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					           Deal Design

            P.V. Viswanath




Class Notes for EDHEC course on Mergers and
                 Acquisitions
                     Deal Design

 What is deal design?

 In essence, it is a solution to an economic problem
  between two players




                      P.V. Viswanath                    2
           Elements of M&A Deal Design

 Create Value
      Value Transfer
      Value Destruction
 Improve reported financial results; avoid EPS dilution
      Accounting Dilution (reduction in reported EPS following a stock-
       for-stock acquisition)
      Economic Dilution (reduction in stockholder wealth)
      Voting dilution (reduction in voting power) (cf. Arcelor/Mittal)
 Improve control
      Voting control by stockholders
      Control by lenders and preferred stockholders through covenants
      Control can be thought of as an option on the strategy of the firm.


                               P.V. Viswanath                                3
            Elements of M&A Deal Design

 Build financial flexibility
      Cash deals draw down cash balances or require the issuance of debt
       securities – reduce debt capacity.
      Stock-for-stock deals entail equity issuance; may not be possible to
       issue equity again in the near future
      Financial flexibility is like a call option on future financing (Revco
       drug stores – find other examples; RJR Nabisco?)
 Manage risk
      Possibility of adverse movements in security prices; M&A
       transactions take long from deal design to consummation and
       security prices can move in the interim.
      If the deal spans international borders, exchange rate fluctuations
       may matter.


                                P.V. Viswanath                                  4
            Elements of M&A Deal Design

 Preserve and improve competitive standing
      Retain good retail locations, customer relatinoships, assets and talent
       – these lay the foundation for strategic success.
 Manage signals to the capital markets
      Share-for-share deals tell the market that the acquirer is overpriced.
 Manage incentives
      The resulting capital structure can provide more or less incentives to
       the managers to do better. For example, increased debt can reduce
       free cashflow and put pressure on managers to produce – 1980s
       hostile mergers.




                                P.V. Viswanath                                  5
           Elements of M&A Deal Design

 Enhance the governance and management structure
      Can affect the composition of the shareholder group, board of
       directors or management team.
      Research shows that acquisition of small private targets in stock-for-
       stock deals can create monitoring shareholder block.
 Shape impact on employees and communities
      Provide continuity of employment for employees
      Protect pension assets
      Minimize impact of plant closings
      Build employee morale (Arcelor/ Mittal merger)




                               P.V. Viswanath                               6
                                       Terms

 Price
 Form
      Fixed Payments: cash and senior debt securities
           Little uncertainty about value conveyed; resolves uncertainty
      Contingent payments: mezzanine debt securities, preferred stock,
       common stock
           Value less certain than cash/senior debt
           Earnouts, warrants, convertible bonds, contingent value rigths, puts,
            guarantees, caps, collars, floors – used to resolve disagreements
            regarding firm value.
           Contingent payments are often structured so that if the target performs
            well in the future, the targeted shareholders receive some extra payoff.
           Contingent payments are also used to hedge risk for one or both sides of
            the transaction.


                                   P.V. Viswanath                                  7
                                     Terms

 Form
      Side payments: payments to parties other than owners of the target
       firm.
           Examples: golden parachutes, warrantes, bonuses, buyouts of
            employment contracts, consulting commitments to managers of the
            target firm.
           Guarantees of work rules, job, training to unions
           Guarantees against plant closing to governments/municipalities.
           Bribes
 Financing
 Timing and Deadlines
      Time Value of Money
      Deferring payments grants the payer an option to renege on the deal.


                                 P.V. Viswanath                               8
                                       Terms

 Commitments: Options granted by seller to buyer – greater
  the uncertainty, greater the value of the option.
      Assumption by seller of various liabilities
           Environmental
           Product
           Liabilities from lawsuits in progress
           Product Warranties
      Seller required to maintain and hand over at closing items that affect
       the value of the firm as a going concern.
           Brand names
           Patents
           Trademarks
           Customer lists
      Noncompete clauses for executives

                                   P.V. Viswanath                           9
                                      Terms

 Control and Governance (Agency problem resolution)
      Composition of new Board
      Limitations on voting power (through standstill agreements)
      Financial covenanats
      Creation of fixed income securities (reducing free cashflow)
 Risk Management
      Likelihood that the value of compensation offered can change due to
       market circumstances
      Possible entry of a competing bidder
      The parties could change their mind
           Can be mitigated by walk-away fees and guarantees to pay
            counterparty’s costs.



                                  P.V. Viswanath                        10
                               Terms

 Accounting Choices
 Form of Transaction and Tax Exposure to the
  parties
 Social issues
      Interplay of titles, compensation and ego in establishing
       governance and managerial hierarchy of new company.
 Social Welfare
      Branch closings, employee layoffs, headquarters
       locations
      In some countries, available choices may be restricted by
       law.

                           P.V. Viswanath                          11

				
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