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Corporate Financial Strategy 4th edition Dr Ruth Bender. Chapter 16 Acquisitions and selling a business. Acquisitions: contents. Acquisition strategies to enhance eps Financing the deal – who gets what? Financing strategy – regardless of the acquisition

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acquisitions contents
Acquisitions: contents

Acquisition strategies to enhance eps

Financing the deal – who gets what?

Financing strategy – regardless of the acquisition

Earn-outs and deferred consideration

Some defence strategies

Indicative sales process

  • Learning objectives
  • Some reasons for making an acquisition
  • Relating synergies to value drivers
  • Synergy checklist
  • Adding value in an acquisition
  • Classifying synergies
  • Illustrative due diligence
  • Financing the acquisition with cash
  • Financing the acquisition with shares
  • Buying a company for shares – some issues
  • Buying a company for cash – some issues
acquisitions learning objectives
Acquisitions: learning objectives
  • Understand how and why companies make acquisitions.
  • Critically evaluate the synergies claimed for an acquisition, and how they affect the valuation of the target business.
  • Explain the different ways in which an acquisition can be financed, and understand how to select the most appropriate funding strategy.
  • Appreciate the governance and finance issues surrounding hostile bids.
  • Identify situations where an earn-out might be of use, and explain the advantages and disadvantages of this deal structure.
  • Outline some key areas of consideration in the sale of a business.
synergy checklist
Synergy checklist
  • Strategic
  • Which of the value drivers will be affected by this transaction?
  • In which direction?
  • Why?
  • Financial
  • By how much will it change?
  • When will this happen?
  • Operational
  • What critical success factors need to be in place to ensure this happens?
  • What needs to be measured?
  • Who is responsible for making it happen?
adding value in an acquisition
Adding value in an acquisition

Deal costs

Working capital

Cost efficiencies

Zone of negotiation

Increased sales

Value to Vendor

Value to Acquirer

Maximum to pay

classifying synergies
Classifying synergies
  • Synergies that any bidder could realize

(E.g., arising through better management)

  • Synergies that any bidder within the industry could realize

(E.g. arising through consolidation of manufacturing, or distribution chains)

  • Synergies unique to this bidder

(E.g., involving the application of a particular brand or R&D capability)

illustrative due diligence
Illustrative due diligence

Financial performance

  • historical information
  • systems of internal control
  • accounting policies
  • review of forecasts

Taxation

  • existing and potential liabilities
  • arrangements (intra-group)
  • transaction

Economicandcommercial

  • industry analysis and key players
  • PESTLE
  • competitive position
  • strategic assets
  • order book
  • contracts

Productionandoperations

  • technologies and systems

Informationsystems

  • IT systems and integration

People and culture

  • who’s who – management and lower tiers
  • capabilities
  • cultural fit

Environmental and social

  • potential liabilities
  • legal & regulatory impact
  • CR stance

Intellectual property

  • existence and ownership

Legal and governance

  • review of contracts
  • potential problems and contingencies
  • competition issues?

Pensions

  • scheme details
  • deficit? (And assumptions)
  • powers of trustees
financing the acquisition with cash
Financing the acquisition with cash

Bidder

Bidder

Cash paid to shareholders

Shareholders in Target

Shareholders in Target

Target’s shareholders have no stake in the business after the acquisition

Target

Target

Before the acquisition

After the acquisition

financing the acquisition with shares
Financing the acquisition with shares

Bidder

Bidder

Shareholders in Target

Shareholders in Target

Target’s shareholders own shares in an enlarged Bidder after the acquisition

Target

Target

Before the acquisition

After the acquisition

acquisition strategies to enhance eps
Acquisition strategies to enhance eps

‘Rule’ 1

Buy companies with a higher p/e using debt or an earn-out, to avoid dilution of eps in the short term

Buy companies with a lower p/e using equity

‘Rule’ 2

Use debt if after-tax cost of debt is less than inverse of target p/e

Enhancing eps is not the same as increasing shareholder value

funding the deal who gets what
Funding the deal – who gets what?

Seller gets

Deal may not be structured as all cash or all debt – could be a mixture

Deal may also be structured so that seller gets loan stock – still has some exposure to the buyer

Need to consider raising funds conditionally

Initial funding may not be the final structure. Borrow to do the deal, and then refinance. The refinancing may be with new debt (on better terms) or with convertibles, or with equity. Alternatively, the refinancing may be from selling assets.

Cash

Shares

No further relationship between buyer and seller. No risk to seller. Buyer is geared.

Cash/ debt

Unlikely

Buyer raises

Buyer cannot afford debt, and seller does not want risk of shares, so rights issue or sale in market to fund deal, or cash underwritten offer

Seller gains from synergies and shares all risks

Shares

financing strategies regardless of the acquisition
Financing strategies – regardless of the acquisition

GROWTH

LAUNCH

business risk – high

financial risk – low

funding – equity

divi pay-out – nominal

p/e high

business risk – v. high

financial risk – v. low

funding – equity

divi pay-out – nil

p/e v. high

MATURITY

DECLINE

business risk – low

financial risk – high

funding – debt

divi pay-out – total

p/e v. low

business risk – med

financial risk – medium

funding – debt

divi pay-out – high

p/e – med

H

X

The financial strategy for the acquisition should be in line with the company’s overall financing strategy

Gearing

X

L

Business risk

H

earn outs and deferred consideration
BUYER CONSIDERATIONS

Delays payment, or delays issue of new shares

Limits eps dilution if share eventually issued at higher price

Limits dilution of control, ditto

Useful if future results of target are uncertain

Retain managers’ commitment in handover period

But…

Is it sloppy negotiating?

Can be difficult to combine businesses

Who runs the business?

Short termism. What happens after the earn-out?

What if own share price falls before the end of the period?

SELLER CONSIDERATIONS

Gives possibility of more consideration at a later date

May wish to earn salary in handover period

Retains their involvement in their business

But…

Is it sloppy negotiating?

May not want to stay on

Protect against buyer changing the business model

Will buyer have sufficient funds to meet the eventual liability?

Fixed value or fixed number of shares for additional consideration?

Will we be able to sell the shares?

Tax issues need to be considered

Earn-outs and deferred consideration
some defence tactics
Some defence tactics
  • Make sure company is priced correctly
  • Strategic issues and profit forecast
  • Good relations with City
  • Friendly shareholders
  • Buy another company
  • Sell/demerge units
  • Look for a white knight
  • Referral to competition authorities
  • Joint ventures
  • Poison pills
indicative sales process
Indicative sales process
  • In the pre-sale period you need to choose advisers, undertake pre-sale grooming, review the alternatives
  • Information memorandum to be prepared
  • Identify potential purchasers and make contact. (Use confidentiality letters?)
  • Initial meetings are likely to be off-site; after receiving indicative valuations, preferred bidders can have site visits
  • Negotiations around price (often P/E-based), deal structure and conditions will lead to Heads of Agreement with preferred bidder
  • Due diligence is done. (May use a data room)
  • Legals completed – contracts, warranties, etc.

Based on ‘Selling a Business, Corporate Finance Faculty, ICAEW, Feb 2009