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2. What are the primary disadvantages and advantages of a reverse merger strategy?
3. In what way might the use of the T-Mobile/MetroPCS impact value?
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4. What are the key assumptions implicit in the Deutsche-Telekom restructuring strategy for T-Mobile?
5. What is the form of payment used in this deal? Why might this form have been selected? What are the advantages and
disadvantages of the form of payment used in this deal?
6. What is the form of acquisition used in this deal? Why might this form have been chosen? What are the advantages and
disadvantages of the form of acquisition used in this case study?
Sanofi Acquires Genzyme in a Test of Wills
Key Points
Contingent value rights help bridge price differences between buyers and sellers when the target’s future earnings
performance is dependent on the realization of a specific event.
They are most appropriate when the target firm is a large publicly traded firm with numerous shareholders.
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Facing a patent expiration precipice in 2015, big pharmaceutical companies have been scrambling to find new sources of
revenue to offset probable revenue losses as many of their most popular drugs lose patent protection. Generic drug
companies are expected to make replacement drugs and sell them at a much lower price.
Focusing on the biotechnology market, French-based drug company Sanofi-Aventis SA (Sanofi) announced on February
17, 2011, the takeover of U.S.-based Genzyme Corp. (Genzyme) for $74 per share, or $20.1 billion in cash, plus a
contingent value right (CVR). The CVR could add as much as $14 a share or another $3.8 billion, to the purchase price if
Genzyme is able to achieve certain performance targets. According to the terms of the agreement, Genzyme will retain its
name and operate as a separate unit focusing on rare diseases, an area in which Genzyme has excelled. The purchase price
represented a 48% premium over Genzyme’s share price of $50 per share immediately preceding the announcement.
The acquisition represented the end of a nine-month effort that began on May 23, 2010, when Sanofi CEO Chris
Viehbacher first approached Genzyme’s Henri Termeer, the firm’s founder and CEO. Sanofi expressed interest in Genzyme
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at a time when debt was cheap and when Genzyme’s share price was depressed, having fallen from a 2008 peak of $83.25
to $47.16 in June 2010. Genzyme’s depressed share price reflected manufacturing problems that had lowered sales of its
best-selling products. Genzyme continued to recover from the manufacturing challenges that had temporarily shut down
operations at its main site in 2009. The plant is the sole source of Genzyme’s top-selling products, Gaucher’s disease
treatment Cerezyme and Fabry disease drug Fabrazyme. Both were in short supply throughout 2010 due to the plant’s
shutdown. By yearend, the supply shortages were less acute. Sanofi was convinced that other potential bidders were too
occupied with integrating recent deals to enter into a bidding war.
In an effort to get Genzyme to engage in discussions and to permit Sanofi to perform due diligence, Sanofi submitted a
formal bid of $69 per share on July 29, 2010. However, Sanofi continued to ignore the unsolicited offer. The offer was 38%
above Genzyme’s price on July 1, 2010, when investors began to speculate that Genzyme was “in play.” Sanofi was betting
that the Genzyme shareholders would accept the offer rather than risk seeing their shares fall to $50. The shares, however,
traded sharply higher at $70.49 per share, signaling that investors were expecting Sanofi to have to increase its bid.
Viehbacher said he might increase the bid if Genzyme would be willing to disclose more information about the firm’s
ongoing manufacturing problems and the promising new market potential for its multiple sclerosis drug.
In a letter made public on August 29, 2010, Sanofi indicated that it had been trying to engage Genzyme in acquisition
talks for months and that its formal bid had been rejected by Genzyme without any further discussion on August 11, 2010.
The letter concludes with a thinly disguised threat that “all alternatives to complete the transaction” would be considered
and that “Sanofi is confident that Genzyme shareholders will support the proposal.” In responding to the public disclosure
of the letter, the Genzyme board said it was not prepared to engage in merger negotiations with Sanofi based on an
opportunistic proposal with an unrealistic starting price that dramatically undervalued the company. Termeer said publicly
that the firm was worth at least $80 per share. He based this value on the improvement in the firm’s manufacturing
operations and the revenue potential of Lemtrada, Genzyme’s experimental treatment for multiple sclerosis, which once
approved for sale by the FDA was projected by Genzyme to generate billions of dollars annually. Despite Genzyme’s
refusal to participate in takeover discussions, Sanofi declined to raise its initial offer in view of the absence of other bidders.
Sanofi finally initiated an all-cash hostile tender offer for all of the outstanding Genzyme shares at $69 per share on
October 4, 2010. Set to expire initially on December 16, 2010, the tender offer was later extended to January 21, 2011,
when the two parties started to discuss a contingent value right (CVR) as a means of bridging their disparate views on the
value of Genzyme. Initially, Genzyme projected peak annual sales of $3.5 billion for Lemtrada and $700 million for Sanofi.
At the end of January, the parties announced that they had signed a nondisclosure agreement to give Sanofi access to
Genzyme’s financial statements.
The CVR helped to allay fears that Sanofi would overpay and that the drug Lemtrada would not be approved by the
FDA. Under the terms of the CVR, Genzyme shareholders would receive $1 per share if Genzyme were able to meet
certain production targets in 2011 for Cerezyme and Fabrazyme, whose output had been sharply curtailed by viral
contamination at its plant in 2009. Each right would yield an additional $1 if Lemtrada wins FDA approval. Additional
payments will be made if Lemtrada hits certain other annual revenue targets. The CVR, which runs until the end of 2020,
entitles holders to a series of payments that could cumulatively be worth up to $14 per share if Lemtrada reaches $2.8
billion in annual sales.
The Genzyme transaction was structured as a tender offer to be followed immediately with a back-end short-form
merger. The short-form merger enables an acquirer, without a shareholder vote, to squeeze out any minority shareholders
not tendering their shares during the tender offer period. To execute the short-form merger, the purchase agreement
included a “top-up” option granted by the Genzyme board to Sanofi. The “top-up” option would be triggered when Sanofi
acquired 75% of Genzyme’s outstanding shares through its tender offer. The 75% threshold could have been lower had
Genzyme had more authorized but unissued shares to make up the difference between the 90% requirement for the short-
form merger and the number of shares accumulated as a result of the tender offer. The deal also involved the so-called dual-
track model of simultaneously filing a proxy statement for a shareholders’ meeting and vote on the merger while the tender
offer is occurring to ensure that the deal closes as soon as possible.
Discussion Questions
1. The deal was structured as a tender offer coupled with a “top up” option to be followed by a backend short
form merger. Why might this structure be preferable to a more common statutory merger deal or a tender offer
followed by a backend merger requiring a shareholder vote?
2. Speculate as to the purpose of the dual track model in which the bidder initiates a tender offer and
simultaneously files a prospectus to hold a shareholders meeting and vote on a merger
3. Describe the takeover tactics employed by Sanofi. Discuss why each one might have been used.
4. Describe the antitakeover strategy employed by Genzyme. Discuss why each may have been employed. In
your opinion, did the Genzyme strategy work?
25
5. What alternatives could Sanofi used instead of the CVR to bridge the difference in how the parties valued
Genzyme? Discuss the advantages and disadvantages of each.
6. How might both the target and bidding firm benefit from the top-up option?
7. How might the existence of a CVR limit Sanofi’s ability to realize certain types of synergies? Be specific.
Swiss Pharmaceutical Giant Novartis Takes Control of Alcon
_________________________________________________________________________________________________
Key Points
Parent firms frequently find it appropriate to buy out minority shareholders to reduce costs and to simplify future decision
making.
Acquirers may negotiate call options with the target firm after securing a minority position to implement so-called
“creeping takeovers.”
_________________________________________________________________________________________________
In December 2010, Swiss pharmaceutical company Novartis AG completed its effort to acquire, for $12.9 billion, the
remaining 23% of U.S.-listed eye care group Alcon Incorporated (Alcon) that it did not already own. This brought the total
purchase price for 100% of Alcon to $52.2 billion. Novartis had been trying to purchase Alcon’s remaining publicly traded
shares since January 2010, but its original offer of 2.8 Novartis shares, valued at $153 per Alcon share, met stiff resistance
from Alcon’s independent board of directors, which had repeatedly dismissed the Novartis bid as “grossly inadequate.”
Novartis finally relented, agreeing to pay $168 per share, the average price it had paid for the Alcon shares it already
owned, and to guarantee that price by paying cash equal to the difference between $168 and the value of 2.8 Novartis
shares immediately prior to closing. If the value of Novartis shares were to appreciate before closing such that the value of
2.8 shares exceeded $168, the number of Novartis shares would be reduced. By acquiring all outstanding Alcon shares,
Novartis avoided interference by minority shareholders in making key business decisions, achieved certain operating
synergies, and eliminated the expense of having public shareholders.
In 2008, with global financial markets in turmoil, Novartis acquired, for cash, a minority position in food giant Nestlé’s
wholly owned subsidiary Alcon. Nestlé had acquired 100% of Alcon in 1978 and retained that position until 2002, when it
undertook an IPO of 23% of its shares. In April 2008, Novartis acquired 25% of Alcon for $143 per share from Nestlé. As
part of this transaction, Novartis and Nestlé received a call and a put option, respectively, which could be exercised at $181
per Alcon share from January 2010 to July 2011. On January 4, 2010, Novartis exercised its call option to buy Nestlé’s
remaining 52% ownership stake in Alcon that it did not already own. By doing so, Novartis increased its total ownership
position in Alcon to about 77%. The total price paid by Novartis for this position amounted to $39.3 billion ($11.2 billion in
2008 plus $28.1 billion in 2010). On the same day, Novartis also offered to acquire the remaining publicly held shares that
it did not already own in a share exchange valued at $153 per share in which 2.8 shares of its stock would be exchanged for
each Alcon share.
While the Nestlé deal seemed likely to receive regulatory approval, the offer to the minority shareholders was assailed
immediately as too low. At $153 per share, the offer was well below the Alcon closing price on January 4, 2010, of
$164.35. The Alcon publicly traded share price may have been elevated by investors’ anticipating a higher bid. Novartis
argued that without this speculation, the publicly traded Alcon share price would have been $137, and the $153 per share
price Novartis offered the minority shareholders would have represented an approximate 12% premium to that price. The
minority shareholders, who included several large hedge funds, argued that they were entitled to $181 per share, the amount
paid to Nestlé. Alcon’s publicly traded shares dropped 5% to $156.97 on the news of the Novartis takeover. Novartis’
shares also lost 3%, falling to $52.81. On August 9, 2010, Novartis received approval from European Union regulators to
buy the stake in Alcon, making it easier for it to take full control of Alcon.
With the buyout of Nestlé’s stake in Alcon completed, Novartis was now faced with acquiring the remaining 23% of the
outstanding shares of Alcon stock held by the public. Under Swiss takeover law, Novartis needed a majority of Alcon board
members and two-thirds of shareholders to approve the terms for the merger to take effect and for Alcon shares to convert
automatically into Novartis shares. Once it owned 77% of Alcon’s stock, Novartis only needed to place five of its own
nominated directors on the Alcon board to replace the five directors previously named by Nestlé to the board. Alcon’s
independent directors set up an independent director committee (IDC), arguing that the price offered to minority
shareholders was too low and that the new directors, having been nominated by Novartis, should abstain from voting on the
Novartis takeover because of their conflict of interest. The IDC preferred a negotiated merger to a “cram down” or forced
merger in which the minority shares convert to Novartis shares at the 2.8 share-exchange offer.
Provisions in the Swiss takeover code require a mandatory offer whenever a bidder purchases more than 33.3% of
another firm’s stock. In a mandatory offer, Novartis would also be subject to the Swiss code’s minimum-bid rule, which
would require Novartis to pay $181 per share in cash to Alcon’s minority shareholders, the same bid offered to Nestlé. By
replacing the Nestlé-appointed directors with their own slate of candidates and owning more than two-thirds of the Alcon
shares, Novartis argued that they were not subject to mandatory-bid requirements. Novartis was betting on the continued
appreciation of its shares, valued in Swiss francs, due to an ongoing appreciation of the Swiss currency and its improving
operating performance, to eventually win over holders of the publicly traded Alcon shares. However, by late 2010,
Novartis’ patience appears to have worn thin. While not always the case, the resistance of the independent directors paid off
for those investors holding publicly traded shares.
Discussion Questions
1. Speculate as to why Novartis acquired only a 25 percent stake in Alcon in 2008.
27
2. Why was the price ($181 per share) at which Novartis exercised its call option in 2010 to increase its stake in
Alcon to 77 so much higher than what it paid ($143 per share) for an approximate 25 percent stake in Alcon in
early 2008?
3. Alcon and Novartis shares dropped by 5 percent and 3 percent, respectively, immediately following the
announcement that Novartis would exercise its option to buy Nestle’s majority holdings of Alcon shares.
Explain why this happened.
4. How do Swiss takeover laws compare to comparable U.S. laws. Which are more appropriate and why?
6. Discuss how Novartis may have arrived at the estimate of $137 per share as the intrinsic value of
Alcon.
What are the key underlying assumptions? Do you believe that the minority shareholders should receive the
same price as Nestle?
Illustrating How Deal Structure Affects Value—The FaceBook / Instagram Deal
_________________________________________________________________________________________________
Key Points:
28
Deal structures affect value by limiting risk to the parties involved or exposing them to risk.
The value of cash received at closing is certain, whereas the value of stock is not.
Mechanisms exist to limit such risk; however, they often come with a cost to the party seeking risk mitigation.
_________________________________________________________________________________________________
While we always look smarter after the fact, social networking giant Facebook’s acquisition of Instagram, a popular photo-
sharing service, highlights risk common to such deals. Instagram’s user base was exploding; Facebook viewed it as a
potential competitor and as a means of extending its own product offering to photo sharing on smartphones and tablet
computers. However, the two-year-old Instagram had no revenue and consisted of a technology platform, a growing and
active user base, and 24 employees. Facebook announced on April 12, 2012, that it had reached an agreement, reportedly
hammered out in less than 48 hours, to buy Instagram for $1 billion, an outsized valuation by most measures.
The purchase price consisted of $300 million in cash and 23 million shares of common stock for all of the outstanding
Instagram shares. The combination of cash and stock is usually offered to give selling-firm shareholders the favorable tax
advantages of acquirer stock, the certainty of cash, and the opportunity to participate in any potential appreciation of the
acquiring firm’s shares. The deal value was predicated on a Facebook share price of $31 per share, giving Facebook a
market value at the time of $75 billion. What is perhaps most remarkable about this transaction is the price paid, the speed
with which it was negotiated, and the absence of protections for the Instagram shareholders. These issues are discussed
next.
Called an important milestone by Facebook founder and CEO Mark Zuckerberg, the deal reflected the dangers of
valuing a firm primarily on its potential. This is an issue that Facebook tackled following its IPO on May 18, 2012.
Originally offered at $38 per share, the stock soon plummeted to less than half that value as investors doubted the firm’s
long-term profitability.
Facebook’s dual class shareholder structure gives Mr. Zuckerberg effective control of the firm, despite owning only
28.4% of outstanding class B shares. This control made it possible for the lofty valuation to be placed on Instagram and for
the deal to be negotiated so rapidly. Indeed, the Instagram offer price may have reflected the euphoria preceding the
Facebook IPO. The heady environment immediately prior to the Facebook IPO also may have convinced the Instagram
shareholders that they had little to lose and much to gain by accepting a mostly stock deal involving a fixed share-exchange
ratio. That is, the number of Facebook shares exchanged for each Instagram share would remain unchanged, despite any
appreciation (depreciation) in Facebook shares between the signing of the agreement and the closing of the deal.
The downside risk to Instagram shareholders was evident by the September 6, 2012, closing date, for the value of the
deal had plummeted to about $715 million, with Facebook shares having closed at $18.05 a share. Instagram shareholders
experienced a substantial loss in value, which could have been averted by adjusting the purchase price within a range if
Facebook’s share price fluctuated significantly between signing and closing. Alternatively, Instagram could have negotiated
the right to cancel the deal due a material change in the value of the transaction.
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
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.
29
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.7 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.
2. What might J&J have done differently to avoid igniting a bidding war?
3. What evidence is given that J&J may not have taken Boston Scientific as a serious bidder?
7. 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?
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?
32
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:
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
33
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).
ACEA = $27.60 x 272 million (Unocal shares outstanding) - 10.1
million (shares electing cash and stock option) x $27.60
= $7.5 - $.3
= $7.2 billion
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.
ECA = $69 x 242 million = $16.7 billion
3. Determine the cash proration factor (CPF): ACEA/ECA
CPF = $7.2 / $16.7 = .4311
4. Determine the prorated cash merger consideration (PCMC): An amount in cash equal
to $69 multiplied by the cash proration factor.
PCMC = $69 x .4311 = $29.74
5. Determine the prorated stock merger consideration (PSMC): 1.03 multiplied by 1 – CPF.
PSMC = 1.03 x (1- .4311) = .5860
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.
SCM = $29.74 + .5860 of a Chevron share
Exhibit 12. Prorating All-Stock Elections
1. Determine the available cash election amount (ACEA): Same as step 1 above.
ACEA = $7.2 billion
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.
ECA = $69 x 22.1 million = $1.5 billion
3. Determine the excess cash amount (EXCA): Difference between ACEA and ECA.
EXCA = $7.2 - $1.5 = $5.7
4. Determine the prorated cash merger consideration (PCMC): EXCA divided by number of Unocal shares
elected the all-stock option.
PCMC = $5.7 / 242 million = $23.55
5. Determine the stock proration factor (SPF): $69 minus the prorated cash merger
consideration divided by $69.
SPF = ($69 - $23.55) / $69 = .$45.45 / $69 = .6587
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.
PSPC = 1.03 x .6587 = .6785
7. Determine the stock and cash mix (SCM): Each Unocal share to be exchanged in an
all-stock election is converted into the right to receive the prorated cash merger
consideration and the prorated stock merger consideration.
SCM = $23.55 + .6785 of a Chevron share for each Unocal share
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
1. What was the form of payment employed by both bidders for Unocal? In your judgment, why were they
different? Be specific.
