M Deal Structuring Process

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					M&A Deal Structuring
Process: Payment &
Legal Considerations
If you can’t convince them,
       confuse them.

    —Harry S. Truman
                                    Course Layout: M&A & Other
                                      Restructuring Activities

 Part I: M&A        Part II: M&A           Part III: M&A         Part IV: Deal         Part V:
 Environment         Process               Valuation &           Structuring &    Alternative Bus.
                                            Modeling              Financing          Strategies

Motivations for      Business &          Public Company           Payment &          Business
     M&A             Acquisition            Valuation                Legal           Alliances
                       Plans                                     Considerations

 Regulatory        Search through            Private              Accounting &     Divestitures,
Considerations        Closing               Company                   Tax          Spin-Offs &
                     Activities             Valuation            Considerations    Carve-Outs

Takeover Tactics   M&A Integration          Financial              Financing       Bankruptcy &
 and Defenses                               Modeling               Strategies       Liquidation

          Learning Objectives

• Primary Learning Objective: To provide
  students with a knowledge of the M&A
  deal structuring process
• Secondary Learning Objectives: To enable
  students to understand
   – the primary components of the process,
   – payment considerations, and
   – legal considerations.
          Deal Structuring Process
• Deal structuring involves identifying
   – The primary goals of the parties involved in the
   – Alternatives to achieve these goals; and
   – How to share risks.
• The appropriate deal structure is that which
   – Satisfies as many of the primary objectives of the
     parties involved as necessary to reach agreement
   – Subject to an acceptable level of risk
   Questions: 1. What are common high priority needs of public company
                 shareholders? Private/family owned firm shareholders?
              2. How would you determine the highest priority needs of the
                 parties involved?
           Major Components of
          Deal Structuring Process
1.   Acquisition vehicle
2.   Post-closing organization
3.   Form of payment
4.   Form of acquisition
5.   Legal form of selling entity
6.   Accounting Considerations
7.   Tax considerations
     Factors Affecting Alternative Forms
              of Legal Entities
1.   Control by owners
2.   Management autonomy
3.   Continuity of ownership
4.   Duration or life of entity
5.   Ease of transferring ownership
6.   Limitation on ownership liability
7.   Ease of raising capital
8.   Tax Status
     Question: Of these factors, which do you believe is often the most
     important? Explain your answer.
              Acquisition Vehicle
  Acquirer’s Objective (s)      Potential Organization
Maximizing control           Corporate (C or S) or
Facilitating postclosing      divisional structure
Minimizing or sharing risk   Partnership/joint venture
                             Holding company
Gaining control while limiting Holding company
Transferring ownership       Employee stock ownership
  interest to employees       plan
          Post-Closing Organization
   Acquirer’s Objective (s)        Potential Organization
Integrate target immediately   Corporate or divisional
Centralize control in parent   structure
Facilitate future funding
Implement earn-out             Holding company
Preserve target’s culture
Exit business in 5-7 years
Assume minority position
Minimize risk                  Partnerships
Minimize taxes                 Limited liability companies
Pass through losses
       Discussion Questions
1. What is an acquisition vehicle? What are
   some of the reasons an acquirer may
   choose a particular form of acquisition
2. What is a post-closing organization?
   What are some of the reasons an
   acquirer may choose a particular form of
   post-closing organization?
                   Form of Payment
• Cash (Simple but creates immediate seller tax liability)
• Non-cash forms of payment
   – Common equity (Possible EPS dilution but defers tax liability)
   – Preferred equity (Lower shareholder risk in liquidation)
   – Convertible preferred stock (Incl. attributes of common & pref.)
   – Debt (secured and unsecured) (Lower risk in liquidation)
   – Real property (May be tax advantaged through 1031 exchange)
   – Some combination (Meets needs of multiple constituencies)
• Closing the gap on price and risk mitigation
   – Balance sheet adjustments (Ignores off-balance sheet value)
   – Earn-outs or contingent payments (May shift risk to seller)
   – Rights, royalties, and fees (May create competitor & seller tax
   – Collar arrangements (Often used when acquirer’s share price
     has a history of volatility)
   Collar Arrangements Based on a Floating Share
Exchange Ratio (SER) to Protect Target Shareholders1,2
  Objective: To guarantee an offer price per share (OPPS) within a range for target firm

  Offer Price Per Share = Share Exchange Ratio (SER) x Acquirer’s Share Price (ASP)
                        = Offer Price Per Target Share x Acquirer’s Share Price
                             Acquirer’s Share Price

  Collar Arrangement: Defines the maximum and minimum price range within which the
      OPPS varies.

                       SER x ASP (lower limit) ≤ Offer Price Per Share ≤ SER x ASP (upper limit)

  Example: A target agrees to a $50 purchase price based on a share exchange ratio of 1.25
     acquirer shares for each target share. The value of the each acquirer share at the time
     of the agreement is $40 per share. The target shareholder is guaranteed to receive $50
     per share as long as the acquirer’s share price stays within a range of $35 to $45 per
     share. The share exchange ratio floats within the $35 to $45 range in order to maintain
     the $50 purchase price.
                       ($50/$35) x $35 ≤ ($50/$40) x $40 ≤ ($50/$45) x $45
                        1.4286 x $35 ≤ 1.25 x $40 ≤ 1.1111 x $45
  1Fora floating share exchange ratio, the dollar offer price per share is fixed and the number of shares exchanged varies with the value of the acquirer’s share price.
        Acquirer share price changes require re-estimating the share exchange ratio. Floating exchange ratios are used most often when the acquirer’s share price
        is volatile. Fixed share exchange ratios are more common since they involve both firms’ share prices and allow both parties to share in the risk or benefit of
        fluctuating share prices.
  2SER generally calculated based on the 10 to 20 trading day period ending 5 days prior to closing. The 5-day period prior to closing provides time to calculate the
        appropriate acquirer share price and incorporate into legal documents.
 Case Study: Alternative Collar Arrangements Based on Fixed
          Value and Fixed Share Exchange Ratios
On 9/5/2009, Flextronics agreed to acquire IDW in a stock- for-stock merger with an aggregate value of
       approximately $300 million. The share exchange ratio used at closing was calculated using the
       Flextronics average daily closing share price for the 20 trading days ending on the fifth trading day
       immediately preceding the closing. Transaction terms identified the following three collars:

1.     Fixed Value Agreement (SER floats): Offer price was calculated using an exchange ratio floating inside
          a 10% collar above and below a Flextronics share price of $11.73 and a fixed purchase price of
          $6.55 per share for each share of IDW common stock. The range in which the exchange ratio floats
          can be expressed as follows:a

                       [$6.55/$10.55] x $10.55 ≤ [$6.55/$11.73] x $11.73 ≤ [$6.55 /$12.90] x $12.90
                            .6209 x $10.55     ≤     .5584 x $11.73      ≤     .5078 x $12.90

       .6209 shares of Flextronics stock issued for each IDW share (i.e., $6.55/$10.55) if Flextronics declines
           by up to 10%
       .5078 shares of Flextronics stock issued for each IDW share (i.e., $6.55 /$12.90) if Flextronics
           increases by up to 10%

2.     Fixed Share Exchange Agreement (SER fixed): Offer price calculated using a fixed exchange ratio
          inside a collar 11% and 15% above and below $11.73 resulting in a floating purchase price if the
          average Flextronics' stock price increases or decreases between 11% and 15% from $11.73 per
          share. (See the next slide.)

3.     The target, IDW, has the right to terminate the agreement if Flextronics' share price falls more than
          15% below $11.73. If Flextronics' share price increases more than 15% above $11.73, the
          exchange ratio floats based on a fixed purchase price of $6.85 per share.b (See the next slide.)

aThe   share exchange ratio varies within a range of plus or minus 10% of the Flextronics’ $11.73 share price.
bIDW   is protected against a potential “free fall” in Flextronics share price, while the purchase price paid by Flextronics is capped at $6.85.
      Multiple Price Collars Around Acquirer Flextronics
        Share Price to Introduce Some Predictability

                                                                                        $11.73 Flextronics Share Price

    Price Increase Above                                                                $11.73 increases (decreases) from
    Acquirer Share Price of                                                               1% to 10% (Offer price fixed at $6.55)
    $11.73                                                                              $11.73 increases (decreases) from 11%
                                                                                          15% (Offer price floats up to $6.85 or
                                                                                          down to $6.18)
                                                                                        $11.73 increases more than 15%,
                                                                                          offer price capped at $6.85
                                                                                        $11.73 falls by more than 15%,
                                                                                          IDW may terminate agreement

                                                                                           Fixed Share Exchange Agreement:
                                                                                           Allows Purchase Price to Change
                                                                                           Within a Range1
                                                                                           Fixed Value Agreement: Allows
                                                                                           Floating Share Exchange Ratio to
                                                                                           Hold Purchase Price Constant2
     Price Decrease Below
     Acquirer Share Price of

1Fixed share exchange agreement represents range in which acquirer and target shareholders share risk of fluctuations in
acquirer share price.
2Fixed value agreement represents range in which the target shareholders are protected from fluctuations in the acquirer’s
share price.
Flextronics-IDW Share Exchange Using Fixed Value (SER Floats)
             and Fixed Share Exchange Agreements
                                           Offer Price                                         Offer Price

                     %Chg.1.     ($6.55/$11.73) x $11.73 =         $6.55   %Chg.1     $(6.55/$11.73) x $11.73 =         $6.55
  Floating SER         1         ($6.55/$11.85) x $11.85 =         $6.55    <1>       ($6.55/$11.61) x $11.61 =         $6.55

                         2       ($6.55/$11.96) x $11.96 =         $6.55     <2>      ($6.55/$11.50) x $11.50 =         $6.55

                         3       ($6.55/$12.08) x $12.08 =         $6.55     <3>      ($6.55/$11.38) x $11.38 =         $6.55

                         4       ($6.55/$12.20) x $12.20 =         $6.55     <4>      ($6.55/$11.26) x $11.26 =         $6.55

                         5       ($6.55/$12.32) x $12.32 =         $6.55     <5>      ($6.55/$11.14) x $11.14 =         $6.55

                         6       ($6.55/$12.43) x $12.43 =         $6.55     <6>      ($6.55/$11.03) x $11.03 =         $6.55

                         7       ($6.55/$12.55) x $12.55 =         $6.55     <7>      ($6.55/$10.91) x $10.91 =         $6.55

                         8       ($6.55/$12.67) x $12.67 =         $6.55     <8>      ($6.55/$10.79) x $10.79 =         $6.55

                         9       ($6.55/$12.79) x $12.79 =         $6.55     <9>      ($6.55/$10.67) x $10.67 =         $6.55

                         10      ($6.55/$12.90) x $12.90 =         $6.55     <10>     ($6.55/$10.56) x $10.56 =         $6.55
  Fixed SER              11      ($6.55/$12.90) x $13.02 =         $6.61     <11>     ($6.55/$10.56) x $10.44 =         $6.48

                         12      ($6.55/$12.90) x $13.14 =         $6.67     <12>     ($6.55/$10.56) x $10.32 =         $6.40

                         13      ($6.55/$12.90) x $13.25 =         $6.73     <13>     ($6.55/$10.56) x $10.21 =         $6.33

                         14      ($6.55/$12.90) x $13.37 =         $6.79     <14>     ($6.55/$10.56) x $10.09 =         $6.26

                         15      ($6.55/$12.90) x $13.49 =         $6.85     <15>     ($6.55/$10.56) x $9.97 =          $6.18

                        >15       SER floats based on fixed $6.85 offer         ><15>     IDW may terminate agreement
  1Percent   change in Flextronics share price. A3.ll changes in the offer price based on percent change from $11.73
    Form of Acquisition (Means of Transferring
     Ownership): Governed by State Statutes
•   Statutory one-stage (compulsory) merger or consolidation:
     – Stock swap statutory merger by majority vote of both firms’ shareholders
     – Cash out statutory merger (form of payment something other than common
•   Asset acquisitions (buying target assets)
     – Stock for assets
     – Cash for assets
•   Stock acquisitions (buying target stock via tender offer)
     – Stock for stock
     – Cash for stock
•   Special applications of basic structures
     – 2-stage stock acquisitions (Obtain control & implement backend merger)
     – Triangular acquisitions
     – Leveraged buyouts
     – Single firm recapitalizations

     Key Point: Each form represents an alternative means of transferring
Statutory One-Stage Mergers and Consolidations
 •      Stock swap statutory merger: Two legally separate and roughly comparable in size
        firms merge with only one surviving. Shareholders of target (selling) firm receive voting
        shares in the surviving firm in exchange for their shares.
 •      Cash-out statutory merger: Selling firm shareholders receive cash, non-voting preferred
        or common shares, or debt issued by the purchasing company.
 •      Procedure for statutory mergers: Assume Firm B is merged into Firm A with Firm A
          – Firm A absorbs Firm B’s assets and liabilities as a “matter of law.”
          – Boards of directors of both firms must approve merger agreement
          – Shareholders of both firms must then approve the merger agreement, usually by a
             majority of outstanding shares. Dissenting shareholders must sell their shares.
 •      Voting rule exceptions: Parent firm shareholder votes not required when
          – Acquiring firm shareholders cannot vote unless their ownership in the acquiring firm
             is diluted by more than one-sixth or 16.67%, i.e., Firm A shareholders must own at
             least 83.33% of the firm’s voting shares following closing. (Small scale merger
          – Parent firm holds over 90% of a subsidiary’s stock. (Parent-sub merger exception;
             also called a short-form merger)
          – Certain holding company structures are created (Holding company exception) .
 •      Advantages/disadvantages: All target assets and liabilities (known/unknown) transfer to
        acquirer as a “matter of law,” flexible payment terms, and no minority shareholders or
        transfer taxes but responsible for all liabilities and subject to shareholder approval.

1This effectively limits the acquirer to issuing no more than 20% of its total shares outstanding. For example, if the acquirer has 80 million shares
outstanding and issues 16 million new shares (.2 x 80), its current shareholders are not diluted by more than one-sixth, since 16/(16 + 80) equals
one-sixth or 16.67%. More than 16 million new shares would violate the small merger exception.
                                     Asset Aquisitions1
•   Cash for assets acquisition: Acquiring firm pays cash for target firm’s
    assets, accepting some, all, or none of target’s liabilities.
     – If substantially all of its assets are acquired, target firm dissolves after
         paying off any liabilities not assumed by acquirer and distributing any
         remaining assets and cash to its shareholders2
     – Shareholders do not vote but are “cashed out”
•   Stock for assets acquisition: Acquirer issues shares for target’s assets,
    accepting some, all, or none of target’s liabilities.
     – If acquirer buys all of target’s assets and assumes all of its liabilities, the
         acquisition is equivalent to a merger.
     – Listing requirements on major stock exchanges require acquiring firm
         shareholders to approve such acquisitions if the issuance of new shares
         is more than 20% of the firm’s outstanding shares
     – Target’s shareholders must approve the transaction if substantially all of
         its assets are to be sold
•   Advantages/disadvantages: Allows acquirer to select only certain target
    assets and liabilities; asset write-up & no minority shareholders but lose tax
    attributes and assets not specified in contract and incur transfer taxes
     1In   acquisitions, acquiring firms usually larger than target firms.
     2Usually,   acquirer purchases 80% or more of the fair market value of the target’s operating assets and may
            assume some or all of the target’s liabilities. In some cases, courts have ruled that acquirer is responsible for
            target liabilities as effectively liquidating or merging with the target.
                Stock Acquisitions

• Cash for stock acquisitions: Acquirer buys target’s
  stock with cash directly from target’s shareholders and
  operates target as a wholly- or partially-owned (if <
  100% of target shares acquired) subsidiary
• Stock for stock acquisitions: Acquirer buys target’s
  stock directly from target’s shareholders, generally
  operating target in a parent/subsidiary structure
• Advantages/disadvantages: Eliminates need for target
  shareholder vote (buying from target shareholders); tax
  attributes, licenses, and contracts transfer to acquirer;
  and may insulate parent from subsidiary creditors but
  responsible for all liabilities and have minority
     Special Applications of Basic Structures
• Two stage stock transactions:
   – First stage: Acquirer buys target stock via a tender offer to gain
      controlling interest and owns target as a partially owned subsidiary
   – Second stage (backend merger): Acquirer merges a partially owned
      subsidiary into a wholly owned subsidiary giving minority
      shareholders cash or debt for their cancelled shares. Also known as
      a freeze out or squeeze out.
   – Advantages/disadvantages: Very popular as acquirers gain control
      more rapidly than if they attempted a one-step statutory merger
      which requires boards and shareholders to approve merger
      agreement but may require substantial premium to gain initial
• Triangular acquisitions: Acquirer creates wholly owned sub which
  merges with target, with either the target or the sub surviving
   – Advantages: Avoids acquirer shareholder vote as parent sole owner
      of sub and limits parent exposure to target liabilities; however,
      acquirer shareholder vote may be required in some states if new
      stock issued dilutes current shareholders by more than one-sixth
Special Applications of Basic Structures Cont’d
 • Leveraged buyout (LBO): LBO sponsor (a limited partnership)
   creates shell corporation funded with sponsor equity.
    – Stage 1: Shell corporation raises cash by borrowing from banks
      and selling debt to institutional investors
    – Stage 2: Shell buys 50.1% of target stock, squeezing out
      minority shareholders with a back end merger in which
      remaining shareholders receive debt or preferred stock.
 • Single firm recapitalization: Enables firm to squeeze out minority
    – Firm with minority shareholders creates a wholly-owned shell
      and merges itself into the shell through a statutory merger.
    – All stock in the original firm is cancelled with the majority
      shareholders in the original firm receiving stock in the surviving
      firm and minority shareholders receiving cash or debt.
         Discussion Questions

1. What is the difference between the form
   of payment and form of acquisition?
2. What factors influence the determination
   of form of payment?
3. What factors influence the form of
 Determining Purchase Price and Control
Premium: The NBC Universal (NBCU) Case

• Comcast and General Electric (GE) announced on
  12/2/09 that they had agreed to form a JV that will be
  51% owned by Comcast, with the remainder owned by
• GE was to contribute NBC Universal (NBCU) valued at
  $30 billion and Comcast was to contribute TV networks
  valued at $7.25 billion.
• Comcast also was to pay GE $6.5 billion in cash. In
  addition, NBCU was to borrow $9.1 billion and distribute
  the cash to GE.
NBC Universal (NBCU) JV Valuation, Purchase Price
  Determination, and Resulting Control Premium
NBC Universal Joint Venture Valuation1                                                      $37.25 billion
Comcast Purchase Price for 51% of NBC Universal JV
  Cash from Comcast paid to GE                                                              $6.50
  Cash proceeds paid to GE from NBCU borrowings2                                             9.10
  Contributed assets (Comcast network)                                                       7.25
      Total                                                                                 $22.85 billion
GE Purchase Price for 49% of NBC Universal JV
  Contributed assets (NBC Universal)                                                        $30.00
  Cash from Comcast Paid to GE                                                                (6.50)
  Cash proceeds paid to GE from NBCU borrowings                                               (9.10)
      Total                                                                                 $14.40 billion
Implied Control / Purchase Price Premium (%)3                                               20.3
Implied Minority/Liquidity Discount (%)4                                                    (21.1)
1Equals the sum of NBCU ($30 billion) plus the fair market value of contributed Comcast properties ($7.25 billion)
and assumes no incremental value due to synergy. These values were agreed to during negotiation.
2The $9.1 billion borrowed by NBCU and paid to GE will be carried on the consolidated books of Comcast, since it

has the controlling interest in the JV. In theory, it reduces Comcast’s borrowing capacity by that amount and should
be viewed as a portion of the purchase price. In practice, it may reduce borrowing capacity by less if lenders view
the JV cash flow as sufficient to satisfy debt service requirements.
3The control premium represents the excess of the purchase price paid over the book value of the net acquired

assets and is calculated as follows: [$22.85 / (.51 x $37.25] -1.
4The minority/liquidity discount represents the excess of the fair market value of the net acquired assets over the

purchase price and is calculated as follows: [$14.40/(.49 x $37.25)] -1.
              Discussion Questions

1.   Suppose two firms, each of which was generating
     operating losses, wanted to create a joint venture. The
     potential partners believed that significant operating
     synergies could be created by combining the two
     businesses resulting in a marked improvement in
     operating performance. How should the ownership
     distribution of the JV be determined?
2.   Discuss the advantages and disadvantages of your
     answer to question one.
3.   Should the majority owner always be the one
     managing the daily operations of the business? Why?
     Why not?
          Things to Remember…
• Deal structuring addresses identifying and
  satisfying as many of the primary objectives of
  the parties involved and determining how risk
  will be shared.
• Deal structuring consists of determining the
  acquisition vehicle, post-closing organization,
  the form of payment, the form of acquisition,
  legal form of selling entity, and accounting and
  tax considerations.
• Choices made in one area of the “deal” are likely
  to impact other aspects of the transaction.

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