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Chapter 11: Structuring the Deal:
Payment and Legal Considerations
Examination Questions and Answers
1. Deal structuring is fundamentally about satisfying as many of the primary objectives of the parties involved and
deciding how risk will be shared. True or False
2. The acquisition vehicle is the legal structure used to acquire the target. True or False
3. Such legal structures as holding company, joint venture, and limited liability corporations are suitable only for
acquisition vehicles but not post closing organizations. True or False
4. Employee stock ownership plans cannot be legally used to acquire companies. True or False
5. Form of payment refers only to the acquirer’s common stock used to make up the purchase price paid to target
shareholders. True or False
6. The appropriate deal structure is that which satisfies, without regard to risk, as many of the primary objectives of
the parties involved as necessary to reach overall agreement. True or False
7. Form of payment may consist of something other than cash, stock, or debt such as tangible and intangible assets.
True or False
8. If the form of acquisition is a statutory merger, the seller retains all known, unknown or contingent liabilities.
True or False
9. The form of payment does not affect whether a transaction is taxable to the seller’s shareholders. True or False
10. The assumption of seller liabilities by the buyer in a merger may induce the seller to demand a higher selling price.
True or False
11. The acquirer may reduce the total cost of an acquisition by deferring some portion of the purchase price. True or
False
12. A holding company structure is the preferred post-closing organization if the acquiring firm is interested in
integrating the target firm immediately following acquisition. True or False
13. The acquired company should be fully integrated into the acquiring company if an earn-out is used to consummate
the transaction. True or False
14. When buyers and sellers cannot reach agreement on price, other mechanisms can be used to close the gap. These
include balance sheet adjustments, earn-outs, rights to intellectual property, and licensing fees. True or False
15. In a balance sheet adjustment, the buyer increases the total purchase price by an amount equal to the decrease in
net working capital or shareholders’ equity of the target company. True or False
16. Because they can be potentially so lucrative to sellers, earn-outs are sometimes used to close the gap between what
the seller wants and what the buyer might be willing to pay. True or False
17. Earn-outs tend to shift risk from the seller to the buyer in that a higher price is paid only when the seller has met or
exceeded certain performance criteria. True or False
18. Rights to intellectual property, royalties from licenses and employment agreements are often used to close the gap
on price between what the seller wants and what the buyer is willing to pay because the income generated is tax
free to the recipient. True or False
19. Asset purchases require the acquiring company to buy all or a portion of the target company’s assets and to assume
at least some of the target’s liabilities in exchange for cash or stock. True or False
20. Stock purchases involve the exchange of the target’s stock for cash, debt, stock of the acquiring company, or some
combination. True or False
21. Sellers may find a sale of assets attractive because they are able to maintain their corporate existence and therefore
ownership of tangible assets not acquired by the buyer and intangible assets such as licenses, franchises, and
patents. True or False
22. In a statutory merger, only assets and liabilities shown on the target firm’s balance sheet automatically transfer to
the acquiring firm. True or False
23. Statutory mergers are governed by the statutory provisions of the state in which the surviving entity is chartered.
True or False
24. Staged transactions may be used to structure an earn-out, to enable the target to complete the development of a
technology or process, to await regulatory approval, to eliminate the need to obtain shareholder approval, and to
minimize cultural conflicts with the target. True or False
25. Decisions made in one area of a deal structure rarely affect other areas of the overall deal structure.
True or False
26. The acquisition vehicle refers to the legal structure created to acquire the target company. True or False
27. A post-closing organization must always be a C corporation. True or False
28. A holding company is an example of either an acquisition vehicle or post-closing organization. True or False
29. The forward triangular merger involves the acquisition subsidiary being merged with the target and the target
surviving. True or False
30. The reverse triangular merger involves the acquisition subsidiary being merged with the target and subsidiary
surviving. True or False
31. By acquiring the target firm through the JV, the corporate investor limits the potential liability to the extent of their
investment in the JV corporation. True or False
32. ESOP structures are rarely used vehicles for transferring the owner’s interest in the business to the employees in
small, privately owned firms. True or False
33. Non-U.S. buyers intending to make additional acquisitions may prefer a holding company structure.
True or False
34. If the acquirer is interested in integrating the target business immediately following closing, the holding structure
may be most desirable. True or False
35. Decision-making in JVs and partnerships is likely to be faster than in a corporate structure. Consequently, JVs and
partnerships are more commonly used if speed is desired during the post-closing integration. True or False
36. A corporate structure is the preferred post-closing organization when an earn-out is involved in acquiring the
target firm. True or False
37. In an earnout agreement, the acquirer must directly control the operations of the target firm to ensure the target
firm adheres to the terms of the agreement. True or False.
38. When the target is a foreign firm, it is often appropriate to operate it separately from the rest of the acquirer’s
operations because of the potential disruption from significant cultural differences. True or False
39. A financial buyer may use a holding company structure because they expect to sell the firm within a relatively
short time period. True or False
40. A partnership or JV structure may be appropriate acquisition vehicle if the risk associated with the target firm is
believed to be high. True or False
41. Sellers who are structured as C corporations generally prefer to sell assets for cash than acquirer stock because of
more favorable tax treatment. True or False
42. Whether cash is the predominant form of payment will depend on a variety of factors. These include the acquirer’s
current leverage, potential near-term earnings per share dilution of issuing new shares, the seller’s preference for
cash or acquirer stock, and the extent to which the acquirer wishes to maintain control over the combined firms.
True or False
43. Acquirer stock is a rarely used form of payment in large transactions. True or False
44. The seller’s preference for stock or cash will reflect their desire for liquidity, the attractiveness of the acquirer’s
shares, and whether the seller is organized as a joint venture corporation. True or False
45. A bidder may choose to use cash rather than to issue voting shares if the voting control of its dominant shareholder
is threatened as a result of the issuance of voting stock to acquire the target firm. True or False
46. Using stock as a form of payment is generally less complicated than using cash from the buyer’s point of view.
True or False
47. The use of convertible preferred stock as a form of payment provides some downside protection to sellers in the
form of continuing dividends, while providing upside potential if the acquirer’s common stock price increases
above the conversion point. True or False
48. Bidders may use a combination of cash and non-cash forms of payment as part of their bidding strategies to
broaden the appeal to target shareholders. True or False
49. The risk to the bidder associated with bidding strategy of offering target firm shareholders multiple payment
options is that the range of options is likely to discourage target firm shareholders from participating in the
bidder’s tender offer for their shares. True or False.
50. The multiple option bidding strategy introduces a certain level of uncertainty in determining the amount of cash
the acquirer will have to ultimately pay out to target firm shareholders, since the number choosing the all cash or
cash and stock option is not known prior to the completion of the tender offer. True or False
51. Balance sheet adjustments most often are used in purchases of stock when the elapsed time between the agreement
on price and the actual closing date is short. True or False
52. Buyers and sellers generally view purchase price adjustments as a form of insurance against any erosion or
accretion in assets, such as plant and equipment. True or False.
53. An earnout agreement is a financial contract whereby a portion of the purchase price of a company is to be paid to
the buyer in the future contingent on the realization of a previously agreed upon future earnings level or some
other performance measure. True or False
54. The value of an earnout payment is never subject to a cap so as not to discourage the seller from working
diligently to exceed the payment threshold. True or False
55. Earnouts tend to shift risk from the seller to the acquirer in that a higher price is paid only when the seller or
acquired firm has met or exceeded certain performance criteria. True of False
56. Offering sellers consulting contracts to defer a portion of the purchase price is illegal in most states. True or False
57. Collar agreements provide for certain changes in the exchange ratio contingent on the level of the acquirer’s share
price around the effective date of the merger. True or False
58. A fixed exchange collar agreement may involve a fixed exchange ratio as long as the acquirer’s share price
remains within a narrow range, calculated as of the effective date of the signing of the agreement of purchase and
sale. True or False
59. Both the acquirer and target boards of directors have a fiduciary responsibility to demand that the merger terms be
renegotiated if the value of the offer made by the bidder changes materially relative to the value of the target’s
stock or if their has been any other material change in the target’s operations. True or False
60. Stock purchases involve the exchange of the target’s stock for acquirer stock only. True or False.
61. If an acquirer buys most of the operating assets of a target firm, the target generally is forced to
liquidate its remaining assets and pay the after-tax proceeds to its shareholders. True or False
Multiple Choice (Circle only one)
1. Which of the following should be considered important components of the deal structuring process?
a. Legal structure of the acquiring and selling entities
b. Post closing organization
c. Tax status of the transaction
d. What is being purchased, i.e., stock or assets
e. All of the above
2. Which of the following may be used as acquisition vehicles?
a. Partnership
b. Limited liability corporation
c. Corporate shell
d. ESOP
e. All of the above
3. In a statutory merger,
a. Only known assets and liabilities are automatically transferred to the buyer.
b. Only known and unknown assets are transferred to the buyer.
c. All known and unknown assets and liabilities are automatically transferred to the buyer except for those
the seller agrees to retain.
d. The total consideration received by the target’s shareholders is automatically taxable.
e. None of the above.
4. Which of the following is not a characteristic of a joint venture corporation?
a. Profits and losses can be divided between the partners disproportionately to their ownership shares.
b. New investors can become part of the JV corporation without having to dissolve the original JV corporate
structure.
c. The JV corporation can be used to acquire other firms.
d. Investors’ liability is limited to the extent of their investment.
e. The JV corporation may be subject to double taxation.
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5. Which of the following are commonly used to close the gap between what the seller wants and what the buyer is
willing to pay?
a. Consulting contracts offered to the seller
b. Earn-outs
c. Employment contracts offered to the seller
d. Giving seller rights to license a valuable technology or process
e. All of the above.
6. Which of the following is a disadvantage of balance sheet adjustments?
a. Protects buyer from eroding values of receivable before closing
b. Audit expense
c. Protects seller from increasing values of receivables before closing
d. Protects from decreasing values of inventories before closing
e. Protects seller from increasing values of inventories before closing
7. Which of the following are disadvantages of an asset purchase?
a. Asset write-up
b. May require consents to assignment of contracts
c. Potential for double-taxation of buyer
d. May be subject to sales, use, and transfer taxes
e. B and D
8. Which of the following is not true of mergers?
a. Liabilities and assets transfer automatically
b. May be subject to transfer taxes.
c. No minority shareholders remain.
d. May be time consuming due to need for shareholder approvals.
e. May have to pay dissenting shareholders appraised value of stock
9. Which of the following is true of collar arrangements?
a. A fixed or constant share exchange ratio is one in which the number of acquirer shares exchanged for
each target share is unchanged between the signing of the agreement of purchase and sale and closing.
b. Collar agreements provide for certain changes in the exchange ratio contingent on the level of the
acquirer’s share price around the effective date of the merger.
c. A fixed exchange collar agreement may involve a fixed exchange ratio as long as the acquirer’s share
price remains within a narrow range, calculated as of the effective date of merger.
d. A fixed payment collar agreement guarantees that the target firm shareholder receives a certain dollar
value in terms of acquirer stock as long as the acquirer’s stock remains within a narrow range, and a fixed
exchange ratio if the acquirer’s average stock price is outside the bounds around the effective date of the
merger.
e. All of the above.
10. Which of the represent disadvantages of a cash purchase of target stock?
a. Buyer responsible for known and unknown liabilities.
b. Buyer may avoid need to obtain consents to assignments on contracts.
c. NOLs and tax credits pass to the buyer.
d. No state sales transfer, or use taxes have to be paid.
e. Enables circumvention of target’s board in the event a hostile takeover is initiated.
11. The form of acquisition refers to which of the following:
a. Tax status of the transaction
b. Acquisition vehicle
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c. What is being acquired, i.e., stock or assets
d. Form of payment
e. How the transaction will be displayed for financial reporting purposes
12. The tax status of the transaction may influence the purchase price by
a. Raising the price demanded by the seller to offset potential tax liabilities
b. Reducing the price demanded by the seller to offset potential tax liabilities
c. Causing the buyer to lower the purchase price if the transaction is taxable to the target firm’s shareholders
d. Forcing the seller to agree to defer a portion of the purchase price
e. Forcing the buyer to agree to defer a portion of the purchase price
13. The seller’s insistence that the buyer agree to purchase its stock may encourage the buyer to
a. offer a lower purchase price because it is assuming all of the target firm’s liabilities
b. offer a higher purchase price because it is assuming all of the target firm’s liabilities
c. offer a lower purchase price because it is receiving all of the target’s tax benefits
d. use its stock rather than cash to purchase the target firm
e. use cash rather than its stock to purchase the target firm
14. A holding company may be used as a post-closing organizational structure for all but which of the following
reasons?
a. A portion of the purchase price for the target firm included an earn-out
b. The target firm has a substantial amount of unknown liabilities
c. The acquired firm’s culture is very different from that of the acquiring firm
d. Profits from operations are not taxable
e. The transaction involves a cross border transaction
15. Form of payment can involve which of the following:
a. Cash
b. Stock
c. Cash and stock
d. Rights, royalties and fees
e. All of the above
16. A “floating or flexible share exchange ratio is used primarily to
a. Protect the value of the transaction for the acquirer’s shareholders
b. Protect the value of the transaction for the target’s shareholders
c. Minimize the number of new acquirer shares that must be issued
d. Increase the value for the acquiring firm
e. Increase the value for the target firm
Case Study Short Essay Examination Questions
Boston Scientific Overcomes Johnson & Johnson to Acquire Guidant—A Lesson in Bidding Strategy
Johnson & Johnson, the behemoth American pharmaceutical company, announced an agreement in December 2004 to
acquire Guidant for $76 per share for a combination of cash and stock. Guidant is a leading manufacturer of implantable
heart defibrillators and other products used in angioplasty procedures. The defibrillator market has been growing at 20
percent annually, and J&J desired to reenergize its slowing growth rate by diversifying into this rapidly growing market.
Soon after the agreement was signed, Guidant's defibrillators became embroiled in a regulatory scandal over failure to
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inform doctors about rare malfunctions. Guidant suffered a serious erosion of market share when it recalled five models of
its defibrillators.
The subsequent erosion in the market value of Guidant prompted J&J to renegotiate the deal under a material adverse
change clause common in most M&A agreements. J&J was able to get Guidant to accept a lower price of $63 a share in
mid-November. However, this new agreement was not without risk.
The renegotiated agreement gave Boston Scientific an opportunity to intervene with a more attractive informal offer on
December 5, 2005, of $72 per share. The offer price consisted of 50 percent stock and 50 percent cash. Boston Scientific, a
leading supplier of heart stents, saw the proposed acquisition as a vital step in the company's strategy of diversifying into
the high-growth implantable defibrillator market.
Despite the more favorable offer, Guidant’s board decided to reject Boston Scientific's offer in favor of an upwardly
revised offer of $71 per share made by J&J on January 11, 2005. The board continued to support J&J's lower bid, despite
the furor it caused among big Guidant shareholders. With a market capitalization nine times the size of Boston Scientific,
the Guidant board continued to be enamored with J&J's size and industry position relative to Boston Scientific.
Boston Scientific realized that it would be able to acquire Guidant only if it made an offer that Guidant could not refuse
without risking major shareholder lawsuits. Boston Scientific reasoned that if J&J hoped to match an improved bid, it
would have to be at least $77, slightly higher than the $76 J&J had initially offered Guidant in December 2004. With its
greater borrowing capacity, Boston Scientific knew that J&J also had the option of converting its combination stock and
cash bid to an all-cash offer. Such an offer could be made a few dollars lower than Boston Scientific's bid, since Guidant
investors might view such an offer more favorably than one consisting of both stock and cash, whose value could fluctuate
between the signing of the agreement and the actual closing. This was indeed a possibility, since the J&J offer did not
include a collar arrangement.
Boston Scientific decided to boost the new bid to $80 per share, which it believed would deter any further bidding from
J&J. J&J had been saying publicly that Guidant was already "fully valued." Boston Scientific reasoned that J&J had created
a public relations nightmare for itself. If J&J raised its bid, it would upset J&J shareholders and make it look like an
undisciplined buyer. J&J refused to up its offer, saying that such an action would not be in the best interests of its
shareholders. Table 1 summarizes the key events timeline.
Table 1
Boston Scientific and Johnson & Johnson Bidding Chronology
Date
Comments
December 15, 2004
J&J reaches agreement to buy Guidant for $25.4 billion in stock and cash.
November 15, 2005
Value of J&J deal is revised downward to $21.5 billion.
December 5, 2005
Boston Scientific offers $25 billion.
January 11, 2006
Guidant accepts a J&J counteroffer valued at $23.2 billion.
January 17, 2006
Boston Scientific submits a new bid valued at $27 billion.
January 25, 2006
Guidant accepts Boston Scientific’s bid when J&J fails to raise its offer.
A side deal with Abbott Labs made the lofty Boston Scientific offer possible. The firm entered into an agreement with
Abbott Laboratories in which Boston Scientific would divest Guidant's stent business while retaining the rights to Guidant's
stent technology. In return, Boston Scientific received $6.4 billion in cash on the closing date, consisting of $4.1 billion for
the divested assets, a loan of $900 million, and Abbott's purchase of $1.4 billion of Boston Scientific stock. The additional
cash helped fund the purchase price. This deal also helped Boston Scientific gain regulatory approval by enabling Abbott
Labs to become a competitor in the stent business. Merrill Lynch and Bank of America each would lend $7 billion to fund a
portion of the purchase price and provide the combined firms with additional working capital.
To complete the transaction, Boston Scientific paid $27 billion, consisting of cash and stock, to Guidant shareholders
and another $800 million as a breakup fee to J&J. In addition, the firm is burdened with $14.9 billion in new debt. Within
days of Boston Scientific's winning bid, the firm received a warning from the U.S. Food and Drug Administration to delay
the introduction of new products until the firm's safety procedures improved.
Between December 2004, the date of Guidant's original agreement with J&J, and January 25, 2006, the date of its
agreement with Boston Scientific, Guidant's stock rose by 16 percent, reflecting the bidding process. During the same
period, J&J's stock dropped by a modest 3 percent, while Boston Scientific's shares plummeted by 32 percent.
As a result of product recalls and safety warnings on more than 50,000 Guidant cardiac devices, the firm's sales and
profits plummeted. Between the announcement date of its purchase of Guidant in December 2005 and year-end 2006,
Boston Scientific lost more than $18 billion in shareholder value. In acquiring Guidant, Boston Scientific increased its total
shares outstanding by more than 80 percent and assumed responsibility for $6.5 billion in debt, with no proportionate
increase in earnings. In early 2010, Boston Scientific underwent major senior management changes and spun off several
business units in an effort to improve profitability. Ongoing defibrillator recalls could shave the firm’s revenue by $0.5
billion during the next two years.1 In 2010, continuing product-related problems forced the firm to write off $1.8 billion in
impaired goodwill associated with the Guidant acquisition. At less than $8 per share throughout most of 2010, Boston
Scientific’s share price is about one-fifth of its peak of $35.55 on December 5, 2005, the day the firm announced its bid for
Guidant.
Discussion Questions
1. What were the key differences between J&J’s and Boston Scientific’s bidding strategy? Be specific.
1. What might J&J have done differently to avoid igniting a bidding war?
2. What evidence is given that J&J may not have taken Boston Scientific as a serious bidder?
3. Explain how differing assumptions about market growth, potential synergies, and the size of the potential
liability related to product recalls affected the bidding?
Buyer Consortium Wins Control of ABN Amro
The biggest banking deal on record was announced on October 9, 2007, resulting in the dismemberment of one of Europe's
largest and oldest financial services firms, ABN Amro (ABN). A buyer consortium consisting of The Royal Bank of
Scotland (RBS), Spain's Banco Santander (Santander), and Belgium's Fortis Bank (Fortis) won control of ABN, the largest
bank in the Netherlands, in a buyout valued at $101 billion.
European banks had been under pressure to grow through acquisitions and compete with larger American rivals to avoid
becoming takeover targets themselves. ABN had been viewed for years as a target because of its relatively low share price.
However, rival banks were deterred by its diverse mixture of businesses, which was unattractive to any single buyer. Under
pressure from shareholders, ABN announced that it had agreed, on April 23, 2007, to be acquired by Barclay's Bank of
London for $85 billion in stock. The RBS-led group countered with a $99 billion bid consisting mostly of cash. In response,
Barclay's upped its bid by 6 percent with the help of state-backed investors from China and Singapore. ABN's management
favored the Barclay bid because Barclay had pledged to keep ABN intact and its headquarters in the Netherlands. However,
a declining stock market soon made Barclay's mostly stock offer unattractive.
While the size of the transaction was noteworthy, the deal is especially remarkable in that the consortium had agreed
prior to the purchase to split up ABN among the three participants. The mechanism used for acquiring the bank represented
an unusual means of completing big transactions amidst the subprime-mortgage-induced turmoil in the global credit
markets at the time. The members of the consortium were able to select the ABN assets they found most attractive. The
consortium agreed in advance of the acquisition that Santander would receive ABN's Brazilian and Italian units; Fortis
would obtain the Dutch bank's consumer lending business, asset management, and private banking operations, and RBS
would own the Asian and investment banking units. Merrill Lynch served as the sole investment advisor for the group's
participants. Caught up in the global capital market meltdown, Fortis was forced to sell the ABN Amro assets it had
acquired to its Dutch competitor ING in October 2008.
Discussion Questions:
1. In your judgment, what are likely to be some of the major challenges in assembling a buyer consortium to acquire
and subsequently dismember a target firm such as ABN Amro? In what way do you thing the use of a single
investment advisor might have addressed some of these issues?
2. The ABN Amro transaction was completed at a time when the availability of credit was limited due to the sub-
prime mortgage loan problem originating in the United States. How might the use of a group rather than a single
buyer have facilitated the purchase of ABN Amro?
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3. The same outcome could have been achieved if a single buyer had reached agreement with other banks to acquire
selected pieces of ABN before completing the transaction. The pieces could then have been sold at the closing.
Why might the use of the consortium been a superior alternative?
Pfizer Acquires Wyeth Labs Despite Tight Credit Markets
Pfizer and Wyeth began joint operations on October 22, 2009, when Wyeth shares stopped trading and each Wyeth share
was converted to $33 in cash and 0.985 of a Pfizer share. Valued at $68 billion, the cash and stock deal was first announced
in late January of 2009. The purchase price represented a 12.6 percent premium over Wyeth’s closing share price the day
before the announcement. Investors from both firms celebrated as Wyeth’s shares rose 12.6 percent and Pfizer’s 1.4 percent
on the news. The announcement seemed to offer the potential for profit growth, despite storm clouds on the horizon.
As is true of other large pharmaceutical companies, Pfizer expects to experience serious erosion in revenue due to
expiring patent protection on a number of its major drugs. Pfizer faced the expiration of patent rights in 2011 to the
cholesterol-lowering drug Lipitor, which accounted for 25 percent of the firm’s $52 billion in 2008 revenue. Pfizer also
faces 14 other patent expirations through 2014 on drugs that, in combination with Lipitor, contribute more than one-half of
the firm’s total revenue. Pfizer is not alone, Merck, Bristol-Myers Squibb, and Eli Lilly are all facing significant revenue
reduction due to patent expirations during the next five years as competition from generic drugs undercuts their pricing.
Wyeth will also be losing its patent protection on its top-selling drug, the antidepressant Effexor XR.
Pfizer’s strategy appears to have been to acquire Wyeth at a time when transaction prices were depressed because of the
recession and tight credit markets. Pfizer anticipates saving more than $4 billion annually by combining the two businesses,
with the savings being phased in over three years. Pfizer also hopes to offset revenue erosion due to patent expirations by
diversifying into vaccines and arthritis treatments.
By the end of 2008, Pfizer already had a $22.5 billion commitment letter in order to obtain temporary or “bridge”
financing and $26 billion in cash and marketable securities. Pfizer also announced plans to cut its quarterly dividend in half
to $0.16 per share to help finance the transaction. However, there were still questions about the firm’s ability to complete
the transaction in view of the turmoil in the credit markets.
Many transactions that were announced during 2008 were never closed because buyers were unable to arrange financing
and would later claim that the purchase agreement had been breached due to material adverse changes in the business
climate. Such circumstances, they would argue, would force them to renege on their contracts. Usually, such contracts
contain so-called reverse termination fees, in which the buyer would agree to pay a fee to the seller if they were unwilling
to close the deal. This is called a reverse termination or breakup fee because traditionally breakup fees are paid by a seller
that chooses to break a contract with a buyer in order to accept a more attractive offer from another suitor.
Negotiations, which had begun in earnest in late 2008, became increasingly contentious, not so much because of
differences over price or strategy but rather under what circumstances Pfizer could back out of the deal. Under the terms of
the final agreement, Pfizer would have been liable to pay Wyeth $4.5 billion if its credit rating dropped prior to closing and
it could not finance the transaction. At about 6.6 percent of the purchase price, the termination fee was about twice the
normal breakup fee for a transaction of this type.
What made this deal unique was that the failure to obtain financing as a pretext for exit could be claimed only under
very limited circumstances. Specifically, Pfizer could renege only if its lenders refused to finance the transaction because of
a credit downgrade of Pfizer. If lenders refused to finance primarily for this reason, Wyeth could either demand that Pfizer
attempt to find alternative financing or terminate the agreement. If Wyeth had terminated the agreement, Pfizer would have
been obligated to pay the termination fee.
Using Form of Payment as a Takeover Strategy:
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Chevron’s Acquisition of Unocal
Unocal ceased to exist as an independent company on August 11, 2005 and its shares were de-listed from the New York
Stock Exchange. The new firm is known as Chevron. In a highly politicized transaction, Chevron battled Chinese oil-
producer, CNOOC, for almost four months for ownership of Unocal. A cash and stock bid by Chevron, the nation’s second
largest oil producer, made in April valued at $61 per share was accepted by the Unocal board when it appeared that
CNOOC would not counter-bid. However, CNOOC soon followed with an all-cash bid of $67 per share. Chevron amended
the merger agreement with a new cash and stock bid valued at $63 per share in late July. Despite the significant difference
in the value of the two bids, the Unocal board recommended to its shareholders that they accept the amended Chevron bid
in view of the growing doubt that U.S. regulatory authorities would approve a takeover by CNOOC.
In its strategy to win Unocal shareholder approval, Chevron offered Unocal shareholders three options for each of their
shares: (1) $69 in cash, (2) 1.03 Chevron shares; or (3) .618 Chevron shares plus $27.60 in cash. Unocal shareholders not
electing any specific option would receive the third option. Moreover, the all-cash and all-stock offers were subject to
proration in order to preserve an overall per share mix of .618 of a share of Chevron common stock and $27.60 in cash for
all of the 272 million outstanding shares of Unocal common stock. This mix of cash and stock provided a “blended” value
of about $63 per share of Unocal common stock on the day that Unocal and Chevron entered into the amendment to the
merger agreement on July 22, 2005. The “blended” rate was calculated by multiplying .618 by the value of Chevron stock
on July 22nd of $57.28 plus $27.60 in cash. This resulted in a targeted purchase price that was about 56 percent Chevron
stock and 44 percent cash.
This mix of cash and stock implied that Chevron would pay approximately $7.5 billion (i.e., $27.60 x 272 million
Unocal shares outstanding) in cash and issue approximately 168 million shares of Chevron common stock (i.e., .618 x 272
million of Unocal shares) valued at $57.28 per share as of July 22, 2005. The implied value of the merger on that date was
$17.1 billion (i.e., $27.60 x 272 million Unocal common shares outstanding plus $57.28 x 168 million Chevron common
shares). An increase in Chevron’s share price to $63.15 on August 10, 2005, the day of the Unocal shareholders’ meeting,
boosted the value of the deal to $18.1 billion.
Option (1) was intended to appeal to those Unocal shareholders who were attracted to CNOOC’s all cash offer of $67
per share. Option (2) was designed for those shareholders interested in a tax-free exchange. Finally, it was anticipated that
option (3) would attract those Unocal shareholders who were interested in cash but also wished to enjoy any appreciation in
the stock of the combined companies.
The agreement of purchase and sale between Chevron and Unocal contained a “proration clause.” This clause enabled
Chevron to limit the amount of total cash it would payout under those options involving cash that it had offered to Unocal
shareholders and to maintain the “blended” rate of $63 it would pay for each share of Unocal stock. Approximately 242
million Unocal shareholders elected to receive all cash for their shares, 22.1 million opted for the all-stock alternative, and
10.1 million elected the cash and stock combination. No election was made for approximately .3 million shares. Based on
these results, the amount of cash needed to satisfy the number shareholders electing the all-cash option far exceeded the
amount that Chevron was willing to pay. Consequently, as permitted in the merger agreement, the all-cash offer was
prorated resulting in the Unocal shareholders who had elected the all-cash option receiving a combination of cash and stock
rather than $69 per share. The mix of cash and stock was calculated as shown in Exhibit 1.
Exhibit 1. Prorating All-Cash Elections
1. Determine the available cash election amount (ACEA): Aggregate cash amount minus the amount of cash
to be paid to Unocal shareholders selecting the combination of cash and stock (i.e., Option 3).
2. Determine the elected cash amount (ECA): Amount equal to $69 multiplied by the
number of shares of Unocal common stock electing the all-cash option.
3. Determine the cash proration factor (CPF): ACEA/ECA
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4. Determine the prorated cash merger consideration (PCMC): An amount in cash equal
to $69 multiplied by the cash proration factor.
5. Determine the prorated stock merger consideration (PSMC): 1.03 multiplied by 1 – CPF.
6. Determine the stock and cash mix (SCM): Sum of the prorated cash (PCMC) and stock
(PSMC) merger considerations exchanged for each share of Unocal common stock.
If too many Unocal shareholders had elected to receive Chevron stock, those making the all-stock election would not
have received 1.03 shares of Chevron stock for each share of Unocal stock. Rather, they would have received a mix of
stock and cash to help preserve the approximate 56 percent stock and 44 percent cash composition of the purchase price
desired by Chevron. For illustration only, assume the number of Unocal shares to be exchanged for the all-cash and all-
stock options are 22.1 and 242 million, respectively. This is the reverse of what actually happened. The mix of stock and
cash would have been prorated as shown in Exhibit 2.
Exhibit 12. Prorating All-Stock Elections
2. Determine the elected cash amount (ECA): Amount equal to $69 multiplied by the number of shares of
Unocal common stock electing the all-cash option.
3. Determine the excess cash amount (EXCA): Difference between ACEA and ECA.
4. Determine the prorated cash merger consideration (PCMC): EXCA divided by number of Unocal shares
elected the all-stock option.
5. Determine the stock proration factor (SPF): $69 minus the prorated cash merger
consideration divided by $69.
6. Determine the prorated stock price consideration (PSPC): The number of shares of
Chevron stock equal to 1.03 multiplied by the stock proration factor.
It is typical of large transactions in which the target has a large, diverse shareholder base that acquiring firms offer
target shareholders a “menu” of alternative forms of payment. The objective is to enhance the likelihood of success by
appealing to a broader group of shareholders. To the unsophisticated target shareholder, the array of options may prove
appealing. However, it is likely that those electing all-cash or all-stock purchases are likely to be disappointed due to
probable proration clauses in merger contracts. Such clauses enable the acquirer to maintain an overall mix of cash and
stock in completing the transaction. This enables the acquirer to limit the amount of cash they must borrow or the number
of new shares they must issue to levels they find acceptable.
Discussion Questions
