% 66 Jordan 52% 59% 60% 50% 35% 56% 73 Lebanon 51% 37% 59% 59% 51% 50% 76 Syria 42% 38% 45% 35% 49% 42% 97 Iraq 36% 16% 53% 13% 44% 57% 115 Yemen 29% 36% 26% 29% 41% 15% 139 Kuwait is ranked among the top 100 countries in the world and with a score above average (53%) in the Middle East Maturity Countries. 4© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 14. KUWAIT: VOLUME AND VALUE TRACKER 500 469 450 400 380 350 300 266 278 241 250 200 153 138 133 150 115 100100 98 100 54 49 53 50 24 32 7 17 8 - Q1 2010 Q2 2010 Q3 2010 Q4 2010 Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 MARC M&A Volume Tracker MARC M&A Value Tracker 4© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 15. KUWAIT: VOLUME AND VALUE 9 14000 8 12000 7 10000 6 5 8000 DOMESTIC DOMESTIC 4 6000 3 INWARD INWARD 4000 2 OUTWARD OUTWARD 1 2000 0 0 2005 2006 2007 2008 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 Domestic deals in Kuwait peaked in the year 2007 and 2009 4© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 16. KUWAIT: VOLUME BY INDUSTRY Volume (%) 25% 20% 15% 10% 5% 0% Volume (%) Top 3 Deals in Kuwait Date Announced Acquirer Name Acquirer Nation Target Name Target Nation Value ($mil) 30/09/10 Zain Group Kuwait Emirates Telecommun UAE 13,028 Dow Chemical Co- 13/12/07 Petrochemicals United States Petrochemical Inds Kuwait 9,500 02/03/07 Wataniya Kuwait Qtel Qatar 3,801 4© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 17. GLOBAL M&A WAVES… © Scott Moeller, 2012 $ trillions (announced) 5.0 4.7 4.5 4.3 4.0 3.8 3.6 3.5 3.0 2.9 2.9 2.8 2.7 2.5 2.2 2.2 2.2 2.0 2.0 2.0 1.9 1.9 1.5 1.3 1.2 1.2 1.0 0.8 0.9 0.6 0.7 0.5 0.6 0.5 0.4 0.5 0.4 0.4 0.2 0.2 0.3 0.1 0.1 0.0 Source: Sanford Bernstein, Thomson Financial© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 18. M&A PARADOX  Most mergers fail, but few companies succeed without acquiring or merging.  Can you be a large organisation without having made acquisitions?  Is organic growth sufficient to become a leading player?  Management’s challenge: How can you reconcile the low odds of deal success with the need to incorporate mergers into the growth strategy. Or… Best Practice to make deals successful© Scott Moeller, 2012 18 Course organised in co-operation with Eureka Financial Ltd
  • 19. THREE COMPONENTS TO AN M&A DEAL Should we do a deal? With whom? Strategy For how much will they sell? How structured? Price What can we afford? How? Post‐merger Integration© Scott Moeller, 2012 19 Course organised in co-operation with Eureka Financial Ltd
  • 20. SOURCES OF DEAL ERROR: RESPONDENTS CITING EACH REASON AS THE PRIMARY SOURCE OF ERRORS IN THE M&A PROCESS Source: Corporate Executive Board, 2012© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 21. CONSIDER FIRST THE ALTERNATIVES TO M&A© Scott Moeller, 2012 21 Course organised in co-operation with Eureka Financial Ltd
  • 22. THREE PRE-REQUISITES FOR BUYING There are 3 pre-requisites for an acquisition to take place  The target must have a “valuable” business to offer  The target must be owned by people who accept losing control  There must be compatible price expectations on both sides (buyer and seller)© Scott Moeller, 2012 22 Course organised in co-operation with Eureka Financial Ltd
  • 23. PUBLIC AND PRIVATE DEALS  There is a fundamental distinction in mergers & acquisitions between  Public take-overs  Private acquisitions  A public takeover offer occurs  When an offer is made for a publicly listed company  By any other person or company (whether listed or unlisted)  Any other M&A deal is ‘private’© Scott Moeller, 2012 23 Course organised in co-operation with Eureka Financial Ltd
  • 24. PUBLIC DEALS  A public deal is likely to have  A fixed timetable  Minimum pricing levels  High documentation requirements  High publicity requirements  Many rules and regulations, especially from the exchange on which the target has its primary listing© Scott Moeller, 2012 24 Course organised in co-operation with Eureka Financial Ltd
  • 25. PROGRESS OF A PUBLIC ACQUISITION (BUY-SIDE) BuyCo: BuyCo: •needs to grow •appoints advisers •decides to grow by •identifies acquisition acquisition criteria BuyCo: BuyCo: •agrees valuation/pricing •identifies specific target(s) •agrees other terms •approaches specific target BuyCo: BuyCo: •carries out due diligence •launches public offer, or •arranges finance & •signs S&P agreement structure© Scott Moeller, 2012 25 Course organised in co-operation with Eureka Financial Ltd Ltd Course organised in co-operation with Eureka Financial
  • 26. PLANNING PROCESS  Planning incorporates the acquisition goals and objectives  These include one or more of the following:  Market share  Transaction synergies; cost or growth  Industry diversification (vertical integration)  Remove competition  Gain control of strategic resources/skills  Market penetration  Beware other factors!  Management ego  Advisers (transaction based fees)© Scott Moeller, 2012 26 Course organised in co-operation with Eureka Financial Ltd
  • 27. SUCCESSFUL M&A PROGRAM STEPS  1. Manage pre-acquisition phase  Instruct staff on secrecy requirements  Evaluate your own company  Identify value-adding approach  Understand industry structure, and strengthen core business  Capitalise on economics of scale  Exploit technology or skills transfer© Scott Moeller, 2012 27 Course organised in co-operation with Eureka Financial Ltd
  • 28. PRE-ACQUISITION PLAN  Management  Small companies do not have management slack  Management role cannot be delegated  Soft issues  Deal size  Look for economies – not too small unless a bolt on  Affordability  Measure risk tolerance  Operating  Financial  Strategic© Scott Moeller, 2012 28 Course organised in co-operation with Eureka Financial Ltd
  • 29. SUCCESSFUL M&A PROGRAM STEPS  2. Screen Candidates  Identify knockout criteria  Decide how to use investment banks and other advisors  Prioritise opportunities  Look at public companies, divisions of companies and privately held companies© Scott Moeller, 2012 29 Course organised in co-operation with Eureka Financial Ltd
  • 30. SCREEN TARGETS  Concentrate on four key areas  Right industry  Right size  Right fit  Right price  Refine the list  Absolute deal breakers  Potential deal breakers  Desirable but lacking essential criteria  Reduce to one or two candidates  Remember lions eat first!© Scott Moeller, 2012 30 Course organised in co-operation with Eureka Financial Ltd
  • 31. EXAMPLE OF SCREENING CRITERIA  Market segment  Product line  Profitability  Degree of leverage  Market share  Willingness of owners to sell … but remember, ‘everyone has their price!’© Scott Moeller, 2012 31 Course organised in co-operation with Eureka Financial Ltd
  • 32. M&A OPPORTUNITIES: TARGET COMPANIES  Need value chain integration - e.g. dependent on supplier - vertical integration  Benefit from greater efficiency - avoid cutthroat competition, achieve production or distribution efficiencies  Company has weak financials - flat earnings, overleveraged  Has several businesses that have no synergies - some growth, some flat Company has businesses with incompatible cultures - or two different companies with compatible cultures  Company is in sector with overcapacity - benefit from consolidation  Company wants to buy competitor who could end up in a rival’s hands  Company wants to do an IPO but is not suitable - e.g. not in a “hot” business, or the size is insufficient  Companies in the same line of business, but with P/E differentials  Conglomerate discount - company is undervalued in the market and would be worth more if some businesses were hived off  Owner wants to retire© Scott Moeller, 2012 32 Course organised in co-operation with Eureka Financial Ltd
  • 33. SUCCESSFUL M&A PROGRAM STEPS  3. Value remaining candidates  Know exactly how you will recoup the takeover premium  Identify real synergies  Decide on restructuring opportunities  Decide on financial engineering opportunities© Scott Moeller, 2012 33 Course organised in co-operation with Eureka Financial Ltd
  • 34. WHERE WILL THE VALUE COME FROM? Gains from merger Synergies Control Top line Bottom line Financial Business restructuring Restructuring (M&A)© Scott Moeller, 2012 34 Course organised in co-operation with Eureka Financial Ltd
  • 35. SUCCESSFUL M&A PROGRAM STEPS  4. Negotiate  Decide on maximum price and stick to it  Understand background and incentives of the other side  Understand value that might be paid by a third party  Establish negotiation strategy  Reach mutual agreement  Conduct due diligence© Scott Moeller, 2012 35 Course organised in co-operation with Eureka Financial Ltd
  • 36. NEGOTIATION STRATEGY  Select the team  Small is best  Establish roles  Continuity is essential  Have clear objectives  Deal breakers  What is negotiable  List of ‘give-aways’ that can be conceded  Deal with the organ grinder not the monkey  Match seniority and experience  Representations and warranties  Disclosure  Sale and purchase agreement© Scott Moeller, 2012 36 Course organised in co-operation with Eureka Financial Ltd
  • 37. FIRST RULE OF NEGOTIATION ‘You pick the price and I pick the terms… And I always will win.’© Scott Moeller, 2012 37 Course organised in co-operation with Eureka Financial Ltd
  • 38. SUCCESSFUL M&A PROGRAM STEPS  5. Manage post merger integration  Move as quickly as possible in making and announcing decisions  Carefully manage the process© Scott Moeller, 2012 38 Course organised in co-operation with Eureka Financial Ltd
  • 39. FAILURE CAN START AT THIS POINT IN THE DEAL  Process failures  Lack of management and financial resources or experience  Failure to plan early for the integration  Wrong (or no) advisors  Commercial failures  Poor information about target (‘due diligence’)  Industry changes  Unfamiliarity with industry characteristics  Acquiring the wrong company© Scott Moeller, 2012 39 Course organised in co-operation with Eureka Financial Ltd
  • 40. KEYS TO SUCCESS  Soft issues  Management (existing and new)  Cultural issues  Communication  Hard issues  Strategic evaluation  Evaluation of the synergies  Post-deal integration planning  Due diligence process  Advisors  Price© Scott Moeller, 2012 40 Course organised in co-operation with Eureka Financial Ltd
  • 41. Day 1 Mergers, Acquisitions & Divestitures Morning, Session 2 SPECIAL ISSUES, INCLUDING REGULATION AND RISK© Scott Moeller, 2012 41 Course organised in co-operation with Eureka Financial Ltd
  • 42. SELLERS: PRIVATE TRANSACTIONS  Private sales of companies are usually the result of one or more of the following factors  An owner/manager of a private company wishing to cash out  A change in strategy by a parent company  As an alternative to a flotation (perhaps to realise higher value and/or to make a clean break)  The company has good prospects but requires new investment to realise them© Scott Moeller, 2012 42 Course organised in co-operation with Eureka Financial Ltd
  • 43. SELLERS: PRIVATE TRANSACTIONS  Three major types of private auctions from the Seller’s viewpoint  Public/open auction (also known as an ‘open auction’)  Limited private auction (‘prioritised auction’)  Bilateral negotiation (‘negotiated sale’)© Scott Moeller, 2012 43 Course organised in co-operation with Eureka Financial Ltd
  • 44. SELLERS: PRIVATE TRANSACTIONS  Public/Open Auction  Useful  For “trophy” assets  Where unlikely to be confidentiality issues  Advantages  Demonstrates to shareholders that best price achieved  Largest possible market of potential buyers  Disadvantages  Embarrassing if it fails  Puts off some buyers  Effect on staff morale, suppliers, customers  Risk of price effect since competitors will see information  Can sometimes lead to “loss of control” by seller© Scott Moeller, 2012 44 Course organised in co-operation with Eureka Financial Ltd
  • 45. SELLERS: PRIVATE TRANSACTIONS  Limited Private Auction  Approach to limited number of parties  Useful where limited identifiable market of potential buyers  Advantages  Usually maintains good level of confidentiality  Less (public) embarrassment on failure  Disadvantages  Skill required to build up “feeding frenzy”  LPAs often become OPAs (One Party Auctions)!© Scott Moeller, 2012 45 Course organised in co-operation with Eureka Financial Ltd
  • 46. SELLERS: PRIVATE TRANSACTIONS  Bilateral Discussions  Useful  For highly confidential issues, such as critical client lists, intellectual property, production method, etc  Where very few potential purchasers due to product, size, competition, etc  Advantages  Can be quicker than open/limited auction  Reduced effect on staff, customers, etc • Disadvantages  Exclusivity rarely in Seller’s interest© Scott Moeller, 2012 46 Course organised in co-operation with Eureka Financial Ltd
  • 47. SELLERS: PRIVATE TRANSACTIONS  After decision to sell, there are four main stages of the process  Preparation (including Pricing)  Stage 1: The “Long List”  Stage 2: The “Short List”  Stage 3: The “Preferred Bidder”© Scott Moeller, 2012 47 Course organised in co-operation with Eureka Financial Ltd
  • 48. STAGES OF A PRIVATE SELL-SIDE Stage 1 Stage 2 Stage 3 Universe Short List Preferred of Buyers of Buyers Bidder Buyers Confidentiality Data room, Exclusivity, What Agreement, Meet management, Due diligence they get Information Site visits Memorandum What Indicative Exchange / they want Final Offers© Scott Moeller, 2012 Offers Completion 48 Course organised in co-operation with Eureka Financial Ltd
  • 49. SELLERS: PRIVATE TRANSACTIONS Preparation  Preparation of Confidential Information Memorandum  Purpose  Contents [shorter is better?]  Responsibility  “Health warning”/disclaimer© Scott Moeller, 2012 49 Course organised in co-operation with Eureka Financial Ltd
  • 50. SELLERS: PRIVATE TRANSACTIONS Stage 1: The “Long List”  Preparation of universe of potential purchasers  Drawing up the list  Horizontal/vertical buyers  MBO team?  Other financial buyers  Previous approaches  Separation of long list into “Tiers” or the “A-List” and the “B-List”  Approval of client to list© Scott Moeller, 2012 50 Course organised in co-operation with Eureka Financial Ltd
  • 51. SELLERS: PRIVATE TRANSACTIONS Stage 1: The “Long List”  Confidentiality agreements  Usual terms  Whose letterhead? (seller’s or buyer’s)  Dealing with larger purchasers  Distribution of information memorandum  Use recorded delivery  Identification numbers for info memo (control)  Contents of the package  Covering letter: purpose and terms© Scott Moeller, 2012 51 Course organised in co-operation with Eureka Financial Ltd
  • 52. SELLERS: PRIVATE TRANSACTIONS Stage 2: The “Short List”  Selection of shortlist for second stage  Why have a shortlist?  Factors to get on the shortlist  Keeping the others warm  Distribution of further information  Either  Each buyer gets information specifically asked for?  Each buyer gets all information asked for in aggregate?© Scott Moeller, 2012 52 Course organised in co-operation with Eureka Financial Ltd
  • 53. SELLERS: PRIVATE TRANSACTIONS Stage 2: The “Short List”  Establishment of document/data room  Where?  “Rules of engagement”  Co-ordination of visits by buyers  How many rooms?  Geography of the room(s)  Developing trend: the Virtual Data Room  Management meetings and “site” visits  “Meet the management”  Preparation of management?  Formal presentations or informal meetings?  Financial adviser monitors questions and answers  Site visits  Financial adviser accompanies buyers, tries to look interested© Scott Moeller, 2012 53 Course organised in co-operation with Eureka Financial Ltd
  • 54. SELLERS: PRIVATE TRANSACTIONS Stage 2: The “Short List”  Receipt of final/second round offers  By fax?  By letter?  By e-mail?© Scott Moeller, 2012 54 Course organised in co-operation with Eureka Financial Ltd
  • 55. SELLERS: PRIVATE TRANSACTIONS Stage 3: The “Preferred Bidder”  Selection of winner/ “preferred bidder”  Factors for selection  First telephone call  Notification to losers  Preferred bidder gets  Exclusivity (if requested)  Due diligence exercise (limited)  Negotiation of Sale & Purchase Agreement  Usual terms  Major negotiating points  Representations and warranties  Restrictive covenants  Escrow arrangements© Scott Moeller, 2012 55 Course organised in co-operation with Eureka Financial Ltd
  • 56. SELLERS: PRIVATE TRANSACTIONS Stage 3: The “Preferred Bidder”  Execution of Contract  Satisfaction of conditions  Regulatory  Financing  Shareholder approval  Completion  Press announcement (if required or desired)  Letter from vendor to major customers of SaleCo (“purchaser’s comfort letter”)© Scott Moeller, 2012 56 Course organised in co-operation with Eureka Financial Ltd
  • 57. SELLERS: PRIVATE TRANSACTIONS Pre-transaction: Preparation: •Appointment of advisers •Preparation of documents •Indicative sell-side valuation •Dealing with deal-busters Stage 2: Stage 1: •Selection of shortlist •Drawing up list of buyers •Data room,site visits,meetings •Distributing info memo Stage 3: Completion: •“Preferred” bidder selected •Vendor gets consideration •Negotiation/execution of S&P •Buyer gets SaleCo© Scott Moeller, 2012 57 Course organised in co-operation with Eureka Financial Ltd
  • 58. SELLERS: PRIVATE TRANSACTIONS  Indicative timetable - Preparation and Pricing 4 - 6 weeks - Stage 1: The “Long List” 3 - 4 weeks - Stage 2: The “Short List” 3 - 4 weeks - Stage 3: The “Preferred Bidder” variable© Scott Moeller, 2012 58 Course organised in co-operation with Eureka Financial Ltd
  • 59. Day 1 Mergers, Acquisitions & Divestitures Afternoon, Session 1 STRATEGY: DEAL TEAM, TARGET SCREENING AND DUE DILIGENCE© Scott Moeller, 2012 59 Course organised in co-operation with Eureka Financial Ltd
  • 60. KEY SHARE OWNERSHIP THRESHOLD LEVELS(EXAMPLE FROM THE UK) Shares of Target Consequences 0.5%+ If target is in offer period, all dealings by a 1%+ shareholder to be disclosed 3%+ Acquirer must disclose level of shareholding to target 10% If target is a bank, FSA approval required for change of control 10%+1 10%+1 shareholder has ability to prevent compulsory acquisition of its stake 25%+1 25%+1 shareholder has ability to block special resolutions 30% Mandatory offer triggered 50%+1 Minimum level of acceptances for an offer to be successful under the Takeover Code 50%+1 50%+1 shareholder has ability to carry ordinary resolutions in a general meeting - effectively equals control 75%+1 75%+1 shareholder has ability to carry special resolutions in a general meeting 90% (dependent) Compulsory acquisition of minorities (otherwise known as a “squeeze-out”)© Scott Moeller, 2012 60 Course organised in co-operation with Eureka Financial Ltd
  • 61. MANDATORY OFFER LEVELS Australia 20% Malaysia 33% Austria 30% Netherlands 30% China 30% New Zealand 20% Dubai (DIFC) 30% Nigeria 30% Finland 30% Norway 33.3% France 33% Portugal 33% Germany 30% Romania 33% Greece 33.3% Russia 30% Hong Kong 30% Singapore 30% India 25% Indonesia 50% South Africa 35% Ireland 30% Sweden 30% Italy 30% Switzerland 33.3% Japan 33.3% United Kingdom 30% Kuwait 30% USA none Source: Allen & Overy (10/12/2008)© Scott Moeller, 2012 61 Course organised in co-operation with Eureka Financial Ltd
  • 62. TIMETABLE ISSUES (IN THE UK) The Bid Timetable Date Event Day before day of announcement Irrevocable undertakings (if any) obtained Day of announcement (“A”) 8.00 am: Offer announced (including all its terms and conditions) Up to 28 days after A (“D”) Offer document posted D + 21 First closing date D + 22 By 8.00am: If offer unsuccessful at the first closing date, Offeror announces the level of acceptances and that the offer is being extended for, normally, 14 days D + 39 (timetable extended on Latest date for release of new information by the target request of the Panel if merger control condition not satisfied by now) D + 42 First date for withdrawal of acceptances D + 46 Latest date for the posting of revised offers: if a revision is to be made, Offeror announces revision of its offer and extension to 1.00 pm on D + 60 and posts a new offer document© Scott Moeller, 2012 62 Course organised in co-operation with Eureka Financial Ltd
  • 63. TIMETABLE ISSUES (IN THE UK) (CONTINUED) D + 60 1.00 pm: Last time for receipt of acceptances counting towards fulfilment of the acceptance condition By 5.00 pm: Offeror announces whether it has received sufficient acceptances to declare its offer unconditional as to acceptances. If not, offer lapses; if so, offer normally declared wholly unconditional or declared unconditional as to acceptances (e.g. if regulatory conditions still outstanding) D + 74 Latest date for the posting of consideration to those shareholders who accepted the offer on or before D + 60, assuming the offer becomes wholly unconditional on that day D + 81 Day by which conditions (other than the acceptance condition) must have been fulfilled or waived D + 95 Latest date for the posting of consideration to shareholders assuming the offer becomes wholly unconditional on D + 81 3 months after last day on which Normal cut-off for serving squeeze-out notices under Section 979 of offer can be accepted the Companies Act 2006 Date of squeeze-out notice + 6 Acquisition of relevant minority shareholdings weeks© Scott Moeller, 2012 63 Course organised in co-operation with Eureka Financial Ltd
  • 64. COMPETITION LAW  Competition law covers (in particular): mergers, anticompetitive agreements (including cartels) and abuse of a dominant position Example: EU rules on level of dominance –  Presumption of anticompetitive at 40%  Indication at 25% market share (referral)© Scott Moeller, 2012 64 Course organised in co-operation with Eureka Financial Ltd
  • 65. TAXABLE VS. NON-TAXABLE DEALS  The basic tax rule in mergers:  Exchanging stock = non-taxable transaction  Cash or Debt = taxable  In practice, it is more complicated  Specialised tax advisors usually required© Scott Moeller, 2012 65 Course organised in co-operation with Eureka Financial Ltd
  • 66. Day 1 Mergers, Acquisitions & Divestitures Afternoon, Session 2 STRATEGY: CROSS BORDER / NEGOTIATION / POST-DEAL© Scott Moeller, 2012 66 Course organised in co-operation with Eureka Financial Ltd
  • 67. Advisors and their Roles ‘The only source of knowledge is experience.’ Albert Einstein© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 68. DIFFERENT ADVISORS IN A DEAL Investment Bank Legal Accounting General Human Funding Management Tax IT Specialist Others Resources Bank Consultants© Scott Moeller, 2012 68 Course organised in co-operation with Eureka Financial Ltd
  • 69. A SERIAL ACQUIRER EXAMPLE: THE GE DEALTEAM IT / Systems Legal / Finance / Tax Intellectual Property Deal Team Leader HR • Strategy Compliance • Communications • Culture Operational Commercial • Risk • Sales & Marketing • Services & Processes • eCommerce • Quality • Sourcing© Scott Moeller, 2012 69 Course organised in co-operation with Eureka Financial Ltd
  • 70. FINANCIAL ADVISOR(S)  Financial advisor role  Gives general financial advice  Drafts some, coordinates all documentation  Controls other advisors and the client/directors  Advises on target valuation and deal pricing  Manages overall strategic direction of the offer  Lend its good name to the transaction  There may be two financial advisors  Investment bank (advisory and possibly underwriting)  Lending bank (funding: short-, medium-, long-term)  Increasingly the financial advisor will play both roles, and also the stockbroker role  Financial advisor role differs depending on whether representing the bidder or target.© Scott Moeller, 2012 70 Course organised in co-operation with Eureka Financial Ltd
  • 71. INVESTMENT BANKERS WITH BIDDERS  Finding acquisition opportunities, e.g. locating an acquisition target.  Evaluating the target from the bidder’s strategic and other perspectives; valuing the target; providing ‘fair value’ opinion.  Devising appropriate financing structure for the deal, covering offer price, method of payment and sources of finance.  Advising the client on negotiating tactics and strategies or, in some cases, negotiating deals.  Collecting information about potential rival bidders.  Profiling the target shareholders to ‘sell’ the bid effectively; helping the bidder with presentations and ‘road shows’.  Gathering feedback from the stock market about the attitudes of financial institutions to the bid and its terms.  Identifying potential ‘show stoppers’, such as antitrust investigation and helping prepare the bidder’s case in any regulatory investigations.  Helping prepare offer document, profit forecast, circulars to shareholders and press releases, and ensuring their accuracy© Scott Moeller, 2012 71 Course organised in co-operation with Eureka Financial Ltd
  • 72. INVESTMENT BANKS WITH TARGETS  Valuing the target and its component businesses to negotiate a higher offer price; providing fair value opinion on the offer.  Helping the target and its accountants prepare profit forecasts.  Arranging buyers for any divestment or management buyout of target assets  Getting feedback concerning the offer and the likelihood of its being accepted  Negotiating with the bidder and its team.  If the bid is hostile or unsolicited:  Crafting effective bid resistance strategies  Finding white knights or white squires to block hostile bid.  Monitoring target share price to track potential bidders and provide early warning to target of a possible bid.© Scott Moeller, 2012 72 Course organised in co-operation with Eureka Financial Ltd
  • 73. DEAL ADVISORY FEES ANNOUNCED TARGET FINANCIAL ANNOUNCED TARGET ACQUIRER TOTAL VALUE ADVISER FEE % (M) ($ IN MILLIONS) 27 Jan 2012 Solutia Eastman Chemical $4,501 $14.3 0.32% 18 Apr 2012 Catalyst Health Solutions SXC Health Solutions $4,167 $25.0 0.60% 30 Jan 2012 Thomas & Betts ABB $3,867 $21.5 0.56% 19 Mar 2012 AboveNet Zayo Group $2,147 $16.3 0.76% 7 Jan 2012 Inhibitex Bristol-Myers Squibb $2,065 $21.5 1.04% 12 Mar 2012 Zoll Medical Asahi Kasei $2,063 $8.4 0.41% 9 Feb 2012 Taleo Oracle $1,838 $20.0 1.09% 21 Feb 2012 CH Energy Fortis $1,443 $6.2 0.43% 30 Jan 2012 Pep Boys-Manny Moe & Jack Gores Group $1,009 $7.8 0.77% 26 Jan 2012 Micromet Amgen $902 $15.0 1.66% 13 Mar 2012 Great Wolf Resorts Apollo Global Management $744 $5.2 0.70% 10 Apr 2012 X-Rite Danaher $626 $8.9 1.42% 6 Feb 2012 SureWest Communications Consolidated Communications Holdings $521 $7.1 1.36% 5 Mar 2012 Archipelago Learning PLATO Learning $324 $5.5 1.70% 7 Mar 2012 Transcend Services Nuance Communications $302 $4.3 1.42% 17 Jan 2012 Convio Blackbaud $272 $5.0 1.84% 16 Apr 2012 Dreams eBay $167 $2.7 1.62% 3 Feb 2012 Swank Randa $81 1.3% 1.65% 19 Mar 2012 Adams Golf Adidas $72 $2.2 3.06% 27 Feb 2012 Access Plans Aon $70 $2.1 3.00%© Scott Moeller, 2012 announced between 1 January Acquisitions and divestitures and 30 April 2012 where fees have been disclosed Source: Bloomberg Course organised in co-operation with Eureka Financial Ltd
  • 74. INVESTMENT BANK FEE LEVELS Relationship between Deal Size and Fee Level 3.50% 3.00% 2.50% Fee Percentage 2.00% 1.50% 1.00% 0.50% 0.00% 0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 Deal Value ($ millions) Acquisitions and divestitures announced between 1 January and 30 April 2012 where fees have been disclosed Source: Bloomberg© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 75. LAWYERS  Draft legal agreements and documents  Draft ‘back end’ of offer and defence documents  Give tax advice (sometimes)  Handles competition concerns, if any, and other regulatory issues  Gives general corporate and regulatory advice  Verification and (legal) due diligence  May negotiate (or renegotiate) senior management and other employee contracts.© Scott Moeller, 2012 75 Course organised in co-operation with Eureka Financial Ltd
  • 76. ACCOUNTANTS  Produce numbers as required  3 year track record for offer document (not required for offeree document)  Profit forecast (but note their role)  Give tax advice (when lawyers don’t)  Take on bulk of due diligence  Sometimes have specialist consultancy roles 76© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 77. GENERAL MANAGEMENT CONSULTANT  Can advise at any point in the deal  For smaller acquisitions, may include some of the roles noted for investment bankers Example: Services provided by Accenture  Training:  M&A Strategy and Pre-Deal Workshop  Due Diligence Workshop  What to do:  Pre-deal Playbook  Clean Room Playbook (when providing information during due diligence)  Synergy Playbook  Divestitures Playbook  Merger Integration Playbook  Toolkits (specifics):  Merger Integration Toolkit 77© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 78. PUBLIC RELATIONS ADVISOR  Helps with selling message  Corporate ‘logo’ / spin  Organises PR campaign  Press briefings  Presentations  Media events  But…don’t let them out alone 78© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 79. IN-HOUSE M&A CORE COMPETENCY  Corporate Development group  Usually populated with transfers from other areas of the company  Can be a feeder to the divisions, especially related to deal integration  Staff who can perform well in an uncertain and chaotic environment often with extreme pressures on time and performance  Sees the deal through from start to post-merger integration, often including execution  Deal Process and Integration Playbook  Tools developed that are unique to the company  Metrics for all phases of the deal  Anticipates potential trouble areas  Incorporates learning from one deal to another  Links corporate strategy and SWOT analysis to the acquisition plans 79© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 80. KEY ELEMENTS OF IN-HOUSE M&A Clear and compelling M&A Merger Integration Playbook Merger Integration Unit Strategy • Create/refine acquisition strategy • A set of diagnostic tools and • The Merger Integration Unit “Why buy?” repeatable processes that is should bring together people who tailored to the company’s can perform well in a chaotic, • Assess strategic needs and gaps acquisition needs uncertain merger environment relative to current business. • Includes customized integration • A Core Integration Management • Determine where and how methodologies, performance team will be responsible in acquisitions may close Corporate metrics, tools, and templates realising the synergies and is also and / or Business Unit gaps given a voice in synergy • Includes diagnostic to assess a estimation of new deals deal’s complexity and likely integration trouble spots to identify what must be integrated successfully Source: ‘The Role of M&A in Driving Convergence: Further Data Points’ (Accenture, March 2007)© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 81. Strategy ‘In preparing for battle I have always found that plans are useless, but planning is indispensable.’ Dwight D. Eisenhower (1890–1969)© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 82. STRATEGIES FOR REALISING VALUE  Categories of seller  Private individuals – family firms, entrepreneurs  Commercial – corporates of all sizes  Financial – PE house, venture capital  Rationale for selling  Financial exit  Diversification  Generate liquidity  Family retirement planning or dispute resolution  Inderperformance  Lack of strategic fit  Tax strategy  Opportunism 82© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 83. DEVELOPING AN ACQUISITION STRATEGY  Define your acquisition objectives  Establish specific acquisition criteria  Focus on the company’s “wish list”: Is it the right target?  Is the market going to like the deal? Why?  What is the business vision that justifies it?  How much dilution in the buyer’s stock price will there be?  What will it take after the deal to make it work? 83© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 84. DISPOSAL ERRORS  Process failures  Lack of planning  No grooming  Separation issues ignored  No sell-side due diligence  Unreasonable price and terms expectations  Wrong marketing approach  Commercial failures  Failure to identify a company that should be sold  Wrong strategy – flotation, joint venture, PE house 84© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 85. TYPICAL LOSING PATTERN FOR MERGERS  Targets are screened on the basis of industry and company growth and profitability  Pressure is building to do a deal  Unrealistic synergies are included in DCF analysis  Negotiation concludes at a high premium  Post acquisition, the synergies are found to be unachievable  Company share price falls with negative external comment 85© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 86. REASONS FOR MERGERS AND ACQUISITIONS  There are good and bad reasons for acquiring another company  At its core, the headline communications demonstrate:  Expansion  Synergistic gain  Financial factors, including investment (e.g., private equity returns)  But - unfortunately - other motives may also provide the impetus 86© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 87. WHY DO A DEAL? Good Questionable: Bad: But still risky Russian Roulette ‘Betting the farm’ •Improve target company •‘Big is Better’: Roll-up •Hubris / Managerialism performance strategy •Management •Reduce competition •Pure diversification •Operating synergy •Reactive to industry changes •Financial synergy (‘me-too’ deals) •Hide internal problems •Prevent a competitor from •Remove excess capacity from doing the same deal the industry •Taxes •‘Shake things up’: Redefine •Accelerate market access for the industry the buyer or seller •Undervaluation / ‘Buying cheap’ •Get skills, technologies, IP •Opportunism: ‘Because it’s faster or at a lower cost than available now’ building. •Shareholder pressure (usually a major shareholder) •Pick winners early •Public relations benefits •Advisor recommendation (being sold a deal) Source: McKinsey (2010) / lecturer 87© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 88. IDENTIFYING COMPANY STRATEGY  Acquirer must know its own existing core competences and therefore its gaps  …to be filled in through acquisitions  Desired competences must be kept in mind throughout the M&A process: planning, screening, due diligence and negotiation  Acquirer’s familiarity with the target and industry will assist in the communications with the target once negotiations have begun  Reducing uncertainty  Assisting in retaining key personnel 88© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 89. STRATEGIC JUSTIFICATION: SIX QUESTIONS TO EVALUATE 1. Sound Strategic Assessment?  Value-creating potential of the acquisition  Transfer of skills must meet three conditions:  Similar enough to be meaningful  Activities lead to competitive advantage  Skills represent a significant source of competitive advantage  Possible mistakes: considering the target only and not the combined firm, static analysis and not the industry’s future 2. Shared View of Purpose?  Without a shared understanding of the strategic role of the acquisition, there will be no clarity for the integration  Possible destruction of value 3. Clear view of the sources of Benefits and Potential Problems?  Identify potential risks, and alternatives to mitigate those risks  Consider that proponents of the acquisition will downplay the risks in selling the idea to senior management 89© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 90. STRATEGIC JUSTIFICATION: SIX QUESTIONS TO EVALUATE 4. Consideration of Organisational Conditions?  Synergy is more than cost control and technical integration  Key factor is who will manage the various departments in the new organisation 5. Plan for Implementation Timing?  Planning for the process, not just the end-point  Milestones need to be set 6. Maximum Price Set?  Must set walk-away price so that all the benefits will not be bid away in the heat of the process  Pricing is dynamic, and will change as market conditions and better information becomes available 90© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 91. LINKING STRATEGY TO SELECTION: 10 GUIDELINES 1. Pay for the past, consider the present but buy the future • Evaluate the business on expected future performance after you buy it 2. Buy a good business and make it great • Buying a mediocre business at a low price is more expensive than buying a good business at a fair price 3. Ingredients are nothing without a recipe • Can you put the parts of the business together at a reasonable cost? 4. Fall in love with the cashflow not the product • Remain objective 5. Stick to your knitting • Do what you do best 91© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 92. LINKING STRATEGY TO SELECTION: 10 GUIDELINES 6 Autopilot • Can the business run on its own so that you can concentrate on driving the profits? 7 What holds the gold? • Where are the hidden values? 8 Can we sell the deal? • You must be enthusiastic about the business and able to sell the idea to others 9 Identify and evaluate what is missing • Sometimes the smallest improvements yield remarkable results 10 Timing and cost • How long will it take to implement and how much will it cost? 92© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 93. EVALUATE THE STRATEGY: TOOLS  Competitive position  Porter’s Five Forces analysis  Resource analysis  7M’s  Product/market strategy  Ansoff matrix  Long term strategic impacts  P.E.S.T.E.L. analysis  S.W.O.T. summary 93© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 94. USING INDUSTRY STRUCTURE ANALYSIS: PORTER BARRIERS TO ENTRY Questions: Do barriers to entry exist? How large are the barriers? Are they sustainable? Potential Actions: Acquire to achieve scale in final product or critical component Lock up supply of critical industry input SUPPLIERS CUSTOMERS Questions: Questions: Is supplier industry Is the customer base concentrating? concentrating? Is supplier value/cost Is value added to added to end product high, COMPETITIVE customer end product changing? high, changing? ADVANTAGE Potential Actions: Potential Actions: Backward - integrate Create differentiated product Forward - integrate SUBSTITUTES Questions: Do substitutes exist? What is their price/ performance? Potential Action: Fund venture capital and joint venture to obtain key skills Acquire position in new segment 94© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 95. THE 7 M’S MODEL  Analysing strategic resources  Materials  Machines Where is the competitive  Method advantage?  Manpower How to integrate?  Management How to retain?  Markets  Money  Relates as well to the due diligence 95© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 96. ANSOFF DEVELOPMENT MATRIX Product Present New Market Market Product Present penetration development New Market Diversification development 96© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 97. S.W.O.T. PLUS P.E.S.T.E.L. ANALYSIS Political Economic Social Technology Environmental Legal Strengths Weaknesses Opportunities Threats 97© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 98. Due Diligence ‘Know thy enemy and know thyself; in a hundred battles you will never be in peril.’ Sun Tzu 400-320 BC 98© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 99. PRE-SALE PLANNING  Vendor due diligence  Advantage for vendor or purchaser?  Identify deal breakers – pre- and post-closing  Grooming and separation issues  Close down marginal activities  Control the deal – no surprises  Information memorandum and due diligence package 99© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 100. SOME THOUGHTS ON DUE DILIGENCE Needs to start before the deal is announced •But most active period is when the deal is public Led from the top… •But needs to involve all divisions and staff at all levels •Outside experts Issues of public vs non-public information •Assume that anything disclosed WILL be public •Non-disclosure agreements Methods used: •Initial information memorandum •Virtual data rooms •Physical data rooms 100© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 101. DUE DILIGENCE ISSUES (CONTINUED)  The target company is not required to provide to a bidder any confidential or non- public information unless:  Compelled by the courts  An auction process has been initiated by the target, in which case they must disclose information equally to all parties when requested by those parties  If the management of the target determines that it is in the best interests of the shareholders that such information is disclosed.  The target is not required to disclose information that the party has not requested.  If non-public information is disclosed during due diligence, then it is necessary to protect that information through a confidentiality agreement.  Increasing use of virtual data rooms. 101© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 102. TYPES OF INFORMATION GATHERED DURING DUE DILIGENCE Financial Ethical Legal Cultural IT People Commercial© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 103. SOURCES OF DUE DILIGENCE INFORMATION Competitors Analysts Customers Target Management Suppliers Staff Former Sales staff Employees Subsidiaries Advisors Regulators Industry Advisors Distributors 103© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 104. DUE DILIGENCE KEY SUCCESS FACTORS Where and What? By Whom? How? • Identifying the • Identifying the • Identifying the most important right sources right people to items to collect of the review the • There isnt time information data to look at • Not just the • This should everything right include people information, who may be but where so it managing the can be rapidly business post- collected acquisition. 104© Scott Moeller, 2011 Course organised in co-operation with Eureka Financial Ltd
  • 105. Post Merger Integration ‘A wise person once said that a beautiful marriage is one in which two people become one. The trouble starts when they try to decide which one.’ 105© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 106. WHY DO M&A DEALS FAIL? Negative Rank Top 10 Pitfalls in Achieving Synergies Impact 1 Incompatible cultures 5.60 2 Inability to manage target 5.39 3 Unable to implement change 5.34 4 Synergy non-existent or overestimated 5.22 5 Did not anticipate foreseeable events 5.14 6 Clash of management styles/egos 5.11 7 Acquirer paid too much 5.00 8 Acquired firm too unhealthy 4.58 9 Need to spin off or liquidate too much 4.05 10 Incompatible marketing systems 4.01 Note: Survey of Forbes 500 CFOs. Assessed on a scale of 1 to 7, where 7 is high. 106© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 107. CHANGE OR PRESERVE? High Brave New Digestion World Target organisation Both companies absorbed into combine to Acquirer become a new business Change in Target Reverse Business Takeover as Usual Acquirer Target remains adopts culture intact within the of target acquirer Low High Change in Acquirer 107© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 108. FOCUS OF INTEGRATIONS Source: Mergermarket / CMS Cameron McKenna, Feb 2007 108© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 109. ‘CLEAN RAID’ PRINCIPLE C L E A N •Communicate •Lead from •Engineer •Use •Nurture the top successes Advisors clients R A I D •Retain key •Adjust, •Integrate •Decide employees plan and the two quickly monitor cultures© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 110. THERE ARE 4 STAGES IN MATURITY OF M&A INTEGRATION Source: Richmond Events© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 111. POST-ACQUISITION INTEGRATION MILESTONES Pre Day One Week 1 Month 1 100 Days Announcement •Gain control •Complete initial •Full PMI plan •Complete all major •Due Diligence with •CEO press communication plan implemented integrations and up focus on post- conference and to stakeholders, •Review process in to 3 levels of acquisition planning internal including all key place (milestones management (including key client communications clients and targets agreed) •‘Wins’ confirmed and key employee •Demonstrate value •Announce overall •First PMI review •PR to all retention) of acquired company structure against plan stakeholders •Design PMI 100- company •Start redundancy •Retention plan in •Staff to know if they day plan •PR to major announcements place for all key will be made stakeholders •Demonstrate an managers redundant or not •Announce top line early ‘win’ management and •Communication board from PMI head, with •Announce PMI plan trickle-down 111© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 112. FACILITATING INTEGRATION: INTEGRATION MANAGERS  Integration managers are needed to:  Speed up the integration process  Create a structure  Forge social connections between the two organisations  Help engineer short-term successes  Who would make the ideal Integration Manager?  Deep knowledge of the acquiring organisation  No need for credit  Comfort with chaos  Willingness to put in the hours  Trusted by senior management in the acquirer  Emotional and cultural intelligence  Ability to delegate Source: Ashkenas & Francis, HBR Nov – Dec 2000, Lecturer 112© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 113. FACILITATING INTEGRATION: TASK FORCES  Integration Task Force  Multiple levels in the organisation  One overall “integration steering committee” to manage the whole process  Cannot be outsourced  Key tasks  Key manager decisions  Aligning strategies  Aligning structures, systems, processes  Corporate identity, brands, names  Communications  Resolving conflicts 113© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 114. POST MERGER INTEGRATION: OUTSIDERS  “Controlled” Outsiders  Consultants  Lawyers  Accountants  “Uncontrollable” Outsiders  Regulators  Press and analysts  Competitors 114© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 115. FACILITATING INTEGRATION: COMMUNICATION  Poor communication usually reflects poor underlying business strategy and definitely poor implementation.  Communication needs to incorporate as many tools as possible, such as:  Hot lines  Newsletters  Presentations  Workshops  From top management of both organisations  Informal lines of communication critical as well 115© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 116. ACHIEVING SHORT-TERM BENEFITS IS EASY  Short-term benefits  Overhead cost reductions  Factory rationalisation  Brand selection  Channel integration  Longer-term benefits are much more difficult to achieve and often even to measure  True cultural integration  Sales force efficiency 116© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 117. HIDDEN MERGER COSTS: DIFFICULT TO QUANTIFY  Hiring and training new employees and existing employees in new positions  Time consuming and distracting meetings and activities during integration (diverting focus from marketing, product development, etc.)  Dysfunctional politicking and power fights  Decrease in employee efficiency during period of uncertainty  Customer uncertainty and competitors attempts to take advantage of the uncertainty 117© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 118. NEED FOR CLEAR OBJECTIVES  Necessary as a corporate road-map  Client and employees must see the end-goal, or will leave Mission Vision Strategy Objectives 118© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 119. MOST DEALS DO NEED THE TARGET’S STAFF  Communicate early and often  Tell the truth  Acknowledge the cultural and business differences  Select some target company strengths and show these are valued and will be retained  Find a few things the target does right, and adopt them quickly  Change only what you must  Involve the target management in decision-making 119© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 120. INTEGRATION MEASUREMENT AREAS Measure Description Examples Integration Assessing specific integration events and thereby  Brief survey of task force members and employee focus  determining whether the overall integration  groups, or feedback received through a confidential  approach is accomplishing its mission of leading the  hotline. organisation through change. Operational Tracking any potential merger‐related impact on the  Statistics that reflect sudden changes in sick days,  organisation’s ability to conduct its continuing, day‐ indicate more than a normal number of productivity‐ or  to‐day business. quality‐related issues, or reveal an inability to process  reports in a timely way. Process &  Determining the status of merger driven efforts to  Reports (in terms of percentages) on the completion  Cultural redesign business processes or elements of the  status of task forces’ integration plans, specific surveys  organizational culture. of the internal customers of a given process (to spot  bottlenecks or new disruptions that are due to the  merger), and periodic feedback identifying pressure  points with respect to how things are being done in the  new organisation. Financial Tracking and reporting on whether the organisation  Ongoing summaries of the actual synergy projects in  is achieving the expected synergies of the deal. process and the economic value of those already  captured, plus some kind of synergy related  communications. Source: Galpin T (2007). The Complete Guide to Mergers and Acquisitions (2nd Ed)© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 121. CHALLENGES TO INTEGRATION Post merger - do you socialise with your new work colleagues? No 53.8% Yes 46.2% 30.0% 35.0% 40.0% 45.0% 50.0% 55.0% Do you believe that the new company has a spirit / dynamic? No 53.8% Yes 46.2% 30.0% 35.0% 40.0% 45.0% 50.0% 55.0% Source: Cass Business School Survey (Falconer), 2010© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 122. Key Success Factors Impact on Pre-Merger Integration Approach 1. Value Creation, Not Just • Sources of value must be clearly identified & communicated; teams must focus on creating value Integration • Customer experience is the key driver of value creation; have a clear vision for Day 1 2. Top 5 Critical Decisions • Focus time and energy on areas that will make a difference and choose the right leaders for each • Invest the effort to develop options and as many facts as possible 3. Setting Clear Aspirations • Define clearly and quickly the market and financial synergy metrics (revenue, EBITDA, cash flow) • Develop leading indicators, stretch targets. Be ready to adapt. Seek a common language. 4. Benevolent Dictatorship – • Inherently messy (whitewater rafting); unpopular decisions will be made – set a productive tone Tight Process • Tighten process (regulatory , focus, efficiency, gaming); keep it as simple as possible 5. Opportunity for Change •Organization is unfrozen; employees/partners/suppliers expecting change • Targeted change where needed 6. Gluttony is Severely Punished • Organizations have limited capacity for change; 70% solution, 100% executable • Lockdown dates but create safety nets and backup plans (brute force backup) 7. Don’t Underestimate Resource • Heavy workload with teams working long hours for long periods of time Requirements • Back up resources such as retirees, consultants leveraged for support 8. Proactively Design the • Make organizational decisions as soon as practical Organization • To facilitate culture change, run processes the way we want the NewCo to run 9. Communicate • Identify and manage many constituencies – customers, employees, regulators, shareholders, partners, suppliers, competitors • Outline rules of engagement and proactively manage messages and perceptions 10. GovernanceM&A in Driving Convergence: Further Data Points’ (Accenture, March 2007) PMO at the onset to create a common process & objectives across  Source: ‘The Role of & Process • Establish a dedicated logically-defined teams and to manage critical interdependencies; ensure ‘apples to apples’ Controls from day 1 analysis • Process execution minimizes issues and implementation risks in later phases Source: ‘The Role of M&A in Driving Convergence: Further Data Points’ (Accenture, March 2007)© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 123. Day 1 Mergers, Acquisitions & Divestitures Afternoon, Session 2 STRATEGY: CASE STUDY 123© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 124. 124© Scott Moeller, 2012
  • 125.  Mobile Telecommunications Company [MTC]  (Rebranded as Zain September 2007)   founded in Kuwait in 1983  Zain Market Cap USD $20.5 billion (2010)  Over 70 million Subscribers (2010)  Acquired Celtel on March 29, 2005  A leading African operation spread across 13  countries with 5.2 million subscribers© Scott Moeller, 2012 125
  • 126. © Scott Moeller, 2012 Source: http://www.zain.com/ 126
  • 127.  All of the Zain deals were:  Acquisitions  Horizontal  Strategic  / Opportunistic  Supplementary/ Complementary  Friendly© Scott Moeller, 2012 127
  • 128. Celtel acquisition in an emerging market  (Africa) – huge opportunities for growth© Scott Moeller, 2012 128 Source: Case Study “Crossing Borders: MTC’s Journey through Africa”
  • 129. “One Network” for all ‐ The world’s first borderless  network offering 160 million subscribers in 6  countries in Central Africa, i.e. free roaming  charges.  Celtel has increased its regional subscriber base  by 10%  At the time, “One network” was the single most  important factor in wrestling market share from  other providers© Scott Moeller, 2012 129
  • 130. A  clear vision for success for the brand:  Top 10 worldwide  telecom operators  Top 100 brands in the world  Motivated management team© Scott Moeller, 2012 130
  • 131. Focusing on the rebranding   Ignoring Celtel brand equity (strong brand  recognition & loyalty in African countries)  Patronizing the Celtel team© Scott Moeller, 2012 131
  • 132. Ignoring market  trends in Africa (competition /  market dynamics)  Losing market share to MTN and other foreign  entrants ;  Zain operating in an environment as a foreign  entrant without providing enough support to  existing operations (Celtel).© Scott Moeller, 2012 132
  • 133. Opportunistic approach   Move for 3rd operating license in KSA – a congested  market  (tough competition) Head to Head with Competition   Ignoring opportunity  to explore a  Win‐Win with MTN  such as a Joint Venture or Strategic Alliance Driven by Hubris / Ego of Leadership© Scott Moeller, 2012 133
  • 134. Resignation of Dr. Saad Al Baraak Zain CEO, the  man behind the success of MTC. He stepped  down on the 3rd of February 2010 after 8 years  in service!  Bharati Airtel an Indian Group acquires Zain  African operations for a price of US $10.7  billion (The African operations equates to 42  million customers out of 70 million of Zain  Group’s customer base)!© Scott Moeller, 2012 134
  • 135. There were a lot of activities during the 2004‐2008 period within MTC / ZAIN.  Some were successful, such as the acquisition of Celtel and entering the African market.  Some were unsuccessful such as the high price paid for KSA license for only 25% share in the consortium. And with the Lack of proper Bid Process, there was a lack of proper DD, and therefore no proper Post‐ Acquisition review, therefore no risk was identified or could potentially be identified The lessons learned from this journey of entering Africa, its exit and back into KSA are as follows: The role of negotiations/ bidding plays in making the The role due diligence deal a success. Such plays in making a deal as if the African successful such as countries were having the right items negotiated for lesser analysed through the than the amount paid. right source of The emotional An organisation should information and bidding for KSA’s always look for received within the license resulting in alternatives of M&A required timeframe. paying a high price before making the could have been decision avoided if proper negotiations and bidding plans / processes were in place.© Scott Moeller, 2012 135
  • 136. Sold in 2010© Scott Moeller, 2012 Source: http://www.zain.com/ 136
  • 137. Day 2 Mergers, Acquisitions & Divestitures Morning, Session 1 INTRODUCTION TO DAY 2 137© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 138. PROGRAMME OVERVIEW  Objectives  Identify key value drivers  Understand the process of M&A  Assess the needs and benefits of M&A for a company and therefore the right and wrong reasons to do a deal  Understand synergies and how to quantify them  Learn the different methods of M&A valuation and pricing, and the appropriate application of these methods  Understand M&A due diligence  Analyse alternative deal structures  We will achieve this through the extensive use of  Real life examples of transactions (case studies)  Discussion amongst all participants  Break-out groups 138© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 139. COURSE PROGRAMME  Day 1: Morning: Reasons for doing deals, funding and exit requirements, risk and regulation.  Day 1: Afternoon: Deal process, deal teams, strategy, due diligence and negotiation, post-deal integration  Day 2: Morning: Financial engineering (deal structuring, financing, pricing vs valuation, covenants)  Day 2: Afternoon: Synergies and summary case study. 139© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 140. Day 2 Mergers, Acquisitions & Divestitures Morning, Session 1 FINANCIAL ENGINEERING: DEAL STRUCTURE 140© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 141. ARBITRAGEURS: ALLIES OR ADVERSARIES  Arbs bet on the price movements in takeover stocks  They absorb a large percentage of available stock when a hostile deal is announced  They provide liquidity to shareholders who do not want to wait out the deal  Given the size of their holdings, as a group they often become the decision makers  They are extremely rational in their decision based almost exclusively on short-term financial factors. 141© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 142. ARBITRAGE HEDGING  Arbs want to hold positions where the exposure is exclusively to the deal, not the market  This typically takes the form of going long the target company and short the bidder  Arbs will consider the following  Current bid  Potential bids from other bidders  Recapitalisation plans or other changes initiated by the target as a defence 142© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 143. CALCULATING ARBITRAGE RETURN:  Target (400p/share) received 600p/share bid. Shares immediately rise to 570p/share  Bidder (530p/share) declines to 500p/share. Arbitrage: 1. Position taken:  100 Target Shares at 570p  100 Bidder Shares sold short at 500p 2. Date position taken: 1 June 2010 3. Date shares tendered: 28 June 2010 4. Date proceeds received: 10 July 2010 5. Total Time of investment: 40 days 143 Source: Bruner© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 144. ARBITRAGE RETURN CALCULATION  Capital employed  Assets  Long 100 shares of Target £570  Liabilities and Capital  Short 100 shares of Bidder £500  Borrowed 100 shares of Bidder (£500)  Bank borrowing (70% of assets) £399  Capital (30% of assets) £171  Total £570  Net Spread Calculation  £30.00 Gross spread (Target: [600p-570p] x 100 plus Buyer: [500p- 500p] x 100)  (£4.37) Interest Cost (10% of bank borrowings for 40 days)  (£2.00) Short dividends foregone  £3.00 Long dividends received  £26.63 Net spread (ROI) 144 Source: Bruner / Moeller© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 145. ARBITRAGE RETURN CALCULATION  Average Capital Employed  40 days/365 days x £171 = £18.74  Annualised Return on Capital Employed  £26.63 / £18.74 = 142%  Annualised return significantly affected by small changes in actual return and time period. 145 Source: Bruner© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 146. SETTING A BID PRICE  Think like the target company’s shareholders – the arbs.  Value of Tendering > Expected Value of Not Tendering (EVNT) EVNT = (Share price No Competing Bid * Probability No Competing Bid) + (Share price Competing Bid * Probability Competing Bid) 146© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 147. MISCONCEPTIONS ABOUT VALUATION  Myth 1: Valuations are accurate  Bias is endemic in valuation and enters in subtle and not so subtle ways  Myth 2: Valuation is a science  A valuation is never precise and is never quite finished  Myth 3: You need complex models  Complexity comes with a cost; more information is not necessarily better than less information 147© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 148. MYTH 4: ACCOUNTANTS KNOW HOW TO MEASURE EARNINGS  Profits are often smoothed by accounting rules  Operating leases and other off balance sheet treatments mask the true picture  R&D is often written off immediately and yet the benefits are in future years  Profits are usually out of date 148© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 149. MYTH 5: VALUATION IS COMPLICATED WITH HUNDREDS OF MODELS Cashflow to Firm Expected Growth EBIT (1 - t) Reinvestment Rate - (Cap Ex - Depn ) * Return on Capital - Change in WC Firm is in stable growth: = FCFF Grows at constant rate forever Terminal Value= FCFF n+1 /(r- g n ) Value of Operating Assets FCFF 1 FCFF 2 FCFF 3 FCFF 4 FCFF 5 FCFF n + Cash & Non - op Assets = Value of Firm Forever - Value of Debt = Value of Equity Dis count at - Value of Equity Options = Value of Common Equity Cost of Equity Cost of Debt Weights (Riskfree Rate Based on Market Value + Default Spread) (1 - t) Riskfree Rate Risk Premium - No default risk Beta - Premium for average - No reinvestment risk + - Measures market risk X risk investment In same currency and in same terms (real or nominal as cash flows Type of Operating Financial Base Equity Country Risk Business Lev erage Leverage Premium Premium 149© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 150. MYTH 6: YOU CANNOT VALUE YOUNG COMPANIES LOSING MONEY  How do we usually value companies?  Use the firm’s current financial statement  How much did the firm sell?  How much did it earn?  The firm’s financial history, usually summarized in its financial statements.  How fast have the firm’s revenues and earnings grown over time? What can we learn about cost structure and profitability from these trends?  Susceptibility to macro-economic factors (recessions and cyclical firms)  The industry and comparable firm data  What happens to firms as they mature? (Margins.. Revenue growth…Reinvestment needs… Risk)  Valuation is most difficult when a company  Has negative earnings and low revenues in its current financial statements  No history  No comparables ( or even if they exist, they are all at the same stage of the life cycle as the firm being valued) 150© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 151. MYTH 7: CASH FLOW STATEMENTS TELL US EVERYTHING ABOUT CAPITAL EXPENDITURES  Capital expenditure in financial statements generally includes only investment in long term tangible assets  Capital expenditure should also include  Research and development expenses  Acquisitions of other firms  Any other item which could be considered long term investment 151© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 152. MYTH 8: EXPECTED GROWTH RATES ARE EXOGENOUS VARIABLES  In most valuations growth is predicted from analyst estimates  In reality growth is a function of how much is reinvested and how good are the reinvestments gEBIT = [(Net capex + Δ in WC)/(EBIT*(1-T))]* ROC 152© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 153. MYTH 9: ONCE YOU HAVE DISCOUNTED THE CASH FLOWS YOU HAVE FINISHED  Cash and marketable securities must be added to the value. You might consider discounting the value if management have a history of bad investments  Minority holdings need to be valued separately and the percentage owned calculated. If there are a large number of small private minorities it is almost impossible to value them correctly  Management options need to be valued and subtracted from the equity value 153© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 154. MYTH 10: GOOD VALUATIONS DO NOT CHANGE  Valuations are not timeless since each of the inputs is susceptible to change as new information becomes available  Market information such as interest rates, risk premium, economic growth  Industry information such as legal or tax changes or new technology  Company specific information such as new financial data or changes in fundamental risk factors 154© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 155. OVERPAYING ON TAKEOVERS  The quickest and perhaps the most decisive way to impoverish stockholders is to overpay on a takeover.  Average target premiums are 20-40%  Higher premiums than this are known as ‘bear hugs’ and are increasingly common  Share prices of bidding firms decline on the takeover announcements a significant proportion of the time.  Many mergers do not work, as evidenced by a number of measures.  The profitability of merged firms relative to their peer groups does not increase significantly after mergers.  An even more damning indictment is that a large number of mergers are reversed within a few years, which is a clear admission that the acquisitions did not work. 155© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 156. IMPORTANCE OF VALUATION IN M&A  Acquirer: Needs to know the proper offering price and whether the target meets financial standards / expectations  Target: Needs to know what it is worth to let shareholders know what is in their best interests  Each company is different, and each deal is unique  Public vs private companies  Knowing what youre buying: the importance of due diligence  Outsiders heavily involved in valuations  Investment bankers  Accountants  Bidder usually at an information disadvantage to the target  Impact of the structure of the deal  Hostile vs. friendly deals  Different access to financial and company data  Cash vs stock 156© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 157. IMPORTANCE OF VALUATION IN M&A (CONTINUED)  Disciplines required:  Economics  Finance  Accounting  Marketing …and experience  Valuation for M&A is both an art and a science!  Traditional corporate finance and private equity methods of valuation are not typically applicable 157© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 158. DIFFERENCES WITH IPO VALUATION AND VENTURE CAPITAL VALUATION M&A Valuation Techniques: Usually with a 20-40% premium paid • Value of Business = Future benefits derived from a business - Costs of the deal • Must be a market clearing price: Value agreed by the seller and at least one buyer IPOs (Initial Public Offerings): Discount generally about 10-15% • Requires market clearing level, but from a consensus market agreed by many buyers • Need to show demand: increase in share price and volumes Venture Capital / Private Equity method: Assumes exit, usually 3 to 7 years • Not strategic – financial investment only • Premiums similar to M&A levels for public deals (sometimes higher) • No (or little) synergies with existing business or portfolio • Requires return of between 25-30% IRR 158© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 159. MERGER VS. ACQUISITION  In an acquisition, the target’s management and shareholders give up control and therefore require a premium  Typically needing 20-40% premium to market  In a merger, the two companies often consider themselves (or try to be) equals  Therefore future control is shared and no premium is required.  Acquisitions typically have premiums; mergers are transacted at market  Example: JP Morgan acquisition of BankOne in 2004  Bill Harrison (JP Morgan) vs. Jamie Dimon (BankOne)  Dimon said the company would sell at market if he was given the top job immediately  Deal settled at 14% premium (+$7 billion) with Harrison keeping the CEO spot 159© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 160. MERGER VS. ACQUISITION  In an acquisition, the target’s management and shareholders give up control and therefore require a premium  Typically needing 20-40% premium to market  In a merger, the two companies often consider themselves (or try to be) equals  Therefore future control is shared and no premium is required.  Acquisitions typically have premiums; mergers are transacted at market  Example: JP Morgan acquisition of BankOne in 2004  Bill Harrison (JP Morgan) vs. Jamie Dimon (BankOne)  Dimon said the company would sell at market if he was given the top job immediately  Deal settled at 14% premium (+$7 billion) with Harrison keeping the CEO spot 160© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 161. ENTERPRISE VALUE VS. EQUITY VALUE  It is important to be explicit about exactly what is being included / excluded  Enterprise Value: The value of the whole company  From an asset valuation perspective, it is the value of the assets, which also equals the debt plus equity  Equity Value: Value of the company excluding outstanding debt Principal question to be resolved: What happens to the targets debt?‘ But the related detailed questions are: What is considered debt? Are there contingent liabilities? How about hybrid debt and equity? For private companies, what about owners debts? 161© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 162. OTHER BUSINESS VALUATION ISSUES  Buyer Value vs. Seller Value: Business and its assets may be worth more to its buyer than seller  Buyer may use assets differently, including planning to sell of assets after purchase  Non-operating Assets: Assets not used in the operations of the business  Valued separately and add to the earnings valuation  Example: Real estate not involved in the business  Minority Discount: If valuing a minority share and not a controlling position, then need to apply a Minority Discount 162© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 163. VALUING PUBLIC VS. PRIVATE COMPANIES  Public Companies:  Easier to value because there is a price for the company from the stock market  Value of Public Company = Value Outstanding Shares + Control Premium  Note: Actually more difficult than it appears Which stock price to select  Most recent  Historical average  Recent and historical figures may already include a takeover premium Amount of Takeover or Control Premium, if any 163© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 164. PRIVATE COMPANIES  Private Companies: Valuation can be more difficult initially  Private companies’ information may not be publicly available  Financial statements do not have to be audited and may not be as reliable  Financial statements may contain many costs that are not really costs but a form of owner return  Companies may be doing this to lower taxes  Solution: Recast the Income Statement / Cash Flow 164© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 165. APPROACHES TO VALUATION  Discounted cashflow valuation, when we try to understand the intrinsic value through theory, guesswork and prayer  Relative valuation, where we choose a group of assets, attach the name ‘comparable’ to them and try to tell a story  Trading multiples  Option valuation, although not common in practice, where we take the DCF value and divide it up between the thieves of value (equity) and the victims of the crime (debt) 165© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 166. MAJOR VALUATION METHODS Reference To Trading Multiples Statistics From Discounted Cash Of Already Listed Recent Flow Analysis Comparable Acquisitions Of Companies Comparable Companies • Estimate • Profit based • Types • Cash flow • IPO’s • Discount rate • Revenue based • M&A • Growth rate • Asset based • Trade sales • Adjust for • Select comparables • Private companies • Analyse key drivers • Analyse datasets • Small, high risk Plus option valuation, although not common in practice, which is where we take the DCF value and divide it up between the thieves of value (equity) and the victims of the crime (debt) 166© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 167. EQUITY VALUATION Net asset value from the Balance Sheet Value of Assets Book Liquidation Use replacement value Replacement when this is a strategic alternative Or what? 167© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 168. IPO VALUATION  Use the same procedure as M&A type valuations  IPO discount generally about 10-15%  “bad reasons” for the discount  lack of background information  private company  “good reasons”  give investors upside  market liquidity  Other issues  IPO waves  main market or AIM  industry, % sold, advisors 168© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 169. VENTURE CAPITAL METHOD  Select a terminal year and estimate EBITDA based on a success scenario  Compute continuing value by applying an EXIT multiple – usually based on the adjusted entry multiple  Use a high discount rate for continuing value  Based on the present value of the cashflows calculate the required equity percentage that needs to owned to give a target return of between 25-30% IRR (can be lower) 169© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 170. SCENARIO ANALYSIS  For some methods, run different scenarios re the expected future performance of the company  Appropriate for use of discounted cash flows, capitalisation of earnings, real options.  Typically:  Optimistic  Most Likely  Pessimistic  Weighting Scheme: Weights may reflect the probability of occurrence Example: High Growth 15% probability Moderate Growth 60% probability Low or Negative Growth 25% probability 170© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 171. COMPANY VALUATION Value is the residual operating cashflows of the company discounted at the weighted average cost of capital t n CF to firm t Value of firm   t 1   WACC t 1 171© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 172. ESTIMATING CASH FLOW EBIT + Depreciation and amortisation - Capital Expenditure - Change in Working Capital - Tax = Free Cash Flow to the firm 172© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 173. EXPECTED GROWTH IN EBIT  Reinvestment Rate and Return on Capital  Net capex   in WC  gEBIT     ROC  EBIT1  t  = Reinvestment Rate * ROC  No firm can expect its operating income to grow over time without reinvesting some of the operating income in net capital expenditures and/or working capital.  The net capital expenditure needs of a firm, for a given growth rate, should be inversely proportional to the quality of its investments. 173© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 174. COMPANY VALUE  Value = PV of cash flows during the forecast period plus PV of cash flows after forecast period  Simple growth assumptions allow calculation of continuing value  Continuing value is usually a large proportion of total value 174© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 175. TOTAL VALUE CONSTITUENTS Forecast Continuing Clothing Sports Skin High goods care tech 175© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 176. GROWING FREE CASH FLOW PERPETUITY  Only valid if g is less than WACC  Easily misused formula  If g is less than the growth in the explicit period then value will be understated unless FCF is enhanced FCFt  1 CV  WACC  g 176© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 177. PERPETUITY MODEL AND P/E Dividends D Price   Discount rate - growth Ke - g If D/E is the dividend payout ratio then reinvestment rate, investment efficiency, risk and growth are all reflected in the P/E ratio 1 D P/E = Ke  g  E Ke = Rf + beta (Rm -Rf) 177© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 178. RELATIVE VALUATION IS PERVASIVE…  Most valuations are relative valuations  Almost 85% of equity research reports are based upon a multiple and comparables  More than 50% of all acquisition valuations are based upon multiples  Rules of thumb based on multiples are not only common but are often the basis for final valuation judgments  While there are more discounted cashflow valuations in consulting and corporate finance, they are often relative valuations masquerading as discounted cash flow valuations  The objective in many discounted cashflow valuations is to back into a number that has been obtained by using a multiple  The terminal value in a significant number of discounted cashflow valuations is estimated using a multiple 178© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 179. EV/EBITDA Enterprise value divided by EBITDA Classic version = value of debt and equity EBITDA This is a type of P/E ratio but excludes the impact of debt, tax and capital investment 179© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 180. FROM FIRM VALUE TO EBITDA MULTIPLES Now the Value of the firm can be rewritten as EBITDA (1- t) + Depr (t) - Cex -  Working Capital Value = WACC- g Dividing both sides of the equation by EBITDA Value (1- t) Depr (t)/EBITDA CEx/EBITDA  Working Capital/EBITDA = + - - EBITDA WACC- g WACC -g WACC - g WACC - g 180© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 181. VALUE/EBITDA MULTIPLE LINKAGE TO DCF VALUATION Firm value can be written as: FCFF1 V0 = WACC - g The numerator can be written as follows: FCFF = EBIT (1-t) - (Capex - Depn) -  Working Capital = (EBITDA - Depr) (1-t) - (Capex - Depn) -  Working Capital = EBITDA (1-t) + Depn (t) - Capex -  Working Capital 181© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 182. A SIMPLE EXAMPLE  Consider a firm with the following characteristics  Tax Rate = 30%  Capital Expenditures/EBITDA = 30%  Depreciation/EBITDA = 20%  Cost of Capital = 10%  The firm has no working capital requirements  The firm is in stable growth and is expected to grow 5% a year forever. 182© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 183. CALCULATING VALUE/EBITDA MULTIPLE In this case, the Value/EBITDA multiple for this firm can be estimated as follows Value (1- .30) (0.2)(.30) 0.3 0 = + - - = 9.2 EBITDA .10- .05 .10- .05 .10- .05 .10- .05 183© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 184. VALUE/EBITDA MULTIPLES: MARKET  The multiple of value to EBITDA varies widely across firms in the market, depending upon:  How capital intensive the firm is (high capital intensity firms will tend to have lower value/EBITDA ratios), and how much reinvestment is needed to keep the business going and create growth  How high or low the cost of capital is (higher costs of capital will lead to lower Value/EBITDA multiples)  How high or low expected growth is in the sector (high growth sectors will tend to have higher Value/EBITDA multiples) 184© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 185. BOOK VALUE  Also called net asset value:Book Value = Assets – Liabilities  Potential for Inaccuracy:  May not reflect the earning power of the business  Assets may be kept on the books at a value that does not reflect market values: Usually valued at historical costs minus depreciation  Intangible assets are not generally included on a balance sheet  The longer an asset is on the books, the more likely there will be greater deviation from Book Value and Value in Use  What are the real liabilities and debts of the company  For some types of firms, this may be an appropriate starting point  Real estate companies or extraction industry companies, with easily valued real assets  Investment banks valued at market to book (market capitalisation divided by book value) as principal assets are daily marked to book 185© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 186. COMPARABLE MULTIPLES METHOD  Common Comparable Multiples (Market Ratios)  P/E Multiples  Price/EBITDA  Price/Book  Other financial ratios vs. industry  Liquidity ratios (e.g., current ratio, quick ratio)  Activity ratios (e.g., avg. collection period, inventory turns)  Financial leverage ratios (e.g., debt ratio, debt / equity, etc.)  Profitability ratios (e.g., ROI, ROE)  Issues:  Control Premium: Market ratios do not include a control premium as they are derived from stock trades that are minority stakes  Best to use recent M&A transactions where available  Companies may be a mix of businesses, so multiple ratios would then be used and applied against each line of business. 186© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 187. ‘BACK OF THE ENVELOPE’ VALUATION METHOD  Capitalisation of Earnings: Treats income as a perpetuity Simple calculation method:  Step 1: Select an Appropriate Earnings Base  Step 2: Select an Appropriate Capitalisation Rate  Select Discount Rate  Select Growth Rate  Subtract Growth Rate from Discount Rate  Step 3: Divide the Earnings Base by the Capitalisation Rate Example: Company X’s earnings are expected to be £20 million  Earnings have been growing at 5% per year; 15% discount rate has been selected  Capitalisation Rate = 15% – 5% = 10%  Value = £20 million / 10% = £200 million Even easier: Capitalisation Rate is the Reciprocal of the P/E Ratio  Company sells for 10x earnings: 1/10 = 10% capitalisation rate  Company sells for 5x earnings: 1/5 = 20% capitalisation rate 187© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 188. SUMMARY OF VALUATION METHODS Discounted cashflow Trading comparables Transaction comparables Fundamentals Fundamentals Fundamentals • value on expected ungeared free cash • analysis based on publicly traded • analysis based on previous similar flows ‘comparable’ companies transactions Advantages Advantages Advantages • captures the company specific long term • reflects current trends in market prices and • reflects the perception of strategic outlook profitability of similar companies business investors • reflects improvement opportunities • availability of public financial information • provides objective valuation information • risk and duration of cashflow is reflected in • valuation generally includes a control the WACC Problems premium • different business perspective of Problems comparables Problems • perceptions of future performance • valuation and strategy could be affected by • different perceptions of risk and return • requires in depth understanding of exogenous market events ( bull or bear • limited information of ‘comparable’ company and business drivers markets) transactions Issues • usually requires country risk, tax and size Issues adjustments • industry dynamics affect revenue and • there are few truly comparable companies margin assumptions Issues • capital structure, tax and country risk • few really comparable transactions assumptions have significant impact on • lack of disclosure in relevant private valuation transactions • applicability in change of control situations 188© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 189. WEIGHTING VALUATION RESULTS  M&A valuations include as many appropriate methods as possible  As all of the methods are not equal in terms of certainty or reliability of data  Methods must be weighted to come up with a single figure or range  Most external advisors will show a large variety of methods in their fairness opinions and pricing recommendations  Scenarios  How do you determine the weight? Think about what aspects of the business tend to give rise to its value  Is it its Assets? Then book value should get greater weight  Is it its Earning Power? Then give cash flow and income methods more weight  Have there been recent similar transactions? Then give more weight to the market multiples. 189© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 190. WEIGHTED VALUATION EXAMPLE Method Value Weight Adjusted Value DCF £19.9 million 50% £10.0 million DCF High £24 million 30% £7.2 million DCF Medium £21 million 50% £10.5 million DCF Low £11 million 20% £2.2 million P/E Method £17 million 30% £5.1 million Book Value £15 million 10% £1.5 million Net Assets £ 5 million 10% £0.5 million Weighted Total 100% £17.1 million Actual valuation recommendation would incorporate many more methods. Then, it would look at deal costs and incorporate a negotiation starting point. 190© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 191. Day 2 Mergers, Acquisitions & Divestitures Morning, Session 2 FINANCIAL ENGINEERING: STRATEGIC VS FINANCIAL / FINANCING 191© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 192. TOTAL DEAL COST Deal Opportunity Expenses Costs Target Value Post-merger Premium Integration Costs© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 193. TOTAL COST OF A MERGER OR ACQUISITION Total Deal Cost = [VA + VB] + P + E + OC + IC Most private sector acquisitions include a premium to existing market value (P) Cash Costs, or the expenses of the acquisition process (E):  Investment banking fees  Legal fees  Accountant fees  Other fees (printers, etc.)  Interest payments on debt Opportunity Costs (OC)  Management distraction  Sales force focus and reaction of customers / clients  Competitive responses Cost of post-merger integration (IC) 193© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 194. EARN OUTS MAY PROTECT THE BUYER  Full payment to target ONLY after certain criteria met AFTER the deal’s completed.  Format can be a variety of measures: EBITDA and PBT are normal  Earn out period is dependent upon prospects and cyclicality of business  Buyer’s adjustments  Exclude buyer generated benefits  Include all relevant expenses  Vendor adjustments  Exclude inflated costs and long term R&D, marketing or capex  Exclude effects of changed accounting policies  ‘Caveat vendor’  Charge over shares until paid  Call on shares if change of control  No double recovery on warranties 194© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 195. SALE AND PURCHASE AGREEMENTS  A legal document which contains the price, terms, conditions and structure of the transaction (including any earn-outs)  Contains financial and legal details of the transaction  Often substantially drafted and redrafted before final agreement  A long and complex document – commonly over 100 pages 195© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 196. SALE AND PURCHASE AGREEMENTS: CONTENTS  Description of parties  Definitions  Agreement to buy and sell  Conditions  Completion obligations  Warranties and indemnities  Post completion obligations  Restrictive covenants  Public announcements  Fees, costs and expenses  Governing law and dispute resolution  Schedules of particulars for vendors, company, warranties, properties, etc 196© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 197. SOME ACQUISITION FINANCING CHOICES  Debt  Bank loans: bridge loans, term financing, asset-based lending  Bond issue; private placement  Seller note, convertible, or performance-related earn-out  Equity  Common or preferred stock  Public share issue;  Venture capital or private equity fund  Mezzanine and Structured Finance  High-yield bonds with sweeteners  Convertible notes, warrants and participation financing  Pay-in-kind notes  Asset-backed securities 197© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 198. SENIOR DEBT  Cheapest and main source of finance  Term loans with fixed repayment schedule  Secured and usually unrated  Large tranches may be syndicated  Tenor: 6 years or less ~ amortising gives a 3-4 year average life  Interest: LIBOR + 2 to 4% but varies by country and risks  Typically limited historically to no more than 4 times EBITDA – today more like 2½ to 3 times 198© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 199. SENIOR DEBT (ALPHABET NOTES)  Senior tranches often structured as two or more tranches ~ A, B, C and sometimes D  All tranches rank pari passu for security but B, C, etc  have longer maturities and bullet payments  higher margins in 50bps increments  Revolving loans can be used for cyclical firms  Tranche A (TLa) is amortising  TLb and TLc are usually bullet payment 199© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 200. SYNDICATION  Syndication is to satisfy two primary investor groups – banks and institutional investors (funds, insurance co’s and structured finance vehicles)  Pro rata debt  revolvers and TLa because they are typically syndicated on a pro rata basis  Institutional debt  First lien TLb and TLc, second lien  Structural flex allows arrangers to move debt between expensive mezzanine to second or first lien or in more difficult times the opposite 200© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 201. SENIOR DEBT PRICING  Traditionally in Europe pro rata debt is priced at about E + 225 bps  Institutional debt is priced up by 50 bps per tranche  TLb at E + 275  TLc at E + 325  Market flex language in the documentation allows arrangers to flex the pricing upwards in the current climate to attract lenders 201© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 202. DEBT TO EBITDA 202© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 203. SENIOR DEBT VOLUME 203© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 204. STRUCTURE 204© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 205. DEBT SUBORDINATION AND RANKING  A junior creditor agrees to subordinate their claim to a senior creditor on interest and principal until the senior has been repaid  Subordination can be achieved in one of two ways  Contractual via an inter creditor agreement  Structural – a creditor does not lend or invest directly in a company but does so via a holding company 205© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 206. CONTRACTUAL SUBORDINATION Hold Co Equity Debt Co Mezz Inter creditor agreement Senior Target/OP Co bank debt 206© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 207. STRUCTURAL SUBORDINATION Hold Co Equity High yield invested from Bond Co to Bid Co via Bond Co High yield equity Senior Bid Co bank debt Target/OP Co 207© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 208. LEVERAGED FINANCE TECHNIQUES  Senior Debt  Asset-backed debt: first lien, mortgage, leasing, ABS Bridge loans, term debt, revolving credit facilities Second lien notes  Mezzanine  High-yield bonds  Subordinated debt with deferred interest: PIKs, step-ups Subordinated debt with equity options: warrants, converts, participating  Seller note  Equity  Hybrid capital note financing and preferred  Common stock: Sponsors; “stub” (previous owners’ share); managers 208© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 209. PRICING – CREDIT SPREADS 209© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 210. HIGH YIELD DEBT  Unsecured bonds rated less than investment grade  Tenor of 7 – 10 years (sometimes 12 years) with bullet payment  Size: € 100 million plus ~ high set up costs  Usually limited to 1 - 1½ times EBITDA  Fees: 2 – 3% upfront  May require a bridging loan in an LBO transaction  High early redemption costs ~ maybe as much as 112% premium 210© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 211. HIGH YIELD BRIDGE  Expensive and the cost usually explodes if not replaced with high yield bond on time (usually 6-12 months)  Target yield of 22%-24% from LIBOR + 50bps and warrants  Risky bridging finance  Typical amount is the target bond issue  New trend – convert bridge to mezzanine if the high market is closed 211© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 212. TRADITIONAL MEZZ  Reaches the parts that equity won’t and senior debt shouldn’t  Definition (original)  A floating rate contractually subordinated, 2nd secured, illiquid debt instrument which ranks after senior but before equity 212© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 213. MEZZANINE FINANCE  Anything between equity and secured debt  Typically subordinated debt with a warrant attached or redemption premium  Cost is based on IRR of 15-20%  Tenor typically 8 – 10 years  Interest: LIBOR + 7% to 11% and some maybe rolled up into a PIK contract  Bullet payment  Usually carries a second or third charge on assets  Fees around 3% up front 213© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 214. MEZZANINE FINANCE  Size of deals: € 3 to € 1000 million with larger deals syndicated  Typically achieve 1 - 1½ times EBITDA or more  High cost limits the amount of mezzanine finance  Junior mezzanine may be structured as pay-if-can with payment holidays up to 3 years  Toggles – switch the cash payment on or off  Usually only 50% of the interest can be toggled 214© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 215. STRUCTURING MEZZANINE  Attempt to achieve higher return without infringing owner / sponsor control  Target lower interest rate with participation in equity or performance  Warrants  Payments linked to turnover, EBITDA or after tax profit  May have a floor and/or a cap 215© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 216. NEW MEZZ - BROADER SPECTRUM Equity PIK (Pay in kind) Junior debt PIYC (Pay if you can) Mezzanine notes Warranted mezz Warrantless mezz Debt Second lien 216© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 217. TYPICAL TERMS FOR TRADITIONAL MEZZ  The 4’s rule: aim for 12% over LIBOR  Cash margin of 4%  PIK accrued of 4%  Warrants giving a further 4% return  Arrangement fees of 3% but varies  Prepayment fees of 3% but varies 217© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 218. WARRANTLESS MEZZANINE – VITERRA ENERGY  €197.5m mezz split into two non-warranted tranches with different call features (first time in Europe)  The sponsor obtained a lower cost of interest and investors requests for call protection were met Call protected Limited call protection Size (m) 84.0 113.5 Cash coupon 5.00% 5.50% PIK coupon 6.00% 6.00% Warrants n/a n/a Total IRR 14.5% range 15% range Call protection Non call 2.5 years 218© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 219. HYBRID MEZZANINE -- ONTEX  €165m mezz 10 year bullet, subordinated, 2nd charge, tranches A&B pari passu  Tranche A  €82.5m  Cash interest of Euribor + 400bps  PIK interest of 400bps  Warrants to provide a total return of 11.5% over cost of funds  Prepayment fees of 2% year 1 and 1% year 2  Tranche B  €82.5m  Cash interest of Euribor + 400bps  PIK interest of 7.5%  No warrants  Prepayment fees of 3% year 1, 2% year 2 and 1% year 3 219© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 220. PIK’S  Non standard, hybrid instrument  Total return target of 20-25 % IRR in two parts  Contractual return – semi annual accretion  Warrants  Usually structurally subordinated to debt  Some prepayment restrictions 220© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 221. ACQUISITION OF MANCHESTER UNITED PIK notes had a 15-year maturity with a premium for redeeming the notes on or before 12 May 2007. If the notes had remained outstanding for 63 months after 12 May 2005, Glazer had to sell 30 per cent of his stake to the hedge funds holding the PIK notes. Now halved to £135 million in a refinancing with a reduction in interest costs from £90 million to £60 million but an increase in overall debt to £660 Million; 2012 IPO 221© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 222. SECOND LIENS  No standard, situation specific junior debt hybrid  US import structured as loan, bond or both  Hedge fund buyers and some CDO’s  Typical features  Contractual subordination  Cash margin of 450-600bps - lower than mezz and high yield  Financial covenants similar to mezz  Call protection varies 222© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 223. SECOND LIEN NOTES  Loaned against remaining value of collateral, sometimes more  Not subordinated in right of payment to first lien lenders  May have second lien claim on most liquid assets, like receivables, but first lien on equipment  Higher rates than senior, but less costly than mezzanine  No warrants or equity kickers  Investor base includes hedge funds, specialized investment funds and mutual funds (unit trusts)  But may have complex inter-creditor agreements 223© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 224. MEZZANINE IN ACQUISITION FINANCING 224© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 225. FINANCIAL STRUCTURING  Match term to asset life  Don’t fund long term assets with overdraft  Determine maximum senior debt  Cashflow cover for interest and repayment  Debt service cover ratio (DSCR) or cashflow available for debt service (CFADS)  Asset cover for security  Consider break up value (BAV) for separate asset categories  How much equity is available ?  Management input and others 225© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 226. VALUE ENHANCEMENT THROUGH AN LBO With pay down of debt Exit value Market value before buyout LBO value 200 150 Assets Debt Debt 700 400 Assets Assets Debt 500 500 350 500 Equity Equity 100 Equity Increase total value = 40% Increase in equity value = 500% 226© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 227. MODERN FINANCIAL PRODUCTS Venture capital Options Ordinary Equity shares Return kickers Quasi equity Junk bonds Preference Subordinated Convertibles shares debt Unsecured Preference and PIK’s debt loan stock Secured debt Risk 227© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 228. TYPICAL MBO FINANCING STRUCTURE } Line of credit financing Secured by receivables Secured by: inventory and receivables Secured by Interest rate: L+1% - 1.5% inventory Term: 1-3 years Represents: 15% - 35% of total Senior debt Lender: Bank or finance company  Lowest cost financing because it is secured by Subordinated debt highly liquid assets Equity 228© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 229. TYPICAL MBO FINANCING STRUCTURE Secured by: fixed assets Secured by receivables Interest rate: L+1% - 2% Term: 5-10 years Secured by Represents: 25% - 50% of total inventory } Lender: Bank or finance company Senior debt  Second lowest cost financing because it is secured by highly liquid assets Subordinated debt Equity 229© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 230. TYPICAL MBO FINANCING STRUCTURE Secured by: second charge on fixed assets, Secured by subordinated to senior debt, based on excess receivables cashflow Secured by Interest rate: cash coupon of L+3% - 7%, with target inventory IRR of 15% - 25% Term: 5-10 years matures after senior Represents: 10% - 25% of total Senior debt Lender: Debt funds, insurance companies, pension funds, seller Subordinated debt }  High cost debt because of poor quality security Equity 230© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 231. TYPICAL MBO FINANCING STRUCTURE Secured by: unsecured Secured by receivables Interest rate: target IRR of 30% - 40% Exit target: 3-7 years Secured by Represents: 10% - 20% of total inventory Source: Management, employees, seller, PE or other external investors Senior debt  Highest risk with commensurate high target returns Subordinated debt Equity } 231© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 232. STRUCTURING PARAMETERS % approach EBITDA x Target returns Equity Equity Equity 40% IRR 25% - 30% 2x EBITDA 3-4x cash Mezz Mezz IRR 15%-20% Mezz 10% 1x EBITDA LIBOR + 12% 1.6x cash Senior debt Senior debt Senior debt IRR 7% 50% 3.5x EBITDA LIBOR + 2.5% 232© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 233. TYPICAL BUYOUT EXIT ROUTES  The Good  Stock market listing  Trade sale  The Bad  Secondary buyout (“BOBO” or “SBO”) – but increasingly seen as attractive by both buyer and seller  New funds urgently seeking investment opportunities  Existing funds urgently needing to monetise gains  Re-leveraging the debt (or “REBO”)  The Ugly  No available exit for value, but no threat of liquidation either (the “Living Dead”)  Receivership and liquidation 233© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 234. SELLER NOTES  …or “hope-we-get-paid-some-day finance”  “Save the deal” financing -- usually because the seller has few choices  Deeply subordinated, no x-default, may be PIK, may be structurally subordinated  May be cheap  Keeps seller honest  “True” financing -- buyer has few choices, so seller offers financing on market terms  Subordinated, transferable, has usual set of covenants, may be at market rates 234© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 235. DEBT TO EQUITY SWAP  Many second-lien lenders are willing to convert debt to equity in a workout situation , in fact, the term “loan to own” was coined to reflect their desire for this outcome in certain situations  Senior lenders may consider a swap where the lender is unlikely to be able to recover fully upon insolvency  The logic of the swap is twofold  Reduces the cash costs of interest  Provides future upside when the current position is underwater  Another benefit where the debt outstrips the assets is to ensure that the directors are not guilty of wrongful trading which is where a company continues to trade in the knowledge that it will be unable to meet its debts when they fall due 235© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 236. DISTRESSED DEBT PRICING 236© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 237. COVENANT TRENDS  Tighter covenant control is likely over borrower and sponsor execution of the business plan.  There will be more limited freedom to make additional acquisitions or otherwise change the original business model.  Committed further acquisition facilities will be smaller.  Uncommitted acquisition facilities may disappear or become prohibitively expensive if any enhanced economics that apply to them have to be applied to committed acquisition facilities too.  Reinvestment of proceeds in the business will be subject to more control. In some instances proceeds may have to be parked in a blocked account rather than used in the business pending reinvestment 237© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 238. COVENANTS  There are three primary types of covenants  Affirmative  Action which must be taken to comply  Pay interest, maintain insurance, pay taxes, etc  Negative  Limit activities in some way  Type and amount of new investment, new debt, liens, asset sales, acquisitions, guarantees  Financial  Quarterly maintenance covenants are a feature of loans but NOT bonds  Minimum cashflow, debt service cover, maximum debt to EBITDA, current ratio, tangible net worth, maximum capex, etc 238© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 239. HAIRCUTS  Mezzanine debt may have identical covenants to first ranking debt or may have a haircut  The haircut refers to how much looser the covenants are compared to senior debt  Standard haircut is around 10% 239© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 240. COVENANT HEADROOM  Covenant headroom compares the credit statistics from the projected financials (one year out) with the first covenant compliance levels  To avoid the risks associated with technical defaults, borrowers prefer to have extra leeway on the covenants incorporated in the original credit agreement  Headroom has grown from the 1999 average of 18% up to 25% or even 30% in the heady credit days but now banks are back to around 20% 240© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 241. DEBT BUYBACK  Recently the Loan Market Association inserted language into its recommended form of leverage facility agreement to regulate borrower and sponsor debt buy back at a discount.  Two mutually exclusive options are provided for in the document.  One option prohibits buy backs altogether.  The second option provides two processes to facilitate the debt buy back but strives to maintain equality of treatment between lenders willing to sell.  The technical uncertainties surrounding borrower debt buy back are largely solved by these new provisions.  It remains to be seen how heavily the new terms will be negotiated by borrowers and sponsors 241© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 242. COVENANT LITE  The growth of non-bank lenders in leveraged deals has had a number of significant effects on deal structures and documentation, particularly in terms of tax and security issues, public/private side information issues and also in what have become known as the "syndicate management" provisions such as  “Snooze you lose" and "yank the bank“ where not all lenders are sufficiently well resourced to respond promptly to requests for consents or waivers.  If the main group of investors who are going to invest in a particular credit  May not want to receive the non-public information on the basis of which the banks would have granted amendments or waivers  May not respond to a request for an amendment or waiver  Then there may be good reasons to use a covenant-lite package; particularly if most of those investors are also frequent buyers of high yield bonds and, therefore, presumably comfortable with a high yield covenant and default package. 242© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 243. P/E DRIVEN CLAUSES  The “yank the bank” clause allows for a company seeking financial restructuring to pay off dissenting lenders. Without this, one dissident creditor could force the company to pay back all lenders rather than restructuring  Will become less popular unless the bank is replaced in the syndicate  The “snooze and lose” clause was devised to counteract stalling tactics used by hedge funds that disagree with restructuring plans  May become more popular as agents see the need for a quick response  Equity cures permit sponsors to put in additional equity to "cure" a cash flow shortfall or even an EBITDA shortfall in the context of a financial covenant breach. Some recent deals put no limit on the number of times the cure can be used, or the frequency with which the cure rights are able to be employed.  The infamous Mulligan clause allows financial covenants to be breached without being treated as a default unless the same covenant is breached a second time  An absence of upward flex rights - reverse flex has characterised deals in recent times, with lenders sometimes foregoing rights to raise the price of debt in the instance of troubled syndications 243© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 244. DEBT INCURRENCE  Borrowers do not want a fixed charges cover ratio or a leverage ratio that is tested all the time – a "maintenance" covenant, which exposes the borrower to the risk of default if, for example, EBITDA declines as a result of trading conditions or a delay in the delivery of the sponsor’s business plan.  High yield bonds use an "incurrence" covenant. This will provide that the borrower cannot incur debt (as defined, and subject to a long list of exceptions) unless the chosen financial ratio is below a stated level.  Therefore, as EBITDA increases, the ability to borrow increases. Conversely, the covenant is not tested unless the borrower seeks to incur further "ratio debt".  If the borrower lists out all possible incurrences of debt that are likely to occur and provides that these are all to be disregarded, it may be a long time before the covenant is tested (if it is tested at all). 244© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 245. STANDSTILL AGREEMENT  This expression covers a variety of arrangements:  In a takeover situation, it is an agreement between a company and a shareholder which restricts the shareholder’s ability to acquire further shares in the company  In a restructuring of a company’s debts, it is an agreement between creditors to give the company time for information to be collected and for a survival strategy to be put together with a view to establishing a formal restructuring  In the context of limitation, a standstill agreement is an agreement which has the effect of suspending or extending a statutory or contractual limitation period  Standard standstill periods for mezzanine debt are either 60/90/120 days or 90/120/150 days for payment defaults, financial covenant defaults and other covenant defaults 245© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 246. EXAMPLE OF STANDSTILL JJB Sports lenders received £8.3 million just for extending the standstill agreement 246© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 247. COVENANT BREACHES  If a business has debt facilities in place, distress or other unforeseen circumstances may give rise to the potential for a breach of banking covenants:  Is it a "blip" where a one-off waiver will suffice? Or is it something which will require a re-setting of the covenants?  Is a "standstill" agreement (allowing enough time to reforecast and properly re- set realistic covenants) needed?  Check any facilities agreement – does it allow for an equity cure?  Are there any assets which can be readily converted into cash?  Remember that any bank consent or waiver will generally only be given in return for a consent fee and margin increases  Consider own debt purchases as a way of de-leveraging. In the current market the chance to buy ones debt at less than face value may be attractive, although tax and accounting issues need careful consideration 247© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 248. CONCLUSIONS ON STRUCTURING  Credit crunch for debt markets and deal pipeline stalled for leveraged deals  This will continue to put pressure on pricing and structures in the short term  “Trickle down” effect to smaller and mid-size deals  2009 started to see some of the recent structures unravel, and this continued in 2010 and 2011, with little change (albeit positive) in 2012. 248© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 249. Day 2 Mergers, Acquisitions & Divestitures Afternoon, Session 1 STRATEGIC VALUATION, INCLUDING SYNERGIES 249© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 250. SYNERGIES IN M&A DEALS Revenues: 5+5=11 +10% Profit: 2+2=6 +50% Expenses: 3+3=5 -17%© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 251. SYNERGIES  Definition of a “Synergy”  A synergy (or a “benefit”) is an improvement in the efficiency of  The target’s business, or  The acquirer’s business, or  Both businesses  The “efficiency” must be brought about only through the putting together of the two businesses  Synergies will (almost!) always be cost-savings, rather than revenue enhancements  Before being able to analyse the synergies likely to be available in any specific deal, we have to understand the type of deal we are undertaking 251© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 252. SYNERGIES  Types of Deals  Buyer’s Position: all deals can be classified from the buyer’s point of view as one of four generic types  Horizontal  Vertical (upstream/downstream)  Conglomerate/diversification  Financial  An important modifier to the above types is  Domestic/ “home” (sometimes called “in-market”), or  International (sometimes called “out-market”) 252© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 253. SYNERGIES DIFFER BY TYPE OF DEAL: HORIZONTAL ACQUISITION  Target has  Same products, and/or  Same services  Same margin level of business  Rationale  Acquirer sticks to a sector it knows  Horizontal deals likely to have more competition issues than other types Note: Far more deals are called “horizontal” than actually are: in particular, acquisition of another business which has only the same customers is probably not a horizontal deal 253© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 254. SYNERGIES DIFFER BY TYPE OF DEAL: VERTICAL ACQUISITION  Target is  Supplier (upstream)  Distributor/Customer (downstream)  Rationale  Protect the upstream or downstream supply chain  Retain the margins that would otherwise be lost Note: A deal that is not horizontal is not (for that reason alone) likely to be vertical -- it is much more likely to be a conglomerate merger 254© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 255. SYNERGIES DIFFER BY TYPE OF DEAL: CONGLOMERATE / DIVERSIFICATION  Target has  Different product or different services  Different customers  Rationale  Management of acquirer wants to spread “risk”  But whose risk are they really spreading? In the private sector, institutional investors don’t need management to do their portfolio investment for them Note: These deals also known (semi-seriously) as “diworsification” Conglomerates suffer in the stock markets from the “diversification discount”, estimated to be (on average) 10-15% 255© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 256. TYPES OF SYNERGIES  All synergies in any deal can be classified as one of three generic types  Operational  Financial  Tax  In general  Occurrence and level/amount of synergies will depend on the circumstances of each particular deal, but  Operational Synergies are likely to be meatier and more tangible than the other two types  It is much harder to realise synergies in an international deal (of any type) than a “home-country” deal  “Cut the fat, not the muscle” 256© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 257. SYNERGIES Operational Synergies Cost Revenue Synergies Synergies 257© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 258. “THE MAGNIFICENT SEVEN” OPERATIONAL COST SYNERGIES 1. Central administrative overheads (HQ and back office) 2. Manufacturing/production capacity 3. Purchasing power 4. Research and development 5. Advertising 6. Distribution 7. Selling and marketing 258© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 259. OPERATIONAL REVENUE SYNERGIES  There may be Operational Revenue Synergies  If there are, they will be because the enlarged group has  Increased sales (that is, number of units sold) at the same price, or  Increased prices (that is, price per unit sold) with the same number of units sold, or  Increased number of units sold at higher prices 259© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 260. BUT IT ISNT SIMPLE… 260© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 261. SYNERGIES: PROBLEMS OF PREDICTION  Human nature, and nature of buyers  Increase of predicted synergies as “deal crisis” approaches  Sunk costs  Sunk management time  Buyer’s ego  Lack of reliable information  Friendly: buyer encouraged to overpay  Hostile: buyer has to guess  Advice: model synergies “top down not bottom up” 261© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 262. SYNERGIES: PROBLEMS OF ACHIEVEMENT  Target management often leave (even if acquirer doesn’t want them to)  Buyers often see the acquisition as the end of the transaction, rather than the beginning: problems arise from  Sustainability of effort  The human factor  Unforeseen problems of achievement  Five of the seven operational cost synergies require job cuts, so this may be politically / regulatorily / socially difficult 262© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 263. EXECUTIVE ATTRITION RATE DOUBLES 30% 25% 20% 15% Nonmerged Firms Merged Firms 10% 5% 0% -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 Source: Accenture (2005) 263© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 264. SYNERGIES: PROBLEMS OF TIMING  The timing to achieve the synergies is usually very uncertain during the planning phase  New information becoming available changes the timing, as do exogenous factors  Credibility issues if timing missed  Should extra time be built into the plans? Should the publicised schedule be different from the internal plans? 264© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 265. SYNERGIES: PROBLEMS OF COSTS  Synergies cost money, which are often underestimated/ignored  Redundancy  Property  Environmental, etc  The costs come before the savings, and so have a higher discounted (negative) value  There is often the possibility of “negative synergies” (e.g., Deutsche Bank / Bankers’ Trust, Daimler Benz / Chrysler)  Don’t forget the costs of doing the deal in the first place  Don’t forget: operational cost and revenue synergies are usually taxable, so don’t over-estimate their value 265© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 266. SYNERGIES CASE STUDY: KRAFT / CADBURY 266© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 267. SYNERGIES CASE STUDY: KRAFT / CADBURY 267© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 268. SYNERGIES CASE STUDY: KRAFT / CADBURY 268© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 269. SYNERGIES CASE STUDY: RBS / ABN AMRO  RBS acquisition in 2007 of ABN Amro  Purchase price of €72 billion  Overall €2.0 billion in synergies  19,000 redundancies expected due to the acquisition (including with Fortis and Santander)  Wholesale / investment bank synergies  €27 billion of the purchase cost with €1.2 billion (65%) of the synergies  58 initiatives  Four principal areas of de-duplication and efficiency savings  IT and Operations: €632 million  Functional Support: €166 million  Procurement and Property: €123 million  Undisclosed front office savings: €379 million  Wholesale / investment bank revenue improvement  RBS generated 1.7x ABN Amros income per customer  …and 2.6x income per front office employee 269© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 270. Day 2 Mergers, Acquisitions & Divestitures Afternoon, Session 2 STRUCTURING: CASE STUDY 270© Scott Moeller, 2012 Course organised in co-operation with Eureka Financial Ltd
  • 271. The Dubai Ports World Debacle and  Its Aftermath© Scott Moeller, 2012
  • 272. The Bidder: • Dubai Ports World (DPW) Target: • Peninsular and Oriental Steam Navigation Company (P&O) DPW’s Objective: • Become 4th largest world port operator • Expand DPW ports operations mainly in China (supplementary acquisition) Other P&O facts: • On top of other operations worldwide, P&O has also 5 ports in the US (=10% of P&O operations) • Total P&O Profits 2004: USD 276 million profits 272© Scott Moeller, 2011
  • 273. Introduction About P&O • Fourth largest port operator in the world • Operating 29 global port terminals • Run container terminals and provide stevedoring and luggage services at a number of U.S.  ports. 273© Scott Moeller, 2011
  • 274. Introduction About Dubai World • Established international developer of container ports • Owned by The Corporate Office (TCO) government holding company • In 2005, the Dubai Port Authority and Dubai Ports International (DPI) were merged into DP World • In January 2005, DPI completed a $1.15 billion acquisition of the global port assets of American‐based CSX  World Corp., giving the company a strong presence in Asia • USD 2.7 bn revenues in 2007, Profit before tax USD 509 mn • DP World has established its presence around the globe© Scott Moeller, 2011 274
  • 275. P&O Acquisition TimelineJan 2005 October 2005• Acquired US‐Based CSX Corporation at $1.14bn •DP World interested in acquiring P&O• Becomes 6th largest port operator A ‐ DAY • P&O recommended its shareholders to  approve initial bidJan 26, 2006• Singapore based, PSA put a bid of $6.3 bn Jan 26, 2006 •DP Revises offer to $6.8 bnFeb 13, 2006• P&O shareholders accept D$6.8bn DP offer Feb 14, 2006 • Senator Charles Schumer criticises  foreign ownership of ports as a  national security issueFeb 27, 2006•DP World requests for 45‐day CFIUS investigation Mar 9, 2006 •Sheikh Mohammed  WITHDRAWAL announces, ”transfer”  of its US operations  to a ”US entity”Dec 11, 2006•DP World sells P&O assets at US ports to AIG, for an undisclosed amount 275
  • 276. Transaction Overview Strategic Acquisition taking DP World from the 6th largest ports operator In  the world to the 4th largest Nature of  Horizontal acquisition Purpose Supplementary No. 6 Strategic  Acquisition No. 4 intent 36.6 mln TEU* Attitude Friendly * 20 foot equivalent units – a standard 20 ft container equals 1 TEU  276© Scott Moeller, 2011
  • 277. Transaction Timeline 17 Jan Deals become subject of  CFIUS approves  controversy   the deal Jan 2005 Oct2005 26 Jan 2006 13 Feb 2006 Mid 2006 8 Mar 2007 9 Mar 2007 15 Mar 2007 . DP acquires   ‘A‐Day’ PSA  puts in  P&O accepts  DP Word  House of  Shaikh  DP announces  US based  First  DP  rival bid of $  offer (inc. P&O)  Republicans  Mohammed  to operate  CSX  Offer of $ 5.8  6.3 bn.  envisaged to  blocks the  announces  independently  Corporation  bn.  cover deal transfer of  Lawmakers  Covers: DP revises  acquired US  introduce  offer to $ 6.8  India assets more bills  China. bn.  effecting  S. Africa Australia future foreign  Peru investments Germany Dominican  Republic Venezuela P&O initially  accepts DP offer 277© Scott Moeller, 2011
  • 278. External Factors   Control on foreign investments (Exon‐Florio Amendment ‐50)   Legal &   Deal was approved by CFIUS Regulatory  Requirement  Ambiguity on port security responsibility  (between local authorities and coast guard) Public  External   Reaction from teamsters and longshoremen Opinion Politics  Eller & Co initiated lobbying against the deal Factors  Public opinion and media against the deal on  the back of UAE’s alleged role in 9/11 events Lobbying  Legislative threat for  anti‐deal bill  Financial muscling of  Hurricane Katrina bill – by House appropriation  committee 278© Scott Moeller, 2011
  • 279. Timing of the US anti - transaction foreign ownership President Iraq war Bush: dropping in popularity Connection US politics with “terrorist”/link with Al Qaeda UAE Post 11th recognised September Taliban Bad perception of US public regarding the Middle East 279© Scott Moeller, 2011
  • 280. External Factors The importance of public opinion http://www.youtube.com/watch?v=lIDrJn9LDek • President Bush criticised for allowing right to run six US • Dubai offers is USD 6.8 bn (this is the total offer not for US assets only) • A lot of Americans complain  • Why we can’t run our ports ourselves? 280© Scott Moeller, 2011
  • 281. US View UAE View • “Middle East countries are all • US Ally similar” (esp. post 9/11) • Stable business partner • P&O acquisition as a threat to US • Acquire P&O to complement Security ( UAE did not stop a nuclear shipment going to South China operations Africa) • Expand global presence and • Perception that Dubai had served business through acquisition of as a hub of nuclear trades in the other ports world wide past • Provide a peaceful and safe • UAE was among one of only 3 heaven in the Middle East countries recognising the Taliban • DP world helped develop a • Alternative motives behind the technology to screen containers acquisition as the US ports for nuclear material provided only 10.2% of total P&O profits • Senator Schumer – ‘homeland security is a risky proposal’ 281© Scott Moeller, 2011
  • 282. Due Diligence • To understand the political and legislative framework in the US and decision making process beyond CFIUS • To understand any political ‘hot potatoes’ US that may have a bearing on the deal. • To better understand the perception of Dubai and the UAE amongst the US public, and US politicians. • To look at potential blockers to deal not just where P and O was registered (i.e. UK) but in all countries with operations. • To understand blockers to the deal through investigating issues with P and O partners and suppliers – e.g. Eller Law.© Scott Moeller, 2011
  • 283. Longer term strategy and tactics • Some scenario planning to anticipate potential issues with DP World involvement in US Ports based on due diligence, and develop strategies on how to overcome these barriers. • To lever the relationship between Dubai and US Government to create a more favourable environment for the deal well in advance. • To use their existing management team to do informal fact finding, and develop important networks and relationships with key stakeholders. • To employ lobbyists, PR and Communication consultancies well in advance to improve reputation and perception of Dubai.© Scott Moeller, 2011
  • 284. Once in negotiation Consider cultural aspects •To ensure successful post-acquisition •To get P and O to undertake lobbying in transformation, the acquirer needs to support of the deal once they had won the understand the culture of the target bidding war company. •Sell benefits of security enhancement •By overlaying the culture analysis of DPW, P&O Global, and P&O USA, we can identify •Ensure bullet-proof approvals from which of its elements might be an obstacle Authorities, check - recheck to successful post-acquisition integration. •Focus on communication, PR •Consider changing name of the company (Dubai Ports World, drop “Dubai”?) 284© Scott Moeller, 2011
  • 285. Prior to bidding for P & O, DP World could have: • Understood potential other bidders, their potential tactics, any damaging information on competitors. • Considered whether P & O was the right target for DP World objectives. Tactics to avoid US difficulties could have included: • Announcing intention to divest US ports on deal closure • Partnering with a high profile US partner to be the face of the brand in the US. Alternatives to acquisition of P & O included: • Undertake a minority investment in P & O first to gain more information. • Go into JV with P & O to start a relationship. • Purchase a competitor (e.g. PSA) and focus on a more familiar region - e.g. Asia. • Buy a division or geographical operations rather than all of P & O - e.g.. Chinese operations only.© Scott Moeller, 2011
  • 286. Alternatives : What DP World could have done differently• Effective due diligence : Different Types – Evaluate the information available – Assess ownership of assets, validity to licenses and compliance regulations – Manage authorities and leverage relationships – Don’t overpay• Adopting a pre‐emptive strategic approach to turn around the situation to its advantage by having a PR communication activity at various platforms (employees directly affected, investors’, political lobby, media, etc.) prior to entering into the cross‐border• Entered into a Joint Venture/ Strategic alliance with the company that has operations in the US (Overcoming political, cultural and legal obstacles)• Taken a measured approach in the US market – may be, by securing a minority position or “Doing Nothing”• Ventured into different markets, rather then US – due to the timing factor• Emerging markets like India and China (where DP World has its presence) offered a opportunity to explore organic growth• Negotiated their position rather than walking away from the deal without any confrontation (legal actions). 286
  • 287. • Even when the deal is closed, it may not be closed. • Primacy of ‘political’ due diligence for overseas M & A. • Importance of perception, lobbying, and communication in securing agreement. • Scenario and contingency planning vital. • There are many ways to achieve the same objective - an extra $1bn worth it? • Does overseas expansion provide enough synergies to justify reputational issues and high price? • Culture: soft aspects of the deal to be looked at prior to the deal closure (national culture and identity) • Never underestimate public opinion in a deal 287© Scott Moeller, 2011
  • 288. • How to approach acquisitions with operations in many countries? • How to anticipate politics and address politics issues? • Is it possible to influence public opinion? • How much cultural integrations ….post acquisitions? • How do you know if you can close a deal? 288© Scott Moeller, 2011
  • 289. 28 9© Scott Moeller, 2011
  • 290. Pre-P&O Acquisition DP World pre-P&O Acquisition • 22 container terminals in 15 countries • Number 7 in global port operator rankings • Growth averaged > 20% pa over previous 3 years • Operations in Africa, Asia, Australia, Europe, Latin America and the Middle East • Total capacity of 20m TEU • Market share 3.2% in 2004 290© Scott Moeller, 2012
  • 291. Pre-P&O Acquisition P&O pre-acquisition by DP World • 29 container terminals in 18 countries, including terminals in Baltimore, Miami, New Jersey, New Orleans and Tampa in the US (along with stevedoring operations in 16 locations along the East and Gulf coasts and a passenger terminal in New York City) • Number 4 in global port operator rankings • Market share 6.1% in 2004 291© Scott Moeller, 2012
  • 292. Pre-P&O Acquisition DP World P&O Combined Number of terminals 22 29 51 Number of countries 15 18 30 Gross capacity (TEUm) 20 30 50 Global ranking No 7 No 4 No 3 DP World post-P&O acquisition: • 51 terminals in 30 countries on five continents • Capacity of 50 million TEU • Number 3 in global port operator rankings 292© Scott Moeller, 2012
  • 293. History of the Deal Feb 2005 • CSX acquisition completes. $1.14b, takes DP World to 6th largest operator Nov 2005: DP World announces a recommended cash offer for P&O • 443p in cash for each unit of Deferred Stock • a premium of 46% to the pre-speculation stock price of 303.5p • a 2004 price/earnings multiple of 24.5x • valuing the existing Deferred Stock at approximately £3.3 billion Jan 2006: PSA makes a counter bid • offers 470p for each unit of Deferred Stock Same day: DP World raises offer • 520p in cash for each outstanding unit of Deferred Stock • a premium of 71.3% to the pre-speculation stock price of 303.5p • equity value of bid = £3.9 billion ($6.8 billion) Dec 2006: US terminals sold • Following political storm in the US, DP World sells POPNA to AIG • Estimated value $565m - $700m. AIG said price was ~$1.2 billion 293© Scott Moeller, 2012
  • 294. Global Trade Global Trade: Quarterly container growth by region 2008 - 2010 294© Scott Moeller, 2012
  • 295. Global Trade Quarterly container growth by region 2007 - 2009 295© Scott Moeller, 2012
  • 296. 2004 Portfolio 296© Scott Moeller, 2012
  • 297. 2005 Portfolio 297© Scott Moeller, 2012
  • 298. 2006 Portfolio 298© Scott Moeller, 2012
  • 299. Portfolio Today • 49 terminals and 9 new developments and major expansions across 31 countries 299 • Capacity set to rise to ~92m TEU by 2020 (timing dependent on market)© Scott Moeller, 2012
  • 300. DP World Today New terminals and new developments post-merger Algeria Peru Algiers Callao Djen Djen Senegal Brazil Dakar Santos Spain Djibouti Tarragona Doraleh Turkey Egypt Yarimca Sokhna Yemen India Aden Vallarpadam (ICTT) Netherlands 300 Rotterdam© Scott Moeller, 2012
  • 301. DP World Global Throughput Throughput 2005 – 2010 in TEU (million) 60 49.6 50 46.2 43.3 43.4 40 36.8 30 TEU = twenty foot equivalent container units 20 12.8 10 0 2005 2006 2007 2008 2009 2010 301© Scott Moeller, 2012
  • 302. EBITDA Multiples From Drewry’s Annual Review of Global Container Terminal Operators 2009: In the peak period of demand growth and interest in acquiring terminals during 2005-2007, port companies were being valued (and paid for) at EBITDA multiples in excess of 20 times. With the crash in demand and the credit crunch, these days are over, at least for the time being. Anecdotal evidence suggests that multiples of around 8-12 times EBITDA are the new benchmark. DP World recently monetised 75% of its share in DP World Australia. The transaction valued DP World Australia at an enterprise value of A$1.8 billion. For the twelve months to 31 December 2009, DP World Australia generated equity-adjusted (i) EBITDA of A$96 million. 1.8bn / 96m = an EBITDA multiple of 18.75. i - 302 Equity adjusted EBITDA takes into account 60% ownership of Adelaide and 90.37% ownership of Sydney© Scott Moeller, 2012
  • 303. The End… The End and ‘Good Luck’© Scott Moeller, 2011 2012 303

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