Market share is usually easy to define. True or False
Answer:
The adjusted present value method values firm without debt and then subtracts the
value of future tax savings resulting from the tax-deductibility of interest. True or False
Answer:
Environmental laws in the European Union are generally more restrictive than in the
U.S. True or False
Answer:
Highly decentralized organizational structures generally expedite the integration effort
more so than highly centralized structures. True or False
Answer:
Market-based valuation methods are less prone to manipulation than discounted cash
flow methods because they require a more detailed statement of assumptions. True or
False
Answer:
Purchase accounting affects only the cash flow of the combined firms but not the
reported net income. True or False
Answer:
Holding companies can gain effective control of other companies by owning
significantly less than 100% of their outstanding voting stock. True or False
Answer:
Horizontal mergers are rarely rejected by antitrust regulators. True or False
Answer:
There is widespread agreement over the magnitude of the liquidity discount. True or
False
Answer:
A business plan articulates a mission or vision for the firm and a strategy for realizing
that mission. True or False
Answer:
The enterprise or free cash flow to the firm approach to valuation discounts the after-tax
free cash flow available to the firm from operations at the weighted average cost of
capital to obtain the enterprise value. True or False
Answer:
A sudden improvement in operating profits in the year in which the business is being
offered for sale may suggest that both revenue and expenses had been overstated during
the historical period.
True or False
Answer:
Asset sales by the target firm just prior to the transaction may threaten the tax-free
status of the deal. Moreover, tax-free deals are disallowed within ten-years of a spin-off.
True or False
Answer:
Managers and owners in public companies are likely to have the same emotional
attachment to their businesses as those in private firms. True or False
Answer:
Mergers and acquisitions rarely pay off for target firm shareholders, but they are usually
beneficial to acquiring firm shareholders. True or False
Answer:
Type A reorganizations are generally viewed as the least flexible of the various types of
tax-free reorganizations. True or False
Answer:
Stock purchases involve the exchange of the target’s stock for cash, debt, stock of the
acquiring company, or some combination. True or False
Answer:
If the tangible book value of a firm significantly exceeds its market value for an
extended period of time, it can become an attractive takeover target. True or False
Answer:
Form of payment refers only to the acquirer’s common stock used to make up the
purchase price paid to target shareholders. True or False
Answer:
In applying the adjusted present value method, the present value of a highly leveraged
transaction should reflect the present value of the firm without leverage plus the present
value of tax savings plus the present value of expected financial distress. True or False
Answer:
Confidentiality agreements are usually signed before any information is exchanged to
protect the buyer and the seller from loss of competitive information. True or False
Answer:
The acquisition vehiclerefers to the legal structure created to acquire the target
company. True or False
Answer:
Improper revenue recognition is the most common form of financial reporting fraud.
True or False
Answer:
Tangible book value is the value of shareholders’ equity less net fixed assets. True or
False
Answer:
Investors in segmented markets will bear a lower level of risk by holding a
disproportionately large share of their investments in their local market as opposed to
the level of risk if they invested in a globally diversified portfolio. True or False
Answer:
The availability and reliability of data for public companies tends to be much greater
than for small private firms. True or False
Answer:
Unlike a limited partnership, the LLC is taxed on all profits before they are paid out to
its members. True or False
Answer:
The current stock price of the acquiring firm may decline, reflecting a potential dilution
of its EPS or a growth in EPS of the combined firms, which is less than the growth that
investors had anticipated for the acquirer as a standalone business. True or False
Answer:
Business alliances may represent attractive alternatives to mergers and acquisitions.
True or False
Answer:
The acquired company should be fully integrated into the acquiring company if an
earn-out is used to consummate the transaction. True or False
Answer:
Operational restructuring refers to the outright or partial sale of companies or product
lines or to downsizing by closing unprofitable or non-strategic facilities. True or False
Answer:
The most important calculation to the financial sponsor in an LBO analysis is the IRR.
True or False
Answer:
In the absence of a voluntary settlement out of court, the debtor firm may seek
protection from its creditors by initiating bankruptcy. However, creditors cannot force
the debtor firm into bankruptcy. True or False
.
Answer:
Firms with significant expertise, brands, patents, copyrights, and proprietary
technologies seek to grow by exploiting these advantages in emerging markets. True or
False
Answer:
The total purchase price paid by the buyer should also reflect the assumption of
liabilities stated on the target’s balance sheet, but it should exclude all off balance sheet
liabilities. True or False
Answer:
The tax status of the transaction may influence the purchase price by
a. Raising the price demanded by the seller to offset potential tax liabilities
b. Reducing the price demanded by the seller to offset potential tax liabilities
c. Causing the buyer to lower the purchase price if the transaction is taxable to the
target firm’s shareholders
d. Forcing the seller to agree to defer a portion of the purchase price
e. Forcing the buyer to agree to defer a portion of the purchase price
Answer:
A diversified automotive parts supplier has decided to sell its valve manufacturing
business. This sale is referred to as a
a. Merger
b. Divestiture
c. Spin-off
d. Equity carveout
e. Liquidation
Answer:
Which other types of legislation can have a significant impact on a proposed
transaction?
a. State anti-takeover laws
b. State antitrust laws
c. Federal benefits laws
d. Federal and state environmental laws
e. All of the above
Answer:
Conoco Phillips Buys a Stake in Russian Oil Giant Lukoil
In late 2004, Conoco Phillips (Conoco) announced the purchase of 7.6 percent of
Lukoil’s (a largely government owned Russian oil and gas company) stock for $2.36
billion during a government auction of Lukoil’s stock. The deal gives Conoco access to
Russia’s huge, but largely undeveloped, oil and natural gas reserves. Conoco intends to
boost its investment to 10 percent by yearend and to 20 percent within two-to-three
years. To help ensure that Conoco’s interests are protected, even though it has only a
minority position, Conoco will have one seat on Lukoil’s board and Lukoil changed its
corporate charter to require unanimous board approval for the most important decisions
such as payment of dividends and major new investments. Conoco will gain one
additional seat once its ownership share climbs to 20 percent. Conoco has also agreed to
pay $370 million to Lukoil for a 30 percent stake in a joint venture to develop reserves
in northern Russia. The two firms will split operational responsibilities equally.
Conoco’s stock fell more than 1 percent immediately following the announcement.
Discussion Questions:
1) Describe the operational and managerial challenges facing the two partners.
2) Do you believe that Conoco gained an effective say in Lukoil’s operations following
its investment? Explain your answer.
3) Why do you believe Conoco’s stock fell immediately following the announcement?
Answer:
Which of the following represent common international market entry strategies?
a. Mergers and acquisitions
b. Licensing
c. Exporting
d. Greenfield or solo ventures
e. All of the above
Answer:
The Bankruptcy Abuse Prevention and Creditor Protection Act of 2005 is intended to
achieve all of the following except:
a. To reduce the maximum length of time debtors have to submit a reorganization plan
b. To give debtors more time to accept or reject leases
c. To limit key employee compensation
d. To enable the debtor to extend the lease indefinitely as long as lease payments are
made on a timely basis
e. B and D only
Answer:
Which of the following is not true about generally accepted accounting principles
(GAAP)?
a. GAAP provide specific guidelines as to how to account for specific events impacting
the financial performance of the firm.
b. The scrupulous application GAAP accounting rules does ensure consistency in
comparing one firm’s financial performance to another.
c. It is customary for definitive agreements of purchase and sale to require that a target
company represent that its financial books are kept in accordance with GAAP.
d. GAAP guarantees that a firm’s financial books are accurate.
e. Differences between how a firm records actual financial transactions and how they
should be recorded based on GAAP may indicate fraud or mismanagement.
Answer:
The market governance model is applicable when which of the following conditions are
true?
a. Capital markets are liquid
b. Equity ownership is widely dispersed
c. Ownership and control are separate
d. Board members are largely independent
e. All of the above
Answer:
.
Deb Ltd. Seeks an Exit Strategy
In late 2004, Barclay’s Private Equity acquired slightly more than one half the equity in
Deb Ltd. (Deb), valued at about $250 million. The private equity arm of Britain’s
Barclay’s bank outbid other suitors in an auction to acquire a controlling interest in the
firm. PriceWaterhouseCooper had been hired by the Williamson family, the primary
stockholder in the firm, to find a buyer.
The sale solved a dilemma for Nick Williamson, the firm’s CEO and son of the founder,
who had invented the firm’s flagship product, Swarfega. The company had been
founded some 60 years earlier based on a single product, a car cleaning agent. Since
then, the Swarfega brand name had grown into a widely known brand associated with a
broad array of cleaning products.
In 1990, the elder Williamson wanted to retire and his son Nick, along with business
partner Roy Tillead, bought the business from his father. Since then, the business has
continued to grow, and product development has accelerated. The company developed
special Swarfega-dispensing cartridges that have applications in hospitals, clinics, and
other medical faculties.
After 13 years of sustained growth, Williamson realized that some difficult decisions
had to be made. He knew he did not have a natural successor to take over the company.
He no longer believed the firm could be managed successfully by the same
management team. It was now time to think seriously about succession planning. So in
early 2004, he began to seek a buyer for the business. He preferably wanted somebody
who could bring in new talents, ideas, and up-to-date management techniques to
continue the firm’s growth.
The terms of the agreement called for Williamson to work with a new senior
management team until Barclays decided to take the firm public. This was expected
some time during the five-to-seven year period following the sale. At that point,
Williamson would sell the remainder of his family’s stock in the business (Goodman,
2005).
Discussion Questions
1) Succession planning issues are often a reason for family-owned businesses to sell.
Why do you believe it may have been easier for Nick than his father to sell the business
to a non-family member?
2) What other alternatives could Nick have pursued? Discuss the advantages and
disadvantages of each.
3)What do you believe might be some of the unique challenges in valuing a
family-owned business? Be specific.
Answer:
Pixar and Disney Part Company
The announcement on February 5, 2004, of the end of the wildly successful partnership
between Walt Disney Company (“Disney”) and Pixar Animation Studios (“Pixar”)
rocked the investment and entertainment world. While the partnership continued until
the end of 2005, the split-up underscores the nature of the rifts that can develop in
business alliances of all types. The dissolution of the partnership ends a relationship in
existence since 1995 in which Disney produced and distributed the highly popular films
created by Pixar. Under the terms of the original partnership agreement, the two firms
cofinanced each film and split the profits evenly. Moreover, Disney received 12.5
percent of film revenues for distributing the films. Negotiations to renew the
partnership after 2005 foundered on Pixar’s desire to get a greater share of the
partnership’s profits. Disney CEO Michael Eisner refused to accept a significant
reduction in distribution fees and film royalties; while Steve Jobs, Pixar’s CEO,
criticized Disney’s creative capabilities and noted that marketing alone does not make a
poor film successful.
After 10 months of talks between Disney and Pixar, Disney rejected a deal that would
have required it to earn substantially less from future Pixar releases. Disney also would
have had to relinquish potentially lucrative copyrights to existing films such as Toy
Story and Finding Nemo. Disney shares immediately fell by almost 2 percent on the
news of the announcement, while Pixar’s shares skyrocketed almost 4 percent by the
end of the day. Pixar contributed more than 50 percent of Disney Studio’s operating
profits, and Disney Studios accounted for about one fourth of Disney’s total operating
profits. While Disney now faces Pixar as a competitor, it retains the rights to make
video and theatrical sequels and TV shows to the movies covered by the current
partnership agreement. However, while Disney does retain the right to make sequels to
Pixar films, it does not own the underlying technology and must recreate the millions of
lines of computer code for each character.
The key challenge for Disney will be to fill the creative vacuum left by the loss of Pixar
writers and animators. Disney is particularly vulnerable in that it has severely cut back
its own feature animation department and stumbled in recent years with a variety of box
office duds (e.g., Treasure Planet). Reflecting concern that Disney would not be able to
compete with Pixar, bond-rating service, Fitch Ratings suggested a possible downgrade
of Disney debt. Pixar announced that it was seeking another production studio.
Immediately following this announcement, Sony and others approached Pixar with
proposals to collaborate in making animated films.
Epilogue
In early 2006, Pixar agreed to be acquired by Disney.
Discussion Questions:
1) In your opinion, what were the motivations for forming the Disney-Pixar partnership
in 1995? Which partner do you believe had the greatest leverage in these negotiations?
Explain your answer.
2) What happened since 1995 that might have contributed to the break-up? (Hint:
Consider partner objectives, perceived relative contribution and in-house capabilities.)
3) How does the dissolution of the partnership leave Disney vulnerable? What could
Disney have done to protect itself from these vulnerabilities in the original
negotiations? (Hint: Consider scope of the agreement, management and control, dispute
resolution mechanisms, valuation of tangible and intangible assets, ownership of
partnership assets following dissolution, performance criteria)
4) What does the reaction of the stock market and credit rating agencies tell you about
how investors value the contribution of the two partners to the partnership? Do you
think investors may have over-reacted?
Answer:
Autos R Us and Pre-owned Inc represent used car dealers that compete in the same city.
These competitors each invest $15 million to form a new, jointly owned company, Real
Value Inc, that will sell cars in a nearby city. The new firm is best described by which of
the following terms:
a. Merger
b. Acquisition
c. Leveraged buyout
d. Joint venture
e. Consolidation
Answer:
Fair market value is
a. The cash or cash equivalent value that a willing buyer would pay or seller would
accept for a business
b. The cash or cash equivalent value that a willing buyer would pay or seller would
accept for a business, assuming each had access to all necessary information
c. The cash or cash equivalent value that a willing buyer would pay or seller would
accept for a business, assuming each had access to all necessary information and that
neither party is under duress.
d. The discounted value of free cash flow to the firm
e. The discounted value of free cash flow to equity investors.
Answer:
Which of the following are generally considered restructuring activities?
a. A merger
b. An acquisition
c. A divestiture
d. A consolidation
e. All of the above
Answer:
Studies show that which of the following combinations of corporate defenses can be
most effective in discouraging
hostile takeovers?
a. Poison pills and staggered boards
b. Poison pills and golden parachutes
c. Golden parachutes and staggered boards
d. Standstill agreements and White Knights
e. Poison Pills and tender offers
Answer:
Which of the following is generally not true about communication during the
integration period?
a. Communication should be as frequent as possible
b. Employees should be sheltered from bad news
c. The CEO of the combined firms should lead the effort to communicate to employees
at all levels
d. Regularly scheduled employee meetings are often the best way to communicate
progress to plan
e. The reasons for changing work practices and compensation must be thoroughly
explained to employees
Answer:
Premiums paid to LBO firm shareholders average
a. 20%
b. 70%
c. 5%
d. Less than typical mergers
e. More than typical mergers
Answer:
Which of the following is not true of licensing?
a. Licensing allows a firm to purchase the right to manufacture and sell another firm’s
products within a specific country or set of countries.
b. The licensor is normally paid a royalty on each unit sold.
c. Licensors have considerable control the manufacturing and marketing of their
products marketed in foreign countries.
d. The licensee takes the risks and makes the investments in facilities for
manufacturing, marketing and distribution of goods and services.
e. Licensing is an increasingly popular entry mode for smaller firms with insufficient
capital and limited brand recognition.
Answer:
Which of the following is the most common reason that M&As often fail to meet
expectations?
a. Overpayment
b. Form of payment
c. Large size of target firm
d. Inadequate post-merger due diligence
e. Poor post-merger communication
Answer:
Which of the following is a common problem associated with tracking stocks?
a. Tracking stocks often de-motivate managers of the business for which the stock is
created
b. Such stocks are too complicated for investors to understand
c. Tracking stocks may create internal operating conflicts among the parent’s business
units
d. Such stocks often create huge tax liabilities for the parent
e. None of the above
Answer:
Which of the following is not a characteristic of a spin-off?
a. The parent creates a new legal subsidiary for the business to be spun-off
b. The shares of the new subsidiary are sold to the public
c. The ownership of shares in the new legal subsidiary is the same as the stockholders’
proportional ownership of shares in the parent firm
d. The new business once spun-off has its own management and board
e. Spin-offs are generally not taxable to the parent’s shareholders if properly structured
Answer:
Which one of the following factors is not considered calculating a firm’s PEG ratio?
a. Projected growth rate of the value indicator (e.g., earnings)
b. Ratio of market price to value indicator (e.g., P/E)
c. Share exchange ratio
d. Historical growth rate of the value indicator
e. None of the above
Answer:
Which of the following statements about the comparable companies’ valuation method
is not true?
a. Requires the use of firms that are ‘substantially” similar to the target firm
b. Uses market based rather than cash flow based valuations
c. Often used as the basis of investment banker fairness opinions
d. Generally provides the most accurate valuation method
e. Provides an estimate of the target firm at a moment in time.
Answer:
Which of the following is not typically true of post-closing evaluation of an
acquisition?
a. It is important not to change the performance benchmarks against which the
acquisition is measured
b. It is critical to ask the tough questions
c. It is an opportunity to learn from mistakes
d. It is commonly done
e. It is frequently avoided by acquiring firms because of the potential for
embarrassment.
Answer:
Factors that are most likely to contribute to the magnitude of premiums paid to LBO
target firm shareholders are
a. Tax benefits
b. Improved operating efficiency
c. Improved decision making
d. A, B, and C
e. A and C only
Answer:
Inside M&A. Financial Services Firms Streamline their Operations
During 2005 and 2006, a wave of big financial services firms announced their
intentions to spin-off operations that did not seem to fit strategically with their core
business. In addition to realigning their strategies, the parent firms noted the favorable
tax consequences of a spin-off, the potential improvement in the parent’s financial
returns, the elimination of conflicts with customers, and the removal of what, for some,
had become a management distraction.
American Express announced plans in early 2005 to jettison its financial advisory
business through a tax-free spin-off to its shareholders. The firm also noted that it
would incur significant restructuring-related expenses just before the spin-off. Such
one-time write-offs by the parent are sometimes necessary to “clean up” the balance
sheet of the unit to be spun off and unburden the newly formed company’s earnings
performance. American Express anticipated substantial improvement in future financial
returns on assets as it will be eliminating more than $410 billion in assets from its
balance sheet that had been generating relatively meager earnings.
Investment bank Morgan Stanley announced in mid-2005 its intent to spin-off its
Discover Credit Card operation. While Discover Card generated about one fifth of the
firm’s pretax profits, Morgan Stanley had been unable to realize significant synergies
with its other operations. The move represented an attempt by senior Morgan Stanley
management to mute shareholder criticism of the company’s lackluster stock
performance due to what many viewed had been the firm’s excessive diversification.
Similarly, J.P. Morgan Chase announced plans in 2006 to spin off its $13 billion private
equity fund, J.P. Morgan Partners. The bank would invest up to $1 billion in a new fund
J.P. Morgan Partners plans to open as a successor to the current Global Fund. Because
the bank’s ownership position would be less than 25 percent, it would be classified as a
passive partner. The expectation is that, by jettisoning this operation, the bank would be
able to reduce earnings volatility and decrease competition between the bank and large
customers when making investments.
Discussion Questions:
1) Speculate as to why a firm may choose to spin-off rather than divest a business?
2) In what ways might the spin-offs harm parent firm shareholders?
Answer:
Stakeholders include which of the following groups?
a. Shareholders
b. Customers
c. Lenders
d. Suppliers
e. All of the above
Answer:
To decide if a business is worth more to the shareholder if sold, the parent firm
generally considers all of the following factors except for
a. The after-tax cash flows of the business to be sold
b. The after-tax sale value of the business to be sold
c. The parent’s cost of capital
d. A and B
e. A, B, and C
Answer:
The following takeover defenses are generally put in place by a firm before a takeover
attempt is
initiated.
a. Standstill agreements
b. Poison pills
c. Recapitalization
d. Corporate restructuring
e. Greenmail
Answer:
Which of the following tends to be true of LBOs
a. LBOs rely heavily on management incentives to improve operating performance
b. The premium paid to target firm shareholders often exceeds 40%
c. Tax benefits are predictable and are built into the purchase price premium
d. The cost of equity is likely to change as the LBO repays debt
e. All of the above
Answer:
Alcatel Merges with Lucent, Highlighting Cross-Cultural Issues
Alcatel SA and Lucent Technologies signed a merger pact on April 3, 2006, to form a
Paris-based telecommunications equipment giant. The combined firms would be led by
Lucent’s chief executive officer Patricia Russo. Her charge would be to meld two
cultures during a period of dynamic industry change. Lucent and Alcatel were
considered natural merger partners because they had overlapping product lines and
different strengths. More than two-thirds of Alcatel’s business came from Europe, Latin
America, the Middle East, and Africa. The French firm was particularly strong in
equipment that enabled regular telephone lines to carry high-speed Internet and digital
television traffic. Nearly two-thirds of Lucent’s business was in the United States. The
new company was expected to eliminate 10 percent of its workforce of 88,000 and save
$1.7 billion annually within three years by eliminating overlapping functions.
While billed as a merger of equals, Alcatel of France, the larger of the two, would take
the lead in shaping the future of the new firm, whose shares would be listed in Paris, not
in the United States. The board would have six members from the current Alcatel board
and six from the current Lucent board, as well as two independent directors that must
be European nationals. Alcatel CEO Serge Tehuruk would serve as the chairman of the
board. Much of Ms. Russo’s senior management team, including the chief operating
officer, chief financial officer, the head of the key emerging markets unit, and the
director of human resources, would come from Alcatel. To allay U.S. national security
concerns, the new company would form an independent U.S. subsidiary to administer
American government contracts. This subsidiary would be managed separately by a
board composed of three U.S. citizens acceptable to the U.S. government.
International combinations involving U.S. companies have had a spotty history in the
telecommunications industry. For example, British Telecommunications PLC and
AT&T Corp. saw their joint venture, Concert, formed in the late 1990s, collapse after
only a few years. Even outside the telecom industry, transatlantic mergers have been
fraught with problems. For example, Daimler Benz’s 1998 deal with Chrysler, which
was also billed as a merger of equals, was heavily weighted toward the German
company from the outset.
In integrating Lucent and Alcatel, Russo faced a number of practical obstacles,
including who would work out of Alcatel’s Paris headquarters. Russo, who became
Lucent’s chief executive in 2000 and does not speak French, had to navigate the
challenges of doing business in France. The French government has a big influence on
French companies and remains a large shareholder in the telecom and defense sectors.
Russo’s first big fight would be dealing with the job cuts that were anticipated in the
merger plan. French unions tend to be strong, and employees enjoy more legal
protections than elsewhere. Hundreds of thousands took to the streets in mid-2006 to
protest a new law that would make it easier for firms to hire and fire younger workers.
Russo has extensive experience with big layoffs. At Lucent, she helped orchestrate
spin-offs, layoffs, and buyouts involving nearly four-fifths of the firm’s workforce.
Making choices about cuts in a combined company would likely be even more difficult,
with Russo facing a level of resistance in France unheard of in the United States, where
it is generally accepted that most workers are subject to layoffs and dismissals. Alcatel
has been able to make many of its job cuts in recent years outside France, thereby
avoiding the greater difficulty of shedding French workers. Lucent workers feared that
they would be dismissed first simply because it is easier than dismissing their French
counterparts.
After the 2006 merger, the company posted six quarterly losses and took more than $4.5
billion in write-offs, while its stock plummeted more than 60 percent. An economic
slowdown and tight credit limited spending by phone companies. Moreover, the market
was getting more competitive, with China’s Huawei aggressively pricing its products.
However, other telecommunications equipment manufacturers facing the same
conditions have not fared nearly as badly as Alcatel-Lucent. Melding two
fundamentally different cultures (Alcatel’s entrepreneurial and Lucent’s centrally
controlled cultures) has proven daunting. Customers who were uncertain about the new
firm’s products migrated to competitors, forcing Alcatel-Lucent to slash prices even
more. Despite the aggressive job cuts, a substantial portion of the projected $3.1 billion
in savings from the layoffs were lost to discounts the company made to customers in an
effort to rebuild market share.
Frustrated by the lack of progress in turning around the business, the Alcatel-Lucent
board announced in July 2008 that Patricia Russo, the American chief executive, and
Serge Tchuruk, the French chairman, would leave the company by the end of the year.
The board also announced that, as part of the shake-up, the size of the board would be
reduced, with Henry Schacht, a former chief executive at Lucent, stepping down.
Perhaps hamstrung by its dual personality, the French-American company seemed
poised to take on a new personality of its own by jettisoning previous leadership.
Discussion Questions:
1) Explain the logic behind combining the two companies. Be specific.
2) What are the major challenges the management of the combined companies are
likely to face? How would you recommend resolving these issues?
3) Most corporate mergers are beset by differences in corporate cultures. How do
cross-border transactions compound these differences?
4) Why do you think mergers, both domestic and cross-border, are often communicated
by the acquirer and target firms’ management as mergers of equals?
5) In what way would you characterize this transaction as a merger of equals? In what
ways should it not be considered a merger of equals?
Answer:
Post merger earnings per share are affected by all of the following factors, except for
a. Acquiring firm’s outstanding shares
b. Price offered for the target company
c. Number of target firm’s outstanding shares
d. Current price of the acquiring company’s stock
e. Current price of the target firm’s stock
Answer:
Earn-outs tend to shift risk from the seller to the buyer in that a higher price is paid only
when the seller has met or exceeded certain performance criteria. True or False
Answer:
Which of the following best defines market segmentation
a. The identification of customers with common characteristics and needs
b. The identification of customers with heterogeneous characteristics and needs
c. The grouping of customers with different characteristics
d. The process of reducing large markets into smaller markets without regard to
customer characteristics
e. The process of identifying the various markets that comprise an industry without
regard to customer characteristics
Answer:
Each of the following is true about the acquisition search process except for
a. A candidate search should start with identifying the primary selection criteria.
b. The number of selection criteria should be as lengthy as possible.
c. At a minimum, the primary criteria should include the industry and desired size of
transaction.
d. The size of the transaction may be defined in terms of the maximum purchase price
the acquirer is willing to pay.
e. A search strategy entails the use of electronic databases, trade publications, and
querying the acquirer’s law, banking, and accounting firms for qualified candidates.
Answer:
Excess capacity in many industries often drives M&A activity as firms strive to achieve
which of the following?
a. Greater economies of scale
b. Greater economies of scope
c. Greater pricing power with customers
d. Greater pricing power with suppliers
e. All of the above
Answer:
“Grave Dancer” Takes Tribune Corporation Private in an Ill-Fated Transaction
At the closing in late December 2007, well-known real estate investor Sam Zell
described the takeover of the Tribune Company as “the transaction from hell.” His
comments were prescient in that what had appeared to be a cleverly crafted, albeit
highly leveraged, deal from a tax standpoint was unable to withstand the credit malaise
of The end came swiftly when the 161-year-old Tribune filed for bankruptcy on
December 8, 2008.
On April 2, 2007, the Tribune Corporation announced that the firm’s publicly traded
shares would be acquired in a multistage transaction valued at $8.2 billion. Tribune
owned at that time 9 newspapers, 23 television stations, a 25% stake in Comcast’s
SportsNet Chicago, and the Chicago Cubs baseball team. Publishing accounts for 75%
of the firm’s total $5.5 billion annual revenue, with the remainder coming from
broadcasting and entertainment. Advertising and circulation revenue had fallen by 9%
at the firm’s three largest newspapers (Los Angeles Times, Chicago Tribune, and
Newsday in New York) between 2004 and 2006. Despite aggressive efforts to cut costs,
Tribune’s stock had fallen more than 30% since 2005.
The transaction was implemented in a two-stage transaction, in which Sam Zell
acquired a controlling 51% interest in the first stage followed by a backend merger in
the second stage in which the remaining outstanding Tribune shares were acquired. In
the first stage, Tribune initiated a cash tender offer for 126 million shares (51% of total
shares) for $34 per share, totaling $4.2 billion. The tender was financed using $250
million of the $315 million provided by Sam Zell in the form of subordinated debt, plus
additional borrowing to cover the balance. Stage 2 was triggered when the deal received
regulatory approval. During this stage, an employee stock ownership plan (ESOP)
bought the rest of the shares at $34 a share (totaling about $4 billion), with Zell
providing the remaining $65 million of his pledge. Most of the ESOP’s 121 million
shares purchased were financed by debt guaranteed by the firm on behalf of the ESOP.
At that point, the ESOP held all of the remaining stock outstanding valued at about $4
billion. In exchange for his commitment of funds, Mr. Zell received a 15-year warrant
to acquire 40% of the common stock (newly issued) at a price set at $500 million.
Following closing in December 2007, all company contributions to employee pension
plans were funneled into the ESOP in the form of Tribune stock. Over time, the ESOP
would hold all the stock. Furthermore, Tribune was converted from a C corporation to a
Subchapter S corporation, allowing the firm to avoid corporate income taxes. However,
it would have to pay taxes on gains resulting from the sale of assets held less than ten
years after the conversion from a C to an S corporation (Figure 13.4).
Tribune deal structure.
The purchase of Tribune’s stock was financed almost entirely with debt, with Zell’s
equity contribution amounting to less than 4% of the purchase price. The transaction
resulted in Tribune being burdened with $13 billion in debt (including the approximate
$5 billion currently owed by Tribune). At this level, the firm’s debt was ten times
EBITDA, more than two and a half times that of the average media company. Annual
interest and principal repayments reached $800 million (almost three times their
preacquisition level), about 62% of the firm’s previous EBITDA cash flow of $1.3
billion. While the ESOP owned the company, it was not be liable for the debt
guaranteed by Tribune.
The conversion of Tribune into a Subchapter S corporation eliminated the firm’s current
annual tax liability of $348 million. Such entities pay no corporate income tax but must
pay all profit directly to shareholders, who then pay taxes on these distributions. Since
the ESOP was the sole shareholder, Tribune was expected to be largely tax exempt,
since ESOPs are not taxed.
In an effort to reduce the firm’s debt burden, the Tribune Company announced in early
2008 the formation of a partnership in which Cablevision Systems Corporation would
own 97% of Newsday for $650 million, with Tribune owning the remaining 3%.
However, Tribune was unable to sell the Chicago Cubs (which had been expected to
fetch as much as $1 billion) and the minority interest in SportsNet Chicago to help
reduce the debt amid the 2008 credit crisis. The worsening of the recession, accelerated
by the decline in newspaper and TV advertising revenue, as well as newspaper
circulation, thereby eroded the firm’s ability to meet its debt obligations.
By filing for Chapter 11 bankruptcy protection, the Tribune Company sought a reprieve
from its creditors while it attempted to restructure its business. Although the extent of
the losses to employees, creditors, and other stakeholders is difficult to determine, some
things are clear. Any pension funds set aside prior to the closing remain with the
employees, but it is likely that equity contributions made to the ESOP on behalf of the
employees since the closing would be lost. The employees would become general
creditors of Tribune. As a holder of subordinated debt, Mr. Zell had priority over the
employees if the firm was liquidated and the proceeds distributed to the creditors.
Those benefitting from the deal included Tribune’s public shareholders, including the
Chandler family, which owed 12% of Tribune as a result of its prior sale of the Times
Mirror to Tribune, and Dennis FitzSimons, the firm’s former CEO, who received $17.7
million in severance and $23.8 million for his holdings of Tribune shares. Citigroup and
Merrill Lynch received $35.8 million and $37 million, respectively, in advisory fees.
Morgan Stanley received $7.5 million for writing a fairness opinion letter. Finally,
Valuation Research Corporation received $1 million for providing a solvency opinion
indicating that Tribune could satisfy its loan covenants.
What appeared to be one of the most complex deals of 2007, designed to reap huge tax
advantages, soon became a victim of the downward-spiraling economy, the credit
crunch, and its own leverage. A lawsuit filed in late 2008 on behalf of Tribune
employees contended that the transaction was flawed from the outset and intended to
benefit Sam Zell and his advisors and Tribune’s board. Even if the employees win, they
will simply have to stand in line with other Tribune creditors awaiting the resolution of
the bankruptcy court proceedings.
Discussion Questions:
1) What is the acquisition vehicle, post-closing organization, form of payment, form of
acquisition, and tax strategy described in this case study?
2) Describe the firm’s strategy to finance the transaction?
3) Is this transaction best characterized as a merger, acquisition, leveraged buyout, or
spin-off? Explain your answer.
4) Is this transaction taxable or non-taxable to Tribune’s public shareholders? To its
post-transaction shareholders? Explain your answer.
5) Comment on the fairness of this transaction to the various stakeholders involved.
How would you apportion the responsibility for the eventual bankruptcy of Tribune
among Sam Zell and his advisors, the Tribune board, and the largely unforeseen
collapse of the credit markets in late 2008? Be specific.
Answer:
Financing Challenges in the Home Depot Supply Transaction
Buyout firms Bain Capital, Carlyle Group, and Clayton, Dubilier & Rice (CD&R) bid
$10.3 billion in June 2007 to buy Home Depot Inc.’s HD Supply business. HD Supply
represented a collection of small suppliers of construction products. Home Depot had
announced earlier in the year that it planned to use the proceeds of the sale to pay for a
portion of a $22.5 billion stock buyback.
Three banks, Lehman Brothers, JPMorgan Chase, and Merril Lynch agreed to provide
the firms with a $4 billion loan. The repayment of the loans was predicated on the
ability of the buyout firms to improve significantly HD Supply’s current cash flow.
Such loans are normally made with the presumption that they can be sold to investors,
with the banks collecting fees from both the borrower and investor groups. However, by
July, concern about the credit quality of subprime mortgages spread to the broader debt
market and raised questions about the potential for default of loans made to finance
highly leveraged transactions. The concern was particularly great for so-called
“covenant-lite” loans for which the repayment terms were very lenient.
Fearing they would not be able to resell such loans to investors, the three banks
involved in financing the HD Supply transaction wanted more financial protection.
Additional protection, they reasoned, would make such loans more marketable to
investors. They used the upheaval in the credit markets as a pretext for reopening
negotiations on their previous financing commitments. Home Depot was willing to
lower the selling price thereby reducing the amount of financing required by the buyout
firms and was willing to guarantee payment in the event of default by the buyout firms.
While Bain, Carlyle, and CD&R were willing to increase their cash investment and pay
higher fees to the banks, they were unwilling to alter the original terms of the loans.
Eventually the banks agreed to provide financing consisting of a $1 billion
“covenant-lite” loan and a $1.3 billion “payment-in-kind” loan. Home Depot agreed to
assume the loan payments on the $1 billion loan if the investor firms were to default
and to lower the selling price to $8.5 billion for 87.5 percent of HD Supply, with Home
Depot retaining the remaining 12.5 percent.
By the end of August, Home Depot had succeeded in raising the cash needed to help
pay for its share repurchase, and the banks had reduced their original commitment of $4
billion in loans to $2.3 billion. While they had agreed to put more money into the
transaction, the buyout firms had been successful in limiting the number of new
restrictive covenants.
Case Study Discussion Questions:
1) Based on the information given it the case, determine the amount of the price
reduction Home Depot accepted for HD Supply and the amount of cash the three
buyout firms put into the transaction?
2) Why did banks lower their lending standards in financing LBOs in 2006 and early
2007? How did the lax
standards contribute to their inability to sell the loans to investors? How did the
inability to sell the loans once made curtail their future lending?
Answer:
Kraft Foods Undertakes Split-Off of Post Cereals in Merger-Related Transaction
In August 2008, Kraft Foods announced an exchange offer related to the split-off of its
Post Cereals unit and the closing of the merger of its Post Cereals business into a
wholly-owned subsidiary of Ralcorp Holdings. Kraft is a major manufacturer and
distributor of foods and beverages; Post is a leading manufacturer of breakfast cereals;
and Ralcorp manufactures and distributes brand-name products in grocery and mass
merchandise food outlets. The objective of the transaction was to allow Kraft
shareholders participating in the exchange offer for Kraft Sub stock to become
shareholders in Ralcorp and Kraft to receive almost $1 billion in cash or cash
equivalents on a tax-free basis.
Prior to the transaction, Kraft borrowed $300 million from outside lenders and
established Kraft Sub, a shell corporation wholly owned by Kraft. Kraft subsequently
transferred the Post assets and associated liabilities, along with the liability Kraft
incurred in raising $300 million, to Kraft Sub in exchange for all of Kraft Sub’s stock
and $660 million in debt securities issued by Kraft Sub to be paid to Kraft at the end of
ten years. In effect, Post was conveyed to Kraft Sub in exchange for assuming Kraft’s
$300 million liability, 100% of Kraft Sub’s stock, and Kraft Sub debt securities with a
principal amount of $660 million. The consideration that Kraft received, consisting of
the debt assumption by Kraft Sub, the debt securities from Kraft Sub, and the Kraft Sub
stock, is considered tax free to Kraft, since it is viewed simply as an internal
reorganization rather than a sale.1 Kraft later converted to cash the securities received
from Kraft Sub by selling them to a consortium of banks.
In the related split-off transaction, Kraft shareholders had the option to exchange their
shares of Kraft common stock for shares of Kraft Sub, which owned the assets and
liabilities of Post. If Kraft was unable to exchange all of the Kraft Sub common shares,
Kraft would distribute the remaining shares as a dividend (i.e., spin-off) on a pro rata
basis to Kraft shareholders.
With the completion of the merger of Kraft Sub with Ralcorp Sub (a Ralcorp
wholly-owned subsidiary), the common shares of Kraft Sub were exchanged for shares
of Ralcorp stock on a one for one basis. Consequently, Kraft shareholders tendering
their Kraft shares in the exchange offer owned 0.6606 of a share of Ralcorp stock for
each Kraft share exchanged as part of the split-off.
Concurrent with the exchange offer, Kraft closed the merger of Post with Ralcorp. Kraft
shareholders received Ralcorp stock valued at $1.6 billion, resulting in their owning
54% of the merged firm. By satisfying the Morris Trust tax code regulations,2 the
transaction was tax free to Kraft shareholders. Ralcorp Sub was later merged into
Ralcorp. As such, Ralcorp assumed the liabilities of Ralcorp Sub, including the $660
million owed to Kraft.
The purchase price for Post equaled $2.56 billion. This price consisted of $1.6 billion in
Ralcorp stock received by Kraft shareholders and $960 million in cash equivalents
received by Kraft. The $960 million included the assumption of the $300 million
liability by Kraft Sub and the $660 million in debt securities received from Kraft Sub.3
The steps involved in the transaction are described in Exhibit 1.
Discussion Questions and Answers:
1) What does the decision to split up the firm say about Kraft’s decision to buy Cadbury
in 2010?
2) Why did Kraft chose not to divest its grocery business, using the proceeds to either
reinvest in its faster growing snack business, to buy back its stock, or a combination of
the two?
3) How might a spin-off create shareholder value for Kraft Foods shareholders?
4) Kraft CEO Irene Rosenfeld argued that an important justification for the Cadbury
acquisition in 2010 was to create two portfolios of businesses: some very strong cash
generating businesses and some very strong growth businesses in order to increase
shareholder value. How might this strategy have boosted the firm’s value?
5) While Kraft’s share value did increase following the Cadbury deal, it lagged the
performance of key competitors. Why do you believe this was the case? Explain your
answer.
6) There is often a natural tension between so-called activist investors interested in
short-term profits and a firm’s management interested in pursuing a longer-term vision.
When is this tension helpful to shareholders and when does it destroy shareholder
value?
Answer:
The Bear Stearns SagaWhen Failure Is Not an Option
Prodded by the Fed and the U.S. Treasury Department, J.P. Morgan Chase (JPM), the
nation’s third largest bank, announced, on March 17, 2008, that it had reached an
agreement to buy 100 percent of Bear Stearns’s outstanding equity for $2 per share. As
one of the nation’s larger investment banks, Bear Stearns had a reputation for being
aggressive in the financial derivatives markets. Hammered out in two days, the
agreement called for the Fed to guarantee up to $30 billion of Bear Stearns’s “less
liquid” assets. In an effort to avoid what was characterized as a ‘systemic meltdown,”
regulatory approval was obtained at a breakneck pace. The Office of the Comptroller of
Currency and Fed approvals were in place at the time of the announcement. The SEC
elected not to review the deal. Federal and state antitrust regulatory approvals were
obtained in record time.
With investors fleeing mortgage-backed securities, the Fed was hoping to prevent any
further deterioration in the value of such investments. The fear was that the financial
crisis that beset Bear Stearns could spread to other companies and ultimately test the
Fed’s resources after it had said publicly that it would lend up to $200 billion to banks
in exchange for their holdings of mortgages.
Interestingly, Bear Stearns was not that big among investment banks when measured by
asset size. However, it was theoretically liable for as much as $10 trillion due to its
holdings of such financial derivatives as credit default swaps, in which it agreed to pay
lenders in the event of a borrower defaulting. If credit defaults became widespread,
Bear Stearns would not have been able to honor its contractual commitments, and the
ability of other investment banks in similar positions would have been questioned and
the panic could have spread.
With Bear Stearns’s shareholders threatening not to approve what they viewed as a “fire
sale,” JPM provided an alternative bid, within several days of the initial bid, in which it
offered $2.4 billion for about 40 percent of the stock, or about $10 per share. In
exchange for the higher offer, Bear Stearns agreed to sell 95 million newly issued
shares to JPM, giving JPM a 39.5 percent stake and an almost certain majority in any
shareholder vote, effectively discouraging any alternative bids. Under the new offer,
JPM assumed responsibility for the first $1 billion in asset losses, before the Fed’s
guarantee of up to $30 billion takes effect..
Discussion Questions
1) Why do you believe government regulators encouraged a private firm (J.P. Morgan
Chase) to acquire Bear Stearns rather than have the government take control? Do you
believe this was the appropriate course of action? Explain your answer.
2) By facilitating the merger, the Fed sent a message to Wall Street that certain financial
institutions are “too big to fail.” What effect do you think the merger will have on the
future investment activities of investment banks? Be specific.
Answer:
Cox Enterprises Offers to Take Cox Communications Private
In an effort to take the firm private, Cox Enterprises announced on August 3, 2004 a
proposal to buy the remaining 38% of Cox Communications’ shares that they did not
currently own for $32 per share. The deal is valued at $7.9 billion and represented a
16% premium to Cox Communication’s share price at that time. Cox Communications
would become a subsidiary of Cox Enterprises and would continue to operate as an
autonomous business. In response to the proposal, the Cox Communications Board of
Directors formed a special committee of independent directors to consider the proposal.
Citigroup Global Markets and Lehman Brothers Inc. have committed $10 billion to the
deal. Cox Enterprises would use $7.9 billion for the tender offer, with the remaining
$2.1 billion used for refinancing existing debt and to satisfy working capital
requirements.
Cable service firms have faced intensified competitive pressures from satellite service
providers DirecTV Group and EchoStar communications. Moreover, telephone
companies continue to attack cable’s high-speed Internet service by cutting prices on
high-speed Internet service over phone lines. Cable firms have responded by offering a
broader range of advanced services like video-on-demand and phone service. Since
2000, the cable industry has invested more than $80 billion to upgrade their systems to
provide such services, causing profitability to deteriorate and frustrating investors. In
response, cable company stock prices have fallen. Cox Enterprises stated that the
increasingly competitive cable industry environment makes investment in the cable
industry best done through a private company structure.
Discussion Questions::
1) Why did the board feel that it was appropriate to set up special committee of
independent board directors?
2) Why does Cox Enterprises believe that the investment needed for growing its cable
business is best done through a private company structure?
Answer:
GHS Helps Itself by Avoiding an IPO
In 1999, GHS, Inc., a little known supplier of medical devices, engineered a reverse
merger to avoid the time-consuming, disclosure-intensive, and costly process of an
initial public offering to launch its new internet-based self-help website. GHS spun off
its medical operations as a separate company to its shareholders. The remaining shell is
being used to launch a ”self-help” Website, with self-help guru Anthony Robbins as its
CEO. The shell corporation will be financed by $3 million it had on hand as GHS and
will receive another $15 million from a private placement. With the inclusion of
Anthony Robbins as the first among many brand names in the self-help industry that it
hopes to feature on its site, its stock soared from $.75 per share to more than $12
between May and August 1999. Robbins, who did not invest anything in the venture,
has stock in the new company valued at $276 million. His contribution to the company
is the exclusive online rights to his name, which it will use to develop Internet self-help
seminars, chat rooms, and e-commerce sites.
Discussion Questions:
1) What are the advantages of employing a reverse merger strategy in this instance?
2) Why was the shell corporation financed through a private placement?
Answer:
The Man Behind the Legend at Berkshire Hathaway
Although not exactly a household name, Berkshire Hathaway (“Berkshire”) has long
been a high flier on Wall Street. The firm’s share price has outperformed the total return
on the Standard and Poor’s 500 stock index in 32 of the 36 years that Warren Buffet has
managed the firm. Berkshire Hathaway’s share price rose from $12 per share to $71,000
at the end of 2000, an annual rate of growth of 27%. With revenue in excess of $30
billion, Berkshire is among the top 50 of the Fortune 500 companies.
What makes the company unusual is that it is one of the few highly diversified
companies to outperform consistently the S&P 500 over many years. As a
conglomerate, Berkshire acquires or makes investments in a broad cross-section of
companies. It owns operations in such diverse areas as insurance, furniture, flight
services, vacuum cleaners, retailing, carpet manufacturing, paint, insulation and roofing
products, newspapers, candy, shoes, steel warehousing, uniforms, and an electric utility.
The firm also has “passive” investments in such major companies as Coca-Cola,
American Express, Gillette, and the Washington Post.
Warren Buffet’s investing philosophy is relatively simple. It consists of buying
businesses that generate an attractive sustainable growth in earnings and leaving them
alone. He is a long-term investor. Synergy among his holdings never seems to play an
important role. He has shown a propensity to invest in relatively mundane businesses
that have a preeminent position in their markets; he has assiduously avoided businesses
he felt that he did not understand such as those in high technology industries. He also
has shown a tendency to acquire businesses that were “out of favor” on Wall Street.
He has built a cash-generating machine, principally through his insurance operations
that produce “float” (i.e., premium revenues that insurers invest in advance of paying
claims). In 2000, Berkshire acquired eight firms. Usually flush with cash, Buffet has
developed a reputation for being nimble. This most recently was demonstrated in his
acquisition of Johns Manville in late 2000. Manville generated $2 billion in revenue
from insulation and roofing products and more than $200 million in after-tax profits.
Manville’s controlling stockholder was a trust that had been set up to assume the firm’s
asbestos liabilities when Manville had emerged from bankruptcy in the late 1980s. After
a buyout group that had offered to buy the company for $2.8 billion backed out of the
transaction on December 8, 2000, Berkshire contacted the trust and acquired Manville
for $2.2 billion in cash. By December 20, Manville and Berkshire reached an
agreement.
Discussion Questions:
1) To what do you attribute Warren Buffet’s long-term success?
2) In what ways might Warren Buffet use “financial synergy” to grow Berkshire
Hathaway? Explain your answer.
Answer:
Justice Department Requires VeriFone Systems to Sell Assets
before Approving Hypercom Acquisition
Key Points:
Asset sales commonly are used by regulators to thwart the potential build-up of
market power resulting from a merger or acquisition.
In such situations, defining the appropriate market served by the merged firms is
crucial to identifying current and potential competitors.
______________________________________________________________________
________
In late 2011, VeriFone Systems (VeriFone) reached a settlement with the U.S. Justice
Department to acquire competitor Hypercom Corp on the condition it sold Hypercom’s
U.S. point-of-sale terminal business. Business use point-of-sale terminals are used by
retailers to accept electronic payments such as credit and debit cards.
The Justice Department had sued to block the $485 million deal on concerns that the
combination would limit competition in the market for retail checkout terminals. The
asset sale is intended to create a significant independent competitor in the U.S. The
agreement stipulates that private equity firm Gores Group LLC will buy the terminals
business.
San Jose, California-based VeriFone is the second largest maker of electronic payment
equipment in the U.S. and Hypercom, based in Scottsdale, Arizona, is number three.
Together, the firms control more than 60 percent of the U.S. market for terminals used
by retailers. Ingenico SA, based in France, is the largest maker of card-payment
terminals. The Justice Department had blocked a previous attempt to sell Hypercom’s
U.S. point-of-sale business to rival Ingenico, saying that it would have increased
concentration and undermined competition.
VeriFone will retain Hypercom’s point-of-sale equipment business outside the U.S. The
acquisition will enable VeriFone to expand in the emerging market for payments made
via mobile phones by giving it a larger international presence in retail stores and the
opportunity to install more terminals capable of accepting mobile phone payments
abroad.
Discussion Questions
1) Do you believe requiring consent decrees that oblige the acquiring firm to dispose of
certain target
company assets is an abuse of government power? Why or why not?
2) What alternative actions could the government take to limit market power resulting
from a business
combination?
Answer:
Justice Department Approves Maytag/Whirlpool Combination
Despite Resulting Increase in Concentration
When announced in late 2005, many analysts believed that the $1.7 billion transaction
would face heated anti-trust regulatory opposition. The proposed bid was approved
despite the combined firms’ dominant market share of the U.S. major appliance market.
The combined companies would control an estimated 72 percent of the washer market,
81 percent of the gas dryer market, 74 percent of electric dryers, and 31 percent of
refrigerators. Analysts believed that the combined firms would be required to divest
certain Maytag product lines to receive approval. Recognizing the potential difficulty in
getting regulatory approval, the Whirlpool/Maytag contract allowed Whirlpool (the
acquirer) to withdraw from the contract by paying a “reverse breakup” fee of $120
million to Maytag (the target). Breakup fees are normally paid by targets to acquirers if
they choose to withdraw from the contract.
U.S. regulators tended to view the market as global in nature. When the appliance
market is defined in a global sense, the combined firms’ share drops to about one fourth
of the previously mentioned levels. The number and diversity of foreign manufacturers
offered a wide array of alternatives for consumers. Moreover, there are few barriers to
entry for these manufacturers wishing to do business in the United States. Many of
Whirlpool’s independent retail outlets wrote letters supporting the proposal to acquire
Maytag as a means of sustaining financially weakened companies. Regulators also
viewed the preservation of jobs as an important consideration in its favorable ruling.
Discussion Questions:
1) What is anti-trust policy and why is it important?
2) What factors other than market share should be considered in determining whether a
potential merger might result in an increased pricing power?
Answer:
Overcoming Culture Clash:
Allianz AG Buys Pimco Advisors LP
On November 7, 1999, Allianz AG, the leading German insurance conglomerate,
acquired Pimco Advisors LP for $3.3 billion. The Pimco acquisition boosts assets under
management at Allianz from $400 billion to $650 billion, making it the sixth largest
money manager in the world.
The cultural divide separating the two firms represented a potentially daunting
challenge. Allianz’s management was well aware that firms distracted by culture clashes
and the morale problems and mistrust they breed are less likely to realize the synergies
and savings that caused them to acquire the company in the first place. Allianz was
acutely aware of the potential problems as a result of difficulties they had experienced
following the acquisition of Firemen’s Fund, a large U.S.-based propertycasualty
company.
A major motivation for the acquisition was to obtain the well-known skills of the elite
Pimco money managers to broaden Allianz’s financial services product offering.
Although retention bonuses can buy loyalty in the short run, employees of the acquired
firm generally need much more than money in the long term. Pimco’s money managers
stated publicly that they wanted Allianz to let them operate independently, the way
Pimco existed under their former parent, Pacific Mutual Life Insurance Company.
Allianz had decided not only to run Pimco as an independent subsidiary but also to
move $100 billion of Allianz’s assets to Pimco. Bill Gross, Pimco’s legendary bond
trader, and other top Pimco money managers, now collect about one-fourth of their
compensation in the form of Allianz stock. Moreover, most of the top managers have
been asked to sign long-term employment contracts and have received retention
bonuses.
Joachim Faber, chief of money management at Allianz, played an essential role in
smoothing over cultural differences. Led by Faber, top Allianz executives had been
visiting Pimco for months and having quiet dinners with top Pimco fixed income
investment officials and their families. The intent of these intimate meetings was to
reassure these officials that their operation would remain independent under Allianz’s
ownership.
Discussion Questions:
1) How did Allianz attempt to retain key employees? In the short run? In the long run?
2) How did the potential for culture clash affect the way Alliance acquired Pimco?
3) What else could Allianz have done to minimize potential culture clash? Be specific.
Answer:
Sony Buys MGM
Sony’s long-term vision has been to create synergy between its consumer electronics
products and music, movies, and games. Sony, which bought Columbia Pictures in
1989 for $3.4 billion, had wanted to control Metro-Goldwyn-Mayer’s film library for
years, but it did not want to pay the estimated $5 billion it would take to acquire it. On
September 14, 2004, a consortium, consisting of Sony Corp of America, Providence
Equity Partners, Texas Pacific Group, and DLJ Merchant Banking Partners, agreed to
acquire MGM for $4.8 billion, consisting of $2.85 billion in cash and the assumption of
$2 billion in debt. The cash portion of the purchase price consisted of about $1.8 billion
in debt and $1 billion in equity capital. Of the equity capital, Providence contributed
$450 million, Sony and Texas Pacific Group $300 million, and DLJ Merchant Banking
$250 million.
The combination of Sony and MGM will create the world’s largest film library of about
7,600 titles, with MGM contributing about 54 percent of the combined libraries. Sony
will control MGM and Comcast will distribute the films over cable TV. Sony will shut
down MGM’s film making operations and move all operations to Sony. Kirk Kerkorian,
who holds a 74 percent stake in MGM, will make $2 billion because of the transaction.
The private equity partners could cash out within three-to-five years, with the
consortium undertaking an initial public offering or sale to a strategic investor. Major
risks include the ability of the consortium partners to maintain harmonious relations and
the problematic growth potential of the DVD market.
Sony and MGM negotiations had proven to be highly contentious for almost five
months when media giant Time Warner Inc. emerged to attempt to satisfy Kerkorian’s
$5 billion asking price. The offer was made in stock on the assumption that Kerkorian
would want a tax-free transaction. MGM’s negotiations with Time Warner stalled
around the actual value of Time Warner stock, with Kerkorian leery about Time
Warner’s future growth potential. Time Warner changed its bid in late August to an all
cash offer, albeit somewhat lower than the Sony consortium bid, but it was more
certain. Sony still did not have all of its financing in place. Time Warner had a
“handshake agreement” with MGM by Labor Day for $11 per share, about $.25 less
than Sony’s.
The Sony consortium huddled throughout the Labor Day weekend to put in place the
financing for a bid of $12 per share. What often takes months to work out in most
leveraged buyouts was hammered out in three days of marathon sessions at law firm
Davis Polk & Wardwell. In addition to getting final agreement on financing
arrangements including loan guarantees from J.P. Morgan Chase & Company, Sony was
able to reach agreement with Comcast to feature MGM movies in new cable and
video-on-demand TV channels. This distribution mechanism meant additional revenue
for Sony, making it possible to increase the bid to $12 per share. Sony also offered to
make a $150 non-refundable cash payment to MGM. As a testament to the adage that
timing is everything, the revised Sony bid was faxed to MGM just before the beginning
of a board meeting to approve the Time Warner offer.
Discussion Questions:
1) Do you believe that MGM is an attractive LBO candidate? Why? Why not?
2) In what way do you believe that Sony’s objectives might differ from those of the
private equity investors making up the remainder of the consortium? How might such
differences affect the management of MGM? Identify possible short-term and long-term
effects.
3) How did Time Warner’s entry into the bidding affect pace of the negotiations and the
relative bargaining power of MGM, Time Warner, and the Sony consortium?
4) What do you believe were the major factors persuading the MGM board to accept the
Revised Sony bid? In your judgment, do these factors make sense? Explain your
answer.
Answer:
Oracle Continues Its Efforts to Consolidate the Software Industry
Oracle CEO Larry Ellison continued his effort to implement his software industry
strategy when he announced the acquisition of Siebel Systems Inc. for $5.85 billion in
stock and cash on September 13, 2005. The global software industry includes hundreds
of firms. During the first nine months of 2005, Oracle had closed seven acquisitions,
including its recently completed $10.6 billion hostile takeover of PeopleSoft. In each
case, Oracle realized substantial cost savings by terminating duplicate employees and
related overhead expenses. The Siebel acquisition accelerates the drive by Oracle to
overtake SAP as the world’s largest maker of business applications software, which
automates a wide range of administrative tasks. The consolidation strategy seeks to add
the existing business of a competitor, while broadening the customer base for Oracle’s
existing product offering.
Siebel, founded by Ellison’s one-time protégé turned bitter rival, Tom Siebel, gained
prominence in Silicon Valley in the late 1990s as a leader in customer relationship
management (CRM) software. CRM software helps firms track sales, customer service,
and marketing functions. Siebel’s dominance of this market has since eroded amidst
complaints that the software was complicated and expensive to install. Moreover, Siebel
ignored customer requests to deliver the software via the Internet. Also, aggressive
rivals, like SAP and online upstart Salesforce.com have cut into Siebel’s business in
recent years with simpler offerings. Siebel’s annual revenue had plunged from about
$2.1 billion in 2001 to $1.3 billion in 2004.
In the past, Mr. Ellison attempted to hasten Siebel’s demise, declaring in 2003 that
Siebel would vanish and putting pressure on the smaller company by revealing he had
held takeover talks with the firm’s CEO, Thomas Siebel. Ellison’s public announcement
of these talks heightened the personal enmity between the two CEOs, making Siebel an
unwilling seller.
Oracle’s intensifying focus on business applications software largely reflects the
slowing growth of its database product line, which accounts for more than three fourths
of the company’s sales.
Siebel’s technology and deep customer relationships give Oracle a competitive software
bundle that includes a database, middleware (i.e., software that helps a variety of
applications work together as if they were a single system), and high-quality customer
relationship management software. The acquisition also deprives Oracle competitors,
such as IBM, of customers for their services business.
Customers, who once bought the so-called best-of-breed products, now seek a single
supplier to provide programs that work well together. Oracle pledged to deliver an
integrated suite of applications by 2007. What brought Oracle and Siebel together in the
past was a shift in market dynamics. The customer and the partner community is
communicating quite clearly that they are looking for an integrated set of products.
Germany’s SAP, Oracle’s major competitor in the business applications software
market, played down the impact of the merger, saying they had no reason to react and
described any deals SAP is likely to make as “targeted, fill-in acquisitions.” For IBM,
the Siebel deal raised concerns about the computer giant’s partners falling under the
control of a competitor. IBM and Oracle compete fiercely in the database software
market. Siebel has worked closely with IBM, as did PeopleSoft and J.D. Edwards,
which had been purchased by PeopleSoft shortly before its acquisition by Oracle.
Retek, another major partner of IBM, had also been recently acquired by Oracle. IBM
had declared its strategy to be a key partner to thousands of software vendors and that it
would continue to provide customers with IBM hardware, middleware, and other
applications.
Discussion Questions:
1) How would you characterize the Oracle business strategy (i.e., cost leadership,
differentiation, niche, or some combination of all three)? Explain your answer.
2) What other benefits for Oracle, and for the remaining competitors such as SAP, do
you see from further industry consolidation? Be specific.
3) Conduct an external and internal analysis of Oracle. Briefly describe those factors
that influenced the development of Oracle’s business strategy. Be specific.
4) In what way do you think the Oracle strategy was targeting key competitors? Be
specific.
Answer:
Kinder Morgan Buyout Raises Ethical Questions
In the largest management buyout in U.S. history at that time, Kinder Morgan Inc.’s
management proposed to take the oil and gas pipeline firm private in 2006 in a
transaction that valued the firm’s outstanding equity at $13.5 billion. Under the
proposal, chief executive Richard Kinder and other senior executives would contribute
shares valued at $2.8 billion to the newly private company. An additional $4.5 billion
would come from private equity investors, including Goldman Sachs Capital partners,
American International Group Inc., and the Carlyle Group. Including assumed debt, the
transaction was valued at about $22 billion. The transaction also was notable for the
governance and ethical issues it raised. Reflecting the struggles within the corporation,
the deal did not close until mid-2007.
The top management of Kinder Morgan Inc. waited more than two months before
informing the firm’s board of its desire to take the company private. It is customary for
boards governing firms whose managements are interested in buying out public
shareholders to create a committee within the board consisting of independent board
members to solicit other bids. While the Kinder Morgan board did eventually create
such a committee, the board’s lack of awareness of the pending management proposal
gave management an important lead over potential bidders in structuring a proposal. By
being involved early on in the process, a board has more time to negotiate terms more
favorable to shareholders. The transaction also raised questions about the potential
conflicts of interest in cases where investment bankers who were hired to advise
management and the board on the “fairness” of the offer price also were potential
investors in the buyout.
Kinder Morgan’s management hired Goldman Sachs in February 2006 to explore
‘strategic” options for the firm to enhance shareholder value. The leveraged buyout
option was proposed by Goldman Sachs on March 7, followed by their proposal to
become the primary investor in the LBO on April 5. The management buyout group
hired a number of law firms and other investment banks as advisors and discussed the
proposed buyout with credit-rating firms to assess how much debt the firm could
support without experiencing a downgrade in its credit rating.
On May 13, 2006, the full board was finally made aware of the proposal. The board
immediately demanded that a standstill agreement that had been signed by Richard
Kinder, CEO and leader of the buyout group, be terminated. The agreement did not
permit the firm to talk to any alternative bidders for a period of 90 days. While
investment banks and buyout groups often propose such an agreement to ensure that
they can perform adequate due diligence, this extended period is not necessarily in the
interests of the firm’s shareholders because it puts alternative suitors coming in later at a
distinct disadvantage. Later bidders simply lack sufficient time to make an adequate
assessment of the true value of the target and structure their own proposals. In this way,
the standstill agreement could discourage alternative bids for the business.
A special committee of the board was set up to negotiate with the management buyout
group, and it was ultimately able to secure a $107.50 per share price for the firm,
significantly higher than the initial offer. The discussions were rumored to have been
very contentious due to the board’s annoyance with the delay in informing them.1
Reflecting the strong financial performance of the firm and an improving equity market,
Kinder Morgan raised $2.4 billion in early 2011 in the largest private equitybacked IPO
in history. The majority of the IPO proceeds were paid out to the firm’s private equity
investors as a dividend.
Financing LBOs–The SunGard Transaction
With their cash hoards accumulating at an unprecedented rate, there was little that
buyout firms could do but to invest in larger firms. Consequently, the average size of
LBO transactions grew significantly during 2005. In a move reminiscent of the
blockbuster buyouts of the late 1980s, seven private investment firms acquired 100
percent of the outstanding stock of SunGard Data Systems Inc. (SunGard) in late
SunGard is a financial software firm known for providing application and transaction
software services and creating backup data systems in the event of disaster. The
company’s software manages 70 percent of the transactions made on the Nasdaq stock
exchange, but its biggest business is creating backup data systems in case a client’s
main systems are disabled by a natural disaster, blackout, or terrorist attack. Its large
client base for disaster recovery and back-up systems provides a substantial and
predictable cash flow.
SunGard’s new owners include Silver lake Partners, Bain Capital LLC, The Blackstone
Group L.P., Goldman Sachs Capital Partners, Kohlberg Kravis Roberts & Co.,
Providence Equity Partners Inc. and Texas Pacific Group. Buyout firms in 2005 tended
to band together to spread the risk of a deal this size and to reduce the likelihood of a
bidding war. Indeed, with SunGard, there was only one bidder, the investor group
consisting of these seven firms.
The software side of SunGard is believed to have significant growth potential, while the
disaster-recovery side provides a large stable cash flow. Unlike many LBOs, the deal
was announced as being all about growth of the financial services software side of the
business. The deal is structured as a merger, since SunGard would be merged into a
shell corporation created by the investor group for acquiring SunGard. Going private,
allows SunGard to invest heavily in software without being punished by investors, since
such investments are expensed and reduce reported earnings per share. Going private
also allows the firm to eliminate the burdensome reporting requirements of being a
public company.
The buyout represented potentially a significant source of fee income for the investor
group. In addition to the 2 percent management fees buyout firms collect from investors
in the funds they manage, they receive substantial fee income from each investment
they make on behalf of their funds. For example, the buyout firms receive a 1 percent
deal completion fee, which is more than $100 million in the SunGard transaction.
Buyout firms also receive fees paid for by the target firm that is “going private” for
arranging financing. Moreover, there are also fees for conducting due diligence and for
monitoring the ongoing performance of the firm taken private. Finally, when the buyout
firms exit their investments in the target firm via a sale to a strategic buyer or a
secondary IPO, they receive 20 percent (i.e., so-called carry fee) of any profits.
Under the terms of the agreement, SunGard shareholders received $36 per share, a 14
percent premium over the SunGard closing price as of the announcement date of March
28, 2005, and 40 percent more than when the news first leaked about the deal a week
earlier. From the SunGard shareholders’ perspective, the deal is valued at $11.4 billion
dollars consisting of $10.9 billion for outstanding shares and “in-the-money” options
(i.e., options whose exercise price is less than the firm’s market price per share) plus
$500 million in debt on the balance sheet.
The seven equity investors provided $3.5 billion in capital with the remainder of the
purchase price financed by commitments from a lending consortium consisting of
Citigroup, J.P. Morgan Chase & Co., and Deutsche Bank. The purpose of the loans is to
finance the merger, repay or refinance SunGard’s existing debt, provide ongoing
working capital, and pay fees and expenses incurred in connection with the merger. The
total funds necessary to complete the merger and related fees and expenses is
approximately $11.3 billion, consisting of approximately $10.9 billion to pay SunGard’s
stockholders and about $400.7 million to pay fees and expenses related to the merger
and the financing arrangements. Note that the fees that are to be financed comprise
almost 4 percent of the purchase price. Ongoing working capital needs and capital
expenditures required obtaining commitments from lenders well in excess of $11.3
billion.
The merger financing consists of several tiers of debt and “credit facilities.” Credit
facilities are arrangements for extending credit. The senior secured debt and senior
subordinated debt are intended to provide “permanent” or long-term financing. Senior
debt covenants included restrictions on new borrowing, investments, sales of assets,
mergers and consolidations, prepayments of subordinated indebtedness, capital
expenditures, liens and dividends and other distributions, as well as a minimum interest
coverage ratio and a maximum total leverage ratio.
If the offering of notes is not completed on or prior to the closing, the banks providing
the financing have committed to provide up to $3 billion in loans under a senior
subordinated bridge credit facility. The bridge loans are intended as a form of temporary
financing to satisfy immediate cash requirements until permanent financing can be
arranged. A special purpose SunGard subsidiary will purchase receivables from
SunGard, with the purchases financed through the sale of the receivables to the lending
consortium. The lenders subsequently finance the purchase of the receivables by issuing
commercial paper, which is repaid as the receivables are collected. The special purpose
subsidiary is not shown on the SunGard balance sheet. Based on the value of
receivables at closing, the subsidiary could provide up to $500 million. The obligation
of the lending consortium to buy the receivables will expire on the sixth anniversary of
the closing of the merger.
The following table provides SunGard’s post-merger proforma capital structure. Note
that the proforma capital structure is portrayed as if SunGard uses 100 percent of bank
lending commitments. Also, note that individual LBO investors may invest monies
from more than one fund they manage. This may be due to the perceived attractiveness
of the opportunity or the limited availability of money in any single fund. Of the $9
billion in debt financing, bank loans constitute 56 percent and subordinated or
mezzanine debt comprises represents 44 percent.
SunGard Proforma Capital Structure
1The roman numeral II refers to the fund providing the equity capital managed by
the partnership.
Case Study Discussion Questions:
1) SunGard is a software company with relatively few tangible assets. Yet, the ratio of
debt to equity of almost 5 to 1. Why do you think lenders would be willing to engage in
such a highly leveraged transaction for a firm of this type?
2) Under what circumstances would SunGard refinance the existing $500 million in
outstanding senior debt after the merger? Be specific.
3) In what ways is this transaction similar to and different from those that were
common in the 1980s? Be specific.
4) Why are payment-in-kind securities (e.g., debt or preferred stock) particularly well
suited for financing LBOs? Under what circumstances might they be most attractive to
lenders or investors?
5) Explain how the way in which the LBO is financed affects the way it is operated and
the timing of when equity investors choose to exit the business. Be specific.
Answer:
Bridgestone Acquires Firestone’s Tire Assets
Bridgestone Tire, a Japanese company, lacking a source of retail distribution in the
United States, approached its competitor, Firestone, to create a JV whose formation
involved two stages. In the first stage, Firestone, which consisted of a tire
manufacturing and distribution division and a diversified rubber products division,
agreed to transfer its tire manufacturing operations into a subsidiary. This subsidiary
was owned and operated by Firestone’s worldwide tire business. In the second stage,
Firestone sold three-fourths of its equity in the tire subsidiary to Bridgestone, making
the subsidiary a JV corporation. Firestone received $1.25 billion in cash, $750 million
from Bridgestone, and $500 million from the JV. Firestone also retained 100%
ownership in the diversified products division and 25% of the tire JV corporation. For
its investment, Bridgestone acquired a 75% ownership interest in a worldwide tire
manufacturing and distribution system.
Case Study Discussion Questions
1) What other options for entering the United States could Bridgestone have
considered?
2) Why do you believe Bridgestone chose to invest in Firestone rather than pursue
another option?
Answer:
Creating a Global Luxury Hotel Chain
Fairmont Hotels & Resorts Inc. announced on January 30, 2006, that it had agreed to be
acquired by Kingdom Hotels and Colony Capital in an all-cash transaction valued at
$45 per share. The transaction is valued at $3.9 billion, including assumed debt. The
purchase price represents a 28% premium over Fairmont’s closing price on November
4, 2005, the last day of trading when Kingdom and Colony expressed interest in
Fairmont. The combination of Fairmont and Kingdom will create a luxury global hotel
chain with 120 hotels in 24 countries. Discounted cash-flow analyses, including
estimated synergies and terminal value, value the firm at $43.10 per share. The net asset
value of Fairmont’s real estate is believed to be $46.70 per share.
Discussion Questions
1) Is it reasonable to assume that the acquirer could actually be getting the operation for
“free,” since the value of the real estate per share is worth more than the purchase price
per share? Explain your answer.
2) Assume the acquirer divests all of Fairmont’s hotels and real estate properties but
continues to manage the hotels and properties under long-term management contracts.
How would you estimate the net present value of the acquisition of Fairmont to the
acquirer? Explain your answer.
Answers to Case Study Questions:
1) Is it reasonable to assume that the acquirer could actually be getting the operation for
“free,” since the value of the real estate per share is worth more than the purchase price
per share? Explain your answer.
2) Assume the acquirer divests all of Fairmont’s hotels and real estate properties but
continues to manage the hotels and properties under long-term management contracts.
How would you estimate the net present value of the acquisition of Fairmont to the
acquirer? Explain your answer.
Answer:
The Legacy of GE’s Aborted Attempt to Merge with Honeywell
Many observers anticipated significant regulatory review because of the size of the
transaction and the increase in concentration it would create in the markets served by
the two firms. Most believed, however, that, after making some concessions to
regulatory authorities, the transaction would be approved, due to its perceived benefits.
Although the pundits were indeed correct in noting that it would receive close scrutiny,
they were completely caught off guard by divergent approaches taken by the U.S. and
EU antitrust authorities. U.S regulators ruled that the merger should be approved
because of its potential benefits to customers. In marked contrast, EU regulators ruled
against the transaction based on its perceived negative impact on competitors.
Honeywell’s avionics and engines unit would add significant strength to GE’s jet engine
business. The deal would add about 10 cents to GE’s 2001 earnings and could
eventually result in $1.5 billion in annual cost savings. The purchase also would enable
GE to continue its shift away from manufacturing and into services, which already
constituted 70 percent of its revenues in 2000.1 The best fit is clearly in the combination
of the two firms’ aerospace businesses. Revenues from these two businesses alone
would total $22 billion, combining Honeywell’s strength in jet engines and cockpit
avionics with GE’s substantial business in larger jet engines. As the largest supplier in
the aerospace industry, GE could offer airplane manufacturers “one-stop shopping” for
everything from engines to complex software systems by cross-selling each other’s
products to their biggest customers.
Honeywell had been on the block for a number of months before the deal was
consummated with GE. Its merger with Allied Signal had not been going well and
contributed to deteriorating earnings and a much lower stock price. Honeywell’s shares
had declined in price by more than 40 percent since its acquisition of Allied Signal.
While the euphoria surrounding the deal in late 2000 lingered into the early months of
2001, rumblings from the European regulators began to create an uneasy feeling among
GE’s and Honeywell’s management.
Mario Monti, the European competition commissioner at that time, expressed concern
about possible “conglomerate effects” or the total influence a combined GE and
Honeywell would wield in the aircraft industry. He was referring to GE’s perceived
ability to expand its influence in the aerospace industry through service initiatives. GE’s
services offerings help differentiate it from others at a time when the prices of many
industrial parts are under pressure from increased competition, including low-cost
manufacturers overseas. In a world in which manufactured products are becoming
increasingly commodity-like, the true winners are those able to differentiate their
product offering. GE and Honeywell’s European competitors complained to the EU
regulatory commission that GE’s extensive services offering would give it entrée into
many more points of contact among airplane manufacturers, from communications
systems to the expanded line of spare parts GE would be able to supply. This so-called
range effect or portfolio power is a relatively new legal doctrine that has not been tested
in transactions of this size.2
On May 3, 2001, the U.S. Department of Justice approved the buyout after the
companies agreed to sell Honeywell’s helicopter engine unit and take other steps to
protect competition. The U.S. regulatory authorities believed that the combined
companies could sell more products to more customers and therefore could realize
improved efficiencies, although it would not hold a dominant market share in any
particular market. Thus, customers would benefit from GE’s greater range of products
and possibly lower prices, but they still could shop elsewhere if they chose. The U.S.
regulators expressed little concern that bundling of products and services could hurt
customers, since buyers can choose from among a relative handful of viable suppliers.
To understand the European position, it is necessary to comprehend the nature of
competition in the European Union. France, Germany, and Spain spent billions
subsidizing their aerospace industry over the years. The GEHoneywell deal has been
attacked by their European rivals from Rolls-Royce and Lufthansa to French avionics
manufacturer Thales. Although the European Union imported much of its antitrust law
from the United States, the antitrust law doctrine evolved in fundamentally different
ways. In Europe, the main goal of antitrust law is to guarantee that all companies be
able to compete on an equal playing field. The implication is that the European Union is
just as concerned about how a transaction affects rivals as it is consumers. Complaints
from competitors are taken more seriously in Europe, whereas in the United States it is
the impact on consumers that constitutes the litmus test. Europeans accepted the legal
concept of “portfolio power,” which argues that a firm may achieve an unfair advantage
over its competitors by bundling goods and services. Also, in Europe, the European
Commission’s Merger Task Force can prevent a merger without taking a company to
court.
The EU authorities continued to balk at approving the transaction without major
concessions from the participantsconcessions that GE believed would render the deal
unattractive. On June 15, 2001, GE submitted its final offer to the EU regulators in a
last-ditch attempt to breathe life into the moribund deal. GE knew that if it walked
away, it could continue as it had before the deal was struck, secure in the knowledge
that its current portfolio of businesses offered substantial revenue growth or profit
potential. Honeywell clearly would fuel such growth, but it made sense to GE’s
management and shareholders only if it would be allowed to realize potential synergies
between the GE and Honeywell businesses.
GE said it was willing to divest Honeywell units with annual revenue of $2.2 billion,
including regional jet engines, air-turbine starters, and other aerospace products.
Anything more would jeopardize the rationale for the deal. Specifically, GE was
unwilling to agree not to bundle (i.e., sell a package of components and services at a
single price) its products and services when selling to customers. Another stumbling
block was the GE Capital Aviation Services unit, the airplane-financing arm of GE
Capital. The EU Competition Commission argued that that this unit would use its
influence as one of the world’s largest purchasers of airplanes to pressure airplane
manufacturers into using GE products. The commission seemed to ignore that GE had
only an 8 percent share of the global airplane leasing market and would therefore
seemingly lack the market power the commission believed it could exert.
On July 4, 2001, the European Union vetoed the GE purchase of Honeywell, marking it
the first time a proposed merger between two U.S. companies has been blocked solely
by European regulators. Having received U.S. regulatory approval, GE could ignore the
EU decision and proceed with the merger as long as it would be willing to forego sales
in Europe. GE decided not to appeal the decision to the EU Court of First Instance (the
second highest court in the European Union), knowing that it could take years to
resolve the decision, and withdrew its offer to merge with Honeywell.
On December 15, 2005, a European court upheld the European regulator’s decision to
block the transaction, although the ruling partly vindicated GE’s position. The European
Court of First Instance said regulators were in error in assuming without sufficient
evidence that a combined GEHoneywell could crush competition in several markets.
However, the court demonstrated that regulators would have to provide data to support
either their approval or rejection of mergers by ruling on July 18, 2006, that regulators
erred in approving the combination of Sony BMG in 2004. In this instance, regulators
failed to provide sufficient data to document their decision. These decisions affirm that
the European Union needs strong economic justification to overrule cross-border deals.
GE and Honeywell, in filing the suit, said that their appeal had been made to clarify
European rules with an eye toward future deals, since they had no desire to resurrect the
deal.
In the wake of these court rulings and in an effort to avoid similar situations in other
geographic regions, coordination among antitrust regulatory authorities in different
countries has improved. For example, in mid-2010, the U.S. Federal Trade Commission
reached a consent decree with scientific instrument manufacturer Agilent in approving
its acquisition of Varian, in which Agilent agreed to divest certain overlapping product
lines. While both firms were based in California, each has extensive foreign operations,
which necessitated gaining the approval of multiple regulators. Throughout the
investigation, FTC staff coordinated enforcement efforts with the staffs of regulators in
the European Union, Australia, and Japan. The cooperation was conducted under the
auspices of certain bilateral cooperation agreements, the OECD Recommendation on
Cooperation among its members, and the European Union Best Practices on
Cooperation in Merger Investigation protocol.
Discussion Questions
1) What are the important philosophical differences between U.S. and EU antitrust
regulators?
Explain the logic underlying these differences? To what extent are these differences
influenced by
political rather than economic considerations? Explain your answer.
2) This is the first time that a foreign regulatory body has prevented a deal involving
U.S. firms only from occurring. What do you think are the long-term implications, if
any, of this precedent?
3) What were the major obstacles between GE and the EU regulators? Why do you
think these were obstacles? Do you think the EU regulators were justified in their
position? Why/why not?
4) Do you think that competitors are using antitrust to their advantage? Explain your
answer.
5) Do you think the EU regulators would have taken a different position if the deal had
involved a less visible firm than General Electric? Explain your answer.
Answer:
Hewlett Packard Spins Out Its Agilent Unit in a Staged Transaction
Hewlett Packard (HP) announced the spin-off of its Agilent Technologies unit to focus
on its main business of computers and printers, where sales have been lagging behind
such competitors as Sun Microsystems. Agilent makes test, measurement, and
monitoring instruments; semiconductors; and optical components. It also supplies
patient-monitoring and ultrasound-imaging equipment to the health care industry. HP
will retain an 85% stake in the company. The cash raised through the 15% equity
carve-out will be paid to HP as a dividend from the subsidiary to the parent. Hewlett
Packard will provide Agilent with $983 million in start-up funding. HP retained a
controlling interest until mid-2000, when it spun-off the rest of its shares in Agilent to
HP shareholders as a tax-free transaction.
Case Study Discussion Questions
1) Discuss the reasons why HP may have chosen a staged transaction rather than an
outright divestiture of the business.
2) Discuss the conditions under which this spin-off would constitute a tax-free
transaction.
Answer:
Pfizer Acquires Warner-Lambert in a Hostile Takeover
In 1996 Pfizer and Warner Lambert (Warner) agreed to co-market worldwide the
cholesterol-lowering drug Lipitor, which had been developed by Warner. The combined
marketing effort was extremely successful with combined 1999 sales reaching $3.5
billion, a 60% increase over 1998. Before entering into the marketing agreement, Pfizer
had entered into a confidentiality agreement with Warner that contained a standstill
clause that, among other things, prohibited Pfizer from making a merger proposal
unless invited to do so by Warner or until a third party made such a proposal.
In late 1998, Pfizer became aware of numerous rumors of a possible merger between
Warner and some unknown entity. William C. Steere, chair and CEO of Pfizer, sent a
letter on October 15, 1999, to Lodeijk de Vink, chair and CEO of Warner, inquiring
about the potential for Pfizer to broaden its current strategic relationship to include a
merger. More than 2 weeks passed before Steere received a written response in which
de Vink expressed concern that Steere’s letter violated the spirit of the standstill
agreement by indicating interest in a merger. Speculation about an impending merger
between Warner and American Home Products (AHP) came to a head on November 19,
1999, when an article appeared in the Wall Street Journal announcing an impending
merger of equals between Warner and AHP valued at $58.3 billion.
The public announcement of the agreement to merge between Warner and AHP released
Pfizer from the standstill agreement. Tinged with frustration and impatience at what
Pfizer saw as stalling tactics, Steere outlined in the letter the primary reasons why the
proposed combination of the two companies made sense to Warner’s shareholders. In
addition to a substantial premium over Warner’s current share price, Pfizer argued that
combining the companies would result in a veritable global powerhouse in the
pharmaceutical industry. Furthermore, the firm’s product lines are highly
complementary, including Warner’s over-the-counter drug presence and substantial
pipeline of new drugs and Pfizer’s powerful global marketing and sales infrastructure.
Steere also argued that the combined companies could generate annual cost savings of
at least $1.2 billion annually within 1 year following the completion of the merger.
These savings would come from centralizing computer systems and research and
development (R&D) activities, consolidating more than 100 manufacturing facilities,
and combining two headquarters and multiple sales and administrative offices in 30
countries. Pfizer also believed that the two companies’ cultures were highly
complementary.
In addition to the letter from Steere to de Vink, on November 4, 1999, Pfizer announced
that it had commenced a legal action in the Delaware Court of Chancery against
Warner, Warner’s directors, and AHP. The action sought to enjoin the approximately $2
billion termination fee and the stock option granted by Warner-Lambert to AHP to
acquire 9% of Warner’s common stock valued at $83.81 per share as part of their
merger agreement. The lawsuit charged that the termination fee and stock options were
excessively onerous and were not in the best interests of the Warner shareholders
because they would discourage potential takeover attempts.
On November 5, 1999, Warner explicitly rejected Pfizer’s proposal in a press release
and reaffirmed its commitment to its announced business combination with AHP. On
November 9, 1999, de Vink sent a letter to the Pfizer board in which he expressed
Warner’s disappointment at what he perceived to be Pfizer’s efforts to take over Warner
as well as Pfizer’s lawsuit against the firm. In the letter, he stated Warner-Lambert’s
belief that the litigation was not in the best interest of either company’s stockholders,
especially in light of their co-promotion of Lipitor, and it was causing uncertainty in the
financial markets. Not only did Warner reject the Pfizer bid, but it also threatened to
cancel the companies’ partnership to market Lipitor.
Pfizer responded by exploiting a weakness in the Warner Lambert takeover defenses by
utilizing a consent solicitation process that allows shareholders to change the board
without waiting months for a shareholders’ meeting. Pfizer also challenged in court two
provisions in the contract with AHP on the grounds that they were not in the best
interests of the Warner Lambert shareholders because they would discourage other
bidders. Pfizer’s offers for Warner Lambert were contingent on the removal of these
provisions. On November 12, 1999, Steere sent a letter to de Vink and the Warner board
indicating his deep disappointment as a result of their refusal to consider what Pfizer
believes is a superior offer to Warner. He also reiterated his firm’s resolve in completing
a merger with Warner. Not hearing anything from Warner management, Pfizer decided
to go straight to the Warner shareholders on November 15, 1999, in an attempt to
change the composition of the board and to get the board to remove the poison pill and
break-up fee.
In the mid-November proxy statement sent to Warner shareholders, Pfizer argued that
the current Warner Lambert board has approved a merger agreement with American
Home, which provides 30% less current value to the Warner-Lambert stockholders than
the Pfizer merger proposal. Moreover, Warner shareholders would benefit more in the
long run in a merger with Pfizer, because the resulting firm would be operationally and
financially stronger than a merger created with AHP. Pfizer also argued that its
international marketing strength is superior in the view of most industry analysts to that
of American Home and will greatly enhance Warner-Lambert’s foreign sales efforts.
Pfizer stated that Warner Lambert was not acting in the best interests of its shareholders
by refusing to even grant Pfizer permission to make a proposal. Pfizer also alleged that
Warner Lambert is violating its fiduciary responsibilities by approving the merger
agreement with American Home in which AHP is entitled to a termination fee of
approximately $2 billion.
Pressure intensified from all quarters including such major shareholders as the
California Public Employees Retirement System and the New York City Retirement
Fund. After 3 stormy months, Warner Lambert agreed on February 8, 2000, to be
acquired by Pfizer for $92.5 billion, forming the world’s second largest pharmaceutical
firm. Although they were able to have the Warner poison pill overturned in court as
being an unreasonable defense, Pfizer was unsuccessful in eliminating the break-up fee
and had to pay AHP the largest such fee in history. The announced acquisition of
Warner Lambert by Pfizer ended one of the most contentious corporate takeover battles
in recent memory.
Discussion Questions:
1) What takeover defenses did Warner employ to ward off the Pfizer merger proposal?
What tactics
did Pfizer employ to overcome these defenses? Comment on the effectiveness of these
defenses.
2) What other defenses do you think Warner could or should have employed? Comment
on the effectiveness of each alternative defense you suggest Warner could have
employed?
3) What factors may have contributed to Warner Lambert’s rejection of the Pfizer
proposal?
4) What factors may make it difficult for this merger to meet or exceed industry average
returns? What are the implications for the long-term financial performance of the new
firm of only using Pfizer stock to purchase Warner Lambert shares?
5) What is a standstill agreement and why might it have been included as a condition
for the Pfizer-Warner Lambert Lipitor distribution arrangement? How did the standstill
agreement affect Pfizer’s effort to merge with Warner Lambert? Why would Warner
Lambert want a standstill agreement?
Answer:
FCC Uses Its Power to Stimulate Competition in the Telecommunications Market
Oh, So Many Hurdles
Having received approval from the Justice Department and the Federal Trade
Commission, Ameritech and SBC Communications received permission from the
Federal Communications Commission to combine to form the nation’s largest local
telephone company. The FCC gave its approval of the $74 billion transaction, subject to
conditions requiring that the companies open their markets to rivals and enter new
markets to compete with established local phone companies.
Satisfying the FCC’s Concerns
SBC, which operates under Southwestern Bell, Pacific Bell, SNET, Nevada Bell, and
Cellular One brands, has 52 million phone lines in its territory. It also has 8.3 million
wireless customers across the United States. Ameritech, which serves Illinois, Indiana,
Michigan, Ohio, and Wisconsin, has more than 12 million phone customers. It also
provides wireless service to 3.2 million individuals and businesses.
The combined business would control 57 million, or one-third, of the nation’s local
phone lines in 13 states. The FCC adopted 30 conditions to ensure that the deal would
serve the public interest. The new SBC must enter 30 new markets within 30 months to
compete with established local phone companies. In the new markets, it would face
fierce competition from Bell Atlantic, BellSouth, and U.S. West. The company is
required to provide deep discounts on key pieces of their networks to rivals who want to
lease them. The merged companies also must establish a separate subsidiary to provide
advanced telecommunications services such as high-speed Internet access. At least 10%
of its upgraded services would go toward low-income groups. Failure to satisfy these
conditions would result in stiff fines. The companies could face $1.2 billion in penalties
for failing to meet the new market deadline and could pay another $1.1 billion for not
meeting performance standards related to opening up their markets.
A Costly Remedy for SBC
SBC has had considerable difficulty in complying with its agreement with the FCC.
Between December 2000 and July 2001, SBC paid the U.S. government $38.5 million
for failing to provide adequately rivals with access to its network. The government
noted that SBC failed repeatedly to make available its network in a timely manner, to
meet installation deadlines, and to notify competitors when their orders were filled.
Discussion Questions:
1) Comment on the fairness and effectiveness of using the imposition of heavy fines to
promote social policy.
2) Under what circumstances, if any, do you believe the government should relax the
imposition of such fines in the SBC case?
Answer:
A Reorganized Dana Corporation
Emerges from Bankruptcy Court
Dana Corporation, an automotive parts manufacturer, announced on February 1, 2008,
that it had emerged from bankruptcy court with an exit financing facility of $2 billion.
The firm had entered Chapter 11 reorganization on March 3, 2006. During the ensuing
21 months, the firm and its constituents identified, agreed on, and won court approval
for approximately $440 million to $475 million in annual cost savings and the
elimination of unprofitable products. These annual savings resulted from achieving
better plant utilization due to changes in union work rules, wage and benefit reductions,
the reduction of ongoing obligations for retiree health and welfare costs, and
streamlining administrative expenses.
The plan of reorganization accepted by the court, creditors, and investors included a
$750 million equity investment provided by Centerbridge Capital Partners to fund a
portion of the firm’s health-care and pension obligations. Under the plan, shareholders
received no payout. Bondholders of some $1.62 billion in various maturities and
holders of $1.63 billion in unsecured claims recovered about 6090 percent of their
claims. Centerbridge would acquire $250 million of convertible preferred stock in the
reorganized Dana operation, and creditors, who had agreed to support the
reorganization plan, could acquire up to $500 million of the convertible preferred
shares. The preferred shares were issued as an inducement to get creditors to support
the plan of reorganization. Under the reorganization plan, Dana sold some businesses,
cut plants in the United States and Canada, reduced its hourly and salaried workforce,
and sought price increases on parts from customers.
Discussion Questions
1) Does the process outlined in this business case seem equitable for all parties to the
bankruptcy proceedings? Why? Why not? Be specific.
2) Why did Centerbridge receive convertible preferred rather than common stock?
Answer: