If an investor anticipates a future cash flow stream of five or ten years, she needs to use
either a five- or ten-year Treasury bond rate
as the risk-free rate. True or False
Answer:
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
Answer:
Junk bonds are always high risk. True or False
Answer:
Product liability claims are generally more frequent and judgments are larger outside
the U.S. True or False
Answer:
The filing of a petition triggers an automatic stay once the court accepts the request,
which provides a period suspending all judgments, collection activities, foreclosures,
and repossessions of property by the creditors on any debt or claim that arose before the
filing of the bankruptcy petition. True or False
Answer:
In an equity carve-out, minority shareholders are eliminated. True or False
Answer:
Fraudulent conveyance laws are intended to prevent shareholders, secured creditors,
and others from benefiting at the expense of unsecured creditors. True or False
Answer:
The targeted industry and the maximum size of the potential transaction are often the
most important selection criteria used in the search process. True or False
Answer:
Bankruptcyis a state-level legal proceeding designed to protect the technically or legally
insolvent firm from lawsuits by its creditors until a decision can be made to shut down
or to continue to operate the firm. True or False
Answer:
Chapter 11 of the U.S. bankruptcy code deals with liquidation while Chapter 7
addresses reorganization. True or False
Answer:
Executive stock option plans have little impact on the way management runs the firm.
True or False
Answer:
Price-to-earnings ratios of comparable companies provide an excellent means of
valuing the target firm at any point in the business cycle. True or False
Answer:
A firm is said to be technically solvent when it is unable to pay its liabilities as they
come due. True or False
Answer:
In the absence of debt, measures the volatility of a firm’s financial return to changes in
the general market’s overall financial
return. True or False
Answer:
The unlevered cost of equity is often viewed as the appropriate discount rate rather than
the cost of debt or a risk-free rate because tax savings are subject to risk, since the firm
may default on its debt or be unable to utilize the tax savings due to continuing
operating losses. True or False
Answer:
In hostile takeovers, the employees that are on the post-merger integration team should
come from the acquiring firm because of concerns that the target firm’s employees
cannot be trusted.
True or False
Answer:
Studies show that it is generally unnecessary to adjust the capital asset pricing model
for the size of the firm. True or False
Answer:
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
Answer:
The loan agreement stipulates the terms and conditions under which the lender will loan
the firm funds. True or False
Answer:
Liquidation value is the projected sale value of a firm’s assets. True or False
Answer:
Despite the pressure of an attractive purchase price premium, the composition of the
target’s board greatly influences what the board does and the timing of its decisions.
True or False
Answer:
A merger of equals is a merger framework usually applied whenever the merger
participants are comparable in size, competitive position, profitability, and market
capitalization. True or False
Answer:
In cross-border M&As, acquirer shares often are less attractive to potential targets
because of the absence of a liquid market for resale or because the acquirer is not
widely recognized by the target firm’s shareholders. True or False
Answer:
The IRS treats the reverse triangular cash merger as a purchase of target shares, with the
target firm, including its assets, liabilities, and tax attributes, ceasing to exist. True or
False
Answer:
Studies show that the market risk premium is unstable, lower during periods of
prosperity and higher during periods of economic slowdowns. True or False
Answer:
Concern about their fiduciary responsibility to shareholders and shareholder lawsuits
often puts pressure on a target firm’s board of directors to accept an offer if it includes a
significant premium to the target’s current share price. True or False
Answer:
If a firm enters into a workout in which a voluntary negotiated agreement with debtors
is achieved, the firm may lose its right to claim NOLs in its tax filing. True or False
Answer:
The present value of net synergy is the difference between the present value of
projected cash flows from sources and destroyers of value. True or False
Answer:
Corporate governance refers to the way firms elect CEOs. True or False
Answer:
If an investor initiates a tender offer, it must make a 14(d) filing with the SEC. True or
False
Answer:
Most highly leveraged transactions consist of acquisitions of private rather public firms.
True or False
Answer:
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
Answer:
A differentiation strategy is one in which a firm’s products are perceived by customers
to be slightly different from other firms’ products in the same industry. True or False
Answer:
Joint ventures are cooperative business relationships formed by two or more separate
parties to achieve common strategic objectives True or False
Answer:
The major advantage of the value driver approach to valuation is the implied
assumption that a single value driver or factor is representative of the total value of the
business. True or False
Answer:
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.
Answer:
Which of the following is not a typical question that must be addressed in defining how
ownership interests will be transferred?
a. What are the restrictions on transfer
b. How will new alliance participants be treated
c. Will there be a right of first refusal
d. How is the alliance to be managed
e. Will there by drag along, tag along, or put provisions
Answer:
Which of the following are often viewed as disadvantages of the adjusted present value
method?
a. Ignores the effects of leverage on the discount rate as debt is repaid
b. Requires estimation of the cost and probability of financial distress
c. It is unclear how to define the proper discount rate
d. A and B only
e. A, B, and C
Answer:
When evaluating an acquisition, you should do which of the following:
a. Ignore market values of assets and focus on book value
b. Ignore the timing of when the cash flows will be received
c. Ignore acquisition fees and transaction costs
d. Apply the discount rate that is relevant to the incremental cash flows
e. Ignore potential losses of management talent
Answer:
The board of directors of a firm approves an exchange offer in which their shareholders
are offered stock in one of the firm’s subsidiaries in exchange for their holdings of
parent company stock. This offer is best described as a
a. Split-up
b. Split-off
c. Equity carve-out
d. Spin-off
e. Tender offer
Answer:
Which of the following is true about segmented capital markets?
a. Exhibit different bond and equity prices in different geographic areas for identical
assets in terms of risk and maturity.
b. Exhibit the same bond and equity prices in different geographic areas for identical
assets in terms of risk and maturity.
c. Exhibit different bond and equity prices in the same geographic areas for identical
assets in terms of risk and maturity.
d. Exhibit different bond prices but the same equity prices in different geographic areas
for identical assets in terms of risk and maturity.
e. None of the above
Answer:
Which of the following is not true about the recommendation that integration should
occur rapidly?
a. All significant operations of the two firms must be integrated immediately.
b. Rapid integration helps to minimize customer attritition.
c. Rapid integration reduces unwanted employee turnover.
d. Rapid integration reduces employee anxiety.
e. None of the above
Answer:
The General Motors’ BankruptcyThe Largest Government-Sponsored Bailout in
U.S. History
Rarely has a firm fallen as far and as fast as General Motors. Founded in 1908, GM
dominated the car industry through the early 1950s with its share of the U.S. car market
reaching 54 percent in 1954, which proved to be the firm’s high water mark. Efforts in
the 1980s to cut costs by building brands on common platforms blurred their
distinctiveness. Following increasing healthcare and pension benefits paid to
employees, concessions made to unions in the early 1990s to pay workers even when
their plants were shut down reduced the ability of the firm to adjust to changes in the
cyclical car market. GM was increasingly burdened by so-called legacy costs (i.e.,
healthcare and pension obligations to a growing retiree population). Over time, GM’s
labor costs soared compared to the firm’s major competitors. To cover these costs, GM
continued to make higher margin medium to full-size cars and trucks, which in the
wake of higher gas prices could only be sold with the help of highly attractive incentive
programs. Forced to support an escalating array of brands, the firm was unable to
provide sufficient marketing funds for any one of its brands.
With the onset of one of the worst global recessions in the postWorld War II years, auto
sales worldwide collapsed by the end of 2008. All automakers’ sales and cash flows
plummeted. Unlike Ford, GM and Chrysler were unable to satisfy their financial
obligations. The U.S. government, in an unprecedented move, agreed to lend GM and
Chrysler $13 billion and $4 billion, respectively. The intent was to buy time to develop
an appropriate restructuring plan.
Having essentially ruled out liquidation of GM and Chrysler, continued government
financing was contingent on gaining major concessions from all major stakeholders
such as lenders, suppliers, and labor unions. With car sales continuing to show
harrowing double-digit year over year declines during the first half of 2009, the threat
of bankruptcy was used to motivate the disparate parties to come to an agreement. With
available cash running perilously low, Chrysler entered bankruptcy in early May and
GM on June 1, with the government providing debtor in possession financing during
their time in bankruptcy. In its bankruptcy filing for its U.S. and Canadian operations
only, GM listed $82.3 billion in assets and $172.8 billion in liabilities. In less than 45
days each, both GM and Chrysler emerged from government-sponsored sales in
bankruptcy court, a feat that many thought impossible.
Judge Robert E. Gerber of the U.S. Bankruptcy Court of New York approved the sale in
view of the absence of alternatives considered more favorable to the government’s
option. GM emerged from the protection of the court on July 10, 2009, in an economic
environment characterized by escalating unemployment and eroding consumer income
and confidence. Even with less debt and liabilities, fewer employees, the elimination of
most “legacy costs,” and a reduced number of dealerships and brands, GM found itself
operating in an environment in 2009 in which U.S. vehicle sales totaled an anemic 4
million units. This compared to more than 16 million in 2008. GM’s 2009 market share
slipped to a postWorld War II low of about 19 percent.
While the bankruptcy option had been under consideration for several months, its
attraction grew as it became increasingly apparent that time was running out for the
cash-strapped firm. Having determined from the outset that liquidation of GM either
inside or outside of the protection of bankruptcy would not be considered, the
government initially considered a prepackaged bankruptcy in which agreement is
obtained among major stakeholders prior to filing for bankruptcy. The presumption is
that since agreement with many parties had already been obtained, developing a plan of
reorganization to emerge from Chapter 11 would move more quickly. However, this
option was not pursued because of the concern that the public would simply view the
postChapter 11 GM as simply a smaller version of its former self. The government in
particular was seeking to position GM as an entirely new firm capable of profitably
designing and building cars that the public wanted.
Time was of the essence. The concern was that consumers would not buy GM vehicles
while the firm was in bankruptcy. Consequently, a strategy was devised in which GM
would be divided into two firms: “old GM,” which would contain the firm’s unwanted
assets, and “new GM,” which would own the most attractive assets. “New GM” would
then emerge from bankruptcy in a sale to a new company owned by various stakeholder
groups, including the U.S. and Canadian governments, a union trust fund, and
bondholders. Only GM’s U.S. and Canadian operations were included in the bankruptcy
filing. Figure 2 illustrates the GM bankruptcy process.
Buying distressed assets can be accomplished through a Chapter 11 plan of
reorganization or a post-confirmation trustee. Alternatively, a 363 sale transfers the
acquired assets free and clear of any liens, claims, and encumbrances. The sale of GM’s
attractive assets to the “new GM” was ultimately completed under Section 363 of the
U.S. Bankruptcy Code. Historically, firms used this tactic to sell failing plants and
redundant equipment. In recent years, so-called 363 sales have been used to completely
restructure businesses, including the 363 sales of entire companies. A 363 sale requires
only the approval of the bankruptcy judge, while a plan of reorganization in Chapter 11
must be approved by a substantial number of creditors and meet certain other
requirements to be approved. A plan of reorganization is much more comprehensive
than a 363 sale in addressing the overall financial situation of the debtor and how its
exit strategy from bankruptcy will affect creditors. Once a 363 sale has been
consummated and the purchase price paid, the bankruptcy court decides how the
proceeds of sale are allocated among secured creditors with liens on the assets sold.
Total financing provided by the U.S. and Canadian (including the province of Ontario)
governments amounted to $69.5 billion. U.S. taxpayer-provided financing totaled $60
billion, which consisted of $10 billion in loans and the remainder in equity. The
government decided to contribute $50 billion in the form of equity to reduce the burden
on GM of paying interest and principal on its outstanding debt. Nearly $20 billion was
provided prior to the bankruptcy, $11 billion to finance the firm during the bankruptcy
proceedings, and an additional $19 billion in late 2009. In exchange for these funds, the
U.S. government owns 60.8 percent of the “new GM’s common shares, while the
Canadian and Ontario governments own 11.7 percent in exchange for their investment
of $9.5 billion. The United Auto Workers’ new voluntary employee beneficiary
association (VEBA) received a 17.5 percent stake in exchange for assuming
responsibility for retiree medical and pension obligations. Bondholders and other
unsecured creditors received a 10 percent ownership position. The U.S. Treasury and
the VEBA also received $2.1 billion and $6.5 billion in preferred shares, respectively.
The new firm, which employs 244,000 workers in 34 countries, intends to further
reduce its head count of salaried employees to 27,200 by The firm will also have shed
21,000 union workers from the 54,000 UAW workers it employed prior to declaring
bankruptcy in the United States and close 12 to 20 plants. GM did not include its
foreign operations in Europe, Latin America, Africa, the Middle East, or Asia Pacific in
the Chapter 11 filing. Annual vehicle production capacity for the firm will decline to 10
million vehicles in 2012, compared with 15 to 17 million in 1995. The firm exited
bankruptcy with consolidated debt at $17 billion and $9 billion in 9 percent preferred
stock, which is payable on a quarterly basis. GM has a new board, with Canada and the
UAW healthcare trust each having a seat on the board.
Following bankruptcy, GM has four core brandsChevrolet, Cadillac, Buick, and
GMCthat are sold through 3,600 dealerships, down from its existing 5,969-dealer
network. The business plan calls for an IPO whose timing will depend on the firm’s
return to sufficient profitability and stock market conditions.
By offloading worker healthcare liabilities to the VEBA trust and seeding it mostly with
stock instead of cash, GM has eliminated the need to pay more than $4 billion annually
in medical costs. Concessions made by the UAW before GM entered bankruptcy have
made GM more competitive in terms of labor costs with Toyota.
Assets to be liquidated by Motors Liquidation Company (i.e., “old GM) were split into
four trusts, including one financed by $536 million in existing loans from the federal
government. These funds were set aside to clean up 50 million square feet of industrial
manufacturing space at 127 locations spread across 14 states. Another $300 million was
set aside for property taxes, plant security, and other shutdown expenses. A second trust
will handle claims of the owners of GM’s prebankruptcy debt, who are expected to get
10 percent of the equity in General Motors when the firm goes public and warrants to
buy additional shares at a later date. The remaining two trusts are intended to process
litigation such as asbestos-related claims. The eventual sale of the remaining assets
could take four years, with most of the environmental cleanup activities completed
within a decade. 1
Reflecting the overall improvement in the U.S. economy and in its operating
performance, GM repaid $10 billion in loans to the U.S. government in April 2010.
Seventeen months after emerging from bankruptcy, the firm completed successfully the
largest IPO in history on November 17, 2010, raising $23.1 billion. The IPO was
intended to raise cash for the firm and to reduce the government’s ownership in the
firm, reflecting the firm’s concern that ongoing government ownership hurt sales.
Following completion of the IPO, government ownership of GM remained at 33
percent, with the government continuing to have three board representatives.
GM is likely to continue to receive government support for years to come. In an
unusual move, GM was allowed to retain $45 billion in tax loss carryforwards, which
will eliminate the firm’s tax payments for years to come. Normally, tax losses are
preserved following bankruptcy only if the equity in the reorganized company goes to
creditors who have been in place for at least 18 months. Despite not meeting this
criterion, the Treasury simply overlooked these regulatory requirements in allowing
these tax benefits to accrue to GM. Having repaid its outstanding debt to the
government, GM continued to owe the U.S. government $36.4 billion ($50 billion less
$13.6 billion received from the IPO) at the end of 2010. Assuming a corporate marginal
tax rate of 35 percent, the government would lose another $15.75 in future tax
payments as a result of the loss carryforward. The government also is providing $7,500
tax credits to buyers of GM’s new all-electric car, the Chevrolet Volt.
Discussion Questions
1) Do you agree or disagree that the taxpayer financed bankruptcy represented the best
way to save jobs. Explain your answer.
2) Discuss the relative fairness to the various stakeholders in a bankruptcy of a more
traditional Chapter 11 bankruptcy in which a firm emerges from the protection of the
bankruptcy court following the development of a plan of reorganization versus an
expedited sale under Section 363 of the federal bankruptcy law. Be specific.
3) Identify what you believe to be the real benefits and costs of the bailout of General
Motors? Be specific.
4) The first round of government loans to GM occurred in December 2008. The firm
did not file for bankruptcy until June 1, 2009. Discuss the advantages and disadvantages
of the firm having filed for bankruptcy much earlier in 2009. Be specific.
5) What alternative restructuring strategies do you believe may have been considered
for GM? Of these, do you believe that the 363 sale in bankruptcy represented the best
course of action? Explain your answers.
Answer:
InBev Buys An American Icon for $52 Billion
For many Americans, Budweiser is synonymous with American beer, and American
beer is synonymous with Anheuser-Busch. Ownership of the American icon changed
hands on July 14, 2008, when beer giant Anheuser Busch agreed to be acquired by
Belgian brewer InBev for $52 billion in an all-cash deal. The combined firms would
have annual revenue of about $36 billion and control about 25 percent of the global
beer market and 40 percent of the U.S. market. The purchase is the largest in a wave of
consolidation in the global beer industry, reflecting an attempt to offset rising
commodity costs by achieving greater scale and purchasing power. While expecting to
generate annual cost savings of about $1.5 billion, InBev stated publicly that the
transaction is more about the two firms being complementary rather than overlapping.
The announcement marked a reversal from AB’s position the previous week when it
said publicly that the InBev offer undervalued the firm and subsequently sued InBev for
“misleading statements” it had allegedly made about the strength of its financing. To
court public support, AB publicized its history as a major benefactor in its hometown
area (St. Louis, Missouri). The firm also argued that its own long-term business plan
would create more shareholder value than the proposed deal. AB also investigated the
possibility of acquiring the half of Grupo Modelo, the Mexican brewer of Corona beer
that it did not already own to make the transaction too expensive for InBev.
While it publicly professed to want a friendly transaction, InBev wasted no time in
turning up the heat. The firm launched a campaign to remove Anheuser’s board and
replace it with its own slate of candidates, including a Busch family member. However,
AB was under substantial pressure from major investors to agree to the deal, since the
firm’s stock had been lackluster during the preceding several years. In an effort to gain
additional shareholder support, InBev raised its initial $65 bid to $70. To eliminate
concerns over its ability to finance the deal, InBev agreed to fully document its credit
sources rather than rely on the more traditional but less certain credit commitment
letters.
In an effort to placate AB’s board, management, and the myriad politicians who railed
against the proposed transaction, InBev agreed to name the new firm Anheuser-Busch
InBev and keep Budweiser as the new firm’s flagship brand and St. Louis as its North
American headquarters. In addition, AB would be given two seats on the board,
including August A. Busch IV, AB’s CEO and patriarch of the firm’s founding family.
InBev also announced that AB’s 12 U.S. breweries would remain open.
By the end of 2010, the combined firms seemed to be progressing well, with the debt
accumulated as a result of the takeover being paid off faster than planned. Earnings per
share exceeded investor expectations. The sluggish growth in the U.S. market was
offset by increased sales in Latin America. Challenges remain, however, since AB Inbev
still must demonstrate that it can restore growth in the U.S.1
Discussion Questions:
1) Why would rising commodity prices spark industry consolidation?
2) Why would the annual cost savings not be realized until the end of the third year?
3) What is a friendly takeover? Speculate as to why it may have turned hostile?
Answer:
For an acquirer evaluating a target firm in another country, the target’s cash flows can
be expressed in which of the following ways?
a. Expressed in the home country’s currency
b. Local country’s currency
c. In real terms
d. A & B only
e. A, B, and C
Answer:
In general, business alliances are not intended to become permanent arrangements. All
of the following are common reasons for terminating such arrangements except for
a. Diverging objectives of the partners
b. Successful operations resulting in merger of the partners
c. Completion of the project
d. Unexpectedly favorable financial performance
e. Antitrust considerations
Answer:
The cost of capital reflects all of the following except for
a. Cost of equity
b. The firm’s beta
c. The book value of the firm’s debt
d. The after-tax cost of interest paid by the firm
e. The risk free rate of return
Answer:
All of the following are true about a confidentiality agreement except for
a. Often applies to both the buyer and the seller
b. Stipulates the type of seller information available to the buyer and how the
information can be used
c. Limits the use of information about the seller that is publicly available
d. Includes a termination date
e. Limits the ability of either party to disclose publicly the nature of discussion between
the buyer and seller
Answer:
All of the following are true about a consent decree except for
a. Requires the merging parties to divest overlapping businesses
b. An acquirer may seek to negotiate a consent decree in advance of consummating a
deal.
c. In the absent of a consent decree, a buyer usually makes the receipt of regulatory
approval necessary to closing the deal.
d. FTC studies indicate that consent decrees have historically been largely ineffectual in
promoting competition
e. Consent decrees tend to be most effective in promoting competition if the divestitures
made by the acquiring firms are to competitors.
Answer:
The purpose of the 1968 Williams Act was to
a. Give target firm shareholders time to review takeover proposals
b. Prosecute target firm shareholders who misuse information
c. Protect target firm employees from layoffs
d. Prevent tender offers
e. Promote tender offers
Answer:
All of the following are true of the bankruptcy process except for
a. Creditors and the debtor-in-possession have considerable flexibility in working
together.
b. The purpose of creditor committees is to work with the debtor firm to develop an
acceptable reorganization plan
c. The bankruptcy judge may choose to ignore the objections of creditors and
shareholders and accept a reorganization plan.
d. The government is responsible for paying the expenses of all those who contributed
to the formulation of a reorganization plan.
e. The debtor firm may emerge from Chapter 11 as an ongoing concern or be merged
with another firm.
Answer:
AT&T (1984 2005)A POSTER CHILD
FOR RESTRUCTURING GONE AWRY
Between 1984 and 2000, AT&T underwent four major restructuring programs. These
included the government-mandated breakup in 1984, the 1996 effort to eliminate
customer conflicts, the 1998 plan to become a broadband powerhouse, and the most
recent restructuring program announced in 2000 to correct past mistakes. It is difficult
to identify another major corporation that has undergone as much sustained trauma as
AT&T. Ironically, a former AT&T operating unit acquired its former parent in 2005.
The 1984 Restructure: Changed the Organization But Not the Culture
The genesis of Ma Bell’s problems may have begun with the consent decree signed with
the Department of Justice in 1984, which resulted in the spin-off of its local telephone
operations to its shareholders. AT&T retained its long-distance and telecommunications
equipment manufacturing operations. Although the breadth of the firm’s product
offering changed dramatically, little else seems to have changed. The firm remained
highly bureaucratic, risk averse, and inward looking. However, substantial market share
in the lucrative long-distance market continued to generate huge cash flow for the
company, thereby enabling the company to be slow to react to the changing competitive
dynamics of the marketplace.
The 1996 Restructure: Lack of a Coherent Strategy
Cash accumulated from the long-distance business was spent on a variety of
ill-conceived strategies such as the firm’s foray into the personal computer business.
After years of unsuccessfully attempting to redefine the company’s strategy, AT&T once
again resorted to a major restructure of the firm. In 1996, AT&T spun-off Lucent
Technologies (its telecommunications equipment business) and NCR (a computer
services business) to shareholders to facilitate Lucent equipment sales to former AT&T
operations and to eliminate the non-core NCR computer business. However, this had
little impact on the AT&T share price.
The 1998 Restructure: Vision Exceeds Ability to Execute
In its third major restructure since 1984, AT&T CEO Michael Armstrong passionately
unveiled in June of 1998 a daring strategy to transform AT&T from a struggling
long-distance telephone company into a broadband internet access and local phone
services company. To accomplish this end, he outlined his intentions to acquire cable
companies MediaOne Group and Telecommunications Inc. for $58 billion and $48
billion, respectively. The plan was to use cable-TV networks to deliver the first fully
integrated package of broadband internet access and local phone service via the
cable-TV network.
AT&T Could Not Handle Its Early Success
During the next several years, Armstrong seemed to be up to the task, cutting sales,
general, and administrative expense’s share of revenue from 28 percent to 20 percent,
giving AT&T a cost structure comparable to its competitors. He attempted to change the
bureaucratic culture to one able to compete effectively in the deregulated environment
of the post-1996 Telecommunications Act by issuing stock options to all employees,
tying compensation to performance, and reducing layers of managers. He used AT&T’s
stock, as well as cash, to buy the cable companies before the decline in AT&T’s
long-distance business pushed the stock into a free fall. He also transformed AT&T
Wireless from a collection of local businesses into a national business.
Notwithstanding these achievements, AT&T experienced major missteps. Employee
turnover became a big problem, especially among senior managers. Armstrong also
bought Telecommunications and MediaOne when valuations for cable-television assets
were near their peak. He paid about $106 billion in 2000, when they were worth about
$80 billion. His failure to cut enough deals with other cable operators (e.g., Time
Warner) to sell AT&T’s local phone service meant that AT&T could market its services
only in regional markets rather than on a national basis. In addition, AT&T moved large
corporate customers to its Concert joint venture with British Telecom, alienating many
AT&T salespeople, who subsequently quit. As a result, customer service deteriorated
rapidly and major customers defected. Finally, Armstrong seriously underestimated the
pace of erosion in AT&T’s long-distance revenue base.
AT&T May Have Become Overwhelmed by the Rate of Change
What happened? Perhaps AT&T fell victim to the same problems many other
acquisitive companies have. AT&T is a company capable of exceptional vision but
incapable of effective execution. Effective execution involves buying or building assets
at a reasonable cost. Its substantial overpayment for its cable acquisitions meant that it
would be unable to earn the returns required by investors in what they would consider a
reasonable period. Moreover, Armstrong’s efforts to shift from the firm’s historical
business by buying into the cable-TV business through acquisition had saddled the firm
with $62 billion in debt.
AT&T tried to do too much too quickly. New initiatives such as high-speed internet
access and local telephone services over cable-television network were too small to
pick up the slack. Much time and energy seems to have gone into planning and
acquiring what were viewed as key building blocks to the strategy. However, there
appears to have been insufficient focus and realism in terms of the time and resources
required to make all the pieces of the strategy fit together. Some parts of the overall
strategy were at odds with other parts. For example, AT&T undercut its core
long-distance wired telephone business by offers of free long-distance wireless to
attract new subscribers. Despite aggressive efforts to change the culture, AT&T
continued to suffer from a culture that evolved in the years before 1996 during which
the industry was heavily regulated. That atmosphere bred a culture based on consensus
building, ponderously slow decision-making, and a low tolerance for risk.
Consequently, the AT&T culture was unprepared for the fiercely competitive
deregulated environment of the late 1990s (Truitt, 2001).
Furthermore, AT&T created individual tracking stocks for AT&T Wireless and for
Liberty Media. The intention of the tracking stocks was to link the unit’s stock to its
individual performance, create a currency for the unit to make acquisitions, and to
provide a new means of motivating the unit’s management by giving them stock in their
own operation. Unlike a spin-off, AT&T’s board continued to exert direct control over
these units. In an IPO in April 2000, AT&T sold 14 percent of AT&T’s Wireless tracking
stock to the public to raise funds and to focus investor attention on the true value of the
Wireless operations.
Investors Lose Patience
Although all of these actions created a sense that grandiose change was imminent,
investor patience was wearing thin. Profitability foundered. The market share loss in its
long-distance business accelerated. Although cash flow remained strong, it was clear
that a cash machine so dependent on the deteriorating long-distance telephone business
soon could grind to a halt. Investors’ loss of faith was manifested in the sharp decline in
AT&T stock that occurred in 2000.
The 2000 Restructure: Correcting the Mistakes of the Past
Pushed by investor impatience and a growing realization that achieving AT&T’s vision
would be more time and resource consuming than originally believed, Armstrong
announced on October 25, 2000 the breakup of the business for the fourth time. The
plan involved the creation of four new independent companies including AT&T
Wireless, AT&T Consumer, AT&T Broadband, and Liberty Media.
By breaking the company into specific segments, AT&T believed that individual units
could operate more efficiently and aggressively. AT&T’s consumer long-distance
business would be able to enter the digital subscriber line (DSL) market. DSL is a
broadband technology based on the telephone wires that connect individual homes with
the telephone network. AT&T’s cable operations could continue to sell their own fast
internet connections and compete directly against AT&T’s long-distance telephone
business. Moreover, the four individual businesses would create “pure-play” investor
opportunities. Specifically, AT&T proposed splitting off in early 2001 AT&T Wireless
and issuing tracking stocks to the public in late 2001 for AT&T’s Consumer operations,
including long-distance and Worldnet Internet service, and AT&T’s Broadband (cable)
operations. The tracking shares would later be converted to regular AT&T common
shares as if issued by AT&T Broadband, making it an independent entity. AT&T would
retain AT&T Business Services (i.e., AT&T Lab and Telecommunications Network)
with the surviving AT&T entity. Investor reaction was swift and negative. Not swayed
by the proposal, investors caused the stock to drop 13 percent in a single day. Moreover,
it ended 2000 at 17 ½, down 66 percent from the beginning of the year.
The More Things Change The More They Stay The Same
On July 10, 2001, AT&T Wireless Services became an independent company, in
accordance with plans announced during the 2000 restructure program. AT&T Wireless
became a separate company when AT&T converted the tracking shares of the
mobile-phone business into common stock and split-off the unit from the parent. AT&T
encouraged shareholders to exchange their AT&T common shares for Wireless common
shares by offering AT&T shareholders 1.176 Wireless shares for each share of AT&T
common. The exchange ratio represented a 6.5 percent premium over AT&T’s current
common share price. AT&T Wireless shares have fallen 44 percent since AT&T first
sold the tracking stock in April 2000. On August 10, 2001, AT&T spun off Liberty
Media.
After extended discussions, AT&T agreed on December 21, 2001 to merge its
broadband unit with Comcast to create the largest cable television and high-speed
internet service company in the United States. Without the future growth engine offered
by Broadband and Wireless, AT&T’s remaining long-distance businesses and business
services operations had limited growth prospects. After a decade of tumultuous change,
AT&T was back where it was at the beginning of the 1990s. At about $15 billion in late
2004, AT&T’s market capitalization was about one-sixth of that of such major
competitors as Verizon and SBC. SBC Communications (a former local AT&T
operating company) acquired AT&T on November 18, 2005 in a $16 billion deal and
promptly renamed the combined firms AT&T.
1) What were the primary factors contributing to AT&T’s numerous restructuring efforts
since 1984? How did they differ? How were they similar?
2) Why do you believe that AT&T chose to split-off its wireless operations rather than
to divest the unit? What might you have done differently?
3) Was AT&T proactive or reactive in initiating its 2000 restructuring program? Explain
your answer.
4) AT&T overpaid for many of its largest acquisitions made during the 1990s? How
might this have contributed to its subsequent restructuring efforts?
5) To what extent did AT&T’s ineffectual restructuring reflect factors beyond their
control and to what extent was it poor implementation?
6) What challenges did AT&T face in trying to split-up the company in 2000? What
might you have done differently to overcome these obstacles?
Answer:
Which of the following statements is not true?
a. Technical insolvency arises when a firm is unable to meet its obligations when they
come due.
b. Legal insolvency occurs when a firm’s liabilities exceed the fair market value of its
assets.
c. A firm must be legally insolvent to enter bankruptcy.
d. Bankruptcy is a legal proceeding which protects a debtor firm from its creditors.
e. A firm is not considered bankrupt until its petition for bankruptcy is accepted by the
court.
Answer:
Private Equity Firms Acquire Yellow Pages Business
Qwest Communications agreed to sell its yellow pages business, QwestDex, to a
consortium led by the Carlyle Group and Welsh, Carson, Anderson and Stowe for $7.1
billion. In a two stage transaction, Qwest sold the eastern half of the yellow pages
business for $2.75 billion in late This portion of the business included directories in
Colorado, Iowa, Minnesota, Nebraska, New Mexico, South Dakota, and North Dakota.
The remainder of the business, Arizona, Idaho, Montana, Oregon, Utah, Washington,
and Wyoming, was sold for $4.35 billion in late 2003. Caryle and Welsh Carson each
put in $775 million in equity (about 21 percent of the total purchase price).
Qwest was in a precarious financial position at the time of the negotiation. The telecom
was trying to avoid bankruptcy and needed the first stage financing to meet impending
debt repayments due in late 2002. Qwest is a local phone company in 14 western states
and one of the nation’s largest long-distance carriers. It had amassed $26.5 billion in
debt following a series of acquisitions during the 1990s.
The Carlyle Group has invested globally, mainly in defense and aerospace businesses,
but it has also invested in companies in real estate, health care, bottling, and
information technology. Welsh Carson focuses primarily on the communications and
health care industries. While the yellow pages business is quite different from their
normal areas of investment, both firms were attracted by its steady cash flow. Such cash
flow could be used to trim debt over time and generate a solid return. The business’
existing management team will continue to run the operation under the new ownership.
Financing for the deal will come from J.P. Morgan Chase, Bank of America, Lehman
Brothers, Wachovia Securities, and Deutsche Bank. The investment groups agreed to a
two stage transaction to facilitate borrowing the large amounts required and to reduce
the amount of equity each buyout firm had to invest. By staging the purchase, the
lenders could see how well the operations acquired during the first stage could manage
their debt load.
The new company will be the exclusive directory publisher for Qwest yellow page
needs at the local level and will provide all of Qwest’s publishing requirements under a
fifty year contract. Under the arrangement, Qwest will continue to provide certain
services to its former yellow pages unit, such as billing and information technology,
under a variety of commercial services and transitional services agreements (Qwest:
2002).
Discussion Questions:
1) Why was QwestDex considered an attractive LBO candidate? Do you think it has
significant growth potential? Explain the following statement: “A business with high
growth potential may not be a good candidate for an LBO.
2) Why did the buyout firms want a 50-year contract to be the exclusive provider of
publishing services to Qwest Communications?
3) Why would the buyout firms want Qwest to continue to provide such services as
billing and information technology support? How might such services be priced?
4) Why would it take five very large financial institutions to finance the transactions?
5) Why was the equity contribution of the buyout firms as a percentage of the total
capital requirements so much higher than amounts contributed during the 1980s?
Answer:
The Anatomy of a Transaction: K2 Incorporated Acquires Fotoball USA
Our story begins in the early 2000s. K2is a sporting goods equipment manufacturer
whose portfolio of brands includes Rawlings, Worth, Shakespeare, Pflueger, Stearns,
K2, Ride, Olin, Morrow, Tubbs and Atlas. The company’s diversified mix of products is
used primarily in team and individual sports activities, and its primary customers are
sporting goods retailers, many of which are not strongly capitalized. Historically, the
firm has been able to achieve profitable growth by introducing new products into
fast-growing markets. Most K2 products are manufactured in China, which helps ensure
cost competitiveness but also potentially subjects the company to a variety of global
uncertainties.
K2’s success depends on its ability to keep abreast of changes in taste and style and to
offer competitive prices. The company’s external analysis at the time showed that the
most successful sporting goods suppliers will be those with the greatest resources,
including both management talent and capital, the ability to produce or source
high-quality, low-cost products and deliver them on a timely basis, and access to
distribution channels with a broad array of products and brands. Management expected
that large retailers would prefer to rely on fewer and larger sporting goods suppliers to
help them manage the supply of products and the allocation of shelf space.
The firm’s primary customers are sporting goods retailers. Many of K2’s smaller
retailers and some larger retailers were not strongly capitalized. Adverse conditions in
the sporting goods retail industry could adversely impact the ability of retailers to
purchase K2 products. Secondary customers included individuals, both hobbyists as
well as professionals.
The firm had a few top competitors, but there were other large sporting goods suppliers
with substantial brand recognition and financial resources with whom K2 did not
compete. However, they could easily enter K2’s currently served markets. In the
company’s secondary business, sports apparel, it did face stiff competition from some of
these same suppliers, including Nike and Reebok.
K2’s internal analysis showed that the firm was susceptible to imitation, despite strong
brand names, and that some potential competitors had substantially greater financial
resources than K2. One key strength was the relationships K2 had built with collegiate
and professional leagues and teams, not easily usurped. Larger competitors may have
had the capacity to take some of these away, but K2 had so many that it could withstand
the loss of one or two. The primary weakness of K2 was its relatively small size in
comparison to major competitors.
As a long-term, strategic objective, K2 set out to be number one in market share in the
markets it served by becoming the low-cost supplier. To that end, K2 wanted to meet or
exceed its corporate cost of capital of 15 percent; achieve sustained double-digit
revenue growth, gross profit margins above 35 percent, and net profit margins in excess
of 5 percent within five years; and reduce its debt-to-equity ratio to the industry average
of 25 percent in the same period. The business strategy for meeting this objective was
to become the low-cost supplier in new niche segments of the sporting goods and
recreational markets. The firm would use its existing administrative and logistical
infrastructure to support entry into these new segments, new distribution channels, and
new product launches through existing distribution channels. Also, K2 planned to
continue its aggressive cost cutting and expand its global sourcing to include low-cost
countries other than China.
All this required an implementation strategy. K2 decided to avoid product or market
extension through partnering because of the potential for loss of control and for creating
competitors once such agreements lapse. Rather, the strategy would build on the firm’s
great success, in recent years, acquiring and integrating smaller sporting goods
companies with well-established brands and complementary distribution channels. To
that end, M&A-related functional strategies were developed. A potential target for
acquisition would be a company that holds many licenses with professional sports
teams. Through its relationship with those teams, K2 could further promote its line of
sporting gear and equipment.
In addition, K2 planned to increase its R&D budget by 10 percent annually over five
years to focus on developing equipment and apparel that could be offered to the
customer base of firms it acquired during the period. Existing licensing agreements
between a target firm and its partners could be enhanced to include the many products
K2 now offers. If feasible, the sales force of a target firm would be merged with that of
K2 to realize significant cost savings.
K2 also thought through the issue of strategic controls. The company had incentive
systems in place to motivate work towards implementing its business strategy. There
were also monitoring systems to track the actual performance of the firm against the
business plan.
In its acquisition plan, K2’s overarching financial objective was to earn at least its cost
of capital. The plan’s primary non-financial objective was to acquire a firm with
well-established brands and complementary distribution channels. More specifically,
K2 sought an acquisition with a successful franchise in the marketing and
manufacturing of souvenir and promotional products that could be easily integrated into
K2’s current operations.
The acquisition plan included an evaluation of resources and capabilities. K2
established that after completion of a merger, the target’s sourcing and manufacturing
capabilities must be integrated with those of K2, which would also retain management,
key employees, customers, distributors, vendors and other business partners of both
companies. An evaluation of financial risk showed that borrowing under K2’s existing
$205 million revolving credit facility and under its $20 million term loan, as well as
potential future financings, could substantially increase current leverage, which could
among other things adversely affect the cost and availability of funds from commercial
lenders and K2’s ability to expand its business, market its products, and make needed
infrastructure investments. If new shares of K2 stock were issued to pay for the target
firm, K2 determined that its earnings per share could be diluted unless anticipated
synergies were realized in a timely fashion. Moreover, overpaying for any firm could
result in K2 failing to earn its cost of capital.
Ultimately, management set some specific preferences: the target should be smaller than
$100 million in market capitalization and should have positive cash flows, and it should
be focused on the sports or outdoor activities market. The initial search, by K2’s
experienced acquisition team, would involve analyzing current competitors. The
acquisition would be made through a stock purchase and K2 chose to consider only
friendly takeovers involving 100 percent of the target’s stock and the form of payment
would be new K2 non-voting common stock. The target firm’s current year P/E should
not exceed 20.
After an exhaustive search, K2 identified Fotoball USA as its most attractive target due
to its size, predictable cash flows, complementary product offering, and many licenses
with most of the major sports leagues and college teams. Fotoball USA represented a
premier platform for expansion of K2’s marketing capabilities because of its expertise
in the industry and place as an industry leader in many sports and entertainment
souvenir and promotional product categories. K2 believed the fit with the Rawlings
division would make both companies stronger in the marketplace. Fotoball also had
proven expertise in licensing programs, which would assist K2 in developing additional
revenue sources for its portfolio of brands. In 2003, Fotoball had lost $3.2 million, so it
was anticipated that they would be receptive to an acquisition proposal and that a
stock-for-stock exchange offer would be very attractive to Fotoball shareholders
because of the anticipated high earning growth rate of the combined firms.
Negotiations ensued, and the stock-for-stock offer contained a significant premium,
which was well received. Fotoball is a very young company and many of its investors
were looking to make their profits through the growth of the stock. The offer would
allow Fotoball shareholders to defer taxes until they decided to sell their stocks and be
taxed at the capital gains rate. An earn-out was also included in the deal to give
management incentives to run the company effectively and meet deadlines in a timely
order.
Valuations for both K2 and Fotoball reflected anticipated synergies due to economies of
scale and scope, namely, reductions in selling expenses of approximately $1 million per
year, in distribution expenses of approximately $500,000 per year, and in annual G&A
expenses of approximately $470,000. The combined market value of the two firms was
estimated at $909 million an increase of $82.7 million over the sum of the standalone
values of the two firms.
Based on Fotoball’s outstanding common stock of 3.6 million shares, and the stock
price of $4.02 at that time, a minimum offer price was determined by multiplying the
stock price by the number of shares outstanding. The minimum offer price was $14.5
million. Were K2 to concede 100 percent of the value of synergy to Fotoball, the value
of the firm would be $97.2 million. However, sharing more than 45 percent of synergy
with Fotoball would have caused a serious dilution of earnings. To determine the
amount of synergy to share with Fotoball’s shareholders, K2 looked at what portion of
the combined firms revenues would be contributed by each of the players and then
applied that proportion to the synergy. Since 96 percent of the projected combined firms
revenues in fiscal year 2004 were expected to come from K2, only 4 percent of the
synergy value was added to the minimum offer price to come up with an initial offer
price of $17.8 million, or $4.94 per share. That represented a premium of 23 percent
over the market value of Fotoball’s stock at the time.
The synergies and the Fotoball’s relatively small size compared to K2 made it unlikely
that the merger would endanger K2’s credit worthiness or near-term profitability.
Although the contribution to earnings would be relatively small, the addition of
Fotoball would help diversify and smooth K2’s revenue stream, which had been subject
to seasonality in the past.
Organizationally, the integration of Fotoball into K2 would be achieved by operating
Fotoball as a wholly owned subsidiary of K2, with current Fotoball management
remaining in place. All key employees would receive retention bonuses as a condition
of closing. Integration teams consisting of employees from both firms were set to move
expeditiously according to a schedule established prior to closing the deal. The
objective would be to implement the best practices of both firms.
On January 26, 2004, K2 Inc. completed the purchase of Fotoball USA in an all-stock
transaction. Immediately after, senior K2 managers communicated (on-site, where
possible) with Fotoball customers, suppliers, and employees to allay any immediate
concerns.
Discussion Questions:
1) How did K2’s acquisition plan objective support the realization of its corporate
mission and strategic objectives?
2) What alternatives to M&As could K2 have employed to pursue its growth strategy?
Why were the
alternatives rejected?
3) What was the role of ‘strategic controls” in implementing the K2 business plan?
4) How did the K2 negotiating strategy seek to meet the primary needs of the Fotoball
shareholders
and employees?
Answer:
The share exchange ratio is defined as
a. Offer price for the target divided by the acquirer’s share price
b. Offer price for the target divided by the target’s share price
c. Acquirer’s share price divided by the target’s share price
d. Target’s share price divided by the offer price
e. Acquirer’s share price divided by the offer price
Answer:
Which one of the following is not an example of a horizontal merger?
a. NationsBank and Bank of America combine
b. U.S. Steel and Marathon Oil combine
c. Exxon and Mobil Oil combine
d. SBC Communications and Ameritech Communications combine
e. Hewlett Packard and Compaq Computer combine
Answer:
All of the following are true of the U.S. Foreign Corrupt Practices Act except for which
of the following:
a. The U.S. law carries anti-bribery limitations beyond U.S. political boundaries to
within the domestic boundaries of foreign states.
b. This Act prohibits individuals, firms, and foreign subsidiaries of U.S. firms from
paying anything of value to foreign government officials in exchange for obtaining new
business or retaining existing contracts.
c. The Act permits so-called facilitation payments to foreign government officials if
relatively small amounts of money are required to expedite goods through foreign
custom inspections, gain approvals for exports, obtain speedy passport approvals, and
related considerations.
d. The payments described in c above are considered legal according to U.S. law and
the laws of countries in which such payments are considered routine
e. Bribery is necessary if a U.S. company is to win a contract that comprises more than
10% of its annual sales.
Answer:
LBO investors must be very careful not to overpay for a target firm because
a. Major competitors tend to become more aggressive when a firm takes on large
amounts of debt
b. High leverage increases the break-even point of the firm
c. Projected cash flows are often subject to significant error limiting the ability of the
firm to repay its debt
d. A and B only
e. A, B, and C
Answer:
The development of search criteria is included in which of the following activities?
a. Development of a business plan
b. Development of the acquisition plan
c. Post-closing integration
d. Post-closing evaluation of the acquisition process
e. None of the above
Answer:
A collaborative arrangement is a term used by regulators to describe agreements among
competitors for all of the following except for
a. Joint ventures
b. Strategic alliances
c. Mergers and acquisitions
d. A & B only
e. A & C only
Answer:
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
Answer:
Which of the following are non-taxable transactions?
a. Statutory stock merger or consolidation
b. Stock for stock merger
c. Stock for assets merger
d. Triangular reverse stock merger
e. All of the above
Answer:
Which of the following is not true about purchase accounting?
a. For financial reporting purposes, all M&As must be recorded using the purchase
method of accounting.
b. Under the purchase method of accounting, the excess of the purchase price over the
target’s net asset value is treated as goodwill on the combined firm’s balance sheet.
c. Goodwill may be amortized up to 40 years.
d. If the fair value of the target’s net assets later falls below its carrying value, the
acquirer must record a loss equal to the difference.
e. None of the above
Answer:
An investor group borrowed the money necessary to buy all of the stock of a company.
Which of the following
terms best describes this transaction?
a. Merger
b. Consolidation
c. Leveraged buyout
d. Tender offer
e. Joint venture
Answer:
Which of the following characteristics of a firm would limit the firm’s attractiveness as
a potential LBO candidate?
a. Substantial tangible assets
b. High reinvestment requirements
c. High R&D requirements
d. B and C
e. All of the above
Answer:
Which of the following factors often affects hostile takeover bids?
a. The takeover premium
b. The composition of the board of the target firm
c. The composition of the ownership of the target’s stock
d. The target’s bylaws
e. All of the above
Answer:
Which of the following factors affect customer attrition that normally accompanies
post-merger integration?
a. Customer uncertainty about on-time delivery
b. More aggressive pricing from competitors
c. Deteriorating customer services
d. Deteriorating product quality
e. All of the above
Answer: